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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 June 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ____________
Commission file number 000-22427
HESKA CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0192527
[State or other jurisdiction [I.R.S. Employer Identification No.]
of incorporation or organization]
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, 1998 was 26,447,876
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HESKA CORPORATION
FORM 10-Q
QUARTERLY REPORT
TABLE OF CONTENTS
PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 1998 (Unaudited) and December 31,
1997 (Restated) .......................................................................... 1
Condensed Consolidated Statements of Operations (Unaudited) for the three months and six
months ended June 30, 1998 and 1997 (Restated) ........................................... 2
Condensed Consolidated Statements of Cash Flows (Unaudited) for the six months ended
June 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..... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk ............................... Not Applicable
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... Not Applicable
Item 2. Changes in Securities and Use of Proceeds................................................. 24
Item 3. Defaults Upon Senior Securities........................................................... Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders ...................................... 24
Item 5. Other Information......................................................................... 25
Item 6. Exhibits and Reports on Form 8-K.......................................................... 25
Exhibit Index......................................................................................... 26
Signatures ........................................................................................... 27
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HESKA CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
ASSETS
June 30, December 31,
1998 1997
------------- -------------
Current assets: (unaudited) (restated)
Cash and cash equivalents $ 6,827 $ 10,679
Marketable securities 47,933 18,073
Accounts receivable, net 5,322 5,327
Inventories, net 13,169 10,562
Other current assets 2,115 1,236
------------- -------------
Total current assets 75,366 45,877
Property and equipment, net 17,388 15,979
Intangible assets, net 5,534 6,009
Restricted marketable securities and other assets 782 1,155
------------- -------------
Total assets $ 99,070 $ 69,020
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,290 $ 6,425
Accrued liabilities 2,588 2,968
Deferred revenue 1,323 284
Current portion of capital lease obligations 611 600
Current portion of long-term debt 5,358 4,137
------------- -------------
Total current liabilities 15,170 14,414
Capital lease obligations, less current portion 1,418 1,620
Long-term debt, less current portion 8,837 9,021
Accrued pension liability 113 113
------------- -------------
Total liabilities 25,538 25,168
Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value, 40,000,000 shares authorized; 24,999,979
and 18,854,015 shares issued and outstanding, respectively 25 19
Additional paid-in capital 167,526 118,448
Deferred compensation (1,572) (1,967)
Stock subscription receivable from officers (163) (158)
Cumulative translation adjustment (19) 1
Accumulated deficit (92,265) (72,491)
------------- -------------
Total stockholders' equity 73,532 43,852
------------- -------------
Total liabilities and stockholders' equity $ 99,070 $ 69,020
============= =============
See accompanying notes to condensed consolidated financial statements
HESKA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ ------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
(restated) (restated)
Revenues:
Products, net $ 9,100 $ 5,870 $ 16,490 $ 10,376
Research and development 119 199 639 637
------------- ------------- ------------- -------------
9,219 6,069 17,129 11,013
Costs and operating expenses:
Cost of goods sold 6,751 4,179 11,562 7,588
Research and development 6,502 5,589 12,680 10,194
Selling and marketing 2,868 2,295 5,958 4,232
General and administrative 2,826 3,705 5,826 6,355
Amortization of intangible assets and
deferred compensation 672 464 1,437 1,114
Purchased research and development - 2,468 - 2,468
------------- ------------- ------------- -------------
19,619 18,700 37,463 31,951
------------- ------------- ------------- -------------
Loss from operations (10,400) (12,631) (20,334) (20,938)
Other income (expense):
Interest income 897 152 1,472 448
Interest expense (468) (235) (938) (451)
Other, net 16 (58) 28 (88)
------------- ------------- ------------- -------------
Net loss $ (9,955) $ (12,772) $ (19,772) $ (21,029)
============= ============= ============= =============
Basic net loss per share $ (0.40) $ (0.86)
============= =============
Unaudited pro forma basic net loss per share $ (0.96) $ (1.61)
============= =============
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
============= ============= ============= =============
See accompanying notes to condensed consolidated financial statements.
HESKA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended June 30,
1998 1997
------------- -------------
CASH FLOWS USED IN OPERATING ACTIVITIES: (restated)
Net cash used in operating activities $ (20,343) $ (16,722)
------------- -------------
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)
Cash deposited in restricted cash account related to Bloxham
acquisition - (244)
------------- -------------
Net cash (used in) provided by investing activities (33,093) 9,901
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 49,084 1,134
Proceeds from borrowings 3,869 2,604
Repayment of debt and capital lease obligations (3,368) (1,252)
------------- -------------
Net cash provided by financing activities 49,585 2,486
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EFFECT OF EXCHANGE RATE CHANGES ON CASH (1) 7
------------- -------------
DECREASE IN CASH AND CASH EQUIVALENTS (3,852) (4,328)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 10,679 6,630
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 6,827 $ 2,302
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 918 $ 372
Non-cash investing and financing activities:
Issuance of debt related to acquisitions - 320
Issuance of common and preferred stock related to acquisitions,
net of cash acquired 6,997 3,116
Purchase of assets under direct capital lease financing - 255
See accompanying notes to condensed consolidated financial statements
HESKA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 (UNAUDITED)
1. ORGANIZATION AND BASIS OF PRESENTATION
Organization
Heska Corporation (the "Company") 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-
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-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
its research and development and sales and marketing activities. Cumulative net
losses from inception of the Company in 1988 through June 30, 1998 have totaled
$92.3 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 successfully 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. 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 June 30, 1998, the
statements of operations for the three months and six months ended June 30, 1998
and 1997 and the statements of cash flows for the six months ended June 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 the 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 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, 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 per Share, which
the Company adopted in 1997. Also, the Company has adopted the guidance of
Securities and Exchange Commission ("SEC") Staff Accounting Bulletin ("SAB") No.
98 and related interpretations. Due to the automatic conversion of all shares of
convertible preferred stock into common stock 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 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 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
JUNE 30, 1997 JUNE 30, 1997
------------------ ----------------
Pro forma basic net loss per share as reported (restated)....................... $ (0.88) $ (1.47)
Impact of adoption of SAB 98.................................................... (0.08) (0.14)
------------------ ----------------
Unaudited pro forma basic net loss per share (restated)......................... $ (0.96) $ (1.61)
================== ================
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 JUNE 30, 1998
-------------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ----------
Weighted average common shares outstanding (actual)................. N/A 24,920 N/A
-------------
Basic net loss per share............................................ $(9,955) 24,920 $ (0.40)
=========== ============= ==========
FOR THE THREE MONTHS ENDED JUNE 30, 1997
-------------------------------------------
(RESTATED)
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 1,811 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........................ $(21,029) 13,100 $ (1,61)
=========== ============= ==========
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
======== ============
4. BUSINESS ACQUISITION - EFFECTS OF POOLING-OF-INTERESTS ACCOUNTING
Acquisition of Sensor Devices, Inc. ("SDI") - In March 1998 the Company
completed its acquisition of all of the outstanding shares of SDI, a
manufacturer of medical sensor products, in a transaction using the pooling-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
------------- -------------------- --------
Total assets as of December 31, 1997........................ $ 65,248 $ 3,772 $69,020
Total shareholders' equity as of December 31, 1997.......... 43,672 180 43,852
Total revenues:
For the three months ended June 30, 1997................ 4,132 1,937 6,069
For the six months ended June 30, 1997.................. 7,196 3,817 11,013
Loss from operations:
For the three months ended June 30, 1997................ (12,552) (79) (12,631)
For the six months ended June 30, 1997.................. (20,779) (159) (20,938)
Net loss:
For the three months ended June 30, 1997................ (12,652) (120) (12,772)
For the six months ended June 30, 1997.................. (20,759) (270) (21,029)
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 six months ended June 30, 1998 and 1997.
This customer, which represented 19% and 24% of the Company's total revenues for
the three months ended June 30, 1998 and 1997, respectively, and 14% and 25% of
total revenues for the six months ended June 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 six months ended June 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 both the first
and second 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 JUNE 30,
------------------------------------------------------------------------------------
1998 1997
------------------------------------------ ---------------------------------------
(RESTATED)
NORTH AMERICA EUROPE CONSOLIDATED NORTH AMERICA EUROPE CONSOLIDATED
------------- -------- ------------ ------------- ------- ------------
Product revenues, net.......... $ 8,259 $ 841 $ 9,100 $ 5,319 $ 551 $ 5,870
Loss from operations........... $ (9,801) $ (599) $(10,400) $(12,594) $ (37) $(12,631)
Identifiable assets............ $ 94,715 $ 4,355 $ 99,070 $ 31,051 $2,239 $ 33,290
FOR THE SIX MONTHS ENDED JUNE 30,
------------------------------------------------------------------------------------
1998 1997
------------------------------------------ ---------------------------------------
(RESTATED)
NORTH AMERICA EUROPE CONSOLIDATED NORTH AMERICA EUROPE CONSOLIDATED
------------- -------- ------------ ------------- ------- ------------
Product revenues, net.......... $ 14,833 $ 1,657 $ 16,490 $ 9,637 $ 739 $ 10,376
Loss from operations........... $(19,138) $(1,196) $(20,334) $(20,876) $ (62) $(20,938)
8. COMPREHENSIVE INCOME
In 1998 the Company adopted SFAS No. 130, Reporting Comprehensive 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) 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)
================= ================
9
9. RECENT ACCOUNTING PRONOUNCEMENTS
During the quarter, the Company adopted the provisions of a new
accounting standard, AICPA Statement of Position 98-5, Reporting on the Costs of
Start-up 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 1998, the Financial Accounting Standards Board issued FASB No.
133, Accounting for Derivative Instruments and Hedging Activities. The Statement
establishes accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at fair value. The Statement requires that changes in the derivative's
fair value be recognized currently in earnings unless specific hedging criteria
are met. The Company will adopt FASB 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 EVENTS
Asset Purchase Agreement - In July 1998 the Company issued approximately
206,000 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 1.165
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 $12.87 per
share increases 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 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 from time to time.
The Company undertakes no obligation to publicly update, review or revise any
forward-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 net losses since inception. As of June 30, 1998, the Company's
accumulated deficit was $92.3 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.
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"). 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 additional
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 June 30, 1998 and 1997
Total revenues, which include product and research and development
revenues, increased to $9.2 million in the second quarter of 1998 as compared
to $6.1 million in the second quarter of 1997. Product revenues increased to
$9.1 million in the second quarter of 1998 as compared to $5.9 million for the
second quarter of 1997. The growth in revenue during the second 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 in
the second quarter of 1998 from $199,000 in the second 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.
Cost of goods sold totaled $6.8 million in the second quarter of 1998 as
compared to $4.2 million in the second quarter of 1997. The resulting gross
margin for the second quarter of 1998 increased to $2.3 million from $1.7
million in the second quarter of 1997, due primarily to increased product sales
and manufacturing volumes.
12
Research and development expenses increased to $6.5 million in the second
quarter of 1998 from $5.6 million in the second 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 in research and development expenses will be required to
maintain its current research and development activities.
Selling and marketing expenses increased to $2.9 million in the second
quarter of 1998 from $2.3 million in the second 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 decreased to $2.8 million in the
second quarter of 1998 from $3.7 million in the second 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 in the second quarter of 1998 from $464,000 in the second quarter of
1997. Amortization of intangible assets resulted primarily from the Company's
1997 and 1996 business acquisitions. Net intangible assets at June 30, 1998 and
December 31, 1997 totaled $5.5 million and $6.0 million, respectively. The
amortization of deferred compensation resulted in a non-cash charge to
operations in the second quarter of 1998 of $188,000 as compared to $259,000 in
the second 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. The Company will incur a non-cash charge to
operations of approximately $730,000, $629,000, $574,000 and $34,000 per year
for 1998, 1999, 2000 and 2001, respectively, for amortization of deferred
compensation.
Interest income increased to $897,000 in the second quarter of 1998 from
$152,000 in the second 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.
Interest expense increased to $468,000 in the second quarter of 1998 from
$235,000 in the second quarter of 1997 due to an increase 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 second quarter of 1998 of $9.95
million as compared to a second quarter 1997 net loss of $12.8 million. The
decrease in net losses between the periods is primarily due to one-time charges
recorded in the second quarter of 1997 for purchased research and development
and the supply agreement termination fee included in general and administrative
expenses.
Six Months Ended June 30, 1998 and 1997
Total revenues, which include product and research and development
revenues, increased to $17.1 million in the first half of 1998 as compared to
$11.0 million in the first half of 1997. Product revenues increased
13
to $16.5 million in the first half of 1998 as compared to $10.4 million for the
first half of 1997. The growth in revenue 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 in the first
half of 1998 remained essentially the same as compared to $637,000 in the first
half of 1997. 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.
Cost of goods sold totaled $11.6 million in the first half of 1998 as
compared to $7.6 million in the first half of 1997. The resulting gross margin
for the first half of 1998 increased to $4.9 million from $2.8 million in the
first half of 1997, due primarily to increased product sales and manufacturing
volumes.
Research and development expenses increased to $12.7 million in the first
half of 1998 from $10.2 million in the first half 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 in research and development expenses will be required
to maintain its current research and development activities.
Selling and marketing expenses increased to $6.0 million in the first
half of 1998 from $4.2 million in the first half 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 decreased to $5.8 million in the
first half of 1998 from $6.4 million in the first half of 1997. The decrease in
the first half 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 million in the first half of 1998 from $1.1 million in the first half of
1997. Amortization of intangible assets resulted primarily from the Company's
1997 and 1996 business acquisitions. Net intangible assets at June 30, 1998 and
December 31, 1997 totaled $5.5 million and $6.0 million, respectively. The
amortization of deferred compensation resulted in a non-cash charge to
operations in the first half of 1998 of $395,000 as compared to $278,000 in the
first half 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. The Company will incur a non-cash charge to operations of
approximately $730,000, $629,000, $574,000 and $34,000 per year for 1998, 1999,
2000 and 2001, respectively, for amortization of deferred compensation.
14
Interest income increased to $1.5 million in the first half of 1998 from
$448,000 in the first half 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.
Interest expense increased to $938,000 in the first half of 1998 from $451,000
in the first half of 1997 due to an increase 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 half of 1998 of $19.8
million as compared to a first half 1997 net loss of $21.0 million. The decrease
in losses between the periods is primarily due to 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.
LIQUIDITY AND CAPITAL RESOURCES
In July 1997, the Company completed its initial public offering ("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 June 30, 1998, the Company had received aggregate proceeds of
$148.0 million from various equity transactions, including $48.6 million from
the March 1998 follow-on offering, $43.9 million from the July 1997 IPO, $36.0
million from the April 1996 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.
In addition, the Company has received proceeds from equipment financing
totaling $10.8 million through June 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
million as of June 30, 1998, with installments payable through 2006.
Expenditures for property and equipment totaled $2.9 million and $3.7 million
for the six months ended June 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 has secured lines of credit for its subsidiaries
totaling approximately $3.6 million, against which borrowings of approximately
$2.5 million were outstanding at June 30, 1998. These financing facilities are
secured by assets of the respective subsidiaries and corporate guarantees of
Heska Corporation. The Company expects to seek additional asset-based borrowing
facilities.
Net cash used for operating activities was $20.3 million and $16.7
million for the six months ended June 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 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 June 30, 1998 the Company's principal source of liquidity was
$54.8 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 products gain market
acceptance, the extent to which products under 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, the procurement and
enforcement of patents important to the Company's business, 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 for current operations 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 may 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. 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 Company has initiated procedures to identify, evaluate and implement
any necessary changes to computer systems and applications 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 2000 conversion will have a material
adverse effect on its business.
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 Development and Introduction of New Products
Many of the Company's products are still under development and there can
be no assurance such products will be successfully developed or commercialized
on a timely basis, or at all. The Company believes that its revenue growth and
profitability, if any, will substantially depend upon its ability 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. There can be no assurance that
the Company will not experience difficulties that could delay or prevent
successfully developing, obtaining regulatory approvals to market or introducing
these new products, that regulatory clearance or approval of any new products
will be granted by the USDA, the FDA, the 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. 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 and
development activities on behalf of the Company. In order to successfully
commercialize any new products, the Company will be required to establish and
maintain a reliable, cost-efficient source of manufacturing for such products.
If the Company is unable, for technological or other reasons, to complete the
development, introduction or scale up of manufacturing of any new product or if
any new product is not approved for marketing or does not achieve a significant
level of market acceptance, the Company could be materially and adversely
affected. Following the introduction of a product, adverse side effects may be
discovered that make the product no longer commercially viable. Publicity
regarding such adverse effects could affect sales of the Company's other
products for an indeterminate time period. The Company is dependent on the
acceptance of its products by both veterinarians and pet owners. The failure of
the Company to engender confidence in its products and services could affect the
Company's ability to attain sustained market acceptance of its products.
17
Loss History and Accumulated Deficit; Uncertainty of Future Profitability;
Quarterly Fluctuations and Customer Concentration
Heska has incurred net losses since its inception. At June 30, 1998, the
Company's accumulated deficit was $92.3 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. Revenues from one Diamond customer comprised
approximately 21% of total revenues in the year ended December 31, 1997. 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 its operating expenses for personnel, new product
development and marketing, the Company's operating results will be adversely
affected if its sales do not correspondingly increase or if its product
development efforts are unsuccessful or subject to delays.
Limited Sales and Marketing Experience; Dependence on Others
To be successful, Heska will have to continue to develop and train its
direct sales force or rely on marketing partners or other arrangements with
third parties for the marketing, distribution and sale of its products. The
Company is currently marketing its products to veterinarians through a direct
sales force and certain third parties. There can be no assurance that the
Company will be able to successfully maintain marketing, distribution or sales
capabilities or make arrangements with third parties to perform those activities
on terms satisfactory to the Company. 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 rights to certain products
under development to third parties, including Novartis AG ("Novartis"), Bayer AG
("Bayer") and Eisai Co., Ltd. ("Eisai"). 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. 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.
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 only through veterinarians, a
substantial segment of the potential market may not be reached, and the Company
may not be able to offer its products at prices which are competitive with those
of companies that distribute their products through retail channels. There can
be no assurance that the Company's competitors will not develop or market
technologies or products that are more effective or commercially attractive than
the Company's current or future products or that would render the Company's
technologies and products obsolete. Moreover, there can be no assurance that the
Company will have the financial resources, technical expertise or marketing,
distribution or support capabilities to compete successfully.
Uncertainty of Patent and Proprietary Technology Protection; License of
Technology of Third Parties
The Company's ability to compete effectively will depend in part on its
ability to develop and maintain proprietary aspects of its technology and either
to operate without infringing the proprietary rights of others or to obtain
rights to such technology. Heska has United States and foreign issued patents
and is currently prosecuting patent applications in the United States and with
certain foreign patent offices. There can be no assurance that any of the
Company's pending patent applications will result in the issuance of any patents
or that, if issued, any such patents will offer protection against competitors
with similar technology. There can be no assurance that any patents issued to
the Company will not be challenged, invalidated or circumvented in the future or
that the rights created thereunder will provide a competitive advantage.
The biotechnology and pharmaceutical industries have been characterized
by extensive litigation regarding patents and other intellectual property
rights. 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.
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 intends 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 such regulatory requirements, and any
failure to do so would have a material adverse effect on the Company's business,
financial condition or results of operations.
There can be no assurance that the Company will not incur significant
costs to comply with laws and regulations in the future or that laws and
regulations will not have a material adverse effect upon the Company's business,
financial condition or results of operations.
21
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,
the scope of its operating and financial systems and the geographic area of its
operations as new products are developed and commercialized. This growth will
result in an increase in responsibilities for both existing and new management
personnel. The Company's ability to manage growth effectively will require it to
continue to implement and improve its operational, financial and management
information systems and to train, motivate and manage its current employees and
hire new employees. There can be no assurance that the Company will be able to
manage its expansion effectively, and a failure to do so could have a material
adverse effect on the Company's business, financial condition or results of
operations.
In 1996, Heska consummated the acquisitions of Diamond and of assets
relating to its canine allergy business. The Company's 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 of medical sensor
products. 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, 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. Because of the specialized scientific
nature of the Company's business, the Company is highly dependent on its ability
to attract and retain qualified scientific and technical personnel. There is
intense competition among major pharmaceutical and chemical companies,
specialized biotechnology firms and universities and other research institutions
for qualified personnel in the areas of the Company's activities. Loss of the
services of, or failure to recruit, key scientific and technical personnel could
adversely affect the Company's business, financial condition or results of
operations.
Potential Product Liability; Limited Insurance Coverage
The testing, manufacturing and marketing of the Company's current
products as well as those currently under development entail an inherent risk of
product liability claims and associated adverse publicity. To date, the Company
has not experienced any material product liability claims, but any such claims
arising in the future could have a material adverse effect on the Company's
business, financial condition or results of operations. Potential product
liability claims may exceed the amount of the Company's insurance coverage or
may be excluded from coverage under the terms of the policy. There can be no
assurance that the Company will be able to continue to obtain adequate insurance
at a reasonable cost, if at all. In the event that the Company is held liable
for a claim against which it is not indemnified or for damages exceeding the
limits of its insurance coverage or which results in significant adverse
publicity against the Company, such claim could have a material adverse effect
on the Company's business, financial condition or results of operations.
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.
23
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,
1998, the Company had used the entire net proceeds of the offering
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, 1998 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 description of the matters voted upon
and the results of the voting:
1. Proposal to elect two Class I directors for 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 auditors of the Company for its fiscal year ended
December 31, 1997. 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 to 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 received 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
Secretary of the Company pursuant to certain procedures set forth in the
Company's bylaws, a copy of which is available upon request from the Secretary
of the Company. These procedures provide, among other things, that such
shareholder's written notice of intent must be delivered to 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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See Exhibit Index on Page 26
(b) Reports on Form 8-K
None
25
EXHIBIT INDEX
Exhibit
Number Description of Document
- --------- -----------------------
27 Financial Data Schedule
- ----------
26
HESKA CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HESKA CORPORATION
Date: August 13, 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)
27