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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 March 31, 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 May 10, 1999 was 27,228,840
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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 March 31, 1999 (Unaudited) and
December 31, 1998................................................................... 3
Consolidated Statements of Operations and Comprehensive Loss (Unaudited)
for the three months ended March 31, 1999 and 1998.................................. 4
Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months
ended March 31, 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.......................................................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 22
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.................................................... 22
Exhibit Index............................................................................... 23
Signatures.................................................................................. 24
</TABLE>
2
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HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
ASSETS
MARCH 31, DECEMBER 31,
1999 1998
------------ ---------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents......................................................... $ 5,565 $ 5,921
Marketable securities............................................................. 34,630 46,009
Accounts receivable, net.......................................................... 7,621 6,659
Inventories, net.................................................................. 13,712 12,197
Other current assets.............................................................. 912 734
--------- ---------
Total current assets...................................................... 62,440 71,520
Property and equipment, net.............................................................. 21,634 21,226
Intangible assets, net................................................................... 3,611 4,311
Restricted marketable securities and other assets........................................ 738 997
--------- ---------
Total assets............................................................. $ 88,423 $ 98,054
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................................................. $ 7,688 $ 7,542
Accrued liabilities............................................................... 2,953 3,871
Deferred revenue.................................................................. 1,001 656
Current portion of capital lease obligations...................................... 555 562
Current portion of long-term debt................................................. 5,714 6,942
--------- ---------
Total current liabilities................................................ 17,911 19,573
Capital lease obligations, less current portion.......................................... 998 1,129
Long-term debt, less current portion..................................................... 10,240 10,162
Accrued pension liability................................................................ 76 76
--------- ---------
Total liabilities....................................................... 29,225 30,940
--------- ---------
Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value, 40,000,000 shares authorized; 26,697,791 and
26,458,424 shares issued and outstanding, respectively........................ 27 26
Additional paid-in capital........................................................ 185,349 185,163
Deferred compensation............................................................. (1,110) (1,277)
Stock subscription receivable from officers....................................... (122) (120)
Accumulated other comprehensive income (loss)..................................... (297) 88
Accumulated deficit............................................................... (124,649) (116,766)
--------- ---------
Total stockholders' equity.............................................. 59,198 67,114
--------- ---------
Total liabilities and stockholders' equity.............................. $ 88,423 $ 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 MARCH 31,
---------------------------------
1999 1998
------------- ------------------
<S> <C> <C>
Revenues:
Products, net........................................................... $11,010 $ 7,390
Research and development................................................ 41 520
------- -------
11,051 7,910
Costs and operating expenses:
Cost of goods sold...................................................... 7,709 4,811
Research and development................................................ 4,244 6,178
Selling and marketing................................................... 3,410 3,090
General and administrative.............................................. 2,736 3,000
Amortization of intangible assets and deferred compensation............. 857 765
------- -------
18,956 17,844
------- -------
Loss from operations....................................................... (7,905) (9,934)
Other income (expense):
Interest income......................................................... 602 575
Interest expense........................................................ (534) (470)
Other, net.............................................................. (46) 12
------- -------
Net loss................................................................... (7,883) (9,817)
------- -------
Other comprehensive income (loss):
Foreign currency translation adjustments................................ (40) 6
Unrealized loss on marketable securities................................ (345) --
------- -------
Other comprehensive income (loss).......................................... (385) 6
------- -------
Comprehensive loss......................................................... $(8,268) $(9,811)
======= =======
Basic net loss per share................................................... $ (0.30) $ (0.46)
======= =======
Shares used to compute basic net loss per share............................ 26,605 21,233
</TABLE>
See accompanying notes to consolidated financial statements
4
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HESKA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------------
1999 1998
------------ -------------
<S> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net cash used in operating activities........................... $(9,193) $(10,004)
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of businesses, net of cash acquired..................... -- (6)
Additions to intangible assets....................................... -- (13)
Purchase of marketable securities.................................... -- (54,988)
Proceeds from sale of marketable securities.......................... 11,000 15,005
Proceeds from disposition of property and equipment.................. 262 --
Purchases of property and equipment.................................. (1,344) (1,611)
------- --------
Net cash provided by (used in) investing activities............. 9,918 (41,613)
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock............................... 186 48,693
Proceeds from borrowings............................................. 1,562 1,657
Repayments of debt and capital lease obligations..................... (2,649) (1,510)
------- --------
Net cash provided by (used in) financing activities............. (901) 48,840
------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH..................................... (180) 23
------- --------
DECREASE IN CASH AND CASH EQUIVALENTS....................................... (356) (2,754)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............................. 5,921 10,679
------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................................... $ 5,565 $ 7,925
======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest...................................................... $ 525 $ 460
</TABLE>
See accompanying notes to consolidated financial statements
5
<PAGE>
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 bovine vaccine products and pharmaceutical and
human 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
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 March 31, 1999 have totaled $124.6
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. There can be no guaranty 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 March 31, 1999, the statements of
operations and comprehensive loss for the three months ended March 31, 1999 and
1998 and the statements of cash flows for the three months ended March 31, 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
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Inventories, net of provisions, consist of the following (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
-------------- -------------
(UNAUDITED)
<S> <C> <C>
Raw materials....................... $ 3,628 $ 3,271
Work in process..................... 6,800 5,338
Finished goods...................... 3,284 3,588
------- -------
$13,712 $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 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 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 three months ended March 31, 1999 (in thousands):
<TABLE>
<CAPTION>
PAYMENTS/CHARGES
BALANCE AT FOR THE THREE BALANCE AT
DECEMBER 31, MONTHS ENDED MARCH 31,
1998 MARCH 31, 1999 1999
----------- -------------- ----------
(UNAUDITED)
<S> <C> <C> <C>
Severance pay, benefits and relocation expenses............. $1,093 $(755) $338
Noncancellable leased facility closure costs................ 430 (73) 357
Asset write-offs............................................ -- -- --
Other....................................................... 108 (37) 71
------ ----- ----
Total....................................................... $1,631 $(865) $766
====== ===== ====
</TABLE>
The balances of $766,000 and $1.6 million are included in accrued
liabilities in the accompanying consolidated balance sheets as of March 31, 1999
and December 31, 1998, respectively.
8
<PAGE>
4. MAJOR CUSTOMERS
No customer accounted for more than 10% of total revenue during the three
months ended March 31, 1999 or 1998.
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
------ ------------- ----- -----
THREE MONTHS ENDED MARCH 31, 1999:
<S> <C> <C> <C> <C>
Revenues.............................................. $ 10,031 $1,773 $ (753) $ 11,051
Operating loss........................................ (7,078) (74) (753) (7,905)
Total assets.......................................... 117,337 7,749 (36,663) 88,423
Capital expenditures.................................. 1,180 164 -- 1,344
Depreciation and amortization......................... 800 106 -- 906
THREE MONTHS ENDED MARCH 31, 1998:
Revenues.............................................. $ 7,365 $2,121 $ (1,576) $ 7,910
Operating loss........................................ (10,033) (151) (250) (9,934)
Total assets.......................................... 128,078 7,820 (26,556) 109,342
Capital expenditures.................................. 1,206 405 -- 1,611
Depreciation and amortization......................... 737 89 -- 826
</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 three months ended March 31, 1999 and 1998, European subsidiaries
purchased products from North America for sale to European customers. Transfer
prices to international subsidiaries are intended to allow
9
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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.
<TABLE>
<CAPTION>
NORTH
AMERICA EUROPE OTHER TOTAL
------- ------ ----- -----
<S> <C> <C> <C> <C>
THREE MONTHS ENDED MARCH 31, 1999:
Revenues....................................... $ 10,798 $1,006 $ (753) $ 11,051
Operating loss................................. (7,455) (450) -- (7,905)
Total assets................................... 120,802 4,284 (36,663) 88,423
Capital expenditures........................... 1,325 19 -- 1,344
Depreciation and amortization.................. 845 61 -- 906
THREE MONTHS ENDED MARCH 31, 1998:
Revenues....................................... $ 8,662 $ 824 $ (1,576) $ 7,910
Operating loss................................. (9,587) (597) 250 (9,934)
Total assets................................... 131,419 4,479 (26,556) 109,342
Capital expenditures........................... 1,450 161 -- 1,611
Depreciation and amortization.................. 666 160 -- 826
</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.
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 bovine vaccine products and pharmaceutical
and human healthcare products which are marketed and distributed by third
parties. In addition to manufacturing veterinary
10
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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 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 March 31, 1999 have totaled $124.6
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-Loss
History and Accumulated Deficit; Uncertainty of Future Profitability; Quarterly
Fluctuations and Customer Concentration".
RESULTS OF OPERATIONS
Three Months Ended March 31, 1999 and 1998
Total revenues, which include product and research and development
revenues, increased 40% to $11.1 million in the first quarter of 1999 compared
to $7.9 million for the first quarter of 1998. Product revenues increased 49% to
$11.0 million in the first quarter of 1999 compared to $7.4 million for the
first quarter of 1998.
11
<PAGE>
The growth in revenues during 1999 was primarily due to sales of new products
introduced by the Company during 1998 and 1999.
Revenues from sponsored research and development decreased to $41,000 in
the first quarter of 1999 from $520,000 in the first quarter of 1998.
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 $7.7 million in the first quarter of 1999
compared to $4.8 million in the first quarter of 1998, and the resulting gross
profit for 1999 increased to $3.3 million from $2.6 million in 1998. The
increase in cost of goods sold was attributable to increased product sales. The
Company's product mix in the first quarter of 1999, compared to the first
quarter of 1998, included a higher proportion of revenues attributable to
products manufactured for sale by third parties, which carry lower gross profit
margins than the Company's proprietary products. The Company believes that gross
profit 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 decreased to $4.2 million in the first
quarter of 1999 from $6.2 million in the first quarter of 1998. The decrease in
1999 was primarily due to decreases 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.
Selling and marketing expenses increased to $3.4 million in the first
quarter of 1999 from $3.1 million in the first quarter of 1998. 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. 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 $2.7 million in the first
quarter of 1999 from $3.0 million in the first quarter of 1998. The decrease in
1999 was 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 increased to
$857,000 in the first quarter of 1999 from $765,000 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 the first quarter of
1999 of $189,000 compared to $206,000 in the first quarter of 1998. 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 March 31, 1999 of approximately $658,000,
$585,000 and $34,000 per year for 1999, 2000 and 2001, respectively, for
amortization of deferred compensation.
Interest income increased to $602,000 in the first quarter of 1999 from
$575,000 in the first quarter of 1998 as a result of increased cash available
for investment arising from the proceeds from the Company's follow-on public
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 $534,000 in the first quarter of 1999 from $470,000 in the
first quarter of 1998 due to increases in debt financing for laboratory and
manufacturing equipment.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity at March 31, 1999 was its $40.2
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 $3.2 million, against
which borrowings of approximately $2.7 million were outstanding at March 31,
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 $9.2 million in the first quarter of
1999, compared to $10.0 million in the first quarter of 1998. Inventory levels
increased by $1.6 million in the first quarter of 1999, primarily to support
increased sales of existing products and inventory build-up for new product
introductions. The increase of $2.1 million in accounts receivable was mainly
due to increased sales volume. Accounts payable increased by $1.4 million in the
first quarter of 1999, primarily as a result of the increase in inventory
levels. Expenses which were recognized as a result of the Company's
restructuring in 1998 and paid in the first quarter of 1999 accounted for
$865,000 of the reduction in accrued liabilities during the first quarter of
1999.
The Company's investing activities provided $9.9 million in the first
quarter of 1999, compared to the use of $41.6 million in cash for investing
activities during the first quarter of 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. The
Company also received proceeds of $262,000 from the disposition of certain
assets in the first quarter 1999, compared to none in the first quarter of 1998.
Expenditures for property and equipment totaled $1.3 million for the first
quarter of 1999 compared to $1.6 million in the first quarter 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 $3.5 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 $901,000 in the first quarter of
1999 compared to the generation of $48.8 million in cash in the first quarter of
1998. The primary source of funds in the first quarter of 1999 was due to
borrowings of $1.6 million, primarily from the Company's available credit
facilities. In the first quarter 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 borrowings of $1.7 million from available
credit facilities. Repayments of debt and capital lease obligations totaled $2.6
million in the first quarter of 1999 compared to $1.6 million in the first
quarter 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.
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The Company believes that its available cash and cash from operations will
be sufficient to satisfy its projected cash requirements for the next 12 months,
assuming no significant uses of cash in acquisition activities. Thereafter, if
cash generated from operations is insufficient to satisfy the Company's 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.
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 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
initiated 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 done an initial survey of
the installed control systems, computers, and applications software, and it
appears 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.
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Costs
The Company has a plan to validate each of these systems by mid-year 1999.
This plan (75% of total expected hours were completed as of March 31, 1999) will
be accomplished through a combination of written vendor confirmations, when
available, and specific validation testing. This validation process is expected
to be accomplished primarily with internal corporate staff. This validation
phase is expected to cost approximately $100,000, including consulting and
internal resources.
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 approximately $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 will 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
Dependence on Development and Successful Introduction of New Products
Some of the Company's products have only recently been introduced and many
are still under development. There can be no assurance that current products
will gain market acceptance or that products will be successfully developed or
commercialized on a timely basis, or at all. Several of the Company's current
products as well as a number of products under development, are novel. The
Company must expend substantial efforts in educating and convincing its customer
base in the use of and the need for such products. The Company believes that its
revenue growth and profitability, if any, will substantially depend upon its
ability to improve market acceptance of its current products and complete
development of and successfully introduce and commercialize its new products.
The development and regulatory approval activities necessary to bring new
products to market are time-consuming and costly. The Company has experienced
delays in receiving regulatory approvals. There can be no assurance that the
Company will not experience difficulties that could delay or prevent
successfully developing, obtaining regulatory approvals to market or introducing
these new products, that regulatory clearance or approval of any new products
will be granted by the USDA, the FDA, the EPA or foreign regulatory authorities
on a timely basis, or at all, or that the new products will be successfully
commercialized. The Company's strategy is to develop a broad range of products
addressing different disease indications. The Company has limited resources to
devote to the development of all its products and consequently a delay in the
development of one product or the use of resources for product development
efforts that prove unsuccessful may delay or jeopardize the development of its
other product candidates. Further, for certain of the Company's proposed
products, the Company is dependent on collaborative partners to successfully and
timely perform research and development activities on behalf of the Company. In
order to successfully commercialize any new products, the Company will be
required to establish and maintain a reliable, cost-efficient source of
manufacturing for such products. If the Company is unable, for technological or
other reasons, to complete the development, introduction or scale up of
manufacturing of any new product or if any new product is not approved for
marketing or does not achieve a significant level of market acceptance, the
Company could be materially and adversely affected. Following the introduction
of a product, adverse side
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effects may be discovered that make the product no longer commercially viable.
Publicity regarding such adverse effects could affect sales of the Company's
other products for an indeterminate time period. The Company is dependent on the
acceptance of its products by both veterinarians and pet owners. The failure of
the Company to engender confidence in its products and services could affect the
Company's ability to attain sustained market acceptance of its products.
Loss History and Accumulated Deficit; Uncertainty of Future Profitability;
Quarterly Fluctuations and Customer Concentration
Heska has incurred net losses since its inception. At March 31, 1999, the
Company's accumulated deficit was $124.6 million. The Company anticipates that
it will continue to incur additional operating losses in the near term. Such
losses have resulted principally from expenses incurred in the Company's
research and development programs and, to a lesser extent, from general and
administrative and sales and marketing expenses. Currently, a substantial
portion of the Company's revenues are from Diamond, which manufactures
veterinary biologicals and pharmaceuticals for 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
terminates in January 2000. If this customer does not continue to purchase from
Diamond and if the lost revenues are not replaced by other customers or
products, the Company's financial condition and results of operations could be
adversely affected.
There can be no assurance that the Company will attain profitability or, if
achieved, will remain profitable on a quarterly or annual basis in the future.
The Company believes that future operating results will be subject to quarterly
fluctuations due to a variety of factors, including whether and when new
products are successfully developed and introduced by the Company or its
competitors, market acceptance of current or new products, regulatory delays,
product recalls, competition and pricing pressures from competitive products,
manufacturing delays, shipment problems, product seasonality and changes in the
mix of products sold. Because the Company has high operating expenses for
personnel, new product development and marketing, the Company's operating
results will be adversely affected if its sales do not correspondingly increase
or if its product development efforts are unsuccessful or subject to delays.
Limited Sales and Marketing Experience; Dependence on Others
To be successful, Heska will have to continue to develop and train its
direct sales force or rely on marketing partners or other arrangements with
third parties for the marketing, distribution and sale of its products. The
Company is currently marketing its products to veterinarians through a direct
sales force and certain third parties. There can be no assurance that the
Company will be able to successfully maintain marketing, distribution or sales
capabilities or make arrangements with third parties to perform those activities
on terms satisfactory to the Company.
In addition, the Company has 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 developed by the Company on or
before December 31, 2005. The Company retained the right to co-exclusively
manufacture and market these products throughout the world under its own trade
names. Accordingly, if both elect to market these products, the Company and
Novartis will be direct competitors, with each party sharing revenues on the
other's sales. Heska also granted Novartis a right of first refusal pursuant to
which, prior to granting rights to any third party for any products or
technology developed or acquired by the Company for either companion animal or
food animal applications, Heska must first offer Novartis such rights. In Japan,
Novartis also has the exclusive right upon regulatory approval to distribute the
Company's heartworm diagnostics, periodontal disease therapeutic, trivalent and
bivalent feline vaccines and certain other Heska products. Bayer has exclusive
marketing rights to the Company's canine heartworm vaccine and its feline
toxoplasmosis vaccine (except in countries where Eisai has such rights). Eisai
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has exclusive marketing rights. In addition, the Company recently granted to
Ralston Purina the exclusive rights to develop and commercialize the Company's
discoveries, know-how and technologies in certain pet food products. There can
be no assurance that Novartis, Bayer or Eisai or any other collaborative party
will devote sufficient resources to marketing the Company's products.
Furthermore, there is nothing to prevent Novartis, Bayer or Eisai or any other
collaborative party from pursuing alternative technologies or products that may
compete with the Company's products.
Highly Competitive Industry
The market in which the Company competes is intensely competitive. Heska's
competitors include companion animal health companies and major pharmaceutical
companies that have animal health divisions. Companies with a significant
presence in the animal health market, such as American Home Products, Bayer,
Merial Ltd., Novartis, Pfizer Inc and IDEXX Laboratories, Inc., have developed
or are developing products that do or would compete with the Company's products.
These competitors may have substantially greater financial, technical, research
and other resources and larger, more established marketing, sales, distribution
and service organizations than the Company. Moreover, such competitors may
offer broader product lines and have greater name recognition than the Company.
Novartis and Bayer are marketing partners of the Company, and their agreements
with the Company do not restrict their ability to develop and market competing
products. The market for companion animal healthcare products is highly
fragmented, with discount stores and specialty pet stores accounting for a
substantial percentage of such sales. As Heska intends to distribute its
products only through veterinarians, a substantial segment of the potential
market may not be reached, and the Company may not be able to offer its products
at prices which are competitive with those of companies that distribute their
products through retail channels. There can be no assurance that the Company's
competitors will not develop or market technologies or products that are more
effective or commercially attractive than the Company's current or future
products or that would render the Company's technologies and products obsolete.
Moreover, there can be no assurance that the Company will have the financial
resources, technical expertise or marketing, distribution or support
capabilities to compete successfully. 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 Bayer and AgriLabs compete with each other and 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.
Uncertainty of Patent and Proprietary Technology Protection; License of
Technology of Third Parties
The Company's ability to compete effectively will depend in part on its
ability to develop and maintain proprietary aspects of its technology and either
to operate without infringing the proprietary rights of others or to obtain
rights to such technology. Heska has United States and foreign issued patents
and is currently prosecuting patent applications in the United States and with
certain foreign patent offices. There can be no assurance that any of the
Company's pending patent applications will result in the issuance of any patents
or that, if issued, any such patents will offer protection against competitors
with similar technology. There can be no assurance that any patents issued to
the Company will not be challenged, invalidated or circumvented in the future or
that the rights created thereunder will provide a competitive advantage.
The biotechnology and pharmaceutical industries have been characterized by
extensive litigation regarding patents and other intellectual property rights.
In 1998, Synbiotics Corporation filed a lawsuit against Heska alleging
infringement of a Synbiotics patent relating to heartworm diagnostic technology.
See Item 3 of this Form 10-K-Legal Proceedings. There can be no assurance that
the Company will not in the future become
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subject to additional patent infringement claims and litigation in the United
States or other countries or interference proceedings conducted in the USPTO to
determine the priority of inventions. The defense and prosecution of
intellectual property suits, USPTO interference proceedings, and related legal
and administrative proceedings are costly, time consuming and distracting.
Litigation may be necessary to enforce any patents issued to the Company or its
collaborative partners, to protect trade secrets or know-how owned by the
Company or its collaborative partners, or to determine the enforceability, scope
and validity of the proprietary rights of others. Any litigation or interference
proceeding will result in substantial expense to the Company and significant
diversion of effort by the Company's technical and management personnel. An
adverse determination in litigation or interference proceedings to which the
Company may become a party could subject the Company to significant liabilities
to third parties. Further, either as the result of such litigation or
proceedings or otherwise, the Company may be required to seek licenses from
third parties which may not be available on commercially reasonable terms, if at
all.
The Company licenses technology from a number of third parties. The
majority of such license agreements impose due diligence or milestone
obligations and in some cases impose minimum royalty and/or sales obligations
upon the Company in order for the Company to maintain its rights thereunder.
The Company's products may incorporate technologies that are the subject of
patents issued to, and patent applications filed by, others. As is typical in
its industry, from time to time the Company and its collaborators have received
and may in the future receive notices claiming infringement from third parties
as well as invitations to take licenses under third-party patents. It is the
Company's policy when it receives such notices to conduct investigations of the
claims asserted. With respect to notices the Company has received to date, the
Company believes, after due investigation, that it has meritorious defenses to
the infringement claims asserted. Any legal action against the Company or its
collaborators may require the Company or its collaborators to obtain a license
in order to market or manufacture affected products or services. However, there
can be no assurance that the Company or its collaborators will be able to obtain
licenses for technology patented by others on commercially reasonable terms,
that they will be able to develop alternative approaches if unable to obtain
licenses, or that the current and future licenses will be adequate for the
operation of their businesses. The failure to obtain necessary licenses or to
identify and implement alternative approaches could prevent the Company and its
collaborators from commercializing certain of their products under development
and could have a material adverse effect on the Company's business, financial
condition or results of operations.
The Company also relies upon trade secrets, technical know-how and
continuing invention to develop and maintain its competitive position. There
can be no assurance that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
the Company's trade secrets.
Limited Manufacturing Experience and Capacity; Reliance on Third-Party
Manufacturers
To be successful, the Company must manufacture, or contract for the
manufacture of, its current and future products in compliance with regulatory
requirements, in sufficient quantities and on a timely basis, while maintaining
product quality and acceptable manufacturing costs. In order to provide for
manufacturing of its products, the Company acquired Diamond in April 1996 and
certain assets of Center in July 1997. Significant work will be required for
the scaling up of manufacturing of many new products and there can be no
assurance that such work can be completed successfully or on a timely basis.
In addition to Diamond and Center, the Company intends to rely on third-
party manufacturers for certain of its products. The Company currently has
supply agreements with Atrix for its canine periodontal disease therapeutic and
a supply agreement with Quidel for certain manufacturing services relating to
its point-of-care diagnostic tests. Patient monitoring equipment and associated
consumable products are also manufactured to the Company's specifications by
third parties. These agreements typically require the manufacturing partner to
supply the Company's requirements within certain parameters. There can be no
assurance that these partners will
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be able to manufacture products to regulatory standards and the Company's
specifications or in a cost-effective and timely manner. The Company has
experienced some delays in manufacturing scale-up at Quidel in the production of
certain diagnostic products. If a supplier were to be delayed in scaling up
commercial manufacturing, were to be unable to produce a sufficient quantity of
products to meet market demand, or were to request renegotiation of contract
prices, the Company's business could be materially and adversely affected. While
the Company typically retains the right to manufacture products itself or
contract with an alternative supplier in the event of the manufacturer's breach,
any transfer of production would necessarily involve significant delays in
production and additional expense to the Company to scale up production at a new
facility and to apply for regulatory licensure for the production of products at
that new facility. In addition, there can be no assurance that the Company will
be able to locate suitable manufacturing partners for its products under
development or alternative suppliers if present arrangements are not
satisfactory.
Government Regulation; No Assurance of Obtaining Regulatory Approvals
The development, manufacture and marketing of most of the Company's
products are subject to regulation by various governmental authorities,
consisting principally of the USDA and the FDA in the United States and various
regulatory agencies outside the United States. Delays in obtaining, or failure
to obtain any necessary regulatory approvals would have a material adverse
effect on the Company's future product sales and operations. Any acquisitions of
new products and technologies may subject the Company to additional government
regulation.
The Company's manufacturing facilities and those of any third-party
manufacturers the Company may use are subject to the requirements of and subject
to periodic regulatory inspections by the FDA, USDA and other federal, state and
foreign regulatory agencies. There can be no assurance that the Company or its
contractors will continue to satisfy such regulatory requirements, and any
failure to do so would have a material adverse effect on the Company's business,
financial condition or results of operations.
There can be no assurance that the Company will not incur significant costs
to comply with laws and regulations in the future or that laws and regulations
will not have a material adverse effect upon the Company's business, financial
condition or results of operations.
Future Capital Requirements; Uncertainty of Additional Funding
The Company believes that its available cash and cash from operations will
be sufficient to satisfy its projected cash requirements for the next 12 months,
assuming no significant uses of cash in acquisition activities. The Company has
incurred negative cash flow from operations since inception and does not expect
to generate positive cash flow sufficient to fund its operations for the next
several years. Thus, the Company may need to raise additional capital to fund
its research and development, manufacturing and sales and marketing activities.
The Company's future liquidity and capital 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 of 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 recent 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. 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
currently planned 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. See
"Liquidity and Capital Resources".
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Potential Difficulties in Management of Growth; Identification and Integration
of Acquisitions
The Company anticipates growth in the number of its employees, the scope of
its operating and financial systems and the geographic area of its operations as
new products are developed and commercialized. This growth will result in an
increase in responsibilities for both existing and new management personnel.
The Company's ability to manage growth effectively will require it to continue
to implement and improve its operational, financial and management information
systems and to train, motivate and manage its current employees and hire new
employees. There can be no assurance that the Company will be able to manage
its expansion effectively, and a failure to do so could have a material adverse
effect on the Company's business, financial condition or results of operations.
In 1996, Heska consummated the acquisitions of Diamond and of certain
assets relating to its canine allergy business. The Company's recent
acquisitions include: the February 1997 purchase of Heska UK; the July 1997
purchase of the allergy immunotherapy products business of Center; the 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 the
March 1998 acquisition of Heska Waukesha. The Company may issue additional
shares of Common Stock to effect future acquisitions, and such issuances may be
dilutive. Identifying and pursuing acquisition opportunities, integrating the
acquired businesses and managing growth requires a significant amount of
management time and skill. There can be no assurance that the Company will be
effective in identifying and effecting attractive acquisitions, integrating
acquisitions or managing future growth. The failure to do so may have a
material adverse effect on the Company's business, financial condition or
results of operations.
Dependence on Key Personnel
The Company is highly dependent on the efforts of its senior management and
scientific team. The loss of the services of any member of its senior
management or scientific staff may significantly delay or prevent the
achievement of product development and other business objectives. Because of
the specialized scientific nature of the Company's business, the Company is
highly dependent on its ability to attract and retain qualified scientific and
technical personnel. There is intense competition among major pharmaceutical
and chemical companies, specialized biotechnology firms and universities and
other research institutions for qualified personnel in the areas of the
Company's activities. Loss of the services of, or failure to recruit, key
scientific and technical personnel could adversely affect the Company's
business, financial condition or results of operations.
Potential Product Liability; Limited Insurance Coverage
The testing, manufacturing and marketing of the Company's current products
as well as those currently under development entail an inherent risk of product
liability claims and associated adverse publicity. To date, the Company has not
experienced any material product liability claims, but any such claims arising
in the future could have a material adverse effect on the Company's business,
financial condition or results of operations. Potential product liability
claims may exceed the amount of the Company's insurance coverage or may be
excluded from coverage under the terms of the policy. There can be no assurance
that the Company will be able to continue to obtain adequate insurance at a
reasonable cost, if at all. In the event that the Company is held liable for a
claim against which it is not indemnified or for damages exceeding the limits of
its insurance coverage or which results in significant adverse publicity against
the Company, such claim could have a material adverse effect on the Company's
business, financial condition or results of operations.
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Year 2000 Compliance and Risks
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
initiated procedures to identify, evaluate and implement any necessary changes
to its computer systems, applications and embedded technologies resulting from
the Y2K conversion. The Company is coordinating these activities with suppliers,
distributors, financial institutions and others with whom it does business.
There can be no assurance that full compliance will be achieved in a timely
manner or at all. 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, however, there can be no assurance in this regard.
Risk of Liability from Release of Hazardous Materials
The Company's products and development programs involve the controlled use
of hazardous and biohazardous materials, including chemicals, infectious disease
agents and various radioactive compounds. Although the Company believes that
its safety procedures for handling and disposing of such materials comply with
the standards prescribed by applicable local, state and federal regulations, the
risk of accidental contamination or injury from these materials cannot be
completely eliminated. In the event of such an accident, the Company could be
held liable for any damages or fines that result and any such liability could
exceed the resources of the Company. The Company may incur substantial costs to
comply with environmental regulations as the Company expands its manufacturing
capacity.
Possible Volatility of Stock Price
The securities markets have from time to time experienced significant price
and volume fluctuations that are unrelated to the operating performance of
particular companies. The market prices of securities of many publicly-held
biotechnology companies have in the past been, and can in the future be expected
to be, especially volatile. Announcements of technological innovations or new
products by the Company or its competitors, release of reports by securities
analysts, developments or disputes concerning patents or proprietary rights,
regulatory developments, changes in regulatory policies, economic and other
external factors, as well as quarterly fluctuations in the Company's financial
results, may have a significant impact on the market price of the Common Stock.
Control by Directors, Executive Officers, Principal Stockholders and Affiliated
Entities
The Company's directors, executive officers, principal stockholders and
entities affiliated with them beneficially own approximately 46% of the
Company's outstanding Common Stock. Three major stockholders of the Company,
who together beneficially own approximately 40% of the Company's outstanding
Common Stock, have entered into a voting agreement dated as of April 12, 1996
(the "Voting Agreement") whereby each agreed to collectively vote its shares in
such manner so as to ensure that each major stockholder was represented by one
member on the Company's Board of Directors. The Voting Agreement terminates on
December 31, 2005 unless prior to such date any of the investors ceases to
beneficially hold 2,000,000 shares of the voting stock of the Company, at which
time the Voting Agreement would terminate. The major stockholders, if acting
together, could substantially influence matters requiring approval by the
stockholders of the Company, including the election of directors and the
approval of mergers or other business combination transactions.
21
<PAGE>
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. Historically and as of March 31, 1999,
the Company has not used derivative instruments or engaged in hedging
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 March 31, 1999, approximately
$2.7 million was outstanding with a weighted average interest rate of 8.9%. 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. The
Company manages interest rate risk by investing excess funds in cash equivalents
or marketable securities which bear interest rates which reflect current market
yields. Additionally, the Company monitors interest rates and at March 31, 1999
had sufficient cash balances to pay off the lines-of-credit should interest
rates increase significantly. As a result, the Company does not believe that
reasonably possible near-term changes in interest rates will result in a
material effect on future earnings, fair values or cash flows 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.
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 March 31, 1999.
22
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description of Document
- ------ -----------------------
27 Financial Data Schedule
23
<PAGE>
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: May 14, 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)
24
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION FROM THE REGISTRANT'S
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) AS FO AND FOR THE
QUARTER ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) INCLUDED IN THE COMOPANY'S
REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
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