<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934, FOR THE QUARTERLY PERIOD
ENDED SEPTEMBER 30, 1998.
Commission File Number
0-19659
CHRYSALIS INTERNATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 22-2877973
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
575 Route 28, Raritan, New Jersey 08869
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (908) 722-7900
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
---- ----
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date.
Common Stock $0.01 par value 11,523,257 shares
outstanding at November 4, 1998
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This Form 10-Q/A of Chrysalis International Corporation for the quarter ended
September 30, 1998 is being filed to correct certain inconsistencies and
typographical errors contained in the Form 10-Q as originally filed. Capitalized
terms used herein and not defined herein are used as defined in the original
Form 10-Q of Chrysalis International Corporation for the quarterly period ended
September 30, 1998 (the "original Form 10-Q"). All information set forth in
this Form 10-Q/A is given as of November 16, 1998, the date of the filing of
the original Form 10-Q.
1. Note 4 of the Notes to Unaudited Consolidated Financial Statements
contained in Item 1 of Part 1 of the original Form 10-Q is hereby amended
and restated to read as follows:
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Note 4. Stock Option Repricing
----------------------
In June 1988, the Company authorized the repricing of potentially
524,000 stock options, held by non-officer employees, under the Company's 1991
and 1996 Stock Option Plans. The repricing excluded officers, directors and all
non-employee option holders. This repricing, with the agreement of the affected
employees, was a 2 for 1 exchange in option shares. Pursuant to the repricing,
208,100 options were repriced at $1.6875, resulting in 104,050 new options.
One-half of these options will vest one year after the date of the agreement and
the remaining one-half will vest daily for a period of one year beginning
June 25, 1999.
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2. Item 2 of Part I of the original Form 10-Q is hereby amended and restated
to read as follows:
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL SUMMARY
The Company is an international contract research organization
("CRO") providing certain drug development services primarily to the
pharmaceutical and biotechnology industries. The portfolio of drug development
services includes transgenic discovery research, preclinical development and
clinical capabilities. In addition, the Company is the only CRO that is
currently able to use its proprietary transgenic and licensed gene targeting
technology to provide services for its clients that require transgenic animal
models in order to determine the function of human genes and identify
therapeutic targets implicated in disease and for the evaluation of therapeutic
lead compounds for further development. The Company generates substantially all
of its revenues from its drug development services.
POTENTIAL MERGER
The Company is in the final stages of negotiating an agreement and
plan of merger (the "Merger Agreement") pursuant to which the Company would be
acquired by an unaffiliated third party ("Buyer") in a merger (the "Merger").
Consummation of the Merger would be subject to receipt of necessary regulatory
approvals (including the expiration or termination of the waiting period under
the Hart-Scott- Rodino Antitrust Improvements Act of 1976, as amended), a proxy
solicitation to obtain the approval of the Merger Agreement (and receipt of such
approval) by the Company's stockholders and other closing conditions, some of
which would be beyond the control of the Company. There can be no assurance that
the Merger Agreement will be executed or that the Merger will be consummated.
RESTRUCTURING OF CLINICAL OPERATIONS
In connection with the execution of the Merger Agreement, the Company
would agreed to shut down and discontinue providing clinical services in the
United States and at several of its clinical operations in Europe. The draft
Merger Agreement contemplates the shut down of the Company's clinical operations
in Austin, Texas, Dusseldorf, Germany and Cham, Switzerland. As a result of
these shut downs, the Company would no longer provide services for Phase I
clinical studies and it would focus on providing services for any Phase II or
Phase III clinical studies in Germany, Eastern Europe and Israel. These shut
downs in Dusseldorf, Germany, Austin, Texas and a significant downsizing of
European Clinical operations will occur even if the Merger Agreement is not
executed or the Merger is not consummated. If the Merger is not consummated, the
Company expects to continue to provide Phase II and Phase III clinical services
focused on Eastern Europe and Israel, as well as in Western Europe on a
significantly downsized basis. Adequate provisions are being made to perform
fully or transfer existing clinical studies at shut down and downsized locations
to other Company locations or, upon or after consummation of the Merger, to
Buyer's locations. The Company expects to take a charge in the fourth quarter of
1998, related to this restructuring, currently estimated at $3,700,000. If the
Merger Agreement is executed and the Merger is consummated, the Company's
principal executive offices are also likely to be shut down.
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DEFAULT
Based on third quarter 1998 financial results, at September 30,
1998, the Company failed to satisfy certain financial covenants contained in the
loan agreement related to its senior secured term loan and, thus, was in default
under the loan agreement. In addition, the Company anticipates that it will fail
to satisfy those covenants at December 31, 1998. The amount outstanding under
this loan is $4,687,500 at September 30, 1998. As a result of the default, the
entire outstanding amount of the senior secured term loan is classified as
short-term borrowings at September 30, 1998. The lender has not yet accelerated
the term loan or exercised its rights under the loan agreement. In connection
with negotiating the Merger Agreement, the Company has also been in discussions
with the lender.
OTHER MATTERS
On March 16, 1998, the Company issued a $5.0 million subordinated
note to a wholly-owned subsidiary of MDS Inc., a Canadian corporation ("MDS").
As part of this transaction, the Company also issued a warrant to purchase
2,000,000 shares of Common Stock at an exercise price of $2.50 per share. In
addition, the Company and MDS entered into a standstill agreement, which, among
other things, governs the ownership and acquisition of securities of the Company
by MDS and its affiliates.
Chrysalis is also the exclusive commercial licensee of a U.S.
patent covering DNA Microinjection, the process widely used in the
pharmaceutical and biotechnology industries to develop transgenic animals. The
Company utilizes this license for its drug development services and grants
sublicenses for the use of this technology. These sublicenses entitle the
Company to receive revenues consisting of fees and, in certain cases, royalties.
The Company's financial statements are denominated in U.S. dollars
and, accordingly, changes in the exchange rate between non-U.S. currencies and
the U.S. dollar will affect the translation of non-U.S. revenues and operating
results into U.S. dollars for purposes of reporting the Company's financial
results. For the three and nine month periods ended September 30, 1998,
approximately 59% and 62%, respectively, of the Company's revenues were from
operations outside the U.S. Approximately 48% and 44% of the Company's revenues
for the three and nine months ended September 30, 1998, respectively, were from
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operations in France and denominated in French Francs; accordingly,
fluctuations in the exchange rate between the French Franc and the U.S. dollar
may have a material effect on the Company's operating results. See
"-- Liquidity and Capital Requirements -- Exchange Rate Fluctuations."
In addition, the Company may be subject to foreign currency
transaction risk when the Company's multi-country contracts are denominated in a
currency other than the currency in which the Company incurs the expenses
related to such contracts. For such multi-country drug contracts, the Company
seeks to require its client to incur the effect of fluctuations in the relative
values of the contract currency and the currency in which the expenses are
incurred. To the extent the Company is unable to require its clients to incur
the effects of currency fluctuations, these fluctuations could have a material
effect on the results of operations of the Company. The Company does not
currently hedge against the risk of exchange rate fluctuations.
The Company's contracts are typically fixed price contracts that
require a portion of the contract amount to be paid at or near the time the
trial is initiated. The Company generally bills its clients upon the completion
of negotiated performance requirements and, to a lesser extent, on a date
certain basis. Certain of the Company's contracts are subject to cost
limitations, which cannot be exceeded without client approval. Because, in many
cases, the Company bears the risk of cost overruns, unbudgeted costs in
connection with performing these contracts may have a detrimental effect on the
financial results of the Company. If it is determined that a loss will result
from the performance of a contract, the entire amount of the estimated loss is
charged against income in the period in which the determination is made.
The Company's contracts generally may be terminated with or
without cause. In the event of termination, the Company is typically entitled to
all sums owed for work performed through the notice of termination and all costs
associated with termination of the study. In addition, some of the Company's
contracts provide for an early termination fee, the amount of which usually
declines as the work progresses. The Company's service contracts also contain
certain provisions designed to address the negative impact on the Company's
revenues and profitability as a result of non-controllable delays. These
provisions, however, may not be included in all of the Company's service
contracts. In any event, the Company attempts to negotiate reimbursement of
certain fees whether or not such provisions are included in the service
contract. However, the Company is not always successful in negotiating such
reimbursement. The loss of or delay in a large contract or the loss of multiple
contracts could adversely affect the Company's future revenues and
profitability. In addition, termination or delay in the performance of a
contract occurs for various reasons, including; but not limited to, unexpected
or undesired results, inadequate patient enrollment or investigator recruitment,
production problems resulting in shortages of the drug being tested, adverse
patient reactions to the drug being tested, or the client's decision to not
proceed with a particular trial.
Revenue for contracts is recognized on a percentage of completion
basis as work is performed. Revenue is affected by the mix of trials conducted
and the degree to which effort is expended. The Company will incur travel costs
and may subcontract with third-party investigators in connection with multi-site
clinical trials. These costs are passed through to clients and, in accordance
with industry practice, are included in service revenue. The costs may vary
significantly from contract to contract; therefore, changes in service revenue
may not be indicative of trends in revenue growth. Accordingly, the Company
considers net service revenue, which consists of service revenue less these
costs, as its primary measure of revenue growth.
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The Company has had, and may continue to have, certain clients
from which at least 10% of the Company's overall revenue is generated over
multiple contracts. Such concentration of business is not uncommon within the
CRO industry. For the three and nine month periods ended September 30, 1998, the
Company's top ten customers accounted for approximately 40% and 46%,
respectively, of its combined net revenue. Two customers accounted for 12% and
11% of the Company's combined net revenue for the nine months ended September
30, 1998. The Company believes that the loss of any of these customers, if not
replaced or if services provided to existing customers are not expanded, may
have a material adverse effect on the Company. There can be no assurance that
the loss of any such customer would be replaced or services to existing
customers would be expanded on terms acceptable to the Company.
Between July 1997 and June 1998, the Company incurred expenses
expanding and retaining its infrastructure, primarily in the clinical
operations, to support global drug development capabilities and utilized
management's resources primarily to communicate these expanded capabilities to
its existing client base and the pharmaceutical and biotechnology industries.
See "-- Discontinuation of Large Clinical Trial." However, the Company would
agree in connection with the proposed Merger to shut down and discontinue
providing services at certain of its clinical operations in Europe and the
United States. If the Merger Agreement is not executed or the potential Merger
is not consummated, the Company will discontinue operations in Dusseldorf,
Germany and Austin, Texas and to downsize significantly its European clinical
operations. See "-- Potential Merger" and "-- Restructuring of Clinical
Operations" above.
The Company's future operating results will be contingent upon
successfully controlling its expenses and utilizing its transgenics, preclinical
and remaining clinical infrastructure which will require the Company to convert
proposals into contracts and revenues. There can be no assurance that the
Company will be able to successfully utilize its remaining clinical
infrastructure in a cost efficient manner or that proposals will be converted
into revenues in a timely manner. The Company's ability to convert its remaining
infrastructure into future operating results may also be affected by factors
such as delays in initiating or completing significant preclinical and clinical
trials, the lengthening of lead times to convert proposals into contracts and
revenues, and the termination of preclinical and clinical trials, all of which
may be beyond the control of the Company. See "-- Quarterly Results."
DISCONTINUATION OF LARGE CLINICAL TRIAL
One of the Company's largest clients, a leading pharmaceutical
company, notified the Company that it decided to change a clinical protocol and
thereby delay a large clinical trial which was originally expected to begin
during the fourth quarter of 1997. As a result, consistent with management's
expectations, results during the first nine months of 1998 were negatively
impacted. In April 1998, the Company was informed that the drug being developed
in this trial would be out-licensed or co-developed with a partner. There can be
no assurance that Chrysalis would be retained to assist in the further
development of this drug. This event, coupled with the prior strategic decision
to maintain clinical infrastructure utilized for this trial, will have a
significant negative impact on the Company's results of operations for the
remainder of 1998 and for 1999. Additionally, while the Company has recently
obtained additional clients and contracts, these new clients and contracts will
not result in significant revenue in the near term. As a result, these
additional contracts are not sufficient to offset the significant loss created
by the loss of the large clinical trial. See "-- Restructuring of Clinical
Operations."
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RESULTS OF OPERATIONS
REVENUES
Revenues were $8,799,000 for the three months ended September 30,
1998 as compared to $10,623,000 for the same period in 1997. For the nine month
period ended September 30, 1998, revenues were $28,764,000 as compared to
$30,674,000 for the same period in 1997. The decrease in revenues for the three
and nine month periods ended September 30, 1998 as compared to the same periods
in 1997, was primarily the result of the following: (i) a decrease in the
worldwide clinical business resulting from the completion of a large global
clinical study with one of the Company's largest customers, in the second
quarter of 1998 and the cancellation of a large clinical trial in April 1998 and
(ii) a decrease in the preclinical business in Europe. These decreases were
slightly offset by (i) an increase in the Company's transgenic based services,
particularly those supporting functional genomics research programs and (ii) an
increase in preclinical business in North America. See "-- Discontinuation of
Large Clinical Trial" above.
OPERATING EXPENSES
Direct costs were $7,832,000 or 89% of net revenues for the three
months ended September 30, 1998 and $7,423,000 or 70% of net revenues for the
same period in 1997. For the nine months ended September 30, 1998, direct costs
were $23,646,000 or 82% of net revenue and $21,545,000 or 70% of net revenues
for the same period in 1997. This increase in direct costs for the three and
nine month periods ended September 30, 1998 as compared to the same period in
1997 was primarily due to (i) investments made between July 1997 and June 1998
to expand and maintain the Company's clinical personnel and infrastructure to
support its business strategy at that time and to accommodate the large clinical
trial which was discontinued in April 1998 and (ii) investments in personnel and
infrastructure to support the growth in the Company's transgenic based services,
particularly those supporting functional genomics research programs. See "--
Discontinuation of Large Clinical Trial" above. The increase in these costs, as
a percent of revenues, is due to a base cost structure, primarily in the
clinical business, of personnel, facilities and related expenses which was
capable of supporting a higher level of business than experienced during the
first nine months of 1998 and for 1999. Although the Company is currently
undertaking cost-cutting measures (see "--Potential Merger" and "--
Restructuring of Clinical Operations" above), the existing infrastructure
intended to be used for the discontinued large clinical trial will have a
significant negative impact on the Company's results for the remainder of 1998.
Additionally, while the Company has recently obtained additional clients and
contracts, these new clients and contracts will not result in significant
revenue in the short term. As a result, these new contracts are not sufficient
to offset the significant loss and continuing expense created by the loss of the
large clinical trial.
General, administrative and marketing expenses were $2,924,000 for
the three months ended September 30, 1998 versus $3,123,000 for the same period
in 1997. This decrease was primarily due to the implementation of certain cost
reduction actions in 1998 in the clinical business. For the nine month periods
ended September 30, 1998 and 1997, general, administrative and marketing
expenses were $9,257,000 and $8,973,000, respectively. This increase in expenses
for the nine month period was primarily due to the increase in the last half of
1997 in personnel and related costs for marketing and business development,
strategic planning, information systems and general management.
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Depreciation and amortization expense decreased to $522,000 for
the three months ended September 30, 1998 as compared to $708,000 for the same
period last year. For the nine months ended September 30, 1998 depreciation and
amortization expense decreased to $1,529,000 as compared to $2,001,000 for the
same period last year. This decrease is the result of certain assets, primarily
associated with the Company's preclinical European business that were fully
depreciated prior to 1998.
OTHER INCOME (EXPENSE)
Other income (expense) represented expense of $315,000 for the
three months ended September 30, 1998 compared to income of $579,000 for the
same period last year. For the nine month period ended September 30, 1998, other
income (expense) represented expense of $812,000 compared to income of $524,000
for the same period in 1997. The increase in expense for 1998 as compared to
1997 is primarily the result of (i) a settlement agreement with Virginia
Commonwealth University ("VCU"), signed in the third quarter of 1997, which
resulted in a $700,000 gain in 1997, (ii) an increase in interest expense in the
three and nine month periods ended September 30, 1998 as compared to the same
period in 1997 resulting from higher outstanding debt balances and the
amortization of the warrants associated with the subordinated debenture in the
transaction with MDS and (iii) a decrease in interest income earned in the three
and nine month periods ended September 30, 1998 as compared to the same period
in 1997 as a result of a decrease in average available cash and other investment
balances.
TAXES
The Company's foreign subsidiaries are subject to foreign income
taxes under foreign tax laws on the profits generated in such countries which in
general may not be offset by losses from operations in other countries. The
Company recorded a net expense of $86,000 compared to $41,000 for the three
months ended September 30, 1998 and 1997, respectively. For the nine months
ended September 30, 1998 and 1997, the Company recorded a net expense of
$205,000 and $81,000, respectively. These provisions are primarily associated
with the Company's French operations.
The impact from United States federal income taxes is currently
not significant due to the Company's available net operating loss carryforwards.
At December 31, 1997, the Company had available net operating loss carryforwards
of approximately $26,434,000 for United States federal income tax purposes. Such
loss carryforwards expire through 2012. The Company also has research and
development tax credit carryforwards of approximately $3,012,000 for U.S.
federal income tax reporting purposes which are available to reduce U.S. federal
income taxes, if any, through 2011. The Company has alternative minimum tax
credit carryforwards of approximately $164,000 for U.S. federal income tax
purposes, which are available to reduce U.S. federal income taxes, if any. These
tax credits have an unlimited carryforward period. The Company's acquisition of
the clinical drug development business in December 1996 resulted in an ownership
change under the Internal Revenue Code of 1986, as amended (the "Code").
Accordingly, the Company's ability to utilize its net operating loss
carryforwards to offset operating profits may be subject to certain limitations
in the future under the Code. These net operating loss carryforwards may not be
utilized to offset profit in other countries.
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BACKLOG
The Company reports backlog based on anticipated net revenues from
uncompleted projects, which have been authorized by the client, through a
written contract or otherwise. Once work under a letter of intent or contract
commences, net service revenue is recognized over the life of the contract using
the percentage-of-completion method of accounting. In certain cases, the Company
will commence work on a project prior to finalizing a letter of intent or
contract. Contracts included in backlog are subject to termination or delay at
any time by the client or regulatory authorities. Terminations or delays can
result from a number of factors, many of which are beyond the Company's control.
Delayed contracts remain in the Company's backlog pending determination of
whether to continue, modify or cancel the contract.
The Company believes that its backlog as of any date is not
necessarily a meaningful indicator of future results and no assurance can be
given that the Company will be able to realize net service revenue included in
backlog. As of September 30, 1998, the Company's backlog was approximately $15
million compared to approximately $41 million as of December 31, 1997. This
decrease in backlog primarily reflects the cancellation of the large clinical
trial. See "-- Discontinuation of Large Clinical Trial" above.
QUARTERLY RESULTS
The Company's quarterly operating results are subject to
variation, and are expected to continue to be subject to variation, as a result
of factors such as delays in initiating or completing significant preclinical
and clinical trials, the lengthening of lead times to convert proposals into
contracts and revenues, termination of preclinical and clinical trials,
restructuring of clinical operations and exchange rate fluctuations. Delays and
terminations of studies or trials are often the result of actions taken by
clients or regulatory authorities and are not typically subject to the control
of the Company. Since a large amount of the Company's operating costs are
relatively fixed while its revenues are subject to fluctuation, minor variations
in the commencement, progress or completion of preclinical and clinical trials
may cause significant variations in quarterly operating results. The Company
expects to take a charge currently estimated at $3,700,000 in the fourth quarter
of 1998 due to the shutdowns. See "-- Potential Merger" and "-- Restructuring of
Clinical Operations" above.
The following table presents unaudited quarterly operating results
for each of the fiscal quarters beginning September 30, 1997 through September
30, 1998. In the opinion of the Company, this information has been prepared on
the same basis as the audited consolidated financial statements of the Company
and reflects all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of results of operations for those periods.
This quarterly financial data should be read in conjunction with the
consolidated audited financial statements and notes thereto included in the
Company's 1997 Annual Report on Form 10-K. The operating results for any quarter
are not necessarily indicative of the results to be expected in any future
period.
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<TABLE>
<CAPTION>
QUARTER ENDED ($000'S EXCEPT PER SHARE DATA)
-------------------------------------------------------------------------------
(UNAUDITED)
Sept. 30, Dec. 31, March 31, June 30, Sept. 30,
1997 1997 1998 1998 1998
---------- --------- ---------- --------- ------
<S> <C> <C> <C> <C> <C>
Net revenues $ 10,623 11,624 9,673 10,292 8,799
Operating expenses:
Direct costs 7,423 7,838 7,702 8,112 7,832
General, administrative &
marketing 3,123 3,442 3,223 3,110 2,924
Depreciation & amortization 708 699 493 514 522
-------- -------- -------- -------- --------
11,254 11,979 11,418 11,736 11,278
Loss from operations (631) (355) (1,745) (1,444) (2,479)
Other income (expense):
Interest income 93 72 127 56 87
Interest expense (206) (213) (248) (420) (399)
Foreign currency gain -- 11 -- -- --
Other 692 (4) (7) (5) (3)
-------- -------- -------- -------- --------
579 (134) (128) (369) (315)
-------- -------- -------- -------- --------
Loss before income taxes (52) (489) (1,873) (1,813) (2,794)
Income tax expense (benefit) 41 159 129 (11) 86
-------- -------- -------- -------- --------
Net loss $ (93) (648) (2,002) (1,802) (2,880)
======== ======== ======== ======== ========
Basic loss per share $ (0.01) $ (0.06) $ (0.18) $ (0.16) $ (0.25)
======== ======== ======== ======== ========
Diluted loss per share $ (0.01) $ (0.06) $ (0.18) $ (0.16) $ (0.25)
======== ======== ======== ======== ========
Shares used in computing
per share amounts 11,405 11,419 11,431 11,452 11,481
======== ======== ======== ======== ========
<CAPTION>
REVENUES BY BUSINESS AND GEOGRAPHIC REGION BY QUARTER
QUARTER ENDED ($000'S)
--------------------------------------------------------------------------
(UNAUDITED)
Sept 30, Dec. 31, March 31, June 30, Sept. 30,
1997 1997 1998 1998 1998
-------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
Preclinical $ 6,476 7,355 6,043 7,466 7,394
Clinical 3,972 4,085 3,406 2,624 1,180
Licensing 175 184 224 202 225
------- ------- ------- ------- -------
Total 10,623 11,624 9,673 10,292 8,799
======= ======= ======= ======= =======
International 6,168 7,170 5,952 6,554 5,194
North America 4,280 4,270 3,497 3,536 3,380
Licensing 175 184 224 202 225
------- ------- ------- ------- -------
Total $10,623 11,624 9,673 10,292 8,799
======= ======= ======= ======= =======
</TABLE>
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LIQUIDITY AND CAPITAL REQUIREMENTS
DEFAULT
Based on third quarter 1998 financial results, at September 30,
1998, the Company failed to satisfy certain financial covenants contained in the
loan agreement related to its senior secured term loan and, thus, was in default
under the loan agreement. In addition, the Company anticipates that it will fail
to satisfy those covenants at December 31, 1998. The amount outstanding under
this loan is $4,687,500 at September 30, 1998. As a result of the default, the
entire outstanding amount of the senior secured term loan is classified as
short-term borrowings at September 30, 1998. The lender has not yet accelerated
the term loan or exercised its rights under the loan agreement. In connection
with negotiating the Merger Agreement, the Company has also been in discussions
with the lender.
CASH RESERVES
The Company finances its operations and activities by relying on (i)
cash flows from operating activities, (ii) its cash reserves and (iii) its
available lines of credit. As of September 30, 1998, the Company had cash
reserves (consisting of cash and cash equivalents, short-term investments and
marketable debt securities) of $4,110,000 and restricted cash of $4,688,000. See
"--Default" above. The Company invests its excess cash in a diversified
portfolio of high-grade money market funds, United States Government-backed
securities and commercial paper and corporate obligations. The Company's cash
reserves increased by $1,413,000 during the first nine months of 1998 from the
fourth quarter of 1997 primarily due to the following: (i) the receipt of
$5,000,000 related to the subordinated note issued on March 16, 1998 (see
"--Debt"), which was partially offset by (ii) net cash used in operating
activities of approximately $1,843,000 and (iii) approximately $1,985,000 in
capital expenditures.
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DEBT
The Company has a working line of credit with a Swiss bank. As of
September 30, 1998, the outstanding balance under this line of credit was
approximately $3,396,000 and is fully drawn. This line is secured by the
European clinical operation's trade accounts receivable and a guarantee by the
Company. The Company maintains a cash balance at this Swiss Bank in the amount
of $2,728,000 as of September 30, 1998, which the Company and the Swiss Bank
expect will satisfy the majority of the outstanding amount under the line.
Additionally, the Company has lines of credit and overdraft privileges with
French banks in the aggregate amount of 10.5 million French Francs ($1.9 million
at the exchange rate in effect on September 30, 1998). At September 30, 1998,
there were no short-term borrowings outstanding under these French facilities.
On March 16, 1998, the Company issued, in exchange for $5,000,000 cash,
a subordinated note and a warrant to purchase 2,000,000 shares of Common Stock
at an exercise price of $2.50 per share, to a wholly-owned subsidiary of MDS.
The terms of the subordinated note provide for semi-annual interest payments
with the aggregate principal amount payable on March 16, 2001. This debenture is
subordinate to certain outstanding indebtedness of the Company, including its
existing bank debt and mortgages. In addition, a portion or the entire principal
amount of the note may, at the option of the holder, be satisfied by issuance of
the shares of Common Stock in accordance with the terms of the warrant.
In the third quarter of 1997, the Company entered into a five year $5.0
million senior secured term loan with a large commercial bank, with the
principal payable in quarterly installments beginning September 1998. The
balance outstanding at September 30, 1998 is $4,687,500. Interest is paid
monthly over the life of the loan. This loan is secured by substantially all of
the Company's domestic assets, including the capital stock of its subsidiaries.
At September 30, 1998, the Company was in default under this loan. See "--
Default " above and "-- Capital Requirements" below.
In connection with its U.S. preclinical facility, the Company secured
(i) a $1.5 million mortgage with a bank and (ii) a $1.2 million mortgage from a
Pennsylvania agency, which required cash collateral of $450,000. These two
loans, due in monthly installments through 2009, are secured by mortgages on the
property acquired. As of September 30, 1998 the aggregate outstanding balance
under these mortgages was approximately $2,210,000. The cash collateral of
$450,000 on the mortgage loan with the Pennsylvania agency was classified on the
balance sheet as restricted cash as of December 31, 1997. As a result of
satisfying certain financial covenants, this $450,000 of cash collateral was
released in July 1998. Additionally, the favorable interest rate on the mortgage
with the Pennsylvania agency is subject to change upon review by the agency of
certain future conditions.
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CAPITAL REQUIREMENTS
The ability of the Company to meet ongoing debt service requirements,
to meet cash funding requirements and to otherwise satisfy its obligations to
vendors and lenders from cash solely provided by operations has been adversely
affected by significant losses from clinical operations. In response to such
liquidity constraints, the Company will commence discontinuation of certain of
its clinical operations. See"-- Potential Merger" and "-- Restructuring of
Clinical Operations" above.
The Company anticipates that its capital requirements for the next
six months will include satisfying working capital needs, costs to shut down
certain of its European and United States clinical operations, capital
expenditures for the Preclinical and Transgenic businesses and meeting its
principal and interest requirements under debt arrangements. Cash, cash
equivalents and restricted cash (which was $8,798,000 at September 30, 1998) and
cash provided by operations is expected to fund certain of these cash
requirements including satisfying the outstanding balance of $3,396,000 under a
line of credit with a Swiss bank and any obligation to pledge cash as security
to its senior lender. See "-- Default" above. If the lender does not
accelerate the term loan, the Company believes that it will have sufficient
cash to continue to fund operating activities until December 31, 1998.
However, if the lender accelerates the term loan or exercises its other rights
and remedies under the loan agreement, the Company will not have sufficient
cash to satisfy its obligations to its creditors and fund operating activities.
There can be no assurance that the lender will not accelerate the term loan,
or exercise its rights and remedies under the loan agreement (including
requiring a cash collateral pledge).
As a result of these issues, the Company must execute the Merger
Agreement and consummate the Merger in a timely manner. While the Company has
been exploring various strategic alternatives for some period of time, it now
believes that an outright sale of the Company through a vehicle other than the
proposed Merger is unlikely. After evaluating a number of strategic alternatives
with the assistance of Vector Securities International, Inc., the Company
currently believes that the Merger Agreement offers the most viable solution to
the Company's financial condition. There can be no assurance, however, that the
Merger Agreement will be executed or that the Merger will be consummated. Due to
the Company's limited liquidity, there can be no assurance that the Company will
have sufficient time to consummate the Merger even if the Merger Agreement is
executed. If the Company cannot consummate the Merger or otherwise resolve its
liquidity constraints by December 31, 1998, the Company will likely not have
sufficient liquidity both to operate its business and to satisfy its obligations
to various lenders. In addition, if the lender were to accelerate the term loan,
other of the Company's debt would also be in default. It is the intention of the
Company to pursue alternatives outside of bankruptcy; however, there is no
assurance that alternative strategies will be successful, and it is possible
that the Company could be forced into bankruptcy by its creditors. In these
circumstances, the Company would most likely seek reorganization under chapter
11 of the Bankruptcy Code. Although it would be the intention of the Company to
seek reorganization under chapter 11 of the Bankruptcy Code, it currently
believes that a successful reorganization would likely require a similar
strategic transaction involving a sale of one or more of the Company's
facilities or operations to generate a source of liquidity during any bankruptcy
proceeding.
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EXCHANGE RATE FLUCTUATIONS
Approximately 59% and 58% of the Company's net revenues for the
quarters ended September 30, 1998 and 1997, respectively, and 62% and 64% of the
Company's net revenues for the nine months ended September 30, 1998 and 1997,
respectively, were derived from the Company's operations outside the United
States. The Company's consolidated financial statements are denominated in U.S.
dollars and, accordingly, changes in exchange rates between the applicable
foreign currency and the U.S. dollar will affect the translation of such
subsidiary's financial results into U.S. dollars for purposes of reporting the
Company's consolidated financial results. Translation adjustments are reported
as a separate section of stockholders' equity.
The Company may be subject to foreign currency transaction risks when
the Company's multi-country contracts are denominated in a currency other than
the currency in which the Company incurs the expenses related to such contracts.
For such multi-country contracts, the Company seeks to require its client to
incur the effect of fluctuations in the relative values of the contract currency
and the currency in which the expenses are incurred. To the extent the Company
is unable to require its clients to incur the effects of currency fluctuations,
these fluctuations could have a material effect on the results of operations of
the Company. The Company generally does not hedge its currency translation and
transaction exposure.
Due to its preclinical operations in France, the percentage of the
Company's total revenues recorded in French Francs is significant. For the
quarters ended September 30, 1998 and 1997, the French operations accounted for
approximately 48% and 40%, respectively, of the Company's revenues. For the nine
month periods ended September 30, 1998 and 1997, the French operations accounted
for approximately 44% and 45%, respectively, of the Company's revenues.
Accordingly, changes in the exchange rate between the French Franc and the U.S.
dollar will affect the translation of the French preclinical operation's
revenues and operating results into U.S. dollars for purposes of reporting the
Company's consolidated financial results, and also affect the U.S. dollar
amounts actually received by the Company from the French preclinical operations.
Based on the assumption that the French preclinical operations will continue to
represent a significant portion of the business of the Company, the depreciation
of the U.S. dollar against the French Franc would have a favorable impact on the
Company's revenues and an unfavorable impact on the Company's operating expenses
due to the effect of such currency translation on the French preclinical
operation's operating results; however, the appreciation of the U.S. dollar
against the French Franc would have an unfavorable
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impact on the Company's revenues and a favorable impact on the Company's
operating expenses.
For purposes of the Company's consolidated financial results, the
results of operations of the French preclinical business denominated in French
Francs have been translated from French Francs into U.S. dollars using the
following exchange rates:
<TABLE>
<CAPTION>
French Franc U.S. dollar per
Period per U.S. dollar French Franc
------ --------------- ------------
<S> <C> <C>
1st quarter 1997 5.6038 .1785
2nd quarter 1997 5.7831 .1729
3rd quarter 1997 6.0838 .1644
4th quarter 1997 5.8817 .1700
1st quarter 1998 6.0948 .1641
2nd quarter 1998 6.0157 .1662
3rd quarter 1998 5.8835 .1700
</TABLE>
The rates in the above table represent an average exchange rate calculated using
rates quoted in The Wall Street Journal. As of October 30, 1998 the French Franc
per U.S. dollar rate was 5.548.
ACCUMULATED DEFICIT
Since its inception in 1988 until the formation in 1994 and
subsequent sale of its partnership interest in Nextran in 1995, the Company
expended substantial funds for research and development and capital
expenditures. A significant portion of such expenditures was made to support the
Company's organ transplantation and blood substitute research and development
programs, which programs were transferred to the Nextran partnership.
Historically, these expenditures accounted for a substantial portion of the
Company's accumulated deficit. Also contributing to the accumulated deficit are
the historical costs associated with the prior strategy to develop a worldwide
clinical business.
INFLATION
The Company believes that inflation has not had a material impact
on its results of operations.
YEAR 2000
Information technology systems ("IT Systems") are an integral part
of the services and products the Company provides. Non-IT Systems play a nominal
role in the Company's operations. The Company has been assessing Year 2000
compliance issues from an internal, supplier and customer perspective and has
been actively involved in
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resolving related issues since 1997. The Company is in the process of
undertaking actions to ensure that its IT Systems are Year 2000 compliant and
expects to finish such process by the end of the second quarter of 1999. The
Company has not yet determined whether a testing phase of its IT Systems will be
necessary or, if necessary, when such testing would be undertaken or completed.
Any failure of the Company to adequately correct its IT Systems or any failure
of any supplier or customer on whom the Company is dependent to be Year 2000
compliant could materially adversely affect the Company's ability to conduct
operations and, therefore, could materially adversely affect its financial
condition, results of operations and cash flows. The Company currently estimates
that costs and expenses of assessment and corrective activities will be
approximately $1,000,000, of which approximately $400,000 has been spent to
date. However, the Company's current financial condition may prevent it from
expending sufficient sums to adequately resolve in a timely manner all Year 2000
issues. See "Capital Requirements". Further, the Company is dependent on the
efforts of a limited number of key employees to address Year 2000 compliance
issues, and the loss of one or more of such employees could materially adversely
impact the Company's ability to assess and resolve Year 2000 issues in a timely
manner. There can be no assurance that (i) the Company will have the resources
or ability to resolve in a timely manner the Year 2000 compliance of its IT
Systems and third parties on which it depends, (ii) the Company will be able to
retain the services of the key employees addressing Year 2000 compliance issues,
(iii) the costs related to assessing and resolving Year 2000 issues will not be
material or (iv) the Company's operations, financial condition and results of
operations will not be materially adversely impacted by a failure to achieve any
of the foregoing.
EURO CONVERSION
On January 1, 1999, eleven of the fifteen countries that are
members of the European Union are scheduled to introduce a new currency unit
called the "euro", which will ultimately replace the national currencies of
these eleven countries. The conversion rates between the euro and the
participating countries' currencies will be fixed irrevocably as of January 1,
1999, with the participating countries' national currencies being removed from
circulation between January 1, 1999 and June 30, 2002 and replaced by euro notes
and coinage. During the "transition period" from January 1, 1999 through
December 31, 2001, public and private entities as well as individuals may pay
for goods and services using either checks, drafts or wire transfers denominated
in euro or the participating country's national currency.
Under the regulations governing the transition to the euro, there
is a "no compulsion, no prohibition" rule which states that no one is obligated
to use the euro until the notes and coinage have been introduced on January 1,
2002. In keeping with this rule, by January 1, 1999, the Company expects to be
able to (i) receive euro denominated payments, (ii) invoice in euro as requested
by customers and suppliers and (iii) perform appropriate conversion and rounding
calculations. Full conversion of all affected country operations to the euro is
expected to be completed by the time national currencies are removed from
circulation. The cost of software and business process conversion required to
achieve such abilities is not expected to be material. However,
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<PAGE> 18
there can be no assurance that the Company and its significant customers and
suppliers in the affected countries will be euro compliant by January 1, 1999 or
that any such failure to be euro compliant will not have a material adverse
effect on the Company's results of operations, financial condition or cash
flows.
The Company does not anticipate that the introduction and use of
the euro will materially affect the Company's foreign exchange and hedging
activities or the Company's use of derivative instruments, or will have a
material adverse effect on operating results, financial condition or cash flows.
However, the ultimate effect that the euro will have on competition due to price
transparency, foreign currency risks and relationships and transactions with
third parties cannot yet be determined. The Company continues to monitor and
assess the potential risks imposed by the euro.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued Statement No. 131, Disclosures about
Segments of an Enterprise and Related Information ("SFAS 131"). This Statement
establishes standards for the way that public business enterprises report
information about operating segments in annual and interim financial statements.
It also establishes standards for related disclosures about products and
services, geographic areas and major customers. This Statement shall be
effective for financial statements for fiscal years beginning after December 15,
1997. Financial statement disclosures for prior periods are required to be
restated. This statement, by its nature, will not impact the Company's
consolidated results of operations, financial position or cash flows.
In March 1998, the Accounting Standards Executive Committee
("AcSEC") of the American Institute of Certified Public Accountants issued
Statement of Position 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use ("SOP 98-1"). SOP 98-1 provides guidance
for the accounting treatment of various costs typically incurred during the
development or purchase of computer software for internal use. SOP 98-1 shall be
effective for fiscal periods beginning after December 15, 1998. The impact on
the Company's consolidated results of operations, financial position and cash
flows of the application of SOP 98-1 is currently being evaluated.
In April 1998, The AcSEC issued Statement of Position 98-5,
Reporting on the Costs of Start-Up Activities ("SOP 98-5"). SOP 98-5 provides
guidance on the financial reporting of start-up and organization costs;
requiring such costs be expensed as incurred. SOP 98-5 shall be effective for
fiscal periods beginning after December 15, 1998. Application of SOP 98-5 is not
expected to have a material impact on the Company's consolidated results of
operations, financial position or cash flows.
In June 1998, the FASB issued Statement No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS 133"). SFAS 133 provides a
comprehensive and consistent standard for the recognition and measurement of
derivatives and hedging activities and requires all derivatives to be recorded
on the
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balance sheet at fair value. SFAS 133 is effective for years beginning after
June 15, 1999. Adoption of SFAS 133 is not expected to have a material impact on
the Company's consolidated results of operations, financial position or cash
flows.
FORWARD LOOKING STATEMENTS
The statements contained in "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and elsewhere throughout this
Quarterly Report on Form 10-Q that are not historical facts are "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange of 1934. These forward-looking statements
are subject to certain risks and uncertainties described below, which could
cause actual results to differ materially from those reflected in the
forward-looking statements. These forward- looking statements reflect
management's analysis, judgment, belief or expectation only as of the date
hereof. The Company undertakes no obligation to publicly revise these
forward-looking statements to reflect events or circumstances that arise after
the date hereof or to publicly release the results of any revisions to such
forward-looking statements that may be made to reflect events or circumstances
after the date hereof. In addition to the disclosure contained herein, readers
should carefully review any disclosure of risks and uncertainties contained in
other documents the Company files or has filed from time to time with the
Securities and Exchange Commission pursuant to the Securities Exchange Act of
1934.
In addition to factors discussed above in "-- Year 2000," factors
that could cause actual results to differ materially from those reflected in the
forward looking statements include, without limitation: the execution of a
definitive Merger Agreement, the consummation of the Merger, if the Merger
Agreement is executed, the success in obtaining the necessary regulatory and
stockholder approvals for the Merger, the satisfaction of other closing
conditions (some of which would be beyond the Company's control) and the
subsequent consummation of the Merger; the degree of the Company's success in
obtaining new contracts; the scope and duration of existing drug development
trials; the loss or downsizing of, or delay in, existing drug development
trials; the lengthening of the lead time to convert proposals into contracts and
revenues; the Company's exposure to cost overruns under fixed-price contracts;
the Company's dependence on certain clients, especially its larger clients, and
on the pharmaceutical and biotechnology industries; adverse trends in the
regulatory environment, including health care reform measures; the Company's
dependence on key management personnel; competition and consolidation in the
drug development services industry; liability for negligence or errors and
omissions arising out of drug development trials; foreign exchange rate
fluctuations, the ability to obtain future financings; costs of restructuring
the clinical operations; and the costs associated with dispositions or
integrating future acquired businesses. In addition, the Company's quarterly
operating results will continue to be subject to variation as a result of
factors such as those discussed above in "-- Quarterly Results" as well as the
costs associated with discontinuing clinical businesses as discussed under "--
Restructuring of Clinical Operations".
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3. Item 3 of Part II of the original Form 10-Q is hereby amended and restated
to read in its entirety as follows:
Item 3. Defaults under Senior Securities
--------------------------------
See "-- Default" and "-- Capital Requirements" in Item 2 of Part
I above.
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CHRYSALIS INTERNATIONAL CORPORATION
SIGNATURES
Pursuant to the requirements 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: November 25, 1998 CHRYSALIS INTERNATIONAL
CORPORATION
/s/ Paul J. Schmitt /s/ John G. Cooper
- ---------------------------------- -----------------------------------
Chairman of the Board, President & John G. Cooper
Chief Executive Officer Sr. Vice President, Chief Financial
Officer and Treasurer
(Duly Authorized Officer and Chief
Accounting Officer)
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