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FILED PURSUANT TO RULE 424(b)(4)
REGISTRATION NO. 333-90433
PROSPECTUS
6,500,000 SHARES
HESKA CORPORATION
[HESKA LOGO]
COMMON STOCK
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We are offering up to 6,500,000 shares of our common stock, $.001 par
value per share, to selected institutional investors, including current
institutional holders of our common stock. The State of Wisconsin Investment
Board, Charter Ventures II, L.P. and Zesiger Capital Group LLC, all of whom are
existing shareholders, have expressed an interest in participating in this
offering. As provided in a securities purchase agreement, the purchase price per
share of our common stock will be $2.063. Heska will receive approximately $13.3
million in net proceeds from this offering.
Our common stock is quoted on the Nasdaq National Market under the
symbol HSKA. On November 30, 1999 the last reported closing price of our common
stock was $2.063 per share.
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INVESTING IN THE SHARES INVOLVES SUBSTANTIAL RISKS. PLEASE REFER TO THE
RISK FACTORS SECTION BEGINNING ON PAGE 4.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The date of this prospectus is December 1, 1999.
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TABLE OF CONTENTS
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PROSPECTUS SUMMARY...........................................................................3
RISK FACTORS.................................................................................4
FORWARD-LOOKING STATEMENTS..................................................................12
USE OF PROCEEDS.............................................................................12
PRICE RANGE OF COMMON STOCK.................................................................13
DIVIDEND POLICY.............................................................................13
CAPITALIZATION..............................................................................14
DILUTION....................................................................................15
SELECTED CONSOLIDATED FINANCIAL DATA........................................................16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......17
BUSINESS....................................................................................26
MANAGEMENT..................................................................................39
PRINCIPAL STOCKHOLDERS......................................................................47
RELATED PARTY TRANSACTIONS..................................................................49
DESCRIPTION OF CAPITAL STOCK................................................................50
PLAN OF DISTRIBUTION........................................................................53
LEGAL MATTERS...............................................................................53
EXPERTS.....................................................................................53
WHERE YOU CAN FIND MORE INFORMATION.........................................................54
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS..................................................F-1
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ABOUT THIS PROSPECTUS
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT.
THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL TO SELL THESE SECURITIES. THE
INFORMATION IN THIS DOCUMENT IS ACCURATE ONLY AS OF THE DATE OF THIS PROSPECTUS.
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PROSPECTUS SUMMARY
The following summary highlights information we present more fully
elsewhere in this prospectus. This prospectus contains forward-looking
statements that involve risks and uncertainties. Our actual results could differ
materially from those anticipated in the forward-looking statements as a result
of factors described under the heading "Risk Factors" and elsewhere in this
prospectus.
OUR COMPANY
Heska discovers, develops, manufactures and markets companion animal
health products, primarily for dogs, cats and horses. Heska has a sophisticated
scientific effort devoted to applying biotechnology to create a broad range of
diagnostic, therapeutic and vaccine products for the large and growing companion
animal health market. In addition to its diagnostic, therapeutic and vaccine
products, Heska also offers patient monitoring instrumentation and supplies, as
well as laboratory diagnostic services in the United States and Europe to
veterinarians, and operates USDA- and FDA-licensed facilities, which manufacture
certain of our products. Our principal executive offices are located at 1613
Prospect Parkway, Fort Collins, Colorado 80525 and our telephone number is (970)
493-7272.
In addition to manufacturing certain of Heska's companion animal
products, our primary manufacturing subsidiary, Diamond Animal Health, Inc.
("Diamond"), also manufactures animal health vaccine products which are marketed
and distributed by third parties. In addition to manufacturing veterinary
allergy products for marketing and sale by Heska, our subsidiaries, Center
Laboratories, Inc. ("Center") and CMG-Heska Allergy Products S.A. ("CMG"), a
Swiss corporation, also manufacture and sell human allergy products. Heska UK
Ltd. ("Heska UK," formerly Bloxham Laboratories) is a veterinary diagnostic
laboratory and sells our patient diagnostic and medical instruments in the
United Kingdom.
RISK FACTORS
See the section of this prospectus entitled "Risk Factors," starting on
page 4, for a discussion of factors that you should consider before investing in
the common stock offered by this prospectus.
THE OFFERING
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Common stock offered ............................... 6,500,000 shares
Common stock outstanding after the offering......... 33,361,658 shares
Nasdaq National Market symbol....................... HSKA
Use of proceeds..................................... Proceeds will be used for research and development,
sales and marketing activities, working capital and
general corporate purposes. See "Use of Proceeds."
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The foregoing information is based on shares outstanding as of September
30, 1999. The total number of shares that we assume will be outstanding after
the offering excludes 3,817,734 shares issuable upon exercise of outstanding
stock options as of September 30, 1999; and 1,262,392 shares reserved for
issuance under our stock option plans as of September 30, 1999.
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RISK FACTORS
You should carefully consider the following risk factors and all other
information contained in this prospectus before purchasing our common stock.
Investing in our common stock involves a high degree of risk. Risks and
uncertainties, in addition to those we describe below, that are not presently
known to us or that we currently believe are immaterial may also impair our
business operations. If any of the following risks occur, our business,
operating results and financial condition could be seriously harmed. In
addition, the trading price of our common stock could decline due to the
occurrence of any of these risks, and you may lose all or part of your
investment.
WE HAVE A HISTORY OF LOSSES AND MAY NEVER ACHIEVE PROFITABILITY.
We have incurred net losses since our inception. At September 30, 1999,
our accumulated deficit was $139.9 million. We anticipate that we will continue
to incur additional operating losses in the near term. These losses have
resulted principally from expenses incurred in our research and development
programs and from general and administrative and sales and marketing expenses.
We cannot assure you that we will attain profitability or, if we do, that we
will remain profitable on a quarterly or annual basis in the future.
WE HAVE LIMITED RESOURCES TO DEVOTE TO PRODUCT DEVELOPMENT AND
COMMERCIALIZATION.
Our strategy is to develop a broad range of products addressing
companion animal healthcare. We believe that our revenue growth and
profitability, if any, will substantially depend upon our ability to:
- improve market acceptance of our current products;
- complete development of new products; and
- successfully introduce and commercialize new products.
We have introduced some of our products only recently and many of our
products are still under development. Because we have limited resources to
devote to product development and commercialization, any delay in the
development of one product or reallocation of resources to product development
efforts that prove unsuccessful may delay or jeopardize the development of our
other product candidates. If we fail to develop new products and bring them to
market, our business could be substantially harmed.
WE MAY EXPERIENCE DIFFICULTY IN COMMERCIALIZING OUR PRODUCTS.
Because several of our current products, as well as a number of products
under development, are novel, we may need to expend substantial efforts in order
to educate our customers about the uses of our products and to convince them of
the need for our products. We cannot assure you that any of our products will
achieve satisfactory market acceptance or that we will successfully
commercialize them on a timely basis, or at all. If any of our products do not
achieve a significant level of market acceptance, our business could be
substantially harmed.
WE MUST OBTAIN COSTLY REGULATORY APPROVALS IN ORDER TO BRING OUR PRODUCTS TO
MARKET.
Many of the products we develop and market are subject to regulation by
one or more of the United States Department of Agriculture, the Food and Drug
Administration, the Environmental Protection Agency and foreign regulatory
authorities. The development and regulatory approval activities necessary to
bring new products to market are time-consuming and costly. We have experienced
in the past, and may experience in the future, difficulties that could delay or
prevent us from obtaining the regulatory approvals necessary to introduce new
products or to market them. We cannot assure you that the USDA, the FDA, the EPA
or foreign regulatory authorities will issue regulatory clearance or new product
approvals on a timely basis, or at all. Any acquisitions of new products and
technologies may subject us to additional government regulation. If
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we do not secure the necessary regulatory approvals for our products, our
business could be substantially harmed.
FACTORS BEYOND OUR CONTROL MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE AND MANY
OF OUR EXPENSES ARE FIXED.
We believe that our future operating results will fluctuate on a
quarterly basis due to a variety of factors, including:
- the introduction of new products by us or by our competitors;
- market acceptance of our current or new products;
- regulatory and other delays in product development;
- product recalls;
- competition and pricing pressures from competitive products;
- manufacturing delays;
- shipment problems;
- product seasonality; and
- changes in the mix of products sold.
We have high operating expenses for personnel, new product development
and marketing. Many of these expenses are fixed in the short term. If any of the
factors listed above cause our revenues to decline, our operating results could
be substantially harmed.
WE MAY NEED TO SEEK ADDITIONAL FINANCING IN THE FUTURE.
We have incurred negative cash flow from operations since inception. We
do not expect to generate positive cash flow sufficient to fund our operations
in the near term. We believe that our available cash, cash from operations and
available borrowings, together with the proceeds of this offering, will be
sufficient to satisfy our projected cash requirements through 2000, assuming no
significant uses of cash in acquisition activities. Thus, we may need to raise
additional capital to fund our research and development, manufacturing, sales
and marketing activities. Our future liquidity and capital requirements will
depend on numerous factors, including:
- the extent to which our present and future products gain market
acceptance;
- the extent to which we successfully develop products from
technologies under research or development;
- the timing of regulatory actions concerning our products;
- the costs and timing of expansions of our sales, marketing and
manufacturing activities;
- the cost, timing and business management of recent and potential
acquisitions and contingent liabilities associated with
acquisitions;
- the procurement and enforcement of important patents, and
- the results of competition.
We cannot assure you that additional capital will be available on
acceptable terms, if at all. Furthermore, any additional equity financing would
likely be dilutive to stockholders, and debt financing, if available, may
include restrictive covenants which may limit our currently planned operations
and strategies. If adequate funds are not available, we may be required to
curtail our operations significantly or to obtain funds by entering into
collaborative agreements or other arrangements on unfavorable terms. If we fail
to raise capital on acceptable terms when we need to, our business could be
substantially harmed. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
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A SMALL NUMBER OF LARGE CUSTOMERS ACCOUNT FOR A LARGE PERCENTAGE OF OUR
REVENUES.
We currently derive a substantial portion of our revenues from Diamond,
which manufactures certain of our products and products for other companies in
the animal health industry. Revenues from one Diamond customer comprised
approximately 15% of total revenues in 1998 under the terms of a take-or-pay
contract which ends in February 2000. If this customer does not continue to
purchase from Diamond and if we fail to replace the lost revenues with revenues
from other customers, our business could be substantially harmed.
WE HAVE LIMITED EXPERIENCE IN MARKETING OUR PRODUCTS.
The market for companion animal healthcare products is highly
fragmented, with discount stores and specialty pet stores accounting for a
substantial percentage of sales. Because we sell our companion animal health
products only to veterinarians, we may fail to reach a substantial segment of
the potential market, and we may not be able to offer our products at prices
which are competitive with those of companies that distribute their products
through retail channels. We currently market our products to veterinarians
through a direct sales force and through third parties. To be successful, we
will have to continue to develop and train our direct sales force or rely on
marketing partnerships or other arrangements with third parties to market,
distribute and sell our products. We cannot assure you that we will successfully
develop and maintain marketing, distribution or sales capabilities, or that we
will be able to make arrangements with third parties to perform these activities
on satisfactory terms. If we fail to develop a successful marketing strategy,
our business could be substantially harmed.
WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY.
The market in which we operate is intensely competitive. Our competitors
include independent 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 compete with our products or would compete with them if
developed. These competitors may all have substantially greater financial,
technical, research and other resources and larger, better-established
marketing, sales, distribution and service organizations than we do. Our
competitors offer broader product lines and have greater name recognition than
we do. We cannot assure you that our competitors will not develop or market
technologies or products that are more effective or commercially attractive than
our current or future products, or that would render our technologies and
products obsolete. Moreover, we cannot assure you that we will have the
financial resources, technical expertise or marketing, distribution or support
capabilities to compete successfully. If we fail to compete successfully, our
business could be substantially harmed.
WE HAVE GRANTED THIRD PARTIES SUBSTANTIAL MARKETING RIGHTS TO OUR PRODUCTS UNDER
DEVELOPMENT.
We have granted marketing rights to certain products under development
to third parties, including Novartis, Bayer, Eisai and Ralston Purina. 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 we develop on or before December 31,
2005. We have retained the right to co-exclusively manufacture and market these
products throughout the world under our own trade names. Accordingly, we and
Novartis may become direct competitors, with each party sharing revenues on the
other's sales. We have also granted Novartis a right of first refusal pursuant
to which, prior to granting rights to any third party for any products or
technology we develop or acquire for either companion animal or food animal
applications, we must first offer Novartis such rights. In Japan, Novartis also
has the exclusive right, upon regulatory approval, to distribute our (a)
heartworm diagnostics, (b) trivalent and bivalent feline vaccines and (c)
certain other Heska products. Bayer has exclusive marketing rights to our canine
heartworm vaccine and our 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 our feline and canine heartworm vaccines,
feline and canine
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flea control vaccines and feline toxoplasmosis vaccine. In addition, we granted
Ralston Purina the exclusive rights to develop and commercialize our
discoveries, know-how and technologies in various pet food products.
Our agreements with our corporate marketing partners generally contain
no minimum purchase requirements in order for them to maintain their exclusive
or co-exclusive marketing rights. We cannot assure you that Novartis, Bayer or
Eisai or any other collaborative party will devote sufficient resources to
marketing our 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 our products. If we fail to develop and
maintain our own marketing capabilities, we may find it necessary to continue to
rely on potential or actual competitors for third-party marketing assistance.
Third party marketing assistance may not be available in the future on
reasonable terms, if at all.
WE MAY FACE COSTLY INTELLECTUAL PROPERTY DISPUTES.
Our ability to compete effectively will depend in part on our ability to
develop and maintain proprietary aspects of our technology and either to operate
without infringing the proprietary rights of others or to obtain rights to
technology owned by third parties. We have United States and foreign-issued
patents and are currently prosecuting patent applications in the United States
and with various foreign patent offices. We cannot assure you that any of our
pending patent applications will result in the issuance of any patents or that
any issued patents will offer protection against competitors with similar
technology. We cannot assure you that any patents we receive will not be
challenged, invalidated or circumvented in the future or that the rights created
by those patents will provide a competitive advantage. We also rely on trade
secrets, technical know-how and continuing invention to develop and maintain our
competitive position. We cannot assure you that others will not independently
develop substantially equivalent proprietary information and techniques or
otherwise gain access to our trade secrets.
The biotechnology and pharmaceutical industries have been characterized
by extensive litigation relating to patents and other intellectual property
rights. In 1998, Synbiotics Corporation filed a lawsuit against us alleging
infringement of a Synbiotics patent relating to heartworm diagnostic technology.
See "Business--Legal Proceedings." We cannot assure you that we will not become
subject to additional patent infringement claims and litigation in the United
States or other countries or interference proceedings conducted in the United
States Patent and Trademark Office to determine the priority of inventions. The
defense and prosecution of intellectual property suits, USPTO interference
proceedings, and related legal and administrative proceedings are costly,
time-consuming and distracting. We may also need to pursue litigation to enforce
any patents issued to us or our collaborative partners, to protect trade secrets
or know-how owned by us or our 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 us
and significant diversion of the efforts of our technical and management
personnel. Any adverse determination in litigation or interference proceedings
could subject us to significant liabilities to third parties. Further, as a
result of litigation or other proceedings, we may be required to seek licenses
from third parties which may not be available on commercially reasonable terms,
if at all.
We license technology from a number of third parties. The majority of
these license agreements impose due diligence or milestone obligations on us,
and in some cases impose minimum royalty and/or sales obligations on us, in
order for us to maintain our rights under these agreements. Our products may
incorporate technologies that are the subject of patents issued to, and patent
applications filed by, others. As is typical in our industry, from time to time
we and our collaborators have received, and may in the future receive, notices
from third parties claiming infringement and invitations to take licenses under
third-party patents. It is our policy that when we receive such notices, we
conduct investigations of the claims they assert. With respect to the notices we
have received to date, we believe, after due investigation, that we have
meritorious defenses to the infringement claims asserted. Any legal action
against us or our collaborators may require us or our collaborators to obtain
one or more licenses in order to market or manufacture affected products or
services. However, we cannot assure you that we or our collaborators will be
able to obtain licenses for technology
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patented by others on commercially reasonable terms, that we 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 our businesses.
Failure to obtain necessary licenses or to identify and implement alternative
approaches could prevent us and our collaborators from commercializing certain
of our products under development and could substantially harm our business.
WE HAVE LIMITED MANUFACTURING EXPERIENCE AND CAPACITY AND RELY SUBSTANTIALLY ON
THIRD-PARTY MANUFACTURERS.
To be successful, we must manufacture, or contract for the manufacture
of, our 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 increase our
manufacturing capacity, we acquired Diamond in April 1996 and certain assets of
Center in July 1997. We must complete significant improvements in our
manufacturing infrastructure in order to scale up for the manufacturing of our
new products. We cannot assure you that we can complete such work successfully
or on a timely basis.
We currently rely on third parties to manufacture those products we do
not manufacture at our Diamond or Center facilities. We currently have supply
agreements with Atrix Laboratories, Inc., for our canine periodontal disease
therapeutic, and with Quidel Corporation, for certain manufacturing services
relating to our point-of-care diagnostic tests. Third parties also manufacture
our patient monitoring instruments and associated consumable products. We cannot
assure you that these partners will manufacture products to regulatory standards
and our specifications in a cost-effective and timely manner. If one or more of
our suppliers experiences delays in scaling up commercial manufacturing, fails
to produce a sufficient quantity of products to meet market demand, or requests
renegotiation of contract prices, our business could be substantially harmed.
While we typically retain the right to manufacture products ourselves or
contract with an alternative supplier in the event of a manufacturer's breach,
any transfer of production would cause significant production delays and
additional expense to us to scale up production at a new facility and to apply
for regulatory licensure at that new facility. In addition, we cannot assure you
that suitable manufacturing partners or alternative suppliers will be available
for our products under development if present arrangements are not satisfactory.
OUR MANUFACTURING FACILITIES ARE SUBJECT TO GOVERNMENTAL REGULATION.
Our manufacturing facilities and those of any third-party manufacturers
we may use are subject to the requirements of and periodic regulatory
inspections by one or more of the Food and Drug Administration, the United
States Department of Agriculture and other federal, state and foreign regulatory
agencies. We cannot assure you that we or our contractors will continue to
satisfy these regulatory requirements. Any failure to do so would substantially
harm our business, financial condition or results of operations. We cannot
assure you that we will not incur significant costs to comply with laws and
regulations in the future or that new laws and regulations will not
substantially harm our business.
WE DEPEND ON PARTNERS IN OUR RESEARCH AND DEVELOPMENT ACTIVITIES.
For certain of our proposed products, we are dependent on collaborative
partners to successfully and timely perform research and development activities
on our behalf. We cannot assure you that these collaborative partners will
complete research and development activities on our behalf in a timely fashion,
or at all. If our collaborative partners fail to complete research and
development activities, or fail to complete them in a timely fashion, our
business could be substantially harmed.
WE DEPEND ON KEY PERSONNEL FOR OUR FUTURE SUCCESS.
Our future success is substantially dependent on the efforts of our
senior management and scientific team. The loss of the services of members of
our senior management or scientific staff may significantly delay
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or prevent the achievement of product development and other business objectives.
Because of the specialized scientific nature of our business, we depend
substantially on our ability to attract and retain qualified scientific and
technical personnel. There is intense competition among major pharmaceutical and
chemical companies, specialized biotechnology firms and universities and other
research institutions for qualified personnel in the areas of our activities. If
we lose the services of, or fail to recruit, key scientific and technical
personnel, our business could be substantially harmed.
WE MUST MANAGE OUR GROWTH EFFECTIVELY.
We anticipate that our business will grow as we develop and
commercialize new products, and that this growth will result in an increase in
responsibilities for both existing and new management personnel. In order to
manage growth effectively, we will need to continue to implement and improve our
operational, financial and management information systems, to train, motivate
and manage our current employees, and to hire new employees. We cannot assure
you that we will be able to manage our expansion effectively. Failure to do so
could substantially harm our business.
WE MUST IDENTIFY AND INTEGRATE ACQUISITIONS EFFECTIVELY.
In 1996, we consummated the acquisitions of Diamond and of certain
assets relating to our canine allergy business. Other acquisitions include:
- our February 1997 purchase of Heska UK;
- our July 1997 purchase of the allergy immunotherapy products
business of Center;
- our September 1997 purchase of CMG which manufactures and
markets allergy diagnostic products for use in veterinary and
human medicine, primarily in Europe and Japan; and
- our March 1998 acquisition of Sensor Devices, Inc., now Heska
Waukesha.
We may issue additional shares of common stock to effect future
acquisitions. These 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. We cannot
assure you that we will be effective in identifying and effecting attractive
acquisitions, integrating acquisitions or managing future growth. Failure to do
so may substantially harm our business, financial condition or results of
operations.
WE MAY FACE PRODUCT LIABILITY LITIGATION AND THE EXTENT OF OUR INSURANCE
COVERAGE IS LIMITED.
The testing, manufacturing and marketing of our current products as well
as those currently under development entail an inherent risk of product
liability claims and associated adverse publicity. To date, we have not
experienced any material product liability claims, but any claim arising in the
future could substantially harm our business. Potential product liability claims
may exceed the amount of our insurance coverage or may be excluded from coverage
under the terms of the policy. We cannot assure you that we will be able to
continue to obtain adequate insurance at a reasonable cost, if at all. In the
event that we are held liable for a claim against which we are not indemnified
or for damages exceeding the limits of our insurance coverage or which results
in significant adverse publicity against us, our business could be substantially
harmed.
SIDE EFFECTS OF OUR PRODUCTS MAY GENERATE ADVERSE PUBLICITY.
Following the introduction of a product, adverse side effects may be
discovered that make a product no longer commercially viable. Publicity
regarding such adverse effects could affect sales of our other products for an
indeterminate time period. We are dependent on the acceptance of our products by
both veterinarians and pet owners. If we fail to engender confidence in our
products and services, our ability to attain and sustain market acceptance of
our products could be substantially harmed.
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THE YEAR 2000 PROBLEM COULD CAUSE SIGNIFICANT HARM TO OUR OPERATIONS.
The Year 2000 problem is the result of computer programs being written
using two digits, rather than four, to define the applicable year. Date
sensitive hardware and software may recognize a date ending in "00" as the year
1900 rather than the year 2000. As a result, computer systems and software used
by many organizations and governmental agencies may need to be upgraded to
comply with these Year 2000 requirements or risk system failure or
miscalculations causing disruptions of normal business activities.
We have substantially completed procedures to identify, evaluate and
implement any necessary changes to our computer systems, applications and
embedded technologies resulting from the Year 2000 conversion. We are
coordinating these activities with suppliers, distributors, financial
institutions and others with whom we do business. We cannot assure you that we
will achieve full compliance in a timely manner, or at all. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Year
2000 Compliance."
WE MAY BE HELD LIABLE FOR THE RELEASE OF HAZARDOUS MATERIALS.
Our products and development programs involve the controlled use of
hazardous and biohazardous materials, including chemicals, infectious disease
agents and various radioactive compounds. Although we believe that our safety
procedures for handling and disposing of such materials comply with the
standards prescribed by applicable local, state and federal regulations, we
cannot completely eliminate the risk of accidental contamination or injury from
these materials. In the event of such an accident, we could be held liable for
any damages or fines that result. Our liability for the release of hazardous
materials could exceed our resources. We may incur substantial costs to comply
with environmental regulations as we expand our manufacturing capacity.
WE EXPECT TO EXPERIENCE VOLATILITY IN OUR 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. The market price of our common stock may fluctuate
substantially due to factors such as:
- announcements of technological innovations or new products by us
or by our competitors;
- releases of reports by securities analysts;
- developments or disputes concerning patents or proprietary
rights;
- regulatory developments;
- changes in regulatory policies;
- economic and other external factors; and
- quarterly fluctuations in our financial results.
OUR DIRECTORS, EXECUTIVE OFFICERS AND ENTITIES AFFILIATED WITH THEM HAVE
SUBSTANTIAL CONTROL OVER OUR AFFAIRS.
Our directors, executive officers and entities affiliated with them own
approximately 44% of our outstanding common stock. Three of our major
stockholders, Charter Ventures, Novartis and Volendam, who together own
approximately 39% of our outstanding common stock, have entered into a voting
agreement dated as of April 12, 1996 whereby each agreed to collectively vote
its shares in such a manner so as to ensure that each major stockholder was
represented by one member on our Board of Directors. The voting agreement
terminates on December 31, 2005 unless prior to that date any of the investors
ceases to beneficially hold 2,000,000 shares of our voting stock, at which time
the voting agreement will terminate. Our major stockholders, acting together,
could substantially influence matters requiring approval by our stockholders,
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including the election of directors and the approval of mergers or other
business combination transactions. These stockholders may have interests
different from, or in addition to, those of non-affiliated stockholders.
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FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements within the meaning
of the federal securities laws that relate to future events or our future
financial performance. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "expects," "plans,"
"anticipates," "believes," "estimates," "predicts," "intend," "potential" or
"continue" or the negative of such terms or other comparable terminology. In
addition, these forward-looking statements include, but are not limited to,
statements regarding the following: (1) our ability to successfully develop and
commercialize new products, (2) our ability to achieve market acceptance of
existing and new products, (3) our ability to receive required regulatory
approvals for our products, (4) our intellectual property portfolio and (5) our
business strategies and plans. These statements are only predictions.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. Moreover, neither we nor any
other person assumes responsibility for the accuracy and completeness of these
statements. We are under no duty to update any of the forward-looking statements
after the date of this prospectus or to conform these statements to actual
results.
USE OF PROCEEDS
Heska will receive net proceeds of approximately $13.3 million from this
offering.
We expect to use the net proceeds from this offering for general
corporate purposes, including working capital, research and development and
sales and marketing. We may use a portion of the net proceeds to acquire
complementary products, technologies or businesses when the opportunity arises;
however, we currently have no commitments or agreements and are not in any
negotiations with respect to any such transaction. Until applied to any use, the
net proceeds will be invested in short-term interest-bearing, investment-grade
securities.
-12-
<PAGE> 13
PRICE RANGE OF COMMON STOCK
Our common stock is quoted on the Nasdaq National Market under the
symbol "HSKA" since our initial public offering on July 1, 1997. The following
table sets forth the intraday high and low prices for our common stock as
reported by the Nasdaq National Market, for the periods indicated below.
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
1997
Third Quarter ............................. $ 16.00 $ 7.125
Fourth Quarter ............................ 15.625 11.25
1998
First Quarter ............................. 14.875 9.25
Second Quarter ............................ 16.75 8.75
Third Quarter ............................. 11.938 5.125
Fourth Quarter ............................ 7.625 3.00
1999
First Quarter ............................. 6.00 3.00
Second Quarter ............................ 5.125 2.25
Third Quarter ............................. 3.938 2.00
Fourth Quarter (through November 30) ...... 2.938 1.375
</TABLE>
On November 30, 1999, the last reported sale price of our common stock
was $2.063 per share. As of September 30, 1999, there were approximately 275
holders of record of our common stock.
DIVIDEND POLICY
We have never declared or paid any dividends on our capital stock. We
currently expect to retain future earnings, if any, to support the development
of our business and do not anticipate paying any cash dividends in the
foreseeable future.
-13-
<PAGE> 14
CAPITALIZATION
The following table sets forth our capitalization as of September 30,
1999, and as adjusted to reflect the sale of the our common stock offered hereby
and the receipt of net proceeds from the sale.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999
(UNAUDITED)
---------------------------
ACTUAL AS ADJUSTED
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Long-term obligations, less current portion(1) ............ $ 7,993 $ 7,993
--------- ---------
Stockholders' equity:
Preferred Stock, $.001 par value; 25,000,000 shares
authorized; none outstanding ......................... -- --
Common Stock, $.001 par value; 40,000,000 shares
authorized; 26,861,658 issued and
outstanding (actual); 33,361,658 issued
and outstanding (as adjusted)(2) ..................... 27 33
Additional paid-in capital .............................. 185,621 198,925
Deferred compensation ................................... (798) (798)
Accumulated other comprehensive loss .................... (272) (272)
Stock subscription receivable ........................... (123) (123)
Accumulated deficit ..................................... (139,903) (139,903)
--------- ---------
Total stockholders' equity ........................... 44,552 57,862
--------- ---------
Total capitalization ................................. $ 52,545 $ 65,855
========= =========
</TABLE>
- ------------
(1) See Notes 4, 6 and 7 to Audited Consolidated Financial Statements.
(2) Does not include 3,817,734 shares issuable upon exercise of outstanding
stock options as of September 30, 1999 and 1,262,392 shares reserved for
issuance under our stock option plans as of September 30, 1999. See Note
11 to Audited Consolidated Financial Statements.
-14-
<PAGE> 15
DILUTION
Our net tangible book value as of September 30, 1999 (based on our
unaudited financial statements) was approximately $41.8 million or $1.55 per
share. "Net tangible book value" per share of common stock represents our total
tangible assets reduced by our total liabilities and divided by the number of
shares of common stock outstanding. At an offering price of $2.063 per share,
our adjusted net tangible book value as of September 30, 1999 would have been
approximately $55.1 million or approximately $1.65 per share. The increase in
net tangible book value of $0.10 per share would be due solely to the purchase
of the shares in this offering. Purchasers in this offering will immediately
incur a dilution of $0.413 per share from the $2.063 offering price of the
shares. "Dilution" is determined by subtracting net tangible book value per
share after the offering from the offering price.
<TABLE>
<S> <C> <C>
Public offering price per share ................................. $ 2.063
Net tangible book value per share as of September 30, 1999 .... $ 1.55
Increase per share attributable to new investors .............. 0.10
--------
Net tangible book value per share after the offering ............ 1.65
--------
Dilution per share to new investors ............................. $ 0.413
========
</TABLE>
-15-
<PAGE> 16
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial data as of and for each of the five
years in the period ended December 31, 1998 are derived from our audited
financial statements. The statement of operations data for each of the
nine-month periods ended September 30, 1999 and 1998, and the balance sheet data
as of September 30, 1999 were derived from unaudited financial statements
prepared by us. The unaudited interim financial statements have been prepared on
substantially the same basis as the audited financial statements and, in the
opinion of management, include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the results of
operations for such periods. The historical results are not necessarily
indicative of results to be expected for any future period. This data should be
read in conjunction with our consolidated financial statements and related notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this prospectus.
In March 1998, the Company acquired all of the outstanding shares of
Heska Waukesha which was recorded as a pooling of interests. The consolidated
financial data has been restated to include the accounts of Heska Waukesha for
all periods presented.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
-------------------------------------------------------- ---------------------
1994 1995 1996 1997 1998 1998 1999
------- -------- -------- -------- --------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(RESTATED) (RESTATED) (RESTATED) (RESTATED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Products, net .......................... $ 2,929 $ 4,719 $ 15,570 $ 26,725 $ 38,451 $ 26,313 $ 36,478
Research and development ............... 3,858 2,230 1,946 2,578 1,321 677 518
------- -------- -------- -------- --------- --------- --------
Total revenues ....................... 6,787 6,949 17,516 29,303 39,772 26,990 36,996
Costs and operating expenses:
Cost of goods sold ..................... 2,004 2,842 12,002 20,077 29,087 19,596 24,697
Research and development ............... 3,890 6,412 14,513 20,343 25,126 18,991 12,477
Selling and marketing .................. 349 902 4,168 9,954 13,188 9,117 10,548
General and administrative ............. 1,248 1,442 5,514 13,192 11,939 8,891 8,253
Amortization of intangible assets and
deferred compensation ................ 170 278 1,289 2,500 2,745 2,087 1,960
Purchased research and development ..... -- -- -- 2,399 -- -- --
Loss on assets held for sale ........... -- -- -- -- 1,287 -- --
Restructuring expense .................. -- -- -- -- 2,356 -- 1,210
------- -------- -------- -------- --------- --------- --------
Total costs and operating expenses ... 7,661 11,876 37,486 68,465 85,728 58,682 59,145
------- -------- -------- -------- --------- --------- --------
Loss from operations ...................... (874) (4,927) (19,970) (39,162) (45,956) (31,692) (22,149)
Other income (expense) .................... (622) 19 721 298 1,682 1,067 (988)
------- -------- -------- -------- --------- --------- --------
Net loss .................................. $(1,496) $ (4,908) $(19,249) $(38,864) $ (44,274) $ (30,625) $(23,137)
======= ======== ======== ======== ========= ========= ========
Basic net loss per share .................. $ (1.79) $ (1.27) $ (0.87)
========= ========= ========
Unaudited pro forma basic net loss per
Share(1) ............................... $ (1.53) $ (2.42)
======== ========
Shares used to compute basic net
loss per share and unaudited pro forma
basic net loss per share(1) ............ 12,609 16,042 24,693 24,077 26,717
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------------------------------- ----------------------
1994 1995 1996 1997 1998 1999
------- -------- -------- -------- --------- ---------
(IN THOUSANDS)
(RESTATED) (RESTATED) (RESTATED) (RESTATED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities ......................... $ 546 $ 6,849 $ 23,721 $ 28,752 $ 51,930 $ 20,459
Working capital...................... 575 6,843 24,224 31,461 51,947 26,752
Total assets......................... 3,989 11,291 45,651 69,020 98,054 73,175
Long-term obligations................ 501 903 5,077 10,754 11,367 7,993
Accumulated deficit.................. (9,471) (14,379) (33,628) (72,492) (116,766) (139,903)
Total stockholders' equity........... 1,391 7,414 32,671 43,850 67,114 44,552
</TABLE>
- ------------
(1) See Note 2 to Audited Consolidated Financial Statements.
-16-
<PAGE> 17
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements based
upon current expectations that involve risks and uncertainties. When used in
this prospectus, the words "intend," "anticipate," "believe," "estimate," "plan"
and "expect" and similar expressions are included to identify forward-looking
statements. Our actual results and the timing of events could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth under "Risk Factors" and elsewhere in
this prospectus.
This discussion contains, in addition to historical information,
forward-looking statements that involve risks and uncertainties. The Company's
actual results and the timing of certain events could differ materially from the
results discussed in the forward-looking statements. When used in this
discussion the words "expects," "anticipates," "estimates" and similar
expressions are intended to identify forward-looking statements. Such
statements, which include statements concerning future revenue sources and
concentration, gross margins, research and development expenses, selling and
marketing expenses, general and administrative expenses, capital resources,
additional financings or borrowings and additional losses, are subject to risks
and uncertainties, including those set forth in "Risk Factors" that could cause
actual results to differ materially from those projected. These forward-looking
statements speak only as of the date hereof. The Company expressly disclaims any
obligation or undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any change in the
Company's expectations with regard thereto or any change in events, conditions,
or circumstances on which any such statement is based.
OVERVIEW
Heska is primarily focused on the discovery, development and marketing
of companion animal health products. In addition to manufacturing certain of
Heska's companion animal products, the Company's primary manufacturing
subsidiary, Diamond, also manufactures animal health vaccine products which are
marketed and distributed by third parties. In addition to manufacturing
veterinary allergy products for marketing and sale by Heska, Heska's
subsidiaries, Center and CMG, also manufacture and sell human allergy products.
The Company also offers diagnostic services to veterinarians at its Fort
Collins, Colorado location and in the United Kingdom through a wholly-owned
subsidiary.
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. 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
expanded in the United States through the acquisition of Center, an FDA and USDA
licensed manufacturer of allergy immunotherapy products located in Port
Washington, New York, and internationally through the acquisitions of Heska UK,
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. Each of the Company's
acquisitions during this period 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.
-17-
<PAGE> 18
During the first quarter of 1998 the Company acquired Heska Waukesha
(formerly Sensor Devices, Inc.), a manufacturer and marketer of patient
monitoring devices. The financial results of Heska Waukesha have been
consolidated with those of the Company under the pooling-of-interests accounting
method for all periods presented.
The Company has incurred net losses since its inception and anticipates
that it will continue to incur additional net losses in the near term as it
introduces new products, expands its sales and marketing capabilities and
continues its research and development activities. Cumulative net losses from
inception of the Company in 1988 through September 30, 1999 have totaled $139.9
million.
The Company's ability to achieve profitability will depend primarily
upon its ability to successfully market its products, commercialize products
that are currently under development, develop new products and efficiently
integrate acquired businesses. Most of 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. There can also be no assurance that the Company will attain
profitability or, if achieved, will remain profitable on a quarterly or annual
basis in the future. Until the Company attains positive cash flow, the Company
may continue 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. See "Risk Factors--We have a history of
losses and may never achieve profitability."
RESULTS OF OPERATIONS
Three Months And Nine Months Ended September 30, 1999 and 1998
Total revenues, which include product and research and development
revenues, increased 33% to $13.1 million for the three months ended September
30, 1999 compared to $9.9 million for the same period of 1998. Product revenues
increased 31% to $12.9 million in the third quarter of 1999 compared to $9.8
million for the third quarter of 1998. Total revenues for the nine months ended
September 30, 1999 increased 37% to $37.0 million compared to $27.0 million for
the same period a year ago. Product revenues have increased 39% to $36.5 million
compared to $26.3 million for the first nine months of 1998. The growth in
revenues during 1999 was primarily due to sales of new products introduced by
the Company during 1998 and 1999.
Cost of goods sold totaled $8.7 million in the third quarter of 1999
compared to $8.0 million in the third quarter of 1998, and the resulting gross
profit from product sales for 1999 increased to $4.2 million from $1.8 million
in 1998. Cost of goods sold totaled $24.7 million for the nine-month period
ended September 30, 1999 compared to $19.6 million for the same period in 1998.
Gross profit from product sales increased to $11.8 million in 1999 from $6.7
million in 1998. The increase in cost of goods sold was attributable to
increased product sales. For both the three- and nine-month periods ended
September 30, 1999, the gross profit margins improved as the Company's product
mix included a higher percentage of proprietary products with higher gross
profit margins. Earlier in this fiscal year, the Company eliminated certain
product lines that did not meet current gross profit requirements. The Company
believes that gross profit margins as a percentage of revenues will continue to
improve in future years, as more of the Company's proprietary diagnostic,
vaccine and pharmaceutical products are approved by the applicable regulatory
bodies and achieve market acceptance.
Research and development expenses decreased to $3.9 million in the third
quarter of 1999 from $6.3 million in the third quarter of 1998. Research and
development expenses for the first three quarters of 1999 were $12.5 million
compared to $19.0 million for the same period of 1998. The decreases in 1999
were primarily due to reductions in the Company's internal research and
development activities, resulting from the Company's restructuring in December
1998 and the decision to eliminate or defer research projects
-18-
<PAGE> 19
which appeared to have greater long-term risk or lower market potential.
Research and development expenses are expected to decrease as a percentage of
total revenues in future years.
Selling and marketing expenses increased to $3.7 million in the third
quarter of 1999 from $3.2 million in the third quarter of 1998. For the nine
months ended September 30, 1999, selling and marketing expenses increased to
$10.5 million compared to $9.1 million for the same period in 1998. These
increases primarily reflect the expansion of the Company's sales and marketing
organization and costs associated with the introduction and marketing of new
products. The Company expects selling and marketing expenses to increase as
sales volumes increase and new products are introduced to the marketplace, but
to decrease as a percentage of total revenues in future years.
General and administrative expenses decreased to $2.8 million in the
third quarter of 1999 from $3.1 million in the third quarter of 1998. These
expenses decreased to $8.3 million year-to-date 1999 compared to $8.9 million in
1998. The decreases in 1999 were primarily due to reductions in staffing and
expenditures, resulting from the Company's restructuring in December 1998.
General and administrative expenses are expected to decrease as a percentage of
total revenues in future years.
Amortization of intangible assets and deferred compensation decreased to
$276,000 in the third quarter of 1999 from $650,000 in the third quarter of
1998. For the nine months ended September 30, 1999, amortization of intangible
assets and deferred compensation decreased to $2.0 million from $2.1 million for
the same period in 1998. Intangible assets resulted primarily from the Company's
1997 and 1996 business acquisitions and are being amortized over lives of 2 to
10 years. The amortization of deferred compensation resulted in a non-cash
charge to operations in the third quarter of 1999 of $140,000 compared to
$174,000 in the third quarter of 1998. The amortization of deferred compensation
for the nine months ended September 30, 1999 and 1998 was $478,000 and $569,000,
respectively. In connection with the grant of certain stock options in 1997 and
1996, the Company recorded deferred compensation representing the difference
between the deemed value of the common stock for accounting purposes and the
exercise price of such options at the date of grant. In 1998 the Company also
granted stock options to non-employees in exchange for consulting services.
Compensation costs, equal to the fair value of the options on the date of grant,
will be recognized over the service period. The Company will incur a non-cash
charge to operations as a result of option grants outstanding at September 30,
1999 of approximately $658,000, $585,000 and $34,000 per year for 1999, 2000 and
2001, respectively, for amortization of deferred compensation.
During the third quarter ended September 30, 1999, the Company announced
plans to consolidate its Heska Waukesha operations with existing operations in
Fort Collins, Colorado and Des Moines, Iowa. A restructuring expense of $1.2
million was recorded related primarily to personnel severance costs and the cost
of closing the facilities.
Interest income decreased to $327,000 in the third quarter of 1999 from
$879,000 in the third quarter of 1998. Interest income decreased to $1.3 million
for the nine months ended September 30, 1999 from $2.4 million for the same
period a year ago. The lower interest income for both periods of 1999 are a
result of lower cash balances available for investment as the Company has funded
its business operations. Interest expense decreased to $409,000 in the third
quarter of 1999 from $521,000 in the third quarter of 1998. Interest expense for
the nine months ended September 30, 1999 decreased slightly compared to the same
period a year ago. The decreases in interest expense are related to the
repayment of certain borrowings of the Company as the debts matured.
Year Ended December 31, 1998
Total revenues, which include product and research and development
revenues, increased 36% to $39.8 million in 1998 compared to $29.3 million in
1997. Product revenues increased 44% to $38.5 million in 1998
-19-
<PAGE> 20
compared to $26.7 million in 1997. The growth in revenues during 1998 was
primarily due to sales of new products introduced during 1998, increased sales
of the Company's existing products and from consolidating revenues of Center and
CMG subsequent to their acquisitions in July 1997 and September 1997,
respectively. Sales to one customer, Bayer, represented 15% of total revenues in
1998 and are expected to decline as a percentage of total revenues in future
years. See "Business-Food Animal Products."
Revenues from sponsored research and development decreased to $1.3
million in 1998 from $2.6 million in 1997. Fluctuations in revenues from
sponsored research and development are generally the result of changes in the
number of funded research projects as well as the timing and performance of
contract milestones. 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, although the Company may
engage in additional sponsored research if such projects become available and
are consistent with the Company's research priorities.
Cost of goods sold totaled $29.1 million in 1998 compared to $20.1
million in 1997, and the resulting gross profit for 1998 increased to $9.4
million from $6.6 million in 1997. The Company's gross margin percentage was 24%
in 1998, compared to 25% in 1997. Gross profit margins in 1998 were adversely
affected by inventory write-downs of approximately $1.5 million during the year.
Without these inventory write-downs, gross profit margins would have been 28%.
The Company believes that gross margins as a percentage of revenues will improve
in future years, as more of the Company's proprietary diagnostic, vaccine and
pharmaceutical products are approved by the applicable regulatory bodies and
achieve market acceptance.
Research and development expenses increased to $25.1 million in 1998
from $20.3 million in 1997. The increase in 1998 was primarily due to increases
in the level and scope of the Company's internal research and development
activities, expenses related to new collaborative agreements and licenses to
support research efforts for potential products to be developed by the Company.
The Company expects that research and development expenses will be lower in the
near term as a result of the Company's restructuring in December 1998.
Selling and marketing expenses increased to $13.2 million in 1998 from
$10.0 million in 1997. This increase reflects primarily the expansion of the
Company's sales and marketing organization and costs associated with the
introduction and marketing of new products. Selling and marketing expenses
consist primarily of salaries, commissions and benefits for sales and marketing
personnel, commissions paid to contract sales agents and expenses of product
advertising and promotion. The Company expects selling and marketing expenses to
increase as sales volumes increase and new products are introduced to the
marketplace, but to decrease as a percentage of total revenues in future years.
General and administrative expenses decreased to $11.9 million in 1998
from $13.2 million in 1997. The decrease in 1998 was primarily due to a one-time
charge in 1997 relating to a supply agreement termination fee. General and
administrative expenses are expected to decrease as a percentage of total
revenues in future years.
Amortization of intangible assets and deferred compensation increased to
$2.7 million in 1998 from $2.5 million in 1997. Intangible assets resulted
primarily from the Company's 1997 and 1996 business acquisitions and are being
amortized over lives of 2 to 10 years. The amortization of deferred compensation
resulted in a non-cash charge to operations in 1998 of approximately $736,000
compared to $645,000 in 1997. In connection with the grant of certain stock
options in 1997 and 1996, the Company recorded deferred compensation
representing the difference between the deemed value of the common stock for
accounting purposes and the exercise price of such options at the date of grant.
In 1998 the Company also granted stock options to non-employees in exchange for
consulting services. Compensation costs, equal to the fair value of the options
on the date of grant, will be recognized over the service period. The Company
will incur a non-cash charge to operations as a result of option grants
outstanding at December 31, 1998 of approximately $658,000, $585,000 and $34,000
per year for 1999, 2000 and 2001, respectively, for amortization of deferred
compensation.
-20-
<PAGE> 21
The loss on assets held for sale recorded in 1998 reflects the
write-down of certain tangible and intangible assets to their expected net
realizable values.
In December 1998 the Company completed a cost reduction and
restructuring plan. The restructuring was based on the Company's determination
that, while revenues had been increasing steadily, management believed that
reducing expenses was necessary in order to accelerate the Company's efforts to
reach profitability. In connection with the restructuring, the Company
recognized a charge to operations in 1998 of approximately $2.4 million. These
expenses primarily related to personnel severance costs and costs associated
with excess facilities and equipment.
Interest income increased to $3.2 million in 1998 from $1.6 million in
1997 as a result of increased cash available for investment arising from the
proceeds from the Company's IPO in July 1997, the follow-on offering completed
in March 1998 and the private placement of common stock with Ralston Purina in
July 1998. Interest income is expected to decline in the future as the Company
uses cash to fund its business operations. Interest expense increased to $2.0
million in 1998 from $1.4 million in 1997 due to increases in debt financing for
laboratory and manufacturing equipment and debt related to the Company's 1997
business acquisitions.
Year Ended December 31, 1997
Total revenues, which include product and research and development
revenues, increased 67% to $29.3 million in 1997 compared to $17.5 million in
1996. Product revenues increased 71% to $26.7 million in 1997 compared to $15.6
million in 1996. The growth in revenues during 1997 was primarily due to new
product introductions, increased sales of the Company's existing products and
from consolidating revenues of Diamond, Center and CMG subsequent to their
acquisitions in April 1996, July 1997 and September 1997, respectively. Sales to
one customer, Bayer, represented 21% of total revenues in 1997.
Revenues from sponsored research and development increased to $2.6
million in 1997 from $1.9 million in 1996. Fluctuations in revenues from
sponsored research and development are generally the result of changes in the
number of funded research projects as well as the timing and performance of
contract milestones.
Cost of goods sold totaled $20.1 million in 1997 compared to $12.0
million in 1996, and the resulting gross profit for 1997 increased to $6.6
million from $3.6 million in 1996. The Company's gross profit margin was 25% in
1997, compared to 23% in 1996.
Research and development expenses increased to $20.3 million in 1997
from $14.5 million in 1996. The increase in 1997 was primarily due to increases
in the level and scope of the Company's internal research and development
activities, expenses related to new collaborative agreements and licenses to
support research efforts for potential products to be developed by the Company.
Selling and marketing expenses increased to $10.0 million in 1997 from
$4.2 million in 1996. This increase reflects primarily the expansion of the
Company's sales and marketing organization and costs associated with the
introduction and marketing of new products. Selling and marketing expenses
consist primarily of salaries, commissions and benefits for sales and marketing
personnel, commissions paid to contract sales agents and expenses of product
advertising and promotion.
General and administrative expenses increased to $13.2 million in 1997
from $5.5 million in 1996. The increase in 1997 primarily 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.
Amortization of intangible assets and deferred compensation increased to
$2.5 million in 1997 from $1.3 million in 1996. Intangible assets resulted
primarily from the Company's 1997 and 1996 business acquisitions and
-21-
<PAGE> 22
are being amortized over lives of 2 to 10 years. The amortization of deferred
compensation resulted in a non-cash charge to operations in 1997 of
approximately $645,000 compared to $188,000 in 1996. In connection with the
grant of certain stock options in 1997 and 1996, the Company recorded deferred
compensation representing the difference between the deemed value of the common
stock for accounting purposes and the exercise price of such options at the date
of grant.
Purchased research and development expenses of $2.4 million 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 in 1997 from $1.4 million in
1996 as a result of increased cash available for investment resulting from the
proceeds from the Company's IPO. Interest expense increased to $1.4 million in
1997 from $500,000 in 1996 due to increases in debt financing for laboratory and
manufacturing equipment and debt related to the Company's 1996 and 1997 business
acquisitions.
Year Ended December 31, 1996
Total revenues, which include product and research and development
revenues, increased 154% to $17.5 million in 1996 compared to $6.9 million in
1995. Product revenues increased 232% to $15.6 million in 1996 compared to $4.7
million in 1995. The growth in revenues during 1996 was primarily due to
consolidating revenues from Diamond subsequent to its acquisition in April 1996
and increased sales of the Company's products. Sales to one customer, Bayer,
represented 36% of total consolidated revenues in 1996.
Revenues from sponsored research and development decreased to $1.9
million in 1996 from $2.2 million in 1995. Fluctuations in revenues from
sponsored research and development are generally the result of changes in the
number of funded research projects as well as the timing and performance of
contract milestones.
Cost of goods sold totaled $12.0 million in 1996 compared to $2.8
million in 1995, and the resulting gross profit for 1996 increased to $3.6
million from $1.9 million in 1995. The Company's gross profit margin declined to
23% in 1996 from 40% in 1995, primarily as a result of consolidating the results
of Diamond subsequent to its acquisition in April 1996.
Research and development expenses increased to $14.5 million in 1996
from $6.4 million in 1995. The increase in 1996 was primarily due to increases
in the level and scope of the Company's internal research and development
activities, expenses related to new collaborative agreements and licenses to
support research efforts for potential products to be developed by the Company.
Selling and marketing expenses increased to $4.2 million in 1996 from
$900,000 in 1995. This increase reflects primarily the expansion of the
Company's sales and marketing organization and costs associated with the
introduction and marketing of new products. Selling and marketing expenses
consist primarily of salaries, commissions and benefits for sales and marketing
personnel and expenses of product advertising and promotion.
General and administrative expenses increased to $5.5 million in 1996
from $1.4 million in 1995. The increase in 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, and to a lesser extent, as a
result of consolidating the general and administrative expenses from Diamond
subsequent to its acquisition.
Amortization of intangible assets and deferred compensation increased to
$1.3 million in 1996 from $278,000 in 1995. Intangible assets resulted primarily
from the Company's 1996 business acquisitions and are being amortized over lives
of 2 years to 37 months. The amortization of deferred compensation resulted in a
non-cash charge to operations in 1996 of approximately $188,000 compared to
$278,000 in 1995. In connection with the grant of certain stock options in 1996,
the Company recorded deferred compensation representing the difference between
the deemed value of the common stock for accounting purposes and the exercise
price of such options at the date of grant.
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Interest income increased to $1.4 million in 1996 from $172,000 in 1995
as a result of increased cash available for investment resulting from the
proceeds from the private placement of preferred stock with Novartis in April
1996. Interest expense increased to $490,000 in 1996 from $143,000 in 1995 due
to increases in debt financing for laboratory and manufacturing equipment and
debt assumed as part of the Company's 1996 business acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity at September 30, 1999 was its
$20.5 million in cash, cash equivalents and marketable securities. The source of
these funds was primarily attributable to the Company's follow-on public
offering of common stock in March 1998 and the July 1998 private placement of
common stock with Ralston Purina, which provided the Company with net proceeds
of approximately $48.6 million and $15.0 million, respectively. As additional
sources of liquidity, the Company and its subsidiaries have secured lines of
credit and other debt facilities totaling approximately $3.3 million, against
which borrowings of approximately $2.2 million were outstanding at September 30,
1999. These financing facilities are secured by assets of the respective
subsidiaries and by corporate guarantees of Heska. The Company expects to seek
additional asset-based borrowing facilities.
Cash used in operating activities was $25.2 million in the nine months
ended September 30, 1999, compared to $29.9 million in the same period in 1998.
Inventory levels increased by $4.9 million in the first nine months of 1999,
primarily to support increased sales of existing products and inventory build-up
for new product introductions. The increase of $2.0 million in accounts
receivable during the first nine months of 1999 was mainly due to increased
sales volume. Accounts payable increased by $200,000 in the first nine months of
1999, primarily as a result of the increase in inventory levels.
The Company's investing activities provided $29.5 million for the first
nine months of 1999, compared to the use of $41.2 million in cash for investing
activities during the same period in 1998. Cash provided by and used for
investing activities was primarily related to the sale and purchase of
marketable securities by the Company to fund its business operations and invest
the proceeds of the Company's issuance of common stock, respectively.
Expenditures for property and equipment totaled $3.2 million for the nine months
ended September 30, 1999 compared to $4.8 million for the same period of 1998.
The Company has historically used capital equipment lease and debt facilities to
finance equipment purchases and, if possible, leasehold improvements. The
Company currently expects to spend approximately $4.3 million in 1999 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's financing activities used $2.8 million in the first nine
months of 1999 compared to the generation of $67.0 million in cash in the first
nine months of 1998. The primary source of funds year-to-date in 1999 was due to
borrowings of $2.0 million, primarily from the Company's available credit
facilities. In the first nine months of 1998 the Company's sources of funds were
primarily attributable to $48.6 million in proceeds from the Company's follow-on
public offering of common stock and $15.0 million from the private placement of
common stock with Ralston Purina. Repayments of debt and capital lease
obligations totaled $5.3 million in the first nine months of 1999 compared to
$5.8 million in the first nine months of 1998.
The Company's primary short-term needs for capital, which are subject to
change, are for its continuing research and development efforts, its sales,
marketing and administrative activities, working capital associated with
increased product sales and capital expenditures relating to developing and
expanding the Company's manufacturing operations. The Company's future liquidity
and capital requirements will depend on numerous factors, including the extent
to which the Company's present and future products gain market acceptance, the
extent to which products or technologies under research or development are
successfully developed, the timing of regulatory actions regarding the Company's
products, the costs and timing of expansion of sales, marketing and
manufacturing activities, the cost, timing and business management of current
and potential acquisitions and
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contingent liabilities associated with such acquisitions, the procurement and
enforcement of patents important to the Company's business and the results of
competition.
The Company believes that its available cash, cash from operations and
available borrowings, together with the proceeds from this offering, will be
sufficient to satisfy its projected cash requirements through 2000, assuming no
significant uses of cash in acquisition activities. Thereafter, if cash
resources are insufficient to satisfy the Company's cash requirements, the
Company will need to raise additional capital to continue its business
operations. 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 would likely be dilutive to stockholders and debt
financing, if available, may include restrictive covenants which may limit the
Company's operations and strategies. 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.
NET OPERATING LOSS CARRYFORWARDS
As of December 31, 1998, the Company had a net operating loss ("NOL")
carryforward of approximately $94.5 million and approximately $2.3 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 2012. 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. The amount of NOLs which may be utilized will be approximately
$4.7 million per year for periods subsequent to the Diamond acquisition. Similar
limitations also apply to utilization of R&D tax credits to offset taxes
payable.
In addition, the Company believes that its follow-on public offering of
common stock in March 1998 resulted in a further "change of ownership." NOLs
incurred subsequent to the Diamond acquisition and prior to the follow-on
offering will also be limited. The amount of these NOLs which may be utilized
will be approximately $12.5 million per year for periods subsequent to the
follow-on offering. The Company believes that these limitations may 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 COMPLIANCE
The Year 2000 ("Y2K") issue is the result of computer programs being
written using two digits, rather than four, to define the applicable year.
Mistaking "00" for the year 1900, rather than 2000, could result in
miscalculations and errors and cause significant business interruptions for the
Company, as well as the government and most other companies. The Company has
substantially completed procedures to identify, evaluate and implement any
necessary changes to its computer systems, applications and embedded
technologies resulting from the conversion. The Company is coordinating these
activities with suppliers, distributors, financial institutions and others with
whom it does business. Based on the results of its current evaluation, the
Company does not believe that the Y2K conversion will have a material adverse
effect on its business.
State of Readiness
The Company relies on software in its information systems and
manufacturing and laboratory equipment. Most of this equipment and software was
installed and written within the past three years. The Company has
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conducted a full assessment of the installed control systems, computers, and
applications software at all of its operating locations in the US and Europe,
and has determined that these systems are either Y2K compliant, or the vendors
claim Y2K compliance, or the problems can be corrected by purchasing or
receiving relatively small amounts of hardware, software, or software upgrades.
Costs
The final testing phase of Y2K compliance at all of the Company's sites
was substantially complete as of September 30, 1999. Final testing is expected
to be completed by mid-November 1999. This validation testing has been
accomplished primarily with internal corporate staff at a cost of approximately
$100,000.
Based on management's evaluations to date, remediation costs are not
expected to be material due to the fact that the Company's information and
embedded systems are generally new, off-the-shelf systems, and that vendor
relationships still exist for most of the equipment and software affected. These
costs are expected to consist of replacing relatively low-cost personal
computers, and installations of hardware and software upgrades from major
manufacturers of equipment, along with some custom software fixes. These costs,
including hardware replacements accelerated by the Y2K situation, and other
contingency plan activities, are not expected to exceed $200,000.
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BUSINESS
We are primarily focused on the discovery, development and marketing of
companion animal health products. In addition to manufacturing certain of our
companion animal products, our primary manufacturing subsidiary, Diamond Animal
Health, Inc., also manufactures animal health vaccine products which are
marketed and distributed by third parties. In addition to manufacturing
veterinary allergy products for marketing and sale by us, our subsidiaries,
Center Laboratories, Inc. and CMG-Heska Allergy Products S.A., a Swiss
corporation, also manufacture and sell human allergy products.
ANIMAL HEALTH PRODUCTS
We presently sell a variety of companion animal health products, among
the most significant of which are the following.
DIAGNOSTICS
Heartworm Diagnostics
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.
In 1997, we 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. This test was
first offered through our own veterinary diagnostic laboratories. A simple,
rapid, and easy to use point-of-care version of this test (Solo Step(TM) CH) was
introduced in Italy in 1998. We received regulatory clearance to sell Solo
Step(TM) CH in the United States in January 1999, and the product has been
successfully introduced in the United States.
Also in 1997, we introduced a new test in our veterinary diagnostic
laboratories for feline heartworm infections of cats which allowed 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, we introduced a rapid, point-of-care version of this test in Italy. After
receiving regulatory clearance, we introduced this point-of-care feline
heartworm test (Solo Step(TM) FH) in the United States in 1998.
Allergy
Allergy is common in companion animals, and it is estimated to affect
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 effectiveness of the immunotherapy
that is prescribed to treat allergic disease is inherently limited by
inaccuracies in the diagnostic process.
We have 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. During 1997, we adapted
this technology to a broad range of our canine and feline allergy tests. This
allergy testing is conducted in our HESKA(TM) Veterinary Diagnostic Laboratories
in the United States and the United Kingdom using an enzyme-linked immunoassay
("ELISA") to screen the blood serum of potentially allergic animals against a
panel of known allergens. A typical test panel consists primarily of various
pollens, grasses, molds and insects.
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BIOLOGICS AND VACCINES
Allergy Immunotherapy
Veterinarians who use our diagnostic laboratories for in vitro allergy
testing services often purchase immunotherapy treatment sets for those animals
with positive test results. 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. Both canine
and feline immunotherapy treatment sets are offered by Heska.
Feline Respiratory Disease
In 1997, we introduced in the United States a three-way modified live
vaccine (HESKA(TM) Trivalent Intranasal/Intraocular Vaccine) for the three most
common viral diseases of cats: calicivirus, rhinotracheitis virus and
panleukopenia virus. This vaccine is 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 injection site-associated side
effects. The most serious of these side effects are injection site sarcomas,
tumors which, if untreated, are nearly always fatal. Our vaccines avoid
injection site side effects and we believe them to be very efficacious.
PHARMACEUTICALS
Dentistry
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 dog's teeth. 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.
In November 1997, we received United States Food and Drug Administration
clearance to market and introduced our periodontal disease therapeutic in the
United States (PERIOceutic(TM) Gel), an innovative product for the treatment of
periodontal disease in dogs. This product received approval by the European
Commission in September 1999 for marketing and distribution in Europe, and we
are currently considering distribution alternatives in Europe. 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. Although we have experienced slow
market acceptance of this product, our 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 dog's teeth.
Canine Thyroid Supplement
Canine hypothyroidism is a serious disease that is usually caused by
abnormalities of the thyroid gland. It is estimated that 3% to 4% 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, we introduced a thyroid supplement for dogs in the United
States, which we believe is the first and only vitamin-enriched, chewable tablet
for the treatment of hypothyroidism in dogs. These chewable tablets,
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which are administered daily for the life of the dog, provide levothyroxine
sodium, a replacement therapy for the hormone normally produced by the body.
Nutritional Supplements
Arising partly from our allergy expertise, in 1998, we developed and
introduced in the United States a novel fatty acid supplement (HESKA(TM) F.A.
Granules). The unique source of the fatty acids in this product, flaxseed oil,
leads to high omega-3:omega-6 ratios of fatty acids. Diets high in omega-3 fatty
acids are believed to lead to lower levels of inflammatory response. The
HESKA(TM) F.A. Granules include vitamins and are formulated in a palatable
flavor base that makes the product convenient and easy to administer.
MEDICAL INSTRUMENTS
In March 1998, we acquired Heska Waukesha, a manufacturer and marketer
of patient monitoring and diagnostic instruments, located in Waukesha,
Wisconsin. During 1998, we also completed the development and adaptation of
certain other instrument products and entered into agreements for the
distribution of additional instrument products. We currently offer a broad line
of monitoring, diagnostic and other instruments as described below. In August
1999, we announced that we are consolidating these operations into our existing
operations in Fort Collins, Colorado and Des Moines, Iowa.
Monitoring Instruments
The use by veterinarians of the types of patient monitoring products
that are taken for granted in human medicine is becoming the state of the art in
companion animal health. We offer what we believe is the broadest line of these
monitoring products presently available in the veterinary market. The
centerpiece of our monitoring instrument product line is a family of oxygen
saturation monitors designed for monitoring animals under anesthesia: the
VET/OX(R) 4400, VET/OX(R) 4404 and VET/OX(R) 4700, each of which includes a
variety of additional monitoring parameters, such as pulse rate and strength,
body temperature, respiration and ECG. We also offer a monitor, the VET/CAP(R)
7001 for monitoring CO2 for animals under anesthesia. We also offer a
proprietary esophageal ECG sensor for monitoring ECG, temperature and heart and
breath sounds of anesthetized dogs. Our monitoring line also includes the
VET/DOPP(TM) 100 blood pressure monitor and the VET/ECG(TM) 2000 hand-held ECG
monitor.
Diagnostic Instruments
Our line of diagnostic instruments was initiated with the i-STAT(R)
Portable Clinical Analyzer, a hand-held, portable clinical analyzer that
provides quick, easy analysis of blood gasses and other key analytes, such as
sodium, potassium and glucose, with whole blood. In the United States and the
United Kingdom, we also added the Vet ABC Hematology Analyzer, an easy to use
blood analyzer that measures such key parameters as white blood cell count, red
blood cell count, platelet count and hemoglobin levels in animals. We also offer
the Reflovet(R) Clinical Analyzer, an easy to operate, cost effective blood
chemistry analyzer that measures a broad range of animal blood analytes, such as
amylase, creatinine, uric acid, bilirubin and glucose.
Other Instruments
Among the other medical instruments that we offer to our veterinary
customers is the VET/IV(TM) 2.2 infusion pump. This compact, affordable IV pump
allows veterinarians to easily provide regulated infusion of blood or
nutritional products for their patients. We also offer the Medfusion(TM) 2010
syringe pump for regulated delivery of drugs held in syringes.
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VETERINARY DIAGNOSTIC LABORATORIES
In 1996, we established a veterinary diagnostic laboratory at our Fort
Collins facility. This diagnostic laboratory currently offers our allergy
diagnostics, canine and feline heartworm diagnostics and flea bite allergy
assays, in addition to other diagnostic and pathology services. Our 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.
We intend to continue to use our Fort Collins diagnostic laboratory both
as a stand-alone service center for our customers and as an adjunct to our
product development efforts. Many of the assays which we intend to develop in a
point-of-care format will initially be validated and made available in the
veterinary diagnostic laboratory and will also remain available there after the
introduction of the analogous point-of-care test.
In addition to the United States veterinary diagnostic laboratory, we
provide to veterinarians in the United Kingdom a full range of diagnostic and
pathology services, including our proprietary diagnostic laboratory tests
marketed through Heska UK Limited ("Heska UK", formerly Bloxham Laboratories
Limited), one of the largest veterinary diagnostic laboratories in the United
Kingdom. Heska UK was acquired by Heska in 1997.
FOOD ANIMAL PRODUCTS
In addition to manufacturing companion animal health products for
marketing and sale by Heska, Diamond has completed the research, development and
testing of new bovine vaccines that were licensed by the USDA in the United
States in 1998. Diamond has entered into an agreement with a food animal
products distributor, Agri Laboratories, Ltd. ("AgriLabs"), for the exclusive
marketing and sale of these vaccines worldwide. AgriLabs currently has
agreements with Bayer for the distribution of these vaccines in the United
States and Canada, and with Intervet, Inc., a division of Akzo Nobel, for the
distribution of these vaccines worldwide except in the United States. Diamond is
the sole manufacturer of these products.
Diamond also manufactures bovine vaccines which are marketed and sold by
Bayer, primarily in the United States, pursuant to a contract which terminates
in February 2000. It is expected that sales of these products by Diamond will
decrease but that some or all of the sales decrease will be replaced by sales of
the new vaccines to AgriLabs for distribution by Bayer and others. Diamond also
manufactures vaccine products for a number of other animal health companies.
This ranges from providing bulk vaccine antigens which are included in the
vaccines which are manufactured by other companies to filling and finishing
final products using bulk antigens provided by other animal health companies.
HUMAN ALLERGY PRODUCTS
In addition to manufacturing veterinary products for marketing and sale
by Heska, Center manufactures a broad line of allergenic extracts, such as
pollens, grasses and trees, for use in human allergy immunotherapy and diagnosis
in the United States. Center provides these allergenic extracts to human
allergists both in bulk form to those allergists who wish to mix their own
allergenic immunotherapy treatment sets and in the form of custom-made patient
immunotherapy treatment sets of multiple allergens.
In addition to manufacturing and marketing veterinary allergy products
primarily in Europe, CMG markets a broad range of human allergy diagnostic
products for use primarily in Europe. These products are sold primarily through
distributors.
PRODUCT CREATION
We are committed to creating innovative products to address significant
unmet health needs of companion animals. We create products both through
internal research and development and through external collaborations. Internal
research is managed by multidisciplinary product-associated project teams
consisting of
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veterinarians, biologists, molecular and cellular biologists, biochemists and
immunologists. We believe that we have one of the most sophisticated scientific
efforts in the world devoted to applying biotechnology to the creation of
companion animal products.
We are also committed to identifying external product opportunities and
creating business and technical collaborations that lead to the creation of
other products. We are currently funding research at academic institutions. We
believe that our active participation in scientific networks and our reputation
for investing in research enhances our ability to acquire external product
opportunities.
The vast majority of all research and development resources at Heska are
directed towards the development of new companion animal health products. We
incurred expenses of $14.5 million, $20.3 million and $25.1 million in the years
ended December 31, 1996, 1997 and 1998, respectively in support of our research
and development activities.
Set forth below are descriptions of some of the companion animal health
products we are working to develop. See "Risk Factors--We have limited resources
to devote to product development and commercialization; We may experience
difficulty in commercializing our products."
Equine Influenza Vaccine
Equine influenza is a common viral disease of horses and is similar to
human influenza. This health issue poses a significant risk to the estimated six
million horses in the United States. 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 effective duration
of immunity for existing vaccines is often measured in weeks or months. We
currently believe that approximately half of the six million horses in the
United States receive vaccination. Industry sources have estimated the total
vaccine market at $50 million in the U.S. alone. Heska has developed a unique
vaccine for equine influenza, Flu Avert(TM) I.N., which it believes will have
improved efficacy and duration of immunity. This product was approved by the
USDA on November 17, 1999 and is currently available to be shipped to
veterinarians.
Bartonellosis (Cat Scratch Fever) Vaccine
Bartonella henselae is the causative agent of cat scratch fever. This
bacterium 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. People with weak immune systems, such as HIV-positive
individuals, children and the elderly may develop very severe disease following
infection, and this organism is a cause of a significant number of opportunistic
infections in HIV-positive individuals. We are working with scientists at the
United States Centers for Disease Control and Prevention in Atlanta, Georgia to
develop a novel vaccine for cats. The vaccine is intended to prevent cats from
harboring Bartonella henselae 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.
Canine Leishmaniosis Vaccine
Canine leishmaniosis is endemic in certain areas of Mediterranean
Europe, the Middle East and South America, and infected dogs may act as a
reservoir for the parasite. A vaccine to prevent disease or a novel therapeutic
approach would significantly improve the health of dogs in these areas and
potentially reduce transmission to humans. Candidate Leishmania vaccine antigens
have been identified by our collaborators at Corixa, and we are currently
conducting leishmaniosis vaccine trials. Because little is yet known of the
natural progression of disease in Leishmania-infected dogs, it is anticipated
that this research effort, and any subsequent vaccine trials, will not be
completed for at least several years, if at all.
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Flea Control Vaccines and Pharmaceuticals
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. No single product, however,
can presently 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.
One of our goals is to develop vaccines that will produce an immune
response in the dog or cat that will kill fleas or reduce their reproduction.
Experimental studies with the first vaccine candidates are ongoing, but this is
a very difficult scientific challenge and commercial vaccines are not
anticipated for at least several years, if at all. If we succeed in creating
such a flea control vaccine, Novartis has rights to market the vaccine. See
"--Collaborative Agreements."
Our expertise in flea molecular physiology has also led to the creation
of in vitro tests amenable to chemical screening and in vivo tests that measure
the effect of compounds on fleas. Thousands of compounds have been screened in
vitro and hundreds of compounds have been tested for flea control activity. We
are attempting to identify a novel small molecule flea pharmaceutical and, if
successful, will initiate clinical trials in companion animals.
Heartworm Vaccines
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. Drugs to prevent heartworm infections in
dogs are generally available and widely prescribed, but require monthly or daily
administration during the heartworm transmission season.
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. A drug to prevent heartworm
infections of cats, similar to the products available for dogs, was introduced
by Merial Ltd. in January 1997.
In order to avoid the need for repeated administration of drugs and the
resulting compliance and convenience problems, our goal is to develop vaccines
for annual administration that would prevent cardiopulmonary infection in dogs
and cats caused by heartworms. We have identified many candidate vaccine
antigens and the genes encoding them have been cloned. We are using these
proprietary molecules in vaccination studies of dogs and cats. Each vaccination
trial requires approximately one year to complete. Accordingly,
commercialization of vaccines for heartworm infections of dogs and cats, if it
occurs, is at least several years away. If we succeed in creating such vaccines
to prevent heartworm infections in dogs and cats, they may be marketed by Bayer
and Novartis, respectively. See "--Collaborative Agreements."
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. Despite this, most cancer treatments are less than optimal and employ "off
label" therapeutic products developed for use in humans. We believe that it is
critical that a cancer therapeutic product not substantially decrease the
quality of life of the treated dog or cat. Instead of systemically applying
toxins that kill rapidly growing cells (both tumor cells and normal cells), our
scientists are attempting to stimulate immune responses to a tumor through gene
therapy technology. Scientists at National Jewish Hospital in Denver, Colorado
first demonstrated that a combination of immune stimulatory genes, when injected
into canine melanomas, could
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stimulate the regression of the primary tumor and could prevent subsequent
metastatic disease. We are collaborating with these scientists at National
Jewish Hospital and with scientists at Valentis, Inc. to develop gene
formulations that could be used by the veterinarian for such treatments. We are
currently testing these gene formulations for safety and efficacy. We do not
expect to have a commercial product in this area for at least several years, if
at all.
SALES AND MARKETING
We presently market our products in the United States directly to
veterinarians through the use of our field sales force, inside customer
service/tele-sales force and veterinary distributors acting as contract sales
agents. As of September 1999, we had approximately 37 field sales
representatives and field sales supervisors and 23 customer service/tele-sales
representatives and supervisors. The 16 veterinary distributors with whom we
have entered into sales agency relationships, and three direct sales
distributors employ approximately 700 field and customer service/tele-sales
representatives, although some of these distributors do not sell all of our
products. In October 1999 we entered into an agreement with a third party to
provide a contract sales force with respect to the distribution of our products
to equine veterinarians. Internationally, we market our products to
veterinarians primarily through distributors.
We estimate that 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. We plan to market our products to these clinics primarily through the
use of our field and telephone sales force, sales agents, trade shows and print
advertising. During the past year, we sold our products to more than 15,000 such
clinics in the United States.
Certain of the products which we have under research and development, if
completed, may be marketed partially or wholly by parties with whom we have
collaborative agreements. (See "--Collaborative Agreements.") Center's human
allergy immunotherapy products are marketed and sold in the United States by
Center Pharmaceuticals, Inc., an unaffiliated sales and marketing company that
markets allergy related products primarily to human allergists in the United
States. Center Pharmaceuticals markets and sells Center's human allergy products
as a contract sales agent of Center.
MANUFACTURING
Our products are manufactured by our Diamond, Center and CMG
subsidiaries and/or by third-party manufacturers. Diamond's facility is a USDA
and FDA licensed biological and pharmaceutical manufacturing facility in Des
Moines, Iowa. We expect that we will manufacture most or all of our biological
products at this facility, as well as most or all of our recombinant proteins
and other proprietary reagents for our diagnostic products. We manufacture all
of our allergy immunotherapy products at Center's USDA and FDA licensed
manufacturing facility in Port Washington, New York. CMG manufactures its
veterinary and human allergy diagnostic products at its leased facility in
Fribourg, Switzerland. Diamond and Center's facilities are subject to regulation
and inspection by the USDA and the FDA. See "Risk Factors--Our manufacturing
facilities are subject to governmental regulation." Our point-of-care diagnostic
products are manufactured by Quidel Corporation and Diamond. Our periodontal
disease therapeutic is manufactured by Atrix Laboratories, Inc., the company
that developed this product for human use. Our patient monitoring and diagnostic
instruments, including our clinical and hematology analyzers and veterinary
sensors, are manufactured by third-party manufacturers. Our reliance upon
third-party manufacturers poses a significant risk. See "Risk Factors--We have
limited manufacturing experience and capacity and rely substantially on
third-party manufacturers."
In addition to manufacturing our proprietary products, Diamond
manufactures animal health vaccine products for marketing and sale by other
companies. 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
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agents, sterile filling, lyophilization and packaging. In addition, Diamond
offers to support its customers through research services, regulatory compliance
services, validation support and distribution services.
In addition to manufacturing our proprietary products, Center
manufactures allergy immunotherapy products which are distributed in the human
market using an independent and unaffiliated distribution company, Center
Pharmaceuticals, Inc.
COLLABORATIVE AGREEMENTS
Novartis
In April 1996, we entered into several agreements with Novartis. These
agreements included a $36.0 million equity investment by Novartis. Novartis
obtained certain rights to manufacture and market any flea control vaccine or
feline heartworm control vaccine developed by us as to which USDA prelicensing
serials are completed on or before December 31, 2005. We and Novartis have
co-exclusive rights to market these products under our own trade names
throughout the world (other than in countries in which Eisai Co., Ltd. ("Eisai")
has such rights) and, if we both elect to market, we will share revenues on each
other's sales. The marketing agreements remain in force through 2010 or longer,
if Novartis is still actively marketing such products. In addition, we entered
into a screening and development agreement under which we may undertake joint
research and development activities in certain fields. If we fail to agree to
perform joint research activities, then Novartis has the right to use certain of
our materials on an exclusive basis to develop food animal pharmaceutical
products or on a co-exclusive basis with us 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 under this agreement, although
several are in the proposal stage. We also entered into a right of first refusal
agreement under which, prior to granting licenses to any third-party to any
products or technology developed or acquired by us for either companion animal
or food animal applications, we must first notify and offer Novartis such
rights. If we are unable to come to an agreement within 150 days of the first
notice, we may thereafter license such rights to third parties on terms not
materially more favorable than the terms last offered by us to Novartis. The
screening and development agreement and right of first refusal agreement each
terminate in 2005.
In October 1998, we also entered into an exclusive distribution
agreement pursuant to which Novartis has the exclusive right to distribute
selected Heska products in Japan, including our in-clinic feline and canine
heartworm diagnostic products, periodontal disease therapeutic and feline viral
vaccines, upon obtaining regulatory approval in Japan for such products.
Novartis also granted us a right of first refusal to evaluate for possible
development and marketing worldwide certain new product technologies for the
veterinary market as they may become available from Novartis.
Bayer
In June 1994, we entered into research agreements with Bayer providing
for funding of research by Bayer on a recombinant feline toxoplasmosis vaccine
and a canine heartworm vaccine. Bayer has the option to obtain an exclusive,
royalty-bearing license to sell these vaccines in all countries except in those
in which Eisai has rights. If Bayer exercises this option, we will negotiate
license and distribution agreements. We have the first option to manufacture any
products sold pursuant to any such distribution agreement. These 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 our breach), although
it would have non-exclusive access to technology developed in the research
program for use other than in similar vaccines. In the event Bayer elects to
terminate the research agreements (other than due to our breach), we would
recover the right to market the vaccines, subject to certain royalties to Bayer
intended to repay certain amounts Bayer paid under the research agreements.
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Eisai
In January 1993, we entered into an agreement with Eisai, a leading
Japanese pharmaceutical company, pursuant to which we granted Eisai the
exclusive right to market our feline and canine heartworm vaccines, flea control
vaccine and feline toxoplasmosis vaccine in Japan and most other countries in
East Asia. In exchange, we received an up-front license fee and research funding
for the development of these products. We will have the right to manufacture any
such products pursuant to a supply agreement to be negotiated. 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.
Ralston Purina Company
In July 1998, we entered into a strategic alliance with Ralston Purina
Company, the world's largest manufacturer of dry dog and dry and soft-moist cat
foods. Ralston Purina acquired exclusive rights to license our discoveries,
know-how and technologies for innovative diets for dogs and cats. We are jointly
developing therapeutic diets for both dogs and cats. The Company believes that
the combination of our expertise in companion animal disease physiology with
Ralston Purina's expertise in formulation and diet testing will permit the
development of novel nutritional products. Testing of experimental formulations
is ongoing. In the event any products that are the subject of the collaboration
are commercialized by Ralston Purina, Ralston Purina will pay us a royalty on
products incorporating our technology. In connection with this alliance, Ralston
Purina made a $15 million equity investment.
Quidel
We have entered into a development agreement with Quidel under which we
are jointly developing certain of our point-of-care diagnostic tests using
Quidel's rapid in-clinic test technology. We also have entered into a supply
agreement under which Quidel performs manufacturing services with respect to
certain of our tests.
INTELLECTUAL PROPERTY
We believe that patents, trademarks, copyrights and other proprietary
rights are important to our business. We also rely upon trade secrets, know-how,
continuing technological innovations and licensing opportunities to develop and
maintain our competitive position.
Heska actively seeks patent protection both in the United States and
abroad. As of October 12, 1999, we owned or co-owned 40 issued U.S. patents and
93 pending U.S. patent applications. Our issued U.S. patents primarily relate to
our proprietary flea bite allergy, flea control, heartworm, vaccine delivery and
certain patient monitoring instrument technologies. Our pending patent
applications primarily relate to proprietary allergy, flea control, heartworm,
vaccine production and delivery and patient monitoring instrument technologies.
Applications corresponding to pending U.S. applications have been or will be
filed in other countries. As of October 12, 1999, we had 9 issued foreign
patents and 121 pending foreign filings, including 19 pending Patent Cooperation
Treaty ("PCT") filings.
We also have obtained exclusive and non-exclusive licenses for numerous
other patents held by academic institutions and biotechnology and pharmaceutical
companies. The proprietary technologies of Diamond, Center, Heska Waukesha,
Heska UK and CMG are primarily protected through trade secret protection of, for
example, their manufacturing processes. In general, the intellectual property of
Diamond's customers belongs to such customers.
As patent applications in the United States are maintained in secrecy
until patents issue and as publication of discoveries in the scientific or
patent literature often lags behind the actual discoveries, we cannot be certain
that we were the first to make the inventions covered by each of our pending
patent applications or that we were the first to file patent applications for
such inventions. Furthermore, the patent positions of biotechnology and
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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 our
patent applications or, should patents issue, that we 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 us, or that the United States Patent and Trademark Office ("USPTO") or
private parties, including competitors, will not successfully challenge our
patents or circumvent our patent position. In the absence of adequate patent
protection, our 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 our 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 we will be able to take advantage
of the patent term extension provisions of this law.
We also rely on trade secrets and continuing technological innovation
which we seek to protect with reasonable business procedures for maintaining
trade secrets, including confidentiality agreements with our collaborators,
employees and consultants. There can be no assurance that these agreements will
not be breached, that we will have adequate remedies for any breach or that our
trade secrets and proprietary know-how will not otherwise become known or be
independently discovered by competitors. Under certain of our research and
development agreements, inventions discovered in certain cases become jointly
owned by us and the corporate sponsor or partner and in other cases become our
property or the property of the corporate sponsor or partner. Disputes may arise
with respect to ownership of any such inventions.
Our commercial success also depends in part on us and our collaborators neither
infringing patents or proprietary rights of third-parties nor breaching any
licenses that may relate to our technologies and products. We are aware of
several third-party patents and patent applications that may relate to the
practice of our technologies. There can be no assurance that we or our
collaborators do not or will not infringe any valid patents or proprietary
rights of third parties. Furthermore, to the extent that we or our consultants
or research collaborators use intellectual property owned by others in work
performed for us, disputes may arise as to the rights in such intellectual
property or in related or resulting know-how and inventions. Any legal action
against us or our collaborative partners claiming damages and seeking to enjoin
commercial activities relating to our products and processes affected by
third-party rights, in addition to subjecting us to potential liability for
damages, may require us or our 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 we or our 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 Heska's areas of
interest and we believe that there may be significant litigation in the industry
regarding patent and other intellectual property rights. If we become involved
in such litigation, it could consume a substantial portion of our managerial and
financial resources, which could have a material adverse effect on our business,
financial condition and results of operations. See "Risk Factors--We may face
costly intellectual property disputes."
GOVERNMENT REGULATION
Most of our products being developed will require licensing by a
governmental agency before marketing. In the United States, governmental
oversight of animal health products is primarily provided by two agencies: the
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USDA and the 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. In the United States, governmental oversight of human health products
is provided exclusively by the FDA.
Many 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.
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.
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. However, unlike human drugs, neither preclinical
studies in model systems nor a sequential phase system of clinical trials are
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 the CVM will
review data at appropriate and productive times in the drug development process.
In addition, the time and cost for developing companion animal drugs may be
significantly less than for drugs for food producing animals, as food safety
issues relating to tissue residue levels are not present.
A number of animal health products are not regulated. For example,
assays for use in a veterinary diagnostic laboratory and certain medical
instruments do not have to be licensed by either the USDA or FDA. Additionally,
certain botanically derived products, certain nutritional products, and grooming
and supportive care products are exempt from significant regulation as long as
they do not bear a therapeutic claim that represents the product as a drug.
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.
Delays in obtaining or failure to obtain any necessary regulatory
approvals for our products could have a material adverse effect on our future
product sales and operations. Heska has experienced delays in the past and
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could incur additional delays in the future. Any acquisitions of new products
and technologies may subject us to additional government regulation. See "Risk
Factors--We must obtain costly regulatory approvals in order to bring our
products to market; Our manufacturing facilities are subject to government
regulation."
COMPETITION
The market in which we compete is intensely competitive. Our competitors
include independent animal health companies and major pharmaceutical companies
that have animal health divisions. Companies with a significant presence in the
companion animal health market, such as American Home Products, Bayer, Merial
Ltd., Novartis, Pfizer Inc., Schering-Plough Corp., Pharmacia & Upjohn, Inc. and
IDEXX Laboratories, Inc., have developed or are developing products that do or
would compete with our products. These competitors have substantially greater
financial, technical, research and other resources and larger, more established
marketing, sales, distribution and service organizations than us. Moreover, such
competitors may offer broader product lines and have greater name recognition
than us. Novartis and Bayer are our marketing partners and their agreements with
us do not restrict their ability to develop and market competing products. See
"--Collaborative Agreements." 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 we intend to
distribute our products primarily through veterinarians, a substantial segment
of the potential market may not be reached and we may not be able to offer our
products at prices which are competitive with those of companies that distribute
their products through retail channels.
Center's human allergy immunotherapy products compete with similar
products offered by a number of other companies, some of which have
substantially greater financial, technical, research and other resources than
Center and more established marketing, sales, distribution and service
organizations than Center Pharmaceuticals, Inc. The bovine vaccines sold by
Diamond to AgriLabs compete with similar products offered by a number of other
companies, some of which have substantially greater financial, technical,
research and other resources than Diamond and more established marketing, sales,
distribution and service organizations than AgriLabs.
There can be no assurance that our competitors will not develop or
market technologies or products that are more effective or commercially
attractive than our current or future products or that would render our
technologies and products obsolete. Moreover, there can be no assurance that we
will have the financial resources, technical expertise or marketing,
distribution or support capabilities to compete successfully. See "Risk
Factors--We operate in a highly competitive industry."
EMPLOYEES
As of September 30, 1999, Heska and its subsidiaries employed 487
full-time persons, of whom 185 are in manufacturing, quality control, shipping
and receiving, and materials management, 95 are in research, development and
regulatory affairs, 75 are in management, finance, administration, legal,
information systems, human resources and facilities management; 93 are in sales,
marketing and customer service and 39 are in the diagnostic laboratories. There
can be no assurance that we will continue to be able to attract and retain
qualified technical and management personnel. See "Risk Factors--We depend on
key personnel for our future success." None of our employees are covered by a
collective bargaining agreement, and we believe its employee relations are good.
PROPERTIES
We currently lease an aggregate of approximately 94,000 square feet of
administrative and laboratory space in five 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. We believe
that our present Fort Collins facilities are adequate for our current and
planned activities and that suitable additional or replacement facilities in the
Fort Collins area are readily available on commercially reasonable terms should
such facilities be needed in the future. Diamond's principal manufacturing
facility in Des Moines, Iowa, consisting of 166,000
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square feet of buildings on 34 acres of land, is owned by Diamond. Diamond also
owns a 160-acre farm used principally for research purposes located in Carlisle,
Iowa. Center owns its approximately 27,000 square foot facility in Port
Washington, New York. The Company's European subsidiaries lease their
facilities.
Heska Waukesha currently leases approximately 19,500 feet of office and
manufacturing space in Waukesha, Wisconsin. Heska Waukesha plans to vacate this
space by December 31, 1999 and is currently seeking a subtenant. In August 1999,
we announced that we are consolidating the operations of Heska Waukesha into our
existing operations in Fort Collins, Colorado and Des Moines Iowa.
LEGAL PROCEEDINGS
In November 1998, Synbiotics Corporation filed a lawsuit against us in
the United States District Court for the Southern District of California in
which it alleges that we infringe a patent owned by Synbiotics relating to
heartworm diagnostic technology. We have answered the complaint and discovery is
proceeding. We have obtained legal opinions from our outside patent counsel that
our heartworm diagnostic products do not infringe the Synbiotics patent and that
the patent is invalid. The opinions of non-infringement are consistent with the
results of our internal evaluations. While we believe that we have valid
defenses to Synbiotics' allegations and intend to defend the action vigorously,
there can be no assurance that an adverse result or settlement would not have a
material adverse effect on our financial position, the operations or our cash
flow.
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MANAGEMENT
Our directors and executive officers are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Robert B. Grieve, Ph.D. 48 Vice Chairman and Chief Executive Officer
James H. Fuller 55 President and Chief Operating Officer
Ronald L. Hendrick 53 Executive Vice President, Chief Financial Officer and Secretary
Paul S. Hudnut 41 Executive Vice President
Guisseppe Miozzari, Ph.D. 53 Managing Director, Heska Europe
R. Lee Seward, D.V.M. 53 Executive Vice President
Dan T. Stinchcomb, Ph.D. 45 Vice President, Research
Barr Dolan(1)(2) 50 Director
John F. Sasen, Sr.(1) 57 Director
Lyle A. Hohnke, Ph.D.(1) 56 Director
Denis H. Pomroy(2) 49 Director
Lynnor B. Stevenson, Ph.D. 56 Director
Fred M. Schwarzer 47 Chairman of the Board
Guy Tebbit, Ph.D.(2) 50 Director
</TABLE>
- ----------
(1) Member of the Compensation Committee of the Board of Directors.
(2) Member of the Audit Committee of the Board of Directors.
Robert B. Grieve, Ph.D., a founder of the Company, currently serves as
Chief Executive Officer and Vice Chairman of the Board of Directors. Dr. Grieve
was named Chief Executive Officer effective January 1, 1999 and Vice Chairman
effective December 1994. Dr. Grieve also served as Chief Scientific Officer from
December 1994 to January 1999 and Vice President, Research and Development, from
March 1992 to December 1994. He has been a member of the Company's Board of
Directors since 1990. He holds a Ph.D. degree from the University of Florida and
M.S. and B.S. degrees from the University of Wyoming.
James H. Fuller is President and Chief Operating Officer of the Company.
He joined the Company in January 1999. Prior to joining the Company, Mr. Fuller
served as Corporate Vice President of Allergan, Inc. ("Allergan"), a leading
specialty pharmaceutical company, from 1994 through 1998. Prior to that, Mr.
Fuller served in a number of sales and marketing positions at Allergan since
1974. He holds M.S. and B.S. degrees from the University of Southern California.
Ronald L. Hendrick is Executive Vice President, Chief Financial Officer
and Secretary of the Company. He joined the Company in December 1998. Prior to
joining the Company, Mr. Hendrick was Executive Vice President and Chief
Financial Officer of Xenometrix, Inc., a human biotechnology concern, from 1995
until December 1998. Prior to that, Mr. Hendrick served as Vice President and
Corporate Controller at Alexander & Alexander Services, Inc., a NYSE financial
services firm, from 1993 until 1995 and before that he held a number of finance
and accounting positions at Adolph Coors Company. Mr. Hendrick is a Certified
Public Accountant. He holds a M.B.A. from the University of Colorado and a B.A.
degree from Michigan State University.
Paul S. Hudnut is Executive Vice President of the Company. He was
elected Executive Vice President in September 1998, and prior to that was Vice
President of Business Development of the Company since June 1996. Prior to
joining the Company in June 1996, Mr. Hudnut was a General Manager at US WEST
Media Group and held various positions in management and business development at
subsidiaries of US WEST, Inc. from February 1988. Prior to joining US WEST, Mr.
Hudnut was an associate with the Denver, Colorado law firm of Davis, Graham and
Stubbs. He holds a J.D. degree from the University of Virginia and a B.A. degree
from The Colorado College.
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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.
Dan T. Stinchcomb, Ph.D., was appointed Vice President, Research, in
December 1998. He joined Heska in May 1996 as Vice President, Biochemistry and
Molecular Biology. Prior to joining the Company, from July 1993 until May 1996,
Dr. Stinchcomb was employed by 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.
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.
John F. Sasen, Sr., has been a director of the Company since October
1998. Since April 1998 he has served as Executive Vice President and Chief
Marketing Officer of PSS/World Medical, Inc. ("PSS"), and from December 1993 he
held various other senior executive positions at PSS. From July 1993 to April
1998, Mr. Sasen served as a Director of PSS. Prior to joining PSS in 1993, Mr.
Sasen was Vice President Sales, Marketing and Distributor Relations for a
division of Becton Dickinson & Company ("Becton Dickinson"), a manufacturer of
health care products. Mr. Sasen was with Becton Dickinson for over 20 years. In
addition, Mr. Sasen serves as a director of Humascan, Inc., a manufacturer of a
breast thermal detection device. Mr. Sasen is the immediate past Chairman of the
Health Industry Distributors Association, a non-profit organization that
addresses the needs of the healthcare industry.
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 Animal Health, Inc. ("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 Cytrx, Inc. and several private companies. In addition, he is
a member of the compensation committee of Cytrx, Inc. 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 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 Superscape VR PLC, a publicly traded
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company in the United Kingdom and 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., is a founder of the Company and has been a
director of the Company since March 1988. Dr. Stevenson served as President and
Chief Executive Officer 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 B.Ed. degrees from the
University of Melbourne, Australia.
Fred M. Schwarzer, has been a member of the Board of Directors of the
Company since June 1994 and Chairman of the Board since January 1999. Since July
1999 Mr. Schwarzer has also served as a Senior Vice President of C.M. Capital, a
diversified asset management firm and the parent corporation of Charter Venture
Capital. Mr. Schwarzer served as President and Chief Executive Officer of the
Company from November 1994 to December 31, 1998. Prior to that, Mr. Schwarzer
served as the Executive Vice President responsible for the Company's strategic
planning and corporate partnerships from June 1994. From June through October
1994, Mr. Schwarzer was also an employee of Charter Venture Capital. Mr.
Schwarzer was the founder and a partner in the Mountain View, California law
firm of General Counsel Associates from August 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.
Guy Tebbit, Ph.D., has been a director of the Company since March 1997
when he became Novartis Tiergesundheit AG's ("Novartis") designee 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 Animal Health US, Inc ("Novartis US"). From January 1995 to
January 1997, he held the position of Director, Manufacturing and Regulatory
Affairs at Novartis US and from January 1992 to January 1995 he served as Senior
Product Development Manager at Novartis US. Dr. Tebbit holds a Ph.D. from Oregon
State University and a B.S. degree from Northern Illinois University.
BOARD COMPOSITION AND VOTING AGREEMENT
The Company's Board of Directors is 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. Mr. Pomroy, Dr. Stevenson and Dr. Hohnke serve as
Class III directors, whose terms expire in 2000; Mr. Schwarzer and Dr. Tebbit
serve as Class I directors, whose terms expire in 2001; and Dr. Grieve, Mr.
Dolan and Mr. Sasen serve as Class II directors, whose terms expire in 2002. The
directors of each class hold their positions until the annual meeting of
stockholders at which their respective successors are elected and qualified or
until their earlier resignation, removal from office, death or incapacity. The
Board of Directors has appointed a Compensation Committee and an Audit
Committee. The Compensation Committee and Audit Committee are comprised entirely
of non-employee directors.
Mr. Dolan was appointed to the Company's Board of Directors in
connection with 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"). Dr. Hohnke was appointed to the Board of Directors of the Company
in connection with the Company's April 1996 acquisition of Diamond.
Novartis, Volendam and Charter (collectively, the "Investors") are
parties to 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
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<PAGE> 42
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
that 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. Because Volendam is expected to own less than 2,000,000
shares after this offering, the Voting Agreement is expected to terminate upon
the completion of this offering.
DIRECTORS' COMPENSATION
In August 1999, the Board of Directors approved a policy to compensate
"outside" or non-employee directors with options to purchase Heska common stock.
Non-employee directors will receive an option to purchase 100 shares for
attendance at a meeting of the Board of Directors which is less than four hours.
Non-employee directors will receive an option to purchase 500 shares for
attendance at a meeting of the Board of Directors, which is four hours or more,
or for consulting services of four hours or more. Each of these options is
immediately exercisable.
Directors are also reimbursed for their expenses for each meeting
attended and are eligible to participate in the Company's 1997 Stock Incentive
Plan. In addition, each new non-employee director elected to the Company's Board
of Directors is automatically 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 vest in four equal installments at annual intervals over the
four-year period commencing on the date of grant. Further, each non-employee
director who continues to serve in such capacity following any annual meeting of
stockholders is automatically 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 vest on the first anniversary of grant. No director is eligible to
receive the 10,000-share grant and a 2,000-share grant in the same year.
Directors are eligible to receive a greater number of options or shares than the
automatic grants described above.
See "--Employment Agreements" for a description of the compensation
arrangement with Dr. Grieve, an officer and director of the Company and for a
description of certain separation and future consulting arrangements with Mr.
Schwarzer, a director and former officer of the Company.
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<PAGE> 43
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth compensation for services rendered in all
capacities to the Company for the three fiscal years ended December 31, 1998 of
(i) Fred M. Schwarzer, the Company's former Chief Executive Officer, who
resigned from such position effective December 31, 1998; and (ii) the Company's
four other most highly compensated executive officers as of December 31, 1998
(the "Named Executive Officers").
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION -------------
------------------------------------------ SECURITIES
FISCAL OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($)(1) BONUS $ COMPENSATION($) OPTIONS(#) COMPENSATION($)
- --------------------------- ---- ------------ -------- --------------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Fred M. Schwarzer ................................ 1998 $200,000 -- -- 150,000 $206,000(6)
Former President and Chief Executive 1997 200,000 -- -- --
Officer(2) 1996 200,000 -- -- 150,000
Robert B. Grieve ................................. 1998 $195,000 -- -- 150,000
Vice Chairman and Chief Executive Officer(3) 1997 190,000 -- -- --
1996 190,000 -- -- 150,000
R. Lee Seward .................................... 1998 $185,000 -- -- 60,000
Executive Vice President 1997 180,000 -- -- 20,000
1996 180,000 -- -- --
John A. Shadduck ................................. 1998 $185,000 -- -- -- $185,000(7)
Former Executive Vice President, 1997 160,000 -- -- 100,000
Operations(4) 1996 -- --
Giuseppe Miozzari ................................ 1998 $197,000 -- -- --
Chief Executive Officer of Heska Holding AG 1997 144,000(5) -- -- 100,000
</TABLE>
(1) Salary includes amounts, if any, deferred pursuant to 401(k)
arrangements.
(2) Mr. Schwarzer's employment with the Company terminated effective
December 14, 1998, although he served as President and Chief Executive
Officer through December 31, 1998. Mr. Schwarzer continues to serve as a
director of the Company and, effective January 1, 1999, was appointed
Chairman of the Board of Directors.
(3) Effective January 1, 1999, Dr. Grieve was elected Chief Executive
Officer of the Company and resigned his position as Chief Scientific
Officer.
(4) Dr. Shadduck's employment with the Company commenced February 1997 and
was terminated effective December 14, 1998 although he served as
Executive Vice President, Operations through December 31, 1998.
(5) Dr. Miozzari's employment with the Company commenced in March 1997 and
his 1997 salary reflects a partial year of employment.
(6) Includes $200,000 in separation pay to be paid in twelve equal monthly
installments during 1999 and $6,000 for health insurance premiums for
health insurance coverage through December 31, 1999 or until Mr.
Schwarzer obtains health insurance coverage from another employer. Does
not include the value from the continuation of vesting on all stock
options owned by Mr. Schwarzer through December 31, 1999.
(7) Includes $185,000 in separation pay to be paid in twelve equal monthly
installments during 1999. Does not include the value from the
continuation of vesting on all stock options owned by Dr. Shadduck
through December 31, 1999.
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<PAGE> 44
The following tables summarize option grants to, and exercises by, the
Named Executive Officers during fiscal 1998, and the value of the options held
by each such person at the end of fiscal 1998.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
Individual Grants Potential
------------------------------------------------------ Realizable Value at
Number of Percentage of Assumed Annual Rates of
Securities Total Options Stock Price Appreciation
Underlying Granted to Exercise or for Option Term(4)
Options Employees in Base Price Expiration -------------------------
Name Granted(#)(1) Fiscal Year ($/Share)(2) Date (3) 5%($) 10%($)
- ---- ------------- ----------- ------------ --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Fred M. Schwarzer(5) 150,000 11.79% $ 11.88 01/21/08 $1,120,690 $2,840,049
Robert B. Grieve 150,000 11.79% $ 11.88 01/21/08 $1,120,690 $2,840,049
R. Lee Seward 30,000 2.36% $ 11.88 01/21/08 $ 224,138 $ 568,004
30,000 2.36% $ 10.25 07/30/08 $ 193,385 $ 490,075
John A. Shadduck -- -- -- -- -- --
Giuseppe Miozzari -- -- -- -- -- --
</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.
(5) The amounts shown do not include options to purchase 17,000 shares of
Common Stock granted to Mr. Schwarzer's wife, an employee of the Company
during part of 1998. Mr. Schwarzer disclaims any beneficial ownership of
these options.
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<PAGE> 45
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
SECURITIES UNDERLYING VALUE OF
UNEXERCISED UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
DECEMBER 31, 1998(#) DECEMBER 31, 1998($)(2)
SHARES ACQUIRED VALUE ---------------------------- -------------------------------
NAME ON EXERCISE(#) REALIZED($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- --------------- -------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Fred M. Schwarzer(3) -- -- 238,625 184,375 $ 757,786 $233,237
Robert B. Grieve(4) 4,000 $15,500 327,250 178,750 1,136,185 210,242
R. Lee Seward 802 9,995 57,948 71,250 172,823 57,057
John A. Shadduck -- -- 67,909 52,083 239,880 168,644
Giuseppe Miozzari -- -- 45,833 54,167 148,407 175,392
</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 per
share of the Common Stock at December 31, 1998 ($4.438), minus the
applicable per share exercise price.
(3) The amounts shown for Mr. Schwarzer do not include 16,211 exercisable
and 24,664 unexercisable options at December 31, 1998 held by Mr.
Schwarzer's wife, an employee of the Company during part of 1998. Mr.
Schwarzer disclaims any beneficial ownership of these options.
(4) The amounts shown do not include 15,649 shares owned by Dr. Grieve's
wife. Dr. Grieve disclaims any beneficial ownership of these shares.
PENSION AND LONG-TERM INCENTIVE PLANS
The Company has no pension or long-term incentive plans.
EMPLOYMENT AGREEMENTS
During 1998, the Company was a party to employment agreements with each
of the Named Executive Officers. All of the agreements provide for severance
payments if the individual's employment is terminated without cause, including
terminations in connection with a change in control of the Company. In the case
of Dr. Grieve, the payments set forth in his employment agreement are equal to
one year's salary plus an additional 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. Miozzari, the payments (including
amounts mandated by Swiss law) would be 12 months' salary if he is terminated
without cause prior to July 1, 2000, or six months' salary if he is terminated
without cause after that date.
In December 1998, the Company and each of Mr. Schwarzer and Dr. Shadduck
agreed that the employment of those officers would be terminated effective
December 14, 1998, with Mr. Schwarzer being appointed to the position of
Chairman of the Board of Directors. In connection with the arrangement with Mr.
Schwarzer, the Company and Mr. Schwarzer entered into a Separation Agreement and
a Consultant Services and Confidentiality Agreement. Under the Separation
Agreement, Mr. Schwarzer will be paid his 1998 base salary of $200,000 through
December 31, 1999 and will continue to vest under all outstanding stock options
and stock purchase agreements for so long as he remains a director of the
Company or December 31, 1999, whichever is later. The Company will pay the
health insurance premiums of Mr. Schwarzer and his dependents through December
31, 1999 or until he becomes covered under the health insurance plan of another
employer, whichever
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<PAGE> 46
is earlier. Under Mr. Schwarzer's Consultant Services and Confidentiality
Agreement, Mr. Schwarzer will provide ongoing, part time consulting services to
the Company until the earlier of April 30, 2000 or until the Company's annual
meeting of stockholders in 2000. Under this agreement, Mr. Schwarzer also agrees
that during this period he will not provide services to any business which is
competitive with the present or anticipated business of the Company. In
consideration for such services, the Company will pay to Mr. Schwarzer $30,000,
payable in two installments of $15,000 each on March 31, 1999 and June 30, 1999.
In addition, the Company has agreed to forgive Mr. Schwarzer's outstanding
principal indebtedness to the Company under a promissory note in the amount of
$61,950 plus accrued interest, thereon. See "Related Party Transactions" for a
description of the debt forgiveness. The Company will also reimburse Mr.
Schwarzer his reasonable out-of-pocket expenses incurred in performing
consulting services for the Company.
Under Dr. Shadduck's Separation Agreement, the Company will pay to Dr.
Shadduck his 1998 base salary of $185,000 through December 31, 1999, and his
outstanding stock options will continue to vest through December 31, 1999. In
addition, pursuant to a Consultant Services and Confidentiality Agreement
between the Company and Dr. Shadduck, Dr. Shadduck will provide ongoing part
time consulting services to the Company and, in consideration for such services,
the Company will pay to Dr. Shadduck $500 per day, together with that number of
shares of Company Common Stock equal in value to $200 per full day that Dr.
Shadduck provides consulting services (pro rated for partial days), and will
reimburse Dr. Shadduck for his reasonable out-of-pocket expenses incurred in
providing consulting services to the Company.
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 in 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.
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 director 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.
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<PAGE> 47
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of Heska's common stock as of September 30, 1999 and as adjusted to
reflect the sale of the common stock offered by Heska by: (i) each person who is
known by the Company to own beneficially more than 5% of Heska's common stock,
(ii) each of Heska's directors, (iii) each of Heska's officers named under
"Management--Summary Compensation Table," and (iv) all directors and executive
officers of Heska as a group.
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
NUMBER OF OUTSTANDING(1)
SHARES ----------------------
BENEFICIALLY PRIOR TO AFTER
NAME OF BENEFICIAL OWNER OWNED(1) OFFERING OFFERING
- ------------------------ ------------ -------- --------
<S> <C> <C> <C>
Entities associated with
Charter Ventures(2) .............................. 4,406,924 16.4% 15.6%
525 University Avenue, Suite 1500
Palo Alto, CA 94301
Novartis Tiergesundheit AG .......................... 3,705,389 13.8% 11.1%
Klybeckstrasse A4A
4002 Basel
Switzerland
Volendam Investeringen, N.V.(3) ..................... 2,304,633 8.6% 6.9%
14 John B. Gorsiraweg, P.O. Box 3889
Curacao, Netherlands Antilles
Dresdner RCM Global Investors LLC
Dresdner RCM Global Investors Holdings LLC
Dresdner Bank AG(4) ................................. 2,411,403 9.0% 7.2%
Four Embarcadero Center
San Francisco, CA 94111
Ralston Purina Company(5) ........................... 2,331,184 8.3% 6.8%
Checkerboard Square
St. Louis, MO 63164
Zesiger Capital Group LLC(6) ........................ 1,504,000 5.6% 8.1%
320 Park Avenue, 30th Floor
New York, NY 10022
A. Barr Dolan(7)(12) ................................ 4,408,924 16.4% 15.6%
Robert B. Grieve, Ph.D.(8)(12) ...................... 530,725 1.9% 1.6%
Lyle A. Hohnke, Ph.D.(12) ........................... 106,369 * *
Denis H. Pomroy(9)(12) .............................. 2,335,633 8.7% 7.0%
John F. Sasen, Sr. .................................. 5,000 * *
Fred M. Schwarzer(10)(12) ........................... 385,231 1.4% 1.1%
Lynnor B. Stevenson, Ph.D.(12) ...................... 181,000 * *
Guy Tebbit, Ph.D.(11) ............................... 3,705,389 13.8% 11.1%
R. Lee Seward, D.V.M.(12) ........................... 217,427 * *
John A. Shadduck, D.V.M., Ph.D.(12) ................. 95,298 * *
Giuseppe Miozzari, Ph.D.(12) ........................ 72,396 * *
All directors and executive officers as a group
(15 persons)(12)(13) ............................. 12,240,976 43.9% 37.9%
</TABLE>
- ----------------
* Amount represents less than 1% of the Company's common stock.
(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 or warrants exercisable within
60 days of March 15, 1999 are
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<PAGE> 48
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 3,386,510 shares and options to purchase 1,000 shares of Common
Stock held by Charter Ventures and 1,018,414 shares and options to
purchase 1,000 shares of Common Stock held by Charter Ventures II, L.P.
(3) Based upon information provided by Volendam Investeringen N.V. on its
most recent Form 144 filing.
(4) Based upon information derived from a Schedule 13G, as amended, filed by
the Dresdner RCM Global Investors LLC, Dresdner RCM Global Investors US
Holdings LLC and Dresdner Bank AG (collectively, "Dresdner") pursuant to
Section 13 of the Securities Exchange Act of 1934 and the rules
promulgated thereunder (the "Exchange Act"), reporting its beneficial
ownership of Common Stock as of February 16, 1999. According to the
Schedule 13G, Dresdner has sole power to vote 1,806,503 shares and the
sole power to dispose of 2,421,603 shares.
(5) Based upon information derived from a Schedule 13G filed by Ralston
Purina Company ("Ralston Purina") pursuant to Section 13G of the
Exchange Act, reporting its beneficial ownership of shares as of August
4, 1998. Includes 1,165,592 shares of Common Stock which may be acquired
upon exercise of warrants and do not have voting rights until issued
upon exercise. According to the Schedule 13G, Ralston Purina has sole
power to vote and dispose of these shares.
(6) Based upon information derived from a Schedule 13G filed by Zesiger
Capital Group LLC ("Zesiger") pursuant to Section 13G of the Exchange
Act reporting its beneficial ownership of Common Stock as of January 13,
1999. According to the Schedule 13G, Zesiger has the sole power to vote
1,105,000 shares and the sole power to dispose of 1,504,000 shares.
(7) 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.
(8) Does not include 15,649 shares of Common Stock held by Dr. Grieve's
wife, with respect to which Dr. Grieve disclaims beneficial ownership.
(9) Includes 2,304,633 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 11,480 shares of
Common Stock subject to repurchase by the Company.
(10) Does not include 949 shares of Common Stock held by Mr. Schwarzer's
wife, with respect to which Mr. Schwarzer disclaims beneficial
ownership. Also does not include shares and options held by Charter
Ventures and Charter Ventures II, L.P., with respect to which Mr.
Schwarzer disclaims beneficial ownership except to the extent of his
proportionate share therein. Mr. Schwarzer, Chairman of Heska, is a
senior vice president of C.M. Capital, the parent corporation of Charter
Venture Capital, but has no voting power with respect to such shares.
(11) Represents shares held by Novartis, with respect to which Dr. Tebbit
disclaims beneficial ownership.
(12) Includes an aggregate of 1,047,805 shares of Common Stock issuable upon
exercise of stock options currently exercisable within 60 days of
September 30, 1999 as follows: Mr. Dolan, 2,000; Mr. Fuller, 72,916; Dr.
Grieve, 436,375; Dr. Hohnke, 19,978; Mr. Pomroy, 6,000; Mr. Sasen,
5,000; Mr. Schwarzer, 209,292; Dr. Shadduck, 90,825; Dr. Stevenson,
4,000; Dr. Seward, 36,458; Dr. Miozzari, 72,396; Mr. Hendrick, 22,917;
Mr. Hudnut, 30,960; Dr. Stinchcomb, 38,688.
(13) Includes shares held by entities referenced in footnotes 7, 9 and 11
which are affiliated with certain directors.
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<PAGE> 49
RELATED PARTY TRANSACTIONS
In July 1998, we entered into a Research and Licensing Agreement with
Ralston Purina. Pursuant to that agreement, Ralston Purina acquired exclusive
rights to license certain of our discoveries, know-how and technologies for
innovative diets for dogs and cats, and we have agreed to allocate certain
resources to research, develop and commercialize pet food products that are the
subject of the collaboration. In the event any products that are the subject of
the collaboration are commercialized by Ralston Purina, they would owe us
certain royalties. In addition, Ralston Purina acquired 1.165 million shares of
our common stock for $14.75 million in cash, and also acquired, for an
additional cash payment of $250,000, warrants to purchase an additional 1.165
million shares of common stock. The exercise price of the warrants is $12.67 for
the first year of the warrants, increasing by 20% per year for each of the
second and third years of the warrant. The warrant was vested immediately as of
July 30, 1998 and expires in three years with respect to any unexercised shares.
Novartis, a principal stockholder of Heska, has ongoing marketing rights
to certain of the Company's products under development and is a party to a
Screening and Development Agreement and Right of First Refusal Agreement.
Novartis obtained such rights in connection with its purchase of our preferred
stock in April 1996 (which converted into common stock upon the closing of our
initial public offering), but did not make any separate payments for these
rights.
Effective as of August 18, 1998, we entered into an Exclusive
Distribution Agreement with Novartis Agro K.K., Tokyo ("Novartis Agro"), an
affiliate of Novartis. Under the terms of the agreement Novartis Agro will have
exclusive rights to market and distribute selected Heska-branded products in
Japan. Novartis Agro is responsible for the registration of these products in
Japan. The initial products to be marketed under the agreement are Solo Step(TM)
CH and Solo Step(TM) FH, our in-clinic heartworm diagnostic tests for canines
and felines, the HESKA(TM) Trivalent Intranasal/Intraocular Vaccine for felines
and the HESKA(TM) Bivalent Intranasal/Intraocular Vaccine for felines. In
consideration of these distribution rights, Novartis has entered into a Right of
First Refusal Agreement wherein Novartis granted us any a right of first refusal
to evaluate for possible development and marketing worldwide certain new product
technologies for the veterinary market as they become available from Novartis.
On August 15, 1998, we entered into a License Agreement with Vaxcel,
Inc. ("Vaxcel"). Under this agreement, we obtained a non-exclusive worldwide
license to Vaxcel's rights to use certain microcapsules for oral delivery of
antigens. We are no longer pursuing this technology, and the license has been
terminated. Dr. Lyle Hohnke, a director of the Company, was a director of Vaxcel
in August 1998 although he is no longer a director of Vaxcel.
On February 9, 1999, we entered into an Evaluation and Option Agreement
with Cascade Oncogenics, Inc. ("Cascade"), pursuant to which we obtained the
right to evaluate for veterinary diagnostic applications certain technologies
and biological materials to which Cascade has rights. In addition, we acquired
an option to enter into a license agreement with respect to such technologies.
In consideration of such rights, we paid or will pay to Cascade a fee and, if
the option to enter into the license agreement is exercised, we would pay to
Cascade certain royalties and milestone payments following the sale of any
diagnostic product developed and sold by us pursuant to such license. Dr. Lynnor
Stevenson, a director and founder of Heska, is a director, the chief executive
officer and a significant stockholder of Cascade.
In December 1994, Mr. Schwarzer executed a promissory note to Heska in
the principal amount of $61,950 as payment for 177,000 shares of common stock.
The note accrues interest at the rate of seven and one-half percent per annum.
As of December 31, 1998, the total amount due, principal and accrued interest
was $81,311. In December 1998, we entered into a Consultant Services and
Confidentiality Agreement with Mr. Schwarzer wherein we agreed to forgive all of
the outstanding indebtedness for principal and interest under the note on the
earliest of (i) April 30, 2000 or (ii) the annual meeting of stockholders held
in 2000. (See "Management--Employment Agreements.")
-49-
<PAGE> 50
DESCRIPTION OF CAPITAL STOCK
We are authorized to issue 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 September 30, 1999, there were 26,861,658 shares of our common
stock outstanding that were held of record by approximately 275 stockholders.
There will be 33,361,658 shares of common stock outstanding (assuming no
exercise of options and warrants outstanding as of September 30, 1999 or granted
thereafter) after giving effect to the sale of common stock offered by this
prospectus.
Voting rights. Each holder of the common stock is entitled to one vote
for each share of common stock held of record on the applicable record date on
all matters submitted to a vote of stockholders. There are no cumulative voting
rights, which means that the holders of a majority of the shares voted can elect
all of the directors then standing for election.
Dividend rights; rights upon liquidation. The holders of common stock
are entitled to receive dividends out of assets legally available for dividends
at times and in amounts as the board of directors may determine. These dividend
rights are subject to any preferential dividend rights granted to the holders of
any outstanding preferred stock. We have never paid cash dividends. We presently
intend to retain all earnings for use in our business and have no present
intention to pay cash dividends in the foreseeable future.
In the event of our liquidation, dissolution or winding up, each share
of common stock is entitled to share pro rata in any distribution of our assets
after payment or providing for the payment of liabilities and the liquidation
preference of any outstanding preferred stock.
Preemptive and other rights. Holders of common stock have no preemptive
or conversion rights or other rights to purchase, subscribe for or otherwise
acquire any unissued or treasury shares or other securities. There are no
redemption or sinking fund provisions applicable to the common stock.
PREFERRED STOCK
As of the date of prospectus, we have no shares of preferred stock
issued or outstanding.
Our board has the authority, without stockholder approval, to create and
issue one or more series of preferred stock and to fix the number of shares,
designations, preferences, powers and relative, participating, optional or other
special rights of the shares of that series, and the qualifications or
restrictions on those preferences or rights. The specific matters that may be
determined by the board with respect to a series of preferred stock include:
- the designation of the series;
- the number of shares of the series;
- the rate of dividends, if any;
- whether dividends, if any, are cumulative or non-cumulative;
- the terms of redemption, if any;
- the amount payable in the event of any voluntary or involuntary
liquidation, dissolution or winding up of the affairs of the
company;
-50-
<PAGE> 51
- rights and terms of conversion or exchange, if any;
- restrictions on the issuance of shares of the same series or any
other series, if any; and
- voting rights, if any.
The issuance of preferred stock, while providing desirable flexibility
in connection with possible acquisitions and other corporate purposes, 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. Also, the issuance of preferred stock
may have the effect of delaying, deferring or preventing a change in control of
our company and may adversely affect the market price of our common stock. We
have no current plans to issue any shares of preferred stock.
REGISTRATION RIGHTS
Holders of approximately 11,746,130 shares of our common stock,
including shares issuable upon exercise of the warrant (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 we
propose to register any of our securities under the Securities Act for our own
account, holders of these Registrable Shares are entitled to notice of the
registration and are entitled to include their shares in the registration,
provided, among other conditions, that the underwriters of any such offering
have the right to limit the number of shares included in the registration. In
addition, holders of at least 35% of the Registrable Shares may require Heska to
prepare and file a registration statement under the Securities Act, provided the
reasonably expected aggregate offering price will equal or exceed $5,000,000. We
are obligated to effect up to two of these stockholder-initiated registrations.
DELAWARE ANTI-TAKEOVER LAW AND CERTAIN CHARTER PROVISIONS
We are subject to Section 203 of the Delaware General Corporation 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.
Our certificate of incorporation provides for a classified board of
directors and eliminates the right of stockholders to call special meetings of
stockholders. In addition, those provisions of the certificate of incorporation
may only be amended or repealed by the holders of at least two-thirds of the
voting power of all the then-outstanding shares of stock entitled to vote
generally for the election of directors, voting together as a single class.
The provisions described above, together with the ability of our board
to issue preferred stock as described above under "--Preferred Stock" could have
the following effects:
- delaying, deferring or preventing a change in control;
- delaying, deferring or preventing the removal of existing
management;
- deterring potential acquirers from making an offer to our
stockholders; and
- limiting any opportunity of our stockholders to realize premiums
over prevailing market prices of our common stock in connection
with offers by potential acquirers.
-51-
<PAGE> 52
This could be the case even if a majority of our stockholders might
benefit from such a change in control or offer.
WARRANT
As of September 30, 1999, we had outstanding a warrant to purchase
1,165,592 shares of our common stock.
TRANSFER AGENT AND REGISTRAR
American Securities Transfer and Trust, Inc. is the transfer agent and
registrar for our common stock.
-52-
<PAGE> 53
PLAN OF DISTRIBUTION
We are offering the shares to selected institutional investors,
including current institutional holders of our common stock. The State of
Wisconsin Investment Board, Charter Ventures II, L.P. and Zesiger Capital Group
all of whom are existing shareholders, have expressed an interest in
participating in the offering. We may sell the common stock offered in this
prospectus directly to investors on our own behalf in jurisdictions where we are
authorized to do so, acting through our officers and directors. Our officers and
directors will not be separately compensated for their services in connection
with this offering. Alternatively, we may offer the shares through agents who
may receive compensation from us in the form of commissions, which may be in
excess of ordinary brokerage commissions, and who may be reimbursed for certain
expenses. We have no agreements with or commitments from any such agents as of
the date of this prospectus. Any agents that participate in the distribution of
the shares may be deemed to be "underwriters" as defined in the Securities Act,
and any profit on the sale of shares by them and any selling commissions
received by any such agents may be deemed to be underwriting discounts and
selling commissions under the Securities Act.
We will obtain indications of interest from potential investors for the
amount of the offering. We will distribute confirmations and definitive
prospectuses to all investors at the time of pricing. We will not accept any
investor funds prior to effectiveness of the registration statement. The
offering will not continue after the closing date, and we will deregister any
shares not sold.
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.
EXPERTS
The audited 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.
-53-
<PAGE> 54
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a Registration
Statement on Form S-1. This prospectus, which forms a part of the Registration
Statement, does not contain all the information included in the Registration
Statement. Certain information is omitted and you should refer to the
Registration Statement and its exhibits. With respect to references made in this
prospectus to any contract or other document of Heska, such references are not
necessarily complete and you should refer to the exhibits attached to the
Registration Statement for copies of the actual contract or document. You may
review a copy of the Registration Statement, including exhibits and schedule
filed therewith, at the Securities and Exchange Commission's public reference
facilities in Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549, and at the regional offices of the Securities and Exchange
Commission located at 7 World Trade Center, Suite 1300, New York, New York
10048, and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661. You may also obtain copies of such materials from the Public
References Section of the Securities and Exchange Commission, Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates. The Securities and Exchange Commission maintains a Web site
(http://www.sec.gov) that contains reports, proxy and information statements and
other information regarding registrants, such as Heska, that file electronically
with the Securities and Exchange Commission.
-54-
<PAGE> 55
INDEX TO CONSOLIDATED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
<S> <C>
Audited Financial Statements:
Report of Independent Public Accountants.................................................. F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998.............................. F-3
Consolidated Statements of Operations and Comprehensive Loss for the years ended
December 31, 1996, 1997 and 1998..................................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31,
1996, 1997 and 1998.................................................................. F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1996,
1997 and 1998........................................................................ F-6
Notes to Consolidated Financial Statements................................................ F-7
Unaudited Financial Statements:
Consolidated Balance Sheets as of September 30, 1999 (Unaudited) and
December 31, 1998.................................................................... F-27
Consolidated Statements of Operations and Comprehensive Loss (Unaudited)
for the three and nine months ended September 30, 1999 and 1998...................... F-28
Consolidated Statements of Cash Flows (Unaudited) for the nine months ended
September 30, 1999 and 1998.......................................................... F-29
Notes to Consolidated Financial Statements (Unaudited).................................... F-30
</TABLE>
F-1
<PAGE> 56
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, 1997
and 1998, and the related consolidated statements of operations and
comprehensive loss, stockholders' equity and cash flows for the three years
ended December 31, 1996, 1997 and 1998. 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, 1997 and 1998, and the results of their
operations and their cash flows for the three years ended December 31, 1996,
1997 and 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Denver, Colorado
January 22, 1999
F-2
<PAGE> 57
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1997 1998
--------- ---------
(RESTATED)
<S> <C> <C>
Current assets:
Cash and cash equivalents .................................................. $ 10,679 $ 5,921
Marketable securities ...................................................... 18,073 46,009
Accounts receivable, net ................................................... 5,327 6,659
Inventories, net ........................................................... 10,562 12,197
Other current assets ....................................................... 1,236 734
--------- ---------
Total current assets ................................................. 45,877 71,520
Property and equipment, net ....................................................... 15,979 21,226
Intangible assets, net ............................................................ 6,009 4,311
Restricted marketable securities and other assets ................................. 1,155 997
--------- ---------
Total assets ......................................................... $ 69,020 $ 98,054
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................... $ 6,425 $ 7,542
Accrued liabilities ........................................................ 2,970 3,871
Deferred revenue ........................................................... 284 656
Current portion of capital lease obligations ............................... 600 562
Current portion of long-term debt .......................................... 4,137 6,942
--------- ---------
Total current liabilities ............................................ 14,416 19,573
Capital lease obligations, less current portion ................................... 1,620 1,129
Long-term debt, less current portion .............................................. 9,021 10,162
Accrued pension liability ......................................................... 113 76
--------- ---------
Total liabilities .................................................... 25,170 30,940
--------- ---------
Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value, 40,000,000 shares authorized; 19,491,022
and 26,458,424 shares issued and outstanding, respectively ........... 19 26
Additional paid-in capital ................................................. 118,447 185,163
Deferred compensation ...................................................... (1,967) (1,277)
Stock subscription receivable from officers ................................ (158) (120)
Accumulated other comprehensive income ..................................... 1 88
Accumulated deficit ........................................................ (72,492) (116,766)
--------- ---------
Total stockholders' equity ........................................... 43,850 67,114
--------- ---------
Total liabilities and stockholders' equity ........................... $ 69,020 $ 98,054
========= =========
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE> 58
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1996 1997 1998
-------- -------- --------
(RESTATED) (RESTATED)
<S> <C> <C> <C>
Revenues:
Products, net .................................................. $ 15,570 $ 26,725 $ 38,451
Research and development ....................................... 1,946 2,578 1,321
-------- -------- --------
17,516 29,303 39,772
Costs and operating expenses:
Cost of goods sold ............................................. 12,002 20,077 29,087
Research and development ....................................... 14,513 20,343 25,126
Selling and marketing .......................................... 4,168 9,954 13,188
General and administrative ..................................... 5,514 13,192 11,939
Amortization of intangible assets and deferred compensation .... 1,289 2,500 2,745
Purchased research and development ............................. -- 2,399 --
Loss on assets held for sale ................................... -- -- 1,287
Restructuring expense .......................................... -- -- 2,356
-------- -------- --------
37,486 68,465 85,728
-------- -------- --------
Loss from operations .................................................. (19,970) (39,162) (45,956)
Other income (expense):
Interest income ................................................ 1,356 1,571 3,183
Interest expense ............................................... (490) (1,364) (2,009)
Other, net ..................................................... (145) 91 508
-------- -------- --------
Net loss .............................................................. (19,249) (38,864) (44,274)
-------- -------- --------
Other comprehensive income:
Foreign currency translation adjustments ....................... -- 1 2
Unrealized gain on marketable securities ....................... -- -- 85
-------- -------- --------
Other comprehensive income ............................................ -- 1 87
-------- -------- --------
Comprehensive loss .................................................... $(19,249) $(38,863) $(44,187)
-------- -------- --------
Basic net loss per share .............................................. $ (1.79)
========
Unaudited pro forma basic net loss per share .......................... $ (1.53) $ (2.42)
======== ========
Shares used to compute basic net loss per share
and unaudited pro forma basic net loss per share .................. 12,609 16,042 24,693
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
F-4
<PAGE> 59
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except per share data)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
--------------------- --------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
------- -------- ------ ------ ----------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1995 ............................... 6,618 $ 19,516 919 $ 1 $ 143
Effects of pooling-of-interests resulting from Heska
Waukesha acquisition .................................... -- -- 449 -- 2,573
------- -------- ------ --- --------
Balances, December 31, 1995 (restated) .................... 6,618 19,516 1,368 1 2,716
Issuance of preferred stock to acquire Diamond .......... 842 7,072 -- -- --
Grant of options to purchase common stock ............... -- -- -- -- 8
Exercise of options to purchase common stock for cash ... -- -- 202 -- 1,246
Issuance of preferred stock for cash ................... 3,000 36,000 -- -- --
Deferred compensation related to stock options .......... -- -- -- -- 933
Amortization of deferred compensation ................... -- -- -- -- --
Interest on stock subscription receivable ............... -- -- -- -- --
Net loss ................................................ -- -- -- -- --
------- -------- ------ --- --------
Balances, December 31, 1996 (restated) .................... 10,460 62,588 1,570 1 4,903
Issuance of common stock for cash ....................... -- -- 89 -- 1,342
Issuance of common stock for stock
subscription receivable ............................... -- -- 25 -- 30
Issuance of preferred stock related to
business acquisitions ................................. 124 1,236 -- -- --
Issuance of common stock related to
business acquisitions ................................. -- -- 454 -- 2,656
Issuance of common stock upon the Company's initial
public offering ("IPO"), net ......................... -- -- 5,638 6 43,867
Conversion of preferred stock into
common stock upon the IPO ............................. (10,584) (63,824) 11,289 11 63,813
Issuance of common stock for services ................... -- -- 1 -- --
Cashless exercise of warrants to purchase common stock .. -- -- 5 -- --
Issuance of common stock related to options and the
Employee Stock Purchase Plan (the "ESPP") ............ -- -- 420 1 299
Interest on stock subscription receivable ............... -- -- -- -- --
Foreign currency translation adjustments ................ -- -- -- -- --
Deferred compensation related to stock options .......... -- -- -- -- 1,537
Amortization of deferred compensation ................... -- -- -- -- --
Net loss ................................................ -- -- -- -- --
------- -------- ------ --- --------
Balances, December 31, 1997 (restated) .................... -- -- 19,491 19 118,447
Issuance of common stock for cash ....................... -- -- 3 -- 6
Issuance of common stock upon the Company's follow-on
public offering, net .................................. -- -- 5,250 5 48,595
Issuance of common stock and warrants for cash .......... -- -- 1,165 1 14,999
Issuance of common stock in exchange for assets and in
repayment of debt ..................................... -- -- 206 -- 2,262
Issuance of common stock for services -- -- 32 -- 461
Cashless exercise of warrants to purchase common stock .. -- -- 5 -- --
Issuance of common stock related to
options, the ESPP and other ........................... -- -- 306 1 347
Deferred compensation related to stock options .......... -- -- -- -- 46
Amortization of deferred compensation ................... -- -- -- -- --
Interest on stock subscription receivable ............... -- -- -- -- --
Payments received on stock subscription receivable ...... -- -- -- -- --
Foreign currency translation adjustments ................ -- -- -- -- --
Unrealized gain on marketable securities ................ -- -- -- -- --
Net loss ................................................ -- -- -- -- --
------- -------- ------ --- --------
Balances, December 31, 1998 ............................... -- $ -- 26,458 $26 $185,163
======= ======== ====== === ========
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
STOCK OTHER TOTAL
DEFERRED SUBSCRIPTION COMPREHENSIVE ACCUMULATED STOCKHOLDERS'
COMPENSATION RECEIVABLE INCOME DEFICIT EQUITY
------------ ------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1995 ............................... $ -- $(110) $-- $ (12,301) $ 7,249
Effects of pooling-of-interests resulting from Heska
Waukesha acquisition .................................... (330) -- -- (2,078) 165
------- ----- --- --------- --------
Balances, December 31, 1995 (restated) .................... (330) (110) -- (14,379) 7,414
Issuance of preferred stock to acquire Diamond .......... -- -- -- -- 7,072
Grant of options to purchase common stock ............... -- -- -- -- 8
Exercise of options to purchase common stock for cash ... -- -- -- -- 1,246
Issuance of preferred stock for cash ................... -- -- -- -- 36,000
Deferred compensation related to stock options .......... (933) -- -- -- --
Amortization of deferred compensation ................... 188 -- -- -- 188
Interest on stock subscription receivable ............... -- (8) -- -- (8)
Net loss ................................................ -- -- -- (19,249) (19,249)
------- ----- --- --------- --------
Balances, December 31, 1996 (restated) .................... (1,075) (118) -- (33,628) 32,671
Issuance of common stock for cash ....................... -- -- -- -- 1,342
Issuance of common stock for stock
subscription receivable ............................... -- (30) -- -- --
Issuance of preferred stock related to
business acquisitions ................................. -- -- -- -- 1,236
Issuance of common stock related to
business acquisitions ................................. -- -- -- -- 2,656
Issuance of common stock upon the Company's initial
public offering ("IPO"), net ......................... -- -- -- -- 43,873
Conversion of preferred stock into
common stock upon the IPO ............................. -- -- -- -- --
Issuance of common stock for services ................... -- -- -- -- --
Cashless exercise of warrants to purchase common stock .. -- -- -- -- --
Issuance of common stock related to options and the
Employee Stock Purchase Plan (the "ESPP") ............ -- -- -- -- 300
Interest on stock subscription receivable ............... -- (10) -- -- (10)
Foreign currency translation adjustments ................ -- -- 1 -- 1
Deferred compensation related to stock options .......... (1,537) -- -- -- --
Amortization of deferred compensation ................... 645 -- -- -- 645
Net loss ................................................ -- -- -- (38,864) (38,864)
------- ----- --- --------- --------
Balances, December 31, 1997 (restated) .................... (1,967) (158) 1 (72,492) 43,850
Issuance of common stock for cash ....................... -- -- -- -- 6
Issuance of common stock upon the Company's follow-on
public offering, net .................................. -- -- -- -- 48,600
Issuance of common stock and warrants for cash .......... -- -- -- -- 15,000
Issuance of common stock in exchange for assets and in
repayment of debt ..................................... -- -- -- -- 2,262
Issuance of common stock for services ................... -- -- -- -- 461
Cashless exercise of warrants to purchase common stock .. -- -- -- -- --
Issuance of common stock related to
options, the ESPP and other ........................... -- -- -- -- 348
Deferred compensation related to stock options .......... (46) -- -- -- --
Amortization of deferred compensation ................... 736 -- -- -- 736
Interest on stock subscription receivable ............... -- (13) -- -- (13)
Payments received on stock subscription receivable ...... -- 51 -- -- 51
Foreign currency translation adjustments ................ -- -- 2 -- 2
Unrealized gain on marketable securities ................ -- -- 85 -- 85
Net loss ................................................ -- -- -- (44,274) (44,274)
------- ----- --- --------- --------
Balances, December 31, 1998 ............................... $(1,277) $(120) $88 $(116,766) $ 67,114
======= ===== === ========= ========
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE> 60
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1997 1998
-------- -------- ---------
(RESTATED) (RESTATED)
<S> <C> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net loss ................................................................... $(19,249) $(38,864) $ (44,274)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization ........................................ 1,190 2,391 3,600
Amortization of intangible assets and deferred compensation .......... 1,289 2,500 2,745
Purchased research and development ................................... -- 2,399 --
Loss (gain) on disposition of assets ................................. 60 (132) 2
Interest receivable on stock subscription ............................ (8) (10) (13)
Increase (decrease) in accrued pension liability ..................... 62 (14) (37)
Changes in operating assets and liabilities:
Accounts receivable, net .......................................... (1,028) (3,142) (1,177)
Inventories, net .................................................. (445) (2,951) (1,608)
Other assets ...................................................... (87) (950) 406
Contract receivable ............................................... 500 -- --
Accounts payable .................................................. 979 3,111 1,189
Accrued liabilities ............................................... 235 1,707 896
Deferred revenue .................................................. 987 (1,129) 502
Other ............................................................. 141 23 (352)
-------- -------- ---------
Net cash used in operating activities ........................... (15,374) (35,061) (38,121)
-------- -------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of businesses, net of cash acquired ........................... (478) (2,714) --
Cash deposited in restricted cash account
related to Bloxham Acquisition ......................................... -- (238) --
Additions to intangible assets ............................................. (203) (157) (549)
Purchase of marketable securities .......................................... (31,243) (18,718) (123,842)
Purchase of restricted marketable securities ............................... (1,219) -- --
Proceeds from sale of marketable securities ................................ 14,152 18,342 96,248
Proceeds from disposition of property and equipment ........................ -- 343 --
Purchases of property and equipment ........................................ (5,289) (6,248) (6,470)
-------- -------- ---------
Net cash used in investing activities ........................... (24,280) (9,390) (34,613)
-------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock ..................................... 1,246 45,515 64,505
Proceeds from stock subscription receivable ................................ -- -- 51
Proceeds from borrowings ................................................... 3,718 5,528 10,171
Repayments of debt and capital lease obligations ........................... (1,529) (2,537) (6,804)
Proceeds from issuance of preferred stock .................................. 36,000 -- --
-------- -------- ---------
Net cash provided by financing activities ....................... 39,435 48,506 67,923
-------- -------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH ............................................. -- (6) 53
-------- -------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .................................... (219) 4,049 (4,758)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ........................................ 6,849 6,630 10,679
-------- -------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR .............................................. $ 6,630 $ 10,679 $ 5,921
======== ======== =========
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE> 61
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. ORGANIZATION AND BUSINESS
Heska Corporation ("Heska" or the "Company") is primarily focused on the
discovery, development and marketing of companion animal health products. In
addition to manufacturing certain of Heska's companion animal health products,
the Company's primary manufacturing subsidiary, Diamond Animal Health, Inc.
("Diamond"), also manufactures bovine vaccine products and pharmaceutical and
personal healthcare products which are marketed and distributed by third
parties. In addition to manufacturing veterinary allergy products for marketing
and sale by Heska, Heska's subsidiaries, Center Laboratories, Inc. ("Center")
and CMG-Heska Allergy Products S.A. ("CMG"), a Swiss corporation, also
manufacture and sell human allergy products. The Company also offers diagnostic
services to veterinarians at its Fort Collins, Colorado location and in the
United Kingdom through a wholly-owned subsidiary.
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. 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, a Food and Drug Administration ("FDA") and United States
Department of Agriculture ("USDA") licensed manufacturer of allergy
immunotherapy products located in Port Washington, New York, and internationally
through the acquisitions of Heska UK Limited ("Heska UK", formerly Bloxham
Laboratories Limited), a veterinary diagnostic laboratory in Teignmouth, England
and CMG (formerly Centre Medical des Grand'Places S.A.) in Fribourg,
Switzerland, which manufactures and markets allergy diagnostic products for use
in veterinary and human medicine, primarily in Europe. Each of the Company's
acquisitions during this period 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.
During the first quarter of 1998 the Company acquired Heska Waukesha
(formerly Sensor Devices, Inc.) a manufacturer and marketer of patient
monitoring devices used in both animal health and human applications. The
financial results of Heska Waukesha have been consolidated with those of the
Company under the pooling-of-interests accounting method for all periods
presented.
The Company has incurred net losses since its inception and anticipates
that it will continue to incur additional net losses in the near term as it
introduces new products, expands its sales and marketing capabilities and
continues its research and development activities. Cumulative net losses from
inception of the Company in 1988 through December 31, 1998 have totaled $116.8
million.
The Company's ability to achieve profitable operations will depend
primarily upon its ability to successfully market its products, commercialize
products that are currently under development, develop new products and
efficiently integrate acquired businesses. Most of the Company's products are
subject to long development and regulatory approval cycles and there can be no
guaranty that the Company will successfully develop, manufacture or market these
products. There can also be no guaranty that the Company will attain
profitability or, if achieved, will remain profitable on a quarterly or annual
basis in the future. Until the Company attains positive cash flow, the Company
may continue to finance operations with additional equity and debt financing.
There can be no guaranty that such financing will be available when required or
will be obtained under favorable terms.
F-7
<PAGE> 62
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 acquisitions when accounted for under the purchase method of accounting, and
for all periods presented when accounted for under the pooling-of-interests
method of accounting. 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 component of accumulated other
comprehensive income.
At December 31, 1997 these securities had an aggregate amortized cost of
$18.7 million, which approximated fair market value, a maximum maturity of
approximately three years and consisted entirely of U.S. government obligations.
At December 31, 1998 these securities had an aggregate amortized cost of $46.2
million, a maximum maturity of approximately ten years and consisted entirely of
U.S. government agency obligations. The fair market value of marketable
securities at December 31, 1998 was approximately $46.3 million. The unrealized
gain of approximately $85,000 has been recorded as a component of accumulated
comprehensive income within stockholders' equity. Marketable securities at
December 31, 1997 and 1998 included approximately $645,000 and $281,000 of
restricted investments held as collateral for capital leases (see Note 4) and
$18.1 million and $46.0 million of short-term marketable securities,
respectively.
Fair Value of Financial Instruments
The Company's financial instruments consist of cash and cash
equivalents, short-term trade receivables and payables, capital lease
obligations and long-term debt. The carrying values of cash and cash equivalents
and short-term trade receivables and payables approximate fair value. The fair
value of capital lease obligations and long-term debt is estimated based on
current rates available for similar debt with similar maturities and collateral,
and, at December 31, 1998 and 1997, approximate carrying value. Certain debts
assumed as a result of acquisitions were restated using imputed interest rates
at the dates of acquisition.
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.
F-8
<PAGE> 63
Inventories, net of provisions, consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1998
------- -------
(RESTATED)
<S> <C> <C>
Raw materials ................. $ 2,652 $ 3,271
Work in process ............... 3,567 5,338
Finished goods ................ 4,343 3,588
------- -------
$10,562 $12,197
------- -------
</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 primarily 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 1997 1998
-------------- -------- --------
(RESTATED)
<S> <C> <C> <C>
Land ............................................... N/A $ 291 $ 435
Buildings .......................................... 10 to 20 years 1,811 4,091
Machinery and equipment ............................ 3 to 15 years 15,462 20,431
Leasehold improvements ............................. 7 to 15 years 2,472 3,404
-------- --------
20,036 28,361
Less accumulated depreciation and amortization ..... (4,057) (7,135)
-------- --------
$ 15,979 $ 21,226
======== ========
</TABLE>
F-9
<PAGE> 64
Intangible assets consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
ESTIMATED -----------------------
USEFUL LIFE 1997 1998
-------------- ------- -------
(RESTATED)
<S> <C> <C> <C>
Take-or-pay contract ................... 37 months $ 3,873 $ 3,873
Customer lists and market presence ..... 7 years 2,848 2,848
Other intangible assets ................ 2 to 10 years 2,296 2,594
------- -------
9,017 9,315
Less accumulated amortization .......... (3,008) (5,004)
------- -------
$ 6,009 $ 4,311
======= =======
</TABLE>
The take-or-pay contract resulted from the acquisition of Diamond in
April 1996. The customer lists and market presence resulted from the Company's
1997 acquisitions. The remaining intangible assets resulted primarily from the
acquisitions of certain lines of business and assets in 1996, 1997 and 1998.
Revenue Recognition
Product revenues are recognized at the time goods are shipped to the
customer, or at the time services are performed, 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 of advance payments
received during the current year until research activities are performed or
development milestones are completed.
Cost of Sales
Royalties payable in connection with certain research, development and
licensing agreements (see Note 10) are reflected in cost of sales as incurred.
Unaudited Pro Forma Basic Net Loss Per Share
The Company has computed net loss per share in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 128, Earnings per Share, which
the Company adopted in 1997. Also, the Company has adopted the guidance of
Securities and Exchange Commission ("SEC") Staff Accounting Bulletin ("SAB") No.
98 and related interpretations. Due to the automatic conversion of all shares of
convertible preferred stock into common stock upon the closing of the Company's
initial public offering in July 1997 (the "IPO"), historical basic net loss per
common share for fiscal 1996 and 1997 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. The Company has assumed the
conversion of convertible preferred stock issued into common stock for all
periods presented.
Prior to the current period and pursuant to SEC SAB No. 83 rules, 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 ("SAB 83 Shares"), were included in the calculation of
basic weighted average number of shares of common stock as if they were
F-10
<PAGE> 65
outstanding for all periods presented (using the treasury stock method),
regardless of whether they were anti-dilutive. In February 1998 the SEC issued
SAB No. 98 which replaced SAB No. 83 in its entirety. As a result, SAB 83 Shares
which were originally included in the previously reported 1996 and 1997 weighted
average common shares outstanding have now been excluded in the restated 1996
and 1997 weighted average common shares outstanding. The effect of the adoption
of SAB No. 98 was as follows (per share amounts for 1996 and 1997 have been
restated to include the effects of the Heska Waukesha acquisition recorded under
the pooling-of-interests accounting method. See Note 3):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1996 1997
-------- --------
<S> <C> <C>
Pro forma basic net loss per share as reported (restated) ..... $ (1.40) $ (2.34)
Impact of adoption of SAB No. 98 .............................. (.13) (.08)
-------- --------
Unaudited pro forma basic net loss per share (restated) ....... $ (1.53) $ (2.42)
======== ========
</TABLE>
The following table shows the reconciliation of the numerators and
denominators of the basic net loss per share and unaudited 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
---------------------------------------------
(RESTATED)
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Weighted average common shares outstanding (actual) ..... N/A 1,426 N/A
Assumed conversion of preferred stock from original
date of issuance ................................... N/A 11,183 N/A
------
Unaudited pro forma basic net loss per share ............ $(19,249) 12,609 $ (1.53)
======== ====== ========
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
---------------------------------------------
(RESTATED)
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Weighted average common shares outstanding (actual) ..... N/A 10,172 N/A
Assumed conversion of preferred stock from original
date of issuance ................................... N/A 5,870 N/A
------
Unaudited pro forma basic net loss per share ............ $(38,864) 16,042 $ (2.42)
======== ====== ========
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1998
---------------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Weighted average common shares outstanding (actual) ..... N/A 24,693 N/A
------
Basic net loss per share ................................ $(44,274) 24,693 $ (1.79)
======== ====== ========
</TABLE>
N/A = not applicable
Foreign Currency Translation
The functional currencies of the Company's international subsidiaries
are the Pound Sterling ("Pound Sterling") for Heska UK and the Swiss Franc
("CHF") for all others. Assets and liabilities of the Company's international
subsidiaries are translated
F-11
<PAGE> 66
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 ACQUISITION
Acquisition of Heska Waukesha - In March 1998 the Company completed its
acquisition of all of the outstanding shares of Heska Waukesha, a manufacturer
and marketer of medical sensor products, in a transaction valued at
approximately $8.9 million using the pooling-of-interests accounting method. The
Company issued 639,622 shares of its common stock and also reserved an
additional 147,898 shares of its common stock for issuance in connection with
outstanding Heska Waukesha options that were assumed by the Company in the
merger. Accordingly, the consolidated financial statements of the Company have
been restated to include the accounts of Heska Waukesha for all periods
presented. There were no adjustments required to the net assets or previously
reported results of operations of the Company or Heska Waukesha as a result of
the adoption of the same accounting practices by the respective entities. The
following table shows the reconciliation of restating the accounts of the
Company resulting from the pooling-of-interests on previously reported financial
statements (in thousands):
<TABLE>
<CAPTION>
EFFECT OF
AS PREVIOUSLY POOLING-OF-
REPORTED INTERESTS RESTATED
------------- ----------- --------
<S> <C> <C> <C>
Total assets as of December 31, 1997 ..................... $ 65,248 $ 3,772 $ 69,020
Total stockholders' equity as of December 31, 1997 ....... 43,672 178 43,850
Total revenues:
For the year ended December 31, 1996 ................ 9,959 7,557 17,516
For the year ended December 31, 1997 ................ 20,877 8,426 29,303
Loss from operations:
For the year ended December 31, 1996 ................ (18,861) (1,109) (19,970)
For the year ended December 31, 1997 ................ (37,768) (1,394) (39,162)
Net loss:
For the year ended December 31, 1996 ................ (17,975) (1,274) (19,249)
For the year ended December 31, 1997 ................ (37,292) (1,572) (38,864)
</TABLE>
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, 1997 and 1998, the
Company had capitalized machinery and equipment under capital leases with a net
book value of approximately $3.1 million and $1.9 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 2003, 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 25% of the borrowed amount when the Company's
annual revenues reach $28.0 million. The lease also requires the Company to
maintain minimum levels of cash and cash equivalent balances throughout the
F-12
<PAGE> 67
term of the lease. As of December 31, 1997 and 1998, the Company was in
compliance with all covenants of the master lease and held restricted U.S.
Treasury Bonds of approximately $645,000 and $281,000 as additional collateral
under the lease, respectively.
The future annual minimum required payments under capital lease
obligations as of December 31,1998 were as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
- ------------
<S> <C>
1999 $ 702
2000 597
2001 543
2002 88
2003 26
-------
Total minimum lease payments 1,956
Less amount representing interest (265)
-------
Present value of net minimum lease payments 1,691
Less current portion (562)
-------
Total long-term capital lease obligations $ 1,129
=======
</TABLE>
5. RESTRUCTURING EXPENSES
In December 1998 the Company completed a cost reduction and
restructuring plan. The restructuring was based on the Company's determination
that, while revenues had been increasing steadily, management believed that
reducing expenses was necessary in order to accelerate the Company's efforts to
reach profitability. In connection with the restructuring, the Company
recognized a charge to operations in 1998 of approximately $2.4 million. These
expenses related to personnel severance costs for 69 individuals and costs
associated with excess facilities and equipment, primarily at the Company's Fort
Collins, Colorado location.
Shown below is a reconciliation of restructuring costs for the year
ended December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
PAYMENTS/CHARGES
THROUGH BALANCE AT
ORIGINAL DECEMBER 31, DECEMBER 31,
RESERVE 1998 1998
-------- ---------------- ------------
<S> <C> <C> <C>
Severance pay, benefits and relocation expenses ...... $1,723 $(630) $1,093
Noncancellable leased facility closure costs ......... 430 -- 430
Asset write-offs ..................................... 77 (77) --
Other ................................................ 126 (18) 108
------ ----- ------
Total .................................... $2,356 $(725) $1,631
====== ===== ======
</TABLE>
The balance of $1.6 million is included in accrued liabilities in the
accompanying balance sheet as of December 31, 1998.
F-13
<PAGE> 68
6. LONG-TERM DEBT AND NOTES PAYABLE
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1997 1998
-------- --------
(RESTATED)
<S> <C> <C>
Heska, Diamond, Center and Heska Waukesha obligations:
Equipment financing due in monthly installments through November 2001, and final
payments due March 2000 through January 2002, with stated interest rates
between 14.0% and 18.1%, secured by certain equipment and fixtures ............. $ 5,551 $ 6,957
Center obligations:
Promissory note to former owner of Center due in July 2000, with quarterly interest
payments at a stated interest rate of prime (8.5% and 7.75% at December 1997
and 1998, respectively) plus 0.75% ............................................. 3,464 3,464
Diamond obligations:
9.5% real estate mortgage to Hartford-Carlisle Bank, paid in full in September 1998 ... 201 --
9.2% term note to Iowa Business Growth, paid in full in September 1998 ................ 152 --
Promissory note to the Iowa Department of Economic Development ("IDED"), due in annual
installments through June 2004, with $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 ..................................................... 183 175
Promissory note to the City of Des Moines, due in monthly installments through May
2004, with a stated interest rate of 3% and a 9.5% imputed interest rate, net .. 112 97
10.0% promissory notes, paid in full in September 1998 ................................ 348 --
Unsecured promissory note to customer, forgiven in July 1998 .......................... 407 --
$2,000 commercial bank line of credit, due September 1999, with monthly interest
payments at prime (7.75% at December 1998) plus 1.75% .......................... 667 1,749
Real estate mortgage to Norwest Business Credit, Inc., due in monthly installments
through September 2003, with a stated interest rate of prime (7.75% at December
1998) plus 1.75% ............................................................... -- 1,520
Heska Waukesha obligations:
$800 commercial bank line of credit, due November 1999, with monthly interest payments
at prime (7.75% at December 1998) plus 1.75% ................................... 750 800
Note payable to bank, guaranteed by the Small Business Administration ("SBA"), due in
monthly installments through November 2001, with a stated interest rate of prime
(7.75% at December 1998) plus 1.75% ............................................ 426 350
Note payable to the State of Wisconsin, due in monthly installments through January
2000, with a stated interest rate of 5% ........................................ 71 50
Unsecured note payable, due in monthly installments, with no stated interest rate ..... 44 44
Heska obligations:
Promissory notes to former Heska UK stockholders due in semi-annual interest payments
through February 2007, due on demand in whole or in part at any time together
with accrued interest, with a stated interest rate of 4.5%, denominated in
pounds sterling ................................................................ 329 262
Heska UK obligations:
Commercial bank loan, due in monthly principal payments and quarterly interest payments
through December 2006, with a stated interest rate of a bank's base rate (7.25%
and 7.75% at December 1997 and 1998, respectively) plus 2.75%, denominated in
pounds sterling ................................................................ 117 142
Pound Sterling725 commercial bank line of credit, due February 1999, with semi-annual
interest payments, with a stated interest rate of LIBOR (5.1% at December 1998)
plus 4.0% ...................................................................... 165 1,153
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 .......... 171 341
-------- --------
13,158 17,104
Less installments due within one year ..................................................... (4,137) (6,942)
-------- --------
$ 9,021 $ 10,162
======== ========
</TABLE>
F-14
<PAGE> 69
The IDED and City of Des Moines 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 Heska Waukesha line of credit and SBA and State of Wisconsin loans
are secured by a first security interest in essentially all assets of Heska
Waukesha except assets acquired through capital leases and are included as
cross-collateralized obligations by the respective lenders. These obligations,
along with the unsecured note payable, were assumed as a result of the
acquisition of Heska Waukesha in March 1998.
One of the Company's Swiss subsidiaries also has a CHF250,000 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, 1998.
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, 1998, the Company was in compliance with all
covenants of the debt agreements.
Maturities of long-term debt and notes payable as of December 31, 1998
were as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
- ------------
<S> <C>
1999 $ 6,942
2000 6,526
2001 1,685
2002 722
2003 404
Thereafter 825
-------
$17,104
=======
</TABLE>
7. 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.
F-15
<PAGE> 70
The following table sets forth the plan's funded status and amounts
recognized in the accompanying balance sheets (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
------- -------
<S> <C> <C>
Change in benefit obligation:
Benefit obligation, beginning .............. $ 1,089 $ 1,117
Service cost ............................... -- --
Interest cost .............................. 75 76
Actuarial loss ............................. 7 2
Benefits paid .............................. (54) (69)
------- -------
Benefit obligation, ending ................. 1,117 1,126
------- -------
Change in plan assets:
Fair value of plan assets, beginning ....... 962 1,004
Actual return on plan assets ............... 96 115
Employer contribution ...................... -- --
Benefits paid .............................. (54) (69)
------- -------
Fair value of plan assets, ending .......... 1,004 1,050
------- -------
Funded status .................................... (113) (76)
Unrecognized net actuarial loss .................. 190 150
------- -------
Prepaid benefit cost ............................. $ 77 $ 74
======= =======
Additional minimum liability disclosures:
Accrued benefit liability .................. $ (113) $ (76)
------- -------
Components of net periodic benefit costs:
Service cost ............................... $ -- $ --
Interest cost .............................. 74 76
Expected return on plan assets ............. (72) (75)
Recognized net actuarial loss .............. 4 3
------- -------
Net periodic benefit cost .................. $ 6 $ 4
======= =======
</TABLE>
Assumptions used by Diamond in the determination of the pension plan
information consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
------- -------
<S> <C> <C>
Discount rate .......................................... 7.00% 7.00%
Expected long-term rate of return on plan assets ....... 7.75% 7.75%
</TABLE>
8. INCOME TAXES
The Company accounts for income taxes under the provisions SFAS No. 109,
Accounting for Income Taxes. As of December 31, 1998 the Company had
approximately $94.5 million of net operating loss ("NOL") carryforwards for
income tax purposes and approximately $2.3 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
F-16
<PAGE> 71
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. In addition, the Company believes that its
follow-on public offering of common stock in March 1998 resulted in a further
"change of ownership." This limitation will total approximately $12.5 million
per year for periods subsequent to the follow-on offering. The Company believes
that these limitations may 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,
1997 CHANGES 1998
------------ -------- ------------
(RESTATED)
<S> <C> <C> <C>
Deferred tax assets:
Research and development credits ........ $ 1,148 $ 1,170 $ 2,318
Inventory valuation and reserves ........ 222 566 788
Deferred revenue ........................ 38 81 119
Pension liability ....................... 43 (14) 29
Accrued compensation .................... 128 (7) 121
Amortization of intangible assets ....... 218 97 315
Loss on assets held for sale ............ -- 492 492
Restructuring reserve ................... -- 624 624
Other ................................... 53 11 64
Net operating loss carryforwards ........ 23,679 12,475 36,154
-------- -------- --------
25,529 15,495 41,024
Less valuation allowance ................ (24,826) (15,644) (40,470)
-------- -------- --------
703 (149) 554
-------- -------- --------
Deferred tax liability:
Property and equipment .................. (703) 149 (554)
-------- -------- --------
(703) 149 (554)
-------- -------- --------
Net deferred taxes ............... $ -- $ -- $ --
======== ======== ========
</TABLE>
9. 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.
F-17
<PAGE> 72
In exchange for the above, Bayer agreed to provide research funding to
the Company, of which $500,000 was received in 1996, $550,000 in 1997 and $1.1
million in 1998. The Company expects to receive periodic research payments until
December 1999 as the related expenses are incurred and specified milestones are
reached. In connection with this contract, the Company recognized research
revenue of $1.3 million, $1.2 million and $850,000 for the years ended December
31, 1996, 1997 and 1998, 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. No revenue
was recognized for the years ended December 31, 1996, 1997 or 1998. 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 and $460,000 for the years ended
December 31, 1997 and 1998, respectively. 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>
1999 .......................... $ 925
2000 .......................... 600
------
$1,525
======
</TABLE>
10. COMMITMENTS AND CONTINGENCIES
The Company holds certain rights to market and manufacture all products
developed or created under certain research, development and licensing
agreements with various entities. In connection with such agreements, the
Company has agreed to pay the entities royalties on net product sales. In the
years ended December 31, 1997 and 1998, $15,000 and $52,000 in royalties became
payable under these agreements, respectively.
In connection with an equity investment by a pharmaceutical firm in
April 1996 (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.
F-18
<PAGE> 73
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, 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, with sales commission rates which vary from 20% to 25%.
The agreement expires in December 2002.
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, 1998 as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
- ------------
<S> <C>
1999 ........................... $1,490
2000 ........................... 1,300
2001 ........................... 1,143
2002 ........................... 1,100
2003 ........................... 869
899
------
Thereafter.................. $6,801
======
</TABLE>
The Company had rent expense of $642,000, $1.4 million and $1.4 million
in 1996, 1997 and 1998, respectively.
11. CAPITAL STOCK
Common Stock
In July 1998, the Company issued 1.165 million shares of the Company's
common stock to Ralston Purina Company ("Ralston Purina"), for $14.75 million in
cash, and also issued, for an additional cash payment of $250,000, warrants to
purchase an additional 1.165 million shares of the Company's common stock. The
exercise price of the warrants is $12.67 for the first year of the warrants,
increasing by 20% per year for each of the second and third years of the
warrants. The warrants were exercisable immediately as of July 30, 1998 and
expire in three years with respect to any unexercised shares.
In July 1998, the Company issued 205,619 shares of common stock to Bayer
Corporation ("Bayer") in consideration for the acquisition by Diamond of certain
assets, including land and buildings formerly leased by Diamond from Bayer, and
as repayment in full of certain indebtedness of Diamond to Bayer, in a
transaction valued at approximately $2.3 million.
In March 1998, the Company completed its follow-on public offering of
5,750,000 shares of common stock (including 500,000 shares offered by a
stockholder of the Company and an underwriters' over-allotment option exercised
F-19
<PAGE> 74
for 750,000 shares) at a price of $9.875 per share, providing the Company with
net proceeds of approximately $48.6 million.
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.
The Company has granted stock purchase rights to acquire 322,000 shares
of common stock to key executives and Directors pursuant to the 1994 Key
Executive Stock Plan. As of December 31, 1998, 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 exercise. The notes mature in six years,
bear interest at 7.5% and are secured by a pledge of the underlying shares of
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, 1997 and 1998, 250,834 and 310,520 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. However, options granted and unexercised
under the prior plans are still outstanding. All shares remaining available for
grant under the terminated plans were rolled into the 1997 Plan. In addition,
all shares which are subsequently cancelled under the prior plans are rolled
into the 1997 Plan on a quarterly basis. The number of shares reserved for
issuance under the 1997 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 under all plans as of January 1, 1999 was
5,291,283.
The stock options granted by the board of directors may be either
incentive stock options ("ISOs") or nonstatutory stock options ("NSOs"). The
purchase price for options under all of the plans 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.
SFAS 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 1996, 1997
and 1998, using the Black-Scholes pricing model and the following weighted
average assumptions:
F-20
<PAGE> 75
<TABLE>
<CAPTION>
1996 1997 1998
---------- ---------- ---------
<S> <C> <C> <C>
Risk-free interest rate 6.12% 6.49% 5.28%
Expected lives 3.11 years 4.93 years 3.8 years
Expected volatility 80% 72% 89%
Expected dividend yield 0% 0% 0%
</TABLE>
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 six months to one and one half years
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 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 was used for 1997 and 1998 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, $5.0 million and $8.8 million for the years ended December 31,
1996, 1997 and 1998, 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, $1.8 million and $3.9 million for 1996,
1997 and 1998, respectively.
A summary of the Company's stock option plans is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1997 1998
----------------------------- -----------------------------
(RESTATED)
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
--------- -------- --------- --------
<S> <C> <C> <C> <C>
Outstanding at beginning of period ....... 2,008,942 $ 0.6814 2,570,533 $ 1.9053
Granted ............................. 1,060,196 $ 4.1842 1,304,443 $10.6166
Cancelled ........................... (100,265) $ 1.7630 (315,543) $ 5.9544
Exercised ........................... (398,340) $ 0.3579 (350,116) $ 1.2188
--------- ---------
Outstanding at end of period ............. 2,570,533 $ 1.9053 3,209,317 $ 5.1204
========= =========
Exercisable at end of period ............. 1,077,284 $ 0.9760 1,531,895 $ 2.9417
========= =========
</TABLE>
The weighted average exercise prices and weighted average estimated fair
value of options granted during the years ended December 31, 1997 and 1998 were
as follows:
F-21
<PAGE> 76
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
1997 1998
----------------------------------- -----------------------------------
(RESTATED)
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
NUMBER AVERAGE AVERAGE NUMBER AVERAGE AVERAGE
OF ESTIMATED EXERCISE OF ESTIMATED EXERCISE
OPTIONS FAIR VALUE PRICE OPTIONS FAIR VALUE PRICE
--------- ---------- --------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Exercise price equal to estimated fair value ... 167,400 $ 5.4622 $ 9.3684 1,304,443 $ 6.7635 $ 10.6166
Exercise price less than estimated fair value... 892,796 $ 3.8469 $ 3.2122 -0- -0- -0-
--------- --------- --------- --------- --------- ---------
1,060,196 $ 4.1019 $ 4.1842 1,304,443 $ 6.7635 $ 10.6166
========= ========= ========= ========= ========= =========
</TABLE>
The Company recorded deferred compensation (as calculated under APB 25)
of $933,000 and $1.5 million during the years ended December 31, 1996 and 1997,
respectively, representing the difference between the deemed value of the common
stock for accounting purposes and the exercise price of such options at the date
of grant. In 1998 the Company also granted stock options to non-employees in
exchange for consulting services, recording deferred compensation of $46,000
based on the estimated fair value of the options at the date of grant. Deferred
compensation is being amortized over the applicable vesting periods. The
amortization of deferred compensation resulted in a non-cash charge to
operations of $188,000, $645,000 and $736,000 in the years ended December 31,
1996, 1997 and 1998, respectively.
The following table summarizes information about stock options
outstanding and exercisable at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------- ------------------------------
NUMBER OF
OPTIONS WEIGHTED NUMBER OF
OUTSTANDING AVERAGE WEIGHTED OPTIONS WEIGHTED
AT REMAINING AVERAGE EXERCISABLE AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE AT DECEMBER 31, EXERCISE
EXERCISE PRICES 1998 LIFE IN YEARS PRICE 1998 PRICE
--------------- ------------ ------------- -------- --------------- --------
<S> <C> <C> <C> <C> <C>
$ 0.15 - $ 0.25 ....... 176,192 3.59 $ 0.2032 176,192 $ 0.2032
$ 0.35 ................ 460,109 6.45 $ 0.3500 376,122 $ 0.3500
$ 1.20 - $ 1.50 ....... 935,995 8.30 $ 1.2259 565,095 $ 1.2429
$ 2.50 - $ 5.25 ....... 491,867 9.20 $ 4.4111 138,895 $ 3.7187
$ 7.62 - $11.75 ....... 409,305 9.22 $ 9.9710 87,383 $ 9.8143
$11.88 ................ 652,747 9.05 $11.8800 162,524 $11.8800
$12.50 - $15.00 ....... 83,102 9.17 $13.0348 25,684 $12.9096
--------- ---------
$ 0.15 - $15.00 ....... 3,209,317 8.21 $ 5.1204 1,531,895 $ 2.9417
========= =========
</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 are expected to work at least 20 hours per
week and five months per year 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 and 1998, using the Black-Scholes pricing model and the following
weighted average assumptions:
F-22
<PAGE> 77
<TABLE>
<CAPTION>
1997 1998
------- -------
<S> <C> <C>
Risk-free interest rate ....... 5.69% 5.01%
Expected lives ................ 2 years 2 years
Expected volatility ........... 72% 89%
Expected dividend yield ....... 0% 0%
</TABLE>
The total fair value of stock sold under the ESPP was computed to be
approximately $103,000 and $268,000 for the years ended December 31, 1997 and
1998, with a weighted-average fair value of the purchase rights granted of $4.73
and $4.57 per share, respectively. Pro forma stock-based compensation, net of
the effect of forfeitures, was approximately $103,000 and $268,000 in 1997 and
1998, respectively, for the ESPP.
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,
-------------------------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Net loss: (RESTATED) (RESTATED)
As reported .................................................... $ (19,429) $ (38,864) $ (44,274)
=========== =========== ===========
Pro forma (unaudited) .......................................... $ (19,796) $ (40,767) $ (48,442)
=========== =========== ===========
Basic net loss per share:
As reported (unaudited pro forma basic net loss per share
for 1996 and 1997) ......................................... $ (1.53) $ (2.42) $ (1.79)
=========== =========== ===========
Pro forma (unaudited) .......................................... $ (1.57) $ (2.54) $ (1.96)
=========== =========== ===========
</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. 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. In April 1998, the Company issued 4,912 shares of common stock in
exchange for the warrant for 6,225 shares at an exercise price of $3.25 per
share in a cashless "net" exercise. The remaining warrants expire on December
30, 2002 and October 20, 2003, respectively. In July 1998, the Company issued
warrants to purchase 1.165 million shares of the Company's common stock in
connection with the private placement with Ralston Purina described previously.
The exercise price of the warrants is $12.67 for the first year of the warrants,
increasing by 20% per year for each of the second and third years of the
warrants. The warrants were exercisable immediately as of July 30, 1998 and
expire in three years with respect to any unexercised shares. No warrants other
than those described above had been exercised as of December 31, 1998.
12. MAJOR CUSTOMERS
The Company had sales of greater than 10% of total revenue to only one
customer during the years ended December 31, 1996, 1997 and 1998. This customer,
which represented 36%, 21% and 15% of total revenues, respectively, purchases
vaccines from Diamond.
F-23
<PAGE> 78
13. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1997 1998
------ ------ ------
(RESTATED) (RESTATED)
(IN THOUSANDS)
<S> <C> <C> <C>
Cash paid for interest ............................................................... $ 496 $1,274 $1,999
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 acquisitions, net of
cash acquired ................................................................ -- 3,892 --
Issuance of common stock in exchange for assets and as repayment of debt .......... -- -- 2,262
Reduction in future payment on debt to customer in exchange
for the granting of certain rights ........................................... 1,250 -- --
Purchase of assets under direct capital lease financing ........................... -- 894 86
</TABLE>
14. SEGMENT REPORTING
During 1998, the Company adopted the provisions of SFAS No. 131,
Disclosures About Segments of an Enterprise, which changes the way the Company
reports information about its operating segments. The information for 1997 has
been restated from the prior year's presentation in order to conform to the 1998
presentation.
The Company's divides its operations into two reportable segments,
Animal Health, which includes the operations of Heska, Diamond, Heska Waukesha,
Heska UK and Heska AG, and Allergy Diagnostics and Treatment, which includes the
operations of Center and CMG.
Summarized financial information concerning the Company's reportable
segments is shown in the following table (in thousands). The "Other" column
includes the elimination of intercompany transactions and other items as noted.
<TABLE>
<CAPTION>
ALLERGY
ANIMAL DIAGNOSTICS AND
HEALTH TREATMENT OTHER TOTAL
--------- --------------- ------------ --------
<S> <C> <C> <C> <C>
1998:
Revenues .......................... $ 35,755 $ 8,479 $ (4,462) $ 39,772
Operating loss .................... (38,768) (1,014) (6,174)(a) (45,956)
Total assets ...................... 123,965 7,495 (33,406) 98,054
Capital expenditures .............. 5,936 868 -- 6,804
Depreciation and amortization ..... 3,235 365 -- 3,600
</TABLE>
- --------
(a) Includes the write-down of certain tangible and intangible
assets to their expected net realizable values, resulting from a loss on assets
held for sale of $1.3 million, restructuring expenses of $2.4 million (see Note
5) and inventory write-downs of $1.5 million.
F-24
<PAGE> 79
<TABLE>
<CAPTION>
ALLERGY
ANIMAL DIAGNOSTICS AND
HEALTH TREATMENT OTHER TOTAL
-------- --------------- -------- --------
<S> <C> <C> <C> <C>
1997:
Revenues .......................... $ 29,465 $ 3,273 $ (3,435) $ 29,303
Operating loss .................... (38,825) (284) (53) (39,162)
Total assets ...................... 82,105 8,670 (21,755) 69,020
Capital expenditures .............. 6,158 90 -- 6,248
Depreciation and amortization ..... 2,230 161 -- 2,391
1996:
Revenues .......................... $ 18,582 $ -- $ (1,066) $ 17,516
Operating loss .................... (19,970) -- -- (19,970)
Total assets ...................... 55,335 -- (9,684) 45,651
Capital expenditures .............. 5,289 -- -- 5,289
Depreciation and amortization ..... 1,190 -- -- 1,190
</TABLE>
The Company manufactures and markets its products in two major
geographic areas, North America and Europe. The Company's three primary
manufacturing facilities are located in North America. Revenues earned in North
America are attributable to Heska, Diamond, Heska Waukesha and Center. Revenues
earned in Europe are primarily attributable to Heska UK, CMG and Heska AG. There
have been no significant exports from North America or Europe.
In 1997 and 1998, European subsidiaries purchased products from North
America for sale to European customers. Transfer prices to international
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 international subsidiaries, nor international
revenues. Certain information by geographic area is shown in the following table
(in thousands). The "Other" column includes the elimination of intercompany
transactions.
<TABLE>
<CAPTION>
NORTH AMERICA EUROPE OTHER TOTAL
------------- ------- -------- --------
<S> <C> <C> <C> <C>
1998:
Revenues ......................... $ 40,573 $ 3,661 $ (4,462) $ 39,772
Operating loss ................... (37,386) (2,396) (6,174) (45,956)
Total assets ..................... 127,003 4,457 (33,406) 98,054
Capital expenditures ............. 6,524 280 -- 6,804
Depreciation and amortization .... 3,009 591 -- 3,600
1997:
Revenues ......................... $ 30,513 $ 2,225 $ (3,435) $ 29,303
Operating loss ................... (38,325) (784) (53) (39,162)
Total assets ..................... 86,262 4,513 (21,755) 69,020
Capital expenditures ............. 6,113 135 -- 6,248
Depreciation and amortization .... 2,254 137 -- 2,391
1996:
Revenues ......................... $ 18,582 $ -- $ (1,066) $ 17,516
Operating loss ................... (19,970) -- -- (19,970)
Total assets ..................... 55,335 -- (9,684) 45,651
Capital expenditures ............. 5,289 -- -- 5,289
Depreciation and amortization .... 1,190 -- -- 1,190
</TABLE>
15. RECENT ACCOUNTING PRONOUNCEMENTS
During 1998, the Company adopted the provisions of a new accounting
standard, American Institute of Certified Public Accountants ("AICPA") Statement
of Position ("SOP") No. 98-5, Reporting on the Costs of Start-up Activities,
F-25
<PAGE> 80
which requires that start-up costs, including organization costs, be expensed as
incurred rather than capitalized. The adoption of this Statement has had no
effect on the Company's reported results of operations.
During 1998, the Company adopted the provisions of SFAS No. 130,
Reporting Comprehensive Income. The Statement establishes standards for
reporting comprehensive income and its components in financial statements.
Comprehensive income, as defined, includes all changes in equity (net assets)
during a period from non-owner sources. The Company has reported comprehensive
income (loss) in the accompanying consolidated statements of stockholders'
equity, and statements of operations and comprehensive loss.
During 1998, the Company adopted the provisions SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities. The Statement establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at fair
value. The Statement requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedging criteria are met. The
adoption of this Statement has had no effect on the Company's reported earnings
or comprehensive income.
The AICPA has also issued SOP No. 98-1, Software for Internal Use, which
provides guidance on accounting for the cost of computer software developed or
obtained for internal use. SOP No. 98-1 is effective for financial statements
for fiscal years beginning after December 15, 1998. The Company does not expect
that the adoption of SOP No. 98-1 will have a material impact on its financial
statements.
F-26
<PAGE> 81
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................................. $ 7,202 $ 5,921
Marketable securities ..................................................... 13,257 46,009
Accounts receivable, net .................................................. 8,679 6,659
Inventories, net .......................................................... 17,104 12,197
Other current assets ...................................................... 1,140 734
--------- ---------
Total current assets .............................................. 47,382 71,520
--------- ---------
Property and equipment, net ............................................................ 21,411 21,226
Intangible assets, net ................................................................. 2,785 4,311
Restricted marketable securities and other assets ...................................... 1,597 997
--------- ---------
Total assets ..................................................... $ 73,175 $ 98,054
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................................... $ 7,717 $ 7,542
Accrued liabilities ....................................................... 4,002 3,871
Deferred revenue .......................................................... 1,621 656
Current portion of capital lease obligations .............................. 577 562
Current portion of long-term debt ......................................... 6,713 6,942
--------- ---------
Total current liabilities ........................................ 20,630 19,573
Capital lease obligations, less current portion ........................................ 832 1,129
Long-term debt, less current portion ................................................... 7,085 10,162
Accrued pension liability .............................................................. 76 76
--------- ---------
Total liabilities ............................................... 28,623 30,940
--------- ---------
Commitments and contingencies
Stockholders' equity:
Preferred Stock, $.001 par value, 25,000,000 shares authorized; none
outstanding ..........................................................
Common stock, $.001 par value, 40,000,000 shares authorized; 26,861,658
and 26,458,424 shares issued and outstanding, respectively ........... 27 26
Additional paid-in capital ................................................ 185,621 185,163
Deferred compensation ..................................................... (798) (1,277)
Stock subscription receivable from officers ............................... (123) (120)
Accumulated other comprehensive income (loss) ............................. (272) 88
Accumulated deficit ....................................................... (139,903) (116,766)
--------- ---------
Total stockholders' equity ........................................... 44,552 67,114
--------- ---------
Total liabilities and stockholders' equity ........................... $ 73,175 $ 98,054
========= =========
</TABLE>
See accompanying notes to consolidated financial statements
F-27
<PAGE> 82
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Products, net .................................... $ 12,915 $ 9,823 $ 36,478 $ 26,313
Research and development ......................... 152 38 518 677
-------- -------- -------- --------
13,067 9,861 36,996 26,990
Costs and operating expenses:
Cost of goods sold ............................... 8,702 8,034 24,697 19,596
Research and development ......................... 3,942 6,311 12,477 18,991
Selling and marketing ............................ 3,736 3,159 10,548 9,117
General and administrative ....................... 2,804 3,065 8,253 8,891
Amortization of intangible assets
and deferred compensation ................... 276 650 1,960 2,087
Restructuring expense ............................ 1,210 -- 1,210 --
-------- -------- -------- --------
20,670 21,219 59,145 58,682
-------- -------- -------- --------
Loss from operations ................................ (7,603) (11,358) (22,149) (31,692)
Other income (expense):
Interest income .................................. 327 879 1,319 2,351
Interest expense ................................. (409) (521) (1,418) (1,459)
Other, net ....................................... (638) 147 (889) 175
-------- -------- -------- --------
Net loss ............................................ (8,323) (10,853) (23,137) (30,625)
-------- -------- -------- --------
Other comprehensive income (loss):
Foreign currency translation adjustments ......... 30 (5) (52) (24)
Unrealized loss on marketable securities ......... 371 523 (220) 523
-------- -------- -------- --------
Other comprehensive income (loss) ................... 401 518 (272) 499
-------- -------- -------- --------
Comprehensive loss .................................. $ (7,922) $(10,335) $(23,409) $(30,126)
======== ======== ======== ========
Basic net loss per share ............................ $ (0.31) $ (0.42) $ (0.87) $ (1.27)
======== ======== ======== ========
Shares used to compute basic net loss per share ..... 26,845 26,023 26,717 24,077
</TABLE>
See accompanying notes to consolidated financial statements
F-28
<PAGE> 83
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1999 1998
-------- ---------
<S> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net cash used in operating activities ........................ $(25,247) $ (29,875)
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to intangible assets ................................. -- (700)
Purchase of marketable securities ..................................... (5,975) (116,062)
Proceeds from sale of marketable securities ........................... 38,425 80,363
Proceeds from disposition of property and equipment ................... 262 --
Purchases of property and equipment ................................... (3,185) (4,785)
-------- ---------
Net cash provided by (used in) investing activities .......... 29,527 (41,184)
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock ................................ 459 64,642
Proceeds from borrowings .............................................. 1,962 8,068
Repayments of debt and capital lease obligations ...................... (5,257) (5,758)
-------- ---------
Net cash provided by (used in) financing activities ... (2,836) 66,952
-------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH ............................................ (163) 2
-------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ................................... 1,281 (4,105)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ..................................... 5,921 10,679
-------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD ........................................... $ 7,202 $ 6,574
======== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest ............................................................. $ 1,418 $ 1,459
Non-cash investing and financing activities:
Issuance of common and preferred stock related to acquisitions,
net of cash acquired ...................................................... -- 7,191
Issuance of common stock in exchange for assets and as repayment of debt ........ -- 2,262
Purchase of assets under direct capital lease financing ......................... 166 84
</TABLE>
See accompanying notes to consolidated financial statements
F-29
<PAGE> 84
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
1. ORGANIZATION AND BUSINESS
Heska Corporation ("Heska" or the "Company") is primarily focused on the
discovery, development and marketing of companion animal health products. In
addition to manufacturing certain of Heska's companion animal health products,
the Company's primary manufacturing subsidiary, Diamond Animal Health, Inc.
("Diamond"), also manufactures animal health vaccine products which are marketed
and distributed by third parties. In addition to manufacturing veterinary
allergy products for marketing and sale by Heska, Heska's subsidiaries, Center
Laboratories, Inc. ("Center") and CMG-Heska Allergy Products S.A. ("CMG"), a
Swiss corporation, also manufacture and sell human allergy products. The Company
also offers diagnostic services to veterinarians at its Fort Collins, Colorado
location and in the United Kingdom through a wholly owned subsidiary.
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. 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
expanded in the United States through the acquisition of Center, a Food and Drug
Administration ("FDA") and United States Department of Agriculture ("USDA")
licensed manufacturer of allergy immunotherapy products located in Port
Washington, New York, and internationally through the acquisitions of Heska UK
Limited ("Heska UK", formerly Bloxham Laboratories Limited), a veterinary
diagnostic laboratory in Teignmouth, England and CMG (formerly Centre Medical
des Grand' Places S.A.) in Fribourg, Switzerland, which manufactures and markets
allergy diagnostic products for use in veterinary and human medicine, primarily
in Europe. Each of the Company's acquisitions during this period 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.
During the first quarter of 1998 the Company acquired Heska Waukesha
(formerly Sensor Devices, Inc.), a manufacturer and marketer of patient
monitoring devices. The financial results of Heska Waukesha have been
consolidated with those of the Company under the pooling-of-interests accounting
method for all periods presented.
The Company has incurred net losses since its inception and anticipates
that it will continue to incur additional net losses in the near term as it
introduces new products, expands its sales and marketing capabilities and
continues its research and development activities. Cumulative net losses from
inception of the Company in 1988 through September 30, 1999 have totaled $139.9
million.
The Company's ability to achieve profitability will depend primarily
upon its ability to successfully market its products, commercialize products
that are currently under development, develop new products and efficiently
integrate acquired businesses. Most of the Company's products are subject to
long development and regulatory approval cycles and there can be no guaranty
that the Company will successfully develop, manufacture or market these
products. There can also be no guaranty that the Company will attain
profitability or, if achieved, will remain profitable on a quarterly or annual
basis in the future. Until the Company attains positive cash flow, the Company
may continue to finance operations
F-30
<PAGE> 85
with additional equity and debt financing. See Note 7 to Consolidated Financial
Statements. 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 unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. The balance sheet as of September 30, 1999, the
statements of operations and comprehensive loss for the three and nine months
ended September 30, 1999 and 1998 and the statements of cash flows for the nine
months ended September 30, 1999 and 1998 are unaudited, but include, in the
opinion of management, all adjustments (consisting of normal recurring
adjustments) which the Company considers necessary for a fair presentation of
its financial position, operating results and cash flows for the periods
presented. The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries since the dates of their respective
acquisitions when accounted for under the purchase method of accounting, and for
all periods presented when accounted for under the pooling-of-interests method
of accounting. All material intercompany transactions and balances have been
eliminated in consolidation. Although the Company believes that the disclosures
in these financial statements are adequate to make the information presented not
misleading, certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission.
Results for any interim period are not necessarily indicative of results
for any future interim period or for the entire year. The accompanying financial
statements and related disclosures have been prepared with the presumption that
users of the interim financial information have read or have access to the
audited financial statements for the preceding fiscal year. Accordingly, these
financial statements should be read in conjunction with the audited financial
statements and the related notes thereto for the year ended December 31, 1998,
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission on March 29, 1999.
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.
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>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(UNAUDITED)
<S> <C> <C>
Raw materials ........... $ 3,581 $ 3,271
Work in process ......... 8,545 5,338
Finished goods .......... 4,978 3,588
------- -------
$17,104 $12,197
======= =======
</TABLE>
F-31
<PAGE> 86
Revenue Recognition
Product revenues are recognized at the time goods are shipped to the
customer, or at the time services are performed, 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 of advance payments
received during the current year until research activities are performed or
development milestones are completed.
Basic Net Loss Per Share
The Company has computed basic net loss per share in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings per
Share, which the Company adopted in 1997.
3. RESTRUCTURING EXPENSES
In August 1999, the Company announced plans to consolidate its Heska
Waukesha operations with existing operations in Fort Collins, Colorado and Des
Moines, Iowa. This consolidation was based on the Company's determination that
significant operating efficiencies could be achieved through the combined
operations. During the third quarter ended September 30, 1999, the Company
recognized a charge to operations of approximately $1.2 million for this
consolidation. These expenses related primarily to personnel severance costs and
the costs associated with facilities being closed and, excess equipment,
primarily at the Company's Waukesha, Wisconsin location. No payments or charges
have been taken against this restructuring expense as of September 30, 1999.
In December 1998 the Company completed a cost reduction and
restructuring plan. The restructuring was based on the Company's determination
that, while revenues had been increasing steadily, reducing expenses was
necessary in order to accelerate the Company's efforts to reach profitability.
In connection with the restructuring, the Company recognized a charge to
operations in 1998 of approximately $2.4 million. These expenses related to
personnel severance costs and costs associated with excess facilities and
equipment, primarily at the Company's Fort Collins, Colorado location.
Shown below is a reconciliation of liabilities related to the
restructuring costs for the nine months ended September 30, 1999 (in thousands):
<TABLE>
<CAPTION>
PAYMENTS/CHARGES
BALANCE AT ADDITIONS FOR THE FOR THE NINE BALANCE AT
DECEMBER 31, NINE MONTHS ENDED MONTHS ENDED SEPTEMBER 30,
1998 SEPTEMBER 30, 1999 SEPTEMBER 30, 1999 1999
------------ ------------------ ------------------ -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Severance pay, benefits and relocation expenses ...... $ 1,093 $ 625 $ (998) $ 720
Noncancellable leased facility closure costs ......... 430 350 (203) 577
Other 108 235 (29) 314
--------- -------- --------- --------
Total .................................... $ 1,631 $ 1,210 $ (1,230) $ 1,611
========= ======== ========= ========
</TABLE>
A balance of $1.6 million for these charges is included in accrued
liabilities in the accompanying consolidated balance sheets as of September 30,
1999 and December 31, 1998, respectively.
F-32
<PAGE> 87
4. MAJOR CUSTOMERS
One customer accounted for 11% of total revenues during the three months
ended September 30, 1999. There were no customers who accounted for more than
10% of the Company's sales for the nine months ended September 30, 1999. The
Company had sales of greater than 10% of total revenue to only one customer
during the three months and nine months ended September 30, 1998. This customer,
who represented 16% of the Company's total revenues for the three months ended
September 30, 1998 and 15% of total revenues for the nine months ended September
30, 1998, purchased animal vaccines from the Company's wholly owned subsidiary,
Diamond.
5. SEGMENT REPORTING
During 1998, the Company adopted the provisions of SFAS No. 131,
Disclosures About Segments of an Enterprise, which changes the way the Company
reports information about its operating segments. The segment information for
1998 has been restated from the prior year's presentation in order to conform to
the 1999 presentation.
The Company divides its operations into two reportable segments, Animal
Health, which includes the operations of Heska, Diamond, Heska Waukesha, Heska
UK and Heska AG, and Allergy Diagnostics and Treatment, which includes the
operations of Center and CMG.
Summarized financial information concerning the Company's reportable
segments is shown in the following table (in thousands). The "Other" column
includes the elimination of intercompany transactions.
<TABLE>
<CAPTION>
ALLERGY
ANIMAL DIAGNOSTICS
HEALTH AND TREATMENT OTHER TOTAL
--------- ------------- -------- ---------
<S> <C> <C> <C> <C>
THREE MONTHS ENDED SEPTEMBER 30, 1999:
Revenues ............................ $ 12,161 $ 1,649 $ (743) $ 13,067
Operating loss ...................... (6,815) (44) (744) (7,603)
Total assets ........................ 110,732 7,818 (45,375) 73,175
Capital expenditures ................ 314 188 -- 502
Depreciation and amortization ....... 1,024 117 -- 1,141
THREE MONTHS ENDED SEPTEMBER 30, 1998:
Revenues ............................ $ 8,690 $ 2,050 $ (879) $ 9,861
Operating loss ...................... (11,248) (110) -- (11,358)
Total assets ........................ 132,615 7,449 (30,962) 109,102
Capital expenditures ................ 1,796 132 -- 1,928
Depreciation and amortization ....... 834 93 -- 927
</TABLE>
<TABLE>
<CAPTION>
ALLERGY
ANIMAL DIAGNOSTICS
HEALTH AND TREATMENT OTHER TOTAL
--------- ------------- -------- ---------
<S> <C> <C> <C> <C>
NINE MONTHS ENDED SEPTEMBER 30, 1999:
Revenues ............................ $ 34,230 $ 5,313 $ (2,547) $ 36,996
Operating loss ...................... (19,485) (116) (2,548) (22,149)
Capital expenditures ................ 2,689 496 -- 3,185
Depreciation and amortization ....... 2,660 385 -- 3,045
</TABLE>
F-33
<PAGE> 88
<TABLE>
<CAPTION>
ALLERGY
ANIMAL DIAGNOSTICS
HEALTH AND TREATMENT OTHER TOTAL
--------- ------------- -------- ---------
<S> <C> <C> <C> <C>
NINE MONTHS ENDED SEPTEMBER 30, 1998:
Revenues ............................ $ 24,258 $ 6,370 $ (3,638) $ 26,990
Operating loss ...................... (31,191) (751) 250 (31,692)
Capital expenditures ................ 4,057 728 -- 4,785
Depreciation and amortization ....... 2,354 281 -- 2,635
</TABLE>
The Company manufactures and markets its products in two major
geographic areas, North America and Europe. The Company's three primary
manufacturing facilities are located in North America. Revenues earned in North
America are attributable to Heska, Diamond, Heska Waukesha and Center. Revenues
earned in Europe are primarily attributable to Heska UK, CMG and Heska AG. There
have been no significant exports from North America or Europe.
In the nine months ended September 30, 1999 and 1998, European
subsidiaries purchased products from North America for sale to European
customers. Transfer prices to international subsidiaries are intended to allow
the North American companies and international subsidiaries to earn reasonable
profit margins. Certain information by geographic area is shown in the following
table (in thousands). The "Other" column includes the elimination of
intercompany transactions, including any sales by North American operations to
the European operations.
<TABLE>
<CAPTION>
NORTH
AMERICA EUROPE OTHER TOTAL
--------- ------- -------- ---------
<S> <C> <C> <C> <C>
THREE MONTHS ENDED SEPTEMBER 30, 1999:
Revenues ............................ $ 12,733 $ 1,077 $ (743) $ 13,067
Operating loss ...................... (6,975) (628) -- (7,603)
Total assets ........................ 114,122 4,427 (45,374) 73,175
Capital expenditures ................ 473 29 -- 502
Depreciation and amortization ....... 1,074 67 -- 1,141
THREE MONTHS ENDED SEPTEMBER 30, 1998:
Revenues ............................ $ 9,860 $ 880 $ (879) $ 9,861
Operating loss ...................... (10,753) (605) -- (11,358)
Total assets ........................ 135,606 4,458 (30,962) 109,102
Capital expenditures ................ 1,878 50 -- 1,928
Depreciation and amortization ....... 757 170 -- 927
</TABLE>
<TABLE>
<CAPTION>
NORTH
AMERICA EUROPE OTHER TOTAL
--------- ------- -------- ---------
<S> <C> <C> <C> <C>
NINE MONTHS ENDED SEPTEMBER 30, 1999:
Revenues ............................ $ 36,413 $ 3,129 $ (2,546) $ 36,996
Operating loss ...................... (20,542) (1,607) -- (22,149)
Capital expenditures ................ 3,094 91 -- 3,185
Depreciation and amortization ....... 2,847 198 -- 3,045
NINE MONTHS ENDED SEPTEMBER 30, 1998:
Revenues ............................ $ 27,949 $ 2,679 $ (3,638) $ 26,990
Operating loss ...................... (30,282) (1,660) 250 (31,692)
Capital expenditures ................ 4,544 241 -- 4,785
Depreciation and amortization ....... 2,143 492 -- 2,635
</TABLE>
F-34
<PAGE> 89
6. RECENT ACCOUNTING PRONOUNCEMENTS
The American Institute of Certified Public Accountants has issued
Statement of Position ("SOP") No. 98-1, Software for Internal Use, which
provides guidance on accounting for the cost of computer software developed or
obtained for internal use. SOP No. 98-1 is effective for financial statements
for fiscal years beginning after December 15, 1998. The adoption of SOP No. 98-1
did not have a material impact on the Company's financial statements.
F-35
<PAGE> 90
================================================================================
6,500,000 SHARES
[HESCA LOGO OMITTED]
COMMON STOCK
---------------------------------------
PROSPECTUS
DECEMBER 1, 1999
---------------------------------------
================================================================================
