<PAGE>
Filed Pursuant to Rule 424(b)(4)
Reg. No. 333-44835
PROSPECTUS
5,000,000 SHARES
[LOGO OF HESKA]
COMMON STOCK
----------------
Of the 5,000,000 shares of Common Stock, $.001 par value (the "Common
Stock"), of Heska Corporation ("Heska" or the "Company") offered hereby,
4,500,000 shares are being offered by the Company and 500,000 shares are being
offered by a stockholder of the Company (the "Selling Stockholder"). See
"Principal and Selling Stockholders." The Company will not receive any of the
proceeds from the sale of the shares of Common Stock by the Selling
Stockholder.
The Common Stock is traded on the Nasdaq National Market under the symbol
"HSKA." On February 25, 1998, the last sale price of the Common Stock as
reported on the Nasdaq National Market was $9 7/8 per share. See "Price Range
of Common Stock."
SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK
OFFERED HEREBY.
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
================================================================================
<TABLE>
<CAPTION>
PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDER
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share..................... $9.875 $.54 $9.335 $9.335
- --------------------------------------------------------------------------------
Total(3)...................... $49,375,000 $2,700,000 $42,007,500 $4,667,500
</TABLE>
================================================================================
(1) The Company and the Selling Stockholder have agreed to indemnify the
several Underwriters against certain liabilities, including certain
liabilities under the Securities Act of 1933, as amended. See
"Underwriting."
(2) Before deducting expenses payable by the Company estimated at $350,000.
(3) The Company has granted the Underwriters an option to purchase up to an
additional 750,000 shares of Common Stock, exercisable within 30 days
after the date hereof, solely to cover over-allotments, if any. If such
option is exercised in full, the total Price to Public, Underwriting
Discount and Proceeds to Company will be $56,781,250, $3,105,000 and
$49,008,750, respectively. See "Underwriting."
----------------
The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if issued to and accepted by them, subject to
approval of certain legal matters by counsel for the Underwriters and certain
other conditions. The Underwriters reserve the right to withdraw, cancel or
modify such offer and to reject orders in whole or in part. It is expected
that the delivery of the shares of Common Stock will be made in New York, New
York on or about March 3, 1998.
----------------
MERRILL LYNCH & CO.
CREDIT SUISSE FIRST BOSTON
HAMBRECHT & QUIST
----------------
The date of this Prospectus is February 25, 1998.
<PAGE>
[INSIDE FRONT COVER OF PROSPECTUS]
[ARTWORK]
DESCRIPTION OF ART ON INSIDE FRONT COVER
[PHOTOGRAPHS OF: MAN AND CHILD WITH DOG; CAT; A HESKA LABORATORY
AND THE HESKA PERIODONTAL DISEASE THERAPEUTIC PRODUCT APPEARS HERE.]
[PHOTOGRAPHS OF: MAN AND CHILD WITH DOG, CAT, A HESKA LABORATORY AND THE HESKA
PERIODONTAL THERAPEUTIC DISEASE PRODUCT APPEARS HERE]
CAPTIONS READ: (1) THE COMPANION ANIMAL HEALTH MARKET IS APPROXIMATELY $3
BILLION WORLDWIDE WITH $1.5 BILLION IN THE UNITED STATES; (2)
ISSUED PATENTS: 13; APPLICATIONS PENDING: 80; (3) HESKA'S
APPROXIMATELY 475 EMPLOYEES HOLD 51 PH.D. AND 33 D.V.M DEGREES;
AND (4) HESKA INTRODUCED 13 NEW PRODUCTS IN 1997. THERE ARE 15
PRODUCTS CURRENTLY ON THE MARKET WITH OVER 25 IN DEVELOPMENT.
Certain persons participating in this offering may engage in transactions that
stabilize, maintain, or otherwise affect the price of the common stock. Such
transactions may include stabilizing, the purchase of common stock to cover
syndicate short positions and the imposition of penalty bids. For a
description of these activities, see "Underwriting."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS (AND SELLING GROUP
MEMBERS) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK
ON NASDAQ IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING."
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information, including "Risk Factors" and the consolidated financial statements
and related notes appearing elsewhere in this Prospectus. Except as otherwise
noted, all information in this Prospectus assumes no exercise of the
Underwriters' over-allotment option. This Prospectus 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 those discussed or projected by the forward-
looking statements. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in the sections entitled "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business," as well as those discussed elsewhere in
this Prospectus.
THE COMPANY
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 USDA and FDA
licensed facilities which manufacture products for Heska and other companies.
Heska has corporate partnerships with Novartis AG, Bayer AG and Eisai Co., Ltd.
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 is large and rapidly growing. 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. 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. In
the United States, the introduction of novel products has been an important
factor in market growth. In addition to rapid growth, the Company believes that
the relative lack of biotechnology-based products and faster, less expensive
regulatory processes for new products make the companion animal health market
very attractive.
The Company's goal is to become the companion animal health care company of
choice for veterinarians. The Company's strategy is to assist veterinarians in
providing comprehensive patient care by offering a broad line of diagnostic,
therapeutic and vaccine products. The Company believes that its recently
introduced products address unmet veterinary medical needs and are expanding
the companion animal health market. For example, in 1997, the Company
introduced a family of allergy diagnostic products that it believes is the new
state-of-the-art in allergy diagnosis. Heska also recently introduced a unique
therapeutic product for canine periodontal disease. In addition to these
recently introduced products, many of Heska's products currently in research
and development will also serve to advance the state of veterinary medicine.
For example, the Company is developing canine and feline flea control and
heartworm vaccines. The development of such vaccines would be a scientific and
commercial breakthrough.
Heska sells its products in the United States directly to veterinarians
through its direct sales force of 33 people and 12 veterinary distributors
employing more than 300 field sales representatives. Heska also recently began
selling its products in Europe through veterinary distributors. In addition to
its direct sales force and sales agents, the Company markets its products and
builds Heska brand recognition through the use of trade shows, scientific
conferences and print advertising. The Company has sold its products to
approximately 6,500 of the approximately 20,000 small animal veterinary clinics
in the United States within the last 12 months. The Company believes its market
penetration will continue to increase rapidly with the introduction and
adoption of its new products.
3
<PAGE>
The Company also intends to continue to grow through the acquisition of
complementary products and businesses. The Company's recent acquisitions
include: the April 1996 purchase of Diamond Animal Health, Inc., a USDA and FDA
licensed biological and pharmaceutical manufacturing facility; the February
1997 purchase of Bloxham Laboratories Limited, one of the largest veterinary
diagnostic laboratories in the United Kingdom; the July 1997 purchase of the
allergy immunotherapy products business of Center Laboratories, 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 company which
manufactures and markets allergy diagnostic products for use in veterinary and
human medicine, primarily in Europe and Japan. The Company believes that
significant acquisition opportunities exist in the companion animal health
market and plans to continue to actively pursue such opportunities.
Heska has entered into agreements with three major pharmaceutical companies,
Novartis AG, Bayer AG and Eisai Co., Ltd., to provide funding for its research
and development programs. In April 1996, Novartis made a $36.0 million equity
investment in the Company. These partners have rights to market certain
resulting Heska products.
The Company is located at 1825 Sharp Point Drive, Fort Collins, Colorado
80525 and its telephone number is (970) 493-7272. Heska and its subsidiaries
currently employ approximately 475 persons. As used in this Prospectus, "Heska"
and the "Company" refer to Heska Corporation, a Delaware corporation, and its
consolidated subsidiaries, unless the context requires otherwise. HESKA, the
HESKA logo, DIAMOND, the DIAMOND logo, BLOXHAM, the BLOXHAM logo, CENTER, the
CENTER logo and HESKA PERIODONTAL DISEASE THERAPEUTIC are trademarks of the
Company. This prospectus also includes trade names and trademarks of companies
other than Heska.
RECENT DEVELOPMENTS
On February 3, 1998, Heska entered into a definitive agreement to acquire all
of the outstanding shares of Sensor Devices, Inc., a privately-held Wisconsin
corporation ("SDI"), in a stock-for-stock transaction valued at approximately
$9 million. SDI manufactures, markets and distributes a line of medical sensor
products that are used in monitoring the vital signs of veterinary patients.
The transaction, which is expected to close by March 31, 1998, is subject to
various closing conditions, including SDI shareholder approval.
4
<PAGE>
THE OFFERING
The offering of 5,000,000 shares of the Company's Common Stock in the United
States and Canada is referred to herein as the "Offering."
<TABLE>
<S> <C>
Common Stock Offered:
By the Company........................... 4,500,000 shares
By the Selling Stockholder............... 500,000 shares
---------
Total................................ 5,000,000 shares
=========
Common Stock to be outstanding after the
Offering.................................... 23,354,015 shares(1)
Use of Proceeds.............................. The net proceeds to be received by the
Company from the Offering will be used for
research and development, sales and
marketing activities, expansion and
development of manufacturing operations,
potential acquisitions, working capital and
general corporate purposes. See "Use of
Proceeds."
Nasdaq National Market Symbol................ HSKA
</TABLE>
- --------
(1) Based on shares outstanding at December 31, 1997. Does not include (i)
3,495,254 shares of Common Stock reserved for issuance at December 31, 1997
under the Company's stock option plans, under which there were options
outstanding as of that date to purchase an aggregate of 2,426,885 shares of
Common Stock, (ii) 24,992 shares of Common Stock issuable upon exercise of
warrants outstanding as of December 31, 1997 or (iii) approximately 650,000
shares of Common Stock to be issued in connection with the pending
acquisition of SDI. See "Capitalization," "Management--Stock Option Plan,"
"Description of Capital Stock--Warrants" and Note 10 of Notes to
Consolidated Financial Statements.
RISK FACTORS
In addition to the other information contained in this Prospectus, the
discussion of risk factors on pages 7 through 13 of this Prospectus should be
considered carefully in evaluating an investment in the Common Stock. The risks
of investing in the Common Stock include the following factors: "Dependence on
Development and Introduction of New Products;" "Loss History and Accumulated
Deficit; Uncertainty of Future Profitability; Quarterly Fluctuations and
Customer Concentration;" "Limited Sales and Marketing Experience; Dependence on
Others;" "Highly Competitive Industry;" "Uncertainty of Patent and Proprietary
Technology Protection; License of Technology of Third Parties;" "Limited
Manufacturing Experience and Capacity; Reliance on Contract Manufacturers;"
"Government Regulation; No Assurance of Obtaining Regulatory Approvals;"
"Future Capital Requirements; Uncertainty of Additional Funding;" "Potential
Difficulties in Management of Growth; Identification and Integration of
Acquisitions;" "Dependence on Key Personnel;" "Potential Product Liability;
Limited Insurance Coverage;" "Risk of Liability from Release of Hazardous
Materials;" "Possible Volatility of Stock Price;" "Potential Adverse Market
Impact of Shares Eligible for Future Sale;" "Broad Discretion to Allocate
Offering Proceeds;" "Control by Directors, Executive Officers, Principal
Stockholders and Affiliated Entities;" "Anti-Takeover Effect of Certain Charter
and Bylaw Provisions and Delaware Law;" and "Forward-Looking Statements."
5
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1993 1994 1995 1996 1997
------- ------ ------- -------- --------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERA-
TIONS 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 devel-
opment....................... -- -- -- -- 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 comput-
ing pro forma net loss per
share(1)....................... 13,307 16,033
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
------------------------
ACTUAL AS ADJUSTED(2)
-------- --------------
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities...... $ 28,746 $70,404
Working capital....................................... 31,544 73,202
Total assets.......................................... 65,248 106,906
Long-term obligations................................. 10,308 10,308
Accumulated deficit................................... (67,568) (67,568)
Total stockholders' equity............................ 43,672 85,330
</TABLE>
- --------
(1) See Note 2 of Notes to Consolidated Financial Statements for information
concerning the computation of pro forma net loss per share.
(2) Adjusted to reflect the sale by the Company of 4,500,000 shares of Common
Stock offered hereby and the application of the estimated net proceeds
therefrom. See "Use of Proceeds" and "Capitalization."
6
<PAGE>
The discussion in this Prospectus 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 those discussed or projected by the forward-looking
statements. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in the sections entitled
"Risk Factors," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Business," as well as those discussed
elsewhere in this Prospectus.
RISK FACTORS
In evaluating the Company's business, prospective investors should consider
carefully the following risk factors in addition to the other information
presented in this Prospectus.
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 United States Department of Agriculture
("USDA"), the United States Food and Drug Administration ("FDA"), the
Environmental Protection Agency ("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 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 Animal Health,
Inc. ("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
7
<PAGE>
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."
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 AG ("Novartis"), Bayer
AG ("Bayer") and Eisai Co., Ltd. ("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 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
8
<PAGE>
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 United States
Patent and Trademark Office ("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 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
9
<PAGE>
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 Laboratories ("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 Laboratories ("Atrix") for its canine periodontal
disease therapeutic and a supply agreement with Quidel Corporation ("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 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."
10
<PAGE>
FUTURE CAPITAL REQUIREMENTS; UNCERTAINTY OF ADDITIONAL FUNDING
While the Company believes that its available cash, together with the
proceeds of the Offering, 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 "Use of Proceeds" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."
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 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 Laboratories Limited, a
veterinary diagnostic laboratory in the United Kingdom ("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.
Moreover, the Company anticipates using a portion of the proceeds from the
Offering to make additional acquisitions. See "Use of Proceeds." 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
11
<PAGE>
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 "Management--Directors, Executive
Officers and Key Employees."
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.
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.
POTENTIAL ADVERSE MARKET IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE
Substantially all of the Company's shares are eligible for sale in the
public market. The Company's officers, directors, and certain of its
stockholders who beneficially own approximately 12,447,000 shares of Common
Stock, or approximately 50% of the shares outstanding after the Offering, have
agreed not to sell any shares of Common Stock for a period of 120 days after
the date of the Purchase Agreement relating to the Offering. Merrill Lynch,
Pierce, Fenner and Smith Incorporated ("Merrill Lynch") may, in its
discretion, permit sales of such shares during such period without public
announcement. Certain existing stockholders have rights to require the Company
to register their shares for future sale. See "Description of Capital Stock--
Registration Rights," "Shares Eligible for Future Sale" and "Underwriting."
12
<PAGE>
BROAD DISCRETION TO ALLOCATE OFFERING PROCEEDS
The Company anticipates that the proceeds of the Offering will be used to
fund research and development efforts and sales and marketing activities, to
expand and develop manufacturing operations and capabilities, to fund
strategic acquisitions of businesses, technologies or products and to finance
working capital and general corporate requirements. The amounts expended for
each such purpose and the timing of such expenditures may vary depending upon
numerous factors. The Company will have broad discretion in determining the
amount and timing of expenditures and in allocating the proceeds of the
Offering. Such discretion will be particularly broad with respect to that
portion of the proceeds available for use for working capital and general
corporate purposes. See "Use of Proceeds."
CONTROL BY DIRECTORS, EXECUTIVE OFFICERS, PRINCIPAL STOCKHOLDERS AND
AFFILIATED ENTITIES
The Company's directors, executive officers, principal stockholders and
entities affiliated with them will, in the aggregate, beneficially own
approximately 50% of the Company's outstanding Common Stock following the
completion of the Offering. The Company's three major stockholders, who
together will beneficially own approximately 45% of the Company's outstanding
Common Stock after the Offering, 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. See "Principal and Selling Stockholders" and "Description of
Capital Stock--Voting Agreement."
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. See "Management" and "Description of Capital Stock."
FORWARD-LOOKING STATEMENTS
Prospective investors are cautioned that the statements in this Prospectus
that are not descriptions of historical facts may be forward-looking
statements that are subject to risks and uncertainties. Actual results could
differ materially from those currently anticipated due to a number of factors,
including those identified under "Risk Factors" and elsewhere in this
Prospectus.
13
<PAGE>
USE OF PROCEEDS
The proceeds to the Company from the sale of the 4,500,000 shares of Common
Stock being offered by the Company are estimated to be $41,657,500
($48,658,750 if the Underwriters' over-allotment option is exercised in full),
after deducting underwriting discounts and commissions and estimated Offering
expenses. The Company currently estimates that it will use approximately $20.0
million of the net proceeds of the Offering to continue to fund the Company's
research and development efforts, approximately $8.0 million to expand and
fund its sales and marketing capabilities and approximately $5.0 million for
capital equipment and other expenditures relating to the expansion and
development of the Company's manufacturing operations and capabilities. The
Company also expects to use a portion of the net proceeds to acquire
businesses, technologies, products or facilities complementary to the
Company's business. In addition to the pending acquisition of SDI, the Company
is continuously evaluating potential acquisition candidates, although no
commitments have been made which would have a material effect on the Company's
operating results. The Company anticipates using the remaining net proceeds
for working capital and general corporate purposes. The cost, timing and
amount of funds required by the Company cannot be precisely determined at this
time and will be based upon numerous factors, including the Company's progress
in research and development; the timing and costs of obtaining regulatory
approvals; the costs involved in preparing, filing, prosecuting and enforcing
patent claims; competing technological and market developments; changes in the
Company's existing research and collaborative relationships; evaluation of the
commercial viability of potential products; and the progress of
commercialization activities and arrangements. The Company has broad
discretion in determining how the net proceeds of the Offering will be
applied. Pending such uses, the Company intends to invest the net proceeds in
short-term, interest-bearing obligations.
The Company will not receive any proceeds from the sale of the shares of
Common Stock by the Selling Stockholder. See "Principal and Selling
Stockholders."
PRICE RANGE OF COMMON STOCK
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 1/2 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>
HIGH LOW
---- -------
<S> <C> <C>
1997
Third Quarter............................................... $16 $ 7 1/8
Fourth Quarter.............................................. 15 5/8 11 1/4
1998
First Quarter (through February 25)......................... 12 5/8 9 1/4
</TABLE>
On Febuary 25, 1998, the last reported sale price of the Common Stock on the
Nasdaq National Market was $9 7/8 per share. As of December 31, 1997, there
were approximately 178 holders of record of the Common Stock.
14
<PAGE>
DIVIDEND POLICY
The Company has never declared or paid dividends on its capital stock and
does not anticipate paying any dividends in the foreseeable future. The
Company currently intends to retain its earnings, if any, for the development
of its business.
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
December 31, 1997, as adjusted to give effect to the sale of the 4,500,000
shares of Common Stock being offered by the Company and the application of the
estimated net proceeds therefrom as set forth under "Use of Proceeds."
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Long-term obligations, less current portion(1)........... $ 10,308 $ 10,308
-------- --------
Stockholders' equity:
Preferred Stock, $.001 par value; 25,000,000 shares
authorized; none outstanding.......................... -- --
Common Stock, $.001 par value; 40,000,000 shares
authorized; 18,854,015 issued and outstanding
(actual); 23,354,015 issued and outstanding (as
adjusted)(2).......................................... 19 23
Additional paid-in capital............................. 113,091 154,745
Deferred compensation.................................. (1,713) (1,713)
Cumulative translation adjustment...................... 1 1
Stock subscription receivable.......................... (158) (158)
Accumulated deficit.................................... (67,568) (67,568)
-------- --------
Total stockholders' equity........................... 43,672 85,330
-------- --------
Total capitalization................................. $ 53,980 $ 95,638
======== ========
</TABLE>
- --------
(1) See Notes 4, 5 and 6 of Notes to Consolidated Financial Statements.
(2) Does not include (i) 3,495,254 shares of Common Stock reserved for
issuance at December 31, 1997 under the Company's stock option plans,
under which there were options outstanding as of that date to purchase an
aggregate of 2,426,885 shares of Common Stock, (ii) 24,992 shares of
Common Stock issuable upon exercise of warrants outstanding as of December
31, 1997 or (iii) approximately 650,000 shares of Common Stock to be
issued in connection with the pending acquisition of SDI. See
"Management--Stock Option Plan," "Description of Capital Stock--Warrants"
and Note 10 of Notes to Consolidated Financial Statements.
15
<PAGE>
DILUTION
The net tangible book value of the Company as of December 31, 1997 was $38.2
million, or $2.03 per share. Pre-offering pro forma net tangible book value
per share represents the amount of total tangible assets less total
liabilities of the Company, divided by the number of shares of Common Stock
outstanding. After giving effect to the sale of the 4,500,000 shares of Common
Stock offered by the Company hereby (after deduction of underwriting discounts
and commissions and estimated offering expenses), the post-offering pro forma
net tangible book value of the Company at December 31, 1997 would have been
$79.9 million, or $3.42 per share. This represents an immediate increase in
such net tangible book value of $1.39 per share to existing stockholders and
an immediate dilution of $6.46 per share to new investors purchasing shares in
the Offering. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Public offering price.......................................... $9.88
Net tangible book value per share before the Offering........ $2.03
Increase per share attributable to new investors............. 1.39
-----
Pro forma net tangible book value per share after the Offer-
ing........................................................... 3.42
-----
Dilution per share to new investors.......................... $6.46
=====
</TABLE>
The following table summarizes, on a pro forma basis as of December 31,
1997, the differences between existing stockholders and new investors with
respect to the number of shares of Common Stock purchased from the Company,
the total consideration paid to the Company, and the average consideration
paid per share (before deduction of underwriting discounts and commissions and
estimated offering expenses payable by the Company):
<TABLE>
<CAPTION>
SHARES PURCHASED(1) TOTAL CONSIDERATION AVERAGE
------------------------------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------ ---------------------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders.. 18,854,015 80.7% $110,872,000 71.4% $5.88
New investors.......... 4,500,000 19.3 44,437,500 28.6 9.88
------------ ------- ------------ -----
Total................ 23,354,015 100.0% $155,309,500 100.0%
============ ======= ============ =====
</TABLE>
- --------
(1) Sales by the Selling Stockholder in the Offering will reduce the number of
shares held by existing stockholders to 18,354,015, or approximately 78.6%
(approximately 76.1% if the Underwriters' over- allotment option is
exercised in full), of the total number of shares of Common Stock
outstanding, and will increase the number of shares held by new investors
to 5,000,000, or approximately 21.4% (or approximately 23.9%, if the
Underwriters' over-allotment option is exercised in full), of the total
number of shares of Common Stock outstanding after the Offering.
The foregoing table assumes no exercise of the Underwriters' over-allotment
option or of any outstanding stock options or warrants. As of December 31,
1997, there were outstanding options to purchase an aggregate of 2,426,885
shares of Common Stock at exercise prices ranging from $0.15 to $14.50 per
share at a weighted average exercise price of $1.8795, and warrants to
purchase 24,992 shares of Common Stock at an exercise price of $3.25 per
share. To the extent these options or warrants are exercised, there will be
further dilution to new investors. See "Management--Stock Option Plan,"
"Description of Capital Stock--Warrants" and Note 10 of the Notes to
Consolidated Financial Statements.
16
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data with respect to the
Company's balance sheet data at December 31, 1996 and 1997 and, with respect
to the Company's consolidated statement of operations data, for each of the
three years in the period ended December 31, 1997 have been derived from the
Company's consolidated financial statements, which have been audited by Arthur
Andersen LLP, independent public accountants, as indicated in their report
included elsewhere herein. The consolidated balance sheet data as of December
31, 1993, 1994 and 1995 and the consolidated statement of operations data for
the years ended December 31, 1993 and 1994 have been derived from audited
consolidated financial statements not included herein. The selected financial
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 notes included elsewhere in this
Prospectus.
<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 develop-
ment................. 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 ex-
penses:
Cost of goods sold.... -- -- -- 6,648 14,245
Research and develop-
ment................. 2,427 3,685 6,031 14,038 19,990
Selling and market-
ing.................. -- -- -- 2,493 8,693
General and adminis-
trative.............. 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 op-
erating 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
<CAPTION>
DECEMBER 31,
----------------------------------------------------
1993 1994 1995 1996 1997
------- ------ -------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE
SHEET DATA:
Cash, cash equivalents
and marketable securi-
ties................... $ 695 $ 539 $ 6,827 $ 23,700 $ 28,746
Working capital (defi-
cit)................... (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' eq-
uity (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.
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This Prospectus 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 Prospectus.
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 "Risk
Factors--Loss History and Accumulated Deficit; Uncertainty of Future
Profitability; Quarterly Fluctuations and Customer Concentration."
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 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
18
<PAGE>
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.
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.
19
<PAGE>
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 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
20
<PAGE>
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 this offering, 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 this Offering or any further
significant issuances of Common Stock will result 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.
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.
21
<PAGE>
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 USDA and FDA
licensed facilities which manufacture products for Heska and other companies.
Heska has corporate partnerships with Novartis, Bayer and 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.
22
<PAGE>
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 currently consists 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.
23
<PAGE>
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>
MARKETING
PRODUCT STAGE OF DEVELOPMENT(1) RIGHTS(2)
- ------------------------------------------------------------------------------
<S> <C> <C>
ALLERGY & DERMATOLOGY
Canine Allergy Diagnos- Second generation launched in 1997 Heska
tic
Feline Allergy Diagnos- Launched in 1997 Heska
tic
Equine Allergy Diagnos- Research Heska
tic
Canine Allergy Currently available Heska
Immunotherapeutic
Feline Allergy Expected in 1998 Heska
Immunotherapeutic
Ancillary Dermatology Launched in 1997 Heska
Products
- ------------------------------------------------------------------------------
FLEA BITE ALLERGY
Canine Flea Bite Al-
lergy Diagnostic
Veterinary Diagnostic Launched in 1997 Heska
Laboratory
Point-of-Care Diagnos- Expected in 1999 Heska
tic
Feline Flea Bite Al-
lergy Diagnostic
Veterinary Diagnostic Launched in 1997 Heska
Laboratory
Point-of-Care Diagnos- Expected in 1999 Heska
tic
Flea Bite Allergy Research Heska
Immunotherapeutic
Canine Flea Bite Al- Research Heska
lergy Vaccine
Feline Flea Bite Al- Research Heska
lergy Vaccine
- ------------------------------------------------------------------------------
FLEA CONTROL
Flea Control Vaccines
Canine Flea Control Research Heska/Novartis/
Vaccine Eisai
Feline Flea Control Research Heska/Novartis/
Vaccine Eisai
Environmental Flea Con- Research Heska
trol
Pharmaceutical Flea Research Heska
Control
</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.
24
<PAGE>
<TABLE>
<CAPTION>
MARKETING
PRODUCT STAGE OF DEVELOPMENT(1) RIGHTS(2)
- -----------------------------------------------------------------------------------
<S> <C> <C>
HEARTWORM INFECTION
Feline Heartworm Diag-
nostic
Veterinary Diagnostic Currently available Heska
Laboratory
Point-of-Care Diagnos- Launched in Italy in 1997; expected in Heska
tic U.S. in 1998
Canine Heartworm Diag-
nostic
Veterinary Diagnostic Launched in 1997 Heska
Laboratory
Point-of-Care Diagnos- Expected in 1998 Heska
tic
Heartworm Vaccines
Canine Heartworm Vac- Research Bayer/Eisai
cine
Feline Heartworm Vac- Research Heska/Novartis/
cine Eisai
- -----------------------------------------------------------------------------------
DENTISTRY
Canine Periodontal Launched in 1997 Heska
Disease Therapeutic
Canine Dental Hygiene Launched in 1997 Heska
Kits
- -----------------------------------------------------------------------------------
OTHER INFECTIOUS DIS-
EASES
Feline Viral Vaccines
Bivalent Launched in 1997; second generation Heska
in research
Trivalent Launched in 1997; second generation Heska
in research
Feline Immunodeficiency Research Heska
Virus Vaccine
Feline Leukemia Virus Research Heska
Vaccine
Bartonellosis (Cat Expected in 1999 Heska
Scratch Fever) Vaccine
Feline Toxoplasmosis Research Heska/Bayer/
Vaccine Eisai
Canine Leishmaniosis
Diagnostic
Veterinary Diagnostic Launched in 1997 Heska
Laboratory
Point-of-Care Diagnos- Expected in Europe in 1998 Heska
tic
Canine Leishmaniosis Research Heska
Vaccine
Canine Viral Vaccines Research Heska
Equine Influenza Vac- Expected in 1999 Heska
cine
- -----------------------------------------------------------------------------------
METABOLIC DISEASES
Canine Thyroid Supple- Launched in 1997 Heska
ment
- -----------------------------------------------------------------------------------
ARTHRITIS Research Heska
- -----------------------------------------------------------------------------------
ONCOLOGY Research Heska
</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.
25
<PAGE>
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.
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.
26
<PAGE>
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.
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.
27
<PAGE>
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 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.
28
<PAGE>
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 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.
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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 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
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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.
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.
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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 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. Bloxham, one of the
largest veterinary diagnostic laboratories in the United Kingdom, was acquired
by Heska in 1997.
OTHER PRODUCTS
Food Animal Products. 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
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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 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.
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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. The Company presently has 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.
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, 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
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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 and Diamond. The Company's periodontal disease
therapeutic is manufactured by 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 "Risk Factors--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
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 Transactions"). 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.
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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.
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 its feline and canine heartworm 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.
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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
USPTO or private parties, including competitors, will not successfully
challenge the Company's patents or circumvent the Company's patent position.
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
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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 "Risk Factors--
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 United States Department of Agriculture ("USDA") and the Food and Drug
Administration ("FDA"). Vaccines and point-of-care diagnostics for animals are
considered veterinary 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
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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 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
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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.
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 "Risk Factors--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.
FACILITIES
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.
LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
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MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The directors, executive officers and key employees of the Company are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
DIRECTORS AND EXECUTIVE
OFFICERS
Fred M. Schwarzer................ 45 President, Chief Executive Officer and Director
Robert B. Grieve, Ph.D........... 46 Chief Scientific Officer and Vice Chairman
Giuseppe 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.
A. Barr Dolan(1)(2).............. 48 Chairman of the Board
Lyle A. Hohnke, Ph.D.(1)......... 54 Director
Denis H. Pomroy(2)............... 47 Director
Lynnor B. Stevenson, Ph.D.(1).... 54 Director
Guy Tebbit, Ph.D.(2)............. 48 Director
KEY EMPLOYEES
David L. Hines, Ph.D............. 51 Vice President, Product Development and Regulatory Affairs
Elizabeth Hodgkins, D.V.M........ 48 Vice President, Marketing
Paul Hudnut, J.D................. 39 Vice President, Business Development
Deborah E. Robbins, J.D.......... 40 Vice President, General Counsel and Secretary
Keith E. Rushlow, Ph.D........... 44 Vice President, Science and Technology
Dan T. Stinchcomb, Ph.D.......... 44 Vice President, Biochemistry and Molecular Biology
Carol Talkington Verser, Ph.D.... 45 Vice President, Intellectual Property
Donald L. Wassom, Ph.D........... 49 Vice President, Allergy and Immunology
Glade Weiser, D.V.M.............. 49 Vice President, Diagnostics
Kenneth Williams................. 51 Vice President, Sales
Terry A. Willkom................. 54 Vice President, Manufacturing
</TABLE>
- --------
(1) Member of Compensation Committee of the Board of Directors.
(2) Member of Audit Committee of the Board of Directors.
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
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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.
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.
A. Barr Dolan has been a director of the Company since March 1988. Mr. Dolan
has been the President of Charter Venture Capital, a venture capital
management firm, since 1982, a general partner of Charter Ventures since 1982
and a general partner of Charter Ventures II, L.P. since 1994. Mr. Dolan is
also a director of several private companies. He holds M.S. and B.A. degrees
from Cornell University, an M.A. degree from Harvard University and an M.B.A.
from Stanford University.
Lyle A. Hohnke, Ph.D. has been a director of the Company since April 1996.
Dr. Hohnke is a general partner of Javelin Capital Fund, L.P., a venture
capital firm, a position he has held since 1994. Dr. Hohnke was a co-founder
of Diamond and served as Chairman and CEO from 1994 until its acquisition by
the Company in April 1996. From January 1991 to October 1993 he was a general
partner of Heart Land Seed Capital Fund. Dr. Hohnke is also a director of
Vaxcel, Inc. and several private companies. He holds Ph.D. and M.A. degrees
from the University of Oregon, an M.B.A. from the Hartford Graduate Institute
and a B.A. degree from Western Michigan University.
Denis H. Pomroy has been a director of the Company since March 1995. He is
the president of Volendam Capital Advisors, Palo Alto, California, a venture
capital management company, which advises on and manages investments for
member companies of the Volendam investment group, including Volendam
Investeringen N.V. Prior to joining Volendam Capital Advisors, Mr. Pomroy
served as chief financial officer from 1989 through
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1996 of Madge Networks N.V., a computer networking company and is currently a
Supervisory Director of such company. Mr. Pomroy serves as a director of
several other private companies, mainly in the emerging growth technology
area. He holds a bachelors degree from The University of Birmingham, England
and is a fellow of The Chartered Institute of Management Accountants, England.
Lynnor B. Stevenson, Ph.D. was a founder of Heska and has been a director of
the Company since March 1988 and served as President of the Company from March
1988 to March 1992. Dr. Stevenson is currently the President and Chief
Executive Officer of Cascade Oncogenics, Inc. From July 1992 to April 1997,
she was Director, Technology Transfer at the University of Oregon. She holds a
Ph.D. degree in biochemistry from Monash University, Australia and B.Sc. and
M.Ed. degrees from the University of Melbourne, Australia.
Guy Tebbit, Ph.D. has been a director of the Company since March 1997 when
he became Novartis' designate on the Board of Directors of the Company. Since
January 1997, Dr. Tebbit has served as Vice President, Research and
Development, Regulatory Affairs and Professional Services at Novartis. From
January 1995 to January 1997, he held the position of Director, Manufacturing
and Regulatory Affairs at Novartis and from January 1992 to January 1995 he
served as Senior Product Development Manager at Novartis. Dr. Tebbit holds a
Ph.D. from Oregon State University and a B.S. degree from Northern Illinois
University.
David L. Hines, Ph.D. has served as Vice President, Product Development and
Regulatory Affairs since February 1997. Prior to joining the Company, Dr.
Hines was the manager of Virus Vaccine Research and Development for Solvay
Animal Health, Inc., where he was employed from February 1989 to December
1995. He holds Ph.D. and B.Sc. degrees from The Ohio State University.
Elizabeth Hodgkins, D.V.M. has served as Vice President, Marketing of the
Company since October 1996. From June 1985 until August 1993, Dr. Hodgkins
held a variety of positions in customer relations and marketing with Hill's
Pet Nutrition Inc. Prior to 1985, Dr. Hodgkins was an Instructor in Residence
in Veterinary Microbiology at the University of California at Davis and an
Oncological Specialist and Associate Clinician at Silverado Veterinary
Hospital in Napa, CA. She holds D.V.M. and B.S. degrees from the University of
California, Davis and a J.D. degree from the University of Kansas.
Paul Hudnut, J.D. has served as Vice President of Business Development of
the Company since June 1996. Prior to joining the Company, Mr. Hudnut was a
General Manager at US WEST Media Group. He held positions in management and
business development at subsidiaries of US WEST Inc. from February 1988 until
joining the Company. Prior to joining US WEST Inc., Mr. Hudnut was associated
with the Denver, Colorado law firm of Davis, Graham & Stubbs. He holds a J.D.
degree from the University of Virginia and a B.A. degree from The Colorado
College.
Deborah E. Robbins, J.D. is Vice President, General Counsel and Secretary of
the Company. She has served in that position since April 1996. From February
1990 until joining the Company, Ms. Robbins was a partner with the Mountain
View, California law firm of General Counsel Associates, and prior to that
time was an associate and partner in the Palo Alto, California law firm of
Wilson, Sonsini, Goodrich & Rosati. She holds a J.D. degree from the
University of Chicago and a B.A. degree from Wellesley College.
Keith E. Rushlow, Ph.D. has served as Vice President of Science and
Technology of the Company since December 1995. From April 1993 until December
1993, he was Senior Director, Molecular Biology. From December 1993 to
December 1994, he was Director of Research. From December 1994 to December
1995, he was Vice President, Research. From September 1990 until joining the
Company, Dr. Rushlow was a Research Associate Professor at the University of
Pittsburgh School of Medicine and Associate Faculty at the Pittsburgh Cancer
Institute. Dr. Rushlow has also held various scientific and research
management positions with the National Cancer Institute, Battelle Memorial
Institute and Syngene/TechAmerica. He holds a Ph.D. degree from the University
of Colorado and a B.S. degree from the University of Michigan.
Dan T. Stinchcomb, Ph.D. has served as Vice President of Biochemistry and
Molecular Biology for the Company since May 1996. Prior to joining the
Company, from July 1993 until May 1996 Dr. Stinchcomb was
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employed at Ribozyme Pharmaceuticals, Inc., most recently as Director of
Biology Research. From 1988 until April 1993, Dr. Stinchcomb held various
positions with Synergen, Inc. Prior to joining Synergen, Dr. Stinchcomb was an
Associate Professor in Cellular and Developmental Biology at Harvard
University. He holds a Ph.D. degree from Stanford University and a B.A. degree
from Harvard University.
Carol Talkington Verser, Ph.D. has served as Vice President of Intellectual
Property of the Company since June 1996. From July 1995 until June 1996, Dr.
Verser was the Director of Intellectual Property for the Company. She was a
patent agent for the law firm of Sheridan, Ross & McIntosh in Denver, Colorado
from 1991 until 1995 and from 1990 through 1992 was a writer and contributing
editor for Bioworld Today. From 1986 until 1989, she was a director at
BioGrowth Inc. She holds a Ph.D. degree from Harvard University and a B.S.
degree from the University of Southern California.
Donald L. Wassom, Ph.D. has served as Vice President of Allergy and
Immunology of the Company since January 1996. From May 1992 until January
1996, Dr. Wassom was Professor of Parasitology at Colorado State University.
Dr. Wassom has also held faculty positions at the University of Wisconsin and
Cornell University. He holds Ph.D. and B.S. degrees from the University of
Utah.
Glade Weiser, D.V.M. has served as Vice President of Diagnostics of the
Company since April 1996. From October 1989 until January 1996, Dr. Weiser was
Professor and Chairperson for the Department of Pathology in the College of
Veterinary Medicine and Biomedical Sciences at Colorado State University. He
was a member of the faculty at the College of Veterinary Medicine of The Ohio
State University from July 1975 until December 1982. Dr. Weiser is a Diplomate
of the American College of Veterinary Pathologists. He holds D.V.M. and B.S.
degrees from the University of California, Davis.
Kenneth Williams has served as Vice President of Sales of the Company since
February 1997. From 1989 until joining the Company, he was Director of Field
Sales for CIBA-GEIGY Animal Health. He holds a B.S. degree from Virginia
Polytechnic Institute. From 1972 until 1989, he was employed by The Upjohn
Company in various animal health sales and sales management positions.
Terry A. Willkom has served as Vice President, Manufacturing since January
1998. Before joining the Company, he was Vice President, Operations of SRC
Computers, Inc. from July 1996 until December 1997. From October 1990 until
December 1995, he was employed by Cray Computer Corporation, initially as the
Director of Manufacturing and in April 1992 became its President and Chief
Operating Officer. He holds a B.S. degree from the University of Wisconsin,
Eau Claire.
Mr. Schwarzer and Ms. Robbins are husband and wife. There are no other
family relationships among any of the directors or executive officers of the
Company.
BOARD COMPOSITION AND COMMITTEES
The Company's Board of Directors are divided into three classes, with one
class of directors elected each year at the annual meeting of stockholders for
a three year term of office. All directors of one class hold their positions
until the annual meeting of stockholders at which their respective successors
are elected and qualified. Mr. Schwarzer and Dr. Tebbit serve in the class
whose term expires in 1998; Dr. Grieve and Mr. Dolan serve in the class whose
term expires in 1999; and Mr. Pomroy, Dr. Stevenson and Dr. Hohnke serve in
the class whose term expires in 2000. Officers are elected at the first board
of directors meeting following the stockholders' meeting at which the
directors are elected and serve at the discretion of the Board of Directors.
Mr. Dolan was appointed to the Company's Board of Directors in connection
with initial and subsequent equity investments in the Company by Charter
Ventures and Charter Ventures II, L.P. (collectively, "Charter"). Dr. Tebbit
was appointed to the Board of Directors in connection with an equity
investment in the Company by Novartis. Mr. Pomroy was appointed to the Board
of Directors of the Company in connection with an investment in the Company by
Volendam Investeringen N.V. ("Volendam"). Volendam, Charter and Novartis are
parties to a voting agreement with the Company pursuant to which each entity
is entitled to elect one director to the
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Company's Board of Directors for as long as each entity owns a specified
amount of the Company's voting stock. See "Description of Capital Stock--
Voting Agreement." Dr. Hohnke was appointed to the Board of Directors of the
Company in connection with the Company's April 1996 acquisition of Diamond.
The Board of Directors has established an Audit Committee and a Compensation
Committee. The Audit Committee, which consists of Messrs. Dolan and Pomroy and
Dr. Tebbit, reviews the results and scope of the annual audit and the services
provided by the Company's independent accountants. The Compensation Committee,
which consists of Mr. Dolan, Dr. Hohnke and Dr. Stevenson, makes
recommendations to the Board of Directors with respect to general and specific
compensation policies and practices of the Company and administers its 1997
Stock Incentive Plan and 1997 Employee Stock Purchase Plan. Mr. Schwarzer also
attends meetings of the Compensation Committee, other than discussions
relating to his own compensation, but does not vote on any matters.
COMPENSATION OF OUTSIDE DIRECTORS
Directors do not receive any fees for service on the Board of Directors, but
are reimbursed for their expenses for each meeting attended. Directors are
eligible to participate in the Company's 1997 Stock Incentive Plan and are
entitled to certain automatic grants of options under such plan as described
below. See "--Stock Option Plan." Dr. Tebbit has declined such options in
accordance with Novartis policies. Mr. Dolan assigns his options in equal
portions to Charter Ventures and Charter Ventures II, L.P. as required by
their partnership agreements.
EXECUTIVE COMPENSATION
The following table summarizes all compensation paid to the Company's Chief
Executive Officer and to each of the Company's other most highly compensated
executive officers whose total annual salary and bonus exceeded $100,000, for
services rendered in all capacities to the Company during the fiscal years
ended December 31, 1997 and 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
--------------------------------------- ---
LONG-TERM
COMPENSATION
AWARDS
------------
SECURITIES
FISCAL OTHER ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY($)(1) BONUS($) COMPENSATION($) OPTIONS(#)
- --------------------------- ------ ------------ -------- --------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Fred M. Schwarzer........ 1997 $ 200,000 -- -- --
President and Chief Ex-
ecutive Officer 1996 200,000 -- -- 150,000
Robert B. Grieve......... 1997 190,000 -- -- --
Chief Scientific Officer
and Vice Chairman 1996 190,000 -- -- 150,000
R. Lee Seward............ 1997 180,000 -- -- 20,000
Executive Vice President 1996 180,000 -- -- --
John A. Shadduck......... 1997 160,000(2) -- -- 100,000
Executive Vice Presi-
dent, Operations 1996 -- -- -- --
Giuseppe Miozzari........ 1997 144,000(3) -- -- 100,000
Managing Director, Heska
Europe 1996 -- -- -- --
</TABLE>
- --------
(1) Salary includes amounts, if any, deferred pursuant to 401(k) arrangements.
(2) Dr. Shadduck's employment with the Company commenced in February 1997 and
his current annual salary is $180,000.
(3) Dr. Miozzari's employment with the Company commenced in March 1997 and his
current annual salary is CHF 300,000.
45
<PAGE>
The following tables set forth certain information as of December 31, 1997
and for the fiscal year then ended with respect to stock options granted to
and exercised by the individuals named in the Summary Compensation Table.
OPTION GRANTS IN FISCAL YEAR 1997
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE
NUMBER OF PERCENTAGE OF AT ASSUMED ANNUAL RATES
SECURITIES TOTAL OPTIONS OF STOCK PRICE APPRECIATION
UNDERLYING GRANTED TO EXERCISE OR FOR OPTION TERM(4)
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION ----------------------------
NAME GRANTED(#)(1) FISCAL YEAR ($/SHARE)(2) DATE(3) 5%($) 10%($)
- ---- ------------- ------------- ------------ ---------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Fred M. Schwarzer....... -- -- % $ -- -- $ -- $ --
Robert B. Grieve........ -- -- -- -- -- --
R. Lee Seward........... 20,000 2.25 3.00 3/15/07 120,807 227,905
John H. Shadduck........ 100,000 11.23 1.20 1/27/07 344,234 619,216
Giuseppe Miozzari....... 100,000 11.23 1.20 2/5/07 572,280 982,340
</TABLE>
- --------
(1) The right to exercise these stock options vests ratably on a monthly basis
over a four-year period. Under the terms of the Company's stock plans, the
committee designated by the Board of Directors to administer such plans
retains the discretion, subject to certain limitations, to modify, extend
or renew outstanding options and to reprice outstanding options. Options
may be repriced by canceling outstanding options and reissuing new options
with an exercise price equal to the fair market value on the date of
reissue, which may be lower than the original exercise price of such
canceled options.
(2) The exercise price is equal to 100% of the fair market value on the date
of grant as determined by the Board of Directors.
(3) The options have a term of ten years, subject to earlier termination in
certain events related to termination of employment.
(4) The 5% and 10% assumed rates of appreciation are suggested by the rules of
the Securities and Exchange Commission and do not represent the Company's
estimate or projection of the future Common Stock price. There can be no
assurance that any of the values reflected in the table will be achieved.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES VALUE DECEMBER 31, 1997(#) DECEMBER 31, 1997($)(2)
ACQUIRED ON REALIZED ------------------------- -------------------------
NAME EXERCISE(#) ($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Fred M. Schwarzer....... -- -- 141,583 131,417 $1,657,931 $1,501,259
Robert B. Grieve........ -- -- 239,375 120,625 2,850,869 1,371,431
R. Lee Seward........... -- -- 23,750 46,250 275,775 513,325
John A. Shadduck........ -- -- 42,857 77,135 499,089 862,413
Giuseppe Miozzari....... -- -- 20,833 79,167 232,913 885,087
</TABLE>
- --------
(1) These values were calculated on the basis of the fair market value of the
underlying securities at the exercise date minus the applicable per share
exercise price.
(2) These values were calculated on the basis of the fair market value of the
Common Stock at December 31, 1997 ($12.38), minus the applicable per share
exercise price.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with each of Fred M.
Schwarzer, its Chief Executive Officer, Robert B. Grieve Ph.D., its Chief
Scientific Officer and Vice Chairman, R. Lee Seward D.V.M., an Executive Vice
President and John Shadduck, D.V.M., an Executive Vice President. These
agreements provide for severance payments if the employment of the individual
is terminated without cause,
46
<PAGE>
including terminations in connection with a change in control of the Company.
In the case of Mr. Schwarzer and Dr. Grieve, the payments would be one year's
salary plus an additional one year of vesting under any stock arrangements if
the termination takes place at any time on or before December 31, 1999, or six
months' salary and an additional six months' vesting under any stock
arrangements if the termination takes place after that date. In the case of
Dr. Seward, the severance payment would be six months' salary if he is
terminated without cause. In the case of Dr. Shadduck, the severance payment
would be one year's salary if the termination takes place at any time prior to
January 27, 2000 and six months' salary if the termination takes place after
that date. Additionally, Louis G. Van Daele, President of Diamond, has an
employment agreement with Diamond, pursuant to which Mr. Van Daele is entitled
to severance payments equal to one year's salary payable in 12 monthly
installments if he is terminated without cause prior to April 2000. Also,
Giuseppe Miozzari, Ph.D., Managing Director of Heska Europe, has an employment
agreement with Heska Europe, pursuant to which Dr. Miozzari is entitled to
severance payments (including amounts mandated by Swiss law) equal to 12
months' salary payable in equal monthly installments if he is terminated
without cause prior to July 1, 2000, or six months' salary if he is terminated
without cause after that date.
STOCK OPTION PLAN
In March 1997, the Company's Board of Directors adopted the Company's 1997
Stock Incentive Plan (the "Stock Plan") under which there were 4,437,955
shares of Common Stock reserved for issuance as of January 1, 1998. If any
options granted under the Stock Plan are forfeited or terminate for any other
reason without having been exercised in full, then the unpurchased shares
subject to those options will become available for additional grants under the
Stock Plan. If shares granted or purchased under the Stock Plan are forfeited,
then those shares will also become available for additional grants under the
Stock Plan. The number of shares reserved for issuance under the Stock Plan
will be increased 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.
Under the Stock Plan, all employees who work 20 hours per week (including
officers) and directors of the Company or any subsidiary and any independent
contractor or advisor who performs services for the Company or a subsidiary
are eligible to purchase shares of Common Stock and to receive awards of
shares or grants of nonstatutory options. Employees are also eligible to
receive grants of incentive stock options ("ISOs") intended to qualify under
Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). The
Stock Plan is administered by the Compensation Committee of the Board of
Directors, which selects the persons to whom shares will be sold or awarded or
options will be granted, determines the number of shares to be made subject to
each sale, award or grant, and prescribes the other terms and conditions of
each sale, award or grant, including the type of consideration to be paid to
the Company upon sale or exercise and the vesting schedule.
The exercise price under any nonstatutory options generally must be at least
85% of the fair market value of the Common Stock on the date of grant. The
exercise price under ISOs cannot be lower than 100% of the fair market value
of the Common Stock on the date of grant and, in the case of ISOs granted to
holders of more than 10% of the voting power of the Company, not less than
110% of such fair market value. The term of an ISO cannot exceed ten years,
and the term of an ISO granted to a holder of more than 10% of the voting
power of the Company cannot exceed five years.
Each new non-employee director who is elected to the Company's Board of
Directors will automatically be granted as of the date of election an option
to purchase 10,000 shares of Common Stock at an exercise price equal to the
fair market value of the Common Stock on the date of grant. The shares subject
to these options will vest in four equal installments at annual intervals over
the four-year period commencing on the date of grant. In addition, each non-
employee director who will continue to serve following any annual meeting of
stockholders will automatically be granted an option as of the date of such
meeting to purchase 2,000 shares of Common Stock at an exercise price equal to
the fair market value of the Common Stock on the date of grant. The shares
subject to these options will vest on the first anniversary of grant. No
director will receive the 10,000-share grant and a 2,000-share grant in the
same year.
47
<PAGE>
EMPLOYEE STOCK PURCHASE PLAN
In April 1997, the Board of Directors of the Company adopted the 1997
Employee Stock Purchase Plan (the "ESPP") to provide employees of the Company
with an opportunity to purchase Common Stock through payroll deductions. Under
the ESPP, 250,000 shares of Common Stock have been reserved for issuance. All
employees of the Company (including all U.S. subsidiaries and certain foreign
subsidiaries) who work more than 20 hours per week are eligible to participate
in the ESPP.
Eligible employees may participate in the ESPP by authorizing payroll
deductions of a specified percentage of their total cash compensation. Amounts
withheld are applied at the end of every six-month accumulation period to
purchase shares of Common Stock (not to exceed 5,000 shares per participant in
any six-month period). The value of the Common Stock (determined as of the
beginning of the offering period) that may be purchased by any participant in
a calendar year is limited to $25,000. Participants may withdraw their
contributions at any time before stock is purchased.
The purchase price is equal to 85% of the lower of (a) the market price of
Common Stock immediately before the beginning of the applicable offering
period or (b) the market price of Common Stock at the time of the purchase. In
general, each offering period is 24 months long, but a new offering period
begins every six months. Thus, up to four overlapping offering periods may be
in effect at the same time. An offering period continues to apply to a
participant for the full 24 months, unless the market price of Common Stock is
lower when a subsequent offering period begins. In that event, the subsequent
offering period automatically becomes the applicable period for purposes of
determining the purchase price.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
The Company has adopted provisions in its Restated Certificate of
Incorporation that limit the liability of its directors for monetary damages
for breach of their fiduciary duty as directors, except for liability that
cannot be eliminated under the Delaware General Corporation Law ("Delaware
Law"). Delaware Law provides that directors of a company will not be
personally liable for monetary damages for breach of their fiduciary duty as
directors, except for liability for any breach of their duty of loyalty to the
Company or its stockholders, for acts or omissions not in good faith or which
involve intentional misconduct or a knowing violation of law, for unlawful
payment of dividends or unlawful stock repurchases or redemptions, as provided
Section 174 of the Delaware Law, or for any transaction from which the
director derived an improper personal benefit. Any amendment or repeal of
these provisions requires the approval of the holders of shares representing
at least 66 2/3% of the shares of the Company entitled to vote in the election
of directors, voting as one class.
The Company's Restated Certificate of Incorporation and Bylaws also provide
that the Company may indemnify its directors and officers to the fullest
extent permitted by Delaware Law. The Company has entered into separate
indemnification agreements with its directors and executive officers that
could require the Company, among other things, to indemnify them against
certain liabilities that may arise by reason of their status or service as
directors or executive officers and to advance their expenses incurred as a
result of any proceeding against them as to which they could be indemnified.
The Company believes that the limitation of liability provision in its
Restated Certificate of Incorporation and the indemnification agreements will
facilitate the Company's ability to continue to attract and retain qualified
individuals to serve as directors and officers of the Company.
48
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of December 31, 1997 and as
adjusted to reflect the sale by the Company and the Selling Stockholder of the
shares offered hereby (assuming no exercise of the Underwriters' over-
allotment option), by: (i) each person who is known by the Company to own
beneficially more than 5% of the Company's Common Stock, (ii) each of the
Company's directors, (iii) each of the Company's officers named under
"Management--Summary Compensation Table," and (iv) all directors and executive
officers of the Company as a group.
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
NUMBER OF BENEFICIALLY OWNED(1)
SHARES NUMBER OF -----------------------
BENEFICIALLY SHARES BEING PRIOR TO AFTER
OWNED(1) OFFERED OFFERING OFFERING
------------ ------------ ---------- ----------
<S> <C> <C> <C> <C>
Entities associated with
Charter Ventures(2)....... 4,216,924 -- 22.4% 18.1%
525 University Avenue
Suite 1500
Palo Alto, CA 94301
Novartis Produkte AG....... 3,705,389 -- 19.7 15.9
Klybeckstrasse A4A
4002 Basel
Switzerland
Volendam Investeringen
N.V. ..................... 3,076,923 500,000 16.3 11.0
14 John B. Gorsiraweg
P.O. Box 3889
Curacao, Netherlands An-
tilles
State of Wisconsin Invest-
ment Board................. 1,000,000 -- 5.3 4.3
P.O. Box 7842
Madison, WI 53707
A. Barr Dolan(3)........... 4,216,924 -- 22.4 18.1
Robert B. Grieve,
Ph.D.(4)(9)............... 355,059 -- 1.9 1.5
Lyle A. Hohnke, Ph.D.(9)... 94,255 -- * *
Denis H. Pomroy(5)(9)...... 3,103,923 16.5 11.1
Fred M. Schwarzer(6)(9).... 340,689 -- 1.8 1.4
Lynnor B. Stevenson,
Ph.D.(9).................. 227,000 -- 1.2 1.0
Guy Tebbit, Ph.D.(7)....... 3,705,389 -- 19.7 15.9
R. Lee Seward,
D.V.M.(8)(9).............. 178,040 -- * *
John A. Shadduck, D.V.M.,
Ph.D...................... 64,583 -- * *
Giuseppe Miozzari, Ph.D.... 25,000 -- * *
All directors and executive
officers as a group
(12 persons)(9)(10)....... 12,447,132 -- 64.1 49.9
</TABLE>
- --------
* Less than 1%.
(1) To the Company's knowledge, the persons named in the table have sole
voting and investment power with respect to all shares of Common Stock
shown as beneficially owned by them, subject to community property laws
where applicable and the information contained in the footnotes to this
table. Beneficial ownership is determined in accordance with the rules of
the Securities and Exchange Commission and includes voting and investment
power with respect to securities. Shares of Common Stock issuable upon
exercise of stock options exercisable within 60 days of December 31, 1997
are deemed outstanding and to be beneficially owned by the person holding
such option for purposes of computing such person's percentage ownership,
but are not deemed outstanding for the purpose of computing the percentage
ownership of any other person.
(2) Includes 3,385,510 shares and options to purchase 1,000 shares of Common
Stock held by Charter Ventures and 829,414 shares and options to purchase
1,000 shares of Common Stock held by Charter Ventures II, L.P.
49
<PAGE>
(3) Represents shares and options held by Charter Ventures and Charter
Ventures II, L.P., with respect to which Mr. Dolan disclaims beneficial
ownership except to the extent of his proportionate share therein. Mr.
Dolan, a director of the Company, is a general partner of each of Charter
Ventures and Charter Ventures II, L.P., and may be deemed a beneficial
owner of the shares held by such entities because of shared voting power
with respect to such shares.
(4) Includes options to purchase 15,575 shares of Common Stock held by Dr.
Grieve's wife, with respect to which Dr. Grieve disclaims beneficial
ownership.
(5) Includes 3,076,923 shares held by Volendam Investeringen N.V., with
respect to which Mr. Pomroy disclaims beneficial ownership except to the
extent of his proportionate interest therein, and 16,680 shares of Common
Stock subject to repurchase by the Company.
(6) Includes 4,730 shares of Common Stock and options to purchase 6,792 shares
of Common Stock held by Mr. Schwarzer's wife, with respect to which Mr.
Schwarzer disclaims beneficial ownership, and 68,318 shares of Common
Stock subject to repurchase by the Company.
(7) Represents shares held by Novartis, with respect to which Dr. Tebbit
disclaims beneficial ownership.
(8) Includes 20,000 shares of Common Stock subject to repurchase by the
Company.
(9) Includes an aggregate of 543,013 shares of Common Stock issuable upon
exercise of stock options currently exercisable within 60 days of December
31, 1997 as follows: Dr. Grieve, 248,959; Dr. Hohnke, 7,864; Mr. Pomroy,
2,000; Mr. Schwarzer, 152,167; Dr. Stevenson, 2,000; Dr. Seward, 27,916;
Mr. Van Daele, 7,115; Dr. Shadduck, 47,075; Dr. Miozzari, 25,000; and Mr.
Skolout, 22,917.
(10) Includes shares held by entities referenced in footnotes 2, 5 and 7 which
are affiliated with certain directors.
50
<PAGE>
CERTAIN TRANSACTIONS
The Company has historically sold its Preferred Stock in private placements
to venture capital firms. Since January 1994, the Company has sold an
aggregate of 3,928,085 shares of Series E Preferred Stock in a series of
private financings for $3.25 per share and 3,000,000 shares of Series F
Preferred Stock for $12.00 per share (all shares of Preferred Stock converted
into Common Stock upon the closing of the Company's initial public offering).
The purchasers of the Preferred Stock include the following directors, holders
of more than 5% of the Company's securities, and entities associated with the
Company's directors:
<TABLE>
<CAPTION>
SHARES OF PREFERRED
STOCK PURCHASED
-------------------
SERIES E SERIES F
--------- ---------
<S> <C> <C>
Entities associated with Charter Ventures................... 851,162 --
Volendam Investeringen N.V.................................. 3,076,923 --
Denis H. Pomroy(1).......................................... 3,076,923 --
A. Barr Dolan(2)............................................ 851,162 --
Novartis.................................................... -- 3,000,000
Guy Tebbit, Ph.D.(3)........................................ -- 3,000,000
</TABLE>
- --------
(1) Represents shares held by Volendam Investeringen N.V. with respect to
which Mr. Pomroy disclaims beneficial ownership except to the extent of
his proportionate share therein. Mr. Pomroy, a director of the Company, is
the president of Volendam Capital Advisors, which advises and manages
investments for Volendam Investeringen N.V. and may be deemed to be a
beneficial owner of the shares held by Volendam Investeringen N.V. because
of shared voting power with respect to such shares.
(2) Represents shares held by Charter Ventures and Charter Ventures II, L.P.
with respect to which Mr. Dolan disclaims beneficial ownership except to
the extent of his proportionate share therein. Mr. Dolan, a director of
the Company, is a general partner of each of Charter Ventures and Charter
Ventures II, L.P. and may be deemed to be a beneficial owner of the shares
held by such entities because of shared voting power with respect to such
shares.
(3) Represents shares held by Novartis, by whom Dr. Tebbit is employed. Dr.
Tebbit does not share voting or investment power with respect to such
shares and disclaims beneficial ownership thereof.
The purchasers of the above shares of Preferred Stock are entitled to
registration rights. See "Description of Capital Stock--Preferred Stock."
In connection with its purchase of Series F Preferred Stock, Novartis was
granted marketing rights to certain of the Company's products under
development. In addition, the Company entered into a Screening and Development
Agreement and Right of First Refusal Agreement with Novartis. See "Business--
Collaborative Agreements" for a description of these agreements. Novartis did
not make any separate payments for these rights.
See "Management--Employment Agreements" for a description of employment
agreements between the Company and certain executive officers. For information
concerning indemnification of directors and officers, see "Management--
Limitation of Liability and Indemnification Matters."
In March 1995, the Company converted $638,567 of indebtedness to entities
associated with Charter Ventures, a principal stockholder of the Company, to
shares of Series E Preferred Stock at $3.25 per share. In December 1994, the
Company converted $2,127,708 of indebtedness to Charter Ventures to shares of
Series E Preferred Stock at $4.00 per share. In connection with the sale of
Series E Preferred Stock in March 1995 at $3.25 per share, the Company
effected a 1.23 to one split of the Series E Preferred Stock to bring the
effective purchase price of the shares purchased at $4.00 to $3.25. A total of
122,753 shares was issued to Charter Ventures as a result of this stock split.
51
<PAGE>
Mr. Schwarzer purchased an aggregate of 177,000 shares of Common Stock from
the Company in February 1995 at a purchase price of $.35 per share, paid by a
full recourse promissory note in the initial principal amount of $61,950. The
note bears interest at 7 1/2% per annum, compounded annually, and is due in
full in February 2001. Mr. Schwarzer is a special limited partner of Charter
Ventures II, L.P.
In May 1997, the Company acquired all of the outstanding capital stock of
Astarix Institute, Inc. in exchange for 70,000 shares of the Company's Series
E Preferred Stock and 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 Institute, Inc. and received 70,000 shares of
the Company's Series E Preferred Stock in this transaction.
52
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 40,000,000 shares of
Common Stock, $.001 par value, and 25,000,000 shares of Preferred Stock, $.001
par value.
COMMON STOCK
As of December 31, 1997, there were approximately 18,850,000 shares of
Common Stock outstanding held by approximately 178 stockholders of record. The
holders of Common Stock are entitled to one vote for each share held of record
on all matters submitted to a vote of the stockholders, including the election
of directors, and do not have cumulative voting rights. Accordingly, the
holders of a majority of the shares of Common Stock entitled to vote in any
election of directors can elect all of the directors standing for election, if
they so choose (subject to the Voting Agreement described below). Subject to
preferences that may be applicable to any then outstanding Preferred Stock,
holders of Common Stock are entitled to receive ratably such dividends, if
any, as may be declared by the Board of Directors out of funds legally
available therefor. See "Dividend Policy." Upon a liquidation, dissolution or
winding up of the Company, the holders of Common Stock will be entitled to
share ratably in the net assets legally available for distribution to
stockholders after the payment of all debts and other liabilities of the
Company, subject to the prior rights of any Preferred Stock then outstanding.
Holders of Common Stock have no preemptive or conversion rights or other
subscription rights and there are no redemption or sinking fund provisions
applicable to the Common Stock. All outstanding shares of Common Stock are,
and the Common Stock to be outstanding upon completion of the Offering will
be, fully paid and nonassessable.
PREFERRED STOCK
The Board of Directors has the authority, without further action by the
stockholders, to issue from time to time the Preferred Stock in one or more
series and to fix the number of shares, designations, preferences, powers, and
relative, participating, optional or other special rights and the
qualifications or restrictions thereof. The preferences, powers, rights and
restrictions of different series of Preferred Stock may differ with respect to
dividend rates, amounts payable on liquidation, voting rights, conversion
rights, redemption provisions, sinking fund provisions, and purchase funds and
other matters. The issuance of Preferred Stock could decrease the amount of
earnings and assets available for distribution to holders of Common Stock or
affect adversely the rights and powers, including voting rights, of the
holders of Common Stock and may have the effect of delaying, deferring or
preventing a change in control of the Company. The Company has no present
plans to issue any shares of Preferred Stock.
WARRANTS
As of December 31, 1997, there were outstanding 24,992 warrants to purchase
Common Stock (the "Warrants") at an exercise price of $3.25 per share. Of the
Warrants, 6,225 will expire on June 7, 2002, 267 will expire on December 30,
2002 and the remaining 18,500 will expire on October 20, 2003.
REGISTRATION RIGHTS
Holders of approximately 10,500,000 shares of Common Stock (the "Registrable
Shares"), or their permitted transferees, are entitled to certain rights with
respect to the registration of such shares under the Securities Act. If the
Company proposes to register any of its securities under the Securities Act
for its own account or the account of any of its stockholders other than the
holders of the Registrable Shares, holders of such Registrable Shares are
entitled, subject to certain limitations and conditions, to notice of such
registration and are, subject to certain conditions and limitations, entitled
to include Registrable Shares therein, provided, among other conditions, that
the underwriters of any such offering have the right to limit the number of
shares included in such registration. In addition, the Company may be required
to prepare and file a registration statement under the Securities Act at its
expense if requested to do so by the holders of at least 35% of the
Registrable Shares, provided the reasonably expected aggregate offering price
will equal or exceed $5,000,000
53
<PAGE>
including underwriting discounts and commissions. The Company is required to
use its best efforts to effect such registration, subject to certain
conditions and limitations. The Company is not obligated to effect more than
two of such stockholder-initiated registrations. Further, holders of
Registrable Shares may require the Company to file additional registration
statements on Form S-3, subject to certain conditions and limitations.
VOTING AGREEMENT
In connection with certain investments in the Company by each of Novartis,
Volendam and Charter (collectively, the "Investors"), the Investors entered
into a Voting Agreement dated as of April 12, 1996 (the "Voting Agreement"),
whereby each Investor agreed to vote or act with respect to all shares of the
Company's voting securities now owned or subsequently acquired by such
Investor such that one designee of each of Novartis, Volendam and Charter
shall be elected to the Board of Directors of the Company. The Investors
further agreed to vote their shares in such manner to elect as the remaining
directors of the Company individuals unaffiliated with any of the Investors
but who are reasonably acceptable to all of the Investors. By executing the
Voting Agreement, the Company agreed to use its best efforts to cause the
nominee of each of Novartis, Volendam and Charter to be elected to 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 (as adjusted for stock splits, recapitalizations and
similar events) of the voting stock of the Company.
DELAWARE ANTI-TAKEOVER LAW AND CERTAIN CHARTER PROVISIONS
The Company is subject to the provisions of Section 203 of the Delaware Law,
an anti-takeover law. In general, the statute prohibits a publicly held
Delaware corporation from engaging in a business combination with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. A "business
combination" includes a merger, asset sale or other transaction resulting in
financial benefit to the stockholder. An "interested stockholder" is a person
who, together with affiliates and associates, owns (or within three years
prior, did own) 15% or more of the corporation's voting stock.
The Company's Restated Certificate of Incorporation provides for a
classified board of directors and eliminates the right of stockholders to call
special meetings of stockholders. The provisions described above, together
with the ability of the Board of Directors to issue Preferred Stock as
described under "--Preferred Stock," may have the effect of deterring a
hostile takeover or delaying a change in control or management of the Company.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is American Securities
Transfer and Trust, Inc.
54
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of Common Stock of the Company in the public
market by existing stockholders could adversely affect the prevailing market
price. Upon completion of the Offering, the Company will have outstanding
23,354,015 shares of Common Stock assuming no exercise of the Underwriter's
over-allotment option and no exercise of outstanding options and warrants.
Substantially all of such shares are freely tradable (other than by an
"affiliate" of the Company as such term is defined in the Securities Act)
without restriction or registration under the Securities Act. The Company's
directors, executive officers and certain stockholders, who collectively own
beneficially an aggregate of approximately 12,447,000 shares of Common Stock,
have agreed pursuant to certain agreements that they will not sell any Common
Stock owned by them without the prior written consent of Merrill Lynch for a
period of 120 days after the date of the Purchase Agreement relating to the
Offering (the "Lockup Period"). Following the expiration of the Lockup Period,
such shares will be available for sale in the public market subject to
compliance with Rule 144 and Rule 701. See "Underwriting."
In general, under Rule 144 as currently in effect, an affiliate of the
Company, or a holder of shares issued and sold by the Company in private
transactions ("Restricted Shares") who owns beneficially shares that were not
acquired from the Company or an affiliate of the Company within the prior
year, would be entitled to sell within any three-month period a number of
shares that does not exceed the greater of 1% of the then outstanding shares
of Common Stock (approximately 233,500 shares immediately after the Offering,
assuming no exercise of the Underwriters' over-allotment option) or the
average weekly trading volume of the Common Stock during the four calendar
weeks preceding the date on which notice of the sale is filed with the
Securities and Exchange Commission. Sales under Rule 144 are subject to
certain requirements relating to manner of sale, notice and availability of
current public information about the Company. However, a person (or persons
whose shares are aggregated) who is not deemed to have been an affiliate of
the Company at any time during the 90 days immediately preceding the sale and
who owns beneficially Restricted Shares is entitled to sell such shares under
Rule 144(k) without regard to the limitations described above, provided that
at least two years have elapsed since the later of the date the shares were
acquired from the Company or from an affiliate of the Company. The Company
believes that approximately 12,447,000 shares of its Common Stock are held by
persons who may be deemed affiliates under Rule 144. The foregoing is a
summary of Rule 144 and is not intended to be a complete description.
In addition, the holders of approximately 10,500,000 shares of Common Stock
are entitled to certain rights to cause the Company to register the sale of
such shares under the Securities Act. Registration of such shares under the
Securities Act would result in such shares becoming freely tradable without
restriction under the Securities Act (except for shares purchased by
affiliates of the Company) immediately upon the effectiveness of such
registration. See "Description of Capital Stock--Registration Rights."
CERTAIN CONSIDERATIONSFOR NON-UNITED STATES HOLDERS
RESALE RESTRICTIONS
The distribution of the Common Stock in Canada will be made only on a
private placement basis exempt from the requirement that the Company prepare
and file a prospectus with the securities regulatory authorities in each
province where trades of the Common Stock are effected. Accordingly, any
resale of the Common Stock in Canada must be made in accordance with
applicable securities laws which will vary depending on the relevant
jurisdiction, and which may require resales to be made in accordance with
available statutory exemptions or pursuant to a discretionary exemption
granted by the applicable Canadian securities regulatory authority. Purchasers
are advised to seek legal advice prior to any resale of the Common Stock.
REPRESENTATIONS OF PURCHASERS
Each purchaser of the Common Stock in Canada who receives a purchase
confirmation will be deemed to represent to the Company and the dealer from
whom such purchase confirmation is received that (i) such
55
<PAGE>
purchaser is entitled under applicable provincial securities laws to purchase
such Common Stock without the benefit of a prospectus qualified under such
securities laws, (ii) where required by law, that such purchaser is purchasing
as principal and not as agent, and (iii) such purchaser has reviewed the text
above under "Resale Restrictions."
RIGHTS OF ACTION (ONTARIO PURCHASERS)
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
section 32 of the Regulation under the Securities Act (Ontario). As a result,
Ontario purchasers must rely on other remedies that may be available,
including common law rights of action for damages or rescission or rights of
action under the civil liability provisions of the U.S. federal securities
laws.
ENFORCEMENT OF LEGAL RIGHTS
All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be
possible for Canadian purchasers to effect service of process within Canada
upon the issuer or such persons. All or a substantial portion of the assets of
the issuer and such persons may be located outside of Canada and, as a result,
it may not be possible to satisfy a judgment against the issuer or such
persons in Canada or to enforce a judgment obtained in Canadian courts against
such issuer or persons outside of Canada.
NOTICE TO BRITISH COLUMBIA RESIDENTS
A purchaser of the Common Stock to whom the Securities Act (British
Columbia) applies is advised that such purchaser is required to file with the
British Columbia Securities Commission a report within ten days of the sale of
any Common Stock acquired by such purchaser pursuant to the Offering. Such
report must be in the form attached to British Columbia Securities Commission
Blanket Order BOR #95/17, a copy of which may be obtained from the Company.
Only one such report must be filed in respect of the Common Stock acquired on
the same date and under the same prospectus exemption.
TAXATION AND ELIGIBILITY FOR INVESTMENT
Canadian purchasers of the Common Stock should consult their own legal and
tax advisors with respect to the tax consequences of an investment in the
Common Stock in their particular circumstances and with respect to the
eligibility of the Common Stock for investment by the purchaser under relevant
Canadian Legislation.
56
<PAGE>
UNDERWRITING
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"), Credit
Suisse First Boston Corporation and Hambrecht & Quist LLC are acting as
representatives (the "Representatives") of each of the Underwriters named
below (the "Underwriters"). Subject to the terms and conditions set forth in a
purchase agreement (the "Purchase Agreement") among the Company, the Selling
Stockholder and the Underwriters, the Company and the Selling Stockholder have
agreed to sell to the Underwriters, and each of the Underwriters severally and
not jointly has agreed to purchase from the Company and the Selling
Stockholder, the number of shares of Common Stock set forth opposite its name
below.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ---------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated............................................. 1,390,000
Credit Suisse First Boston Corporation............................ 1,032,500
Hambrecht & Quist LLC............................................. 1,032,500
CIBC Oppenheimer Corp............................................. 195,000
A.G. Edwards & Sons, Inc.......................................... 195,000
Furman Selz LLC................................................... 195,000
Lazard Freres & Co. LLC........................................... 195,000
J.P. Morgan Securities Inc........................................ 195,000
SBC Warburg Dillon Read Inc....................................... 195,000
Dominick & Dominick, Incorporated................................. 75,000
Genesis Merchant Group Securities................................. 75,000
Gerard Klauer Mattison & Co., Inc................................. 75,000
Needham & Company, Inc............................................ 75,000
Vector Securities International, Inc.............................. 75,000
---------
Total........................................................ 5,000,000
=========
</TABLE>
In the Purchase Agreement the several Underwriters have agreed, subject to
the terms and conditions set forth therein, to purchase all of the shares of
Common Stock being sold pursuant to such agreement if any of the shares of
Common Stock being sold pursuant to such agreement are purchased. Under
certain circumstances, under the Purchase Agreement, the commitments of non-
defaulting Underwriters may be increased.
The Representatives have advised the Company and the Selling Stockholder
that the Underwriters propose initially to offer the shares of Common Stock to
the public at the public offering price set forth on the cover page of this
Prospectus, and to certain dealers at such price less a concession not in
excess of $.30 per share of Common Stock. The Underwriters may allow, and such
dealers may reallow, a discount not in excess of $.10 per share of Common
Stock on sales to certain other dealers. After the public offering, the public
offering price, concession and discount may be changed.
The Company has granted an option to the Underwriters, exercisable for 30
days after the date of this Prospectus, to purchase up to an aggregate of
750,000 additional shares of Common Stock at the public offering price set
forth on the cover page of this Prospectus, less the underwriting discount.
The Underwriters may exercise these options solely to cover over-allotments,
if any, made on the sale of the Common Stock offered hereby. To the extent
that the Underwriters exercise these options, each Underwriter will be
obligated, subject to certain conditions, to purchase a number of additional
shares of Common Stock proportionate to such Underwriter's initial amount
reflected in the foregoing table.
The Company, the Company's executive officers and directors and certain
other stockholders of the Company who beneficially own approximately
12,447,000 shares of Common Stock have agreed, subject to certain exceptions,
not to directly or indirectly (i) offer, pledge, sell, contract to sell, sell
any option or contract to purchase, purchase any option or contract to sell,
grant any option, right or warrant for the sale of or otherwise
57
<PAGE>
dispose of or transfer any shares of Common Stock or securities convertible
into or exchangeable or exercisable for Common Stock, whether now owned or
thereafter acquired by the person executing the agreement or with respect to
which the person executing the agreement thereafter acquires the power of
disposition, or file a registration statement under the Securities Act with
respect to the foregoing or (ii) enter into any swap or other agreement that
transfers, in whole or in part, the economic consequence of ownership of the
Common Stock whether any such swap or transaction is to be settled by delivery
of Common Stock or other securities, in cash or otherwise, without the prior
written consent of Merrill Lynch on behalf of the Underwriters for a period of
120 days from the date of the Purchase Agreement. See "Shares Eligible for
Future Sale."
The Company and the Selling Stockholder have agreed to indemnify the
Underwriters against certain liabilities, including certain liabilities under
the Securities Act, or to contribute to payments the Underwriters may be
required to make in respect thereof.
Until the distribution of the Common Stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriters
and certain selling group members to bid for and purchase the Common Stock. As
an exception to these rules, the Representatives are permitted to engage in
certain transactions that stabilize the price of the Common Stock. Such
transactions consist of bids or purchases for the purpose of pegging, fixing
or maintaining the price of the Common Stock.
If the Underwriters create a short position in the Common Stock in
connection with the Offering, i.e., if they sell more shares of Common Stock
than are set forth on the cover page of this Prospectus, the Representatives
may reduce that short position by purchasing Common Stock in the open market.
The Representatives may also elect to reduce any short position by exercising
all or part of the over-allotment option described above.
The Representatives may also impose a penalty bid on certain Underwriters
and selling group members. This means that if the Representatives purchase
shares of Common Stock in the open market to reduce the Underwriters' short
position or to stabilize the price of the Common Stock, they may reclaim the
amount of the selling concession from the Underwriters and selling group
members who sold those shares as part of the Offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher
than it might be in the absence of such purchases. The imposition of a penalty
bid might also have an effect on the price of the Common Stock to the extent
that it discourages resales of the Common Stock.
Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the
transactions described above may have on the price of the Common Stock. In
addition, neither the Company nor any of the Underwriters makes any
representation that the Representatives will engage in such transactions or
that such transactions, once commenced, will not be discontinued without
notice.
In connection with the Offering, certain Underwriters and selling group
members may engage in passive market making transactions in the Common Stock
on the Nasdaq National Market in accordance with Regulation M under the
Exchange Act during a period before the commencement of offers or sales of
Common Stock hereunder.
58
<PAGE>
LEGAL MATTERS
Certain legal matters with respect to the validity of the Common Stock
offered hereby will be passed upon for the Company by Pillsbury Madison &
Sutro LLP, San Francisco, California. Certain legal matters relating to the
Offering will be passed upon for the Underwriters by Cooley Godward LLP, Palo
Alto, California and Boulder, Colorado.
EXPERTS
The consolidated financial statements of Heska Corporation included in this
Prospectus and elsewhere in the Registration Statement have been audited by
Arthur Andersen LLP, independent public accountants, as indicated in their
report with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in giving said reports.
The statements of income and cash flows of Diamond Animal Health, Inc. for
the year ended March 31, 1996 included in this Prospectus and elsewhere in the
Registration Statement have been audited by McGladrey & Pullen, LLP,
independent public accountants, as indicated in their report with respect
thereto, and are included herein in reliance upon the authority of said firm
as experts in giving said reports.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy and information statements, and other
information with the Securities and Exchange Commission (the "Commission").
Such reports, proxy and information statements, and other information filed by
the Company can be inspected and copied at the public reference facilities
maintained by the Commission at 450 Fifth Street, N.W., Washington, D.C., as
well as the regional offices of the Commission located at Citicorp Center, 500
West Madison Street, Suite 1400, Chicago, Illinois, and 7 World Trade Center,
Suite 1300, New York, New York. Copies of such material can be obtained from
the public reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. The Commission maintains a World
Wide Web site that contains reports, proxy and information statements, and
other information that are filed through the Commission's Electronic Data
Gathering, Analysis and Retrieval System. This Web site can be accessed at
http://www.sec.gov.
The Company has filed with the Commission a Registration Statement on Form
S-1 under the Securities Act with respect to the Common Stock offered hereby.
This Prospectus does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules thereto, certain
portions of which are omitted as permitted by the rules and regulations of the
Commission. For further information with respect to the Company and the Common
Stock offered hereby, reference is hereby made to such Registration Statement,
exhibits and schedules. Statements contained in this Prospectus regarding the
contents of any contract or other document are not necessarily complete; with
respect to each such contract or document filed as an exhibit to the
Registration Statement, reference is made to the exhibit for a more complete
description of the matter involved, and each such statement shall be deemed
qualified in its entirety by such reference. A copy of the Registration
Statement, including the exhibits and schedules thereto, may be inspected
without charge at the principal office of the Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549, and copies of such material may be obtained from
such office upon payment of the fees prescribed by the Commission.
59
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
HESKA CORPORATION
Report of Independent Public Accountants................................ F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997............ F-3
Consolidated Statements of Operations for the years ended December 31,
1995, 1996 and 1997.................................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended De-
cember 31, 1995, 1996 and 1997......................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1995, 1996 and 1997.................................................... F-6
Notes to Consolidated Financial Statements.............................. F-7
DIAMOND ANIMAL HEALTH, INC.
Independent Auditor's Report............................................ F-24
Statement of Income for the year ended March 31, 1996................... F-25
Statement of Cash Flows for the year ended March 31, 1996............... F-26
Notes to Financial Statements........................................... F-27
</TABLE>
F-1
<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
F-2
<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
F-3
<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
F-4
<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
F-5
<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
F-6
<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.
F-7
<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>
F-8
<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.
F-9
<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
F-10
<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.
F-11
<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>
F-12
<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>
F-13
<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>
F-14
<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>
F-15
<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>
F-16
<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.
F-17
<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.
F-18
<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>
F-19
<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
F-20
<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.
F-21
<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.
F-22
<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>
F-23
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Directors
Diamond Animal Health, Inc.
Des Moines, Iowa
We have audited the accompanying statements of income and cash flows of
Diamond Animal Health, Inc. for the year ended March 31, 1996. 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 audit.
We conducted our audit 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 audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations and cash flows of Diamond
Animal Health, Inc. for the year ended March 31, 1996 in conformity with
generally accepted accounting principles.
McGladrey & Pullen, LLP
Des Moines, Iowa
May 14, 1996
F-24
<PAGE>
DIAMOND ANIMAL HEALTH, INC.
STATEMENT OF INCOME
YEAR ENDED MARCH 31, 1996
(in thousands)
<TABLE>
<CAPTION>
1996
-------
<S> <C>
Net sales (Note 6)..................................................... $ 8,124
Cost of goods sold..................................................... 6,467
-------
Gross profit....................................................... 1,657
Selling, general and administrative expenses (Note 5).................. 2,829
-------
Operating loss..................................................... (1,172)
-------
Financial expense:
Interest income...................................................... 12
Interest (expense)................................................... (426)
-------
(414)
-------
Loss before income tax benefit......................................... (1,586)
Income tax benefit (Note 4)............................................ (130)
-------
Net loss........................................................... $(1,456)
=======
</TABLE>
See Notes to Financial Statements.
F-25
<PAGE>
DIAMOND ANIMAL HEALTH, INC.
STATEMENT OF CASH FLOWS
YEAR ENDED MARCH 31, 1996
(in thousands)
<TABLE>
<CAPTION>
1996
-------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)................................................... $(1,456)
Adjustments to reconcile net income (loss) to net cash (used in) op-
erating activities:
Depreciation...................................................... 159
Amortization...................................................... 23
Noncash pension expense........................................... 7
Noncash interest expense.......................................... 195
Change in operating assets and liabilities:
(Increase) in trade receivables................................. (37)
(Increase) in income tax refund claim receivable................ (160)
(Increase) in inventories....................................... (667)
(Increase) in prepaid expenses.................................. (70)
Decrease in other assets........................................ 16
Increase in accounts payable.................................... 421
Increase in accrued expenses.................................... 152
Increase in customer deposits................................... 623
-------
Net cash (used in) operating activities....................... (794)
-------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment.................................. (218)
-------
Net cash (used in) investing activities....................... (218)
-------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from debt.................................................. 1,505
Principal payments on debt, including capital lease obligations..... (482)
-------
Net cash provided by financing activities..................... 1,023
-------
Net increase in cash.......................................... 11
CASH
Beginning........................................................... 83
-------
Ending.............................................................. $ 94
-------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest.......................................................... $ 221
Income taxes...................................................... 5
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Accretion (valuation) of redeemable common stock purchase warrants
(Note 3)........................................................... (116)
Capital lease obligations incurred for the purchase of equipment.... 136
347,028 shares of common stock issued in exchange for redeemable
common stock purchase warrants, net of $100 cash secured (Note 3).. 135
(Decrease) in minimum pension liability as stockholder's equity..... (24)
</TABLE>
See Notes to Financial Statements.
F-26
<PAGE>
DIAMOND ANIMAL HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of business: Diamond Animal Health, Inc. (the "Company") manufactures
and sells animal health products to the agricultural and veterinary markets in
the United States, Canada and Europe. The Company, which was incorporated in
1993 and began operations in its current legal form in 1994, is a successor
corporation to an original manufacturing company which was founded in 1952.
Significant accounting policies:
Cost of goods sold: Inventories are stated at the lower of cost, determined
by using first-in, first-out (FIFO) method, or market.
Depreciation: Depreciation is provided on the straight-line method over the
estimated useful lives of the assets, including 10 to 15 years for buildings
and 5 to 10 years for machinery and equipment. It is the Company's policy to
include amortization of assets acquired under capital leases with depreciation
expense on owned assets.
Amortization: Costs incurred in connection with the organization of the
Company are amortized on the straight-line basis over five years.
Deferred taxes: Deferred taxes are provided on a liability method whereby
deferred tax assets are recognized for deductible temporary differences and
tax credit carryforwards and deferred tax liabilities are recognized for
taxable temporary differences. Temporary differences are the differences
between the reported amounts of assets and liabilities and their tax basis.
Deferred tax assets are reduced by a valuation allowance when, in the opinion
of management, it is more likely than not that some portion or all of the
deferred tax assets will not be realized. Deferred tax assets and liabilities
are adjusted for the effects of changes in tax laws and rates on the date of
enactment.
Stock options and awards: Employee stock options and awards are accounted
for in accordance with Accounting Principles Board Opinion No. 25 using the
intrinsic value method. Under that method, the excess of the fair value of the
underlying stock over the exercise price is determined at the measurement date
and recognized as compensation expense over the related service period.
Research and development: Expenditures for research and development are
charged to expense as incurred. Expense for the year ended March 31, 1996 was
approximately $1,455,000.
Revenue recognition: Revenue is recognized upon shipment of orders.
Estimates and assumptions: 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 revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
NOTE 2. RENT EXPENSE
The Company leases its primary production and office facility under a
noncancelable operating lease expiring on December 31, 1998. The lease
contains a five-year renewal option exercisable at the option of the Company.
In addition, the Company leases certain office equipment and autos under
operating leases expiring from February 1997 to May 2000. Total rent expense
was approximately $182,000 for the year ended March 31, 1996.
NOTE 3. REDEEMABLE COMMON STOCK PURCHASE WARRANTS
In connection with the initial capitalization of the Company, warrants were
issued to subordinated lenders to purchase a total of 337,028 shares of common
stock at an exercise price of $.005 per share. Total proceeds
F-27
<PAGE>
DIAMOND ANIMAL HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
received from the lenders were allocated to long-term debt and warrants based
on fair value, resulting in an initial carrying value of the warrants of
$133,000. The carrying value of the warrants was being accreted to the
estimated redemption price on a pro-rata basis over the period until the
initial redemption date, with a corresponding credit to retained earnings of
$(116,000) for the year ended March 31, 1996. All warrants were exercised
during the year ended March 31, 1996. Under a similar agreement, warrants to
purchase 20,000 shares of common stock were issued in March 1996, with 10,000
warrants exercised at $.01 per share and the remaining 10,000 exercised
subsequent to year-end at $.01 per share.
NOTE 4. INCOME TAXES
The income tax provision differs from the amount of income tax determined by
applying the U.S. federal income tax rate to pretax income (loss) from
continuing operations for the year ended March 31, 1996 due to the following:
<TABLE>
<CAPTION>
1996
---------
<S> <C>
Computed "expected" benefit...................................... $(544,000)
Increase in valuation allowance.................................. 414,000
---------
$(130,000)
=========
</TABLE>
At March 31, 1996, the Company had research and development tax credit
carryforwards of approximately $370,000 which expire in 2000 through 2003. The
Company also had net operating loss carryforwards of $567,000 which expire in
the year 2010.
NOTE 5. EMPLOYEE BENEFIT PLANS
The Company 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. Substantially all employees were
eligible for the plan prior to the plan being frozen. The Company's funding
policy is to make the minimum annual contribution that is required by
applicable regulations. Effective October 1992, the Company froze the plan
restricting new participants and benefits for future service.
Net pension cost for the Company's defined benefit pension plan consisted of
the following components for the year ended March 31, 1996:
<TABLE>
<CAPTION>
1996
---------
<S> <C>
Interest cost on projected benefit obligation..................... $ 72,000
Actual return on plan assets...................................... (171,000)
Net amortization and deferral..................................... 106,000
---------
$ 7,000
=========
</TABLE>
F-28
<PAGE>
DIAMOND ANIMAL HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Assumptions used by the Company in the determination of the pension plan
information consisted of the following as of March 31, 1996:
<TABLE>
<S> <C>
Discount rate.......................................................... 7.00%
Expected long-term rate of return on plan assets....................... 7.75%
</TABLE>
The Company has a 401(k) plan covering substantially all full-time
employees. Under the terms of the plan, participants may contribute up to 15%
of the salary to the plan. The Company matches certain employee contributions,
depending on length of service with the Company. Expense related to this plan
was approximately $82,000 for the year ended March 31, 1996. The Company also
has a defined contribution plan covering substantially all full-time
employees. The Company contributed 3% of all eligible employee earnings for
the year ended March 31, 1996. Expense related to this plan was approximately
$108,000 for the year ended March 31, 1996.
The Company has an employee stock option plan providing for the issuance of
up to 337,028 shares of the Company's common stock. The plan provides for
options to be issued to key employees at an exercise price of not less than
fair market value with a term of ten years and a month to exercise from date
of grant. At March 31, 1996 the Company had options outstanding for a total of
129,737 shares at an exercise price of $3.18 per share, all of which were
fully vested and exercisable and expire in the years ending March 31, 2005 and
2006.
NOTE 6. MAJOR CUSTOMER
Approximately 71% of the Company's revenues for the year ended March 31,
1996 were derived from the Company's major customer representing sales of
approximately $5,766,000. The Company has a supply agreement with the customer
which obligates the customer to purchase a minimum quantity of vaccines from
the Company annually on a calendar year basis starting January 1, 1996. The
agreement is effective through June 1999, renewable annually thereafter. This
agreement is terminable by either party for material breach which remains
uncured by the other party or after June 30, 1999 on 18 months' written
notice.
NOTE 7. INTEREST EXPENSE
The Company had long-term debt, bank and other notes payable totaling
$5,347,000 at March 31, 1996 at interest rates ranging primarily from 8% to
10%.
F-29
<PAGE>
[INSIDE BACK COVER OF PROSPECTUS]
[PHOTOGRAPHS OF DOG, CAT AND HORSE AND DRAWINGS OF THE LOGOS OF HESKA'S
SUBSIDIARIES, BLOXHAM LABORATORIES, LTD., CMG CENTRE MEDICAL DES GRAND'PLACES
SA, DIAMOND ANIMAL HEALTH, AND CENTER LABORATORIES, INCORPORATED. APPEAR HERE]
CAPTION READS: OUR MISSION: TO IMPROVE THE HEALTH AND WELL-BEING OF COMPANION
ANIMALS AND THEIR OWNERS.
<PAGE>
================================================================================
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AU-
THORIZED BY THE COMPANY, THE SELLING STOCKHOLDER OR THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER
TO BUY, THE COMMON STOCK IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM,
IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF
THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES,
CREATE AN IMPLICATION THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET
FORTH IN THIS PROSPECTUS OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HERE-
OF.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Use of Proceeds.......................................................... 14
Price Range of Common Stock.............................................. 14
Dividend Policy.......................................................... 15
Capitalization........................................................... 15
Dilution................................................................. 16
Selected Consolidated Financial Data..................................... 17
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 18
Business................................................................. 22
Management............................................................... 41
Principal and Selling Stockholders....................................... 49
Certain Transactions..................................................... 51
Description of Capital Stock............................................. 53
Shares Eligible for Future Sale.......................................... 55
Certain Considerations for
Non-United States Holders............................................... 55
Underwriting............................................................. 57
Legal Matters............................................................ 59
Experts.................................................................. 59
Available Information.................................................... 59
Index to Consolidated Financial Statements............................... F-1
</TABLE>
================================================================================
5,000,000 SHARES
[LOGO OF HESKA CORPORATION APPEARS HERE]
COMMON STOCK
----------------
PROSPECTUS
----------------
MERRILL LYNCH & CO.
CREDIT SUISSE FIRST BOSTON
HAMBRECHT & QUIST
FEBRUARY 25, 1998
================================================================================
