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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 JuneSeptember 30, 1998
orOR
[ ] 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.[ I.R.S. Employer Identification No.]
of incorporation or organization]
1825 SHARP POINT DRIVE
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
August 10,November 11, 1998 was 26,447,87626,530,655
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HESKA CORPORATION
FORM 10-Q
QUARTERLY REPORT
TABLE OF CONTENTS
PAGE
------------
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets (Unaudited) as of JuneSeptember 30, 1998 (Unaudited) and
December 31, 1997 (Restated) ........................................................................................................................................... 1
Condensed Consolidated Statements of Operations (Unaudited) for the three months and
sixnine months ended JuneSeptember 30, 1998 and 1997 (Restated) ................................................................................ 2
Condensed Consolidated Statements of Cash Flows (Unaudited) for the sixnine months ended
JuneSeptember 30, 1998 and 1997 (Restated) ............................................................................................................... 3
Notes to Condensed Consolidated Financial Statements (Unaudited) ..................................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.....Operations........ 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk ................................................................. Not Applicable
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.........................................................................Proceedings............................................................................ Not Applicable
Item 2. Changes in Securities and Use of Proceeds................................................. 24Proceeds.................................................... 26
Item 3. Defaults Upon Senior Securities...........................................................Securities.............................................................. Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders ...................................... 24Holders.......................................... Not Applicable
Item 5. Other Information......................................................................... 25Not Applicable......................................................................... Not Applicable
Item 6. Exhibits and Reports on Form 8-K.......................................................... 258-K............................................................. 26
Exhibit Index......................................................................................... 26
Signatures ...........................................................................................Index............................................................................................ 27
Signatures............................................................................................... 28
i
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HESKA CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
(unaudited)
ASSETS
JuneSeptember 30, December 31,
1998 1997
-------------
--------------- -------------
Current assets: (unaudited) (restated)
Cash and cash equivalents $ 6,8276,574 $ 10,679
Marketable securities 47,93354,595 18,073
Accounts receivable, net 5,3225,999 5,327
Inventories, net 13,16913,852 10,562
Other current assets 2,1151,593 1,236
------------- ----------------------- ---------
Total current assets 75,36682,613 45,877
Property and equipment, net 17,38820,558 15,979
Intangible assets, net 5,5345,180 6,009
Restricted marketable securities and other assets 782751 1,155
------------- ----------------------- ---------
Total assets $ 99,070109,102 $ 69,020
============= ======================= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,2905,590 $ 6,425
Accrued liabilities 2,5882,663 2,968
Deferred revenue 1,3231,658 284
Current portion of capital lease obligations 611586 600
Current portion of long-term debt 5,3585,538 4,137
------------- ----------------------- ---------
Total current liabilities 15,17016,035 14,414
Capital lease obligations, less current portion 1,4181,254 1,620
Long-term debt, less current portion 8,83710,527 9,021
Accrued pension liability 113 113
------------- ----------------------- ---------
Total liabilities 25,53827,929 25,168
---------- ---------
Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value, 40,000,000 shares authorized; 24,999,97926,492,344
and 18,854,015 shares issued and outstanding, respectively 2526 19
Additional paid-in capital 167,526185,327 118,448
Deferred compensation (1,572)(1,444) (1,967)
Stock subscription receivable from officers (163)(118) (158)
Cumulative translation adjustment (19)Accumulated other comprehensive income 499 1
Accumulated deficit (92,265)(103,117) (72,491)
------------- ----------------------- ---------
Total stockholders' equity 73,53281,173 43,852
------------- ----------------------- ---------
Total liabilities and stockholders' equity $ 99,070109,102 $ 69,020
============= ======================= ========
See accompanying notes to condensed consolidated financial statements
1
HESKA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended JuneSeptember 30, SixNine Months Ended JuneSeptember 30,
------------------------------ ------------------------------------------------------------- -------------------------------
1998 1997 1998 1997
------------- ------------- ------------- ------------------------- ---------- ------------ -----------
(restated) (restated)
Revenues:
Products, net $ 9,1009,823 $ 5,8706,834 $ 16,49026,313 $ 10,37617,211
Research and development 119 199 639 637
------------- ------------- ------------- -------------
9,219 6,069 17,129 11,01338 396 677 1,033
------------ ---------- ------------ -----------
9,861 7,230 26,990 18,244
Costs and operating expenses:
Cost of goods sold 6,751 4,179 11,562 7,5888,034 4,877 19,596 12,465
Research and development 6,502 5,589 12,680 10,1946,311 4,747 18,991 14,942
Selling and marketing 2,868 2,295 5,958 4,2323,159 2,526 9,117 6,757
General and administrative 2,826 3,705 5,826 6,3553,065 2,987 8,891 9,411
Amortization of intangible assets and deferred
compensation 672 464 1,437 1,114650 631 2,087 1,746
Purchased research and development - 2,468 - 2,468
------------- ------------- ------------- -------------
19,619 18,700 37,463 31,951
------------- ------------- ------------- --------------- -- -- 2,399
------------ ---------- ------------ -----------
21,219 15,768 58,682 47,720
------------ ---------- ------------ -----------
Loss from operations (10,400) (12,631) (20,334) (20,938)(11,358) (8,538) (31,692) (29,476)
Other income (expense):
Interest income 897 152 1,472 448879 621 2,351 1,069
Interest expense (468) (235) (938) (451)(521) (371) (1,459) (821)
Other, net 16 (58) 28 (88)
------------- ------------- ------------- -------------147 (11) 175 (100)
------------ ---------- ------------ -----------
Net loss $ (9,955)(10,853) $ (12,772)(8,299) $ (19,772)(30,625) $ (21,029)(29,328)
============ ========== ============= ============= ============= ========================
Basic net loss per share $ (0.40)(0.42) $ (0.86)
============= =============(1.27)
============ ============
Unaudited pro forma basic net loss per share $ (0.96)(0.45) $ (1.61)
============= =============(1.97)
========== ===========
Shares used to compute basic net loss per share and
unaudited pro forma basic net loss per share 24,920 13,279 23,086 13,100
============= ============= ============= =============26,023 18,413 24,077 14,897
============ ========== ============ ===========
See accompanying notes to condensed consolidated financial statements.
2
HESKA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
SixNine Months Ended JuneSeptember 30,
------------------------------
1998 1997
------------- ---------------------- ---------
CASH FLOWS USED IN OPERATING ACTIVITIES: (restated)
Net cash used in operating activities $ (20,343)(29,875) $ (16,722)
------------- -------------(23,942)
CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of marketable securities (64,977) -
Proceeds from sale of marketable securities 35,292 14,227
Purchases of property and equipment (2,857) (3,750)
Additions to intangible assets (551) (74)--------- ---------
Acquisitions of businesses, net of cash acquired - (258)(13) (2,088)
Cash deposited in restricted cash account related to Bloxham
acquisition - (244)
------------- --------------- (241)
Additions to intangible assets (687) (110)
Purchase of marketable securities (116,062) (18,635)
Proceeds from sale of marketable securities 80,363 18,227
Purchases of property and equipment (4,785) (5,757)
--------- ---------
Net cash (used in) provided byused in investing activities (33,093) 9,901
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:(41,184) (8,604)
--------- ---------
Proceeds from issuance of common stock 49,084 1,13464,591 45,325
Proceeds from stock subscription receivable 51 --
Proceeds from borrowings 3,869 2,6048,068 4,574
Repayment of debt and capital lease obligations (3,368) (1,252)
------------- -------------(5,758) (2,103)
--------- ---------
Net cash provided by financing activities 49,585 2,486
------------- -------------66,952 47,796
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (1) 7
------------- -------------
DECREASE2 (6)
--------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (3,852) (4,328)(4,105) 15,244
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 10,679 6,630
------------- ---------------------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 6,8276,574 $ 2,302
============= =============21,874
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 9181,434 $ 372769
Non-cash investing and financing activities:activities
Issuance of debt related to acquisitions - 320-- 3,036
Issuance of common and preferred stock related to acquisitions,
net of cash acquired 6,997 3,1167,191 3,047
Issuance of common stock in exchange for assets and as repayment of debt 2,262 --
Purchase of assets under direct capital lease financing - 25584 281
See accompanying notes to condensed consolidated financial statements
3
HESKA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNESEPTEMBER 30, 1998 (UNAUDITED)
1. ORGANIZATION AND BASIS OF PRESENTATION
Organization
Heska Corporation (the "Company", or "Heska") discovers, develops,
manufactures and markets companion animal health products, primarily for dogs,
cats and horses. The Company operates two United States Department of
Agriculture and Food and Drug Administration licensed facilities which
manufacture products for Heska and other companies. The Company also offers
diagnostic products to veterinarians at its Fort Collins, Colorado location and
in the United Kingdom through a wholly-
ownedwholly-owned subsidiary. In May 1997, the
Company reincorporated in Delaware.
In the first quarter of 1998 the Company added patient monitoring equipment
to its product lines through its acquisition of Sensor Devices, Inc. ("SDI")(See
Note 4). The acquisition of SDI has been accounted for using the pooling-of-interestspooling-of-
interests accounting method and, accordingly, the accompanying consolidated
financial statements of the Company have been restated to include the accounts
of SDI for all periods presented.
The Company continues to incur substantial net losses due principally to
expenses associated with its research and development and sales and marketing
activities.activities and, more recently, to slow sales of its proprietary pharmaceutical
and diagnostic products. Cumulative net losses from inception of the Company in
1988 through JuneSeptember 30, 1998 have totaled $92.3$103.1 million.
The Company's ability to achieve profitable operations will depend
primarily upon its ability to successfully market its products, to commercialize
products that are currently under development, to successfully develop new products and
to successfullyefficiently 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 also can be no assurance that the Company's existing or
future products will achieve market acceptance. 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.
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 sheets as of JuneSeptember 30, 1998 and December
31, 1997, the statements of operations for the three months and sixnine months
ended JuneSeptember 30, 1998 and 1997 and the statements of cash flows for the sixnine
months ended JuneSeptember 30, 1998 and 1997 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
theits 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 (See Note 4). All material intercompany transactions and balances
4
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
4
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, 1997,
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission on March 23, 1998.
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.
Revenue Recognition
Revenues from products and services 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 period until research activities are
performed or development milestones are completed.
2. UNAUDITED PRO FORMA BASIC NET LOSS PER SHARE
The Company has computed net loss per share in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, Earnings"Earnings per Share,Share", which the
Company adopted in 1997. Also, the Company has adopted the guidance of
Securities and Exchange Commission ("SEC") Staff Accounting Bulletin ("SAB") No.
98 and related interpretations. Due to the automatic conversion of all shares of
convertible preferred stock into common stock following the closing of the
Company's initial public offering in July 1997 (the "IPO"), historical basic net
loss per common share is not considered meaningful as it would differ materially
from the pro forma net loss per common share and common stock equivalent shares
given the changes in the capital structure of the Company.
Pro forma basic net loss per common share is computed using the weighted
average number of common shares outstanding during the period. Diluted net loss
per common share is not presented as the effect of common equivalent shares from
stock options and warrants is anti-dilutive. The Company has assumed the
conversion of convertible preferred stock issued into common stock for all
periods presented.
Prior to the current period and pursuant to SEC SAB No. 83 rules, common
stock and common stock equivalent shares issued by the Company during the 12
months immediately preceding the filing of the IPO, plus
5
shares which became issuable during the same period as a result of the granting
of options to purchase common stock ("SAB 83 Shares"), were included in the
calculation of basic weighted average number of shares of common stock as if
they were outstanding for all periods presented (using the treasury stock
method), regardless of
5
whether they were anti-dilutive. In February 1998 the SEC
issued SAB No. 98 which replaced SAB 83 in its entirety. As a result, SAB 83
Shares which were originally included in the previously reported 1997 weighted
average common shares outstanding have now been excluded in the restated 1997
weighted average common shares outstanding. The effect of the adoption of SAB 98
was as follows (per share amounts for 1997 have been restated to include the
effects of the SDI acquisition recorded under the pooling-of-interests
accounting method (see Note 4)):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNEThree Months Ended Nine Months Ended
September 30, 1997 JUNESeptember 30, 1997
------------------ ----------------------------------
Pro forma basic net loss per share as reported (restated)....................... $ (0.88) $ (1.47)....... $(0.45) $(1.87)
Impact of adoption of SAB 98.................................................... (0.08) (0.14)
------------------ ----------------98..................................... - (0.10)
------- ------
Unaudited pro forma basic net loss per share (restated)......................... $ (0.96) $ (1.61)
================== ================.......... $(0.45) $(1.97)
====== ======
The following table shows the reconciliation of the numerators and
denominators of the basic net loss per share and pro forma basic net loss per
share computations as required under SFAS No. 128 (in thousands, except per
share amounts):
FOR THE THREE MONTHS ENDED JUNEFor the Three Months Ended September 30, 1998
-------------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT---------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ----------------
Weighted average common shares outstanding (actual)................. ................ N/A 24,92026,023 N/A
-------------------
Basic net loss per share............................................ $(9,955) 24,920 $ (0.40)
=========== ============= ==========
FOR THE THREE MONTHS ENDED JUNEshare ........................................... $(10,853) 26,023 $(0.42)
========= ====== ======
For the Three Months Ended September 30, 1997
-------------------------------------------
(RESTATED)
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT---------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
------
Weighted average common shares outstanding (actual)................. N/A 1,900 N/A
Assumed conversion of preferred stock from original date of
issuance.......................................................... N/A 11,289 N/A
-------------
Unaudited pro forma basic net loss per share........................ $(12,772) 13,279 $(0.96)
=========== ============= ==========
6
FOR THE SIX MONTHS ENDED JUNE 30, 1998
-------------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ----------
Weighted average common shares outstanding (actual)................. N/A 23,086 N/A
-------------
Basic net loss per share............................................ $(19,772) 23,086 $ (0.86)
=========== ============= ==========
FOR THE SIX MONTHS ENDED JUNE 30, 1997
-------------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ----------
Weighted average common shares outstanding (actual)................. N/A 1,81117,332 N/A
Assumed conversion of preferred stock from original date
of issuance N/A 11,2891,081 N/A
-------------------
Unaudited pro forma basic net loss per share........................ $(21,029) 13,100share ....................... $ (1,61)
=========== ============= ==========(8,299) 18,413 $(0.45)
========= ====== ======
6
For the Nine Months Ended September 30, 1998
-------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------- ------------- ----------
Weighted average common shares outstanding (actual) ........... N/A 24,077 N/A
------
Basic net loss per share ...................................... $(30,625) 24,077 $(1.27)
========= ====== ======
For the Nine Months Ended September 30, 1997
--------------------------------------------------
(restated)
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------ ------------ ---------
Weighted average common shares outstanding (actual) ........... N/A 7,048 N/A
Assumed conversion of preferred stock from original date
of issuance.................................................. N/A 7,849 N/A
------
Unaudited pro forma basic net loss per share................... $(29,328) 14,897 $(1.97)
========= ====== ======
3. BALANCE SHEET INFORMATION
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):
JUNE 30, DECEMBER 31,
1998 1997
-------- ------------
Raw materials............. $ 3,493 $ 2,652
Work in process........... 4,532 3,567
Finished goods............ 5,144 4,343
-------- ------------
$13,169 $10,562
======== ============
September 30, December 31,
1998 1997
------------ ------------
(unaudited) (restated)
Raw materials....... $ 3,679 $ 2,652
Work in process..... 5,760 3,567
Finished goods...... 4,413 4,343
------- -------
$13,852 $10,562
======= =======
4. BUSINESS ACQUISITION - EFFECTS OF POOLING-OF-INTERESTS ACCOUNTING
Acquisition of Sensor Devices, Inc. ("SDI")SDI - In March 1998 the Company completed its acquisition of
all of the outstanding shares of SDI, a manufacturer and marketer of medical
sensor products, in a transaction using the pooling-of-
interestspooling-of-interests accounting
method. Accordingly, the consolidated financial statements of the Company have
been restated to include the accounts of SDI for all periods presented. There
were no adjustments required to the net assets or previously reported results of
operations of the Company or SDI as a result of the adoption of the same
accounting practices by the respective entities. The following table shows the
reconciliation of restating the accounts of the Company resulting from the
pooling-of-interests on previously reported financial statements (in thousands):
7
AS PREVIOUSLY EFFECT OF
REPORTED POOLING-OF-INTERESTS RESTATED
------------- --------------------As Previously Effect of
Reported Pooling-of-Interests Restated
-------- --------------------- --------
Total assets as of December 31, 1997........................1997.................. $ 65,248 $3,772 $ 3,772 $69,02069,020
Total shareholders'stockholders' equity as of December 31, 1997..........1997..... 43,672 180 43,852
Total revenues:
For the three months ended JuneSeptember 30, 1997................ 4,132 1,937 6,0691997..... 4,974 2,256 7,230
For the sixnine months ended JuneSeptember 30, 1997.................. 7,196 3,817 11,0131997...... 12,170 6,074 18,244
Loss from operations:
For the three months ended JuneSeptember 30, 1997................ (12,552) (79) (12,631)1997..... (8,624) 86 (8,538)
For the sixnine months ended JuneSeptember 30, 1997.................. (20,779) (159) (20,938)1997...... (29,403) (73) (29,476)
Net loss:
For the three months ended JuneSeptember 30, 1997................ (12,652) (120) (12,772)1997..... (8,353) 54 (8,299)
For the sixnine months ended JuneSeptember 30, 1997.................. (20,759) (270) (21,029)1997...... (29,112) (216) (29,328)
5. FOLLOW-ON PUBLIC OFFERING
In March 1998 the Company completed its follow-on public offering of
5,750,000 shares of common stock (including 500,000 shares offered by a
stockholder of the Company and an exercised underwriters' over-allotment option
for 750,000 shares) at a price of $9.875 per share, providing the Company with
net proceeds of approximately $48.6 million, after deducting underwriting
discounts and commissions of approximately $2.8 million and offering costs of
approximately $400,000.
6. MAJOR CUSTOMERS
The Company had sales of greater than 10% of total revenue to only one
customer during the three months and sixnine months ended JuneSeptember 30, 1998 and
1997. This customer, which represented 19%16.3% and 24%16.1% of the Company's total
revenues for the three months ended JuneSeptember 30, 1998 and 1997, respectively,
and 14%14.6% and 25%22.5% of total revenues for the sixnine months ended JuneSeptember 30,
1998 and 1997, respectively, purchases animal vaccines from the Company's
wholly-owned subsidiary, Diamond Animal Health, Inc. ("Diamond").
7. GEOGRAPHIC SEGMENT REPORTING
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.
All revenues from research and development are earned in North America by
Heska or Diamond. There have been no material exports from North America or
Europe.
In the three months and sixnine months ended JuneSeptember 30, 1998 and 1997, the
Company's European subsidiaries did not purchase significant amounts of products
from North America for sale to European customers; however, Heska Corporation
sold products
directly to the Company's Italian distributor in botheach of the first and secondthree
quarters of 1998. Transfer prices to foreign subsidiaries are intended to allow
the North American companies to produce profit margins commensurate with their
sales and marketing efforts. Certain information by geographic area is as
follows (in thousands):
8
FOR THE THREE MONTHS ENDED JUNEFor the Three Months Ended September 30,
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1998 1997
------------------------------------------ ---------------------------------------
(RESTATED)
NORTH AMERICA EUROPE CONSOLIDATED NORTH AMERICA EUROPE CONSOLIDATED------------------------------------------------ -------------------------------------------
(restated)
North America Europe Consolidated North America Europe Consolidated
------------- -------- ------------ ------------------------ ------- ------------
Product revenues, net..........net......... $ 8,2598,960 $ 841863 $ 9,1009,823 $ 5,3196,243 $ 551591 $ 5,8706,834
Loss from operations...........operations.......... $(10,735) $ (9,801)(623) $(11,358) $ (599) $(10,400) $(12,594)(8,322) $ (37) $(12,631)(216) $ (8,538)
Identifiable assets............assets........... $104,665 $ 94,7154,437 $109,102 $ 4,35571,357 $4,698 $ 99,070 $ 31,051 $2,239 $ 33,290
FOR THE SIX MONTHS ENDED JUNE76,055
For the Nine Months Ended September 30,
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1998 1997
------------------------------------------ ---------------------------------------
(RESTATED)
NORTH AMERICA EUROPE CONSOLIDATED NORTH AMERICA EUROPE CONSOLIDATED
------------------------------------------------------------ --------------------------------------------
(restated)
North America Europe Consolidated North America Europe Consolidated
----------- -------- ------------ ------------------------ ------- ------------
Product revenues, net..........net........ $ 14,83323,793 $ 1,6572,520 $ 16,49026,313 $ 9,63715,880 $1,331 $ 739 $ 10,37617,211
Loss from operations........... $(19,138) $(1,196) $(20,334) $(20,876)operations......... $(29,873) $(1,819) $(31,692) $(29,198) $ (62) $(20,938)(278) $(29,476)
8. COMPREHENSIVE INCOME
In 1998 the Company adopted SFAS No. 130, Reporting"Reporting Comprehensive Income,Income",
which requires companies to report and display comprehensive income and its
components in a financial statement that is displayed with the same prominence
as other financial statements. The components of comprehensive income (loss)loss are as
follows (in thousands):
FOR THE THREE MONTHS ENDED JUNE 30,
-----------------------------------
1998 1997
----------------- ----------------
(RESTATED)
Net loss............................ $ (9,955) $ (12,772)
Change in foreign currency
translation adjustments............ (26) 2
----------------- ----------------
Total comprehensive income (loss)... $ (9,981) $ (12,770)
================= ================
FOR THE SIX MONTHS ENDED JUNE 30,
-----------------------------------
1998 1997
----------------- ----------------
Net loss............................ $ (19,772) $ (21,029)
Change in foreign currency
translation adjustments............ (18) 3
----------------- ----------------
Total comprehensive income (loss)... $ (19,790) $ (21,026)
================= ================
For the Three Months Ended September 30,
---------------------------------------
1998 1997
--------------- --------------
(restated)
Net loss.................................................... $(10,853) $ (8,299)
Unrealized gain on marketable securities.................... $ 523 $ -
Change in foreign currency translation adjustments.......... (5) (6)
-------- --------
Total comprehensive loss.................................... $(10,335) $ (8,305)
======== ========
For the Nine Months Ended September 30,
---------------------------------------
1998 1997
--------------- ---------------
(restated)
Net loss................................................... $(30,625) $(29,328)
Unrealized gain on marketable securities................... $ 523 -
Change in foreign currency translation adjustments......... (25) (3)
-------- --------
Total comprehensive loss................................... $(30,127) $(29,331)
======== ========
9
9. RECENT ACCOUNTING PRONOUNCEMENTS
During the second quarter of 1998, the Company adopted the provisions of a
new accounting standard, AICPA Statement of Position 98-5, Reporting"Reporting on the
Costs of Start-up Activities,Activities", which requires that start-up costs be expensed as
incurred rather than capitalized. The adoption of this Statement has had no
effect on the Company's reported results of operations.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information". The
Statement establishes reporting standards requiring that a public business
enterprise report financial and descriptive information about its reportable
operating segments. The Company will adopt SFAS No. 133 for the fiscal year
ended December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued FASBSFAS No. 133,
Accounting"Accounting for Derivative Instruments and Hedging Activities.Activities". The Statement
establishes accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at fair value. The Statement requires that changes in the derivative's
fair value be recognized currently in earnings unless specific hedging criteria
are met. The Company will adopt FASBSFAS No. 133 for the fiscal year ended December
31, 1998 and does not expect that the adoption of the Statement will have a
material effect on reported earnings or comprehensive income.
10. SUBSEQUENT EVENTSUNREGISTERED SALES OF COMMON STOCK
Asset Purchase Agreement - In July 1998 the Company issued approximately
206,000205,619 shares
of common stock to Bayer Corporation ("Bayer") in consideration for the
acquisition by Diamond of certain assets, including land and buildings formerly
leased by Diamond from Bayer, and as repayment in full of certain indebtedness
of Diamond to Bayer, in a transaction valued at approximately $2.3 million.
Private Placement of Common Stock - In July 1998 the Company issued
1.1651,165,592 million shares of common stock to Ralston Purina Company ("Ralston"),
providing the Company with proceeds of $14.75 million. In addition, the Company
issued to Ralston a warrant to purchase an equal number of shares of common
stock for a warrant purchase price of $250,000. The initial exercise price of
the warrant is $12.87 per share increasesincreasing over the three year term of the
warrant. The warrant expires in
three years. In addition, the Company and Ralston entered into a strategic product
research and development collaboration.
10
PART I. FINANCIAL INFORMATION
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q, including the Notes to the Condensed
Consolidated Financial Statements and this "Management's Discussion and Analysis
of Financial Condition and Results of Operations," contains express or implied
forward-looking statements. Additional written or oral forward-looking
statements may be made by the Company from time to time in filings with the
Securities and Exchange Commission, in its press releases or other public
statements, or otherwise. The words "believes", "expects", "anticipates",
"intends", "forecasts", "projects", "estimates" and similar expressions identify
forward-looking statements. Such statements reflect the Company's current views
with respect to future events and financial performance or operations and speak
only as of the date the statements are made. Such statements are inherently
subject to risks and uncertainties and future events and actual results could
differ materially from those set forth in, contemplated by, or underlying the
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements. Factors that could cause actual results to
differ materially from those expressed or implied in such forward-looking
statements are set below under the caption "Factors that May Affect Results,"
and elsewhere in this Quarterly Report, including in the Notes to Condensed
Consolidated Financial Statements and in this "Management's Discussion and
Analysis of Financial Condition and Results of Operations". Other factors that
could contribute to or cause such differences are described throughout the
Company's other filings with the Securities and Exchange Commission and in its
press releases and other public statements from time to time. The Company
undertakes no obligation to publicly update, review or revise any forward-lookingforward-
looking statements 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 discovers, develops, manufactures and markets companion animal health
products, primarily for dogs, cats and horses. From the Company's inception in
1988 until early 1996, the Company's operating activities related primarily to
research and development activities, entering into collaborative agreements,
raising capital and recruiting personnel. Prior to 1996, the Company had not
received any revenues from the sale of products, and it has incurred substantial
net losses since inception. As of JuneSeptember 30, 1998, the Company's
accumulated deficit was $92.3$103.1 million.
During 1996, Heska evolved from being primarily a research and development
concern to a fully-integrated research, development, manufacturing and marketing
company. The Company also expanded the scope and level of its scientific and
business development activities, increasing the opportunities for new products.
In recent periods, the company has further evolved into a sales and marketing
company.
11
In 1997, the Company introduced 13 additional companion animal health
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 Bloxham Laboratories Limited ("Bloxham"), a
veterinary diagnostic laboratory in Teignmouth, England, and CMG Centre Medical
des Grand'Places SA ("CMG"), in Fribourg, Switzerland, which manufactures and
markets allergy diagnostic products for use in veterinary and human medicine,
primarily in Europe and Japan. Each of the Company's acquisitions prior to 1998
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.
In the first quarter of 1998 the Company added patient monitoring equipment
to its product lines through its acquisition of Sensor Devices, Inc.
("SDI").SDI. The acquisition of SDI qualified, and has
been accounted for as a pooling-of-interests and, accordingly, the consolidated
financial statements of the Company have been restated to include the accounts
of SDI for all periods presented.
The Company anticipates that it will continue to incur additionalsubstantial
operating losses as it introduces new products, continues its research and
development activities for products under development and integrates newly acquired
businesses. There can be no assurance that the Company will attain profitability
or, if attained, will remain profitable on a quarterly or annual basis in the
future. See "Factors that May Affect Results" below.
RESULTS OF OPERATIONS
Three Months Ended JuneSeptember 30, 1998 and 1997
Total revenues, which include product and research and development
revenues, increased to $9.2$9.9 million in the secondthird quarter of 1998 as compared to
$6.1$7.2 million in the secondthird quarter of 1997. Product revenues increased to $9.1$9.8
million in the secondthird quarter of 1998 as compared to $5.9$6.8 million for the secondthird
quarter of 1997. The growth in revenue during the secondthird quarter of 1998 was
primarily due to increased sales of the Company's products and from
consolidating revenues from acquired businesses. The Company completed its
acquisition of SDI during the first quarter of 1998. The acquisition has been
accounted for using the pooling-of-interests accounting method and, accordingly,
the consolidated financial statements of the Company have been restated to
include the accounts of SDI for all periods presented.
Revenues from sponsored research and development decreased to $119,000$38,000 in
the secondthird quarter of 1998 from $199,000$396,000 in the secondthird quarter of 1997.
Fluctuations in revenues from sponsored research and development are generally
the result of changes in the number of funded research projects as well as the
timing and performance of contract milestones. The Company expects that revenues
from sponsored research and development will decline in future periods,
reflecting the expiration of current funding commitments and the Company's
decision to fund its future research activities primarily from internal sources.sources,
although the Company may engage in additional sponsored research if such
projects become available and are consistent with the Company's policies.
Cost of goods sold totaled $6.8$8.0 million in the secondthird quarter of 1998 as
compared to $4.2$4.9 million in the secondthird quarter of 1997. The resulting gross
margin for the secondthird quarter of 1998 increaseddecreased to $2.3$1.8 million from $1.7$2.0 million
in the secondthird quarter of 1997, due primarilysubstantially to increasedwrite-offs of approximately
$400,000 of periodontal
12
product inventory in anticipation of the expiration of approved sales dates and
approximately $330,000 of vaccine work-in-progress inventory as a result of a
water purity issue. Additional inventory provisions relating to the periodontal
product are likely in the fourth quarter. Additionally, the lower gross margin
percentage is attributable to a higher proportion of revenues resulting from
sales of equipment and contract manufacturing volumes.
12
which have lower gross margins
than the Company's proprietary pharmaceutical and diagnostic products. The
Company expects that gross margins will not significantly improve until more of
the Company's proprietary products are approved by the applicable regulatory
bodies and achieve market acceptance.
Research and development expenses increased to $6.5$6.3 million in the secondthird
quarter of 1998 from $5.6$4.7 million in the secondthird quarter of 1997. The increase in
1998 is due primarily to expenses related to new collaborative agreements and
licenses to support research and development activities for potential products
to be marketed by the Company. The Company currently does not expect that
significant increases inabove current research and development expenses will be
required to maintain its current research and development activities.
Selling and marketing expenses increased to $2.9$3.2 million in the secondthird
quarter of 1998 from $2.3$2.5 million in the secondthird quarter of 1997. This increase
reflects the expansion of the Company's sales and marketing organization, its
introduction and marketing of new products and additional field sales force
personnel. Selling and marketing expenses consist primarily of salaries,
commissions and benefits for sales and marketing personnel, commissions paid to
contract sales agents and expenses of product advertising and promotion. The
Company expects selling and marketing expenses to increase as sales volume
increases and new products are introduced to the market.
General and administrative expenses decreasedincreased to $2.8$3.1 million in the secondthird
quarter of 1998 from $3.7$3.0 million in the secondthird quarter of 1997. The
decrease in the second quarter of 1998 was due primarily to one-time charges in
1997 relating to a supply agreement termination fee. General and
administrative expenses are expected to decrease as a percentage of revenues in
future years.
Amortization of intangible assets and deferred compensation increased to
$672,000$650,000 in the secondthird quarter of 1998 from $464,000$631,000 in the secondthird quarter of
1997. Amortization of intangible assets resulted primarily from the Company's
1997 and 1996 business acquisitions. Net intangible assets at JuneSeptember 30,
1998 and December 31, 1997 totaled $5.5$5.2 million and $6.0 million, respectively.
The amortization of deferred compensation resulted in a non-cash charge to
operations in the secondthird quarter of 1998 of $188,000$174,000 as compared to $259,000$157,000 in
the secondthird quarter of 1997. In connection with the grant of certain stock options
in the years ended December 31, 1997 and 1996, the Company recorded deferred
compensation representing the difference between the deemed value of the common
stock for accounting purposes and the option exercise price of such options at
the date of grant. In 1998 the Company also granted stock options to non-
employees in exchange for consulting services at an exercise price equal to fair
market value on the date of grant, measuring compensation cost as the fair value
of the options on the date of grant and for which expenses will be recognized
over the service period. The Company will incur a non-cash charge to operations
of approximately $730,000, $629,000, $574,000$743,000, $652,000, $585,000 and $34,000 per year for 1998,
1999, 2000 and 2001, respectively, for amortization of deferred compensation.
Interest income increased to $897,000$879,000 in the secondthird quarter of 1998 from
$152,000$621,000 in the secondthird quarter of 1997 due to increased cash available for
investment resulting from the proceeds from the Company's initial public
offering in July 1997, and the follow-on offering completed in March 1998 and the
private placement of common stock with Ralston in July 1998. Interest income is
expected to decline in future periods as the Company uses cash to finance
business operations. Interest expense increased to $468,000$521,000 in the secondthird
quarter of
13
1998 from $235,000$371,000 in the secondthird quarter of 1997 due to an increaseincreases in debt
financing for laboratory and manufacturing equipment and debt related to the
Company's 1997 business acquisitions.
The Company reported a net loss in the secondthird quarter of 1998 of $9.95$10.9
million as compared to a secondthird quarter 1997 net loss of $12.8$8.3 million. The
decrease in net losses between the periods isWhile
revenues increased quarter to quarter, revenue growth stemmed primarily due to one-time charges
recorded in the second quarter of 1997 for purchasedfrom
lower gross margin products such as equipment and contract manufacturing. This
lower gross margin sales mix, combined with inventory write-offs as described
above, higher selling and marketing expenses and higher research and development
andexpenses caused losses to be higher in the supply agreement termination fee included in general and administrative
expenses.
Six Months Ended Junethird quarter of 1998 as compared to
the third quarter of 1997.
Nine months ended September 30, 1998 and 1997
Total revenues, which include product and research and development
revenues, increased to $17.1$27.0 million in the first halfnine months of 1998 as
compared to $11.0$18.2 million in the first halfnine months of 1997. Product revenues
increased 13
to $16.5$26.3 million in the first halfnine months of 1998 as compared to $10.4$17.2
million for the first halfnine months of 1997. The growth in revenuerevenues during the
first half of 1998 was primarily due to increased sales of the Company's
products and from consolidating revenues from acquired businesses.
The Company completed its
acquisition of SDI during the first quarter of 1998. The acquisition has been
accounted for using the pooling-of-interests accounting method and, accordingly,
the consolidated financial statements of the Company have been restated to
include the accounts of SDI for all periods presented.
Revenues from sponsored research and development of $639,000$677,000 in the first
halfnine months of 1998 remained essentially the samedeclined as compared to $637,000$1.0 million in the first halfnine
months of 1997. Fluctuations in revenues from contract research and development
are generally the result of changes in the number of funded projects as well as
timing and performance of contract milestones. The Company expects that
revenues from sponsored research and development will decline in future periods,
reflecting the expiration of current funding commitments and the Company's
decision to fund its future research activities primarily from internal sources.sources,
although the Company may engage in additional sponsored research if such
projects become available and are consistent with the Company's policies.
Cost of goods sold totaled $11.6$19.6 million in the first halfnine months of 1998
as compared to $7.6$12.5 million in the first halfnine months of 1997. The resulting
gross margin for the first halfnine months of 1998 increased to $4.9$6.7 million from
$2.8$4.7 million in the first halfnine months of 1997, due primarily to increased
product sales and manufacturing volumes.volumes, partially offset by the write-offs of
inventories described above. The lower gross margin percentage is attributable
to a higher proportion of revenues resulting from sales of equipment and
contract manufacturing which have lower gross margins than the Company's
proprietary pharmaceutical and diagnostic products. The Company expects that
gross margins will not significantly improve until more of the Company's
proprietary products are approved by the applicable regulatory bodies and
achieve market acceptance.
Research and development expenses increased to $12.7$19.0 million in the first
halfnine months of 1998 from $10.2$14.9 million in the first halfnine months of 1997. The
increase in 1998 is due primarily to increases in the level and scope of the
Company's internal research and development activities and expenses related to
new collaborative agreements and licenses to support research and development
efforts for potential products to be marketed by the Company. The Company does
not expect that significant increases inabove current research and development
expenses will be required to maintain its current research and development
activities.
Selling and marketing expenses increased to $6.0$9.1 million in the first halfnine
months of 1998 from $4.2$6.8 million in the first halfnine months of 1997. This increase
reflects the expansion of the Company's sales and marketing
14
organization, its introduction and marketing of new products and additional
field sales force personnel. Selling and marketing expenses consist primarily of
salaries, commissions and benefits for sales and marketing personnel,
commissions paid to contract sales agents and expenses of product advertising
and promotion. The Company expects selling and marketing expenses to increase as
sales volume increases and new products are introduced to the market.
General and administrative expenses decreased to $5.8$8.9 million in the first
halfnine months of 1998 from $6.4$9.4 million in the first halfnine months of 1997. The
decrease in the first halfnine months of 1998 was due primarily to one-time charges
in 1997 relating to a supply agreement termination fee. General and
administrative expenses are expected to decrease as a percentage of revenues in
future years.
Amortization of intangible assets and deferred compensation increased to
$1.4$2.1 million in the first halfnine months of 1998 from $1.1$1.7 million in the first
halfnine months of 1997. Amortization of intangible assets resulted primarily from
the Company's 1997 and 1996 business acquisitions. Net intangible assets at
JuneSeptember 30, 1998 and December 31, 1997 totaled $5.5$5.2 million and $6.0 million,
respectively. The amortization of deferred compensation resulted in a non-cash
charge to operations in the first halfnine months of 1998 of $395,000$569,000 as compared to
$278,000$435,000 in the first halfnine months of 1997. In connection with the grant of
certain stock options in the years ended December 31, 1997 and 1996, the Company
recorded deferred compensation representing the difference between the deemed
value of the common stock for accounting purposes and the option exercise price
of such options at the date of grant. In 1998 the Company also granted stock
options to non-employees in exchange for consulting services at an exercise
price equal to fair market value on the date of grant, measuring compensation
cost as the fair value of the options on the date of grant and for which
expenses will be recognized over the service period. The Company will incur a
non-cash charge to operations of approximately $730,000, $629,000, $574,000$743,000, $652,000, $585,000 and
$34,000 per year for 1998, 1999, 2000 and 2001, respectively, for amortization
of deferred compensation.
14
Interest income increased to $1.5$2.4 million in the first halfnine months of 1998
from $448,000$1.1 million in the first halfnine months of 1997 due to increased cash
available for investment resulting from the proceeds from the Company's initial
public offering in July 1997, and the follow-on offering completed in March 1998 and
the private placement of common stock with Ralston in July 1998. Interest
income is expected to decline in future periods as the Company uses cash to
finance business operations. Interest expense increased to $938,000$1.5 million in the
first halfnine months of 1998 from $451,000$821,000 in the first halfnine months of 1997 due to
an increaseincreases in debt financing for laboratory and manufacturing equipment and debt
related to the Company's 1997 business acquisitions.
The Company reported a net loss in the first halfnine months of 1998 of $19.8$30.6
million as compared to a first half 1997 net loss of $21.0 million. The decrease$29.3 million in the first nine months of
1997. While revenues increased period to period, revenue growth stemmed
primarily from lower gross margin products such as equipment and contract
manufacturing. This lower gross margin sales mix, combined with the inventory
write-offs described above, higher selling and marketing expenses and higher
research and development expenses caused losses betweento be higher in the periods is primarily due tofirst nine
months of 1998 than the first nine months of 1997. These factors were partially
offset by one-time charges recorded in the second quarter of 1997 for purchased
research and development and supply contract termination fees, offset by increased marketing costs related to both
new and more products, sales commissions on a higher level of sales and
increases in the level and scope of research and development activities.fees.
15
LIQUIDITY AND CAPITAL RESOURCES
In July 1997, the Company completed its initial public offering ("IPO")IPO of 5,637,850 shares of common
stock at a price of $8.50 per share, providing the Company with net proceeds of
approximately $43.9 million. Upon the completion of the IPO, all outstanding
shares of preferred stock were converted into 11,289,388 shares of common stock.
In March 1998 the Company completed a follow-on public offering of
5,750,000 shares of common stock (including 500,000 shares offered by a
stockholder of the Company and an exercised underwriters' over-allotment option
for 750,000 shares) at a price of $9.875 per share, providing the Company with
net proceeds of approximately $48.6 million, after deducting underwriting
discounts and commissions of approximately $2.8 million and offering costs of
approximately $400,000.
As of JuneSeptember 30, 1998, the Company had received aggregate proceeds of
$148.0$163.0 million from various equity transactions, including $15 million from the
July 1998 private placement to Ralston, $48.6 million from the March 1998
follow-on public offering, $43.9 million from the July 1997 IPO, $36.0
millionand the
remainder from the April 1996prior private equity placement to Novartis, $10.0 million
from the 1995 private equity placement to Volendam Investeringen N.V. and $9.5
million from private equity placements to Charter Ventures from 1989 through
1995.placements.
In addition, the Company has received proceeds from equipment financing
totaling $10.8$12.0 million through JuneSeptember 30, 1998. The Company also assumed
$4.3 million in short and long-term debt in connection with its 1996
acquisitions and assumed $3.8 million in long-term debt in connection with its
1997 acquisitions. Capital lease obligations and term debt owed by the Company
totaled $16.2$17.9 million as of JuneSeptember 30, 1998, with installments payable
through 2006. Expenditures for property and equipment totaled $2.9$4.8 million and
$3.7$5.8 million for the sixnine months ended JuneSeptember 30, 1998 and 1997,
respectively. The Company anticipates that it will continue to use capital
equipment lease and debt facilities to finance equipment purchases and, if
possible, leasehold improvements. The Company hasand its subsidiaries have secured
lines of credit for its subsidiariesand other debt facilities totaling approximately $3.6$4.6 million,
against which borrowings of approximately $2.5$3.0 million were outstanding at
JuneSeptember 30, 1998. These financing facilities are secured by assets of Heska
and the respective subsidiaries and corporate guarantees of Heska Corporation.Heska. The Company
expects to seek additional asset-based borrowing facilities.
Net cash used for operating activities was $20.3$29.9 million and $16.7$23.9 million
for the sixnine months ended JuneSeptember 30, 1998 and 1997, respectively. Cash was
used primarily to fund research and development activities, sales and marketing
activities, general and administrative expenses and general working capital
requirements.
The Company currently expects to spend approximately $3.5$1.0 million during
the remainder of 1998 for capital equipment, including expenditures for the
upgrading of certain manufacturing operations to improve
15
efficiencies as well as
various enhancements to assure ongoing compliance with certain regulatory
requirements. The Company expects to finance these expenditures through secured
debt facilities, where possible.
The Company's primary short-term needs for capital, which are subject to
change, are for continuing research and development efforts, its sales,
marketing and administrative activities, working capital and capital
expenditures relating to developing and expanding the Company's manufacturing
operations. At JuneSeptember 30, 1998, the Company's principal source of liquidity
was $54.8$61.2 million in cash, cash equivalents and short-term investments. The
Company expects its working capital requirements to increase over the next
several years as it introduces new products, expands its sales and marketing
capabilities, improves its manufacturing capabilities and facilities and
acquires businesses, technologies or products complementary to the Company's
business. The Company's future liquidity and capital funding requirements will
depend on numerous factors, including the extent to which the Company's present
and future products gain market acceptance, the extent to which products
16
or technologies under research or development are successfully developed, and gain market acceptance, the
timing of regulatory actions regarding the Company's potential products, the costs and the
timing of expansion of sales, marketing and manufacturing activities, the cost,
timing and business management of current and potential acquisitions and
contingent liabilities associated with such acquisitions, the procurement and
enforcement of patents important to the Company's business, and the results of
product trials and competition.
The Company believes that its available cash and cash from operations including the proceeds from the private placement to Ralston subsequent to the
end of the second quarter, will
be sufficient to satisfy its funding requirements forat current operationsoperating levels
for at least the next 12 months, assuming no significant uses of cash in
acquisition activities. Thereafter, if cash generated from operations is
insufficient to satisfy the Company's working capital requirements, the Company
maywill need to raise additional capital to continue funding its research and development activities, scaling up its manufacturing
activities and expanding its sales and marketing force.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 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 potentially unfavorable terms. The failure by the
Company to raise capital on acceptable terms when needed could have a material
adverse effect on the Company's business, financial condition or results of
operations. See "Factors that May Affect Results - Future Capital Requirements;
Uncertainty of Additional Funding".
NET OPERATING LOSS CARRYFORWARDS
As of December 31, 1997, the Company had a net operating loss ("NOL")
carryforward of approximately $59.5 million and approximately $1.1 million of
research and development ("R&D") tax credits available to offset future federal
income taxes. The NOL and tax credit carryforwards, which are subject to
alternative minimum tax limitations and to examination by the tax authorities,
expire from 2003 to 2011. The Company's April 1996 acquisition of Diamond
resulted in a "change of ownership" under the provisions of Section 382 of the
Internal Revenue Code of 1986, as amended. As such, the Company will be limited
in the amount of NOLs incurred prior to the merger that it may utilize to offset
future taxable income. This limitation will total approximately $4.7 million
per year for periods subsequent to the Diamond acquisition. Similar limitations
also apply to utilization of R&D tax credits to offset taxes payable. In
addition, the Company believes that its follow-on public offering of Common
Stock in March 1998 resulted in a further "change of ownership." The Company
does not believe that either of these limitations will affect the eventual
utilization of its total NOL carryforwards.
16
YEAR 2000 CONVERSION
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 applicationsembedded technologies resulting from
the
year 2000 conversion. The Company is coordinating these activities with suppliers,
distributors, financial institutions and others with whom it does business.
Based on the preliminary results of its current evaluation, the Company does not believe
that the year 2000Y2K conversion will have a material adverse effect on its business.
State of Readiness
17
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.
Costs
The Company has a plan to validate each of these systems by the end of the
second quarter of 1999. This plan (40% of total expected hours were completed as
of September 30, 1998) 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 new, generally off-the-shelf, and vendor relationships
still exist for most subject equipment and software. These costs are expected
to consist of replacing relatively low-cost personal computers, and
installations of bug-fixes 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 as they arise. Such contingency plans
are currently being developed by the Company.
FACTORS THAT MAY AFFECT RESULTS
The Company's future operating results and financial condition are
dependent on a number of factors. The following potential risks and
uncertainties, as well as others discussed herein and in the Company's filings
with the SEC, which other filings should be read in conjunction herewith, could
affect the Company's future operating results and financial condition.
Dependence on DevelopmentDevelopment; Introduction and IntroductionAcceptance of New Products
ManySome of the Company's products have only recently been introduced and many
are still under development and theredevelopment. There can be no assurance suchthat current products
will gain market acceptance or that future 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 its
customer base in the need for and use of 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
achieve market acceptance for its future products and to complete development of
and successfully introduce and commercialize its new products. The development
and regulatory approval activities necessary to bring new products to market are
time-consuming and costly. The Company has experienced delays in receiving
regulatory approvals. There can be no assurance that the Company will not
experience difficulties that could delay
18
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 Environmental Protection
Agency ("EPA") or foreign regulatory authorities on a timely basis, or at all, or that
the new products will be accepted by the market.all.
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 of 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, development and developmentcommercialization activities on behalf
of the Company. In order to successfully commercialize any new products, the
Company will be required to establish and maintain a reliable, cost-efficient
source of manufacturing for such products. If the Company is unable, for
technological or other reasons, to complete the development, introduction or
scale up of manufacturing of any new product or if any new product is not
approved for marketing or does not achieve a significant level of market
acceptance, the Company could be materially and adversely affected. Following
the introduction of a product, adverse side effects may be discovered that make
the product no longer commercially viable. Publicity regarding such adverse
effects could adversely affect sales of such products or 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.
17
Loss History and Accumulated Deficit; Uncertainty of Future Profitability;
Quarterly Fluctuations andFluctuations; Customer Concentration
Heska has incurred substantial net losses since its inception. At
JuneSeptember 30, 1998, the Company's accumulated deficit was $92.3$103.1 million. The
Company anticipates that it will continue to incur additional operating losses
for the next several years. Such losses have resulted principally from expenses
incurred in the Company's research and development programs and to a lesser extent, from general and
administrative and sales and marketing expenses. Currently, a substantial
portion of the Company's revenues are from Diamond, which manufactures
veterinary biologicals and pharmaceuticals for major companies in the animal
health industry.industry and products for companies in other industries. Revenues from
one Diamond customer comprised approximately 21% of the Company's total revenues
in the year ended December 31, 1997.1997 and 15% of total revenues for the first nine
months of 1998. 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
and other periodic fluctuations due to a variety of factors, including whether
and when new products are successfully developed and introduced by the Company
or its competitors, market acceptance of current or new products, regulatory
delays, product recalls, competition and pricing pressures from competitive
products, manufacturing delays, shipment problems, product seasonality and
changes in the mix of products sold. Because the Company is
continuing to increase itsCompany's current level of
operating expenses are being incurred in anticipation of higher levels of
revenues and for personnel, new product development and marketing, the Company's operating
results will be adverselymaterially affected if its sales do not correspondingly increase
or if its product development efforts are unsuccessful or subject toexperience delays.
19
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 third party
distribution channels and, to a lesser extent, through its direct sales force and certain third parties.force.
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. With
respect to the Company's recently introduced and anticipated introduction of new
diagnostic products, the Company may experience increased marketing costs and
limitations resulting from the inability of many of the Company's distributors
to carry these products due to contractual agreements with a competitor of the
Company.
In addition, the Company has granted marketing and commercialization rights
to certain products under development to third parties, including Novartis AG
and its Japanese affiliate ("Novartis"), Bayer AG ("Bayer") and, Eisai Co., Ltd.
("Eisai"). and Ralston. 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. Novartis wil also distribute certain of the Company's products in
Japan when such products receive required Japanese regulatory approvals. Bayer
has exclusive marketing rights to the Company's canine heartworm
18
vaccine and its
feline toxoplasmosis vaccine (except in countries where Eisai has such rights).
Eisai has exclusive rights in Japan and most countries in East Asia to market
the Company's feline and canine heartworm vaccines, feline and canine flea
control vaccines and feline toxoplasmosis vaccine. The Company's agreements
with its marketing partners contain no minimum purchase requirements in order
for such parties to maintain their exclusive or co-exclusive marketing rights.
In addition, the Company recently granted to Ralston the exclusive licensing
rights to develop and commercialize the Company's technologies in certain pet
food products. There can be no assurance that Novartis, Bayer, Eisai or any
other collaborative party will devote sufficient resources to marketing or
commercializing the Company's products. Furthermore, there is nothing to
prevent Novartis, Bayer, Eisai or any other collaborative party from pursuing
alternative technologies or products that may compete with the Company's
products.
20
Future Capital Requirements; Uncertainty of Additional Funding
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. The Company believes that its available
cash and cash from operations will be sufficient to satisfy its funding
requirements at current operating levels for at least the next 12 months,
assuming no significant uses of cash in acquisition activities. Thereafter, if
cash generated from operations is insufficient to satisfy the Company's working
capital requirements, the Company will need to raise additional capital to
continue funding its business operations. The Company's future liquidity and
capital funding requirements will depend on numerous factors, including market
acceptance of current and future products; successful development of new
products; timing of regulatory actions regarding the Company's potential
products; costs and timing of expansion of sales, marketing and manufacturing
activities; procurement, enforcement and defense of patents important to the
Company's business; results of product trials; and competition. There can be no
assurance that such additional capital will be available on terms acceptable or
favorable to the Company or its existing stockholders, 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 potentially unfavorable terms. The failure by the
Company to raise capital on acceptable terms when needed could have a material
adverse effect on the Company's business, financial condition or results of
operations.
Highly Competitive Industry
The market in which the Company competes is intensely competitive. Heska's
competitors include companion animal health companies and major pharmaceutical
companies that have animal health divisions. Companies with a significant
presence in the animal health market, such as American Home Products, Bayer,
Merial Ltd., Novartis, Pfizer, Inc., and IDEXX Laboratories, Inc., have
developed or are developing products that do or would compete with the Company's
products. Novartis and Bayer are marketing partners of the Company, and their
agreements with the Company do not restrict their ability to develop and market
competing products. These competitors have substantially greater financial,
technical, research and other resources and larger, more established marketing,
sales, distribution and service organizations than the Company. Moreover, such
competitors may offer broader product lines and have greater name recognition
than the Company. Additionally, the market for companion animal health care
products is highly fragmented, with discount stores and specialty pet stores
accounting for a substantial percentage of such sales. As Heska intends to
distribute its products onlyprincipally 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.
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
21
obtain rights to such technology. Heska has United States and foreign issued
patents and is currently prosecuting patent applications in the United States
and with certain foreign patent offices. There can be no assurance that any of
the Company's pending patent applications will result in the issuance of any
patents or that, if issued, any such patents will offer protection against
competitors with similar technology. There can be no assurance that any patents
issued to the Company will not be challenged, invalidated or circumvented in the
future or that the rights created thereunder will provide a competitive
advantage.
The biotechnology and pharmaceutical industries have been characterized by
extensive litigation regarding patents and other intellectual property rights.
There can be no assurance that the Company will not in the future
19
become subject
to patent infringement claims and litigation in the United States or other
countries or interference proceedings conducted in the United States Patent and
Trademark Office ("USPTO") to determine the priority of inventions. The defense
and prosecution of intellectual property suits, USPTO interference proceedings,
and related legal and administrative proceedings are both costly and time
consuming. Litigation may be necessary to enforce any patents issued to the
Company or its collaborative partners, to protect trade secrets or know-how
owned by the Company or its collaborative partners, or to determine the
enforceability, scope and validity of the proprietary rights of others. Any
litigation or interference proceeding will result in substantial expense to the
Company and significant diversion of effort by the Company's technical and
management personnel. An adverse determination in litigation or interference
proceedings to which the Company may become a party could subject the Company to
significant liabilities to third parties. Further, either as the result of such
litigation or proceedings or otherwise, the Company may be required to seek
licenses from third parties which may not be available on commercially
reasonable terms, if at all.
The Company licenses technology from a number of third parties. The
majority of such license agreements impose due diligence or milestone
obligations and in some cases impose minimum royalty or sales obligations upon
the Company in order for the Company to maintain its rights thereunder.
The Company's products may incorporate technologies that are the subject of
patents issued to, and patent applications filed by, others. As is typical in
its industry, from time to time the Company and its collaborators have received
and may in the future receive notices claiming infringement from third parties
as well as invitations to take licenses under third party patents. 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.
22
Limited Manufacturing Experience and Capacity; Reliance on Contract
Manufacturers
To be successful, the Company must manufacture, or contract for the
manufacture of, its current and future products in compliance with regulatory
requirements, in sufficient quantities and on a timely basis, while maintaining
product quality and acceptable manufacturing costs. In order to provide for
manufacturing of its products, the Company acquired Diamond in April 1996 and
certain assets of Center 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, Center and SDI, the Company relies and intends to
continue to rely on contract manufacturers for certain of its products. The
Company currently has supply agreements with Atrix Laboratories, Inc. for its
canine
20
periodontal disease therapeutic and a supply agreement with Quidel
Corporation for certain manufacturing services relating to its point-of-care
canine and feline heartworm 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 be able to
manufacture products to regulatory standards and the Company's specifications or
in a cost-effective and timely manner. If any supplier were to be delayed in
scaling up commercial manufacturing, were to be unable to produce a sufficient
quantity of products to meet market demand, or were to request renegotiation of
contract prices, the Company's business could be materially and adversely
affected. While the Company typically retains the right to manufacture products
itself or contract with an alternative supplier in the event of the
manufacturer's breach, any transfer of production would necessarily involve
significant delays in production and additional expense to the Company to scale
up production at a new facility and, for regulated products, 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 FDA in the United States and various
regulatory agencies outside the United States. Delays in obtaining or failure
to obtain any necessary regulatory approvals would have a material adverse
effect on the Company's future product sales and operations. Any acquisitions of
new products and technologies may subject the Company to additional government
regulation.
The Company's manufacturing facilities and those of any contract
manufacturers the Company may use are subject to the requirements of and subject
to periodic regulatory inspections by the FDA, USDA and other federal, state and
foreign regulatory agencies. There can be no assurance that the Company or its
contractors will continue to satisfy suchexisting or future 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.
2123
Future Capital Requirements; Uncertainty of Additional Funding
While the Company believes that its available cash, including the
proceeds from the private placement to Ralston subsequent to the end of the
second quarter, will be sufficient to satisfy its funding needs for current
operations for at least the next 12 months, assuming no significant uses of cash
in acquisition activities, the Company has incurred negative cash flow from
operations since inception and does not expect to generate positive cash flow
sufficient to fund its operations for the next several years. Thus, the Company
may need to raise additional capital to fund its research and development,
manufacturing and sales and marketing activities. The Company's future liquidity
and capital funding requirements will depend on numerous factors, including
market acceptance of current and future products; successful development of new
products; timing of regulatory actions regarding the Company's potential
products; costs and timing of expansion of sales, marketing and manufacturing
activities; procurement, enforcement and defense of patents important to the
Company's business; results of product trials; and competition. There can be no
assurance that such additional capital will be available on terms acceptable to
the Company, if at all. Furthermore, any additional equity financing 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 potentially
unfavorable terms. The failure by the Company to raise capital on acceptable
terms when needed could have a material adverse effect on the Company's
business, financial condition or results of operations.
Potential Difficulties in Management of Growth; Identification and Integration
of Acquisitions
The Company anticipates additional growth in the number of its employees,sales and marketing
operations, the scope of its operating and financial systems and the geographic
area of its operations as the Company seeks to increase its sales and marketing
activities, as distribution strategies evolve, and as new products are developed
and commercialized. This growth will result in an increase in responsibilities
for both existing and new management and other personnel. The Company's ability
to manage growth effectively will require it to continue to implement and
improve its operational, financial and management information systems and to
train, motivate and manage its current employees and hire new employees. There
can be no assurance that the Company will be able to manage its expansion
effectively, and a failure to do so could have a material adverse effect on the
Company's business, financial condition or results of operations.
In 1996, Heska consummated the acquisitions of Diamond and of assets
relating to its canine allergy business. The Company's more recent acquisitions
include: the February 1997 purchase of Bloxham; the July 1997 purchase of the
allergy immunotherapy products business of Center, an FDA and USDA licensed
manufacturer of allergy immunotherapy products; the September 1997 purchase of
CMG, a Swiss corporation which manufactures and markets allergy diagnostic
products for use in veterinary and human medicine, primarily in Europe and
Japan; and the March 1998 purchase of SDI, a manufacturer and marketer of
patient monitoring and other medical sensor
products.equipment. The Company also anticipates
issuing additional shares of common stock to effect future acquisitions. Such
issuances may be dilutive. Identifying and pursuing acquisition opportunities,
integrating the acquired businesses and managing growth requires a significant
amount of management time and skill. There can be no assurance that the Company
will be effective in identifying and effecting attractive acquisitions, avoiding
unforeseen contingent liabilities, 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.
22
Dependence on Key Personnel
The Company is highly dependent on the efforts of its senior management and
scientific team, including its Chief Executive Officer and Chief Scientific
Officer. The loss of the services of any member of its senior management or
scientific staff may significantly delay or prevent the achievement of product
development and other business objectives.objectives and strategies or result in a change
of current business strategies. 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
24
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.
Year 2000 Compliance and Risks
The 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 its 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.
2325
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(d) The Company sold 5,637,850 shares of its common stock, par value
$.001, pursuant to a Registration Statement on Form S-1 (File No.
333-25767), declared effective on June 23, 1997 (as amended by a
post-effective amendment dated June 27, 1997). The managing
underwriters of the offering were Credit Suisse First Boston and
Merrill Lynch & Co. and the offering commenced on June 30, 1997.
The aggregate gross proceeds of the offering were approximately
$47.9 million. The Company's net proceeds from the offering were
approximately $43.9 million, after giving effect to underwriting
discounts and commissions of approximately $3.1 million and
offering expenses of approximately $1.0 million. As of June 30,(c) In July 1998, the Company had usedissued 205,619 shares of common stock to
Bayer Corporation ("Bayer") in consideration for the entire net proceedsacquisition
by Diamond of certain assets, including land and buildings
formerly leased by Diamond from Bayer, and as repayment in full of
certain indebtedness of Diamond to Bayer. The Registrant relied
upon the exemption provided by Section 4(2) of the Securities Act
of 1933, as amended (the "Act") because (a) the transaction did
not involve a public offering and (b) the purchaser represented
that it was an "accredited investor" as follows: $19.3 million for research and development efforts,
$8.2 million for its sales and marketing efforts, $2.5 million for
business acquisitions and $13.9 million for working capital and
other general corporate purposes.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's 1998 annual meeting of shareholders (the "1998 Annual
Meeting") was held on April 27, 1998such term is defined in
Fort Collins, Colorado. Two proposals,
as described in the Company's Proxy Statement dated March 23, 1998, were voted
on at the meeting. Following is a brief descriptionrules of the matters voted upon
andSEC promulgated under the resultsAct.
(c) In July 1998, the Company issued 1,165,592 million shares of
common stock to Ralston for an aggregate purchase price of $14.75
million. In addition, the Company issued to Ralston a warrant to
purchase an equal number of shares of common stock for a warrant
purchase price of $250,000. The initial exercise price of the
voting:
1. Proposal to elect two Class I directors forwarrant is $12.87 per share increasing over the three year terms expiring
at the Company's annual meeting in 2001. All directors were elected.
The shares were voted as follows:
Nominee Number of Shares
------- ----------------
Fred M. Schwarzer For 18,622,572
Withheld 617,664
Guy Tebbit, Ph.D. For 18,619,762
Withheld 620,474
2. Proposal to ratify the selection of Arthur Andersen LLP as
independent auditorsterm of
the Company for its fiscal year ended
December 31, 1997.warrant. The shares were voted as follows:
For 19,223,871
Against 8,989
Abstentions 7,376
24
ITEM 5. OTHER INFORMATION
The SEC recently adopted amendments toRegistrant relied upon the rules governing shareholder
proposals and recommended that registrants disclose the deadlines for receiving
stockholder proposals. As disclosed in the Company's 1998 Proxy Statement,
proposals intended to be presented at the 1999 Annual Meeting of shareholders
and included in the Company's 1999 Proxy Statement must be receivedexemption provided by
the
Company no later than November 23, 1998.
In the event a shareholder wishes to nominate a candidate for election as
a director, or wishes to propose any other matter for consideration at the
shareholders' meeting, other than proposals to be included in the Company's 1999
Proxy Statement as set forth in the preceding paragraph, written notice of such
intent to make such nomination or propose such action must be given to the
SecretarySection 4(2) of the Company pursuant to certain procedures set forthAct because (a) the transaction did not
involve a public offering and (b) the purchaser represented that
it was an "accredited investor" as such term is defined in the
Company's bylaws, a copy of which is available upon request from the Secretaryrules
of the Company. These procedures provide, among other things, that such
shareholder's written notice of intent must be delivered toSEC promulgated under the Secretary of the
Company not less than 60 days nor more than 90 days prior to the scheduled
meeting date; unless less than 70 days prior notice or public disclosure of the
date of the meeting is given or made by the Company, in which event such notice
of intent must be received not later than the earlier of the 10th day following
the date on which notice of the meeting was mailed or such public disclosure
made, and two (2) days prior to the date of the scheduled meeting. The chairman
of the annual meeting may refuse to acknowledge the nomination of any person or
the request for such other action not made in compliance with the foregoing
procedures. If the foregoing procedures are not followed and such nomination or
other request for action is nonetheless permitted, the Company may confer
discretionary voting authority with respect to such matters in its Proxy
Statement for the 1999 Annual Meeting of shareholders.Act.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See Exhibit Index on Page 2627
(b) Reports on Form 8-K
None
25No reports on Form 8-K were filed by the Company during the quarter
ended September 30, 1998.
26
EXHIBIT INDEX
Exhibit
Number Description of Document
- --------------- -----------------------
4.2 (a) Waiver and Amendment to First Amended Investors' Rights Agreement
among the Company and certain other parties.
4.2 (b) Second Waiver and Amendment to First Amended Investors' Rights
Agreement among the Company and certain other parties.
4.2 (c) Third Waiver and Amendment to First Amended Investors' Rights
Agreement among the Company and certain other parties.
4.5 Common Stock Warrant Purchase Agreement dated as of July 29, 1998
between the Company and Ralston Purina Company
27 Financial Data Schedule
- ----------
2627
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: August 13,November 16, 1998 By: /s/ William G. Skolout
--------------------------------------------------
WILLIAM G. SKOLOUT
Chief Financial Officer
(on behalf of the Registrant and as the
Registrant's Principal Financial and
Accounting Officer)
2728