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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
Amendment No. 1
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-12992
SYNTHETECH, INC.
(Exact name of registrant as specified in its charter)
Oregon 84-0845771
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1290 Industrial Way, Albany, Oregon 97321
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number,
including area code: 541/967-6575
Securities registered pursuant to
Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $.001 Par Value
(Title of class)
Indicate by check mark whether registrant (1) filed all reports
required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the past 12 months (or for such
shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements
for the past 90 days. YES X NO
Indicate by check mark if disclosure of delinquent filers in
response to Item 405 of Regulation S-K is not contained herein
and will not be contained, to the best of registrant's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of May 22, 1998, the aggregate market value of the voting
stock held by nonaffiliates of the registrant was approximately
$81 million based upon $7.38 per share. Shares of Common Stock
held by each officer and director and by each person who owns 5%
or more of the Common Stock have been excluded in that such
persons may be deemed affiliates. This determination of
affiliate status is not necessarily a conclusive determination
for other purposes.
The number of the shares of the Company's Common Stock
outstanding on May 22, 1998 was 14,142,683.
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In connection with Synthetech, Inc.'s Form 10K for the fiscal
year ended March 31, 1998, "Part I, Item 1. Business" is hereby
amended and restated in its entirety as follows:
PART I
ITEM 1. BUSINESS
This Annual Report contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. Actual results could differ materially from those
projected in the forward-looking statements and as a result of
the factors set forth in "Factors Affecting Future Results" and
elsewhere in this Report.
GENERAL
Synthetech, Inc., an Oregon corporation (the "Company" or
"Synthetech"), produces Peptide Building Blocks ("PBBs") and
other fine chemicals using a combination of organic chemistry and
biocatalysis.
MARKET OVERVIEW
The market for PBBs is driven by the market for the synthetically
manufactured peptides in which they are incorporated. The size
of this market is a function of the number of these peptides
which are initially screened for use in pharmaceuticals, the
number of these pharmaceuticals which progress down the path
toward registration and, ultimately, the number which are found
to be therapeutically useful. The size of the market is also a
function of the quantities and varieties of PBBs necessary to
produce these pharmaceuticals. (See "Industry Factors" set forth
in Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations).
STRATEGY
Synthetech's strategy is to emphasize a commitment to its
customers from the early phases of discovery through clinical
development in order to develop more stable, longer-term, large-
scale orders as the drugs receive regulatory approval. The
receipt of two large-scale orders for marketed drugs in fiscal
1998 exemplified this strategy. The Company had supplied PBBs
for both of these drugs since their early clinical development
stages.
PRODUCT OVERVIEW
Peptide Building Blocks. Peptides are short chains of generally
less than 50 amino acids and are used primarily in
pharmaceuticals. The production of peptides requires amino acids
which have been chemically modified to enable them to more easily
link with other amino acids in a particular sequence to form the
desired peptide. The Company refers to these chemically modified
amino acids as "Peptide Building Blocks" or "PBBs." The amino
acids which are transformed into PBBs may be either natural amino
acids (that is, amino acids which occur in nature) or synthetic
amino acids (that is, amino acids which have a side chain that
does not occur in nature), which the Company refers to as
"Specialty Amino Acids."
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Synthetech chemically modifies natural amino acids to produce
PBBs. The Company also manufactures synthetic amino acids, and
chemically modifies these synthetic amino acids to produce PBBs.
The Company uses a wide array of raw materials to produce PBBs.
These materials generally are in adequate supply from multiple
suppliers.
The Company has developed and scaled up process technology to
produce a wide range of PBB products at the multi-kilogram to
multi-ton scale. Since 1987, the Company has produced over 400
different PBB products. Synthetech's PBBs are used by
pharmaceutical companies to make a wide range of peptide-based
drugs under development and on the market for the treatment of
AIDs, cancer, cardiovascular and other diseases.
Other Fine Chemicals. The Company is capable of producing other
fine chemical compounds. These compounds have included grignard
reagents and other fine chemicals conforming to the customer's
confidential specifications. As the Company's core business in
PBBs expanded over the past three years, the Company stopped
actively marketing these products. The Company has not produced
nor received any revenue from these products since fiscal 1996,
when it sold $60,000 of grignard reagents and other fine
chemicals. While the Company is establishing the additional
processing facility to augment its PBB processing capabilities,
the Company might seek other fine chemical compounds and custom
manufacturing opportunities as appropriate.
_____________________
The Company continues to produce most bulk orders on an as-
ordered basis, although it does carry an inventory of over 300
PBB products. At March 31, 1998, the dollar amount of backlog
orders which the Company believed to be firm was approximately
$11.28 million, all of which the Company expects to ship during
fiscal 1999. This backlog included $7.40 million attributable to
additional production in connection with two large-scale orders
that the Company received in fiscal 1998. The backlog at
March 31, 1997 was $1.32 million. The variation in backlog
between March 1998 and March 1997 underscores the continued
variability in the demand for the Company's PBBs at any given
time (See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations").
In January 1990, the Company entered into supply and technology
agreements with Biomeasure Incorporated, a Boston area
biotechnology company and a subsidiary of Groupe Pharmaceutique
Beaufour-Ipsen of France with several synthetic peptide products
under development. Under the supply agreement, the Company has
agreed to supply all of Biomeasure's requirements for a
particular synthetic PBB. This agreement continues from year to
year unless terminated in writing by one of the parties. The
Company and Biomeasure are also parties to a license agreement
giving Biomeasure the option to receive a license to produce for
its own use the PBB which is the subject of the supply agreement
between the parties. Under this license agreement, Biomeasure
must pay certain royalty amounts based on the amount produced.
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MARKETING
The Company markets its products through attendance at trade
shows, listings in biotechnology and chemical industry
directories and advertisements in chemical trade periodicals. In
addition, the Company maintains ongoing relationships with major
pharmaceutical and other companies which it believes might have a
need for its products.
CUSTOMERS
Although the Company has over 250 customers, the Company expects
that a few customers will continue to account for a significant
portion of revenues each year. During fiscal 1998, the Company
had five customers which accounted for 57% of the Company's
revenues. The Company had two customers- Pfizer, Inc. and F.
Hoffman-La Roche, Ltd.-which individually accounted for over 23%
and 11%, respectively, of the Company's fiscal 1998 revenues.
For the fiscal years ended March 31, 1998, 1997, and 1996, sales
to overseas customers were $2.85 million, $4.14 million and
$1.78 million, respectively, accounting for approximately 34%,
32%, and 21%, respectively, of the Company's total revenues.
These sales were principally to Europe for fiscal 1998, and to
Europe and Japan for fiscal 1997 and 1996. See Note J to
Financial Statements.
COMPETITION
Because peptide-based pharmaceuticals are relatively new, the
market in the past for PBBs has been quite small -- with most
sales in the hundreds of kilos or smaller size. As a result, the
PBB market has not attracted a significant amount of direct
competition. As the market continues to grow with multi-ton
order sizes becoming more prevalent, the Company has begun to see
more competition.
Current competition in multi-kilo or smaller quantities of
natural amino acid based PBBs comes primarily from several
European fine chemical companies. Multi-ton order sizes of these
natural PBBs have begun to attract a wider group of approximately
ten domestic and international chemical companies. In the area
of synthetic amino acid based PBBs, the Company has competition
on a selected product basis at the multi-kilo scale from
approximately five fine chemical producers in Europe and Japan.
Competition also increases for supplying PBBs for drug
development programs that reach late clinical trials and move
into approved status as a result of the increased quantities
typically required at these stages and pharmaceutical company
requirements to have second sources of material available. Many
of the Company's competitors have technical, financial, selling
and other resources available to them which are significantly
greater than those available to the Company.
The principal methods of competition in the market for PBBs and
other fine chemicals are quality, customer service and price.
The Company believes that it competes effectively in each of
these areas. The Company also believes that its production of a
wide range of products and quantities gives it a competitive
advantage in the marketplace. In addition, the Company
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believes that pharmaceutical companies generally view internal
production of PBBs as a misallocation of resources and, given a
reliable source of a quality product, would rather obtain them
from an outside supplier.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts have focused
principally on process development. During the fiscal years ended
March 31, 1998, 1997, and 1996, the Company's research and
development expenses were $215,000, $211,000, and $217,000,
respectively. These figures, however, do not completely reflect
the Company's research and development activity since substantial
process development efforts have been associated with initial
orders for new products and, accordingly, have been expensed as
cost of sales associated with the product revenue rather than as
a research and development expense. The Company estimates that
its combined research and development effort (including effort
directly associated with the sale of product) was approximately
$419,000, $346,000, and $364,000 during the fiscal years ended
March 31, 1998, 1997 and 1996, respectively.
EMPLOYEES
As of May 22, 1998, the Company employed 43 individuals, two of
whom were part-time.
REGULATORY MATTERS
As the Company's products are intermediates sold to
pharmaceutical producers, the Company has been generally
unaffected by FDA regulation which is directed at final products
sold to the public. The Company's customers do, however,
typically impose inspection and quality assurance programs on the
Company. These programs involve materials handling,
recordkeeping and other requirements. As some customers have
begun to request the Company to provide additional processing
steps, these programs often include more extensive requirements.
The Company anticipates that the expenses of complying with such
programs will increase in the future.
The Company's business is also subject to substantial regulation
in the areas of safety, environmental release and hazardous waste
disposal. Although the Company believes that it is in compliance
with these laws, rules and regulations in all material respects,
the failure to comply with present or future regulations could
result in fines being imposed on the Company, suspension of
production or cessation of operations. As additional and more
extensive regulations are being added in these areas at the
federal, state and local levels, the compliance costs will
inevitably continue to increase. The operation of chemical
manufacturing plants entails the inherent risk of environmental
damage or personal injury due to the handling of potentially
harmful substances, and there can be no assurance that material
costs and liabilities will not be incurred in the future because
of an accident or other event resulting in personal injury or an
unauthorized release of such substances to the environment.
Also, the Company generates hazardous and other wastes which are
disposed of at various off-site facilities. The
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Company may be liable, irrespective of fault, for material
cleanup costs or other liabilities incurred at these disposal
facilities due to releases of such substances into the
environment.
The Company estimates that in fiscal 1999 and early fiscal 2000,
it will undertake capital expenditures aggregating $600,000
associated with environmental control facilities. These
expenditures are principally for air quality scrubbers in
connection with the Phase II build out of its new facility and
certain upgrades to the Company's existing plant and equipment.
The Company maintains property damage insurance, liability
insurance, environmental risk insurance, and product liability
insurance.
PRODUCT LIABILITY
Use of the Company's products in pharmaceuticals and the
subsequent testing, marketing and sale of such pharmaceuticals
involves an inherent risk of product liability. There can be no
assurance that claims for product liability will not be asserted
against the Company or that the Company would be able to
successfully defend any claim that may be asserted. A product
liability claim could have a material adverse effect on the
business and/or financial condition of the Company. The Company
maintains product liability insurance with a $1 million limit.
Also, the Company maintains an umbrella liability insurance
policy with an additional $4 million of coverage.
COMPANY BACKGROUND
The Company was formed in 1981 to develop novel chemical process
technology by combining classical organic chemistry with enzyme-
based biocatalysis. For the first several years, it operated
mainly as a research and development group focused on process
development of pharmaceuticals and other fine chemicals. After
its initial public offering in 1984, the Company's research
efforts were concentrated on the development of a proprietary
process for aspartame and L-phenylalanine. Although the Company
has entered into one license for this technology, the Company
discontinued marketing this technology in 1991 and does not
expect additional licensing revenue.
Throughout its development during the 1980s, the Company also
offered contract research services. These research services were
typically provided to pharmaceutical clients and generally
involved the development of biocatalytic processes (that is,
chemical processes which are affected by the use of enzymes or
micro-organisms). Since the end of fiscal 1990, the Company has
phased out contract research services and does not anticipate
receiving any significant revenue from research services in the
future. By the end of the 1980s, the Company, building on it
prior experience, began to focus on the production of PBBs and
other fine chemicals for customers. During the 1990s, the
Company has emerged as a leading producer of PBBs in gram, multi-
kilo and ton quantities.
FACTORS AFFECTING FUTURE RESULTS
This Annual Report on Form 10-K includes forward-looking
statements (as defined in Section 21E of the Securities Exchange
Act of 1934, as amended). Forward-looking statements include,
without limitation, any statement that may predict, forecast,
indicate or imply future results, performance or achievements,
and may contain the words "believe," "anticipate," "expect,"
"estimate," "project," "will be," "will continue," "will likely
result" or words or phrases of similar meanings. Investors are
cautioned that forward-looking statements involve
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risks and uncertainties and various factors could cause actual
results to differ materially from the forward-looking statements.
These risks and uncertainties include, but are not limited to,
the following:
Uncertain Market for Products; Customer Concentration; and
Potential Quarterly Revenue Fluctuations. Historically, the
Company has experienced from time to time substantial period-to-
period revenue fluctuations reflecting the industry environment
in which the Company has operated. The market for PBBs is driven
by the market for the synthetically manufactured peptide-based
drugs into which they are incorporated. The drug development
process is dictated by the marketplace, drug companies and the
regulatory environment. The Company has no control over the pace
of peptide-based drug development, which drugs get selected for
clinical trials, which drugs are approved by the Food and Drug
Administration ("FDA"), and, even if approved, the ultimate
potential of such drugs.
Recurring sales of PBBs for discovery or clinical trial
stage development programs is sporadic at best. The high
cancellation rate for drug development programs results in a
significant likelihood that there will be no subsequent or
"follow-on" PBB sales for any particular drug development
program. Accordingly, the level of purchasing by the Company's
customers for specific drug development programs varies
substantially from year to year and the Company cannot rely on
any one customer as a constant source of revenue.
Sales of PBBs for marketed drugs provide an opportunity for
continuing longer-term sales and the size of the PBB orders for
marketed drugs can be substantially larger than those for the
discovery or clinical trial stages. While not subject to the
same high cancellation rate faced by discovery and clinical trial
stage drug development programs, the demand for the approved
drugs remains subject to many uncertainties, including, without
limitation, the drug price, the drug side effects and the
existence of other competing drugs. These factors, which are
outside of the control of the Company, will affect the level of
demand for the drug itself and, therefore, the demand for PBBs.
Since the Company's revenues are composed of PBB sales in
all three drug development stages, and since even sales of PBBs
for marketed drugs are subject to cancellation or reduction, the
Company is likely to continue to experience significant
fluctuations in its quarterly results.
Industry Cost Factors. The market for PBBs is dependent on
the market for pharmaceuticals products. The levels of revenues
and profitability of pharmaceutical companies may be affected by
the continuing efforts of governmental and third party payors to
contain or reduce the cost of health care through various means.
For example, in certain foreign markets, pricing or profitability
of prescription pharmaceuticals is subject to government control.
In the United States, there have been, and the Company expects
that there will continue to be, a number of federal and state
proposals to implement similar government controls. In addition,
in both the United States and elsewhere, sales of prescription
pharmaceuticals are dependent in part on the availability of
reimbursement to the consumer from third party payors such as
government and private insurance plans. Third party payors are
increasingly challenging the prices charged for
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medical products and services. Peptide-based drugs may not be
considered cost effective, and reimbursement may not be available
or sufficient to allow peptide-based drugs to be sold on a
profitable basis. In addition, as cost pressures in the
pharmaceutical industry have tightened, the cancellation rate for
drug development programs has increased. Industry cost pressures
can also cause pharmaceutical companies to investigate
alternative drug manufacturing processes which may not include
PBBs.
Competition. In the past, the Company has not had a
significant amount of direct competition for discovery and
clinical trial stage drug development projects. The Company
believes that this resulted from peptide-based pharmaceuticals,
particularly those which utilize synthetic amino acids, being
relatively new and the market for PBBs relatively small. As the
market has continued to grow with multi-ton order sizes becoming
more prevalent, the Company has begun to see more competition.
Current competition in the multi-kilo or smaller quantities of
natural amino acid based PBBs comes primarily from several
European fine chemical companies. Multi-ton order sizes of these
natural PBBs have begun to attract a wider group of domestic and
international chemical companies. In the area of synthetic amino
acid based PBBs, the Company has competition on a selective
product basis from fine chemical producers in Europe and Japan.
Competition has also increased for supplying PBBs for drug
development programs that reach late clinical trials and move
into an approved status as a result of increased quantities
typically required at these stages and pharmaceutical company
requirements to have second sources of material available. The
Company's competitors have technical, financial, selling and
other resources available to them that are significantly greater
than those available to the Company.
Regulatory Matters. The Company is subject to a variety of
federal, state and local laws, rules and regulations related to
the discharge or disposal of toxic, volatile or other hazardous
chemicals. Although the Company believes that it is in
compliance with these laws, rules and regulations in all material
respects, the failure to comply with present or future
regulations could result in fines being imposed on the Company,
suspension of production or cessation of operations. Third
parties may also have the right to sue to enforce compliance.
Moreover, it is possible that increasingly strict requirements
imposed by environmental laws and enforcement policies thereunder
could require the Company to make significant capital
expenditures. The operation of a chemical manufacturing plant
entails the inherent risk of environmental damage or personal
injury due to the handling of potentially harmful substances, and
there can be no assurance that material costs and liabilities
will not be incurred in the future because of an accident or
other event resulting in personal injury or unauthorized release
of such substances to the environment. In addition, the Company
generates hazardous materials and other wastes which are disposed
at various offsite facilities. The Company may be liable,
irrespective of fault, for material cleanup costs or other
liabilities incurred at these disposal facilities in the event of
a release of hazardous substances by such facilities into the
environment. The Company has obtained environmental risk
insurance.
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Potential Regulation. The PBBs produced by the Company are
intermediate ingredients which are then processed by the
companies to which they are sold, and are therefore currently not
subject to the requirements of the FDA. The Company's customers
do, however, typically impose inspection and quality assurance
programs on the Company. These programs involve materials
handling, record keeping and other requirements. As many of the
Company's customers are requiring increased processing by the
Company of its products, the Company expects these compliance
programs to become more extensive. The Company may not be able
to comply with the applicable requirements or such requirements
may require the expenditure of significant capital.
Product Liability. Use of the Company's products in
pharmaceuticals and the subsequent testing, marketing and sale of
such pharmaceuticals involves an inherent risk of product
liability. Claims for product liability could be asserted
against the Company and the Company may not be able to
successfully defend any claim that may be asserted. A product
liability claim could have a material adverse effect on the
business and/or financial condition of the Company. The Company
has purchased product liability insurance with a limit of
$1 million. Also, the Company maintains an umbrella liability
insurance policy with an additional $4 million of coverage.
Risks of Technological Change. The market for the Company's
products is characterized by rapid changes in both product and
process technologies. The Company's future results of operations
will depend upon its ability to improve and market its existing
products and to successfully develop, manufacture and market new
products. The Company may not be able to continue to improve and
market its existing products or develop and market new products,
and technological developments could cause the Company's products
and technology to become obsolete or noncompetitive.
Manufacturing Capacity. As a manufacturer of PBBs, the
Company will continually face risks regarding the availability
and costs of raw materials and labor, the potential need for
additional capital equipment, increased maintenance costs, plant
and equipment obsolescence and quality control. The Company has
recently completed an additional manufacturing facility on its
site in Albany, Oregon to increase production capacity.
Initially, processing equipment was installed in two of the six
bays. Recently the Company announced its decision to install
processing equipment in two additional bays. The Company expects
that this additional phase will be completed in calendar 1999.
Completion of the second phase at the new facility could be
delayed and the existing facilities may not have sufficient
capacity to meet the demand for the Company's products,
particularly in the event that several of the peptide-based drugs
for which the Company supplies PBBs simultaneously become
commercially successful. A disruption in the Company's
production or distribution could have a material adverse effect
on the Company's financial results. In addition, the Company may
not have sufficient demand to utilize the additional capacity.
Risks of International Business. Sales to customers outside
the United States accounted for approximately 34% of the
Company's net sales during the fiscal year ended March 31, 1998.
The Company expects that international sales will continue to
account for a significant
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percentage of net sales. The Company's business is and will be
subject to the risks generally associated with doing business
internationally, including changes in demand resulting from
fluctuations in exchange rates, foreign governmental regulation
and changes in economic conditions. These factors, among others,
could influence the Company's ability to sell its products in
international markets. In addition, the Company's business is
subject to the risks associated with legislation and regulation
relating to imports, including quotas, duties or taxes and other
charges, restrictions and retaliatory actions on imports to other
countries in which the Company's products may be sold or
manufactured.
Year 2000 Compliance. The Company relies on computer
systems and software to operate its business. After review, the
Company believes that its software applications will be able to
appropriately interpret the calendar year 2000 and subsequent
years after certain upgrades are completed during fiscal 1999.
The Company does not expect that the cost of these upgrades will
be material. While the Company does not believe it to be the
case, there is a risk that the Company's software applications
will be unable to appropriately interpret such years despite the
installation of these upgrades. Significant compliance costs or
the failure by the Company to achieve full Year 2000 compliance
could have a material adverse effect on the Company's business
and/or financial condition. In addition, the Company could be
adversely affected by the failure of others, including without
limitation, vendors, customers, transportation companies and
utility companies, to become fully Year 2000 compliant.
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In connection with Synthetech, Inc.'s Form 10K for the fiscal
year ended March 31, 1998, "Part I, Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations" is hereby amended and restated in its entirety as
follows:
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
percentage of revenues represented by each item included in the
Statements of Income.
Percent age of Revenues
Fiscal Year Ended March 31,
----------------------------
1998 1997 1996
------ ------ ------
Revenues 100.0% 100.0% 100.0%
Cost of Sales 63.9% 39.9% 43.5%
------ ------ ------
Gross Profit 36.1% 60.1% 56.5%
Research and Development 2.6% 1.6% 2.6%
Selling, general and
administrative 14.1% 9.7% 9.8%
------ ------ ------
Operating Income 19.4% 48.8% 44.1%
Other Income 3.7% 3.0% 3.4%
Interest Expense - - -
------ ------ ------
Income Before Income Taxes 23.1% 51.8% 47.5%
Provision for Income Taxes 8.4% 19.7% 17.1%
------ ------ ------
Net Income 14.7% 32.1% 30.4%
====== ====== ======
Revenues
- --------
Synthetech revenues were $8.32 million, $12.80 million and
$8.47 million in fiscal 1998, fiscal 1997 and fiscal 1996,
respectively, reflecting the unpredictability and potential for
significant revenue fluctuations associated with the industry
environment in which the Company operates. (See "Industry
Factors" below.) The 35% decrease in revenues in fiscal 1998 as
compared to fiscal 1997 and the 51% increase in revenues in
fiscal 1997 as compared to fiscal 1996 primarily reflected the
absence or presence of large-scale orders. Revenues from large-
scale orders were $2.17 million, $8.07 million and $1.97 million
for fiscal 1998, fiscal 1997 and fiscal 1996, respectively. The
Company expects that fiscal 1999 revenues will be substantially
larger than fiscal 1998. At March 31, 1998, the Company had a
backlog of PBB orders for delivery in fiscal 1999 of
approximately $11.28 million. Of this amount, $7.40 million was
attributable to the unfilled balance of the two large-scale
orders that it received in fiscal 1998.
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While the Company produces PBBs for a number of approved drugs,
the two large-scale orders received in fiscal 1998 were the first
large-scale PBB orders in the Company's history to be received
for use in marketed or "approved" drugs. The revenue received
from large-scale orders in fiscal 1997 and fiscal 1996 were
associated with PBBs sold for use in clinical trials. PBB sales
associated with marketed drugs are much more likely to provide a
longer term, ongoing revenue stream. The risk that drug
production is cancelled is substantially lower after it is being
actively marketed. Of course, continuation of customer demand
for these PBBs remains subject to various market conditions,
including continued market demand for the drug, competition from
other suppliers of PBBs and potential use of alternative drug
manufacturing routes not involving PBBs. (See "Industry Factors"
below.)
The two large-scale orders received in fiscal 1998 exemplify
Synthetech's long-term growth strategy of emphasizing a
commitment to its customers from the early phases of discovery
through clinical development in order to develop more stable,
longer-term large-scale orders as the drugs receive regulatory
approval. The Company had supplied the natural amino acid based
PBBs for both of these drugs since their early clinical
development stages.
With the addition of sales from the two large-scale orders, the
Company estimates that in fiscal 1998 approximately 46% of the
Company's PBB sales went into marketed drugs, approximately 41%
went into drugs in clinical or late pre-clinical trials and
approximately 13% went into drugs at the R&D or discovery stage.
With the unfilled balance of the two large-scale orders
aggregating $7.40 million at the beginning of fiscal 1999, the
Company expects the percentage of fiscal 1999 sales of PBBs to be
used in the marketed drug sector to be equal to or higher than
the fiscal 1998 percentage. In fiscal 1997, the Company
estimates that approximately 11% of the Company's PBB sales went
into marketed drugs, approximately 83% went into drugs in
clinical or late pre-clinical trials and approximately 6% went
into drugs at the R&D or discovery stage. In fiscal 1996, the
Company estimates that approximately 12% of the Company's PBB
sales went into marketed drugs, approximately 80% went into drugs
in clinical or late pre-clinical trials and approximately 8% went
into drugs at the R&D or discovery stage. These estimates are
based on an analysis of the Company's sales and information to
the extent available from customers.
The revenues during fiscal 1998, fiscal 1997 and fiscal 1996
represented sales of PBBs, the Company's primary product line,
except for $60,000 of sales in fiscal 1996 associated with the
sale of grignard reagents and other fine chemicals.
Gross Profit
- ------------
Gross profit was $3.00 million, $7.70 million and $4.79 million
in fiscal 1998, 1997 and 1996, respectively. This reflects a
61.0% decrease in gross profit in fiscal 1998 from fiscal 1997,
and a 60.7% increase in gross profit in fiscal 1997 from fiscal
1996. As a percentage of revenues, gross profits were 36.1%,
60.1% and 56.5% in fiscal 1998, 1997 and 1996, respectively.
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Decreased revenues negatively affect gross profit margins.
Product mix (i.e., type and volume of product sold as individual
orders) can also significantly affect gross profit margins either
positively or negatively. The decrease in gross profit margin in
fiscal 1998 from fiscal 1997 reflected a combination of factors:
the decline in revenues resulting from the absence of large-scale
projects until the end of the third quarter of fiscal 1998; the
increased manufacturing overhead costs as the new plant facility
came online in fiscal 1998; costs associated with the start up
and early process development at the new plant facility; and the
product mix in fiscal 1998. The Company anticipates that the
gross profit margin will improve in fiscal 1999 with the
anticipated increase in revenues, although the Company expects to
see some reduction in this margin from fiscal 1996 and fiscal
1997 levels reflecting a higher mix of larger-scale orders.
The increase in the gross profit margin in fiscal 1997 from
fiscal 1996 resulted primarily from the increased level of
revenues and product mix.
The Company expects revenues and product mix to continue to
fluctuate from period to period and cause variation in gross
profit margins.
Operating Expenses
- ------------------
Research and development (R&D) expense increased to $215,000, or
2.6% of sales, in fiscal 1998, from $211,000, or 1.6% of sales,
in fiscal 1997. R&D expense was $217,000, or 2.6%, in fiscal
1996. These figures, however, do not completely reflect the
Company's research and development activity since substantial
process development efforts have been associated with initial
orders for new products and, accordingly, have been expensed as
cost of sales associated with the product revenue rather than as
a research and development expense. The Company estimates that
its combined research and development effort (including effort
directly associated with the sale of product) was approximately
$419,000, $346,000 and $364,000 during the fiscal years ended
March 31, 1998, 1997 and 1996, respectively.
Selling, general and administrative (SG&A) expense was $1.18
million, $1.24 million and $833,000 in fiscal 1998, 1997 and
1996, respectively. The decrease in SG&A in fiscal 1998 from
fiscal 1997 primarily reflected the employee bonus reduction in
fiscal 1998 as the staffing level in this area remained
relatively constant. The increase in SG&A in fiscal 1997 from
fiscal 1996 principally reflected the addition of one staff
employee, base salary and bonus increases, and increases in
marketing, director and officer insurance and expenses related to
the Company's move to the Nasdaq National Market. SG&A as a
percentage of sales was 14.1%, 9.7%, and 9.8% for fiscal 1998,
1997 and 1996, respectively.
Operating Income
- ----------------
Operating income was $1.61 million in fiscal 1998, $6.25 million
in fiscal 1997 and $3.74 million in fiscal 1996. In fiscal 1998,
Company-wide labor costs (including bonus) (hereinafter "labor
costs") decreased to $1.50 million from $1.82 million in fiscal
1997. While the Company hired additional employees during fiscal
1998 in connection with its plant
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expansion, the reduction in the level of bonuses paid during
fiscal 1998 as compared to fiscal 1997 more than offset the
hiring increase, causing the net reduction in labor costs. In
fiscal 1997, labor costs increased nearly 23.9% reflecting
compensation increases and employee additions during the fiscal
year. In fiscal 1996, labor costs increased 28.9%. Over half of
this increase was attributable to compensation increases and the
remainder resulted from an increase in employee hiring beginning
in the second half of fiscal 1995. As a percentage of revenues,
operating income decreased to 19.4% in fiscal 1998 compared to
48.8% in fiscal 1997 and to 44.1% in fiscal 1996. With the
operating expense level in fiscal 1998 and fiscal 1997 being
relatively comparable, the decrease in operating margin in fiscal
1998 as compared to fiscal 1997 principally reflected the
decrease in the gross profit margin discussed above.
Other Income
- ------------
The $312,000 net other income in fiscal 1998 primarily resulted
from $294,000 of interest earnings and a $25,000 recognized gain
from the sale of securities available for sale. The $385,000 net
other income in fiscal 1997 primarily resulted from $376,000 of
interest earnings. The $285,000 net other income in fiscal 1996
primarily resulted from $242,000 of interest earnings and $43,000
of recognized gain on the sale of securities available for sale.
Interest expense was $0 in fiscal 1998, $1,000 in fiscal 1997 and
$0 in fiscal 1996. Near the end of fiscal 1997, the Company
incurred $194,000 in wastewater system development charges
assessed by the City of Albany in connection with the Company's
plant expansion. This fee plus interest on the unpaid portion is
payable over the next ten years. During fiscal 1998, the Company
paid approximately $17,000 of interest in connection with the
unpaid portion of this fee. This payment was capitalized as part
of the plant expansion. Beginning in fiscal 1999, the Company's
interest payments will be deducted as an interest expense.
Net Income
- ----------
In fiscal 1998, the Company earned $1.92 million before income
taxes. A provision for income taxes of $702,000 resulted in net
income of $1.22 million. In fiscal 1997, the Company earned
$6.63 million before income taxes. A provision for income taxes
of $2.52 million resulted in net income of $4.11 million. The
reduction in the effective tax rate in fiscal 1998 compared to
fiscal 1997 was a result of a biennially determined credit from
the State of Oregon. In fiscal 1996, the Company earned
$4.02 million before income taxes. A provision for income taxes
of $1.45 million resulted in net income of $2.57 million. The
provision for income taxes in fiscal 1996 was lower than fiscal
1997 primarily because it included a biennially determined credit
of $132,000 from the State of Oregon.
INDUSTRY FACTORS
The market for PBBs is driven by the market for synthetically
manufactured peptide-based drugs in which they are incorporated.
The drug development process for these peptide-based drugs is
dictated by the marketplace, drug companies and the regulatory
environment. The Company has no control over the pace of peptide-
based drug development, which drugs get selected for clinical
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trials, which drugs are approved by the FDA and, even if
approved, the ultimate market potential of such drugs.
The three stages of the drug development process include: R&D or
discovery stage, clinical trial stage and marketed drug stage.
Synthetech's customers can spend years researching and developing
new drugs, taking only a small percentage to clinical trials and
fewer yet to commercial market. A substantial amount of the
activity continues to occur at the earlier stages of research and
development and clinical trials. In spite of the two large-scale
orders received by the Company in fiscal 1998, the market for
peptide-based drugs is still very early in development.
While the Company has recorded substantial annual sales of PBBs
for discovery and clinical trial stage development, recurring
sales of PBBs for development programs is sporadic at best. The
high cancellation rate for drug development programs results in a
significant likelihood that there will be no subsequent or
"follow-on" PBB sales for any particular drug development
program. Accordingly, the level of purchasing by the Company's
customers for specific drug development programs varies
substantially from quarter to quarter and the Company cannot rely
on any one customer as a constant source of revenue.
While the Company has been selling PBBs for marketed drugs for
several years, these sales represented a relatively small portion
of total revenue. With the two large-scale orders received in
fiscal 1998 for PBBs to be used in marketed drugs, revenues of
PBBs for marketed drugs represent a significant portion of total
revenue for the first time in the Company's history. Sales of
PBBs for marketed drugs provide an opportunity for continuing
longer-term sales. Moreover, the size of the PBB orders for
marketed drugs can be substantially larger than those for the
discovery or clinical trial stages. While not subject to the
same high cancellation rate faced by discovery and clinical trial
stage drug development programs, the demand for the approved
drugs remains subject to many uncertainties, including, without
limitation, the drug price, the drug side effects and the
existence of other competing drugs. These factors, which are
outside of the control of the Company, will affect the level of
demand for the drug itself and, therefore, the demand for PBBs.
Also, with the longer-term, larger-scale orders, the Company
expects increased competition to supply these PBBs, and industry
cost pressures can also cause pharmaceutical companies to
investigate alternative drug manufacturing processes which may
not include PBBs as an intermediate.
In the past, the Company has felt that it had neither a stable
baseload of demand nor an ability to predict future demand beyond
its current order base. With the advent of the two large-scale
PBB orders for use in marketed drugs, the Company has
significantly increased the size and the term of its current
order base. Also, the likelihood of recurring revenue from
reorders is significantly higher for these two PBBs since they
are used in marketed drugs. Nevertheless, since the Company's
revenues are composed of PBB sales in all three drug development
stages, and since even sales of PBBs for marketed drugs are
subject to cancellation or reduction, the Company is likely to
continue to experience significant fluctuations in its quarterly
results.
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LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1998, the Company had working capital of
$8.24 million compared to $9.24 million at March 31, 1997, and
$8.16 million at March 31, 1996. The Company's cash and cash
equivalents at March 31, 1998 totaled $4.98 million, a $1.8
million decrease from the March 31, 1997 level. This reduction
reflected capital expenditures associated with the plant
expansion which were not completely offset by cash from
operations and other positive cash sources in fiscal 1998. Since
the Company expects to incur similar capital expenditures during
fiscal 1999, the impact of these expenditures on cash and cash
equivalents will be largely affected by the level of cash
provided by operating activities and other positive cash sources
in fiscal 1999. The Company no longer holds securities available
for sale after selling its last holding in fiscal 1998. In
addition, the Company has a $1,000,000 unsecured bank line of
credit. As of March 31, 1998 there was no amount outstanding
under the bank line.
The increase in accounts receivable to $1.47 million at March 31,
1998, from $695,000 at March 31, 1997, reflected the higher level
of revenues in the fourth quarter of fiscal 1998 compared to the
fourth quarter in the prior year. The increase of inventory to
$3.18 million at March 31, 1998, from $1.89 million at March 31,
1997, primarily resulted from replenishing lower levels of raw
material and finished product inventory items and the build-up of
raw materials and work-in-process related to the two large-scale
orders received in fiscal 1998. Inventory was $1.92 million at
March 31, 1996. The decrease in accrued compensation to $221,000
at March 31, 1998, from $674,000 at March 31, 1997, primarily
reflected the payment in the first quarter of fiscal 1998 of
bonuses accrued for fiscal 1997.
In November 1997, the Company completed the 20,000 square foot,
two-story new building plant expansion project. In this initial
phase, the Company completed the building structure and built out
two of the six production bays. The overall engineering,
construction and equipment costs for this project spanning 1 1/2
years were approximately $8.23 million. On May 28, 1998, the
Company announced that its Board of Directors had approved a
$5 million second phase expansion to outfit two more bays of the
new plant with four additional multipurpose reactor systems. The
Company is currently operating three production shifts, five days
a week. During fiscal 1998, the Company's capital costs were
approximately $4.09 million, $3.48 million of which were for the
plant expansion and $614,000 for the existing plant and
equipment.
In addition to the $5 million second-phase plant expansion
described above, the Company currently anticipates installing up
to $1 million of additional capital upgrades for the original
facility during fiscal 1999. The Company expects to finance
these capital expenditures from operating cash flow and reserves
and does not anticipate a need for any new debt or equity
financing.
The Company owns its facility and all of its equipment. See
Note D to Financial Statements for a description of the Company's
property, plant and equipment.
The Company has assessed the impact of the Year 2000 issue and
has determined that costs to upgrade its information and
operating systems are not expected to be material.
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The undersigned hereby amends its Annual Report on Form 10-K for
the fiscal year ended March 31, 1998 pursuant to Regulation
240.12b-15 of the Securities Exchange Act of 1934.
The Registrant has duly caused this amendment to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: December 23, 1998 SYNTHETECH, INC.
(Registrant)
By /s/ Charles B. Williams
Charles B. Williams
Vice President of Finance and
Administration, C.F.O.,
Chief Accounting Officer,
Secretary and Treasurer
