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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- --- ACT OF 1934
For the fiscal year ended December 31, 1997
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-22427
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HESKA CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 77-0192527
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[State or other jurisdiction [I.R.S. Employer Identification No.]
of incorporation or organization]
1825 Sharp Point Drive
Fort Collins, Colorado 80525
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[Address of principal executive offices] [Zip Code]
Registrant's telephone number, including area code: (970) 493-7272
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference to Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $158,824,023 as of March 10, 1998, based upon the
closing price on the Nasdaq National Market reported for such date. This
calculation does not reflect a determination that certain persons are affiliates
of the Registrant for any other purpose.
24,790,393 shares of the Registrant's Common Stock, $.0001 par value, were
outstanding at March 10, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10 (as to directors), 11 and 12 of Part III incorporate by reference
information from the Registrant's Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for the Registrant's 1998 Annual Meeting of Stockholders.
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PART I
ITEM 1. BUSINESS.
OVERVIEW
Heska discovers, develops, manufactures and markets companion animal health
products. Heska believes that it is the first company to undertake a concerted
effort to use biotechnology to create a broad range of diagnostic, therapeutic
and vaccine products for companion animals, primarily dogs, cats and horses.
The Company currently has 15 products on the market and over 25 products in
research and development. The Company operates two full scale United States
Department of Agriculture ("USDA") and United States Food and Drug
Administration ("FDA") licensed facilities which manufacture products for Heska
and other companies. Heska has corporate partnerships with Novartis AG
("Novartis"), Bayer AG ("Bayer") and Eisai Co., Ltd. ("Eisai") and plans to
expand its products and services through complementary acquisitions, licenses
and collaborations. In 1997, Heska launched 13 new products, acquired three
operating companies and had total revenues of $20.9 million.
THE COMPANION ANIMAL HEALTH MARKET
Companion animals improve the quality of human life by providing
companionship, affection and acceptance. In addition, numerous studies indicate
that relationships with companion animals have demonstrable therapeutic benefits
for blood pressure, anxiety and loneliness, especially for elderly or depressed
people.
According to industry estimates, the worldwide market for companion animal
health products and diagnostic services exceeds $3.0 billion, of which
approximately $1.5 billion is in the United States. There are approximately 67
million cats, 57 million dogs and seven million horses in the United States, and
more than another 100 million cats, dogs and horses in the rest of the developed
world. The Company believes that due to better nutrition and care, the average
life expectancy of dogs and cats in the United States has been increasing. As
with humans, as companion animals age, their medical needs increase.
There are approximately 30,000 veterinarians in the United States whose
practices are devoted principally to small animal medicine. The practice of
veterinary medicine in the United States is significantly different in several
respects from the practice of human medicine. In addition to providing services
and prescribing drugs, veterinarians act as the pharmacists of companion animal
medicine by selling the products which they use or prescribe in their practice,
and a substantial portion of their practice income is attributable to the sale
of these products. Another distinction from human medicine is that the vast
majority of companion animal veterinarians practice as "general practice"
veterinarians without significant specialization. Access to veterinarians
specializing in diseases common to companion animals can be difficult and
expensive. For example, of the companion animal veterinarians in the United
States, approximately 100 are board certified veterinary dermatologists and
approximately 50 are board certified veterinary dentists.
In the United States, the market for companion animal health products is
growing rapidly as a result in part of the introduction of novel products.
However, the development of biotechnology products for the companion animal
health market has lagged behind development of products for the larger human
health market. To date, it appears that there have only been modest, isolated
efforts to use biotechnology to develop products specifically for companion
animal health applications. For example, at this time, the Company believes
that there are only three recombinant vaccines on the market for companion
animal health and only a handful of diagnostic products that use recombinant
proteins, including Heska's feline heartworm and allergy diagnostic products.
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HESKA'S STRATEGY
Heska's goal is to become a leader in companion animal health. The
Company's strategy to achieve this goal includes the following elements:
. Develop a broad line of innovative products for comprehensive case
management. Heska's strategy is to develop and offer a broad line of
products for comprehensive management of companion animal diseases, such as
allergy, heartworm infection and flea-associated conditions. Heska
believes that it is the only company developing products and services for
each step of veterinary care, from diagnosis to treatment and prevention,
across a broad range of animal diseases. The Company currently has 15
products on the market and over 25 products in research and development.
The Company's strategy is to develop its business so that it is not
substantially dependent on one product or technology.
. Commercialize products from its large, sophisticated research effort.
Heska scientists have developed a large body of knowledge, from the
organism to the molecular genetic level, about the physiology of parasites,
such as fleas and heartworms, and the basic immunology of dogs and cats.
The Company believes that this body of knowledge is unmatched in the
industry. Additionally, Heska benefits from an extensive patent portfolio,
which, as of January 1998, consisted of 13 owned or co-owned issued patents
and 80 pending patent applications, including 11 with allowed claims, in
the United States. The Company's strategy is to use this knowledge and the
skills of its researchers to create innovative, proprietary products.
Heska's current employees hold 33 D.V.M.s and 51 Ph.D.s. Most of these
employees have been affiliated with prestigious academic research
institutions and/or leading biotechnology or animal health companies.
. Promote products through strong relationships with veterinarians. Heska
plans to become the companion animal health care company of choice for
veterinarians, who are the primary distribution channel for companion
animal diagnostic, therapeutic and vaccine products. Heska intends to
accomplish this goal by providing novel products that advance companion
animal medicine, by selling its products exclusively to veterinarians and
by supporting the general practitioner through high quality diagnostic
products and through access to a staff of medical specialists. The Company
believes that support of veterinarians is critical to enhancing Heska brand
loyalty.
. Pursue complementary acquisitions. The Company intends to build its
business in part through the acquisition of complementary technologies,
products and businesses. In 1997, Heska acquired one of the largest
veterinary diagnostic laboratories in the United Kingdom, a second licensed
manufacturing facility and an allergy diagnostic company with sales
primarily in Europe and Japan. The Company believes that significant
acquisition opportunities exist in the companion animal health industry and
plans to continue to actively pursue such opportunities.
. Leverage resources through strong strategic relationships. Heska has
entered into agreements with three major pharmaceutical companies,
Novartis, Bayer and Eisai, to provide funding for its research and
development programs. These partners have rights to market certain
resulting Heska products. Heska believes that the size and experience of
these partners will enable the Company to penetrate markets more quickly
and extensively. Additionally, to broaden its portfolio of products and
technologies, the Company is aggressively pursuing licenses to promising
technologies from leading biotechnology companies and research
institutions.
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PRODUCTS AND PROGRAMS
The Company has introduced 15 products to date and is developing a broad
line of diagnostic, therapeutic and vaccine products targeting a wide range of
companion animal diseases. The following table summarizes Heska's currently
available products and certain of its products in research and development:
<TABLE>
<CAPTION>
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PRODUCT STAGE OF DEVELOPMENT(1) MARKETING
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<S> <C> <C>
ALLERGY & DERMATOLOGY
Canine Allergy Diagnostic Second generation launched in 1997 Heska
Feline Allergy Diagnostic Launched in 1997 Heska
Equine Allergy Diagnostic Research Heska
Canine Allergy Immunotherapeutic Currently available Heska
Feline Allergy Immunotherapeutic Expected in 1998 Heska
Ancillary Dermatology Products Launched in 1997 Heska
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FLEA BITE ALLERGY
Canine Flea Bite Allergy Diagnostic
Veterinary Diagnostic Laboratory Launched in 1997 Heska
Point-of-Care Diagnostic Expected in 1999 Heska
Feline Flea Bite Allergy Diagnostic
Veterinary Diagnostic Laboratory Launched in 1997 Heska
Point-of-Care Diagnostic Expected in 1999 Heska
Flea Bite Allergy Immunotherapeutic Research Heska
Canine Flea Bite Allergy Vaccine Research Heska
Feline Flea Bite Allergy Vaccine Research Heska
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FLEA CONTROL
Flea Control Vaccines
Canine Flea Control Vaccine Research Heska/Novartis/Eisai
Feline Flea Control Vaccine Research Heska/Novartis/Eisai
Environmental Flea Control Research Heska
Pharmaceutical Flea Control Research Heska
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</TABLE>
(1) See "--Government Regulation" for a description of the marketing and
approval process for the company's products.
(2) See "--Collaborative Agreements" for a description of the marketing
rights for these products.
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<TABLE>
<CAPTION>
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PRODUCT STAGE OF DEVELOPMENT(1) MARKETING
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<S> <C> <C>
HEARTWORM INFECTION
Feline Heartworm Diagnostic
Veterinary Diagnostic Laboratory Currently available Heska
Point-of-Care Diagnostic Launched in Italy in 1997; expected in Heska
U.S. in 1998
Canine Heartworm Diagnostic
Veterinary Diagnostic Laboratory Launched in 1997 Heska
Point-of-Care Diagnostic Expected in 1998 Heska
Heartworm Vaccines
Canine Heartworm Vaccine Research Bayer/Eisai
Feline Heartworm Vaccine Research Heska/Novartis/Eisai
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DENTISTRY
Canine Periodontal Disease therapeutic Launched in 1997 Heska
Canine Dental Hygiene Kits Launched in 1997 Heska
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OTHER INFECTIOUS DISEASES
Feline Viral Vaccines
Bivalent Launched in 1997; second generation in Heska
research
Trivalent Launched in 1997; second generation in Heska
research
Feline Immunodeficiency Virus Vaccine Research Heska
Feline Leukemia Virus Vaccine Research Heska
Bartonellosis (Cat Scratch Fever) Expected in 1999 Heska
Vaccine
Feline toxoplasmosis Vaccine Research Heska/Bayer/Eisai
Canine Leishmaniosis Diagnostic
Veterinary Diagnostic Laboratory Launched in 1997 Heska
Point-of-Care Diagnostic Expected in Europe in 1998 Heska
Canine Leishmaniosis Vaccine Research Heska
Canine Viral Vaccines Research Heska
Equine Influenza Vaccine Expected in 1999 Heska
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METABOLIC DISEASES
Canine Thyroid Supplement Launched in 1997 Heska
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ARTHRITIS Research Heska
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ONCOLOGY Research Heska
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</TABLE>
(1) See "--Government Regulation" for a description of the marketing and
approval process for the company's products.
(2) See "--Collaborative Agreements" for a description of the marketing
rights for these products.
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ALLERGY AND DERMATOLOGY
Overview. Allergy is common in companion animals and affects
approximately 10% to 15% of dogs. Clinical symptoms of allergy are variable,
but are often manifested as persistent and serious skin disease in dogs and
cats. Clinical management of allergic disease is problematic as there are a
large number of allergens that may give rise to these conditions. Although skin
testing is often regarded as the most accurate diagnostic procedure, such tests
are painful, subjective and inconvenient. The Company believes that many of the
currently available in vitro diagnostic tests are of questionable accuracy. The
effectiveness of the immunotherapy that is prescribed to treat allergic disease
is inherently limited by inaccuracies in the diagnostic process.
The Company's principal strategy with respect to allergy is to improve the
quality of immunotherapy in part by improving the quality of diagnosis. Heska
has developed more accurate in vitro technology to detect IgE, the antibody
involved in most allergic reactions. This technology permits the design of
tests that, in contrast to other in vitro tests, more specifically identify the
animal's allergic responses to particular allergens.
As part of its plan to support the veterinarian, the Company has adopted a
complete disease management approach to allergy. The Company offers allergy
testing services, immunotherapy products, palliative products and case
management consultation.
Diagnostics. Heska currently markets in vitro canine allergy diagnostic
tests for a wide range of allergens. The allergy testing is conducted in
Heska's veterinary diagnostic laboratories using an enzyme-linked immunoassay
("ELISA") to screen the serum of dogs against a panel of known allergens. A
typical test panel includes 48 different allergens, consisting primarily of
various pollens, grasses, molds and insects.
The binding of IgE antibodies to a cellular receptor is an essential
prerequisite to most allergic reactions. Heska has produced a molecular clone
of the cellular receptor for the IgE antibody. The Company has used this
molecularly cloned receptor in a family of unique diagnostic assays to detect
the presence and quantity of allergen-specific IgE in an animal's blood. The
Company believes that this technology provides the most accurate in vitro
diagnosis of allergy presently available, which in turn enables improved
immunotherapy. During 1997, Heska adapted this technology to a broad range of
its canine and feline allergy tests.
Immunotherapeutics. Veterinarians who use Heska's diagnostic laboratories
for in vitro allergy testing services often purchase immunotherapy treatment
sets for those animals with positive test results. A large percentage of those
tests performed by the Company are positive, and veterinarians order Heska's
immunotherapy treatment sets for a majority of these animals. These
prescription treatment sets are formulated specifically for each allergic animal
and contain only the allergens to which the animal has demonstrated significant
levels of IgE antibodies. The prescription formulations are administered in a
series of injections, with doses increasing over several months, to ameliorate
the allergic condition of the animal. Immunotherapy is generally continued for
an extended time.
Ancillary Dermatology Products. Heska introduced in 1997 a line of
supportive care products consisting of specially formulated allergy shampoos and
rinses to address skin problems associated with allergic disease. These
products are dispensed by veterinarians for use at home, along with client
information brochures explaining allergy and its treatment. The Company has a
full-time board certified veterinary dermatologist on its staff whose primary
job is to provide free case management consultations to any Heska customer.
There are approximately 100 board certified veterinary dermatologists in the
United States, and the Company believes that free, on-demand dermatology
consultations are of tremendous assistance to the veterinarian.
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FLEA BITE ALLERGY
Overview. Flea bite allergy is the most common skin disease afflicting
dogs and cats throughout the world. It is estimated that flea-related problems
account for more than 50% of skin conditions observed by veterinarians in flea
endemic areas. Treatments currently available for flea bite allergy are
limited. For example, steroids may provide temporary symptomatic relief, and
control of fleas on the animal and in its environment is also helpful. However,
prolonged use of steroids may have harmful side effects, and sustained complete
control of flea populations is extremely difficult. To address these issues,
the Company has developed technology for the accurate diagnosis of flea bite
allergy and is researching products to prevent the development of flea bite
allergy in susceptible animals and to provide efficacious immunotherapy for
animals that have already developed an allergy to flea bites.
Heska scientists have found that flea salivary proteins are principally
responsible for the allergic reactions to flea bites. The Company has developed
proprietary methods for collecting pure saliva from feeding fleas. From this
pure saliva, flea salivary allergens were discovered and characterized by Heska
biochemists, and the Company's molecular biologists have cloned many of the
genes that encode these unique allergens. Certain of these recombinant
molecules have been shown to cause reactions in flea bite allergic dogs and
cats.
Diagnostics. Until recently, diagnosis of flea bite allergy was generally
based on the clinical impression of the veterinarian and a positive response to
effective flea control. Intradermal skin testing, performed by injecting small
amounts of an extract of whole fleas into the skin, is used by some veterinary
dermatologists. A characteristic reaction in the skin, occurring within a few
minutes following injection of the extract, is suggestive of allergy to fleas.
However, testing with an extract of whole fleas is of limited value in
diagnosing flea bite allergy, as such extracts contain only minute amounts of
flea saliva in addition to other allergens known not to be involved in flea bite
allergy that may cause the observed reaction.
Using its flea salivary allergens and its novel receptor-based assay for
detection of IgE antibodies in the serum of allergic animals, the Company
developed a reliable in vitro ELISA-based test for flea bite allergy in dogs and
cats. Heska launched these products in 1997 in its veterinary diagnostic
laboratories. The Company is also developing point-of-care diagnostic products
for both dogs and cats to assist the veterinarian in making a prompt flea bite
allergy diagnosis in the veterinary clinic and expects this product to be
available in 1999.
Immunotherapeutics. The Company is using its extensive knowledge of flea
biology, its proprietary flea salivary allergens and its broad understanding of
canine and feline immunology to develop novel flea bite allergy
immunotherapeutics. Such treatments are intended, through repeated exposure to
key, proprietary allergens, to reduce or eliminate the symptoms of allergy in
dogs and cats who have been definitively diagnosed with flea bite allergy.
Vaccines. Heska is also seeking to develop novel vaccines based on
proprietary recombinant allergens to prevent flea bite allergy from occurring in
cats and dogs that are not yet allergic to flea bites. Heska scientists believe
that if the vaccine is successful in producing a non-allergic immune response,
this immune response will aid in the prevention of an allergic immune response
upon later exposure to flea antigens.
FLEA CONTROL
Overview. The common flea which infests dogs and cats, Ctenocephalides
felis, is prevalent worldwide wherever warm ambient temperatures and adequate
humidity exist. This highly successful parasite produces uncomfortable allergic
responses, transmits other diseases, causes anemia and is a nuisance to pets and
their owners. The Company estimates that flea control products for dogs and
cats represent a worldwide market of approximately $1 billion, of which the
Company estimates approximately $660 million is in the United States.
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A number of proprietary and non-proprietary products are currently marketed
for flea control. Certain of the proprietary products introduced in the last
few years have been particularly successful. For example, the systemic flea
control products recently introduced by Novartis and Bayer, "Program" and
"Advantage," each sold $100 million or more in the United States in the year of
their introduction. No single product, however, can be considered to be
completely safe and effective in flea control at all flea life cycle stages. In
addition, certain topical control chemicals, such as those frequently included
in sprays and collars, can be toxic and present safety concerns for animals and
humans. The use of certain flea control chemicals may also, over time, result
in fleas that are resistant to those products.
Vaccines. Heska's goal is to develop vaccines that will produce an immune
response in the dog or cat that will kill fleas and reduce their reproduction.
For a number of reasons, including the complexity of parasites and their
adaptations for life in or on host animals, the development of vaccines against
parasites is generally more difficult than the development of vaccines against
viral or bacterial infections. Heska has devoted substantial resources to basic
research in flea physiology in its efforts to design products that will safely
and effectively control fleas. A team of Heska scientists, with expertise in
flea biology, biochemistry, molecular biology and immunology, is using the
results of this research to undertake the development of vaccines for the
control of fleas. To facilitate this work, Heska has created a substantial flea
insectary at its Fort Collins facility producing more than 25 million fleas
every year. The Company has the capacity to microscopically dissect 10,000
fleas per week. Genomic libraries and numerous tissue-specific cDNA libraries
have been created to discover the relevant product targets. Heska researchers
also study the molecular physiology of fleas, focusing on molecular targets from
virtually every flea life-stage. As candidate molecules are purified and
molecularly cloned, protein and nucleic acid sequence data provide the basis for
composition of matter patent applications. Experimental studies with the first
vaccine candidates were initiated in 1996, but commercial vaccines are not
anticipated for the next several years.
Environmental Control. As an example of Heska's ability to capitalize on
its understanding of flea biology, the Company has also entered into a
collaboration to develop a safe, biologically-based flea control product which
can be applied around the home or kennel to control fleas. The product would be
applied in areas in the home where flea larvae tend to dwell and is intended to
kill fleas at several life stages without the use of harmful chemicals. Product
formulations are presently being created and evaluated.
Pharmaceutical Control. The Company's research of flea molecular
physiology has led to the identification of molecular targets for small molecule
pharmaceuticals. Heska has created and is developing additional in vitro tests
amenable to high throughput chemical screening. These in vitro tests and
additional in vivo screens are expected to facilitate rapid analysis of early
stage product candidates and subsequent product development. The Company
intends to use collaborative arrangements to further develop these
pharmaceutical products.
HEARTWORM INFECTION
Overview. Heartworm infections of dogs and cats are caused by the
parasite Dirofilaria immitis. This parasitic worm is transmitted in larval form
to dogs and cats through the bite of an infected mosquito. Larvae develop into
adult worms which live in the pulmonary arteries and heart of the host, where
they can cause serious cardiovascular, pulmonary, liver and kidney disease. The
adult worms produce offspring called microfilariae, which are ingested by blood-
feeding mosquitoes. In the mosquito, the worms develop into the infective
larval stage and in a subsequent mosquito bite are transmitted to the dog or
cat.
Heartworm infection is common throughout the world, particularly in warm
and humid climates. Dogs are especially susceptible to heartworm infection and
treatment is difficult, expensive and requires the use of toxic compounds with
serious adverse effects for the animal. Chemoprophylactic products to prevent
heartworm infections in dogs are generally available and widely prescribed, but
require monthly or daily administration during
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the heartworm transmission season. As a result, compliance and convenience
issues arise. The Company estimates that the worldwide market for canine
heartworm diagnostic and chemoprophylactic products is more than $270 million
per year, of which approximately $240 million per year is spent in the United
States.
Heartworm infections of cats represent a growing area of concern for
veterinary practitioners. Although cats are somewhat less susceptible to
heartworm infection than are dogs, infected cats may experience serious disease,
even death, from only a single adult worm. Diagnosis of these infections is
very difficult, as there are generally too few adult worms present to allow for
reliable heartworm antigen detection in the blood, as is done for dogs. A
chemoprophylactic product to prevent heartworm infections of cats, similar to
the products available for dogs, was introduced by Merial Ltd. in January 1997.
The label for this product recommends that cats be tested for active infection
prior to administration of its product.
Diagnostics. Heska's heartworm vaccine research effort has resulted in
the characterization of many unique heartworm antigens, certain of which may be
useful for the development of improved diagnostic tests. In January 1997, Heska
introduced a new test in a diagnostic laboratory format for feline heartworm
infections of cats which allows veterinarians for the first time to accurately
establish the prevalence of heartworm exposure in cats in their practices. This
test is highly accurate and identifies antibodies in cat serum that react with a
recombinant heartworm antigen. In 1997, the Company launched a rapid point-of-
care test in Italy for feline heartworm infection using this same technology in
the clinic. Heska expects to launch this product in the United States in 1998.
Heska has also developed a diagnostic test for heartworm infection in dogs.
This test uses monoclonal antibodies reactive with heartworm antigens to detect
the presence of these antigens in the blood of the infected dog. The test is
presently offered through Heska's veterinary diagnostic laboratory. A point-of-
care format for dogs is being developed and is expected to be available in 1998.
Vaccines. In order to avoid the need for repeated administration of
chemoprophylactic drugs and the resulting compliance and convenience problems,
Heska's goal is to develop vaccines for annual administration that would prevent
cardiopulmonary infection in dogs and cats caused by heartworms. The Company
has identified many candidate vaccine antigens and the genes encoding them have
been cloned. Heska is using these proprietary molecules in vaccination studies
of dogs and cats, including trials which involve delivering vaccine candidates
using nucleic acids and viral vectors. Each vaccination trial requires
approximately one year to complete. Accordingly, commercialization of vaccines
for heartworm infections of dogs and cats is not anticipated for several years.
DENTISTRY
Overview. Dentistry for dogs and cats is one of the fastest growing
markets in companion animal health. Within dentistry, the major problems are
general dental hygiene and periodontal disease. It is estimated that more than
80% of all dogs over three years old exhibit symptoms of periodontal disease,
which often manifests as bad breath. Left untreated, periodontal disease can
cause loss of teeth and systemic bacterial infection. The most prevalent
treatment is the cleaning and scaling of the animal's teeth, which requires that
the animal be anesthetized. Although periodic cleaning and scaling is
recommended for all dogs, this procedure alone does not adequately address the
underlying infection in dogs with periodontal disease. Systemic antibiotics to
be administered by the pet owner at home are widely prescribed but present
convenience and compliance issues. Heska's complete disease management approach
to these medical issues is to offer a proprietary periodontal disease
therapeutic, a group of dental hygiene products and case management services
from a board-certified veterinary dental specialist.
Canine Periodontal Disease Therapeutic. In November 1997, Heska received
FDA clearance to market and launched its periodontal disease therapeutic, an
innovative product for the treatment of periodontal disease in dogs. The
product consists of a solution containing the antibiotic doxycycline that is
injected into the tooth pocket. The injected material forms a biodegradable gel
that releases the antibiotic gradually over time, eliminating the need for
repeated antibiotic administration by the pet owner. Heska's goal is to have
this product administered by
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veterinarians on a regular basis for dogs with periodontal disease concurrently
with the regular cleaning and scaling of the animal's teeth.
Ancillary Dental Products. Regular dental hygiene has been proven to be
of value in the prevention of periodontal disease in companion animals. As part
of its comprehensive disease management approach, Heska markets canine dental
care kits, consisting of a toothbrush, toothpaste and rinse, for dental hygiene
following the use of its proprietary periodontal disease therapeutic. The
Company commenced its marketing of these dental hygiene kits concurrently with
the launch of its periodontal therapeutic. The Company has a full-time board
certified veterinary dental specialist on its staff, one of fewer than 50 board
certified veterinary dental specialists in the United States, who is assisting
in the introduction of the periodontal therapeutic and who provides free case
management consultations to any Heska customer.
OTHER INFECTIOUS DISEASES
Feline Viral Vaccines. Heska introduced in 1997 a three-way modified live
vaccine for the three most common viral diseases of cats, namely calicivirus,
rhinotracheitis virus and panleukopenia virus. Heska also introduced in 1997 a
two-way modified live vaccine for calcivirus and rhinotracheitis virus. These
vaccines are administered without needle injection by dropping the liquid
preparation into the eyes and nostrils of cats. While there is one competitive
non-injectable two-way vaccine, all other competitive products are injectable
formulations. The use of injectable vaccines in cats has become controversial
due to the frequency of side effects associated with injection of certain
vaccines. The most serious of these side effects are injection site sarcomas,
tumors which, if untreated, are nearly always fatal. The Company's vaccines
avoid injection site side effects and are believed by the Company to be very
efficacious. The Company is also researching second generation vaccines using
recombinant technology.
Feline Immunodeficiency Virus Vaccine. Feline Immunodeficiency Virus
("FIV") produces a viral disease characterized by immunodeficiency which
ultimately results in the death of the cat. Treatment options are quite
limited, and at this time there are no vaccines available to prevent the
disease, although several of the animal health companies with a feline vaccine
line are believed to be attempting to develop one. Heska is developing a FIV
vaccine, and experimental trials of the Company's vaccine candidates are
expected to be undertaken in 1998.
Feline Leukemia Virus Vaccine. Feline Leukemia Virus ("FeLV") is a viral
disease of cats that is characterized by immunodeficiency and ultimately results
in death. As with FIV, treatment options are quite limited. However, there are
several vaccines presently offered for the prevention of FeLV. There is some
controversy as to the relative efficacy of these vaccines. Heska is developing
a vaccine for FeLV, and experimental trials of the Company's vaccine candidates
are in progress.
Bartonellosis (Cat Scratch Fever) Vaccine. Cat Scratch Fever, caused by
the bacterium Bartonella henselae, is transmitted from cats to humans by a cat's
scratch and perhaps by other means. The human disease is characterized by
malaise, fever and swollen lymph nodes, sometimes lasting several weeks and
sometimes requiring hospitalization. The Company believes that there are over
22,000 cases of Cat Scratch Fever in humans annually, of which 2,000 require
hospitalization. Immunocompromised humans may develop very severe disease
following infection, and this organism is a cause of a significant number of
opportunistic infections in HIV-positive individuals. Therefore, doctors
treating at-risk human populations may recommend that cats be removed from the
household.
The Company is working with scientists at the United States Centers for
Disease Control and Prevention in Atlanta to develop a vaccine for cats. The
vaccine is intended to prevent cats from harboring the bacteria in their blood
with the goal of limiting transmission of the bacteria from cats to humans.
Certain vaccine formulations prepared at Heska have successfully protected cats
from infection. The vaccine is currently being tested in cats
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for safety and efficacy and, assuming success, the Company expects to launch
this vaccine in the United States in 1999.
Feline Toxoplasmosis Vaccine. Toxoplasmosis is caused by a protozoan
parasite, Toxoplasma gondii, that infects cats and other mammals including
humans, pigs and sheep. This disease can be transmitted to humans through
contact with the oocysts (eggs) of the parasite, which are passed exclusively in
the feces of infected cats. In addition, consumption of contaminated undercooked
lamb and pork is a common means of transmission to humans. Toxoplasma
infections are generally not a serious concern for cats, as healthy cats
generally tolerate the infection without obvious disease. However, infections
of other animals, including humans, may have serious consequences. This is
particularly true for immunocompromised individuals, such as HIV-infected
persons, and for unborn fetuses. Such infections may be life threatening in the
former case and lead to birth defects or miscarriage in the latter. Because of
the risk of transmission of this disease from cat feces, doctors sometimes
advise immunocompromised patients and women who are or may become pregnant to
avoid or give away their cats. For this reason, Heska believes that an
appropriate vaccine may encourage such individuals to keep their family pets and
is developing a recombinant vaccine intended to protect cats from shedding
Toxoplasma oocysts. The Company believes that such a vaccine, if widely used,
could help to reduce the transmission of disease to humans and other animals.
The Company has identified and cloned the genes encoding over 80 vaccine
candidate antigens from internally developed gene libraries. Testing of these
antigens for vaccine efficacy will be undertaken in 1998.
Canine Leishmaniosis Diagnostic and Vaccine. Visceral leishmaniosis is a
serious disease of dogs and humans caused by the parasite Leishmania. These
protozoan parasites are transmitted to humans and dogs through the bite of
sandflies. The disease causes profound suffering and, if left untreated,
infected dogs often die. While this disease is generally not a problem in the
United States, it is widespread in Mediterranean and Middle Eastern countries
and in South America. Dogs serve as the primary reservoir of the parasites for
transmission to other dogs and to humans. Previously, reliable diagnosis of
canine visceral Leishmania infections was based on clinical symptoms, the
finding of parasitized cells in lymph node aspirates and the use of a
laboratory-based microscopy assay to detect antibodies in the serum of dogs
reactive with Leishmania antigens. At present there are no vaccines that will
prevent Leishmania infection of dogs. The Company believes that significant
markets exist for both a convenient and reliable diagnostic and an effective
vaccine. These products would improve the quality of life of dogs living in
endemic areas and may reduce the risk of disease transmission to humans.
Using a proprietary molecule developed by Corixa Corporation, the Company
has developed a sensitive diagnostic laboratory immunoassay for diagnosis of
canine Leishmania infection and is developing a point-of-care device for rapid
diagnosis. The reference laboratory test was introduced in the United States
and Italy in 1997, with a point-of-care test and introduction in other European
countries expected to follow in 1998. These tests provide improved accuracy and
are much faster and easier to perform than the currently available laboratory
test.
Leishmaniosis vaccine trials are being conducted by the Company. Because
little is yet known of the natural progression of disease in Leishmania-infected
dogs, it is anticipated that this research effort, and subsequent vaccine
trials, will not be completed for several years.
Canine Viral Vaccines. Heska scientists are researching a next generation
line of vaccines which are intended to protect dogs from their most common viral
diseases. This vaccine line will focus on four principal canine viral diseases:
parvovirus, distemper virus, parainfluenza virus and adenovirus. The Company
intends to develop a vaccine to protect dogs from all four viruses. The Company
does not expect these next generation vaccines to be commercially available for
several years.
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Equine Influenza Vaccine. Equine influenza is a common viral disease of
horses and is similar to human influenza. Horses have diminished performance
and quality of life for an extended period following infection. Currently
available vaccines for equine influenza are of limited efficacy and the duration
of immunity for existing vaccines is measured in weeks or months. Heska is
developing a unique vaccine for equine influenza and believes its vaccine
candidates will have improved efficacy and duration of immunity. The vaccine is
currently being tested in horses for safety and efficacy and, assuming success,
the Company expects to launch this vaccine in the United States in 1999.
METABOLIC DISEASES
Canine Thyroid Supplement. Canine hypothyroidism is a serious disease
that is usually caused by structural and/or functional abnormalities of the
thyroid gland. It is estimated that three to four percent of all dogs require
thyroid hormone replacement therapy. Common clinical signs include dry, coarse,
thin hair, possibly with patches of hair loss and pigment changes. The disease
can affect multiple organ systems and cause recurrent infections. In 1997,
Heska launched a thyroid supplement for dogs, which it believes is the first and
only vitamin-enriched, chewable tablet for the treatment of hypothyroidism in
dogs. These chewable tablets, which are administered daily for the life of the
dog, provide levothyroxine sodium, a replacement therapy for the hormone
normally produced by the body.
ARTHRITIS
Osteoarthritis is a common disease affecting at least 20% of adult dogs.
Mildly affected animals may suffer only stiffness, soreness, lethargy or reduced
activity, while dogs with more severe disease may be unable to exercise or even
to rise without assistance. Treatment options include temporary palliative
relief of clinical signs by using pain relievers such as an oral non-steroidal
anti-inflammatory drug. These palliative drugs provide temporary relief of pain
but do not prevent the affected joints from suffering further erosion of
cartilage and destruction of bone.
Heska has acquired the rights to develop certain of CollaGenex
Pharmaceuticals' proprietary matrix metalloproteinase inhibitors for companion
animal health applications. Heska believes these compounds may be useful for
the prevention and treatment of tissue destruction and disease progression in a
variety of inflammatory and degenerative diseases. The Company is focusing its
development efforts in the prevention of osteoarthritis progression.
ONCOLOGY
With improved diet and medical care, dogs and cats are living longer lives
and, accordingly, developing more age-associated diseases such as cancer. In
fact, cancer is the leading cause of disease-associated death in dogs and cats.
However, most treatments are less than optimal and employ "off label"
therapeutic products developed for use in humans. The Company believes that it
is critical that a cancer therapeutic product not substantially decrease the
quality of life of the treated dog or cat. Accordingly, Heska is pursuing a
number of product opportunities focusing primarily on quality of life during the
course of cancer therapy. Numerous approaches are being taken, including
pursuing licensing opportunities arising from human oncology research and
collaborating with outside scientists on unique immunization techniques for
companion animal cancers. The Company does not expect to have commercial
products in this area for several years.
VETERINARY DIAGNOSTIC LABORATORIES
In 1996, Heska established a veterinary diagnostic laboratory at its Fort
Collins facility. The diagnostic laboratory currently offers the Company's
allergy diagnostics, canine and feline heartworm diagnostics and flea
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bite allergy assays, in addition to other diagnostic and pathology services.
The Fort Collins veterinary diagnostic laboratory is currently staffed by four
diplomates of the American College of Veterinary Pathologists, medical
technologists experienced in animal disease, and several additional technical
staff.
Heska intends to continue to use its Fort Collins diagnostic laboratory
both as a stand-alone service center and as an adjunct to its product
development efforts. Many of the assays which the Company will develop in a
point-of-care format will initially be validated and made available in the
diagnostic laboratory and will remain available in that format after the
introduction of the analogous point-of-care test.
In addition to the United States veterinary diagnostic laboratory, the
Company provides to veterinarians in the United Kingdom a full range of
diagnostic and pathology services, including the proprietary diagnostic
laboratory tests marketed by the Company through Bloxham Laboratories Limited, a
veterinary diagnostic laboratory in the United Kingdom ("Bloxham"). Bloxham,
one of the largest veterinary diagnostic laboratories in the United Kingdom, was
acquired by Heska in 1997.
OTHER PRODUCTS
Food Animal Products. Diamond Animal Health, Inc., a wholly owned
subsidiary of the Company ("Diamond"), is completing the research, development
and testing of a new line of bovine vaccines, which are expected to be
introduced in 1998. Diamond has entered into a strategic collaboration with a
major pharmaceutical company pursuant to which the partner is providing funding
for certain of this bovine vaccine research and development work in exchange for
non-exclusive rights to use the antigens that Diamond develops.
Heska has also developed a unique diagnostic to detect Trichinella
spiralis, a parasite that is transmitted to humans and other animals in
undercooked meat. Infected pork is implicated in most outbreaks of human
trichinosis. Heska has identified what it believes to be the most important
antigen for the diagnosis of Trichinella infection in pigs and other hosts.
This carbohydrate antigen has been synthesized, can be produced in large
quantities and has been shown to be a superior reagent for the serological
diagnosis of Trichinella infections of swine. The Company expects to license
rights to this diagnostic test to a third party.
Potential Human Health Applications. Heska's extensive research in the
molecular and cellular biology of parasites has yielded potential human
applications. Various biotechnology companies are pursuing pharmaceutical
compounds derived from various microscopic organisms, higher invertebrates such
as snails and even amphibians. The Company's research with parasites has
similarly yielded molecules that may also have interesting human pharmaceutical
applications. In addition, although to date the Company's novel work with the
cellular receptor for IgE has been directed toward improving the diagnosis of
allergy in companion animals, the Company is evaluating this technology for the
diagnosis of human allergic disease. After it has completed its initial proof-
of-concept work as to these technologies, Heska intends to explore corporate
partnerships with appropriate human health care companies for the further
development of the human applications while retaining the animal health
applications. With these approaches, Heska hopes to maximize the benefit of the
technologies discovered and developed at Heska, including extending them into
the human health care market where feasible, without distracting the Company
from its companion animal health focus.
PRODUCT CREATION
Heska is committed to creating innovative products to address significant
unmet health needs of companion animals. The Company creates products both
through internal research and development and through external collaborations.
Internal research is managed by multidisciplinary product-associated project
teams consisting of veterinarians, biologists, molecular and cellular
biologists, biochemists and immunologists. Heska believes that it has one of
the largest and most sophisticated scientific efforts in the world devoted to
applying biotechnology
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to the creation of companion animal products. Heska's employees hold 33 D.V.M.s
and 51 Ph.D.s; nine employees hold both D.V.M. and Ph.D. degrees.
The creation of unique and scientifically advanced vaccine and therapeutic
products often requires an investment in basic research. For example,
fundamental knowledge about the immunology of dogs and cats is not well
developed, and the Company has invested significant resources on basic research
to understand immune responses in dogs and cats. Similarly, the Company has
invested significant resources to develop novel virally vectored and nucleic
acid vaccines. The Company believes the information provided by these research
groups is essential to informed and predictable programs aimed at creating
state-of-the-art safe and effective vaccines and immunotherapeutics. Through
this commitment, Heska has developed new knowledge of T-cell biology, cytokines,
immune responses to adjuvants and the use of virally vectored and nucleic acid
vaccines in companion animals.
To support its product research programs, the Company has also developed
core technical support areas which perform commonly-used techniques to a
consistent high standard. These in-house core support areas include a hybridoma
laboratory, a protein and nucleic acid sequencing facility, a recombinant
protein purification laboratory, a diagnostics creation laboratory and a process
development laboratory.
For a number of reasons, including the complexity of parasitic organisms
and their adaptations for life in or on host animals, the development of
vaccines against parasites is generally more difficult than the development of
vaccines against viruses or bacteria. The Company has committed substantial
resources to develop a body of knowledge at a molecular genetic level about the
physiology of parasites such as fleas and heartworms and the diseases they cause
that it believes is unmatched in the industry. The Company has created a flea
production laboratory in Fort Collins that produces tens of millions of fleas
each year for internal research. Similarly, in order to maximize the likelihood
of developing a successful heartworm vaccine, the Company has created a mosquito
insectary, also located at the Company's Fort Collins facility, where tens of
thousands of infective heartworm larvae are produced every week.
Heska is also committed to identifying external product opportunities and
creating business and technical collaborations that could lead to the creation
of other products. The Company is currently funding research at multiple
academic and governmental institutions. In addition, the Company is also
involved in joint research or product development efforts with a number of
companies. See "--Collaborative Agreements." The Company believes that its
active participation in scientific networks and its reputation for investing in
research enhances its ability to acquire external product opportunities.
SALES, MARKETING AND CUSTOMER SERVICE
The Company presently markets its products in the United States directly to
veterinarians through the use of its field sales force, inside customer
service/tele-sales force and veterinary distributors acting as contract sales
agents. As of January 1998, the Company had over 25 field sales representatives
and field sales supervisors and eight customer service/tele-sales
representatives and supervisors. The 12 veterinary distributors with whom the
Company has entered into sales agency relationships employ more than 300 field
and customer service/tele-sales representatives, although some of these
distributors may not sell all of the Company's products. Internationally, the
Company markets its products to veterinarians primarily through distributors.
There are approximately 30,000 veterinarians in the United States whose
practices are devoted principally to small animal medicine. Those veterinarians
practice in approximately 20,000 clinics in the United States. The Company
plans to market its products to these clinics primarily through the use of its
field and telephone sales force, sales agents, trade shows and print
advertising. The Company has sold its products to approximately 6,500 such
clinics within the last 12 months.
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In addition to creating novel products that improve companion animal
health, Heska is committed to supporting the veterinarian through a complete
case management strategy. The average companion animal veterinarian practices
general medicine. Although there are an increasing, albeit small, number of
veterinary specialists available, the economics of companion animal practice
discourage extensive use of these specialists. The Company's strategy is to
help the general practice veterinarian practice more sophisticated medicine in
several ways. Heska currently provides certain specialized diagnostic products
not available in a point-of-care format or in third party laboratories. In
addition, the Company has established a medical and technical consulting group
on site at the Colorado facility consisting of seven employee veterinarians with
specialized expertise in such areas as dermatology, internal medicine,
pathology, dentistry and feline practice. These personnel are available to all
veterinarian customers for interpretation of test results and qualified and
timely advice for continuing management of any given case. The Company believes
that these services enhance practicing veterinarians' ability to provide the
best possible medical care.
Although most veterinary diagnostic, vaccine and therapeutic products are
ordinarily sold only by veterinarians where a doctor-patient relationship
exists, these products are sometimes sold directly to the public by catalogue
and retail outlets that employ veterinarians. In order to support veterinary
clinics and to foster loyalty to Heska products, the Company intends to sell its
products exclusively to veterinarians for use where a doctor-patient
relationship exists.
Heska scientists present examples of the scientific advances that are being
made in the Company's laboratories at important veterinary and other scientific
meetings and are encouraged to publish their research in peer reviewed journals.
The Company believes that these presentations and publications have helped
establish the Company as a scientific leader in companion animal health.
MANUFACTURING
The Company's products are manufactured by Diamond and Center Laboratories
("Center"), its wholly owned subsidiaries, and/or by contract manufacturers.
Diamond's facility consists of a 166,000 square foot USDA and FDA licensed
biological and pharmaceutical manufacturing facility in Des Moines, Iowa. The
Company expects that it will manufacture most or all of its biological products
at this facility, as well as most or all of its recombinant proteins and other
proprietary reagents for its diagnostic products. The Company manufactures all
of its allergy immunotherapy products at Center's USDA and FDA licensed
manufacturing facility in Port Washington, New York. The Company manufactures
its point-of-care diagnostic products for feline and canine heartworm infection
at Quidel Corporation ("Quidel") and Diamond. The Company's periodontal disease
therapeutic is manufactured by Atrix Laboratories ("Atrix"), the company that is
developing this product for human use. The Company's non-proprietary ancillary
products, such as the canine dental hygiene kits and the dermatology line, are
manufactured to its specifications by third parties. As the Company enters into
additional strategic collaborations, it is possible that some of these strategic
partners may manufacture products for sale by the Company. The Company's
reliance upon third party manufacturers poses a significant risk. See "Factors
that May Affect Results--Limited Manufacturing Experience and Capacity; Reliance
on Contract Manufacturers."
In addition to manufacturing products for the Company, Diamond manufactures
veterinary biologicals and pharmaceuticals for other major companies in the
animal health industry. Diamond is one of the few USDA licensed contract
biological manufacturers in this market. Bayer, which is a leader in the bovine
vaccine area, currently purchases a substantial portion of its bovine vaccine
products for the United States market from Diamond. In addition to viral
vaccines, Diamond also manufactures vaccines against bacterial infections.
Diamond currently has the capacity to manufacture more than 50 million doses of
vaccines each year. Diamond's customers purchase products in both bulk and
finished format and Diamond performs all phases of manufacturing, including
growth of the active bacterial and viral agents, sterile filling, lyophilization
and packaging. In addition, Diamond ordinarily
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will support its customers through research services, regulatory compliance
services, validation support and distribution services.
In addition to manufacturing products for the Company, Center manufactures
allergy immunotherapy products which are distributed in the human market through
an independent and unaffiliated distribution company, Center Pharmaceuticals,
Inc.
COLLABORATIVE AGREEMENTS
Novartis
In April 1996, the Company entered into several agreements with Ciba-Geigy
Limited and Ciba-Geigy Corporation ("Ciba"), which agreements were succeeded to
by Novartis, the entity formed upon Ciba's merger with Sandoz Limited. Such
agreements were entered into in connection with a $36.0 million equity
investment by Novartis in the Company (see "Certain Relationships and Related
Transactions" in Item 13 of Part III). Novartis received, under the marketing
agreements, certain rights to manufacture and market any flea control vaccine or
feline heartworm control vaccine developed by the Company as to which USDA
prelicensing serials are completed on or before December 31, 2005. The Company
and Novartis have co-exclusive rights to market these products under their own
trade names throughout the world (other than in countries in which Eisai has
such rights) and, if both parties elect to market, the parties will share
revenues on their sales. The marketing agreements remain in force through 2010
or longer, if Novartis is still actively marketing such products. In addition,
the parties entered into a screening and development agreement under which the
parties may undertake joint research and development activities in certain
fields. If the parties fail to agree to perform joint research activities, then
Novartis has the right to use certain materials of the Company on an exclusive
basis to develop food animal pharmaceutical products or on a co-exclusive basis
with the Company to develop pharmaceutical products for parasite control in
companion animals or food animal vaccines. Novartis would pay royalties on any
such products developed by it. Currently, there are no joint research projects
being undertaken, although several are in the proposal stage. The Company and
Novartis also entered into a right of first refusal agreement under which the
Company, prior to granting licenses to any third party to any products or
technology developed or acquired by the Company for either companion animal or
food animal applications, must first notify and offer Novartis such rights. If
the parties are unable to come to an agreement within 150 days of the Company's
first notice, Heska may thereafter license such rights to third parties on terms
not materially more favorable than the terms last offered by the Company to
Novartis. The screening and development agreement and right of first refusal
agreement each terminate in 2005.
Bayer
In June 1994, the Company entered into research agreements (the "Research
Agreements") with Bayer providing for funding of research (the "Research
Program") by Bayer on a recombinant feline toxoplasmosis vaccine and a canine
heartworm vaccine (the "Vaccines"). Bayer has the option to obtain an
exclusive, royalty-bearing license to sell the Vaccines in all countries except
in those in which Eisai has rights. If Bayer exercises this option, the parties
will negotiate license and distribution agreements. The Company has the first
option to manufacture any products sold pursuant to any such distribution
agreement. The Research Agreements will terminate upon completion of the
Research Program. Bayer may terminate the Research Agreements prior to
completion, but would not have any rights to market the Vaccines (unless it
terminated due to Heska's breach), although it would have non-exclusive access
to technology developed in the Research Program for use other than in Vaccines.
In the event Bayer elects to terminate the Research Agreements (other than due
to Heska's breach), the Company would recover the right to market the Vaccines,
subject to certain royalties to Bayer intended to repay certain amounts Bayer
paid under the Research Agreements.
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Eisai
In January 1993, the Company entered into an agreement with Eisai, a
leading Japanese pharmaceutical company, pursuant to which the Company granted
Eisai the exclusive right to market the Company's feline and canine heartworm
vaccines, flea control vaccine and feline toxoplasmosis vaccine in Japan and
most other countries in East Asia. In exchange, the Company received an up-
front license fee and research funding for the development of these products.
Heska will have the right to manufacture any such products pursuant to a supply
agreement to be negotiated between the parties. The agreement will terminate in
January 2008, unless extended or earlier terminated by either party for material
breach of the agreement or by Eisai pursuant to certain early termination
rights.
Quidel
The Company has entered into a development agreement with Quidel under
which the parties are jointly developing certain of its point-of-care diagnostic
tests using Quidel's rapid in-clinic test technology. The parties also have
entered into a supply agreement under which Quidel will perform manufacturing
services with respect to these tests for the Company.
INTELLECTUAL PROPERTY
Heska believes that patents, trademarks, copyrights and other proprietary
rights are important to its business. Heska also relies upon trade secrets,
know-how, continuing technological innovations and licensing opportunities to
develop and maintain its competitive position.
Heska actively seeks patent protection both in the United States and
abroad. As of January 1998, Heska owned or co-owned 13 issued United States
patents and 80 pending United States patent applications, including 11 with
allowed claims. Heska's issued United States patents primarily relate to the
Company's proprietary flea bite allergy, flea control, heartworm, trichinosis
diagnostic and vaccine delivery technologies. The Company's pending United
States patent applications primarily relate to proprietary allergy, flea bite
allergy, flea control, heartworm, bartonellosis, toxoplasmosis, plague, asthma,
nutrition, trichinosis diagnostic and vaccine production and delivery
technologies. Applications corresponding to pending United States applications
have been or will be filed in other countries. As of January 1998, Heska had
three issued foreign patents and 80 pending foreign filings, including 13
pending Patent Cooperation Treaty ("PCT") filings.
The Company also has obtained exclusive and non-exclusive licenses for
numerous other patents held by academic institutions and biotechnology and
pharmaceutical companies. The proprietary technology of Diamond and Center is
primarily protected through trade secret protection of, for example, their
manufacturing processes. In general, the intellectual property of Diamond's
customers belongs to such customers.
As patent applications in the United States are maintained in secrecy until
patents issue and as publication of discoveries in the scientific or patent
literature often lags behind the actual discoveries, the Company cannot be
certain that it was the first to make the inventions covered by each of its
pending patent applications or that it was the first to file patent applications
for such inventions. Furthermore, the patent positions of biotechnology and
pharmaceutical companies are highly uncertain and involve complex legal and
factual questions, and, therefore, the breadth of claims allowed in
biotechnology and pharmaceutical patents or their enforceability cannot be
predicted. There can be no assurance that patents will issue from any of the
Company's patent applications or, should patents issue, that the Company will be
provided with adequate protection against potentially competitive products.
Furthermore, there can be no assurance that should patents issue, they will be
of commercial value to the Company, or that the United States Patent and
Trademark Office ("USPTO") or private parties, including competitors, will not
successfully challenge the Company's patents or circumvent the Company's patent
position.
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In the absence of adequate patent protection, the Company's business may be
adversely affected by competitors who develop comparable technology or products.
Pursuant to the terms of the Uruguay Round Agreements Act, patents issuing
from applications filed on or after June 8, 1995 have a term of 20 years from
the date of such filing, irrespective of the period of time it may take for such
patent to ultimately issue. This method of patent term calculation can result
in a shorter period of patent protection afforded to the Company's products
compared to the prior method of term calculation (17 years from the date of
issue) as patent applications in the biopharmaceutical sector often take
considerable time to issue. Under the Drug Price Competition and Patent Term
Restoration Act of 1984 and the Generic Animal Drug and Patent Term Restoration
Act, a patent which claims a product, use or method of manufacture covering
drugs and certain other products may be extended for up to five years to
compensate the patent holder for a portion of the time required for FDA review
of the product. There can be no assurance that the Company will be able to take
advantage of the patent term extension provisions of this law.
The Company also relies on trade secrets and continuing technological
innovation which it seeks to protect with reasonable business procedures for
maintaining trade secrets, including confidentiality agreements with its
collaborators, employees and consultants. There can be no assurance that these
agreements will not be breached, that the Company will have adequate remedies
for any breach or that the Company's trade secrets and proprietary know-how will
not otherwise become known or be independently discovered by competitors. Under
certain of the Company's research and development agreements, inventions
discovered in certain cases become jointly owned by the Company and the
corporate sponsor or partner and in other cases become the property of the
Company or the corporate sponsor or partner. Disputes may arise with respect to
ownership of any such inventions.
The commercial success of the Company also depends in part on the Company
and its collaborators neither infringing patents or proprietary rights of third
parties nor breaching any licenses that may relate to the Company's technologies
and products. The Company is aware of several third party patents and patent
applications that may relate to the practice of the Company's technologies.
There can be no assurance that the Company or its collaborators do not or will
not infringe any valid patents or proprietary rights of third parties.
Furthermore, to the extent that Heska or its consultants or research
collaborators use intellectual property owned by others in work performed for
the Company, disputes may arise as to the rights in such intellectual property
or in related or resulting know-how and inventions. Any legal action against
the Company or its collaborative partners claiming damages and seeking to enjoin
commercial activities relating to the Company's products and processes affected
by third party rights, in addition to subjecting the Company to potential
liability for damages, may require the Company or its collaborative partner to
obtain a license in order to continue to manufacture or market the affected
products and processes or to stop the manufacture and marketing of the affected
products and processes. There can be no assurance that the Company or its
collaborative partners would prevail in any such action or that any license
(including licenses proposed by third parties) required under any such patent
would be made available on commercially acceptable terms, if at all. There are
a significant number of United States and foreign patents and patent
applications in the practice of the Company's areas of interest and the Company
believes that there may be significant litigation in the industry regarding
patent and other intellectual property rights. If the Company becomes involved
in such litigation, it could consume a substantial portion of the Company's
managerial and financial resources, which could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Factors that May Affect Results--Uncertainty of Patent and Proprietary
Technology Protection; License of Technology of Third Parties."
GOVERNMENT REGULATION
Most of the products being developed by Heska will require licensing by a
governmental agency before marketing. In the United States, governmental
oversight of animal health products is primarily split between two agencies: the
USDA and the FDA. Vaccines and point-of-care diagnostics for animals are
considered veterinary
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biologics and are regulated by the Center for Veterinary Biologics ("CVB") of
the USDA under the auspices of the Virus-Serum-Toxin Act. Alternatively, animal
drugs, which generally include all synthetic compounds, are approved and
monitored by the Center for Veterinary Medicine ("CVM") of the FDA under the
auspices of the Federal Food, Drug and Cosmetic Act. A third agency, the
Environmental Protection Agency ("EPA"), has jurisdiction over certain products
applied topically to animals or to premises to control external parasites.
Most of the regulated products presently under development by Heska will be
regulated by the USDA. The purpose of the Virus-Serum-Toxin Act is to ensure
that veterinary biologics sold in the United States are safe and efficacious.
Pre-market testing is performed by the manufacturer and the CVB prior to
approval of the product for sale as well as on each new lot. Although the
procedures for licensing products by the USDA are formalized, the acceptable
standards of performance for any product are agreed upon between the
manufacturer and the CVB. For novel products that are unlike others already
licensed, the agreement on expected performance standards is typically reached
through a dialogue between the CVB and the manufacturer. The formal
demonstration of acceptable efficacy of the product is done in carefully
controlled laboratory trials. This is normally a much more efficient and
reliable process than demonstration of efficacy in clinical trials using client-
owned animals.
The drug development process for human therapeutics is much more involved
than that for animal drugs. The company sponsor of a human drug must obtain FDA
marketing approval in a multi-phase process which generally is lengthy,
expensive and subject to unanticipated delays. First, extensive preclinical
studies in animal models to assess safety and efficacy as well as laboratory
toxicology and pharmacokinetic studies of the drug must be conducted. The
company must then submit to the FDA an application for an Investigational New
Drug which must become effective before human clinical trials can commence.
Human clinical trials are then conducted in three sequential phases. Phase I,
which is safety testing, generally involves a small group of patients or healthy
volunteers and typically takes approximately one year to complete. Phase II, in
which the drug is tested for efficacy, optimal dosage and safety risks, is
conducted in a larger, but still limited, patient population and typically takes
18 to 36 months to complete. If the drug proves efficacious in Phase II trials,
expanded Phase III trials are conducted to evaluate the overall risks and
benefits of the drug in relation to available therapies for the disease. This
phase typically takes two and one-half to five years to complete. Only after
these clinical trials are complete may the company submit a New Drug Application
("NDA") to the FDA for marketing approval of the drug, and the NDA review
process takes more than one year on average to complete. The entire process
from research to market introduction on average exceeds 15 years and may cost
hundreds of millions of dollars.
By contrast, recent industry data indicate that it takes about 11 years and
$5.5 million to develop a new drug for animals, from commencement of research to
market introduction. Of this time, approximately three years is spent in the
clinical trial and review process. This approximate time requirement for animal
drugs is significantly shorter than the analogous time requirement for human
drugs in part because neither preclinical studies in model systems nor a
sequential phase system of clinical trials is required. Rather, for animal
drugs clinical trials for safety and efficacy may be conducted immediately in
the species for which the drug is intended. Thus, there is no required phased
evaluation of drug performance, and CVM will review data at the most appropriate
and productive times in the drug development process. In addition, the time and
cost for developing companion animal drugs may be significantly less than for
drugs for food producing animals, as food safety issues relating to tissue
residue levels are not present. Also, for animal drugs, unlike human drugs,
advantages over existing therapies do not have to be demonstrated. In addition,
with the enactment of the Animal Drug Availability Act ("ADA") in October 1996,
substantial reductions in the time and cost to license some new animal drugs by
the FDA are anticipated. The ADA was designed to streamline the animal drug
approval process in order to provide more registered drugs for animal use. The
ADA creates a binding pre-submission conference at which the CVM and the
sponsoring company agree on the types of data the FDA will require. The ADA
also removes the requirement that field investigations be done in every instance
and allows the CVM to accept different types of proof of a drug's safety and
efficacy. For example, as permitted by the ADA, the FDA agreed that data
collected by Atrix in human preclinical trials using dogs with naturally
occurring periodontal disease constituted adequate evidence
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of product efficacy for purposes of regulatory clearance for the Heska
Periodontal Disease Therapeutic. This reduced the approval process time for
this product by eliminating the need to conduct clinical trials in client-owned
dogs. This product has been licensed for use in dogs before the equivalent
product has been licensed by the FDA for use in humans, although the human
clinical trials were initiated significantly before Heska's efforts.
Recent industry data indicates that it takes approximately four years and
$1.0 million to license a conventional vaccine for animals from basic research
through licensing. In contrast to vaccines, point-of-care diagnostics can
typically be licensed by the USDA in about a year with considerably less cost.
However, vaccines or diagnostics that use innovative materials such as those
resulting from recombinant DNA technology usually require additional time to
license. The USDA licensing process involves the submission of several data
packages. These packages include information on how the product will be
prepared, information on the performance and safety of the product in laboratory
studies and information on performance of the product in field conditions.
However, the submission and review of these data packages is not staged so that
one must be completed before beginning the next.
A number of animal health products are not regulated. For example, assays
for use in a veterinary diagnostic laboratory do not have to be licensed by
either the USDA or the FDA. Additionally, grooming and supportive care products
such as those being developed for the dermatology and dental health care product
lines are exempt from significant regulation as long as they do not bear a
therapeutic claim that represents the product as a drug.
Recently, regulations governing the export of drugs and biologics have also
been relaxed by the passage of the Export Reform Enhancement Act of 1996. Under
this act, drugs and biologics produced in the United States do not have to be
licensed for sale in the United States before export if they are approved for
sale in the importing country. Accordingly, Heska is moving quickly to
introduce point-of-care diagnostic products in certain countries, such as Italy
and Australia, where the products would address significant market opportunities
or needs.
The European Union ("EU") is centralizing the regulatory process for
companion animal drugs and biologics for member states. In addition, both the
USDA and the FDA are working with the EU and Japan via the Veterinary
International Cooperation on Harmonization initiative to harmonize the
regulatory requirements for companion animal health products. Thus, in the
future, it is hoped that a single set of requirements will be in place to
streamline the licensing of veterinary products in the major companion animal
markets. Notwithstanding the EU's efforts to streamline the regulatory process
for companion animal health products, certain countries in Europe, including
Italy, where the Company is currently marketing its Leishmania diagnostic
product, have chosen not to stringently regulate veterinary diagnostic products
at this time.
COMPETITION
The market in which the Company competes is intensely competitive. Heska's
competitors include companion animal health companies and major pharmaceutical
companies that have animal health divisions. Companies with a significant
presence in the animal health market, such as American Home Products, Bayer,
Merial Ltd., Novartis, Pfizer Inc and IDEXX Laboratories, Inc., have developed
or are developing products that do or would compete with the Company's products.
Novartis and Bayer are marketing partners of the Company and their agreements
with the Company do not restrict their ability to develop and market competing
products. These competitors have substantially greater financial, technical,
research and other resources and larger, more established marketing, sales,
distribution and service organizations than the Company. Moreover, such
competitors may offer broader product lines and have greater name recognition
than the Company. Additionally, the market for companion animal health care
products is highly fragmented, with discount stores and specialty pet stores
accounting for a substantial percentage of such sales. As Heska intends to
distribute its products only through veterinarians, a substantial segment of the
potential market may not be reached and the Company may not be able
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to offer its products at prices which are competitive with those of companies
that distribute their products through retail channels. There can be no
assurance that the Company's competitors will not develop or market technologies
or products that are more effective or commercially attractive than the
Company's current or future products or that would render the Company's
technologies and products obsolete. Moreover, there can be no assurance that
the Company will have the financial resources, technical expertise or marketing,
distribution or support capabilities to compete successfully.
EMPLOYEES
As of December 31, 1997, Heska and its subsidiaries employed 474 full-time
persons, of whom 110 are in manufacturing and quality control, 154 are in
research, development and regulatory, 126 are in finance and administration, 51
are in sales and marketing and 35 are in the diagnostic laboratories. Heska's
employees hold 33 D.V.M.s and 51 Ph.D.s. There can be no assurance that the
Company will continue to be able to attract and retain qualified technical and
management personnel. See "Factors that May Affect Results--Dependence on Key
Personnel." None of the Company's employees is covered by a collective
bargaining agreement, and the Company believes its employee relations are good.
FACTORS THAT MAY AFFECT RESULTS
When used in this Report on Form 10-K ("Form 10-K"), the words "expects,"
"anticipates," "estimates" and similar expressions are intended to identify
forward-looking statements. Such statements are subject to risks and
uncertainties, including those set forth below and elsewhere in this Form 10-K,
that could cause actual results to differ materially from those projected.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date of this Form 10-K. The Company
expressly disclaims any obligation or undertaking to release publicly any
updates or revisions to any forward-looking statements contained herein to
reflect any change in the Company's expectations with regard thereto or any
change in events, conditions or circumstances on which any such statement is
based.
Dependence on Development and Introduction of New Products
Many of the Company's products are still under development and there can be
no assurance such products will be successfully developed or commercialized on a
timely basis, or at all. The Company believes that its revenue growth and
profitability, if any, will substantially depend upon its ability to complete
development of and successfully introduce and commercialize its new products.
The development and regulatory approval activities necessary to bring new
products to market are time-consuming and costly. There can be no assurance
that the Company will not experience difficulties that could delay or prevent
successfully developing, obtaining regulatory approvals to market or introducing
these new products, that regulatory clearance or approval of any new products
will be granted by the USDA, the FDA, the EPA or foreign regulatory authorities
on a timely basis, or at all, or that the new products will be successfully
commercialized. The Company's strategy is to develop a broad range of products
addressing different disease indications. The Company has limited resources to
devote to the development of all its products and consequently a delay in the
development of one product or the use of resources for product development
efforts that prove unsuccessful may delay or jeopardize the development of its
other product candidates. Further, for certain of the Company's proposed
products, the Company is dependent on collaborative partners to successfully and
timely perform research and development activities on behalf of the Company. In
order to successfully commercialize any new products, the Company will be
required to establish and maintain a reliable, cost-efficient source of
manufacturing for such products. If the Company is unable, for technological or
other reasons, to complete the development, introduction or scale up of
manufacturing of any new product or if any new product is not approved for
marketing or does not achieve a significant level of market acceptance, the
Company could be materially and adversely affected. Following the introduction
of a product, adverse side effects may be discovered that make the product no
longer commercially viable. Publicity regarding
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such adverse effects could affect sales of the Company's other products for an
indeterminate time period. The Company is dependent on the acceptance of its
products by both veterinarians and pet owners. The failure of the Company to
engender confidence in its products and services could affect the Company's
ability to attain sustained market acceptance of its products. See "Business--
Manufacturing," "--Government Regulation" and "--Collaborative Agreements."
Loss History and Accumulated Deficit; Uncertainty of Future Profitability;
Quarterly Fluctuations and Customer Concentration
Heska has incurred net losses since its inception. At December 31, 1997,
the Company's accumulated deficit was $67.6 million. The Company anticipates
that it will continue to incur additional operating losses for the next several
years. Such losses have resulted principally from expenses incurred in the
Company's research and development programs and, to a lesser extent, from
general and administrative and sales and marketing expenses. Currently, a
substantial portion of the Company's revenues are from Diamond, which
manufactures veterinary biologicals and pharmaceuticals for major companies in
the animal health industry. Revenues from one Diamond customer comprised
approximately 29% of total revenues in 1997 under the terms of a take-or-pay
contract which expires in June 1999. If this customer does not continue to
purchase from Diamond and if the lost revenues are not replaced by other
customers or products, the Company's financial condition and results of
operations could be adversely affected.
There can be no assurance that the Company will attain profitability or, if
achieved, will remain profitable on a quarterly or annual basis in the future.
The Company believes that future operating results will be subject to quarterly
fluctuations due to a variety of factors, including whether and when new
products are successfully developed and introduced by the Company or its
competitors, market acceptance of current or new products, regulatory delays,
product recalls, competition and pricing pressures from competitive products,
manufacturing delays, shipment problems, product seasonality and changes in the
mix of products sold. Because the Company is continuing to increase its
operating expenses for personnel, new product development and marketing, the
Company's operating results will be adversely affected if its sales do not
correspondingly increase or if its product development efforts are unsuccessful
or subject to delays. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in Item 7 of Part II of this Form 10-K.
Limited Sales and Marketing Experience; Dependence on Others
To be successful, Heska will have to continue to develop and train its
direct sales force or rely on marketing partners or other arrangements with
third parties for the marketing, distribution and sale of its products. The
Company is currently marketing its products to veterinarians through a direct
sales force and certain third parties. There can be no assurance that the
Company will be able to successfully maintain marketing, distribution or sales
capabilities or make arrangements with third parties to perform those activities
on terms satisfactory to the Company. See "Business--Sales, Marketing and
Customer Service."
In addition, the Company has granted marketing rights to certain products
under development to third parties, including Novartis, Bayer and Eisai.
Novartis has the right to manufacture and market throughout the world (except in
countries where Eisai has such rights) under Novartis trade names any flea
control vaccine or feline heartworm vaccine developed by the Company on or
before December 31, 2005. The Company retained the right to co-exclusively
manufacture and market these products throughout the world under its own trade
names. Accordingly, if both elect to market these products, the Company and
Novartis will be direct competitors, with each party sharing revenues on the
other's sales. Heska also granted Novartis a right of first refusal pursuant to
which, prior to granting rights to any third party for any products or
technology developed or acquired by the Company for either companion animal or
food animal applications, Heska must first offer Novartis such rights. Bayer
has exclusive marketing rights to the Company's canine heartworm vaccine and its
feline toxoplasmosis vaccine (except
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in countries where Eisai has such rights). Eisai has exclusive rights in Japan
and most countries in East Asia to market the Company's feline and canine
heartworm vaccines, feline and canine flea control vaccines and feline
toxoplasmosis vaccine. The Company's agreements with its marketing partners
contain no minimum purchase requirements in order for such parties to maintain
their exclusive or co-exclusive marketing rights. There can be no assurance
that Novartis, Bayer or Eisai or any other collaborative party will devote
sufficient resources to marketing the Company's products. Furthermore, there is
nothing to prevent Novartis, Bayer or Eisai or any other collaborative party
from pursuing alternative technologies or products that may compete with the
Company's products. See "Business--Collaborative Agreements."
Highly Competitive Industry
The market in which the Company competes is intensely competitive. Heska's
competitors include companion animal health companies and major pharmaceutical
companies that have animal health divisions. Companies with a significant
presence in the animal health market, such as American Home Products, Bayer,
Merial Ltd., Novartis, Pfizer Inc and IDEXX Laboratories, Inc., have developed
or are developing products that do or would compete with the Company's products.
Novartis and Bayer are marketing partners of the Company, and their agreements
with the Company do not restrict their ability to develop and market competing
products. These competitors have substantially greater financial, technical,
research and other resources and larger, more established marketing, sales,
distribution and service organizations than the Company. Moreover, such
competitors may offer broader product lines and have greater name recognition
than the Company. Additionally, the market for companion animal health care
products is highly fragmented, with discount stores and specialty pet stores
accounting for a substantial percentage of such sales. As Heska intends to
distribute its products only through veterinarians, a substantial segment of the
potential market may not be reached, and the Company may not be able to offer
its products at prices which are competitive with those of companies that
distribute their products through retail channels. There can be no assurance
that the Company's competitors will not develop or market technologies or
products that are more effective or commercially attractive than the Company's
current or future products or that would render the Company's technologies and
products obsolete. Moreover, there can be no assurance that the Company will
have the financial resources, technical expertise or marketing, distribution or
support capabilities to compete successfully. See "Business--Competition."
Uncertainty of Patent and Proprietary Technology Protection; License of
Technology of Third Parties
The Company's ability to compete effectively will depend in part on its
ability to develop and maintain proprietary aspects of its technology and either
to operate without infringing the proprietary rights of others or to obtain
rights to such technology. Heska has United States and foreign issued patents
and is currently prosecuting patent applications in the United States and with
certain foreign patent offices. There can be no assurance that any of the
Company's pending patent applications will result in the issuance of any patents
or that, if issued, any such patents will offer protection against competitors
with similar technology. There can be no assurance that any patents issued to
the Company will not be challenged, invalidated or circumvented in the future or
that the rights created thereunder will provide a competitive advantage.
The biotechnology and pharmaceutical industries have been characterized by
extensive litigation regarding patents and other intellectual property rights.
There can be no assurance that the Company will not in the future become subject
to patent infringement claims and litigation in the United States or other
countries or interference proceedings conducted in the USPTO to determine the
priority of inventions. The defense and prosecution of intellectual property
suits, USPTO interference proceedings, and related legal and administrative
proceedings are both costly and time consuming. Litigation may be necessary to
enforce any patents issued to the Company or its collaborative partners, to
protect trade secrets or know-how owned by the Company or its collaborative
partners, or to determine the enforceability, scope and validity of the
proprietary rights of others. Any litigation or interference proceeding will
result in substantial expense to the Company and significant diversion of effort
by the
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Company's technical and management personnel. An adverse determination in
litigation or interference proceedings to which the Company may become a party
could subject the Company to significant liabilities to third parties. Further,
either as the result of such litigation or proceedings or otherwise, the Company
may be required to seek licenses from third parties which may not be available
on commercially reasonable terms, if at all.
The Company licenses technology from a number of third parties. The
majority of such license agreements impose due diligence or milestone
obligations and in some cases impose minimum royalty or sales obligations upon
the Company in order for the Company to maintain its rights thereunder.
The Company's products may incorporate technologies that are the subject of
patents issued to, and patent applications filed by, others. As is typical in
its industry, from time to time the Company and its collaborators have received
and may in the future receive notices claiming infringement from third parties
as well as invitations to take licenses under third party patents. It is the
Company's policy when it receives such notices to conduct investigations of the
claims asserted. With respect to notices the Company has received to date, the
Company believes, after due investigation, that it has meritorious defenses to
the infringement claims asserted. Any legal action against the Company or its
collaborators may require the Company or its collaborators to obtain a license
in order to market or manufacture affected products or services. However, there
can be no assurance that the Company or its collaborators will be able to obtain
licenses for technology patented by others on commercially reasonable terms,
that they will be able to develop alternative approaches if unable to obtain
licenses, or that the current and future licenses will be adequate for the
operation of their businesses. The failure to obtain necessary licenses or to
identify and implement alternative approaches could prevent the Company and its
collaborators from commercializing certain of their products under development
and could have a material adverse effect on the Company's business, financial
condition or results of operations.
The Company also relies upon trade secrets, technical know-how and
continuing invention to develop and maintain its competitive position. There
can be no assurance that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
the Company's trade secrets. See "Business--Intellectual Property."
Limited Manufacturing Experience and Capacity; Reliance on Contract
Manufacturers
To be successful, the Company must manufacture, or contract for the
manufacture of, its current and future products in compliance with regulatory
requirements, in sufficient quantities and on a timely basis, while maintaining
product quality and acceptable manufacturing costs. In order to provide for
manufacturing of its products, the Company acquired Diamond in April 1996 and
certain assets of Center in July 1997. Significant work will be required for
the scaling up of manufacturing of many new products and there can be no
assurance that such work can be completed successfully or on a timely basis.
In addition to Diamond and Center, the Company intends to rely on contract
manufacturers for certain of its products. The Company currently has supply
agreements with Atrix for its canine periodontal disease therapeutic and a
supply agreement with Quidel for certain manufacturing services relating to its
point-of-care canine and feline heartworm diagnostic tests. These agreements
all require the manufacturing partner to supply the Company's requirements
within certain parameters. There can be no assurance that these partners will
be able to manufacture products to regulatory standards and the Company's
specifications or in a cost-effective and timely manner. If any supplier were
to be delayed in scaling up commercial manufacturing, were to be unable to
produce a sufficient quantity of products to meet market demand, or were to
request renegotiation of contract prices, the Company's business could be
materially and adversely affected. While the Company typically retains the
right to manufacture products itself or contract with an alternative supplier in
the event of the manufacturer's breach, any transfer of production would
necessarily involve significant delays in production and additional expense to
the Company to scale up production at a new facility and to apply for regulatory
licensure for the production of
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products at that new facility. In addition, there can be no assurance that the
Company will be able to locate suitable manufacturing partners for its products
under development or alternative suppliers if present arrangements are not
satisfactory. See "Business--Manufacturing."
Government Regulation; No Assurance of Obtaining Regulatory Approvals
The development, manufacture and marketing of most of the Company's
products are subject to regulation by various governmental authorities,
consisting principally of the USDA and the FDA in the United States and various
regulatory agencies outside the United States. Delays in obtaining, or failure
to obtain any necessary regulatory approvals would have a material adverse
effect on the Company's future product sales and operations. Any acquisitions of
new products and technologies may subject the Company to additional government
regulation.
The Company's manufacturing facilities and those of any contract
manufacturers the Company may use are subject to the requirements of and subject
to periodic regulatory inspections by the FDA, USDA and other federal, state and
foreign regulatory agencies. There can be no assurance that the Company or its
contractors will continue to satisfy such regulatory requirements, and any
failure to do so would have a material adverse effect on the Company's business,
financial condition or results of operations.
There can be no assurance that the Company will not incur significant costs
to comply with laws and regulations in the future or that laws and regulations
will not have a material adverse effect upon the Company's business, financial
condition or results of operations. See "Business--Government Regulation."
Future Capital Requirements; Uncertainty of Additional Funding
While the Company believes that its available cash will be sufficient to
satisfy its funding needs for current operations for the next 12 months,
assuming no significant uses of cash in acquisition activities, the Company has
incurred negative cash flow from operations since inception and does not expect
to generate positive cash flow sufficient to fund its operations for the next
several years. Thus, the Company may need to raise additional capital to fund
its research and development, manufacturing and sales and marketing activities.
The Company's future liquidity and capital funding requirements will depend on
numerous factors, including market acceptance of current and future products;
successful development of new products; timing of regulatory actions regarding
the Company's potential products; costs and timing of expansion of sales,
marketing and manufacturing activities; procurement, enforcement and defense of
patents important to the Company's business; results of product trials; and
competition. There can be no assurance that such additional capital will be
available on terms acceptable to the Company, if at all. Furthermore, any
additional equity financing may be dilutive to stockholders, and debt financing,
if available, may include restrictive covenants. If adequate funds are not
available, the Company may be required to curtail its operations significantly
or to obtain funds through entering into collaborative agreements or other
arrangements on unfavorable terms. The failure by the Company to raise capital
on acceptable terms when needed would have a material adverse effect on the
Company's business, financial condition or results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" in Item 7 of Part II of this Form
10-K.
Potential Difficulties in Management of Growth; Identification and Integration
of Acquisitions
The Company anticipates additional growth in the number of its employees,
the scope of its operating and financial systems and the geographic area of its
operations as new products are developed and commercialized. This growth will
result in an increase in responsibilities for both existing and new management
personnel. The Company's ability to manage growth effectively will require it
to continue to implement and improve its operational, financial and management
information systems and to train, motivate and manage its current employees and
hire new employees. There can be no assurance that the Company will be able to
manage its expansion
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effectively, and a failure to do so could have a material adverse effect on the
Company's business, financial condition or results of operations.
In 1996, Heska consummated the acquisitions of Diamond and of assets
relating to its canine allergy business. The Company's recent acquisitions
include: the February 1997 purchase of Bloxham; the July 1997 purchase of the
allergy immunotherapy products business of Center, an FDA and USDA licensed
manufacturer of allergy immunotherapy products; and the September 1997 purchase
of CMG Centre Medical des Grand'Places SA, a Swiss corporation ("CMG") which
manufactures and markets allergy diagnostic products for use in veterinary and
human medicine, primarily in Europe and Japan. The Company also anticipates
issuing additional shares of Common Stock to effect future acquisitions. Such
issuances may be dilutive. Identifying and pursuing acquisition opportunities,
integrating the acquired businesses and managing growth requires a significant
amount of management time and skill. There can be no assurance that the Company
will be effective in identifying and effecting attractive acquisitions,
integrating acquisitions or managing future growth. The failure to do so may
have a material adverse effect on the Company's business, financial condition or
results of operations.
Dependence on Key Personnel
The Company is highly dependent on the efforts of its senior management and
scientific team, including its Chief Executive Officer and Chief Scientific
Officer. The loss of the services of any member of its senior management or
scientific staff may significantly delay or prevent the achievement of product
development and other business objectives. Because of the specialized
scientific nature of the Company's business, the Company is highly dependent on
its ability to attract and retain qualified scientific and technical personnel.
There is intense competition among major pharmaceutical and chemical companies,
specialized biotechnology firms and universities and other research institutions
for qualified personnel in the areas of the Company's activities. Loss of the
services of, or failure to recruit, key scientific and technical personnel could
adversely affect the Company's business, financial condition or results of
operations. See "Business--Employees" and "Executive Officers of the
Registrant."
Potential Product Liability; Limited Insurance Coverage
The testing, manufacturing and marketing of the Company's current products
as well as those currently under development entail an inherent risk of product
liability claims and associated adverse publicity. To date, the Company has not
experienced any material product liability claims, but any such claims arising
in the future could have a material adverse effect on the Company's business,
financial condition or results of operations. Potential product liability
claims may exceed the amount of the Company's insurance coverage or may be
excluded from coverage under the terms of the policy. There can be no assurance
that the Company will be able to continue to obtain adequate insurance at a
reasonable cost, if at all. In the event that the Company is held liable for a
claim against which it is not indemnified or for damages exceeding the limits of
its insurance coverage or which results in significant adverse publicity against
the Company, such claim could have a material adverse effect on the Company's
business, financial condition or results of operations.
Risk of Liability from Release of Hazardous Materials
The Company's products and development programs involve the controlled use
of hazardous and biohazardous materials, including chemicals, infectious disease
agents and various radioactive compounds. Although the Company believes that
its safety procedures for handling and disposing of such materials comply with
the standards prescribed by applicable local, state and federal regulations, the
risk of accidental contamination or injury from these materials cannot be
completely eliminated. In the event of such an accident, the Company could be
held liable for any damages or fines that result and any such liability could
exceed the resources of the Company. The Company may incur substantial costs to
comply with environmental regulations as the Company expands its manufacturing
capacity.
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Possible Volatility of Stock Price
The securities markets have from time to time experienced significant price
and volume fluctuations that are unrelated to the operating performance of
particular companies. The market prices of securities of many publicly-held
biotechnology companies have in the past been, and can in the future be expected
to be, especially volatile. Announcements of technological innovations or new
products by the Company or its competitors, release of reports by securities
analysts, developments or disputes concerning patents or proprietary rights,
regulatory developments, changes in regulatory policies, economic and other
external factors, as well as quarterly fluctuations in the Company's financial
results, may have a significant impact on the market price of the Common Stock.
Control by Directors, Executive Officers, Principal Stockholders and Affiliated
Entities
The Company's directors, executive officers, principal stockholders and
entities affiliated with them beneficially own approximately 50% of the
Company's outstanding Common Stock. The Company's three major stockholders, who
together beneficially own approximately 45% of the Company's outstanding Common
Stock, have entered into a voting agreement dated as of April 12, 1996 (the
"Voting Agreement") whereby each agreed to collectively vote its shares in such
manner so as to ensure that each major stockholder was represented by one member
on the Company's Board of Directors. The Voting Agreement terminates on
December 31, 2005 unless prior to such date any of the investors ceases to
beneficially hold 2,000,000 shares of the voting stock of the Company, at which
time the Voting Agreement would terminate. The major stockholders, if acting
together, could substantially control all matters requiring approval by the
stockholders of the Company, including the election of directors and the
approval of mergers or other business combination transactions.
Anti-Takeover Effect of Certain Charter and Bylaw Provisions and Delaware Law
Certain provisions of the Company's Restated Certificate of Incorporation
and Bylaws may have the effect of making it more difficult for a third party to
acquire, or of discouraging a third party from attempting to acquire, control of
the Company. Such provisions could limit the price that certain investors may
be willing to pay in the future for shares of the Company's Common Stock.
Certain of these provisions allow the Company to issue Preferred Stock without
any vote or further action by the stockholders, provide for a classified board
of directors and eliminate the right of stockholders to call special meetings of
stockholders. These provisions may make it more difficult for stockholders to
take certain corporate actions and could have the effect of delaying or
preventing a change in control of the Company. In addition, certain provisions
of Delaware law applicable to the Company could also delay or make more
difficult a merger, tender offer, or proxy contest involving the Company.
ITEM 2. PROPERTIES.
Heska leases an aggregate of approximately 75,000 square feet of
administrative and laboratory space in six buildings located mostly in one
business park in Fort Collins, Colorado under leases expiring from 1999 through
2004, with options to extend through 2010 for the larger facilities. Heska
believes that its present Fort Collins facilities are adequate for its current
and planned activities and that suitable additional or replacement facilities in
the Fort Collins area are readily available on commercially reasonable terms.
Diamond's principal manufacturing facility in Des Moines, Iowa, consisting of
166,000 square feet of buildings on 34 acres of land, is leased from Bayer under
a lease expiring in 1998, with options to extend through 2009. Diamond also
owns a 160-acre farm used principally for research purposes located in Carlisle,
Iowa. Management believes that any new construction required for Diamond's
activities can be accommodated at its present site. Center owns its
approximately 27,000 square foot facility in Port Washington, New York. The
Company's European subsidiaries lease their facilities.
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ITEM 3. LEGAL PROCEEDINGS.
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company and their ages as of March 23, 1998
are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Fred M. Schwarzer 46 President, Chief Executive Officer and Director
Robert B. Grieve, Ph.D. 46 Chief Scientific Officer and Vice Chairman
Guisseppe Miozzari, Ph.D. 50 Managing Director, Heska Europe
R. Lee Seward, D.V.M. 52 Executive Vice President
John A. Shadduck, D.V.M., Ph.D. 58 Executive Vice President, Operations
William G. Skolout 47 Chief Financial Officer
Louis G. Van Daele 54 President, Diamond Animal Health, Inc.
</TABLE>
Fred M. Schwarzer is President, Chief Executive Officer and a director of
the Company. Mr. Schwarzer served as the Executive Vice President responsible
for the Company's strategic planning and corporate partnerships from June 1994
until he was elected to serve as President and Chief Executive Officer of the
Company effective November 1994. He has been a member of the Company's Board of
Directors since June 1994. From June through October 1994, Mr. Schwarzer was an
employee of Charter Venture Capital and continues to hold a small limited
partnership interest in Charter Ventures II, L.P. Mr. Schwarzer was the founder
and a partner in the Mountain View, California law firm of General Counsel
Associates from 1988 to June 1994 and, prior to founding General Counsel
Associates, was a partner in the San Francisco law firm of Pillsbury Madison &
Sutro LLP. He holds a J.D. degree from the University of California, Berkeley
and a B.A. degree from the University of Michigan.
Robert B. Grieve, Ph.D. is Chief Scientific Officer and Vice Chairman of
the Company and is a founder of the Company. Dr. Grieve was named to his
current position in December 1994. He has been a member of the Company's Board
of Directors since 1990. Dr. Grieve was a Professor of Parasitology at Colorado
State University from 1987 until joining the Company in January 1994 as Vice
President, Research and Development. In addition to his duties with the Company,
Dr. Grieve is the Immediate Past President of the American Society of
Parasitologists. In the past, he has served in a formal editorial capacity for
the Journal of Immunology, the Journal of Parasitology and the American Journal
of Veterinary Research. His professional awards and honors include the 1991
Ralston Purina Small Animal Research Award and the 1990 Henry Baldwin Ward medal
for outstanding research in Parasitology, awarded by the American Society of
Parasitologists. He holds a Ph.D. degree from the University of Florida and
M.S. and B.S. degrees from the University of Wyoming.
Giuseppe Miozzari, Ph.D. joined the Company as Managing Director, Heska
Europe in March 1997. From 1980 to March 1997, Dr. Miozzari served in senior
research positions with Novartis, most recently as the Head of Research of the
Animal Health Sector and prior to that, from 1980 to 1983, as Head of the
Molecular Biology Research Unit in the Pharmaceuticals Division. Dr. Miozzari
also served as Novartis' designate on the Board of Directors of the Company from
April 1996 to March 1997. Dr. Miozzari holds Ph.D. and Dipl. Sc. Nat. degrees
from the Federal Institute of Technology (ETH) in Zurich, Switzerland.
28
<PAGE>
R. Lee Seward, D.V.M. is Executive Vice President of the Company. He
joined the Company in October 1994. Before joining the Company, Dr. Seward held
successive positions with Merck & Co., Inc. from May 1981 until September 1994.
His most recent position with Merck was Executive Director, Animal Science
Research, a position in which he headed worldwide animal health product
development. Dr. Seward was in private veterinary practice from March 1980
until he joined Merck & Co., Inc. He holds D.V.M. and B.S. degrees from
Colorado State University.
John A. Shadduck, D.V.M., Ph.D. is Executive Vice President, Operations of
the Company. He was named to this position in January 1997. Dr. Shadduck also
served as a director of the Company from January 1990 to January 1997. Before
joining the Company, he held the position of Dean, College of Veterinary
Medicine, Texas A&M University from July 1988 until January 1997. He holds
D.V.M. and M.Sc. and Ph.D degrees from The Ohio State University.
William G. Skolout was appointed Chief Financial Officer of the Company in
March 1997. Before joining Heska, Mr. Skolout was Chief Financial Officer of
Cardinal Technologies, Inc. from March 1996 to February 1997 and was Chief
Financial Officer and Vice President of Cray Computer Corporation from September
1992 to December 1995. He holds an M.B.A., Finance degree from the University
of Massachusetts, Amherst and a B.S., Business Finance degree from University of
Colorado, Boulder.
Louis G. Van Daele has served as President of Diamond since February 1994.
From February 1989 until January 1994, he served as Director of Quality Control
and Quality Assurance at Diamond. He holds an M.B.A. degree from Wayne State
University and a B.S. degree from Michigan State University.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock has been quoted on the Nasdaq National Market
under the symbol "HSKA" since July 1, 1997. The Company's initial public
offering price was $8.50 per share. The following table sets forth the intraday
high and low prices for the Common Stock as reported by the Nasdaq National
Market.
<TABLE>
<CAPTION>
1997 HIGH LOW
---- ---- ---
<S> <C> <C>
Third Quarter............ $16 7-1/8
Fourth Quarter........... 15-5/8 11-1/4
</TABLE>
As of March 10, 1998, there were approximately 248 stockholders of record of
the Company's Common Stock and approximately 4,000 beneficial stockholders. The
Company has never declared or paid cash dividends on its capital stock and does
not anticipate paying any cash dividends in the foreseeable future. The Company
currently intends to retain future earnings for the development of its business.
29
<PAGE>
RECENT SALES OF UNREGISTERED SECURITIES
On various dates between January 1997 and August 1997, the Registrant issued
an aggregate of 370,145 shares of its Common Stock to 59 employees and
consultants pursuant to the exercise of options granted under its stock option
plans. The exercise prices per share ranged from $1.20 to $8.75, for an
aggregate consideration of $120,613. The Registrant relied on the exemption
provided by Rule 701 under the Act.
In January 1997, the Registrant issued 25,000 shares of its Common Stock to
a director of the Company pursuant to a restricted stock purchase agreement
under a stock option plan. The purchase price was $1.20 per share, for an
aggregate consideration of $30,000. The Registrant relied on the exemption
provided by Section 4(2) and Rule 701 under the Act.
In February 1997, the Registrant issued an aggregate of 54,000 shares of
Series E Preferred Stock to the three shareholders of Bloxham Laboratories
Limited in exchange for all of the outstanding shares of Bloxham. The
Registrant relied upon the exemption provided by Section 4(2) of the Act.
In May 1997, the Registrant issued an aggregate of 376,000 shares of Common
Stock and 70,000 shares of Series E Preferred Stock to the three shareholders of
Astarix Institute, Inc. in exchange for all of the outstanding shares of
Astarix. The Registrant relied upon the exemption provided by Section 4(2) of
the Act.
Between July 1997 and August 1997, the Registrant issued an aggregate of
705,389 shares in connection with the issuance of Common Stock in the
Registrant's initial public offering to an existing stockholder pursuant to
certain anti-dilution provisions contained in the Registrant's Certificate of
Incorporation. The Registrant relied upon the exemption provided by Section
4(2) of the Act.
In September 1997, the Registrant issued 5,323 shares to an equipment lessor
pursuant to the net exercise of a warrant for 6,400 shares of Heska Common
Stock. The Registrant relied upon the exemption provided by Section 4(2) of the
Act.
In October 1997, the Registrant issued 1,200 shares of Common Stock to a
former employee in consideration of the settlement of an employment dispute.
The Registrant relied upon the exemptions provided by Rule 701 and Rule 505 of
Regulation D of the Act.
In October 1997, the Registrant issued 17,606 shares of Common Stock to a
company in exchange for certain assets. The Registrant relied upon the
exemption provided by Rule 505 of Regulation D and Section 4(2) of the Act.
30
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The data set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements and related Notes included as Items 7 and
8 in this Form 10-K.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Products, net...................................... $ -- $ -- $ -- $ 8,013 $ 18,299
Research and development........................... 1,817 3,858 2,230 1,946 2,578
------- ------- -------- -------- --------
Total revenues.................................. 1,817 3,858 2,230 9,959 20,877
Costs and operating expenses:
Cost of goods sold................................. -- -- -- 6,648 14,245
Research and development........................... 2,427 3,685 6,031 14,038 19,990
Selling and marketing.............................. -- -- -- 2,493 8,693
General and administrative......................... 540 904 864 4,540 10,937
Amortization of intangible assets and deferred
compensation..................................... -- -- -- 1,101 2,381
Purchased research and development................. -- -- -- -- 2,399
------- ------- -------- -------- --------
Total costs and operating expenses.............. 2,967 4,589 6,895 28,820 58,645
------- ------- -------- -------- --------
Loss from operations................................. (1,150) (731) (4,665) (18,861) (37,768)
Other income (expense)............................... (37) (153) 99 886 476
------- ------- -------- -------- --------
Net loss............................................. $(1,187) $ (884) $ (4,566) $(17,975) $(37,292)
======= ======= ======== ======== ========
Pro forma net loss per share(1)...................... $(1.35) $(2.33)
======== ========
Number of shares used in computing pro forma net
loss per share(1)................................... 13,307 16,033
DECEMBER 31,
----------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------------- ---------- ----------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities..... $ 695 $ 539 $ 6,827 $ 23,700 $ 28,746
Working capital (deficit)............................ (241) 300 6,522 23,955 31,544
Total assets......................................... 1,031 2,670 8,508 42,169 65,248
Long-term obligations................................ 132 181 302 4,528 10,308
Accumulated deficit.................................. (6,851) (7,735) (12,301) (30,276) (67,568)
Total stockholders' equity (deficit)................. (86) 1,180 7,249 32,383 43,672
</TABLE>
- --------------
(1) See Note 2 of Notes to Consolidated Financial Statements for information
concerning the computation of pro forma net loss per share.
31
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with "Selected
Consolidated Financial Data" and the Consolidated Financial Statements and
related Notes included in Items 6 and 8 of this Form 10-K.
This discussion contains, in addition to historical information, forward-
looking statements that involve risks and uncertainties. The Company's actual
results and the timing of certain events could differ materially from the
results discussed in the forward-looking statements. Factors that could cause
or contribute to such differences include, but are not limited to, those
discussed below, as well as those discussed elsewhere in this Form 10-K.
OVERVIEW
Heska discovers, develops, manufactures and markets companion animal health
products, primarily for dogs, cats and horses. From the Company's inception in
1988 until early 1996, the Company's operating activities related primarily to
research and development activities, entering into collaborative agreements,
raising capital and recruiting personnel. Prior to 1996, the Company had not
received any revenues from the sale of products, and it has incurred net losses
since inception. As of December 31, 1997, the Company's accumulated deficit was
$67.6 million.
During 1996, Heska grew from being primarily a research and development
concern to a fully-integrated research, development, manufacturing and marketing
company. The Company accomplished this by acquiring Diamond, a licensed
pharmaceutical and biological manufacturing facility in Des Moines, Iowa, hiring
key employees and support staff, establishing marketing and sales operations to
support Heska products introduced in 1996, and designing and implementing more
sophisticated operating and information systems. The Company also expanded the
scope and level of its scientific and business development activities,
increasing the opportunities for new products. In 1997, the Company introduced
13 additional products and expanded in the United States through the acquisition
of Center, an FDA and USDA licensed manufacturer of allergy immunotherapy
products located in Port Washington, NY, and internationally through the
acquisitions of Bloxham, a veterinary diagnostic laboratory in Teignmouth,
England and CMG in Fribourg, Switzerland, which manufactures and markets allergy
diagnostic products for use in veterinary and human medicine, primarily in
Europe and Japan. Each of the Company's acquisitions was accounted for under
the purchase method of accounting and accordingly, the Company's financial
statements reflect the operations of these businesses only for the periods
subsequent to the acquisitions. In July 1997, the Company established a new
subsidiary, Heska AG, located near Basel, Switzerland, for the purpose of
managing its European operations.
The Company anticipates that it will continue to incur additional operating
losses as it introduces new products and continues its research and development
activities for products under development. There can be no assurance that the
Company will attain profitability or, if achieved, will remain profitable on a
quarterly or annual basis in the future. See "Business--Factors That May Affect
Results--Loss History and Accumulated Deficit; Uncertainty of Future
Profitability; Quarterly Fluctuations and Customer Concentration" in Part I of
this Form 10-K.
RESULTS OF OPERATIONS
Years Ended December 31, 1997, 1996 and 1995
Product revenues increased to $18.3 million in 1997, as compared to $8.0
million in 1996. The Company had no product revenues prior to 1996. The
revenue growth in 1997 and 1996 was primarily due to increased sales of the
Company's products and from consolidating revenues from acquired businesses.
Revenues from Diamond
32
<PAGE>
were $11.1 million in 1997 as compared to $7.3 million in 1996 subsequent to its
acquisition in April. Sales to one Diamond customer, Bayer, represented 29% and
64% of total revenues in 1997 and 1996, respectively.
Revenues from sponsored research and development were $2.6 million in 1997
as compared to $1.9 million in 1996 and $2.2 million in 1995. Fluctuations in
revenues from sponsored research and development are generally the result of
changes in the number of funded research projects as well as the achievement of
contract milestones. See Note 8 of Notes to Consolidated Financial Statements
for more detailed information about the amounts received under sponsored
research and development agreements in each of these periods. The Company
expects that revenues from sponsored research and development will decline in
future periods, reflecting the expiration of current funding commitments and the
Company's decision to fund its future research activities primarily from
internal sources.
Cost of goods sold totaled $14.2 million in 1997 as compared to $6.6
million in 1996. The Company did not incur cost of goods sold in 1995. The
resulting gross margin for 1997 increased to $4.1 million from $1.4 million in
1996, due primarily to increased product sales and manufacturing volume.
Research and development expenses increased to $20.0 million in 1997 from
$14.0 million in 1996 and $6.0 million in 1995. The increases in 1997 and 1996
are due primarily to increases in the level and scope of research and
development activities for potential products to be marketed by the Company.
The Company does not expect that significant increases in research and
development expenses will be required to maintain its current research and
development activities.
Selling and marketing expenses increased to $8.7 million in 1997 from $2.5
million in 1996. This increase reflects the expansion of the Company's sales
and marketing organization as Heska introduced new products and added field
sales force personnel. Selling and marketing expenses consist primarily of
salaries, commissions and benefits for sales and marketing personnel, market
research, product advertising and promotion, consulting, trade show costs and
sales agency fees. The Company did not incur selling and marketing expenses in
1995. The Company expects selling and marketing expenses to increase as sales
volume increases and new products are introduced to the marketplace.
General and administrative expenses increased to $10.9 million in 1997 from
$4.5 million in 1996 and $864,000 in 1995. The increases in 1997 and 1996
resulted from the growth of accounting and finance, human resources, legal,
administrative, information systems and facilities operations to support the
Company's increased business, financing and financial reporting requirements.
General and administrative expenses for 1997 include a one-time charge of
$750,000 for the termination of a supply agreement. General and administrative
expenses are expected to decrease as a percentage of revenues in future years.
Amortization of intangible assets and deferred compensation increased to
$2.4 million in 1997 from $1.1 million in 1996. Amortization of intangible
assets resulted from the Company's 1997 and 1996 business acquisitions. Net
intangible assets at December 31, 1997 and 1996 totaled $5.5 million and $3.5
million, respectively, as a result of these acquisitions. The amortization of
deferred compensation resulted in a non-cash charge to operations in the year
ended December 31, 1997 of $525,000. No amortization of deferred compensation
was recorded in 1996 or 1995. In connection with the grant of certain stock
options in the years ended December 31, 1997 and 1996, the Company recorded
aggregate deferred compensation of $1.4 million and $879,000, respectively,
representing the difference between the deemed value of the Common Stock for
accounting purposes and the option exercise price of such options at the date of
grant. The Company will incur a non-cash charge to operations of approximately
$560,000 per year through mid-2001 for amortization of deferred compensation.
Purchased research and development expenses for 1997 reflect a one-time
non-cash charge related to the acquisition in May 1997 of a development stage
company.
33
<PAGE>
Interest income increased to $1.6 million from $1.4 million in 1996 and
$172,000 in 1995, as a result of increased cash available for investment from
the proceeds of equity investments in 1997, 1996 and 1995. Interest expense
increased to $1.2 million from $325,000 in 1996 and $63,000 in 1995, due to an
increase in debt financing for laboratory and manufacturing equipment, debt
related to the Company's 1997 business acquisitions and the assumption of debt
in connection with 1996 business acquisitions.
The Company reported a net loss in 1997 of $37.3 million as compared to a
1996 net loss of $18.0 million and a 1995 net loss of $4.6 million. The
significant increase in losses over the periods are primarily due to increases
in research and development expenses, selling and marketing expenses and general
and administrative expenses in 1997 and 1996.
LIQUIDITY AND CAPITAL RESOURCES
In July 1997, the Company completed its initial public offering ("IPO") of
5,637,850 shares of Common Stock at a price of $8.50 per share, providing the
Company with net proceeds of approximately $43.9 million. Upon the completion of
the IPO, all outstanding shares of Preferred Stock were converted into
11,289,388 shares of Common Stock.
As of December 31, 1997, the Company had received aggregate proceeds of
$99.7 million from various equity transactions, including $43.9 million from the
July 1997 IPO, $36.0 million from the April 1996 private equity placement to
Novartis, $10.0 million from the 1995 private equity placement to Volendam
Investeringen N.V. and $9.5 million from private equity placements to Charter
Ventures from 1989 through 1996. The Company has also received funds totaling
$12.0 million through December 31, 1997 under collaborative agreements.
In addition, the Company has received proceeds from equipment financing
totaling $8.7 million through December 31, 1997. The Company also assumed $4.3
million in short and long-term debt in connection with its 1996 acquisitions and
assumed $3.8 million in long-term debt in connection with its 1997 acquisitions.
Capital lease obligations and term debt owed by the Company totaled $14.1
million as of December 31, 1997, with installments payable through 2006.
Expenditures for property and equipment totaled $6.1 million and $5.2 million
for the years ended December 31, 1997 and 1996, respectively. The Company
anticipates that it will continue to use capital equipment lease and debt
facilities to finance equipment purchases and, if possible, leasehold
improvements. The Company has secured lines of credit for its subsidiaries
totaling approximately $1.7 million, against which borrowings of approximately
$1.1 million were outstanding at December 31, 1997. These financing facilities
are secured by assets of the respective subsidiaries and corporate guarantees by
Heska Corporation. The Company expects to seek additional asset-based borrowing
facilities.
Net cash used for operating activities was $34.3 million and $14.1 million
for the years ended December 31, 1997 and 1996, respectively. Cash was used
primarily to fund research and development activities, expansion of sales and
marketing activities, expansion of the administrative infrastructure and general
working capital requirements.
The Company currently expects to spend approximately $5.0 million over the
next 12 months for capital equipment, including expenditures for the upgrading
of certain manufacturing operations to improve efficiencies as well as various
enhancements to assure ongoing compliance with certain regulatory requirements.
The Company expects to finance these expenditures through secured debt
facilities, where possible.
Prior to the IPO, the Company financed its acquisition activities through
the issuance of Preferred Stock. In 1997 and 1996, the Company issued Preferred
Stock valued at $1.2 million and $7.1 million, respectively, in connection with
its acquisitions. In addition, in 1997, the Company issued Common Stock valued
at $1.9 million in connection with an acquisition prior to the IPO. Subsequent
to the IPO, the Company has financed its
34
<PAGE>
acquisitions through the issuance of Common Stock valued at approximately
$775,000, the assumption of approximately $3.8 million in debt and the use of
cash totaling $3.0 million.
The Company's primary short-term needs for capital, which are subject to
change, are for continuing research and development efforts, its sales,
marketing and administrative activities, working capital and capital
expenditures relating to developing and expanding the Company's manufacturing
operations. At December 31, 1997, the Company's principal source of liquidity
was $28.7 million in cash, cash equivalents and short-term investments. The
Company expects its working capital requirements to increase over the next
several years as it introduces new products, expands its sales and marketing
capabilities, improves its manufacturing capabilities and facilities and
acquires businesses, technologies or products complementary to the Company's
business. The Company's future liquidity and capital funding requirements will
depend on numerous factors, including the extent to which the Company's products
under development are successfully developed and gain market acceptance, the
timing of regulatory actions regarding the Company's potential products, the
costs and the timing of expansion of sales, marketing and manufacturing
activities, the cost, timing and business management of current and potential
acquisitions, the procurement and enforcement of patents important to the
Company's business, the results of product trials and competition.
The Company believes that its available cash and cash from operations,
together with the proceeds of its follow-on public offering, which was completed
on March 3, 1998, will be sufficient to satisfy its funding requirements for
current operations for the next 12 months, assuming no significant uses of cash
in acquisition activities. Thereafter if cash generated from operations is
insufficient to satisfy the Company's working capital requirements, the Company
may need to raise additional capital to continue funding its research and
development activities, scaling up its manufacturing activities and expanding
its sales and marketing force. There can be no assurance that such additional
capital will be available on terms acceptable to the Company, if at all.
Furthermore, any additional equity financing may be dilutive to stockholders and
debt financing, if available, may include restrictive covenants. If adequate
funds are not available, the Company may be required to curtail its operations
significantly or to obtain funds through entering into collaborative agreements
or other arrangements on potentially unfavorable terms. The failure by the
Company to raise capital on acceptable terms when needed could have a material
adverse effect on the Company's business, financial condition or results of
operations.
NET OPERATING LOSS CARRYFORWARDS
As of December 31, 1997, the Company had a net operating loss ("NOL")
carryforward of approximately $59.5 million and approximately $1.1 million of
research and development ("R&D") tax credits available to offset future federal
income taxes. The NOL and tax credit carryforwards, which are subject to
alternative minimum tax limitations and to examination by the tax authorities,
expire from 2003 to 2011. The Company's acquisition of Diamond resulted in a
"change of ownership" under the provisions of Section 382 of the Internal
Revenue Code of 1986, as amended. As such, the Company will be limited in the
amount of NOLs incurred prior to the merger that it may utilize to offset future
taxable income. This limitation will total approximately $4.7 million per year
for periods subsequent to the Diamond acquisition. Similar limitations also
apply to utilization of R&D tax credits to offset taxes payable. In addition,
the Company believes that its follow-on public offering of Common Stock in March
1998 resulted in a further "change of ownership." The Company does not believe
that either of these limitations will affect the eventual utilization of its
total NOL carryforwards.
RECENT ACCOUNTING PRONOUNCEMENTS
The Company does not expect the adoption of any standards recently issued
by the Financial Accounting Standards Board to have a material impact on the
Company's financial position or results of operations.
35
<PAGE>
YEAR 2000 CONVERSION
The Company does not believe that the year 2000 conversion will have a
material adverse effect on its business. However, the Company has established
procedures to identify, evaluate and implement any necessary changes to computer
systems and applications. The Company is coordinating these activities with
suppliers, distributors, financial institutions and others with whom it does
business.
SUBSEQUENT EVENTS
Follow-On Public Offering
On March 3, 1998 the Company completed its follow-on public offering of
5,750,000 shares of common stock (including 500,000 shares offered by a
stockholder of the Company and an exercised underwriters' over-allotment option
for 750,000 shares) at a price of $9.875 per share, providing the Company with
net proceeds of approximately $49.0 million, after deducting underwriting
discounts and commissions of approximately $3.1 million and offering costs of
approximately $350,000.
Acquisition of Sensor Devices, Inc. ("SDI")
On March 6, 1998 the Company completed its acquisition of all of the
outstanding shares of SDI, a privately held company that manufactures, markets
and distributes a line of medical sensor products used in monitoring the vital
signs of veterinary patients, in exchange for 622,000 shares of the Company's
common stock valued at approximately $9.0 million. The acquisition has been
accounted for as a pooling-of-interests and, accordingly, in the future the
consolidated financial statements of the Company will be restated to include the
accounts of SDI for all periods presented.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Disclosures under this item are not required for the current period.
36
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants ............................................................... 38
Consolidated Balance Sheets as of December 31, 1996 and 1997 ........................................... 39
Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997 ............. 40
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997 ... 41
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997 ............. 42
Notes to Consolidated Financial Statements ............................................................. 43
</TABLE>
37
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Heska Corporation:
We have audited the accompanying consolidated balance sheets of Heska
Corporation (a Delaware corporation) and subsidiaries as of December 31, 1996
and 1997, and the related consolidated statements of operations, stockholders'
equity and cash flows for the three years ended December 31, 1995, 1996 and
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Heska Corporation and
subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for the three years ended December 31, 1995,
1996 and 1997, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Denver, Colorado
January 16, 1998
38
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31,
------------------
1996 1997
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................ $ 6,609 $ 10,673
Marketable securities.................................... 17,091 18,073
Accounts receivable, net................................. 749 4,374
Inventories, net......................................... 4,430 8,510
Other current assets..................................... 334 1,182
-------- --------
Total current assets................................... 29,213 42,812
Property and equipment, net................................ 8,209 15,814
Intangible assets, net..................................... 3,480 5,475
Restricted marketable securities and other assets.......... 1,267 1,147
-------- --------
Total assets........................................... $ 42,169 $ 65,248
======== ========
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current liabilities:
Accounts payable......................................... $ 1,634 $ 5,570
Accrued liabilities...................................... 940 1,522
Deferred revenue......................................... 1,413 284
Current portion of capital lease obligations............. 464 600
Current portion of long-term debt........................ 807 3,292
-------- --------
Total current liabilities.............................. 5,258 11,268
Capital lease obligations, less current portion............ 1,459 1,620
Long-term debt, less current portion....................... 2,942 8,575
Accrued pension liability.................................. 127 113
-------- --------
Total liabilities...................................... 9,786 21,576
-------- --------
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $.001 par value, 25,000,000
shares authorized; 10,459,999 and no shares issued and
outstanding, with an aggregate liquidation preference of
$62,588 and none, respectively.......................... 62,588 --
Common stock, $.001 par value, 40,000,000 shares autho-
rized; 1,021,645 and 18,854,015 shares issued and out-
standing, respectively.................................. 1 19
Additional paid-in capital............................... 1,067 113,091
Deferred compensation.................................... (879) (1,713)
Stock subscription receivable from officers.............. (118) (158)
Cumulative translation adjustment........................ -- 1
Accumulated deficit...................................... (30,276) (67,568)
-------- --------
Total stockholders' equity............................. 32,383 43,672
-------- --------
Total liabilities and stockholders' equity............. $ 42,169 $ 65,248
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
39
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1995 1996 1997
------- -------- --------
<S> <C> <C> <C>
Revenues:
Products, net.................................. $ -- $ 8,013 $ 18,299
Research and development....................... 2,230 1,946 2,578
------- -------- --------
2,230 9,959 20,877
Costs and operating expenses:
Cost of goods sold............................. -- 6,648 14,245
Research and development....................... 6,031 14,038 19,990
Selling and marketing.......................... -- 2,493 8,693
General and administrative..................... 864 4,540 10,937
Amortization of intangible assets and deferred
compensation.................................. -- 1,101 2,381
Purchased research and development............. -- -- 2,399
------- -------- --------
6,895 28,820 58,645
------- -------- --------
Loss from operations............................. (4,665) (18,861) (37,768)
Other income (expense):
Interest income................................ 172 1,356 1,571
Interest expense............................... (63) (325) (1,209)
Other, net..................................... (10) (145) 114
------- -------- --------
Net loss......................................... $(4,566) $(17,975) $(37,292)
======= ======== ========
Pro forma basic net loss per share (unaudited)... $ (1.35) $ (2.33)
======== ========
Shares used to compute pro forma basic net loss
per share (unaudited)........................... 13,307 16,033
</TABLE>
See accompanying notes to the consolidated financial statements
40
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except per share data)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL STOCK CUMULATIVE TOTAL
---------------- ------------- PAID-IN DEFERRED SUBSCRIPTION TRANSLATION ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION RECEIVABLE ADJUSTMENT DEFICIT EQUITY
------- ------- ------ ------ ---------- ------------ ------------ ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, Decem-
ber 31, 1994 3,345 $ 8,878 613 $ 1 $ 36 $ -- $ -- $-- $ (7,735) $ 1,180
Exercise of op-
tions to pur-
chase Common
Stock for cash
at $0.25-$0.35
per share....... -- -- 9 -- 3 -- -- -- -- 3
Issuance of Se-
ries E Preferred
Stock for can-
cellation of in-
debtedness, val-
ued at $3.25 per
share........... 196 638 -- -- -- -- -- -- -- 638
Issuance of Se-
ries E Preferred
Stock at $3.25
per share....... 3,077 10,000 -- -- -- -- -- -- -- 10,000
Issuance of Com-
mon Stock at
$0.35 per share
for stock sub-
scription re-
ceivable from
officers........ -- -- 297 -- 104 -- (104) -- -- --
Interest on
stock subscrip-
tion receivable
from officers... -- -- -- -- -- -- (6) -- -- (6)
Net loss........ -- -- -- -- -- -- -- -- (4,566) (4,566)
------- ------- ------ --- -------- ------- ----- ---- -------- -------
Balances, Decem-
ber 31, 1995..... 6,618 19,516 919 1 143 -- (110) -- (12,301) 7,249
Issuance of Se-
ries E Preferred
Stock in ex-
change for the
common stock of
Diamond Animal
Health, Inc.,
valued at $8.40
per share....... 842 7,072 -- -- -- -- -- -- -- 7,072
Grant of options
to purchase Com-
mon Stock....... -- -- -- -- 8 -- -- -- -- 8
Exercise of op-
tions to pur-
chase Common
Stock for cash
at $0.25-$0.35
per share....... -- -- 103 -- 37 -- -- -- -- 37
Issuance of Se-
ries F Preferred
Stock at $12.00
per share....... 3,000 36,000 -- -- -- -- -- -- -- 36,000
Interest on
stock subscrip-
tion receivable
from officers... -- -- -- -- -- -- (8) -- -- (8)
Deferred compen-
sation related
to options...... -- -- -- -- 879 (879) -- -- -- --
Net loss........ -- -- -- -- -- -- -- -- (17,975) (17,975)
------- ------- ------ --- -------- ------- ----- ---- -------- -------
Balances, Decem-
ber 31, 1996..... 10,460 62,588 1,022 1 1,067 (879) (118) -- (30,276) 32,383
Exercise of op-
tions to pur-
chase Common
Stock for cash
at $0.10-$5.00
per share....... -- -- 398 1 142 -- -- -- -- 143
Issuance of Com-
mon Stock at
$1.20 per share
for stock sub-
scription re-
ceivable from a
director........ -- -- 25 -- 30 -- (30) -- -- --
Issuance of Pre-
ferred Stock re-
lated to busi-
ness acquisi-
tions, valued at
$8.40-$12.00 per
share........... 124 1,236 -- -- -- -- -- -- -- 1,236
Issuance of Com-
mon Stock re-
lated to busi-
ness acquisi-
tions, valued at
$5.00-$13.50 per
share........... -- -- 454 -- 2,656 -- -- -- -- 2,656
Issuance of Com-
mon Stock at
$8.50 per share
upon the
Company's Ini-
tial Public Of-
fering, net..... -- -- 5,638 6 43,867 -- -- -- -- 43,873
Conversion of
Preferred Stock
into Common
Stock upon the
Company's Ini-
tial Public Of-
fering.......... (10,584) (63,824) 11,289 11 63,813 -- -- -- -- --
Issuance of Com-
mon Stock for
services........ -- -- 1 -- -- -- -- -- -- --
Cashless exer-
cise of warrants
to purchase Com-
mon Stock at
$2.50 per
share........... -- -- 5 -- -- -- -- -- -- --
Issuance of Com-
mon Stock under
the Employee
Stock Purchase
Plan for cash at
$7.23 per
share........... -- -- 22 -- 157 -- -- -- -- 157
Interest on
stock subscrip-
tion receivable
from officers
and a director.. -- -- -- -- -- -- (10) -- -- (10)
Foreign currency
translation ad-
justments....... -- -- -- -- -- -- -- 1 -- 1
Deferred compen-
sation related
to options...... -- -- -- -- 1,359 (1,359) -- -- -- --
Amortization of
deferred compen-
sation.......... -- -- -- -- -- 525 -- -- -- 525
Net loss........ -- -- -- -- -- -- -- -- (37,292) (37,292)
------- ------- ------ --- -------- ------- ----- ---- -------- -------
Balances, Decem-
ber 31, 1997..... -- $ -- 18,854 $19 $113,091 $(1,713) $(158) $ 1 $(67,568) $43,672
======= ======= ====== === ======== ======= ===== ==== ======== =======
</TABLE>
See accompanying notes to consolidated financial statements
41
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1995 1996 1997
------- -------- --------
<S> <C> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net loss........................................ $(4,566) $(17,975) $(37,292)
Adjustments to reconcile net loss to cash used
in operating activities:
Depreciation and amortization................. 253 1,072 2,290
Amortization of intangible assets and deferred
compensation................................. -- 1,101 2,381
Purchased research and development............ -- -- 2,399
Loss (gain) on disposition of assets.......... 16 60 (156)
Interest receivable on stock subscription..... -- (8) (10)
Increase (decrease) in accrued pension liabil-
ity.......................................... -- 62 (14)
Changes in operating assets and liabilities:
Accounts receivable, net.................... -- (508) (3,477)
Inventories, net............................ -- (408) (2,433)
Other assets................................ (83) (66) (968)
Contract receivable......................... 1,000 500 --
Accounts payable............................ 41 744 3,724
Accrued liabilities......................... -- 265 359
Deferred revenue............................ (386) 987 (1,129)
Other....................................... -- 121 22
------- -------- --------
Net cash used in operating activities..... (3,725) (14,053) (34,304)
------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of businesses, net of cash ac-
quired......................................... -- (478) (2,714)
Cash deposited in restricted cash account re-
lated to Bloxham acquisition................... -- -- (238)
Purchase of marketable securities............... -- (31,243) (18,718)
Purchase of restricted marketable securities.... -- (1,219) --
Proceeds from sale of marketable securities..... -- 14,152 18,342
Proceeds from disposition of property and equip-
ment........................................... -- -- 343
Purchases of property and equipment............. (348) (5,232) (6,140)
------- -------- --------
Net cash used in investing activities..... (348) (24,020) (9,125)
------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock.......... 3 37 44,173
Proceeds from borrowings........................ 527 3,318 5,527
Repayments of debt and capital lease obliga-
tions.......................................... (169) (1,500) (2,201)
Proceeds from issuance of preferred stock....... 10,000 36,000 --
------- -------- --------
Net cash provided by financing activi-
ties..................................... 10,361 37,855 47,499
------- -------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH........... -- -- (6)
------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.. 6,288 (218) 4,064
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR...... 539 6,827 6,609
------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR............ $ 6,827 $ 6,609 $ 10,673
======= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
42
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS
Heska Corporation (the "Company") discovers, develops, manufactures and
markets companion animal health products, primarily for dogs, cats and horses.
The Company operates two full scale United States Department of Agriculture
and Food and Drug Administration licensed facilities which manufacture
products for Heska and other companies. The Company also offers diagnostic
products to veterinarians at its Fort Collins, Colorado location and in the
United Kingdom through a wholly-owned subsidiary. In May 1997, the Company
reincorporated in Delaware.
The Company continues to incur substantial net losses due principally to its
research and development and sales and marketing activities. Cumulative net
losses from inception of the Company in 1988 through December 31, 1997 have
totaled $67.6 million.
The Company's ability to achieve profitable operations will depend primarily
upon its ability to commercialize products that are currently under
development. The Company's products are subject to long development and
regulatory approval cycles and there can be no assurance that the Company will
successfully develop, manufacture or market these products. During the period
required to develop its products, the Company intends to finance operations
with additional equity and debt financing. There can be no assurance that such
financing will be available when required or will be obtained under favorable
terms.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
the Company and of its wholly-owned subsidiaries since their respective dates
of acquisition. All material intercompany transactions and balances have been
eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents are stated at cost, which approximates market, and
include short-term highly liquid investments with original maturities of less
than three months. Cash equivalents consist of United States government
obligations.
Marketable Securities and Restricted Investments
The Company classifies its marketable securities as "available-for-sale"
and, accordingly, carries such securities at aggregate fair value. Unrealized
gains or losses, if material, are included as a separate component of
stockholders' equity.
At December 31, 1996 and 1997, these securities had an aggregate amortized
cost of $18.3 million and $18.7 million which approximated fair market value,
a maximum maturity of approximately nine months and three years, respectively,
and consisted entirely of U.S. government obligations. This included $1.2
million and $645,000 of restricted investments held as collateral for capital
leases (see Note 4) and $17.1 million and $18.1 million of short-term
marketable securities, respectively.
43
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The estimated fair value of the Company's long-term debt instruments are
based on borrowing rates that would be substantially equivalent to existing
rates, therefore, there is no material difference in the fair value and the
carrying value.
Inventories, net
Inventories are stated at the lower of cost or market using the first-in,
first-out method. If the cost of inventories exceeds fair market value,
provisions are made for the difference between cost and fair market value.
Inventories, net of provisions, consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1996 1997
------ ------
<S> <C> <C>
Raw materials............................................... $ 885 $1,477
Work in process............................................. 3,103 3,567
Finished goods.............................................. 442 3,466
------ ------
$4,430 $8,510
====== ======
</TABLE>
Property, Equipment and Intangible Assets
Property and equipment are recorded at cost and depreciated on a straight-
line or declining balance basis over the estimated useful lives of the related
assets. Amortization of assets acquired under capital leases is included with
depreciation expense on owned assets.
Leasehold improvements are amortized over the applicable lease period or
their estimated useful lives, whichever is shorter. Maintenance and repairs
are charged to expense when incurred, and major renewals and improvements are
capitalized.
Intangible assets consist of various assets arising from business
combinations and are amortized using the straight-line method over the period
of expected benefit.
The Company periodically reviews the appropriateness of the remaining life
of its property, equipment and intangible assets considering whether any
events have occurred or conditions have developed which may indicate that the
remaining life requires adjustment. After reviewing the appropriateness of the
remaining life and the pattern of usage of these assets, the Company then
assesses their overall recoverability by determining if the net book value can
be recovered through undiscounted future operating cash flows. Absent any
unfavorable findings, the Company continues to amortize and depreciate its
property, equipment and intangible assets based on the existing estimated
life.
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
ESTIMATED ----------------
USEFUL LIFE 1996 1997
-------------- ------- -------
<S> <C> <C> <C>
Land................................... N/A $ 233 $ 291
Buildings.............................. 10 to 20 years 453 1,811
Machinery and equipment................ 3 to 15 years 7,924 15,001
Leasehold improvements................. 7 to 15 years 1,103 2,456
------- -------
9,713 19,559
Less accumulated depreciation and amor-
tization.............................. (1,504) (3,745)
------- -------
$ 8,209 $15,814
======= =======
</TABLE>
44
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Intangible assets consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
ESTIMATED ----------------
USEFUL LIFE 1996 1997
------------- ------- -------
<S> <C> <C> <C>
Take-or-pay contract...................... 37 months $ 3,873 $ 3,873
Customer lists and market presence........ 7 years -- 2,848
Other intangible assets................... 2 to 10 years 707 1,700
------- -------
4,580 8,421
Less accumulated amortization............. (1,100) (2,946)
------- -------
$ 3,480 $ 5,475
======= =======
</TABLE>
The take-or-pay contract resulted from the acquisition of Diamond Animal
Health ("Diamond") in April 1996. The customer lists and market presence
resulted from the Company's 1997 acquisitions (see Note 3). The remaining
intangible assets resulted from the acquisitions of certain lines of business
and assets in 1996 and 1997 (see Note 3).
Revenue Recognition
Product revenues are recognized at the time goods are shipped to the
customer, with an appropriate provision for returns and allowances.
The Company recognizes revenue from sponsored research and development as
research activities are performed or as development milestones are completed
under the terms of the research and development agreements. Costs incurred in
connection with the performance of sponsored research and development are
expensed as incurred. The Company defers revenue recognition related to
payments received during the current year for research activities to be
performed in the following year.
Cost of Sales
Royalties payable in connection with certain research and development
agreements (see Note 8) are reflected in cost of sales as incurred.
Unaudited Pro Forma Basic Net Loss Per Share
Due to the automatic conversion of all shares of convertible preferred stock
into common stock following the closing of the Company's initial public
offering (the "IPO"), historical basic net loss per common share is not
considered meaningful as it would differ materially from the pro forma basic
net loss per common share and common stock equivalent shares given the changes
in the capital structure of the Company.
Pro forma basic net loss per common share is computed using the weighted
average number of common shares outstanding during the period. Diluted net
loss per common share is not presented as the effect of common equivalent
shares from stock options and warrants is anti-dilutive. Pursuant to
Securities and Exchange Commission Staff Accounting Bulletin No. 83 ("SAB
83"), common stock and common stock equivalent shares issued by the Company
during the 12 months immediately preceding the filing of the IPO, plus shares
which became issuable during the same period as a result of the granting of
options to purchase common stock, have been included in the calculation of
basic weighted average number of shares of common stock as if they were
outstanding for all periods presented (using the treasury stock method).
Accordingly, only those common stock and common stock equivalent shares issued
during the 12 months immediately preceding the filing of the IPO have been
included in the computation of pro forma basic net loss per common share. In
addition, the Company has assumed the conversion of convertible preferred
stock issued into common stock for all periods presented.
45
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
128, Earnings per Share in 1997. The adoption of SFAS No. 128 had no effect on
previously reported unaudited pro forma net loss per share. The following
table shows the reconciliation of the numerators and denominators of the pro
forma basic net loss per share computations as required under SFAS No. 128 (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
1996
-----------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Weighted average common shares outstand-
ing (actual)........................... N/A 938 N/A
Assumed conversion of preferred stock
from original date of issuance......... N/A 11,183 N/A
Effect of common stock and common stock
equivalents issued within one year
prior to IPO (SAB 83).................. N/A 1,186 N/A
------
Pro forma basic net loss per share...... $(17,975) 13,307 $(1.35)
======== ====== ======
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
1997
-----------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Weighted average common shares outstand-
ing (actual)........................... N/A 9,570 N/A
Assumed conversion of preferred stock
from original date of issuance......... N/A 5,870 N/A
Effect of common stock and common stock
equivalents issued within one year
prior to IPO (SAB 83).................. N/A 593 N/A
------
Pro forma basic net loss per share...... $(37,292) 16,033 $(2.33)
======== ====== ======
</TABLE>
- --------
N/A=Not applicable
Foreign Currency Translation
The functional currencies of the Company's foreign subsidiaries are the
Pound Sterling ("(Pounds)") for Bloxham Laboratories Limited ("Bloxham") and
the Swiss Franc ("CHF") for the others (See Note 3). Assets and liabilities of
the Company's foreign subsidiaries are translated using the exchange rate in
effect at the balance sheet date. Revenue and expense accounts are translated
using an average of exchange rates in effect during the period. Cumulative
translation gains and losses, if material, are shown in the consolidated
balance sheets as a separate component of stockholders' equity. Exchange gains
and losses arising from transactions denominated in foreign currencies (i.e.
transaction gains and losses) are recognized in current operations. To date,
the Company has not entered into any forward contracts or hedging
transactions.
3. BUSINESS ACQUISITIONS
The Company's acquisitions have all been accounted for under the purchase
method of accounting and, accordingly, the operating results of these
acquisitions are included in the Company's consolidated results of operations
from their respective dates of acquisition.
During the year ended December 31, 1997, the Company completed a number of
acquisitions, including: the February 1997 acquisition of all of the capital
stock of Bloxham, a clinical reference laboratory located in the United
Kingdom; the July 1997 purchase of the allergy immunotherapy products business
of Center Laboratories' Allergy Business ("Center"), a Food and Drug
Administration and United States Department of
46
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Agriculture licensed manufacturer of allergy immunotherapy products, including
allergenic extracts, located in Port Washington, New York; the September 1997
acquisition of all of the outstanding shares of capital stock of CMG Centre
Medical des Grand'Places SA ("CMG"), a Swiss corporation which manufactures
and markets allergy diagnostic products for use in veterinary and human
medicine primarily in Europe and Japan; the May 1997 acquisition of all of the
capital stock of a privately held development stage company specializing in
allergy research; and the October 1997 purchase of certain assets related to
product formulas and packaging technology.
These transactions were valued at a total of approximately $10.5 million and
were consummated by issuing 124,000 shares of Preferred Stock valued at
approximately $1.2 million and 453,500 shares of Common Stock valued at
approximately $2.7 million, assuming approximately $3.8 million in debt, and
approximately $2.7 million cash, including transaction expenses, net of cash
acquired.
The excess purchase price over fair value of the net tangible assets
acquired was approximately $6.2 million, of which $2.4 million was allocated
to purchased research and development and $3.8 million was allocated to
intangible assets. The total purchase price of the acquisitions was allocated
as follows (in thousands):
<TABLE>
<S> <C>
Cash............................................................. $ 99
Other current assets............................................. 2,061
Property and equipment........................................... 3,030
Purchased research and development............................... 2,399
Intangible assets................................................ 3,841
-------
11,430
Less liabilities assumed:
Current liabilities............................................. (734)
Long-term liabilities........................................... (207)
-------
(941)
-------
Total value of acquisitions...................................... $10,489
=======
</TABLE>
The following unaudited pro forma summary presents the consolidated
revenues, net loss and pro forma basic net loss per share as if the Company's
1996 and 1997 acquisitions had been consummated as of January 1, 1996, based
on unaudited financial statements provided by the respective sellers (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1996 1997
-------- --------
(UNAUDITED)
<S> <C> <C>
Revenues............................................ $ 21,770 $ 23,258
======== ========
Net loss............................................ $(23,946) $(36,315)
======== ========
Pro forma basic net loss per share.................. $ (1.73) $ (2.24)
======== ========
Shares used to compute pro forma basic net loss per
share.............................................. 13,831 16,239
</TABLE>
The pro forma results give effect to certain adjustments, including
amortization of intangibles, increased interest costs associated with
assumption of debt, and additional depreciation and amortization expenses due
to increased book basis of the property and equipment. The pro forma results
have been prepared for comparative purposes only and are not necessarily
indicative of the results that would have been attained had the acquisitions
occurred at the beginning of 1996, or of the results which may occur in the
future.
47
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. CAPITAL LEASE OBLIGATIONS
The Company has entered into certain capital lease agreements for laboratory
equipment, office equipment, machinery and equipment, and computer equipment
and software. For the years ended December 31, 1996 and 1997, the Company had
capitalized machinery and equipment under capital leases of approximately $2.0
million and $3.1 million, respectively. The capitalized cost of the equipment
under capital leases is included in the accompanying balance sheets under the
respective asset classes. Under the terms of the Company's lease agreements,
the Company is required to make monthly payments of principal and interest
through the year 2002, at interest rates ranging from 4.05% to 20.00% per
annum. The equipment under the capital leases serves as security for the
leases.
The Company has a capital lease with a commercial bank which requires the
Company to pledge cash or investments as additional collateral for the lease.
The lease agreement, which has a borrowing limit of $2.0 million calls for a
collateral balance equal to 50% and 25% of the borrowed amount when the
Company's annual revenues reach $18.0 million and $28.0 million respectively.
The lease also requires the Company to maintain minimum levels of cash and
cash equivalent balances throughout the term of the lease. As of December 31,
1996 and 1997, the Company was in compliance with all covenants of the master
lease and held restricted U.S. Treasury Bonds of approximately $1.2 million
and $645,000 as additional collateral under the lease, respectively.
The future annual minimum required payments under capital lease obligations
as of December 31, 1997 were as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1998............................................................. $ 761
1999............................................................. 634
2000............................................................. 576
2001............................................................. 568
2002............................................................. 65
------
Total minimum lease payments.................................. 2,604
Less amount representing interest............................. (384)
------
Present value of net minimum lease payments................... 2,220
Less current portion.......................................... (600)
------
Total long-term capital lease obligations................... $1,620
======
</TABLE>
48
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. LONG-TERM DEBT AND NOTES PAYABLE
Long term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1996 1997
------ ------
<S> <C> <C>
Heska and Diamond obligations:
Equipment financing due in monthly installments of $184
through November 2001, and final payments totaling $979 due
March 2000 through December 2001, with stated interest rates
between 14.0% and 18.1%, secured by certain equipment and
fixtures.................................................... $1,689 $5,551
Center obligations:
Promissory note to EM Industries (see Note 3) due in July
2000, with quarterly interest payments at a stated interest
rate of prime (8.5% at December 1997) plus 3/4%............. -- 3,464
Diamond obligations:
9.5% real estate mortgage to Hartford-Carlisle Bank due in
monthly installments of $3 and a final payment of the unpaid
principal balance and accrued interest of $59 in October
2004........................................................ 214 201
Term note to Iowa Business Growth guaranteed by the Small
Business Administration ("SBA"), due in monthly installments
of approximately $3 through July 2004, including interest at
prime (8.5% at December 1997) plus 0.7%..................... 169 152
Promissory note to the Iowa Department of Economic
Development ("IDED"), due in annual installments of $15
through June 2004, with the remaining $125 forgivable in
March 1999 based upon levels of employment at Diamond, with
a stated interest rate of 3.0% and a 9.5% imputed interest
rate, net of an unamortized discount of $39 and $34,
respectively................................................ 189 183
Promissory note to the City of Des Moines, due in monthly
installments of $2 through May 2004, with a stated interest
rate of 3.0% and a 9.5% imputed interest rate, net of an
unamortized discount of $26 and $23, respectively........... 128 112
10.0% promissory notes, due in quarterly installments of $50
through March 1999, with the balance due March 1999......... 498 348
Unsecured promissory note to customer, due in monthly
installments of $25 through June 1999, with no stated
interest rate and a 9.5% imputed interest rate, net of an
unamortized discount of $82 and $30, respectively........... 655 407
$1,000 commercial bank line of credit, due October 1998, with
monthly interest payments, with a stated interest rate of
10.5%....................................................... -- 667
Heska obligations:
Promissory notes to former Bloxham shareholders (see Note 3)
due in semi-annual interest payments through February 2007,
due on demand in whole or in part at any time after February
18, 1998 in increments of (Pounds)1 together with accrued
interest, with a stated interest rate of 4.5%, denominated
in pounds sterling.......................................... -- 329
Promissory note to Bioproducts, paid in full in 1997......... 207 --
Bloxham obligations:
Real estate mortgage due in monthly principal payments of
(Pounds)1 and quarterly interest payments through December
2006, with a stated interest rate of a bank's base rate
(7.25% at December 1997) plus 2.75%, denominated in pounds
sterling.................................................... -- 117
(Pounds)100 commercial bank line of credit, due January 1999,
with semi-annual interest payments, with a stated interest
rate of LIBOR (5.7% at December 1997) plus 4.0%............. -- 165
CMG obligations:
CHF400 commercial bank line of credit, due upon demand, with
quarterly interest payments, with a stated interest rate of
5.5%, plus 0.25% per quarter................................ -- 171
------ ------
3,749 11,867
Less installments due within one year.......................... (807) (3,292)
------ ------
$2,942 $8,575
====== ======
</TABLE>
49
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The SBA, IDED, City of Des Moines and 10.0% promissory notes are secured by
a first security interest in essentially all assets of Diamond except assets
acquired through capital leases, and are included as cross-collateralized
obligations by the respective lenders. These notes, along with the unsecured
note to the customer, were assumed as a result of the 1996 Diamond
acquisition. The $1.0 million commercial bank line of credit requires Diamond
to maintain a minimum net worth of $3.5 million.
One of the Company's Swiss subsidiaries also has a CHF 250,000 line of
credit with a stated interest rate of 5.5%, plus 0.25% per quarter. There were
no borrowings against this credit facility as of December 31, 1997.
The Company's other debt instruments are secured by the assets of the
respective subsidiaries and general corporate guarantees by Heska Corporation.
As of December 31, 1997, the Company was in compliance with all covenants of
the debt agreements.
Maturities of long-term debt and notes payable as of December 31, 1997 were
as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1998............................................................. $ 3,292
1999............................................................. 2,037
2000............................................................. 5,265
2001............................................................. 800
2002............................................................. 85
Thereafter....................................................... 388
-------
$11,867
=======
</TABLE>
6. ACCRUED PENSION LIABILITY
Diamond has a noncontributory defined benefit pension plan covering all
employees who have met the eligibility requirements. The plan provides monthly
benefits based on years of service which are subject to certain reductions if
the employee retires before reaching age 65. Diamond's funding policy is to
make the minimum annual contribution that is required by applicable
regulations. Effective October 1992, Diamond froze the plan, restricting new
participants and benefits for future service.
Net pension cost for Diamond's defined benefit pension plan consisted of the
following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1996 1997
------ ------
<S> <C> <C>
Interest cost on projected benefit obligation............. $ 55 $ 74
Actual return on plan assets.............................. 14 (96)
Net amortization and deferral............................. (70) 28
------ ------
Net periodic pension cost............................. $ (1) $ 6
====== ======
</TABLE>
The following table sets forth the plan's funded status and amounts
recognized in the accompanying balance sheets (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1996 1997
------ -------
<S> <C> <C>
Actual present value of benefit obligations:
Vested benefit obligation.............................. $1,089 $ 1,117
Accumulated benefit obligation......................... $1,089 $ 1,117
Projected benefit obligation........................... $1,089 $ 1,117
Less: plan assets, consisting primarily of bonds and
commercial mortgage notes............................. (962) (1,004)
------ -------
Projected benefit obligation in excess of plan assets.. $ 127 $ 113
====== =======
</TABLE>
50
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Assumptions used by Diamond in the determination of the pension plan
information consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1996 1997
------ ------
<S> <C> <C>
Discount rate............................................. 7.00% 7.00%
Expected long-term ratio of return on plan assets......... 7.75% 7.75%
</TABLE>
7. INCOME TAXES
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes.
As of December 31, 1997 the Company had approximately $59.5 million of net
operating loss ("NOL") carryforwards for income tax purposes and approximately
$1.1 million of research and development tax credits available to offset
future federal income tax, subject to limitations for alternative minimum tax.
The NOL and credit carryforwards are subject to examination by the tax
authorities and expire in various years from 2003 through 2011. The Tax Reform
Act of 1986 contains provisions that may limit the NOL and credit
carryforwards available for use in any given year upon the occurrence of
certain events, including significant changes in ownership interest. A change
in ownership of a company of greater than 50% within a three-year period
results in an annual limitation on the Company's ability to utilize its NOL
carryforwards from tax periods prior to the ownership change. The acquisition
of Diamond in April 1996 resulted in such a change of ownership and the
Company estimates that the resulting NOL carryforward limitation will be
approximately $4.7 million per year for periods subsequent to April 19, 1996.
The Company does not believe that this limitation will affect the eventual
utilization of its total NOL carryforwards.
The acquisition of Diamond was completed on a tax free basis. Accordingly,
the basis of the assets for financial reporting purposes exceeds the basis of
the assets for income tax purposes. The Company has recorded a deferred tax
liability related to this basis difference. As the Company had previously
recorded a valuation allowance against its deferred tax assets, the Company
reduced its valuation allowance in an amount equal to the deferred tax
liability at the date of the merger.
The Company's NOLs represent a previously unrecognized tax benefit.
Recognition of these benefits requires future taxable income, the attainment
of which is uncertain, and therefore, a valuation allowance has been
established for the entire tax benefit and no benefit for income taxes has
been recognized in the accompanying consolidated statements of operations.
Deferred tax assets and liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 CHANGES 1997
------------ ------- ------------
<S> <C> <C> <C>
Deferred tax assets:
Research and development credits.... $ 731 $ 417 $ 1,148
Inventory valuation and reserves.... 71 136 207
Deferred revenue.................... 90 (52) 38
Pension liability................... 49 (6) 43
Accrued compensation................ 122 (1) 121
Amortization of intangible assets... 86 132 218
Other............................... 11 22 33
Net operating loss carryforwards.... 10,317 12,450 22,767
-------- ------- -------
11,477 13,098 24,575
Less valuation allowance............ (10,818) (13,064) (23,882)
-------- ------- -------
659 34 693
Deferred tax liability:
Property and equipment.............. (659) (34) (693)
-------- ------- -------
(659) (34) (693)
-------- ------- -------
Net deferred taxes................ $ -- $ -- $ --
======== ======= =======
</TABLE>
51
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. RESEARCH AND DEVELOPMENT AGREEMENTS
In June 1994, the Company entered into agreements with Bayer AG ("Bayer"), a
pharmaceutical company, pursuant to which Bayer is funding and assisting in
the development of certain technologies. In return, the Company granted Bayer
the option to license the technologies to manufacture certain products for
sale, as well as the right to distribute for all parts of the world, except
Japan and East Asia. To the extent the Company is determined to have
manufacturing capabilities, under the terms of the agreement, Bayer will be
required to purchase its requirements for such products from the Company.
In exchange for the above, Bayer agreed to provide research funding to the
Company, of which $1.5 million was received in 1995, $500,000 in 1996 and
$550,000 in 1997. The Company expects to receive periodic research payments
until June 1999 as the related expenses are incurred and specified milestones
are reached. In connection with this contract, the Company recognized research
revenue of $1.5 million, $1.3 million and $1.2 million for the years ended
December 31, 1995, 1996 and 1997, respectively.
Additionally, the Company will receive royalties based on a percentage of
any net sales of products developed under the agreements not manufactured by
the Company.
Bayer may terminate the agreement for convenience at any anniversary, with
90 days notice, in which case, the product rights revert to the Company. In
the event of such a termination, the Company would be required to pay Bayer a
royalty at a modest rate on net sales of these products exceeding a specified
threshold. The total amount of this royalty would not exceed the amount of
research funding provided by Bayer.
In January 1993, the Company entered into an agreement with Eisai Co., Ltd.
("Eisai") pursuant to which Eisai obtained the exclusive right to market
certain products in Japan and East Asia. Under the terms of the agreement, the
Company is to receive periodic payments for support of research, one half of
which is only to be received upon completion of certain milestones. The
Company recognized $337,000 as research and development revenue for the year
ended December 31, 1995 related to this agreement. No revenue was recognized
for the years ended December 31, 1996 or 1997. Although the agreement does not
expire until 2008, Eisai may terminate its research support for any product
with 90 days written notice.
In October 1996, the Company and Diamond entered into three related
agreements with a pharmaceutical company concerning the research, development,
licensing, manufacturing and marketing of certain products. Under the research
and development agreement, Diamond granted a non-exclusive, royalty-free,
paid-up right and license to develop, manufacture and market certain of its
bovine products. In return, the pharmaceutical company agreed to fund certain
research costs associated with the development of these products, subject to
the achievement of certain milestones. In connection with this research
funding, the Company recognized research and development revenue of $210,000
during the fourth quarter of 1996 and $1.1 million for the year ended December
31, 1997. As additional consideration, the Company received an exclusive,
royalty-free, worldwide license for certain feline biological vaccines. The
Company also has a three-year agreement with the pharmaceutical company for
the manufacture of these feline vaccines.
The Company estimates its future cash flows from its existing research and
development contracts, subject to scheduled completion of specified
milestones, are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1998...................................... $1,195
1999...................................... 925
2000...................................... 600
------
$2,720
======
</TABLE>
52
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. COMMITMENTS AND CONTINGENCIES
The Company holds certain rights to market and manufacture all products
developed under certain research and development agreements with various
entities. In connection with such agreements, the Company has agreed to pay
the entities royalties on net product sales. In the year ended December 31,
1997, $15,000 in royalties became payable under these agreements.
In connection with an equity investment by a pharmaceutical firm in April
1996 (see Note 10)(the "Investor"), the Company granted the Investor the
rights, co-exclusive with the Company's rights, to market two products under
development by the Company, the flea control vaccine and feline heartworm
vaccine. The Company and the Investor have a revenue sharing arrangement for
net sales of these products through the year 2005.
In addition to the marketing agreements described above, the Company entered
into a pharmaceutical screening cooperation agreement with the Investor,
pursuant to which the two parties may enter into joint development
arrangements to develop pharmaceutical and vaccine products. In addition, to
the extent that the Company decides to grant a license to any third party for
any products or technology for companion or food animal applications, the
Investor must be offered first right to negotiate to acquire such license.
In connection with the acquisition of Center (see Note 3), the Company
entered into a sales and marketing agreement with a domestic distribution
company which grants the right to the distribution company to market and sell
Center's allergenic extracts for human use. The agreement expires in December
2002, with sales commission rates which vary from 20 to 25%.
The Company contracts with various parties that conduct research and
development on the Company's behalf. In return, the Company generally receives
the right to commercialize any products resulting from these contracts. In the
event the Company licenses any technology developed under these contracts, the
Company will generally be obligated to pay royalties at specified percentages
of future sales of products utilizing the licensed technology.
The Company has entered into operating leases for its office and research
facilities and certain equipment with future minimum payments as of December
31, 1997 as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1998...................................... $1,438
1999...................................... 1,224
2000...................................... 1,040
2001...................................... 859
2002...................................... 804
Thereafter................................ 1,498
------
$6,863
======
</TABLE>
The Company had rent expense of $208,000, $564,000 and $1.3 million in 1995,
1996 and 1997, respectively.
53
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. CAPITAL STOCK
Preferred Stock
Preferred stock consisted of the following until July 1997 when the Company
completed a public offering and converted all of the outstanding shares of
Series A, B, C, D, E and F Preferred Stock into 11,289,388 shares of Common
Stock:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1996 1997
------- ------
(IN THOUSANDS)
<S> <C> <C>
Series A, $.001 par value, 300,000 shares authorized; 300,000
and no shares issued and outstanding, converted into Common
Stock in connection with the IPO............................ $ 300 $ --
Series B, $.001 par value, 250,000 shares authorized; 250,000
and no shares issued and outstanding, respectively,
converted into Common Stock in connection with the IPO...... 500 --
Series C, $.001 par value, 1,346,400 shares authorized;
1,340,000 and no shares issued and outstanding,
respectively, converted into Common Stock in connection with
the IPO..................................................... 3,350 --
Series D, $.001 par value, 824,992 shares authorized; 800,000
and no shares issued and outstanding, respectively,
converted into Common Stock in connection with the IPO...... 2,600 --
Series E, $.001 par value, 5,100,000 shares authorized;
4,769,999 and no shares issued and outstanding,
respectively, converted into Common Stock in connection with
the IPO..................................................... 19,838 --
Series F, $.001 par value, 3,000,000 shares authorized;
3,000,000 and no shares issued and outstanding,
respectively, converted into Common Stock in connection with
the IPO..................................................... 36,000 --
------- ------
$62,588 $ --
======= ======
</TABLE>
In 1996, the Company increased the total authorized number of preferred
shares to 25,000,000. Preferred stock may be issued in one or more series with
rights and dividend preferences determined by the board of directors.
In April 1996, the Company issued 3,000,000 shares of its Series F preferred
stock to a pharmaceutical firm (the "Investor") at $12.00 per share. In
connection with this equity investment, the Company and the Investor signed
certain joint marketing, pharmaceutical screening and product development
agreements. As a result of the agreements between the Company and the
Investor, the Investor was granted first right of refusal to negotiate for
future distribution of certain products. In addition, the two parties will
participate with royalty rights on sales of specified products (see Note 9).
Common Stock
In July 1997, the Company completed its IPO of 5,637,850 shares of Common
Stock (including an underwriters' over-allotment option exercised for 637,850
shares) at a price of $8.50 per share, providing the Company with net proceeds
of approximately $43.9 million. Upon closing of the IPO, all of the
outstanding shares of Series A, B, C, D, E and F Preferred Stock were
automatically converted into 11,289,388 shares of Common Stock.
54
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company has granted stock purchase rights to acquire 322,000 shares of
common stock to key executives pursuant to the 1994 Key Executive Stock Plan.
As of December 31, 1997, executives had exercised all of these stock purchase
rights by executing promissory notes payable to the Company. The fair market
value of the underlying Common Stock equaled the exercise price on the date of
grant and the date of exercise. The notes mature in six years, bear interest
at 7.5% and are secured by a pledge of certain shares of the Company's Common
Stock. Under the terms of the Key Executive Stock Plan, if the purchaser's
relationship with the Company ceases for any reason within 48 months of the
grant date, the Company may, within 90 days following termination, repurchase
at the original exercise price all of the stock which has not vested. The
stock vests ratably over a 48 month period. During the years ended December
31, 1996 and 1997, 170,350 and 250,834 shares had vested and been released
from the purchase option, respectively.
Stock Option Plans
The Company has a stock option plan which authorizes the grant of stock
options and stock purchase rights to employees, officers, directors and
consultants of the Company to purchase shares of common stock. In 1997, the
board of directors adopted the 1997 Stock Incentive Plan (the "1997 Plan") and
terminated two prior option plans. All shares remaining available for grant
under the terminated plans were rolled into the 1997 Plan. The Board also
increased the total number of shares of Common Stock reserved for issuance
under the 1997 Plan to 3,495,254. The number of shares reserved for issuance
under the plan increases automatically on January 1 of each year by a number
equal to the lesser of (a) 1,500,000 shares or (b) 5% of the shares of Common
Stock outstanding on the immediately preceding December 31. The number of
shares reserved for issuance as of January 1, 1998 was 4,437,955.
The stock options granted by the board of directors may be either incentive
stock options ("ISO") or nonstatutory stock options ("NSO") and expire as
determined by the board of directors. The purchase price for options under the
plan may be no less than 100% of fair market value for ISOs or 85% of fair
market value for NSOs. Options granted will expire no later than the tenth
anniversary subsequent to the date of grant or 90 days following termination
of employment, except in cases of death or disability, in which case the
options will remain exercisable for up to twelve months. Under the terms of
the 1997 Plan, in the event the Company is sold or merged, options granted
will either be assumed by the surviving corporation or vest immediately.
Statement Of Financial Accounting Standards No. 123 ("SFAS 123")
SFAS 123, Accounting for Stock-Based Compensation, defines a fair value
based method of accounting for employee stock options, employee stock
purchases, or similar equity instruments. However, SFAS 123 allows the
continued measurement of compensation cost for such plans using the intrinsic
value based method prescribed by APB Opinion No. 25, Accounting for Stock
Issued to Employees ("APB 25"), provided that pro forma disclosures are made
of net income or loss, assuming the fair value based method of SFAS 123 had
been applied. The Company has elected to account for its stock-based
compensation plans under APB 25; accordingly, for purposes of the pro forma
disclosures presented below, the Company has computed the fair values of all
options granted during 1995, 1996 and 1997, using the Black-Scholes pricing
model and the following weighted average assumptions:
<TABLE>
<CAPTION>
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
Risk-free interest rate.................. 5.93% 6.12% 6.49%
Expected lives........................... 3.30 years 3.11 years 4.93 years
Expected volatility...................... 80% 80% 72%
Expected dividend yield.................. 0% 0% 0%
</TABLE>
55
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
To estimate expected lives of options for this valuation, it was assumed
options will be exercised at varying schedules after becoming fully vested
dependent upon the income level of the option holder. For measurement
purposes, options have been segregated into three income groups, and estimated
exercise behavior of option recipients varies from zero to one year from the
date of vesting, dependent on income group (less highly compensated employees
are expected to have shorter holding periods). All options are initially
assumed to vest. Cumulative compensation cost recognized in pro forma basic
net income or loss with respect to options that are forfeited prior to vesting
is adjusted as a reduction of pro forma compensation expense in the period of
forfeiture. Because the Company's common stock has only recently been publicly
traded, the expected market volatility was estimated for 1995 and 1996 using
the estimated average volatility of four publicly held companies which the
Company believes to be similar with respect to the markets in which they
compete. Actual volatility of the Company's stock has been slightly lower than
this estimate since the date of the Company's IPO and was used for 1997
computations. Fair value computations are highly sensitive to the volatility
factor assumed; the greater the volatility, the higher the computed fair value
of the options granted.
The total fair value of options granted was computed to be approximately
$1.2 million and $3.9 million for the years ended December 31, 1996 and 1997,
respectively. The amounts are amortized ratably over the vesting periods of
the options. Pro forma stock-based compensation, net of the effect of
forfeitures, was $367,000 and $1.8 million for 1996 and 1997, respectively.
A summary of the Company's stock option plans is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1997
------------------- -------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
--------- -------- --------- --------
<S> <C> <C> <C> <C>
Outstanding at beginning of period..... 1,279,592 $0.2973 1,898,992 $0.6250
Granted.............................. 794,624 $1.1031 1,022,250 $3.6177
Cancelled............................ (72,942) $0.4634 (96,017) $1.8866
Exercised............................ (102,282) $0.3559 (398,340) $0.3579
--------- ---------
Outstanding at end of period........... 1,898,992 $0.6250 2,426,885 $1.8795
========= =========
Exercisable at end of period........... 850,662 $0.4049 983,977 $0.8951
========= =========
</TABLE>
The weighted average exercise prices and weighted average estimated fair
value of options granted during the years ended December 31, 1996 and 1997
were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1996 1997
-------------------------- ----------------------------
WEIGHTED WEIGHTED
AVERAGE WEIGHTED AVERAGE WEIGHTED
NUMBER ESTIMATED AVERAGE ESTIMATED AVERAGE
OF FAIR EXERCISE NUMBER OF FAIR EXERCISE
OPTIONS VALUE PRICE OPTIONS VALUE PRICE
------- --------- -------- --------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Exercise price equal to
estimated fair value... 133,523 $0.2400 $0.7147 167,400 $5.4622 $9.3684
Exercise price less than
estimated fair value... 661,101 1.8223 1.2000 854,850 3.5078 2.4916
------- ---------
794,624 $1.5157 $1.1031 1,022,250 $3.8279 $3.6177
======= =========
</TABLE>
The Company recorded deferred compensation (as calculated under APB 25) of
$879,000 as of December 31, 1996 and $1.4 million during the year ended
December 31, 1997 based on the difference between the estimated fair value of
the underlying common stock of $1.80 per share and $4.65 per share,
respectively, and
56
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the relative weighted average exercise prices of options of $1.20 per share
and $2.49 per share, respectively, for options to purchase 661,101 and 854,850
shares of Common Stock, respectively. Deferred compensation is being amortized
over the applicable vesting periods, or 48 months. Amortization of deferred
compensation totaled $525,000 in the year ended December 31, 1997.
Amortization of deferred compensation during the year ended December 31, 1996
was not material.
The following table summarizes information about stock options outstanding
and exercisable at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- --------------------------
NUMBER OF WEIGHTED
OPTIONS AVERAGE WEIGHTED WEIGHTED
OUTSTANDING AT REMAINING AVERAGE NUMBER OF OPTIONS AVERAGE
EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE EXERCISABLE AT EXERCISE
PRICES 1997 LIFE IN YEARS PRICE DECEMBER 31, 1997 PRICE
-------- -------------- ------------- -------- ----------------- --------
<S> <C> <C> <C> <C> <C>
$0.15 90,492 3.58 $ 0.1500 90,492 $ 0.1500
$0.25 156,258 5.48 $ 0.2500 156,258 $ 0.2500
$0.35 579,768 7.43 $ 0.3500 318,450 $ 0.3500
$1.20 1,036,156 8.72 $ 1.2000 347,384 $ 1.2000
$3.00 233,876 9.21 $ 3.0000 42,506 $ 3.0000
$5.00 168,235 9.37 $ 5.0000 21,645 $ 5.0000
$8.63-$12.50 146,850 9.60 $ 8.9131 7,127 $ 8.7591
$13.63-$14.50 15,250 9.83 $13,8154 115 $13.9477
--------- -------
$0.15-$14.50 2,426,885 8.17 $ 1.8795 983,977 $ 0.8951
========= =======
</TABLE>
Employee Stock Purchase Plan (the "ESPP")
Under the 1997 Employee Stock Purchase Plan, the Company is authorized to
issue up to 250,000 shares of common stock to its employees. Employees of the
Company and its U.S. subsidiaries who work at least 20 hours per week are
eligible to participate. Under the terms of the plan, employees can choose to
have up to 10% of their annual base earnings withheld to purchase the
Company's common stock. The purchase price of the stock is 85% of the lower of
its beginning-of-enrollment period or end-of-measurement period market price.
Each enrollment period is two years, with six month measurement periods ending
July 30 and December 31.
The Company has computed the fair values of stock purchased under the ESPP
in 1997, using the Black-Scholes pricing model and the following weighted
average assumptions:
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Risk-free interest rate........................................... 5.69%
Expected lives.................................................... 2 years
Expected volatility............................................... 72%
Expected dividend yield........................................... 0%
</TABLE>
The total fair value of stock sold under the ESPP was computed to be
approximately $103,000 for the year ended December 31, 1997 with a weighted-
average fair value of the purchase rights granted of $4.73 per share. Pro
forma stock-based compensation, net of the effect of forfeitures, was $103,000
in 1997 for the ESPP.
57
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Pro Forma Basic Net Loss per Share under SFAS 123
If the Company had accounted for all of its stock-based compensation plans
in accordance with SFAS 123, the Company's net loss would have been reported
as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Net loss:
As reported.............................. $ (4,566) $(17,975) $(37,292)
======== ======== ========
Pro forma (unaudited).................... $ (4,604) $(18,342) $(39,101)
======== ======== ========
Pro forma basic net loss per share:
As reported (unaudited).................. $ (1.35) $ (2.33)
======== ========
Pro forma (unaudited).................... $ (1.38) $ (2.44)
======== ========
</TABLE>
Stock Warrants
The Company had issued warrants to purchase 6,400 shares of Series C
preferred stock at an exercise price of $2.50 per share and 6,225 shares, 267
shares and 18,500 shares of Series D preferred stock at an exercise price of
$3.25 per share in connection with certain leases discussed in Note 4. Upon
the closing of the IPO, the rights were converted to warrants to purchase the
Company's common stock at the original exercise prices. These warrants expire
on November 7, 1998, June 7, 2002, December 30, 2002 and October 20, 2003,
respectively. In September 1997, the Company issued 5,323 shares of common
stock in exchange for the warrant for 6,400 shares at an exercise price of
$2.50 per share in a cashless "net" exercise. No other warrants have been
exercised as of December 31, 1997.
11. MAJOR CUSTOMERS
The Company had sales of greater than 10% of total revenue to only one
customer during the years ended December 31, 1996 and 1997. This customer,
which represented 64% and 29% of total revenues, respectively, purchases
vaccines from Diamond.
58
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1995 1996 1997
---- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash paid for interest...................................... $ 55 $ 331 $1,119
Non-cash investing and financing activities:
Issuance of debt related to acquisitions.................. -- 207 3,465
Issuance of preferred stock and options to purchase common
stock in exchange for the common stock of Diamond, net of
cash acquired............................................ -- 7,058 --
Issuance of common and preferred stock related to acquisi-
tions, net of cash
acquired................................................. -- -- 3,892
Reduction in future payment on debt to customer in ex-
change for the granting of certain rights................ -- 1,250 --
Issuance of preferred stock in exchange for cancellation
of indebtedness, including accrued interest.............. 639 -- --
Purchase of assets under direct capital lease financing... 416 -- 894
</TABLE>
13. GEOGRAPHIC SEGMENT REPORTING
The Company manufactures and markets its products in two major geographic
areas, North America and Europe. The Company's two manufacturing facilities
are located in North America.
All revenues from research and development are earned in North America by
Heska or Diamond. There have been no significant exports from North America or
Europe.
In 1997, European subsidiaries purchased products from North America for
sale to European customers. Transfer prices to foreign subsidiaries are
intended to allow the North American companies to produce profit margins
commensurate with their sales and marketing efforts. Prior to 1997, the
Company had neither foreign subsidiaries, nor foreign revenues. Certain
information by geographic area is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
----------------------------------
NORTH AMERICA EUROPE CONSOLIDATED
------------- ------ ------------
<S> <C> <C> <C>
Product revenues, net........................ $ 16,075 $2,224 $ 18,299
Loss from operations......................... $(37,187) $ (581) $(37,768)
Identifiable assets.......................... $ 63,379 $1,869 $ 65,248
</TABLE>
59
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
Certain information required by Part III is incorporated by reference to
the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission in connection with the solicitation of proxies for the
Company's 1998 Annual Meeting of Stockholders (the "Proxy Statement").
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this section is incorporated by reference to
the information in the section entitled "Election of Directors--Directors and
Nominees for Directors" in the Proxy Statement. The required information
concerning executive officers of the Company is contained in the section
entitled "Executive Officers of the Registrant" in Part I of this Form 10-K.
Each director and each officer of the Company who is subject to Section 16
of the Securities Exchange Act of 1934 (the "Act") is required by Section 16(a)
of the Act to report to the Securities and Exchange Commission by a specified
date his or her transactions in the Company's securities. Based on information
provided by such persons to the Company, there were no compliance exceptions to
this requirement in fiscal 1997.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this section is incorporated by reference to
the information in the sections entitled "Election of Directors--Directors'
Compensation" and "Executive Compensation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this section is incorporated by reference to
the information in the section entitled "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Novartis, a principal stockholder of the Company, has ongoing marketing
rights to certain of the Company's products under development and is a party to
a Screening and Development Agreement and Right of First Refusal Agreement with
the Company. See "Business--Collaborative Agreements" for a description of
these agreements. Novartis obtained such rights in connection with its purchase
of the Company's Preferred Stock in April 1996 (which converted into Common
Stock upon the closing of the Company's initial public offering), but did not
make any separate payments for the rights.
In May 1997, the Company acquired all of the outstanding capital stock of
Astarix Institute, Inc. ("Astarix") in exchange for 70,000 shares of the
Company's Series E Preferred Stock (which converted into Common Stock upon the
closing of the Company's initial public offering) plus 376,000 shares of the
Company's Common Stock. Charter Ventures II, L.P., a principal stockholder of
the Company, was the only preferred stockholder of Astarix and received 70,000
shares of the Company's Series E Preferred Stock in this transaction.
60
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Form 10-K:
(1) FINANCIAL STATEMENTS:
Reference is made to the Index to Consolidated Financial Statements
under Item 8 in Part II of this Form 10-K.
(2) FINANCIAL STATEMENT SCHEDULES:
All schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
(3) EXHIBITS:
The exhibits listed below are required by Item 601 of Regulation S-K.
Each management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form 10-K has been identified.
Exhibit
Number Notes Description of Document
- ------- ----- -----------------------
4.2 (1) First Amended Investors' Rights Agreement by and among
Registrant and certain stockholders of Registrant dated as
of April 12, 1996.
4.3 (1) Form of warrant to purchase Series C Preferred Stock.
4.4 (1) Form of warrant to purchase Series D Preferred Stock.
9.1 (1) Voting Agreement by and among Registrant and certain
stockholders of Registrant, dated as of April 12, 1996.
10.1+ (1) Collaborative Agreement between Registrant and Eisai Co.,
Ltd. dated January 25, 1993.
10.2+ (1) Canine Heartworm Cooperation Agreement between Registrant
and Bayer AG dated as of June 10, 1994.
10.3+ (1) Feline Toxoplasmosis Cooperation Agreement between
Registrant and Bayer AG dated as of June 10, 1994.
10.4+ (1) Product Supply and License Agreement between Registrant and
Atrix Laboratories, Inc. dated May 1, 1995, as amended June
23, 1995.
10.5+ (1) Screening and Development Agreement between Ciba-Geigy
Limited and Registrant, dated as of April 12, 1996.
10.6 (1) Right of First Refusal Agreement between Ciba-Geigy Limited
and Registrant, dated as of April 12, 1996.
10.7 (1) Marketing Agreement between Registrant and Ciba-Geigy
Limited dated as of April 12, 1996.
10.8+ (1) Marketing Agreement between Registrant and Ciba-Geigy
Corporation dated as of April 12, 1996.
10.9+ (1) Manufacturing and Supply Agreement between and among
Diamond Animal Health, Inc., Agrion Corporation, Diamond
Scientific Co. and Miles Inc. dated December 31, 1993 and
Amendment and Extension thereto dated September 1, 1995.
61
<PAGE>
10.10* (1) Employment Agreement between Registrant and Robert B.
Grieve dated January 1, 1994, as amended March 4, 1997.
10.11* (1) Employment Agreement between Registrant and Fred M.
Schwarzer dated November 1, 1994, as amended March 4, 1997.
10.12* (1) Employment Agreement between Registrant and R. Lee Seward
dated October 17, 1994.
10.13* (1) Employment Agreement between Registrant and Louis G. Van
Daele dated April 14, 1996.
10.14+ (2) Supply Agreement between Registrant and Quidel Corporation
dated July 3, 1997.
10.15* (1) Restricted Stock Purchase Agreement dated February 28, 1995
by and between Registrant and Fred M. Schwarzer.
10.16* (1) Restricted Stock Purchase Agreement dated February 28, 1995
by and between Registrant and R. Lee Seward.
10.17* (1) Restricted Stock Purchase Agreement dated January 11, 1997
by and between Registrant and Denis H. Pomroy.
10.18* (1) Form of Indemnification Agreement entered into between
Registrant and its directors and certain officers.
10.19* (1) 1997 Incentive Stock Plan of Registrant.
10.20* (1) Forms of Option Agreement.
10.21* (1) 1997 Employee Stock Purchase Plan of Registrant.
10.22 (1) Lease Agreement dated March 8, 1994 between Sharp Point
Properties, LLC and Registrant.
10.23 (1) Lease Agreement dated as of June 27, 1996 between GB
Ventures and Registrant.
10.24 (1) Lease Agreement dated as of July 11, 1996 between GB
Ventures and Registrant.
10.25 (1) Lease Agreement dated as of December 31, 1993 between
Miles, Inc. and Diamond Animal Health, Inc., as amended
September 1, 1995.
10.26* (3) Employment Agreement between Registrant and Guiseppe
Miozzari dated July 1, 1997.
10.27* Employment Agreement between Registrant and John A.
Shadduck dated January 27, 1997.
21.1 Subsidiaries of the Company.
23.1 Consent of Arthur Andersen LLP.
24.1 Power of Attorney (see page 63 of this Form 10-K).
27.1 (3) Financial Data Schedule
Notes
-----
* Indicates management contract or compensatory plan or
arrangement.
+ Confidential treatment has been granted with respect to certain
portions of these agreements.
(1) Filed with Registrant's Registration Statement on Form S-1 (File
No. 333-25767).
(2) Filed with the Registrant's Form 10-Q for the quarter ended
September 30, 1997.
(3) Filed with Registrant's Registration Statement on Form S-1 (File
No. 333-44835)
(b) Reports on Form 8-K:
There were no Reports on Form 8-K filed by the Company during the quarter
ended December 31, 1997.
62
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 23, 1998.
HESKA CORPORATION
By /s/ FRED M. SCHWARZER
------------------------------------------
Fred M. Schwarzer
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Fred M. Schwarzer, Robert B. Grieve,
Deborah E. Robbins, William G. Skolout, Paul Hudnut and A. Lynn DeGeorge, and
each of them, his or her true and lawful attorneys-in-fact, each with full power
of substitution, for him or her in any and all capacities, to sign any
amendments to this report on Form 10-K and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact or their substitute or substitutes may do or cause to be done
by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated:
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<S> <C> <C>
/s/ FRED M. SCHWARZER President and Chief Executive Officer March 23, 1998
- ---------------------------------- (Principal Executive Officer) and Director
Fred M. Schwarzer
/s/ WILLIAM G. SKOLOUT Chief Financial Officer (Principal March 23, 1998
- ---------------------------------- Financial and Accounting Officer)
William G. Skolout
/s/ A. BARR DOLAN Chairman of the Board March 23, 1998
- ----------------------------------
A. Barr Dolan
/s/ ROBERT B. GRIEVE, PH.D. Chief Scientific Officer and Vice March 23, 1998
- ---------------------------------- Chairman
Robert B. Grieve, Ph.D.
/s/ LYLE A. HOHNKE, PH.D. Director March 23, 1998
- ----------------------------------
Lyle A. Hohnke, Ph.D.
/s/ DENIS H. POMROY Director March 23, 1998
- ----------------------------------
Denis H. Pomroy
/s/ LYNNOR B. STEVENSON, PH.D. Director March 23, 1998
- ----------------------------------
Lynnor B. Stevenson, Ph.D.
/s/ GUY L. TEBBIT Director March 23, 1998
- ----------------------------------
Guy L. Tebbit
</TABLE>
63
<PAGE>
EXHIBIT 10.27
EMPLOYMENT AGREEMENT
--------------------
THIS EMPLOYMENT AGREEMENT ("Agreement") is entered into by and between
Heska Corporation, a California corporation with its principal office at 1825
Sharp Point Drive, Fort Collins, Colorado 80525 ("Company") and John A. Shadduck
("Employee"), effective as of January 27, 1997.
W I T N E S S E T H:
WHEREAS Company desires to employ Employee to act as its Executive Vice
President, Operations, in an at-will capacity; and
WHEREAS Employee wishes to act as Company's Executive Vice President,
Operations as an employee in an at-will capacity;
N O W, T H E R E F O R E, in consideration of the mutual covenants and
warranties contained herein, the parties agree as follows:
1. Employment. Company hereby employs Employee as its Executive Vice
----------
President, Operations, and Employee hereby accepts such employment.
2. Duties and Responsibilities. Employee shall serve as Executive Vice
---------------------------
President, Operations of Company, with such duties and responsibilities as may
be assigned to him from time to time by the Board of Directors of Company, and
with such on-going daily duties and responsibilities as are typically entailed
in such position. Employee shall devote his full time and energies to such
duties.
3. Compensation. Company shall pay Employee, as compensation for services
------------
rendered under this Agreement, compensation at the rate of $180,000 per year,
payable in accordance with the usual and customary payroll practices of Company.
If for any reason during any given year, Employee does not work an entire year,
other than normal vacations as provided hereunder, the compensation will be
prorated to compensate only for the actual time worked.
4. Expenses. Company shall reimburse Employee for his reasonable out-of-
--------
pocket expenses incurred in connection with the business of Company, including
travel away from the Company's facilities, upon presentation of appropriate
written receipts and reports and subject to the customary practices of Company.
In addition, the Company will reimburse Employee all of his reasonable
expenses related to moving his household to the Fort Collins area, including
reasonable travel expenses, moving expenses and temporary living expenses. Such
reimbursement will be made upon presentation of appropriate written receipts.
The Company will not reimburse Employee for any
<PAGE>
brokerage commissions or other expenses relating to the sale of property in
Texas or the purchase of a home in Colorado. Employee understands that some of
this reimbursement may be treated as taxable income as required under federal or
state tax rules.
5. Employee Benefits. During the term of his employment hereunder,
-----------------
Employee shall be entitled to receive the same benefits that the Board of
Directors establishes generally for the officers and other employees of
Company. These may include from time to time, medical insurance, life
insurance, paid vacation time and medical disability insurance.
6. Termination.
-----------
(a) At-Will. This is an at-will employment agreement and does not bind
-------
either of the parties to any specific term or duration.
(i) Employee is free to terminate employment with Company at any
time, for any reason, or for no reason.
(ii) Company is free to terminate the employment of Employee at any
time, for any reason or for no reason, for cause or without cause, and without
any prior notice.
(b) Severance Pay.
-------------
(i) Upon involuntary termination of his employment, Employee will be
entitled to severance pay as provided below unless he is terminated for "cause,"
as defined below. If Company terminates Employee for "cause," Employee will not
be entitled to any severance pay and shall only receive pay and benefits which
Employee earned as of the date of termination.
(ii) Definition of "Cause". The parties agree that for the purposes
---------------------
of this Employment Agreement, a termination for "cause" will be deemed to have
occurred when Company terminates Employee's employment because of the occurrence
of any of the following events:
(A) Employee shall die, be adjudicated to be mentally incompetent or
become mentally or physically disabled to such an extent that Employee is
unable to perform his duties under this Employment Agreement for a period
of ninety (90) consecutive days;
(B) Company shall discontinue its business (for the purpose of this
provision, a merger, acquisition or sale of Company in which Company's
business is carried on by the surviving entity shall not be deemed to be a
discontinuance of the business of Company);
-2-
<PAGE>
(C) Employee shall commit any material breach of his obligations
under this Agreement;
(D) Employee shall commit any material breach of any material
fiduciary duty to Company;
(E) Employee shall be convicted of, or enter a plea of nolo
contendere to, any crime involving moral turpitude or dishonesty, whether a
felony or misdemeanor, or any crime which reflects so negatively on Company
to be detrimental to Company's image or interests;
(F) Employee shall commit repeated insubordination or refusal to
comply with any reasonable request of the Board of Directors of Company
relating to the scope or performance of Employee's duties;
(G) Employee shall possess any illegal drug on Company premises or
Employee shall be under the influence of illegal drugs or abusing
prescription drugs or alcohol while on Company business or on Company
premises; or
(H) Employee shall conduct himself in a manner which, in the good
faith and reasonable determination of the Board of Directors, demonstrates
Employee's gross unfitness to serve.
(iii) In the event that severance pay is due to Employee as a result
of the involuntary termination of his employment without "cause" within three
years of the date of this Agreement, Employee will be paid one (1) year's salary
in twelve equal monthly installments, with the first such installment due 15
days after the date of such termination and with the following eleven
installments due monthly thereafter on Company's regular payroll dates.
(iv) In the event that severance pay is due to Employee as a result
of the involuntary termination of his employment without "cause" three or more
years after the date of this Agreement, Employee will be paid six (6) months'
salary in six equal monthly installments, with the first such installment due 15
days after the date of such termination and with the following five installments
due monthly thereafter on Company's regular payroll dates.
7. Proprietary Information. Employee agrees that he will promptly execute
-----------------------
Company's standard employee proprietary information and assignment of inventions
agreement. For three (3) years following his termination as an employee,
Employee agrees not to undertake any employment or activity wherein the loyal
and complete fulfillment of the duties of such employment or activity would
necessarily call upon Employee to reveal, to make judgments on or otherwise to
use, any proprietary business information or trade secrets of Company's business
to which Employee had access by reason of Company's business.
-3-
<PAGE>
8. Attorneys' Fees. If any legal action arises under this Agreement or by
---------------
reason of any asserted breach of it, the prevailing party shall be entitled to
recover all costs and expenses, including reasonable attorneys' fees, incurred
in enforcing or attempting to enforce any of the terms, covenants or conditions,
including costs incurred prior to commencement of legal action, and all costs
and expenses, including reasonable attorneys' fees, incurred in any appeal from
an action brought to enforce any of the terms, covenants or conditions. For
purposes of this section, "prevailing party" includes without limitation a party
who agrees to dismiss a suit or proceeding upon the other's payment or
performance of substantially the relief sought.
9. Notices. Any notice to be given to Company under the terms of this
-------
Agreement shall be addressed to Company at the address of its principal place of
business, and any notice to be given to Employee shall be addressed to him at
his home address last shown on the records of Company, or to such other address
as a party shall have given notice of hereunder.
10. Miscellaneous. This Agreement shall be governed by the laws of the
-------------
State of Colorado as applied to contracts between residents of that state to be
performed wholly within that state. This Agreement is the entire agreement of
the parties with respect to the subject matter hereof and supersedes all prior
understandings and agreements. This Agreement may be modified only by a writing
signed by both parties.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement the
day and year hereinabove written.
HESKA CORPORATION
By: /s/ Deborah E. Robbins
_____________________________________
Its: VP
____________________________________
/s/ John A. Shadduck
________________________________________
John A. Shadduck
-4-
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF COMPANY
Astarix Institute, Inc., a Delaware corporation
Bloxham Laboratories Limited, a public limited company organized under the laws
of England
Center Laboratories, Inc., a Delaware corporation
Centre Medical des Grand'Places S. A., a corporation incorporated under the laws
of Switzerland
Diamond Animal Health, Inc., an Iowa corporation
Heska AG, a corporation incorporated under the laws of Switzerland
Heska Holding AG, a corporation incorporated under the laws of Switzerland
Sensor Devices, Inc., a Wisconsin corporation
<PAGE>
[ARTHUR ANDERSEN LLP LETTERHEAD APPEARS HERE]
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Annual Report on Form 10-K, into Heska Corporation's
previously filed Registration Statement File No. 333-47129, Registration
Statement File No. 333-30951 and Registration Statement File No. 333-34111.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Denver, Colorado
March 23, 1998
