-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, T/b4gduhRoj3kQo14QYrd6OgRH3DtEfR+nO+pDU8k7ZC1o3vzW+CZiXgJTzA8c2T NRhL6rA0+zTeEKw8SLD0Zg== 0000950152-98-009287.txt : 19981126 0000950152-98-009287.hdr.sgml : 19981126 ACCESSION NUMBER: 0000950152-98-009287 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981125 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHRYSALIS INTERNATIONAL CORP CENTRAL INDEX KEY: 0000880456 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH [8731] IRS NUMBER: 222877973 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 000-19659 FILM NUMBER: 98759575 BUSINESS ADDRESS: STREET 1: 575 ROUTE 28 CITY: RARITAN STATE: NJ ZIP: 08869 BUSINESS PHONE: 9087227900 MAIL ADDRESS: STREET 1: 575 RT 28 CITY: RARITAN STATE: NJ ZIP: 08869 FORMER COMPANY: FORMER CONFORMED NAME: DNX CORP DATE OF NAME CHANGE: 19930328 10-Q/A 1 CHRYSALIS INTERNATIONAL CORPORATION 10-Q/AMENDED 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 1 2 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: 2 3 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. 3 4 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. 4 5 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 5 6 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. 6 7 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." 7 8 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. 8 9 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. 9 10 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. 10 11
QUARTER ENDED ($000'S EXCEPT PER SHARE DATA) ------------------------------------------------------------------------------- (UNAUDITED) Sept. 30, Dec. 31, March 31, June 30, Sept. 30, 1997 1997 1998 1998 1998 ---------- --------- ---------- --------- ------ 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 ======== ======== ======== ======== ======== 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 -------- -------- -------- ------- -------- 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 ======= ======= ======= ======= =======
11 12 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. 12 13 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. 13 14 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. 14 15 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 15 16 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:
French Franc U.S. dollar per Period per U.S. dollar French Franc ------ --------------- ------------ 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
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 16 17 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, 17 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 18 19 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". 19 20 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. 20 21 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) 21 -----END PRIVACY-ENHANCED MESSAGE-----