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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------- ------------
Commission file number 000-22427
HESKA CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0192527
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1613 PROSPECT PARKWAY
FORT COLLINS, COLORADO 80525
(Address of principal executive offices)
(970) 493-7272
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days.
[X] Yes [ ] No
The number of shares of the Registrant's Common Stock, $.001 par value,
outstanding at November 11, 1999 was 26,872,298
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HESKA CORPORATION
FORM 10-Q
QUARTERLY REPORT
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of September 30, 1999 (Unaudited) and
December 31, 1998................................................................................ 3
Consolidated Statements of Operations and Comprehensive Loss (Unaudited)
for the three and nine months ended September 30, 1999 and 1998.................................. 4
Consolidated Statements of Cash Flows (Unaudited) for the nine months ended
September 30, 1999 and 1998...................................................................... 5
Notes to Consolidated Financial Statements (Unaudited)........................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................... 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.........................................................................Not Applicable
Item 2. Changes in Securities and Use of Proceeds.................................................Not Applicable
Item 3. Defaults Upon Senior Securities...........................................................Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders.......................................Not Applicable
Item 5. Other Information.........................................................................Not Applicable
Item 6. Exhibits and Reports on Form 8-K................................................................ 25
Signatures................................................................................................. 26
Exhibit Index.............................................................................................. 27
</TABLE>
2
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HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
ASSETS
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
3
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HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED 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 gain (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
4
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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 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
5
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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
6
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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. 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.
7
<PAGE> 8
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>
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.
8
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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.
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.
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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
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.
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<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>
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.
7. SUBSEQUENT EVENT
On November 5, 1999, the Company filed a registration statement with
the Securities and Exchange Commission related to the sale of 7,500,000 shares
of its common stock. These shares will be offered directly to selected
institutional investors, including current institutional holders of the
Company's stock. Of the 7,500,000 shares to be offered, 6,500,000 are to be sold
by the Company, and 1,000,000 are to be sold by a selling stockholder.
11
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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 below under "Factors that May
Affect Results," 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.
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 announced in August 1999 that
these operations would be consolidated with existing operations in Fort Collins,
Colorado and Des Moines, Iowa.
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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 "Factors That May Affect Results-We
have a history of losses and may never achieve profitability; Factors beyond our
control may cause our operating results to fluctuate and many of our expenses
are fixed; and we may need to seek additional financing in the future."
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 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
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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.
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.
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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 year-to-date in 1999 was mainly due to increased sales volume.
Accounts payable increased by $200,000 in the first half 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 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 will be sufficient to satisfy its projected cash
requirements through mid-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.
On November 5, 1999, the Company filed a registration statement with
the Securities and Exchange Commission related to the sale of 7,500,000 shares
of its common stock. These shares will be offered directly to selected
institutional investors, including current institutional holders of the
Company's stock. of the 7,500,000 shares to be offered, 6,500,000 are to be sold
by the Company, and 1,000,000 are to be sold by a selling stockholder.
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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 NOL's incurred prior to the merger that it may utilize to offset
future taxable income. The amount of NOL's 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." NOL's
incurred subsequent to the Diamond acquisition and prior to the follow-on
offering will also be limited. The amount of these NOL's 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 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. Final testing is expected to be
completed by mid-November 1999. This has been accomplished through a combination
of written vendor confirmations, when available, and specific validation
testing. This validation testing has been accomplished primarily with internal
corporate staff at a cost of approximately $100,000.
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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.
Risks
The most likely risks to the Company from Y2K issues are external, due
to the difficulty of validating the readiness of key third parties for Y2K. The
Company will seek confirmation of such compliance and seek relationships which
are compliant. However, the risk that a major supplier or customer will become
unreliable due to Y2K problems will still exist. The Company plans to develop
contingency plans for key relationships where non-compliance by third parties
could have a material adverse effect on its business.
FACTORS THAT MAY AFFECT RESULTS
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:
o improve market acceptance of our current products;
o complete development of new products; and
o 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.
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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 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:
o the introduction of new products by us or by our competitors;
o market acceptance of our current or new products;
o regulatory and other delays in product development;
o product recalls;
o competition and pricing pressures from competitive products;
o manufacturing delays;
o shipment problems;
o product seasonality; and
o 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, will be sufficient to satisfy our projected cash
requirements through mid-2000, assuming no significant uses of cash in
acquisition activities. On November 5, 1999, we filed a registration statement
with the SEC for a proposed offering to select institutional investors to raise
additional capital to fund our operations. However, there can be no assurance
that the offering will be completed.
Our future liquidity and capital requirements will depend on numerous
factors, including:
o the extent to which our present and future products gain market
acceptance;
o the extent to which we successfully develop products from
technologies under research or development;
o the timing of regulatory actions concerning our products;
o the costs and timing of expansions of our sales, marketing and
manufacturing activities;
o the cost, timing and business management of recent and potential
acquisitions and contingent liabilities associated with
acquisitions;
o the procurement and enforcement of important patents, and
o the results of competition.
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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 "Liquidity and Capital Resources."
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, Novartis
and we 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
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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 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 Item 3 of our most recent Form 10-K, 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
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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 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.
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<PAGE> 22
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 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:
o our February 1997 purchase of Heska UK;
o our July 1997 purchase of the allergy immunotherapy products
business of Center;
o 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
o 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
22
<PAGE> 23
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.
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 "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:
o announcements of technological innovations or new products by us
or by our competitors;
o releases of reports by securities analysts;
o developments or disputes concerning patents or proprietary
rights;
o regulatory developments;
o changes in regulatory policies;
o economic and other external factors; and
o 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 42% 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. We expect this voting agreement to
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<PAGE> 24
terminate as a result of the sale of shares by the selling stockholder if our
proposed offering is successful. Our major stockholders, acting together, could
substantially influence matters requiring approval by our stockholders,
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.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk represents the risk of loss that may impact the financial
position, results of operations or cash flows of the Company due to adverse
changes in financial and commodity market prices and rates. The Company is
exposed to market risk in the areas of changes in United States and foreign
interest rates and changes in foreign currency exchange rates as measured
against the United States dollar. These exposures are directly related to its
normal operating and funding activities.
Interest Rate Risk
The interest payable on certain of the Company's lines-of-credit is
variable based on the United States prime rate, or LIBOR, and, therefore,
affected by changes in market interest rates. At September 30, 1999,
approximately $2.2 million was outstanding with a weighted average interest rate
of 9.05 %. The lines-of-credit mature through November 1999 and are subject to
annual renewal. The Company may pay the balance in full at any time without
penalty. Additionally, the Company monitors interest rates and at September 30,
1999 had sufficient cash balances to pay off the lines-of-credit should interest
rates increase significantly.
The Company manages interest rate risk by investing its excess cash in
short-term money market funds and in U.S. Government and U.S. Government Agency
fixed rate marketable securities with limited maturity dates. While a sizeable
increase in interest rates could have a negative impact on the fair market
values of certain fixed rate investments, the Company does not believe that
reasonably possible near-term changes in interest rates will result in a
material change in the financial condition of the Company.
Foreign Currency Risk
The Company has wholly-owned subsidiaries located in England and
Switzerland. Sales from these operations are denominated in British Pounds and
Swiss Francs or Euros, respectively, thereby creating exposures to changes in
exchange rates. The changes in the British/U.S. exchange rate, Swiss/U.S.
exchange rate or Euro/U.S. exchange rate may positively or negatively affect the
Company's sales, gross margins and retained earnings. The Company does not
believe that reasonably possible near-term changes in exchange rates will result
in a material effect on future earnings, fair values or cash flows of the
Company, and therefore, has chosen not to enter into foreign currency hedging
instruments. There can be no assurance that such an approach will be successful,
especially in the event of a significant and sudden decline in the value of the
British Pound, Swiss Franc or Euro.
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<PAGE> 25
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See Exhibit Index on Page 27
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the
quarter ended September 30, 1999.
25
<PAGE> 26
HESKA CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HESKA CORPORATION
Date: November 15, 1999 By /s/ Ronald L. Hendrick
-----------------------------
RONALD L. HENDRICK
Executive Vice President and
Chief Financial Officer
(on behalf of the Registrant
and as the Registrant's
Principal Financial and
Accounting Officer)
26
<PAGE> 27
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
- ------- -----------------------
<S> <C>
27 Financial Data Schedule
</TABLE>
27
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION FROM THE REGISTRANT'S
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) AS OF AND FOR THE NINE
MONTHS ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) INCLUDED IN THE
COMPANY'S REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 7,202
<SECURITIES> 13,257
<RECEIVABLES> 8,869
<ALLOWANCES> 190
<INVENTORY> 17,104
<CURRENT-ASSETS> 47,382
<PP&E> 31,410
<DEPRECIATION> (9,999)
<TOTAL-ASSETS> 73,175
<CURRENT-LIABILITIES> 20,630
<BONDS> 0
0
0
<COMMON> 185,648
<OTHER-SE> (139,903)
<TOTAL-LIABILITY-AND-EQUITY> 73,175
<SALES> 36,478
<TOTAL-REVENUES> 36,996
<CGS> 24,697
<TOTAL-COSTS> 24,697
<OTHER-EXPENSES> 34,448
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (99)
<INCOME-PRETAX> (23,137)
<INCOME-TAX> 0
<INCOME-CONTINUING> (23,137)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (23,137)
<EPS-BASIC> (0.87)
<EPS-DILUTED> (0.87)
</TABLE>
