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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, 2000
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 9, 2000 was 33,922,363
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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 (Unaudited):
Consolidated Balance Sheets as of September 30, 2000 and
December 31, 1999........................................................................... 3
Consolidated Statements of Operations and Comprehensive Loss
for the three and nine months ended September 30, 2000 and 1999............................. 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2000 and 1999................................................................. 5
Notes to Consolidated Financial Statements..................................................... 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...................................................... 24
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
Exhibit Index............................................................................................... 26
Signatures.................................................................................................. 27
</TABLE>
2
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HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
ASSETS
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................................. $ 2,043 $ 1,499
Marketable securities ..................................................... 7,303 22,482
Accounts receivable, net .................................................. 8,404 9,652
Inventories, net .......................................................... 9,317 13,957
Other current assets ...................................................... 1,180 1,027
--------- ---------
Total current assets ............................................. 28,247 48,617
Property and equipment, net ............................................................ 13,832 19,574
Intangible assets, net ................................................................. 1,133 1,629
Restricted marketable securities and other assets ...................................... 1,326 1,348
--------- ---------
Total assets ..................................................... $ 44,538 $ 71,168
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................................... $ 3,573 $ 6,928
Accrued liabilities ....................................................... 3,384 4,369
Current portion of deferred revenue ....................................... 328 930
Line of credit borrowings ................................................. 729 917
Current portion of capital lease obligations .............................. 553 604
Current portion of long-term debt ......................................... 1,811 6,635
--------- ---------
Total current liabilities ........................................ 10,378 20,383
Capital lease obligations, less current portion ........................................ 281 718
Long-term debt, less current portion ................................................... 2,953 4,428
Deferred revenue and other long-term liabilities ....................................... 918 200
--------- ---------
Total liabilities ............................................... 14,530 25,729
--------- ---------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, 25,000,000 shares authorized;
none issued and outstanding ........................................... -- --
Common stock, $.001 par value, 75,000,000 shares authorized; 33,908,888 and
33,435,669 shares issued and outstanding, respectively ................ 34 33
Additional paid-in capital ................................................ 199,684 199,156
Deferred compensation ..................................................... (214) (648)
Stock subscription receivable from officers ............................... -- (124)
Accumulated other comprehensive loss ...................................... (530) (376)
Accumulated deficit ....................................................... (168,966) (152,602)
--------- ---------
Total stockholders' equity ...................................... 30,008 45,439
--------- ---------
Total liabilities and stockholders' equity ...................... $ 44,538 $ 71,168
========= =========
</TABLE>
See accompanying notes to consolidated financial statements
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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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Products, net ................................. $ 12,396 $ 12,915 $ 38,533 $ 36,478
Research, development and other ............... 312 152 2,781 518
-------- -------- -------- --------
Total revenues ............................ 12,708 13,067 41,314 36,996
Cost of goods sold ............................... 8,452 8,702 26,338 24,697
-------- -------- -------- --------
4,256 4,365 14,976 12,299
-------- -------- -------- --------
Operating expenses:
Selling and marketing ......................... 3,275 3,736 11,486 10,548
Research and development ...................... 3,605 3,942 11,406 12,477
General and administrative .................... 1,888 2,804 7,217 8,253
Amortization of intangible assets
and deferred compensation .............. 207 276 623 1,960
Restructuring expense ......................... -- 1,210 435 1,210
Gain on sale of subsidiary .................... -- -- (151) --
-------- -------- -------- --------
Total operating expenses .................. 8,975 11,968 31,016 34,448
-------- -------- -------- --------
Loss from operations ............................. (4,719) (7,603) (16,040) (22,149)
Other expense, net ............................... (12) (720) (322) (988)
-------- -------- -------- --------
Net loss ......................................... (4,731) (8,323) (16,362) (23,137)
-------- -------- -------- --------
Other comprehensive income (loss):
Foreign currency translation adjustments ...... (131) 30 75 (52)
Unrealized gain (loss) on marketable securities 71 371 (229) (220)
-------- -------- -------- --------
Other comprehensive income (loss) ................ (60) 401 (154) (272)
-------- -------- -------- --------
Comprehensive loss ............................... $ (4,791) $ (7,922) $(16,516) $(23,409)
======== ======== ======== ========
Basic and diluted net loss per share ............. $ (0.14) $ (0.31) $ (0.49) $ (0.87)
======== ======== ======== ========
Shares used to compute basic and diluted net loss
per share ..................................... 33,872 26,845 33,735 26,717
</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,
-------------------------
2000 1999
-------- --------
<S> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net cash used in operating activities ........ $(14,244) $(25,247)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of marketable securities ................... -- (5,975)
Proceeds from sale of marketable securities ......... 15,546 38,425
Proceeds from sale of subsidiary .................... 6,000 --
Proceeds from disposition of property and equipment . 406 262
Purchases of property and equipment ................. (889) (3,185)
-------- --------
Net cash provided by investing activities .... 21,063 29,527
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock .............. 495 459
Proceeds from borrowings ............................ 136 1,962
Repayments of debt and capital lease obligations .... (6,758) (5,257)
-------- --------
Net cash used in financing activities ........ (6,127) (2,836)
-------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH .......................... (148) (163)
-------- --------
INCREASE IN CASH AND CASH EQUIVALENTS ............................ 544 1,281
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................... 1,499 5,921
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD ......................... $ 2,043 $ 7,202
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest ........................................... $ 1,006 $ 1,418
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
5
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(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 food animal vaccine products that are marketed
and distributed by third parties. In addition to manufacturing veterinary
allergy products for marketing and sale by the Company, Heska's subsidiary,
CMG-Heska Allergy Products S.A. ("CMG"), a Swiss corporation, also manufactures
and sells human allergy products. The Company also offers diagnostic services to
veterinarians at its Fort Collins, Colorado location and through CMG.
From the Company's inception in 1988 until early 1996, the Company's
operating activities related primarily to research and development activities,
entering into collaborative agreements, raising capital and recruiting
personnel. Prior to 1996, the Company had not received any revenues from the
sale of products. During 1996, Heska grew from being primarily a research and
development concern to a fully-integrated research, development, manufacturing
and marketing company. The Company accomplished this by acquiring Diamond, a
licensed pharmaceutical and biological manufacturing facility in Des Moines,
Iowa, hiring key employees and support staff, establishing marketing and sales
operations to support Heska products introduced in 1996, and designing and
implementing more sophisticated operating and information systems. The Company
also expanded the scope and level of its scientific and business development
activities, increasing the opportunities for new products. In 1997, the Company
introduced additional products and expanded in the United States through the
acquisition of Center Laboratories, Inc. ("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 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
operations of Heska Waukesha were combined with existing operations in Fort
Collins, Colorado and Des Moines, Iowa during the fourth quarter of 1999. The
Heska Waukesha facility was closed in December 1999.
In the fourth quarter of 1999, the Company announced its intent to sell
Heska UK. The transaction was completed in March 2000.
During the second quarter of 2000, the Company sold its subsidiary,
Center Laboratories, Inc. The results of operations for the period include a
gain on the sale of approximately $151,000.
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
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and continues its research and development activities. Cumulative net losses
from inception of the Company in 1988 through September 30, 2000 have totaled
approximately $169.0 million.
The Company's ability to achieve profitable operations will depend
primarily upon its ability to successfully market and sell its products, the
product mix and gross margins associated with those products, the ability to
commercialize products that are currently under development, develop new
products and manage its expenses. Most of the Company's products are subject to
long development and regulatory approval cycles and there can be no guarantee
that the Company will successfully develop, manufacture or market these
products. There can also be no guarantee 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 guarantee 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 accounting principles generally accepted
in the U.S. 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,
2000, the statements of operations and comprehensive loss for the three and nine
months ended September 30, 2000 and 1999 and the statements of cash flows for
the nine months ended September 30, 2000 and 1999 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 accounting principles generally
accepted in the U.S. 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, 1999, included in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission on March 24, 2000.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the U.S. requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
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.
7
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Inventories, net
Inventories are stated at the lower of cost or market using the
first-in, first-out method. If the cost of inventories exceeds fair market
value, provisions are made for the difference between cost and fair market
value.
Inventories, net of provisions, consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
<S> <C> <C>
Raw materials .......................................... $ 2,915 $ 3,436
Work in process ........................................ 3,061 6,445
Finished goods ......................................... 3,341 4,076
------- -------
$ 9,317 $13,957
======= =======
</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.
License revenues received under arrangements to license patent rights
or technology rights are deferred and amortized over the life of the related
arrangement. No royalty revenue has been recognized to date. Royalties will be
recognized as products are sold to customers.
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. The Company defers
revenue recognition of advance payments received until research activities are
performed or development milestones are completed. The Company recognizes
revenue from sponsored research and development only after payments have been
received. Costs incurred in connection with the performance of sponsored
research and development are expensed as incurred.
In addition to its direct sales force, the Company utilizes both
distributors and sales agency organizations to sell its products. Distributors
purchase goods from the Company, take title to those goods and resell them to
their customers in the distributors' territory. Sales agents maintain
inventories of goods on consignment from the Company and sell these goods on
behalf of the Company to customers in the sales agents' territory. The Company
recognizes revenue at the time goods are sold to the customers by the sales
agents. Sales agents are paid a fee for their services, which include
maintaining product inventories, sales activities, billing and collections. Fees
earned by sales agents are netted against revenues generated by these entities.
In December 1999, the Securities and Exchange Commission ("SEC") staff
released Staff Accounting Bulletin No. 101, Revenue Recognition ("SAB 101"). SAB
101 provides interpretive guidance on the recognition, presentation and
disclosure of revenue in financial statements. The accounting impact of SAB 101
is continuing to be reviewed by industry and the accounting profession. The
accounting impact of SAB 101 is required to be determined no later than the
Company's fourth fiscal quarter of 2000. If the Company determines that its
revenue recognition policies must change to be in compliance with SAB 101 or any
revisions made to it, the implementation of SAB 101 is expected to be reflected
as a cumulative effect of change in accounting principle as if SAB 101 had been
implemented on January 1, 2000. The Company continues to review SAB 101 and all
additional interpretive guidance to determine what impact, if any, SAB 101 will
have on its financial position and results of operations.
Basic and Diluted Net Loss Per Share
The Company presents basic and diluted net loss per share in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings per
Share, which establishes standards for computing and presenting basic and
diluted earnings per share. Also, the Company has adopted the guidance of SEC
Staff Accounting Bulletin No. 98 and related interpretations. Basic net loss per
common share is computed using the
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weighted average number of common shares outstanding during the period. Diluted
net loss per share is computed using the sum of the weighted average number of
shares of common stock outstanding and, if not anti-dilutive, the effect of
outstanding stock options and warrants determined using the treasury stock
method. At December 31, 1999 and September 30, 2000, securities that have been
excluded from diluted net loss per share because they would be anti-dilutive are
outstanding options to purchase 4,246,183 and 4,008,024 shares, respectively, of
the Company's common stock and warrants to purchase 1,165,000 shares of the
Company's common stock as of each date.
Foreign Currency Translation
The functional currency of the Company's international subsidiaries is
the Swiss Franc. Assets and liabilities of the Company's international
subsidiaries are translated using the exchange rate in effect at the balance
sheet date. Revenue and expense accounts are translated using an average of
exchange rates in effect during the period. Cumulative translation gains and
losses, if material, are shown in the consolidated balance sheets as a separate
component of stockholders' equity. Exchange gains and losses arising from
transactions denominated in foreign currencies (i.e., transaction gains and
losses) are recognized in current operations. To date, the Company has not
entered into any forward contracts or hedging transactions.
3. RESTRUCTURING EXPENSES
During the first quarter of fiscal 2000, the Company initiated a cost
reduction and restructuring plan at its Diamond subsidiary. The restructuring
resulted from the rationalization of Diamond's business including a reduction in
the size of its workforce and the Company's decision to vacate a leased
warehouse and distribution facility no longer needed after the Company's
decision to discontinue contract manufacturing of certain low margin human
healthcare products. The charge to operations of approximately $435,000 related
primarily to personnel severance costs for 12 individuals and the costs
associated with closing the leased facility, terminating the lease and
abandoning certain leasehold improvements. The facility was closed in April
2000.
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. The Company recognized a charge to operations of approximately $1.2
million for this consolidation. These expenses related primarily to personnel
severance costs for 40 individuals and the costs associated with facilities
being closed and excess equipment, primarily at the Company's Waukesha,
Wisconsin location. This facility was closed in December 1999.
Shown below is a reconciliation of restructuring costs for the nine
months ended September 30, 2000 (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,
1999 September 30, 2000 September 30, 2000 2000
------------ ------------------ ------------------ -------------
<S> <C> <C> <C> <C>
Severance pay, benefits and relocation expenses .. $ 429 $ 121 $ (550) $ --
Noncancellable leased facility closure costs ..... 694 314 (773) 235
------- ------- ------- -------
Total ....................................... $ 1,123 $ 435 $(1,323) $ 235
======= ======= ======= =======
</TABLE>
The balances of $235,000 and $1.1 million are included in accrued
liabilities in the accompanying consolidated balance sheets as of September 30,
2000 and December 31, 1999, respectively.
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4. MAJOR CUSTOMERS
The Company had sales of greater than 10% of total revenue to three
customers during the three months and two customers during the nine months ended
September 30, 2000. These customers, which represented 45% of the Company's
total revenue for the three months ended September 30, 2000 and 26% of total
revenue for the nine months ended September 30, 2000, purchased food animal
vaccines from Diamond. One customer accounted for 11% of total revenues for the
three months ended September 30, 1999. No customer accounted for more than 10%
of total revenue during the nine months ended September 30, 1999.
5. SEGMENT REPORTING
The Company divides its operations into two reportable segments, Animal
Health, which includes the operations of Heska Fort Collins, Diamond, Heska
Waukesha, Heska UK and Heska AG, and Allergy Diagnostics and Treatment, which
includes the operations of Center and CMG. The operations of Heska Waukesha were
consolidated into the existing operations at Heska Fort Collins and Diamond as
of December 31, 1999. Heska UK was sold in March 2000 and Center was sold in
June 2000.
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, 2000:
Revenues ........................ $ 12,930 $ 209 $ (431) $ 12,708
Operating loss .................. (4,688) (31) -- (4,719)
Total assets .................... 75,628 823 (31,913) 44,538
THREE MONTHS ENDED SEPTEMBER 30, 1999:
Revenues ........................ $ 12,161 $ 1,649 $ (743) $ 13,067
Operating loss .................. (5,605) (44) (1,954)(b) (7,603)
Total assets .................... 110,732 7,818 (45,375) 73,175
</TABLE>
<TABLE>
<CAPTION>
ALLERGY
ANIMAL DIAGNOSTICS
HEALTH AND TREATMENT OTHER TOTAL
-------- ------------- ------- --------
<S> <C> <C> <C> <C>
NINE MONTHS ENDED SEPTEMBER 30, 2000:
Revenues ....................... $ 39,217 $ 4,001 $(1,904) $ 41,314
Operating loss ................. (15,444) (161) (435)(a) (16,040)
NINE MONTHS ENDED SEPTEMBER 30, 1999:
Revenues ....................... $ 34,230 $ 5,313 $(2,547) $ 36,996
Operating loss ................. (18,275) (116) (3,758)(b) (22,149)
</TABLE>
------------------
(a) Includes restructuring expenses of $435,000 (See Note 3).
(b) Includes restructuring expenses of $1.2 million (See Note 3).
The Company manufactures and markets its products in two major
geographic areas, North America and Europe. The Company's primary manufacturing
facilities are located in North America. Revenues earned in North America are
attributable to Heska Fort Collins, Diamond, and, for periods through June 2000,
Center. Revenues earned in Europe are primarily attributable to CMG and Heska
AG. There have been no significant exports from North America or Europe.
In the nine months ended September 30, 2000 and 1999, European
subsidiaries purchased products from North America for sale to European
customers. Transfer prices to international subsidiaries are intended to allow
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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 SEPTEMBER 30, 2000:
Revenues ........................ $ 12,720 $ 419 $ (431) $ 12,708
Operating loss .................. (4,384) (335) -- (4,719)
Total assets .................... 73,712 2,739 (31,913) 44,538
THREE MONTHS ENDED SEPTEMBER 30, 1999:
Revenues ........................ $ 12,733 $ 1,077 $ (743) $ 13,067
Operating loss .................. (5,765) (628) (1,210)(b) (7,603)
Total assets .................... 114,122 4,427 (45,374) 73,175
</TABLE>
<TABLE>
<CAPTION>
NORTH
AMERICA EUROPE OTHER TOTAL
-------- ------- ------- --------
<S> <C> <C> <C> <C>
NINE MONTHS ENDED SEPTEMBER 30, 2000:
Revenues ....................... $ 41,312 $ 1,906 $(1,904) $ 41,314
Operating loss ................. (14,831) (774) (435)(a) (16,040)
NINE MONTHS ENDED SEPTEMBER 30, 1999:
Revenues ....................... $ 36,413 $ 3,129 $(2,546) $ 36,996
Operating loss ................. (19,332) (1,607) (1,210)(b) (22,149)
</TABLE>
----------------
(a) Includes restructuring expenses of $435,000 (See Note 3).
(b) Includes restructuring expenses of $1.2 million (See Note 3).
6. NEW CREDIT FACILITY
In June 2000, the Company entered into a two-year expanded $13.1
million credit facility with Wells Fargo Business Credit, Inc., an affiliate of
Wells Fargo Bank. The credit facility includes a $10.0 million asset based
revolving line of credit. Under the agreement, the Company is required to comply
with certain financial and non-financial covenants. Among the financial
covenants are requirements for monthly minimum book net worth, quarterly minimum
net income and minimum cash balances or liquidity levels. The Company was in
compliance with all financial covenants at September 30, 2000.
7. RECENT ACCOUNTING PRONOUNCEMENTS
In July 2000, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") reached final consensus on two issues which
are required to be applied no later than the fourth quarter of our fiscal year
2000. EITF No. 00-10, "Accounting for Shipping and Handling Fees and Costs,"
states that all amounts billed to customers for shipping and handling in a sales
transaction must be included as revenue. The EITF was not asked to reach a final
conclusion on the classification of costs incurred by the seller for shipping
and handling. EITF No. 00-14, "Accounting for Certain Sales Incentives,"
requires that all costs for rebates and other sales discounts be accounted for
as a reduction in revenue in the income statement of the seller. Also, the EITF
stated that free goods or services given as a sales incentive should be
classified as operating expenses in the seller's income statement. Upon
application of these pronouncements, comparative financial statements for prior
periods will be reclassified to comply with the new classification guidelines.
The Company does not expect these EITF pronouncements to have a material impact
on its financial position or results of operations.
In July 2000, the EITF began discussing EITF Issue No. 00-21,
"Accounting for Multiple-Element Arrangements." This issue will provide guidance
on accounting for revenue arrangements with multiple elements that may have
obligations for performance extending over a period of time.
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In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation" ("FIN No. 44"). FIN No. 44
clarifies the application of APB No. 25 for certain issues related to equity
based instruments issued to employees. FIN No. 44 is effective on July 1, 2000,
except for certain transactions, and will be applied on a prospective basis. The
Company believes that FIN No. 44 will not have a significant impact on its
financial position or results of operations.
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. Our 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. We
expressly disclaim any obligation or undertaking to release publicly any updates
or revisions to any forward-looking statements contained herein to reflect any
change in our expectations with regard thereto or any change in events,
conditions, or circumstances on which any such statement is based.
OVERVIEW
We are primarily focused on the discovery, development and marketing of
companion animal health products. In addition to manufacturing certain of our
companion animal products, our primary manufacturing subsidiary, Diamond, also
manufactures food animal vaccine products that are marketed and distributed by
third parties. In addition to manufacturing veterinary allergy products for
marketing and sale in Europe, our subsidiary, CMG, also manufactures and sells
human allergy products. We also offer diagnostic services to veterinarians at
our Fort Collins, Colorado location and at CMG.
From our inception in 1988 until early 1996, our operating activities
related primarily to research and development activities, entering into
collaborative agreements, raising capital and recruiting personnel. Prior to
1996, we had not received any revenues from the sale of products. During 1996,
we grew from being primarily a research and development concern to a
fully-integrated research, development, manufacturing and marketing company. We
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 our products
introduced in 1996, and designing and implementing more sophisticated operating
and information systems. We also expanded the scope and level of our scientific
and business development activities, increasing the opportunities for new
products. In 1997, we introduced additional products and expanded in the United
States through the acquisition of Center, an FDA and USDA licensed manufacturer
of allergy immunotherapy products located in New York, and internationally
through the acquisitions of Heska UK, a veterinary diagnostic laboratory in
England and CMG in Switzerland, which manufactures and markets allergy
diagnostic products for use in veterinary and human medicine, primarily in
Europe. Each of our acquisitions during this period was accounted for under the
purchase method of accounting and accordingly, our financial statements reflect
the operations of these businesses only for the periods subsequent to the
acquisitions. In 1997, we established a new subsidiary, Heska AG, located near
Basel, Switzerland, for the purpose of managing our European operations.
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During the first quarter of 1998, we acquired a manufacturer and
marketer of patient monitoring devices. The financial results of this entity
have been consolidated with ours under the pooling-of-interests accounting
method for all periods presented. These operations were consolidated with our
existing operations in Fort Collins, Colorado and Des Moines, Iowa as of
December 31, 1999, and our facility in Waukesha, Wisconsin was closed.
In December 1999, we announced our intent to sell our subsidiary in the
United Kingdom, Heska UK. The sale was completed in March 2000.
We announced the completion of the sale of Center in late June 2000.
The second quarter 2000 statement of operations reflects a gain on the sale of
approximately $151,000.
We have incurred net losses since our inception and anticipate that we
will continue to incur additional net losses in the near term as we introduce
new products, expand our sales and marketing capabilities and continue our
research and development activities. Cumulative net losses from our inception in
1988 through September 30, 2000 have totaled approximately $169.0 million.
Our ability to achieve profitable operations will depend primarily upon
our ability to successfully market and sell our products, the product mix and
gross margins associated with those products, our ability to commercialize
products that are currently under development and to develop new products. Most
of our products are subject to long development and regulatory approval cycles
and there can be no assurance that we will successfully develop, manufacture or
market these products. There can also be no assurance that we will attain
profitability or, if achieved, will remain profitable on a quarterly or annual
basis in the future. Until we attain positive cash flow, we expect to seek
additional financing. See the discussion later in this section titled "Factors
That May Affect Results" for a more in-depth explanation of risks faced by us.
See "Risk Factor--We may need to seek additional financing in the future in
order to continue our operations."
RESULTS OF OPERATIONS
Three Months Ended September 30, 2000 and 1999
Total revenues, which include product and research, development and
other revenues, decreased 3% to $12.7 million in the third quarter of 2000
compared to $13.1 million for the third quarter of 1999. Product revenues
decreased 4% to $12.4 million in the third quarter of 2000 compared to $12.9
million for the third quarter of 1999. These decreases are attributable to the
sale and elimination of unprofitable businesses and product lines during the
past year, as part of the restructuring of our business. The growth in product
revenue from our continuing core business was approximately 30% for the three
months ended September 30, 2000 as compared to the same period in 1999.
Revenues from research, development and other increased to $312,000 in
the third quarter of 2000 compared to $152,000 in the third quarter of 1999.
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 $8.5 million in the third quarter of 2000
compared to $8.7 million in the third quarter of 1999. The decrease in cost of
goods sold was attributable to lower product sales. The gross profit margin on
product sales in the third quarter of 2000 was 31.8%, down from approximately
32.6% in the third quarter of 1999. The decline in gross profit margin was
primarily attributable to the product sales mix in the current quarter, as
revenue growth occurred primarily in vaccine products from Diamond and
veterinary medical instrumentation, both of which have lower gross profit
margins than our proprietary companion animal products.
Selling and marketing expenses decreased to $3.3 million in the third
quarter of 2000 from $3.7 million in the third quarter of 1999. This decrease is
due to the sale of certain unprofitable businesses.
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Research and development expenses decreased to $3.6 million in the
third quarter of 2000 from $3.9 million in the third quarter of 1999.
Fluctuations in research and development expenses are generally the result of
the number of research projects in progress.
General and administrative expenses decreased to $1.9 million in the
third quarter of 2000 from $2.8 million in the third quarter of 1999. This
decrease is due to sale of certain unprofitable businesses and the elimination
of costs resulting from the restructuring of our business.
Amortization of intangible assets and deferred compensation decreased
to $207,000 in the third quarter of 2000 from $276,000 in the third quarter of
1999. The decrease in amortization expense in 2000 is due primarily to the
completed amortization of certain intangible assets and the write-off of
intangible assets related to the sale of Heska UK and certain other intangible
assets in 1999. Intangible assets resulted primarily from the Company's 1997 and
1998 business acquisitions and are being amortized over lives of 6 to 10 years.
The amortization of deferred compensation resulted in a non-cash charge to
operations in the third quarter of 2000 of $140,000 compared to $161,000 in the
third quarter of 1999. 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,
are being recognized over the service period.
Nine Months Ended September 30, 2000 and 1999
Total revenues, which include product, research, development and other
revenues, increased by nearly 12% to $41.3 million in the first nine months of
2000 compared to $37.0 million for the same period of 1999. Product revenues
increased by approximately 6% to $38.5 million in the first nine months of 2000
compared to $36.5 million for the same period of 1999. The growth in revenues
during 2000 was primarily due to improved sales of veterinary medical
instrumentation and vaccines, plus the sales of new products introduced by the
Company during 2000. The growth in product revenue from our continuing core
business was approximately 38% during the first three quarters of 2000 compared
to the same period in 1999.
Research, development and other revenue increased to $2.8 million in
the first nine months of 2000 from $518,000 in the first nine months of 1999.
This increase is primarily attributable to the sale of the PERIOceutic(TM) Gel
product in the first quarter of 2000. 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 $26.3 million in the first nine months of
2000 compared to $24.7 million in the first nine months of 1999. The increase in
cost of goods sold was attributable to increased product sales. Gross profit
margins on products sold during the nine month period ended September 30, 2000
decreased slightly to 31.7% from 32.3% in the same period of 1999. The decline
in gross profit margin was primarily attributable to the product sales mix year
to date, as revenue growth occurred primarily in vaccine products from Diamond
and veterinary medical instrumentation, both of which have lower gross profit
margins than our proprietary companion animal products.
Selling and marketing expenses increased to $11.5 million in the first
nine months of 2000 from $10.5 million in the first nine months of 1999. 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. These increases have been partially offset by decreases from the sale
of unprofitable businesses.
Research and development expenses decreased to $11.4 million in the
first nine months of 2000 from $12.5 million in the first nine months of 1999.
Fluctuations in research and development expenses are generally the result of
the number of research projects in progress.
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General and administrative expenses decreased to $7.2 million in the
first nine months of 2000 from $8.3 million in the first nine months of 1999.
This decrease is due to sale of certain unprofitable businesses and the
elimination of costs from the restructuring of our business.
Amortization of intangible assets and deferred compensation decreased
to $623,000 in the first nine months of 2000 from $2.0 million in the first nine
months of 1999. The decrease in amortization expense in 2000 is due primarily to
the completed amortization of certain intangible assets and the write-off of
intangible assets related to the sale of Heska UK and certain other intangible
assets in 1999. Intangible assets resulted primarily from the Company's 1997 and
1998 business acquisitions and are being amortized over lives of 6 to 10 years.
The amortization of deferred compensation resulted in a non-cash charge to
operations in the first nine months of 2000 of $434,000 compared to $478,000 in
the first nine months of 1999.
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of liquidity at September 30, 2000 are our $9.4
million in cash, cash equivalents and marketable securities and our expanded
$10.0 million asset based revolving line of credit. In June 2000, we entered
into the two-year credit facility with Wells Fargo Business Credit, an affiliate
of Wells Fargo Bank. This credit facility requires us to maintain certain
minimum financial covenants including book net worth, net income and cash
balances or liquidity levels.
Cash used in operating activities was $14.2 million in the first nine
months of 2000, compared to $25.2 million in the first nine months of 1999. The
decrease in cash used for operating activities for the first three quarters of
2000 compared to the same period in 1999 was primarily due to a decrease of
approximately $6.8 million in the net loss for the period and lower inventory
increases in the first nine months of 2000 versus the same period in 1999.
Our investing activities provided $21.1 million in the first nine
months of 2000, compared to $29.5 million during the first nine months of 1999.
Net cash provided by investing activities was primarily related to the net sale
of marketable securities to fund our business operations and the sale of one of
our subsidiaries. During the second quarter of 2000, we sold Center for $6.0
million. Expenditures for property and equipment totaled $889,000 for the first
nine months of 2000 compared to $3.2 million in the first nine months of 1999.
We currently expect to spend approximately $1.3 million in 2000 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.
Our financing activities used $6.1 million in the first nine months of
2000 compared to $2.8 million in the first nine months of 1999. Repayments of
debt and capital lease obligations totaled $6.8 million in the first nine months
of 2000 compared to $5.3 million in the first nine months of 1999. We received
$136,000 in proceeds from borrowings during the first nine months of 2000
compared to $2.0 million in the comparable period in 1999.
Our primary short-term needs for capital, which are subject to change,
are for our continuing research and development efforts, our sales, marketing
and administrative activities, working capital associated with increased product
sales and capital expenditures relating to developing and expanding our
manufacturing operations. Our future liquidity and capital requirements will
depend on numerous factors, including the extent to which our present and future
products gain market acceptance, the extent to which products or technologies
under research or development are successfully developed, the timing of
regulatory actions regarding our 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 our business and the results of competition.
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We believe that our available cash, cash equivalents and marketable
securities, together with cash from operations, available borrowings and
borrowings we expect to be available under our revolving line of credit facility
will be sufficient to satisfy our projected cash requirements into mid-2001, and
we expect to raise additional cash at or before such time. See "Risk Factor--We
may need to seek additional financing in the future in order to continue our
operations."
NET OPERATING LOSS CARRYFORWARDS
As of December 31, 1999, we had a net operating loss carryforward of
approximately $127.5 million and approximately $2.7 million of research and
development 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 2019.
Our 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, we will be limited in the amount of NOL's incurred prior to the merger
that we may utilize to offset future taxable income. This limitation will total
approximately $4.7 million per year for periods subsequent to the Diamond
acquisition. Similar limitations also apply to utilization of R&D tax credits to
offset taxes payable. We believe that this limitation may affect the eventual
utilization of our total NOL carryforwards.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission ("SEC") staff
released Staff Accounting Bulletin No. 101, Revenue Recognition ("SAB 101"). SAB
101 provides interpretive guidance on the recognition, presentation and
disclosure of revenue in financial statements. The accounting impact of SAB 101
is continuing to be reviewed by industry and the accounting profession. The
accounting impact of SAB 101 is required to be determined no later than our
fourth fiscal quarter of 2000. If we determine that our revenue recognition
policies must change to be in compliance with SAB 101 or any revisions made to
it, the implementation of SAB 101 is expected to be reflected as a cumulative
effect of change in accounting principle as if SAB 101 had been implemented on
January 1, 2000. We continue to review SAB 101 and all additional interpretive
guidance to determine what impact, if any, SAB 101 will have on our financial
position and results of operations.
In July 2000, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") reached final consensus on two issues which
are required to be applied no later than the fourth quarter of our fiscal year
2000. EITF No. 00-10, "Accounting for Shipping and Handling Fees and Costs,"
states that all amounts billed to customers for shipping and handling in a sales
transaction must be included as revenue. The EITF was not asked to reach a final
conclusion on the classification of costs incurred by the seller for shipping
and handling. EITF No. 00-14, "Accounting for Certain Sales Incentives,"
requires that all costs for rebates and other sales discounts be accounted for
as a reduction in revenue in the income statement of the seller. Also, the EITF
stated that free goods or services given as a sales incentive should be
classified as operating expenses in the seller's income statement. Upon
application of these pronouncements, comparative financial statements for prior
periods will be reclassified to comply with the new classification guidelines.
We do not expect these EITF pronouncements to have a material impact on our
financial position or results of operations.
In July 2000, the EITF began discussing EITF Issue No. 00-21,
"Accounting for Multiple-Element Arrangements." This issue will provide guidance
on accounting for revenue arrangements with multiple elements that may have
obligations for performance extending over a period of time.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation" ("FIN No. 44"). FIN No. 44
clarifies the application of APB No. 25 for certain issues related to equity
based instruments issued to employees. FIN No. 44 is effective on July 1, 2000,
except for certain transactions, and will be applied on a prospective basis. We
believe that FIN No. 44 will not have a significant impact on our financial
position or results of operations.
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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, 2000,
our accumulated deficit was approximately $169.0 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 sales and marketing and general and administrative
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 may need to seek additional financing in the future in order to continue our
operations.
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. Moreover, based on our current projections, we will need to
raise additional cash in 2001. We expect to raise this additional cash through
one or more of the following:
o sale of additional securities;
o sale of certain assets;
o licensing of technology; and
o sale of certain marketing rights.
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 additional 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.
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 USDA, FDA, EPA 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, FDA, 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 must maintain certain financial and other covenants under our revolving line
of credit agreement.
Under our revolving line of credit agreement with Wells Fargo Business
Credit, Inc., we are required to comply with certain financial and non-financial
covenants and we have made various representations and warranties. Among the
financial covenants are requirements for monthly minimum book net worth, minimum
quarterly net income and minimum cash balances or liquidity levels. Failure to
comply with any of the covenants, representations or warranties would negatively
impact our ability to borrow under the agreement. Our inability to borrow to
fund our operations could materially harm our business.
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 two Diamond customers comprised
approximately 26% of total revenues in the first nine months of 2000. No
customer accounted for more than 10% of total revenue during the nine months
ended September 30, 1999.
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
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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., Schering Plough Corporation, Pharmacia &
Upjohn, 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 have substantially greater financial, technical, research
and other resources and larger, better-established marketing, sales,
distribution and service organizations than us. 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, Eisai and Ralston Purina. Novartis has the
right to manufacture and market throughout the world (except in countries where
Eisai has such rights) under the Novartis trade name 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 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.
Eisai has exclusive rights in Japan and most countries in East Asia to market
our feline and canine heartworm vaccines and our feline and canine flea control
vaccines. In addition, we granted Ralston Purina the exclusive rights to develop
and commercialize our discoveries, know-how and technologies in various
companion animal nutritional 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, Eisai or
Ralston Purina or any other collaborative party will devote sufficient resources
to marketing our products. Furthermore, there is nothing to prevent Novartis,
Eisai or Ralston Purina 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
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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 certain heartworm diagnostic
technology and this litigation remains ongoing. We cannot assure you that we
will not become subject to additional patent infringement claims and litigation
in the United States or other countries or interference proceedings conducted in
the United States Patent and Trademark Office to determine the priority of
inventions. The defense and prosecution of intellectual property suits, USPTO
interference proceedings, and related legal and administrative proceedings are
costly, time-consuming and distracting. We may also need to pursue litigation to
enforce any patents issued to us or our collaborative partners, to protect trade
secrets or know-how owned by us or our collaborative partners, or to determine
the enforceability, scope and validity of the proprietary rights of others. Any
litigation or interference proceeding will result in substantial expense to us
and significant diversion of the efforts of our technical and management
personnel. Any adverse determination in litigation or interference proceedings
could subject us to significant liabilities to third parties. Further, as a
result of litigation or other proceedings, we may be required to seek licenses
from third parties which may not be available on commercially reasonable terms,
if at all.
We license technology from a number of third parties. The majority of
these license agreements impose due diligence or milestone obligations on us,
and in some cases impose minimum royalty and/or sales obligations on us, in
order for us to maintain our rights under these agreements. Our products may
incorporate technologies that are the subject of patents issued to, and patent
applications filed by, others. As is typical in our industry, from time to time
we and our collaborators have received, and may in the future receive, notices
from third parties claiming infringement and invitations to take licenses under
third-party patents. It is our policy that when we receive such notices, we
conduct investigations of the claims they assert. With respect to the notices we
have received to date, we believe, after due investigation, that we have
meritorious defenses to the infringement claims asserted. Any legal action
against us or our collaborators may require us or our collaborators to obtain
one or more licenses in order to market or manufacture affected products or
services. However, we cannot assure you that we or our collaborators will be
able to obtain licenses for technology 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. Center was sold in June 2000. 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 facility. We currently have a supply agreement
with Quidel Corporation for certain manufacturing services relating to our
point-of-care diagnostic tests. Third parties also manufacture our patient
monitoring instruments
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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 may 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 agreements with certain of the suppliers of the veterinary medical
devices require us to meet minimum annual sales levels to maintain our position
as the exclusive distributor of these devices. We cannot assure that we will
meet these minimum sales levels in 2000, or in the future, and maintain
exclusivity over the distribution and sale of these products. If we are not the
exclusive distributor of these products, competition may increase.
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 FDA, USDA 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 could
substantially harm our business, financial condition or results of operations.
We cannot assure you that we will not incur significant costs to comply with
laws and regulations in the future or that new laws and regulations will not
substantially harm our business.
We depend on partners in our research and development activities.
For certain of our proposed products, we are dependent on collaborative
partners to successfully and timely perform research and development activities
on our behalf. We cannot assure you that these collaborative partners will
complete research and development activities on our behalf in a timely fashion,
or at all. If our collaborative partners fail to complete research and
development activities, or fail to complete them in a timely fashion, our
business could be substantially harmed.
We depend on key personnel for our future success.
Our future success is substantially dependent on the efforts of our
senior management and scientific team. The loss of the services of members of
our senior management or scientific staff may significantly delay 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.
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We may face product liability litigation and the extent of our insurance
coverage is limited.
The testing, manufacturing and marketing of our current products as well
as those currently under development entail an inherent risk of product
liability claims and associated adverse publicity. To date, we have not
experienced any material product liability claims, but any claim arising in the
future could substantially harm our business. Potential product liability claims
may exceed the amount of our insurance coverage or may be excluded from coverage
under the terms of the policy. We cannot assure you that we will be able to
continue to obtain adequate insurance at a reasonable cost, if at all. In the
event that we are held liable for a claim against which we are not indemnified
or for damages exceeding the limits of our insurance coverage or which results
in significant adverse publicity against us, our business could be substantially
harmed.
Side effects of our products may generate adverse publicity.
Following the introduction of a product, adverse side effects may be
discovered that make a product no longer commercially viable. Publicity
regarding such adverse effects could affect sales of our other products for an
indeterminate time period. We are dependent on the acceptance of our products by
both veterinarians and pet owners. If we fail to engender confidence in our
products and services, our ability to attain and sustain market acceptance of
our products could be substantially harmed.
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.
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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 due to adverse changes in
financial and commodity market prices and rates. We are 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 our normal operating and funding
activities. Historically and as of September 30, 2000, we have not used
derivative instruments or engaged in hedging activities.
Interest Rate Risk
The interest payable on our revolving line of credit and certain other
borrowings is variable based on the United States prime rate and, therefore,
affected by changes in market interest rates. At September 30, 2000,
approximately $3.7 million was outstanding on this line of credit and other
borrowings with a weighted average interest rate of 10.7%. We manage interest
rate risk by investing excess funds principally in cash equivalents or
marketable securities which bear interest rates that reflect current market
yields. Additionally, we monitor interest rates and at September 30, 2000 had
sufficient cash balances to pay off the lines of credit should interest rates
increase significantly. As a result, we do not believe that reasonably possible
near-term changes in interest rates will result in a material effect on our
future earnings, financial position or cash flows.
Foreign Currency Risk
At September 30, 2000, we had wholly-owned subsidiaries located in
Switzerland. Sales from these operations are denominated in Swiss Francs or
Euros, thereby creating exposures to changes in exchange rates. The changes in
the Swiss/U.S. exchange rate or Euro/U.S. exchange rate may positively or
negatively affect our sales, gross margins and retained earnings. We do 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, and
therefore, have 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 Swiss Franc
or Euro.
PART II. OTHER INFORMATION
ITEM 2. (c) CHANGES IN SECURITIES AND USE OF PROCEEDS
In July 2000, the Registrant issued 2,527 shares of Common Stock to a
consultant in consideration of services rendered in accordance with the terms of
his consulting agreement between the Registrant the consultant. The Registrant
relied upon the exemption provided by Section 4(2) of the Act.
The recipient of the above-described securities represented his intention to
acquire the securities for investment only and not with a view to distribution
thereof. Appropriate legends were affixed to the stock certificates issued in
such transaction. The recipient had adequate access, through employment or other
relationships, to information about the Registrant.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See Exhibit Index on Page 26
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the
quarter ended September 30, 2000.
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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 13, 2000 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)
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EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Description of Document
-------------- -----------------------
<S> <C>
27 Financial Data Schedule
</TABLE>
