<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended DECEMBER 31, 1998 Commission File Number: 1-12748
----------------- -------
CHESAPEAKE BIOLOGICAL LABORATORIES, INC.
--------------------------------------------------------
(Exact name of registrant as specified in its charter)
MARYLAND 52-1176514
- -----------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1111 S. PACA STREET, BALTIMORE, MARYLAND 21230 2834
- ------------------------------------------ ------------------------- --------
(Address of principal executive offices) (zip code) (SIC)
(410) 843-5000
---------------------------------------------------
(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 outstanding of each of the issuer's classes of common stock
as of DECEMBER 31, 1998 AND DECEMBER 31, 1997:
OUTSTANDING AT OUTSTANDING AT
CLASS DECEMBER 31, 1998 DECEMBER 31, 1997
----- ----------------- -----------------
Class A Common Stock, $.01 par value 5,329,290 5,216,450
Class B Common Stock, $.01 par value -0- -0-
1
<PAGE>
CHESAPEAKE BIOLOGICAL LABORATORIES, INC.
TABLE OF CONTENTS
PAGE
Part I. Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheets as of
December 31, 1998 and March 31, 1998 . . . . 3
Consolidated Statements of Operations for
the three and nine months ended December 31, 1998
and 1997 . . . . . . . . . . . . . . . . . . . .. . 4
Consolidated Statement of Changes in
Stockholders' Equity for the nine months
ended December 31, 1998 . . . . . . . . . . . . . 5
Consolidated Statements of Cash Flows
for the nine months ended December 31, 1998
and 1997 . . . . . . . . . . . . . . . . . . . . 6
Notes to Consolidated Financial
Statements . . . . . . . . . . . . . . . . . . . 7-11
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations . . . . . . . . . . . . . . . . . . .. . . 12-14
Part II. Other Information
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . .. 14
Item 5. Other Information . . . . . . . . . . . . . . . . . . 14
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . .15
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
2
<PAGE>
CHESAPEAKE BIOLOGICAL LABORATORIES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, 1998 MARCH 31, 1998
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,573,893 $ 3,041,705
Restricted cash 350,000 350,000
Accounts receivable, net 726,691 1,259,560
Inventories 651,601 524,996
Prepaid expenses 333,419 404,696
Deferred tax asset 124,084 92,208
Interest receivable 8,483 18,817
---------- ---------
TOTAL CURRENT ASSETS 3,768,171 5,691,982
Property and equipment, net 10,266,214 9,428,831
Bond funds held by trustee --- 778,454
Deferred financing costs 344,506 344,021
Other assets 162,053 69,912
---------- ---------
TOTAL ASSETS $ 14,540,944 $ 16,313,200
---------- ---------
---------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 366,142 $ 223,481
Line of credit 549,390 ---
Current portion of long term debt 712,581 389,547
Current portion of capital lease obligations 5,004 28,098
Deferred revenue 214,871 177,593
---------- ----------
TOTAL CURRENT LIABILITIES 1,847,988 818,719
LONG TERM LIABILITIES:
Long term debt, net of current portion 7,739,581 8,283,102
Capital lease obligations, net of current portion --- 854
Deferred rent --- 22,523
Deferred tax liability 124,084 124,084
---------- ----------
TOTAL LIABILITIES 9,711,653 9,249,282
---------- ----------
COMMITMENTS AND CONTINGENCIES --- ---
STOCKHOLDERS' EQUITY
Class A common stock, par value $.01 per share;
8,000,000 shares authorized; 5,329,290 and
5,276,195 shares issued and outstanding 53,293 52,762
Class B common stock, par value $.01 per share;
2,000,000 shares authorized; no shares issued
and outstanding --- ---
Additional paid-in capital 7,385,225 7,369,039
Accumulated deficit (2,609,227) (357,883)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 4,829,291 7,063,918
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 14,540,944 $ 16,313,200
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
3
<PAGE>
CHESAPEAKE BIOLOGICAL LABORATORIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------- ----------------------------
1998 1997 1998 1997
---- ---- ---- ----
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
OPERATING REVENUE $ 1,621,277 $ 1,720,225 $ 5,021,145 $ 5,182,085
COST OF REVENUE 1,986,402 1,196,199 5,170,730 3,870,573
--------- --------- --------- ---------
GROSS (LOSS) PROFIT (365,125) 524,026 (149,585) 1,311,512
OPERATING EXPENSES:
General and administrative 439,533 348,828 1,274,287 1,101,171
Selling and marketing 249,499 201,757 707,860 495,816
Research and development -- 11,848 -- 51,587
--------- --------- --------- ---------
LOSS FROM OPERATIONS (1,054,157) (38,407) (2,131,732) (337,062)
OTHER (EXPENSE) INCOME
Interest and other expense (143,551) (77,600) (289,616) (150,554)
Interest and other income 24,331 74,449 138,128 274,462
--------- --------- --------- ---------
LOSS BEFORE BENEFIT FROM INCOME TAXES (1,173,377) (41,558) (2,283,220) (213,154)
(PROVISION FOR)/BENEFIT
FROM INCOME TAXES (412,061) 15,376 31,876 78,867
--------- --------- --------- ---------
NET LOSS $(1,585,438) $ (26,182) $(2,251,344) $ (134,287)
--------- --------- --------- ---------
--------- --------- --------- ---------
LOSS PER COMMON AND COMMON
EQUIVALENT SHARE:
Basic
Net Loss $ (0.30) $ (0.01) $ (0.42) $ (0.03)
Diluted
Net Loss $ (0.30) $ (0.01) $ (0.42) $ (0.03)
WEIGHTED AVERAGE COMMON
COMMON OUTSTANDING
Basic 5,328,627 5,216,259 5,310,975 4,906,366
Diluted 5,328,627 5,216,259 5,310,975 4,906,366
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
4
<PAGE>
CHESAPEAKE BIOLOGICAL LABORATORIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL ACCUMULATED
SHARES PAR VALUE PAID-IN CAPITAL DEFICIT TOTAL
--------- ----------- --------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
BALANCE, MARCH 31, 1998 5,276,195 $ 52,762 $ 7,369,039 $ (357,883) $ 7,063,918
Issuance of shares pursuant to
exercise of stock options 53,095 531 16,186 -- 16,717
Net loss -- -- -- (2,251,344) (2,251,344)
--------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1998 5,329,290 $ 53,293 $ 7,385,225 $(2,609,227) $ 4,829,291
--------- ----------- ----------- ----------- -----------
--------- ----------- ----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of this consolidated statement.
5
<PAGE>
CHESAPEAKE BIOLOGICAL LABORATORIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
DECEMBER 31,
------------ -----------
1998 1997
------------ -----------
(Unaudited) (Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,251,344) $ (134,287)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 368,688 258,766
Increase in deferred income taxes (31,876) --
Decrease (increase) in accounts receivable 532,869 (381,389)
(Increase) decrease in inventories (126,605) 265,394
Decrease (increase) in prepaid expenses 71,277 (412,222)
Decrease in interest receivable 10,334 747
(Increase) decrease in other assets (92,141) 11,590
Increase (decrease) in accounts payable
and accrued expenses 142,661 (270,979)
Increase (decrease) in deferred revenue 37,278 (23,750)
Decrease in deferred rent (22,523) (22,550)
----------- -----------
NET USED IN OPERATING ACTIVITIES (1,361,382) (708,680)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,195,018) (4,232,268)
Decrease in bond funds held by Trustee 778,454 3,671,507
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (416,564) (560,761)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short term borrowings net 549,390 --
Repayments of long term debt (220,487) (16,814)
Repayments of capital lease obligations (23,948) (22,252)
Net proceeds from sales of stock 16,717 3,322,069
Payment of debt issuance costs (11,538) --
Proceeds from long-term note and bond -- 150,000
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 310,134 3,433,003
----------- -----------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,467,812) 2,163,562
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,041,705 1,432,944
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,573,893 $ 3,596,506
----------- -----------
----------- -----------
CASH PAID DURING THE PERIOD FOR:
Interest $ 255,448 $ 133,225
----------- -----------
----------- -----------
Income taxes $ -- $ 1,300
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
6
<PAGE>
CHESAPEAKE BIOLOGICAL LABORATORIES, INC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION:
Chesapeake Biological Laboratories, Inc. ("CBL" or "the Company") is an
established provider of pharmaceutical and biopharmaceutical product
development and production services on a contract basis for a broad
range of customers, from major international pharmaceutical firms to
emerging biotechnology companies. Since 1990, CBL has provided its
product development services to more than 90 pharmaceutical and
biotechnology companies and has contributed to the development and
production of more than 100 therapeutic products intended for human
clinical trials. Customers contract with the Company to produce
development stage products for use in Food and Drug Administration
("FDA") clinical trials and to produce and manufacture FDA approved
products for commercial sale. The Company's business depends, in part,
on strict government regulation of the drug development process,
especially in the United States. CBL's production facility operates
under the current Good Manufacturing Practices ("cGMP") established and
regulated by the FDA.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
In management's opinion, the accompanying interim financial statements
of the Company include all adjustments, necessary for a fair
presentation of the Company's financial position for the interim periods
presented. These statements are presented in accordance with the rules
and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in the Company's
annual financial statements have been omitted from these statements, as
permitted under the applicable rules and regulations. The results of
operations presented in the accompanying interim financial statements
are not necessarily representative of operation for an entire year. The
information included in this Form 10-Q should be read in conjunction
with the financial statements and notes thereto included in the
Company's Form 10-K for the fiscal year ended March 31, 1998.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of CBL and its wholly-owned subsidiary, CBL Development Corp.
ACCOUNTS RECEIVABLE
Accounts receivable are stated net of allowances for doubtful accounts
of $42,147 and $70,300 as of December 31, 1998 and March 31, 1998,
respectively.
INVENTORIES
Inventories consist of raw materials and work-in-process which are
stated at the lower of cost or market, determined under the first-in,
first-out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Equipment is depreciated using the straight-line method over estimated
useful lives of three to ten years. The building is depreciated over an
estimated useful life of thirty years. Leasehold improvements are
amortized over the term of the lease.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include amounts invested in securities with
maturities of three months or less which are readily convertible to
known amounts of cash. Included in restricted cash are Company funds of
$350,000 which are being held by the First Union National Bank (the
"Bank") as collateral for the Company's obligations under the Letter of
Credit and Reimbursement Agreement with the Bank (see Note 6).
7
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CHESAPEAKE BIOLOGICAL LABORATORIES, INC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REVENUE RECOGNITION
The Company recognizes income when product is shipped or the service has
been provided to the customer. Deferred revenues represent deposits
normally required of customers with development products.
INCOME TAXES
Deferred income taxes are computed using the liability method, which
provides that deferred tax assets and liabilities are recorded based on
the differences between the tax bases of assets and liabilities and
their carrying amounts for financial reporting purposes. As of December
31, 1998, the Company has substantially not reflected the tax benefit
applicable to the year-to-date losses due to uncertainty over
realization.
STOCK OPTION PLANS
The Company accounts for its stock-option plans in accordance with the
provisions of Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees", and related interpretations.
As such compensation expense would be recorded on the date of the grant
only if the current market price of the underlying stock exceeded the
exercise price.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities as of the date of
the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
RECLASSIFICATION
Certain prior period balances have been reclassified to conform with the
current period presentation.
3. CONCENTRATIONS OF CREDIT RISK/SIGNIFICANT CUSTOMERS:
The Company's customers span the range of the pharmaceutical and medical
device industries. For many customers, the Company requires an up-front
payment on orders. There are several customers, however, for which CBL
has waived that practice.
The contract manufacturing agreement between the Company and Allergan
Botox, Ltd. ("Allergan") for the production of Vitrax-TM- originally
expired in February 1997. Subsequent thereto, an agreement was reached
between CBL and Allergan which called for the production of Vitrax-TM-
through December 31, 1997, on modified terms using active ingredients
supplied by Allergan, rather than active ingredients manufactured by
CBL. In addition, Allergan was relieved of any obligation to purchase
Vitrax-TM- exclusively from the Company. In September 1997, the Company
made its final shipment of Vitrax-TM- to Allergan and no further
shipments have been made and no further revenues are expected from
Allergan relative to Vitrax-TM-.
The Company has been actively seeking to increase and diversify its
customer base and has been successful in its diversification efforts;
however, there can be no assurance that the Company's annual results
will not be dependent upon the performance of a few large projects.
Twenty-eight potential customers, several of which have already become
customers, have visited or audited the Company's new Camden Industrial
Park facility this year (see note 6).
8
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CHESAPEAKE BIOLOGICAL LABORATORIES, INC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 MARCH 31, 1998
----------------- --------------
<S> <C> <C>
Raw materials $ 319,762 $ 280,344
Work-in-process 331,839 244,652
--------- -----------
$ 651,601 $ 524,996
--------- -----------
--------- -----------
</TABLE>
5. LEASES:
The Company's Seton Business Park facility is primarily used for
experimental development and production and is occupied under a
non-cancelable operating lease agreement with an initial six and
one-half year term, which expired December 31, 1998 and has two renewal
terms of two years each. Related rental payments for the nine months
ended December 31, 1998 and 1997, were $177,959 and $177,426,
respectively. The original operating lease agreement for the Seton
Business Park facility contained terms which feature reduced rental
payments in the early years and increased payments toward the end of the
lease term. For financial reporting purposes, rental expense represents
an average of the minimum annual rental payments over the initial six
and one-half year term. On an annual basis, this expense was
approximately $192,000.
On April 14, 1998, the Company exercised the right to renew the lease of
its Seton facility. The lease now expires on December 31, 2000, and may,
at the Company's option, be renewed again for another two year period
thereafter. On an annual basis this expense is approximately $244,000.
During previous years, the Company entered into several non-cancelable
capital lease obligations for various pieces of laboratory equipment and
furniture that expire during fiscal year 1999. Additionally, during
fiscal years 1997 through 1999, the Company entered into several
operating leases that expire throughout fiscal years 2001 through 2004.
6. LONG TERM DEBT:
In November 1996, the Company completed the acquisition of an
approximately 70,000 square foot building on 3.48 acres in Baltimore,
Maryland, which the Company has renovated to provide CBL with office,
warehouse and pharmaceutical manufacturing space. The Company
successfully completed the initial FDA general facility inspection on
this commercial production facility in July 1998. The Company is
actively seeking opportunities and customer contracts to utilize these
FDA approved expanded capabilities. The purchase and renovation costs
were financed, at that time, with a tax-exempt $7,000,000 Economic
Development Bond issued by the Maryland Industrial Development Financing
Authority (MIDFA), and a $1,500,000 loan from the Mayor and City Council
of Baltimore City by and through the Department of Housing and Community
Development. The loan from the City of Baltimore has an interest rate
which is fixed at 6.5%. The bonds are variable rate and may be converted
to a fixed rate.
The Company has also entered into an interest rate agreement with First
Union National Bank to reduce the potential impact of the variable
interest rates on the bonds. This agreement results in a maximum
interest rate on the bonds of 5.51% as long as the Bonds remain
tax-exempt, and relates to $6 million of the outstanding bonds. The
agreement became effective in November 1996 and will expire in November
2003.
The principal portion of the Bonds, and the accrued interest thereon, is
payable from monies drawn under a direct pay Letter of Credit issued by
First Union National Bank (the "Bank"), in amounts up to $7,280,000. A
Letter of Credit fee of 1.125%
9
<PAGE>
CHESAPEAKE BIOLOGICAL LABORATORIES, INC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
is paid annually to the Bank. Interest is payable quarterly, commencing
February 1, 1997, and principal portions of the bonds are subject to
redemption, in part, commencing November 1998, in accordance with a
schedule set forth in the bonds. The Maturity Date is August 1, 2018.
The loan from the City of Baltimore requires interest only payments for
the first two years, and monthly principal and interest payments due
thereafter through November 2016.
In November, the Company converted the $7,000,000 MIDFA Bonds from a
tax-exempt to a taxable bond. This eliminated the capital expenditure
restriction associated with the tax-exempt bonds. The maximum interest
rate associated with the Bond conversion increased to 6.99% and expires
in November 2005.
Under the documentation applicable to the Bond financing, the Company is
obligated to maintain certain financial ratios and balances, including a
minimum tangible net worth, a liability to net worth ratio, an EBITDA
ratio and a current ratio, all as defined and established in the
applicable documents. The documentation applicable to the Bond financing
includes several additional covenants, including a ceiling on capital
expenditures and a limitation on the incurrence of other indebtedness,
as defined and established therein. During fiscal year 1998, and
subsequent thereto, the Company and the Bank agreed to modify certain
ratios and balances provided for under the Bond financing documentation,
and the Bank agreed to waive through April 1, 1999, the requirement that
the Company maintain a certain EBITDA ratio. As of December 31, 1998,
the Company was out of compliance with certain covenants under the
documentation applicable to the bond financing. CBL's tangible net worth
was $5,788,000 compared to the $6,000,000 require under the applicable
covenant. As a result of the decision not to record the tax benefit for
the current fiscal year losses as of December 31, 1998, the Company's
current ratio is 2.0:1 as compared to the 2.5:1 covenant.
Other long term debt as of December 31, 1998, consists of loans for
various equipment. The equipment loan bears interest at 8.5% and is
repayable through April 1, 1999 in variable monthly installments.
7. EARNINGS PER SHARE:
In March 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings
per Share." SFAS 128 simplifies the standards for computing earnings per
share ("EPS") previously found in APB Opinion No. 15, "Earnings per
Share." It replaces the presentation of primary and fully diluted EPS
with a presentation of basic and diluted EPS and requires a
reconciliation of the numerator and denominator of the basic and diluted
EPS calculation. Basic EPS excludes dilution and is computed by dividing
income available to common stockholders by the weighted average number
of common shares outstanding for the period. Diluted EPS is computed
similarly to primary EPS pursuant to APB Opinion No. 15. The adoption of
SFAS 128 did not have a significant impact on the Company for the nine
months ended December 31, 1998, because of the Company's net loss.
Earnings per share information for the prior quarter has been restated
to reflect the new requirements.
8. NEW ACCOUNTING PRONOUNCEMENTS:
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The statement establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. The statement is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999 and will be
adopted as a cumulative catch-up. Management does not expect the
adoption of this statement to have a material impact on the Company's
financial position or results of operation.
During March 1998, the American Institute of Certified Public
Accountants issued Statement of Position (SOP) 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP
98-1 provides that computer software costs that are incurred in the
preliminary project stage should be expensed as incurred. Once the
capitalization criteria of SOP 98-1 have been met, external direct costs
of materials and services consumed in developing or
10
<PAGE>
CHESAPEAKE BIOLOGICAL LABORATORIES, INC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
obtaining internal-use computer software; payroll and payroll-related
costs for employees who are directly associated with and who devoted
time to the internal-use computer software project (to the extent of the
time spent directly on the project); and the interest costs incurred
when developing computer software for internal use should be
capitalized.
Under SOP 98-1, training costs, data conversion costs and internal costs
incurred for upgrades, enhancements and maintenance should be expensed
as incurred. Impairment of capitalized software should be recognized in
accordance with the provision of FASB Statement No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of." The SOP is effective for fiscal years beginning after
December 15, 1998 and is to be adopted prospectively. Management does
not believe that the adoption of SOP 98-1 will have a material affect on
the Company's financial condition or results of operations.
11
<PAGE>
CHESAPEAKE BIOLOGICAL LABORATORIES, INC. AND SUBSIDIARY
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The management discussion below should be read in conjunction with the
Company's Annual Report on Form 10-K for the fiscal year ended March 31,
1998.
NINE MONTHS ENDED DECEMBER 31, 1998 AND 1997.
During 1998, the Company successfully completed the initial cGMP
validation and FDA inspection of the Company's new 71,000 square foot
pharmaceutical manufacturing facility located at the Camden Industrial
Park (Camden), Baltimore, Maryland. As a result of the completion, the
Company's business capabilities have expanded significantly to include
larger scale commercial pharmaceutical production at Camden. The
services offered at Camden complement the process development and
smaller scale pharmaceutical production as historically conducted at the
Company's 15,000 square foot cGMP facility which continues to operate at
the Seton Business Park (Seton), also in Baltimore, Maryland.
Revenues for the third quarter were $1,621,000 compared to $1,720,000
for the third quarter last year. Year to date revenues of $5,021,000,
which do not include any sales to Allergan, decreased 3% as compared to
the same period last year. Excluding prior year sales related to the
since expired contract manufacturing agreement between the Company and
Allergan, year to date sales this year reflect a 19% increase when
compared to the corresponding period last year. Products historically
produced at Seton accounted for 88% of second quarter and 93% of year to
date revenues, as the expanded capabilities of Camden have initially
been utilized to only a limited degree.
In September 1998, the Company hired two experienced pharmaceutical
sales representatives which have initiated proposals and contracts with
existing and potential customers. Twenty-eight potential customers have
audited and or visited the Camden facility during this fiscal year.
These on site activities have resulted in several quotes and proposals
and in some cases generated revenue for the development of commercial
products. The Company believe that this development work will lead to
the establishment of long-term contracts for the commercial production
of those products, if commercial sale is approved by the FDA.
Costs of sales for the quarter ended December 31, 1998 were $1,986,000
or 123% of sales compared to $1,196,000 or 69% of sales for the same
period last year. The costs related to Camden were $885,000 for the
period versus $137,000 last year. For the nine months ended December 31,
1998 cost of sales were $5,171,000 or 103% of revenues, including
$2,051,000 of costs related to Camden. In the nine months ended December
31, 1997 cost of sales were $3,871,0100 or 75% of revenues including
$356,000 of Camden related costs. As the revenues at Camden increase, it
is anticipated the overall margin will significantly improve as volume
covers the fixed overhead cost required to maintain the FDA approved
facility.
Operating expenses during the three and nine month periods ended
December 31, 1998 increased $127,000 and $334,000, respectively. The
increase was largely the result of Selling and Marketing activities
associated with Camden. The increase of $212,000 in year to date Selling
and Marketing cost were attributed to the recently established sales
force and include several marketing and advertising programs related to
the opening of Camden. General and Administrative increases during the
period were attributed to increased professional fees and temporary
salary costs.
The operating loss for the quarter was $1,054,000 as compared to $38,000
for the same period last year. The operating loss is attributed
primarily to a Camden related loss of $845,000 and a loss of $210,000 at
Seton as a result of lower sales level. The $2,132,000 year-to-date
operating loss compares to a $337,000 loss in the prior year. The
increased loss is attributable primarily to the Camden loss of
$2,177,000 offset in part by Seton operating profit.
Other expenses were $119,000 for the quarter compared to other expenses
of $3,000 for the comparable period last year. The change reflects the
interest expense on the bonds secured in November 1996 and a reduction
in interest income earned on the bond funds as they were drawn down to
pay the construction and validation costs of the Camden facility.
12
<PAGE>
Overall the Company experienced a net loss of $1,585,000 for the quarter
ended December 31, 1998, as compared to a reported a net loss of $26,000
for the comparable quarter last year. Also contributing toward the loss
for the quarter was the Company's decision not to record the tax benefit
applicable to the quarter's operation. Additionally due to the
uncertainty and the timing as to the start of significant commercial
production at the new Camden facility, the Company substantially
eliminated the tax benefit associated with the losses incurred for the
first six months. This adjustment was another significant component of
the loss for the quarter and the year-to-date period. The net loss for
the nine months ended December 31, 1998, was $2,251,000 compared to a
$134,000 loss for the same period last year.
FINANCIAL CONDITION AND LIQUIDITY
On December 31, 1998, CBL had cash and cash equivalents of $1,574,000
compared to $3,042,000 at March 31, 1998. These balances do not include
$350,000 held as collateral for the Company's obligations under the
Letter of Credit and Reimbursement Agreement with First Union National
Bank, pursuant to which a letter of credit was issued as credit
enhancement for bonds issued by the Maryland Industrial Development
Financing Authority. The proceeds of these bonds were used by the
Company to finance a portion of the purchase price and the renovation
and equipping of the Company's new commercial production facility
located at the Camden Industrial Park, Baltimore, Maryland. In November
1998, the Company converted the $7,000,000 tax-exempt MIDFA Bonds to a
taxable bond which eliminated the capital expenditure restriction
associated with the tax-exempt bonds. The increase in the interest
associated with the Bond conversion is 1.5% per annum. As of December
31, 1998, the Company was out of compliance with certain covenants under
the documentation applicable to the bond financing. CBL's tangible net
worth was $5,788,000 compared to the $6,000,000 require under the
applicable covenant. As a result of the decision not to record the tax
benefit for the current fiscal year losses as of December 31, 1998, the
Company's current ratio is 2.0:1 as compared to the 2.5:1 covenant. The
Company continues to maintain a $750,000 Revolving Line of Credit from
the First Union National Bank and there was an outstanding balance of
$549,000 at December 31, 1998.
Net cash used in operating activities of $1,361,000 for the nine months
ended December 31, 1998, was primarily the result of the net loss for
the period which was offset in part by decreases in accounts receivable
and depreciation costs. This compares to net cash used in operating
activities for the comparable period in the prior year of $709,000 which
was primarily due to a net loss and increases in accounts receivable and
prepaid expenses. Net cash used in investing activities of $417,000 for
the nine months ended December 31, 1998, was the result of the
completion of the FDA approved Camden production facility offset in part
by the final disbursements from the bond Trustee. This compares to net
cash used in investing activities for the comparable period in the prior
year of $561,000 which was due to purchases of property and equipment
offset by funds released by the trustee. Net cash provided by financing
activities of $310,000 for the nine months ended December 31, 1998, was
comprised primarily of short term borrowings from the Company's
revolving Line of Credit. This compares to the net cash provided by
financing activities for the comparable period in the prior year of
$3,433,000, which was comprised largely of proceeds from the Company's
follow-on public offering of Class A Common Stock. As a result of the
Company's December 31, 1998, cash position, in addition to the funds
required to operate below the sales break-even point for the fourth
quarter and a portion of fiscal year 2000, the Company's working capital
position is not adequate to meet its anticipated operating requirements.
The Company's objective is to raise equity funding to cover the
anticipated shortfall in working capital and provide for its long-term
growth.
NEW ACCOUNTING PRONOUNCEMENTS:
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The statement establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. The statement is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999 and will be
adopted as a cumulative catch-up. Management does not expect the
adoption of this statement to have a material impact on the Company's
financial position or results of operation.
13
<PAGE>
YEAR 2000 ISSUE
In conjunction with the Company's expansion of its commercial production
capabilities, the Company is upgrading both its computer hardware and
software. Management believes the software upgrade will resolve the Year
2000 (Y2K) issue for the Company. An independent consultant studied the
Company's information technology status and recommended changes,
including the installation of commercially available software packages.
Installation of critical modules, which are Y2K compliant, was completed
by late 1998. Time-sensitive internal programs have been reviewed and
will require only minor modifications, at nominal cost, to resolve the
Year 2000 issue.
In addition, CBL has requested critical suppliers to report the status
of the Y2K compliance of their information technology systems.
Seventy-four suppliers including CBL's major suppliers have responded to
CBL's questionnaire that they are Y2K compliant. Due to the nature of
CBL's business it is unlikely that a customer with a Y2K problem would
adversely effect CBL to any significant degree. Also, CBL does not
expect to be dependent on one customer or a small group of customers
which limits CBL's exposure if some customers have not resolved their
Y2K problems. After CBL's current information technology upgrade is
complete the Company plans to assess and address any contingency issues.
STATEMENTS REGARDING FORWARD-LOOKING DISCLOSURE
This Quarterly Report on Form 10-Q contains 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, which are intended to be covered by Safe Harbors
created thereby. You can identify forward-looking statements by the use
of forward-looking terminology, such as "may", "expect", "should",
"believes", "anticipates", "intends", or words of similar import.
Forward-looking statements may involve known and unknown risks and
uncertainties that could cause the actual results, performance or
achievements of the Company to be materially different from future
results, performance, or achievements of the Company expressed or
implied by such forward-looking statements. These risks and
uncertainties include, without limitation, general economic and business
conditions, changes in business strategy or development plans, and the
ability of the Company to successfully produce product and to
successfully market and sell products and services. Given these
uncertainties, the reader is cautioned not to place undue reliance on
such forward-looking statements.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 5. OTHER INFORMATION
On December 22, 1998 CBL announced that Thomas P. Rice, who has served
as a member of the Board of Directors of the Company since 1997, would
become President and Chief Executive Officer of the Company, effective
January 11, 1999.
Mr. Rice began his career with the international accounting firm of
Deloitte & Touche, and since leaving that firm in 1985, has served as
Executive Vice President, Chief Operating Officer and Chief Financial
Officer, and a member of the Board of Directors, of Circa
Pharmaceuticals, Inc., in Copaigue, New York from 1993 - 1995, and
before that as Vice President of Administration and Finance and Chief
Financial Officer of Pharmakinetics Laboratories, Baltimore, Maryland.
Mr. Rice will continue to serve on the Board of Directors of CBL.
CBL also announced that John C. Weiss, III, who has served as President
and as member of the Board of Directors of CBL, has resigned from the
Board of Directors and as President of the Company. Mr. Weiss will serve
as consultant to the Company.
The Company and William P. Tew, Ph.D., who has served as Chief
Executive Officer and Chairman of the Board of the Company for many
years, also agreed to certain modifications to the Employment Agreement
previously existing by and between the Company and Dr. Tew. Dr. Tew
will continue to serve as Chairman of the Board of the Company.
14
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS:
10 (gg) Letter Agreement dated February 10, 1999, by and
between the Company and William P. Tew, Ph.D.
27 - Financial Data Schedule
B. REPORTS ON FORM 8-K:
No reports on Form 8-K were filed by the Registrant
during the quarter for which this report is filed.
15
<PAGE>
CHESAPEAKE BIOLOGICAL LABORATORIES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned there unto duly authorized.
CHESAPEAKE BIOLOGICAL
LABORATORIES, INC.
Registrant
DATE: 2/10/99 By: /s/ THOMAS P. RICE
---------- -----------------------
Thomas P. Rice
President & CEO
DATE: 2/10/99 By: /s/ JOHN T. JANSSEN
---------- -----------------------
John T. Janssen
CFO & Treasurer
16
<PAGE>
Exhibit 10(gg)
February 10, 1999
William P. Tew, Ph.D
c/o Chesapeake Biological Laboratories, Inc.
1111 South Paca Street
Baltimore, Maryland 21230
Dear Bill:
As you know, Chesapeake Biological Laboratories, Inc. (the
"Corporation") and you entered into a letter agreement dated as of December 22,
1998, amending certain provisions of your then existing employment arrangement
with the Corporation, in an effort to better position the Corporation for future
growth. Since that date, however, further discussions have ensued, and it has
been determined that the December 22, 1998 letter agreement did not fully
reflect the intentions of the parties and that certain additional modifications
to the employment arrangement by and between you and the Corporation are
warranted. Accordingly, the purpose of this letter is to set forth all of the
changes to your employment arrangement which have recently been agreed upon,
including those changes which were intended or embodied in the letter agreement
dated December 22, 1998 and the changes which have been discussed and agreed to
in principle since that date. These changes, modifications and agreements are as
follows:
1. Effective January 1, 1999, the Employment Agreement dated
July 1, 1995, by and between you and the Corporation, as amended by a letter
agreement dated November 21, 1996 (the "Employment Agreement"), shall be deemed
to be further amended as follows (all capitalized terms used herein and not
otherwise specifically defined shall have the meanings ascribed thereto in the
Employment Agreement):
(i) Paragraph 4 of the Employment Agreement is amended
and restated as follows:
At all times during the Employment Term, the Corporation
agrees to engage the Employee as Chairman of the Board of
Directors of the Corporation and the Employee agrees to
perform such services as are customarily rendered by chairmen
of the board of directors of publicly held companies
comparable to the Corporation and which consider the position
of Chairman of the Board as an officer position. In addition,
the Employee will perform such other executive services for
the Corporation as shall from time to time be reasonably
assigned to him by the Board of Directors of the Corporation,
consistent with the terms of this Agreement and the stature
and position of the Employee. Both the Employee and the
Corporation
17
<PAGE>
William P. Tew, Ph.D
February 10, 1999
Page 18
acknowledge that the ability of the Employee to serve as
Chairman of the Board of the Corporation is conditioned upon
the Employee serving as a member of the Board of Directors of
the Corporation; accordingly, at all times during the
Employment Term, the Corporation, through its Board of
Directors, agrees to nominate the Employee as a member of the
Board of Directors of the Corporation, and provided the
Employee shall remain a member of the Board of Directors of
the Corporation, at all times during the Employment Term the
Board of Directors of the Corporation shall designate the
Employee as Chairman of the Board of Directors of the
Corporation. The failure of the stockholders of the
Corporation to elect the Employee as a director of the
Corporation when nominated from time to time during the
Employment Term (and assuming that the Employee agrees to
serve if so elected) will be deemed a material diminution in
the title or scope of the Employee's responsibilities within
the meaning of Paragraph 1(a)(iii) of this Agreement.
(ii) Paragraph 3 of the Employment Agreement shall
be amended such that the Renewal Term in effect as of the date hereof shall
continue from the date hereof until December 31, 1999, whereupon the
Employment Term shall be automatically extended for an indefinite number of
successive one (1) year Renewal Terms (in lieu of three (3) year Renewal
Terms as currently provided in the Employment Agreement) thereafter, unless
and until, not less than one hundred eighty (180) days prior to the last day
of the Renewal Term ending December 31, 1999 or any successive Renewal Term
then in effect, the Corporation shall have delivered to you, or you shall
have delivered to the Corporation, written notice that the term of your
employment under the Employment Agreement will not be so extended.
(iii) Your Base Salary, as provided for under
Paragraph 5 of the Employment Agreement shall be changed from $170,000 per
year as currently in effect, to $125,000 per year. All other terms currently
existing under Paragraph 5 of the Employment Agreement, including those
regarding the manner in which the Base Salary is to be paid, shall continue
to apply.
(iv) The reference to "the number two (2)" in
clause (ii) of Paragraph 12(d)(x) of the Employment Agreement shall be
amended to read "the number one (1)" in lieu of "the number two (2)", such
that any severance payment becoming due to you under paragraph 12(d)(x) of
the Employment Agreement will be reduced by one-half of the amount which
would have been payable prior to this amendment.
(v) The definition of "Change in Control of the
Corporation" as set forth in subparagraph (d) of Paragraph 1 of the Agreement
shall be modified to include, in addition to the events otherwise described
therein as constituting the occurrence of a change in control of the
Corporation, a merger, sale of substantially all of the assets of the
Corporation, share exchange, consolidation or other business combination (as
defined in the Maryland General Corporation Law) of the Corporation and any
other person, entity or group of persons or entities acting in concert, as a
result of which the Corporation's common stock becomes exchangeable for other
securities or property or cash.
2. In consideration for your agreement to the modifications to
your Employment Agreement
18
<PAGE>
William P. Tew, Ph.D
February 10, 1999
Page 19
as described herein above, the Corporation agrees to pay you the sum of
$170,000, and to grant to you options under the Corporation's Fourth Incentive
Stock Option Plan, on the following terms and conditions:
(i) The sum of $50,000 will be paid to you on January
4, 1999, without condition; and the Company agrees to pay you an additional
$120,000, in two equal installments of $60,000 each, payable on the fifteenth
day of the first calendar month and the fifteenth day of the second calendar
month, respectively, following the fiscal quarter of the Corporation during
which a Qualifying Event (as defined below) occurs.
For purposes hereof, a "Qualifying Event" shall
mean the first to occur of either (a) receipt by the Corporation at any time
or from time to time hereafter of one or more equity investments or loans of
new money (but not refinancing of existing loans) or any other infusion of
capital, whether through the sale of common or preferred stock of the
Corporation or otherwise, in an amount equal to or exceeding, in the
aggregate, $3,000,000 or (b) in any fiscal quarter of the Corporation, the
Corporation shall have gross revenues which exceed $3,200,000; or (c) there
shall occur any Change in Control of the Corporation, as such term is defined
in the Employment Agreement.
It is expressly acknowledged that your right to
receive payment of the sums which will become due and owing to you upon the
occurrence of the Qualifying Event shall not be conditioned upon your
continued employment or any other continuing relationship with the
Corporation, but shall be an obligation of the Corporation to you independent
of your continuing status as an employee, officer or director.
(ii) In addition, the Corporation agrees to grant
to you an incentive stock option under the Corporation's Fourth Incentive
Stock Option Plan, pursuant to which you will be entitled to purchase up to
125,000 shares of the Corporation's Class A Common Stock at an exercise price
equal to the closing "ask" price as quoted on the NASDAQ National Market on
the date hereof. The option will be evidenced by an option agreement typical
for options of this type, and will provide that the option shall be for a
term of ten (10) years and exercisable in whole or in part at any time and
from time to time during the term thereof.
3. It is understood and agreed that, notwithstanding the date
hereof, it is the intention of you and the intention of the Corporation that the
agreements set forth herein be effective as of December 22, 1998. In addition,
it is understood and agreed that this letter shall supercede in its entirety the
letter agreement previously executed and delivered by and between you and the
Corporation, dated December 22, 1998.
Provided that the terms set forth above are acceptable to you,
we ask that you execute the enclosed counterpart of this letter, and that you
return one fully executed counterpart to me, whereupon this letter
19
<PAGE>
William P. Tew, Ph.D
February 10, 1999
Page 20
will constitute a legally binding agreement between you and the Corporation, and
the provisions set forth in Paragraph 1 above will constitute an amendment to
your Employment Agreement. As noted above, this letter agreement will supercede
in its entirety the letter agreement dated as of December 22, 1998.
Very truly yours,
Chesapeake Biological Laboratories, Inc.
By: /s/ ROBERT J. MELLO
----------------------------------------
Robert J. Mello
Vice President
20
<PAGE>
William P. Tew, Ph.D
February 10, 1999
Page 21
The foregoing terms and conditions are hereby accepted and agreed to by
the undersigned on this 10th day of February, 1999, with an effective date as of
December 22, 1998, as hereinabove provided.
By: /s/ WILLIAM P. TEW, PH.D.
------------------------------------
William P. Tew, Ph.D.
21
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