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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
--- ACT OF 1934
For the fiscal year ended December 31, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-22427
HESKA CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 77-0192527
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[State or other jurisdiction [I.R.S. Employer Identification No.]
of incorporation or organization]
1613 Prospect Parkway
Fort Collins, Colorado 80525
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[Address of principal executive offices] [Zip Code]
Registrant's telephone number, including area code: (970) 493-7272
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
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 shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference to Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $97,400,000 as of March 20, 2000 based upon the
closing price on the Nasdaq National Market reported for such date. This
calculation does not reflect a determination that certain persons are affiliates
of the Registrant for any other purpose.
33,660,166 shares of the Registrant's Common Stock, $.001 par value, were
outstanding at March 20, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10 (as to directors), 11, 12 and 13 of Part III incorporate by reference
information from the Registrant's Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for the Registrant's 2000 Annual Meeting of Stockholders.
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PART I
ITEM 1. BUSINESS.
We are primarily focused on the discovery, development and marketing of
companion animal health products. In addition to manufacturing certain of our
companion animal products, our primary manufacturing subsidiary, Diamond Animal
Health, Inc. ("Diamond"), also manufactures animal health vaccine products which
are marketed and distributed by third parties. In addition to manufacturing
veterinary allergy products for marketing and sale by us, our subsidiaries,
Center Laboratories, Inc. ("Center") and CMG-Heska Allergy Products S.A.
("CMG"), a Swiss corporation, also manufacture and sell human allergy products.
ANIMAL HEALTH PRODUCTS
We presently sell a variety of companion animal health products, among the
most significant of which are the following.
DIAGNOSTICS
Heartworm Diagnostics
Heartworm infections of dogs and cats are caused by the parasite,
Dirofilaria immitis. This parasitic worm is transmitted in larval form to dogs
and cats through the bite of an infected mosquito. Larvae develop into adult
worms which live in the pulmonary arteries and heart of the host, where they can
cause serious cardiovascular, pulmonary, liver and kidney disease.
In 1997, we developed a diagnostic test for heartworm infection in dogs.
This test uses monoclonal antibodies reactive with heartworm antigens to detect
the presence of these antigens in the blood of the infected dog. This test was
first offered through our own veterinary diagnostic laboratory. A simple, rapid,
and easy to use point-of-care version of this test, Solo Step(TM) CH, was
introduced in Italy in 1998. We received regulatory clearance to sell Solo
Step(TM) CH in the United States in January 1999, and the product has been
successfully introduced in the United States. In March 2000 we received
regulatory clearance to sell a batch test version of this product, Solo Step(TM)
CH Batch Test Strips, and we expect to make this product available to
veterinarians shortly.
Also in 1997, we introduced a new test in our veterinary diagnostic
laboratory for feline heartworm infections of cats which allowed veterinarians
for the first time to accurately establish the prevalence of heartworm exposure
in cats in their practices. This test is highly accurate and identifies
antibodies in cat serum that react with a recombinant heartworm antigen. In
1997, we introduced a rapid, point-of-care version of this test in Italy. After
receiving regulatory clearance, we introduced this point-of-care feline
heartworm test, Solo Step(TM) FH, in the United States in 1998.
Allergy
Allergy is common in companion animals, and it is estimated to affect
approximately 10% to 15% of dogs. Clinical symptoms of allergy are variable, but
are often manifested as persistent and serious skin disease in dogs and cats.
Clinical management of allergic disease is problematic, as there are a large
number of allergens that may give rise to these conditions. Although skin
testing is often regarded as the most accurate diagnostic procedure, such tests
are painful, subjective and inconvenient.
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The effectiveness of the immunotherapy that is prescribed to treat allergic
disease is inherently limited by inaccuracies in the diagnostic process.
We have developed the HESKA(R) ALLERCEPT(TM) Detection System, a more
accurate in vitro technology, to detect IgE, the antibody involved in most
allergic reactions. This technology permits the design of tests that, in
contrast to other in vitro tests, more specifically identify the animal's
allergic responses to particular allergens. During 1997, we adapted this
technology to a broad range of our canine and feline allergy tests. ALLERCEPT
uses a recombinant version of the natural IgE receptor to screen the serum of
potentially allergic animals for IgE directed against a panel of known
allergens. A typical test panel consists primarily of various pollen, grass,
mold and insect allergens.
BIOLOGICS AND VACCINES
Equine Influenza Vaccine
Equine influenza is a common viral disease of horses and is similar to
human influenza. This disease poses a significant risk to the estimated six
million horses in the United States. Infected horses have severe respiratory
disease and diminished performance for an extended period following infection.
We currently believe that approximately half of the six million horses in the
United States receive vaccination. Most competitive equine influenza vaccines
are administered as a component of a multi-purpose vaccine, intended to provide
protection against multiple infectious diseases. Industry sources have estimated
the total equine vaccine market at $50 million in the United States. Currently
available vaccines for equine influenza are of limited efficacy. We have
developed a unique vaccine for equine influenza, Flu Avert(TM) I.N. vaccine,
which we believe has improved efficacy and duration of immunity compared to
existing products. This product was approved by the USDA on November 17, 1999
and was first sold to veterinarians in December 1999.
Allergy Immunotherapy
Veterinarians who use our in vitro allergy testing services often purchase
immunotherapy treatment sets for those animals with positive test results. These
prescription treatment sets are formulated specifically for each allergic animal
and contain only the allergens to which the animal has demonstrated significant
levels of IgE antibodies. The prescription formulations are administered in a
series of injections, with doses increasing over several months, to ameliorate
the allergic condition of the animal. Immunotherapy is generally continued for
an extended time. We offer both canine and feline immunotherapy treatment sets.
Feline Respiratory Disease
In 1997, we introduced in the United States a three-way modified live
vaccine (HESKA(TM) Trivalent Intranasal/Intraocular Vaccine) for the three most
common viral diseases of cats: calicivirus, rhinotracheitis virus and
panleukopenia virus. This vaccine is administered without needle injection by
dropping the liquid preparation into the eyes and nostrils of cats. While there
is one competitive non-injectable two-way vaccine, all other competitive
products are injectable formulations. The use of injectable vaccines in cats has
become controversial due to the frequency of injection site-associated side
effects. The most serious of these side effects are injection site sarcomas,
tumors which, if untreated, are nearly always fatal. Our vaccines avoid
injection site side effects and we believe them to be very efficacious.
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PHARMACEUTICALS
Dentistry
It is estimated that more than 80% of all dogs over three years old exhibit
symptoms of periodontal disease, which often manifests as bad breath. Left
untreated, periodontal disease can cause loss of teeth and systemic bacterial
infection. The most prevalent treatment is the cleaning and scaling of the dog's
teeth. Although periodic cleaning and scaling is recommended for all dogs, this
procedure alone does not adequately address the underlying infection in dogs
with periodontal disease. Systemic antibiotics to be administered by the pet
owner at home are widely prescribed but present convenience and compliance
issues.
Our periodontal disease therapeutic, PERIOceutic(TM) Gel, is an innovative
product for the treatment of periodontal disease in dogs which is currently
marketed in the United States. This product received approval by the European
Commission in September 1999 for marketing and distribution in Europe, and we
are currently considering distribution alternatives in Europe.
Canine Thyroid Supplement
Canine hypothyroidism is a serious disease that is usually caused by
abnormalities of the thyroid gland. It is estimated that 3% to 4% of all dogs
require thyroid hormone replacement therapy. Common clinical signs include dry,
coarse, thin hair, possibly with patches of hair loss and pigment changes. The
disease can affect multiple organ systems and cause recurrent infections.
In 1997, we introduced a thyroid supplement for dogs in the United States,
which we believe is the first and only vitamin-enriched, chewable tablet for the
treatment of hypothyroidism in dogs. These chewable tablets, which are
administered daily for the life of the dog, provide levothyroxine sodium, a
replacement therapy for the hormone normally produced by the dog.
Nutritional Supplements
Arising partly from our allergy expertise, in 1998, we developed and
introduced in the United States a novel fatty acid supplement, HESKA(TM) F.A.
Granules. The unique source of the fatty acids in this product, flaxseed oil,
leads to high omega-3:omega-6 ratios of fatty acids. Diets high in omega-3 fatty
acids are believed to lead to lower levels of inflammatory response. The
HESKA(TM) F.A. Granules include vitamins and are formulated in a palatable
flavor base that makes the product convenient and easy to administer.
MEDICAL INSTRUMENTS
We currently offer a broad line of monitoring, diagnostic and other
instruments which are described below. We entered this line of business in March
1998, when we acquired a manufacturer and marketer of patient monitoring and
diagnostic instruments, which was located in Waukesha, Wisconsin. Following that
acquisition, we completed the development of certain other instruments and
entered into agreements for the distribution of additional instruments to
veterinarians. In 1999, we consolidated all of these operations into our
existing operations in Fort Collins, Colorado and Des Moines, Iowa.
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Diagnostic Instruments
Our line of diagnostic instruments includes the i-STAT(R) Portable Clinical
Analyzer(1), a hand-held, portable clinical analyzer that provides quick, easy
analysis of blood gases and other key analytes, such as sodium, potassium and
glucose, with whole blood. In the United States we also market the Heska(TM) Vet
Diff ABC Hematology Analyzer, an easy to use blood analyzer that measures such
key parameters as white blood cell count, red blood cell count, platelet count
and hemoglobin levels in animals. We also offer the Reflovet(R) Clinical
Analyzer(2), an easy to operate, cost effective blood chemistry analyzer that
measures a broad range of animal blood analytes, such as amylase, creatinine,
uric acid, bilirubin and glucose. Consumable supplies for the i-STAT, Vet ABC
Hematology Analyzer and Reflovet are also provided to veterinarians through
Heska sales and distribution channels.
Monitoring and Other Instruments
The use by veterinarians of the types of patient monitoring products that
are taken for granted in human medicine is becoming the state of the art in
companion animal health. The centerpiece of our monitoring instrument product
line are oxygen saturation monitors designed for monitoring animals under
anesthesia: the VET/OX(R) 4404 and VET/OX(R) 4800, each of which includes a
variety of additional monitoring parameters, such as pulse rate and strength,
body temperature, respiration and ECG. We also offer a proprietary esophageal
ECG sensor, VET E/Sig(TM) probe for monitoring ECG, temperature and heart and
breath sounds of anesthetized dogs. Our monitoring line also includes the
VET/ECG(TM) 2000 hand-held ECG monitor. The VET/IV(TM) 2.2 infusion pump is a
compact, affordable IV pump that allows veterinarians to easily provide
regulated infusion of blood or nutritional products for their patients.
VETERINARY DIAGNOSTIC LABORATORY
We have a veterinary diagnostic laboratory at our Fort Collins facility.
This diagnostic laboratory currently offers our allergy diagnostics, canine and
feline heartworm diagnostics and flea bite allergy assays, in addition to other
diagnostic and pathology services. Our Fort Collins veterinary diagnostic
laboratory is currently staffed by four diplomates of the American College of
Veterinary Pathologists, medical technologists experienced in animal disease and
several additional technical staff.
We intend to continue to use our Fort Collins diagnostic laboratory both as
a stand-alone service center for our customers and as an adjunct to our product
development efforts. Many of the assays which we intend to develop in a
point-of-care format are initially validated and made available in the
veterinary diagnostic laboratory and will also remain available there after the
introduction of the analogous point-of-care test.
In 1999, we also offered veterinary diagnostic laboratory services in the
United Kingdom through our U.K. subsidiary, Heska UK, formerly known as Bloxham
Laboratories. We sold this business in March 2000, as we did not believe
operation of a veterinary diagnostic laboratory in the U.K. was strategic to our
business.
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(1) i-STAT(R)is a registered trademark of i-STAT Corporation.
(2) Reflovet(R)is a registered trademark of Boehringer Manheim GmBH.
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FOOD ANIMAL PRODUCTS
In addition to manufacturing companion animal health products for marketing
and sale by Heska, Diamond has completed the development of new bovine vaccines
that were licensed by the USDA in the United States in 1998 and 1999. Diamond
has entered into an agreement with a food animal products distributor, Agri
Laboratories, Ltd., for the exclusive marketing and sale of these vaccines
worldwide. AgriLabs currently has agreements with Bayer for the distribution of
these vaccines in the United States and Canada and with Intervet, Inc., a
division of Akzo Nobel, for the distribution of these vaccines worldwide except
in the United States. Diamond is the sole manufacturer of these products. In
1999, Diamond also manufactured bovine vaccines which were marketed and sold by
Bayer, primarily in the United States, pursuant to a take-or-pay contract which
expired in February 2000. It is expected that a portion of these sales will be
replaced by sales of the new vaccines to AgriLabs for distribution by Bayer and
others.
Diamond also manufactures vaccine products for a number of other animal
health companies. This activity ranges from providing bulk vaccine antigens
which are included in the vaccines which are manufactured by other companies to
filling and finishing final products using bulk antigens provided by other
animal health companies.
HUMAN ALLERGY PRODUCTS
In addition to manufacturing veterinary products for marketing and sale by
Heska, Center manufactures a broad line of allergenic extracts, such as those
from pollens, grasses and trees, for use in human allergy immunotherapy and
diagnosis in the United States. Center provides these allergenic extracts to
human allergists both in bulk form to those allergists who wish to mix their own
allergenic immunotherapy treatment sets and in the form of custom-made patient
immunotherapy treatment sets of multiple allergens. In December 1999, we
announced that our operations at Center were under strategic review. We continue
to evaluate Center's business from both a strategic and operational perspective
and are looking for opportunities to optimize this business.
In addition to manufacturing and marketing veterinary allergy products, CMG
manufactures and markets a broad range of human allergy diagnostic products for
sale primarily in Europe. These products are sold primarily through
distributors.
PRODUCT CREATION
We are committed to creating innovative products to address significant
unmet health needs of companion animals. We create products both through
internal research and development and through external collaborations. Internal
research is managed by multidisciplinary product-associated project teams
consisting of veterinarians, biologists, molecular and cellular biologists,
biochemists and immunologists. We believe that we have one of the most
sophisticated scientific efforts in the world devoted to applying biotechnology
to the creation of companion animal products.
We are also committed to identifying external product opportunities and
creating business and technical collaborations that lead to the creation of
other products. We believe that our active participation in scientific networks
and our reputation for investing in research enhances our ability to acquire
external product opportunities.
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Our product pipeline currently includes numerous products in various stages
of development. Products under development include several point-of-care
diagnostic products, vaccines for infectious diseases in cats, dogs and horses
and therapeutic products for allergy, cancer, osteoarthritis and flea control.
The vast majority of all our research and development resources are
directed towards the development of new companion animal health products. We
incurred expenses of $20.3 million, $25.1 million and $17.0 million in the years
ended December 31, 1997, 1998 and 1999, respectively in support of our research
and development activities.
SALES AND MARKETING
We presently market our products in the United States directly to
veterinarians through the use of our field sales force, inside customer
service/tele-sales force and veterinary distributors acting as contract sales
agents. As of December 1999, we had approximately 36 field sales representatives
and field sales supervisors and 15 customer service/tele-sales representatives
and supervisors. The 17 veterinary distributors with whom we have entered into
sales agency relationships, and three direct sales distributors employ
approximately 700 field and customer service/tele-sales representatives,
although some of these distributors do not sell all of our products. In October
1999, we entered into an agreement with a third party to provide a contract
sales force for the sale of our products to equine veterinarians.
Internationally, we market our products to veterinarians primarily through
distributors.
We estimate that there are approximately 30,000 veterinarians in the United
States whose practices are devoted principally to small animal medicine. Those
veterinarians practice in approximately 20,000 clinics in the United States. We
plan to market our products to these clinics primarily through the use of our
field and telephone sales force, sales agents, direct sales distributors, trade
shows and print advertising. During the past year, we sold our products to more
than 14,000 such clinics in the United States.
Certain of the products which we have under research and development, if
completed, may be marketed partially or wholly by third parties with whom we
have collaborative agreements. Center's human allergy immunotherapy products are
marketed and sold in the United States by Center Pharmaceuticals, Inc., an
unaffiliated sales and marketing company that markets allergy related products
primarily to human allergists in the United States. Center Pharmaceuticals
markets and sells Center's human allergy products as a contract sales agent of
Center.
MANUFACTURING
Our products are manufactured by our Diamond, Center and CMG subsidiaries
and/or by third-party manufacturers. Diamond's facility is a USDA and FDA
licensed biological and pharmaceutical manufacturing facility in Des Moines,
Iowa. We expect that we will manufacture most or all of our biological products
at this facility, as well as most or all of our recombinant proteins and other
proprietary reagents for our diagnostic products. We manufacture all of our
allergy immunotherapy products at Center's USDA and FDA licensed manufacturing
facility in Port Washington, New York. CMG manufactures its veterinary and human
allergy diagnostic products at its facility in Fribourg, Switzerland. Diamond
and Center's facilities are subject to regulation and inspection by the USDA and
the FDA. Our heartworm point-of-care diagnostic products are manufactured by
Quidel Corporation and Diamond. Our periodontal disease therapeutic is
manufactured by Atrix Laboratories, Inc., the company that developed this
product for human use. Our patient monitoring and diagnostic instruments,
including
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our clinical and hematology analyzers and veterinary sensors, are manufactured
by third-party manufacturers.
In addition to manufacturing our proprietary products, Diamond manufactures
animal health vaccine products for marketing and sale by other companies.
Diamond currently has the capacity to manufacture more than 50 million doses of
vaccines each year. Diamond's customers purchase products in both bulk and
finished format, and Diamond performs all phases of manufacturing, including
growth of the active bacterial and viral agents, sterile filling, lyophilization
and packaging. In addition, Diamond offers to support its customers through
research services, regulatory compliance services, validation support and
distribution services.
In addition to manufacturing our proprietary products, Center manufactures
allergy immunotherapy products which are distributed in the human market using
an independent and unaffiliated distribution company, Center Pharmaceuticals,
Inc.
COLLABORATIVE AGREEMENTS
Novartis
We have entered into several agreements with Novartis. Novartis has certain
rights to manufacture and market any flea control vaccine or feline heartworm
control vaccine developed by us as to which USDA prelicensing serials are
completed on or before December 31, 2005. We and Novartis have co-exclusive
rights to market these products under our own trade names throughout the world
(other than in countries in which Eisai Co., Ltd. has such rights) and, if we
both elect to market, we will share revenues on each other's sales. The
marketing agreements remain in force through 2010 or longer, if Novartis is
still actively marketing such products. In addition, we entered into a screening
and development agreement under which we may undertake joint research and
development activities in certain fields. If we fail to agree to perform joint
research activities, then Novartis has the right to use certain of our materials
on an exclusive basis to develop food animal pharmaceutical products or on a
co-exclusive basis with us to develop pharmaceutical products for parasite
control in companion animals or food animal vaccines. Novartis would pay
royalties on any such products developed by it. Currently, there are no joint
research projects being undertaken under this agreement. We also entered into a
right of first refusal agreement under which, prior to granting licenses to any
third-party to any products or technology developed or acquired by us for either
companion animal or food animal applications, we must first notify and offer
Novartis such rights. If we are unable to come to an agreement within 150 days
of the first notice, we may thereafter license such rights to third parties on
terms not materially more favorable than the terms last offered by us to
Novartis. The screening and development agreement and right of first refusal
agreement each terminate in 2005. Heska and Novartis have subsequently entered
into additional research and development agreements.
We also have an exclusive distribution agreement pursuant to which Novartis
has the exclusive right to distribute selected Heska products in Japan,
including our in-clinic feline and canine heartworm diagnostic products and
feline viral vaccines, upon obtaining regulatory approval in Japan for such
products. Novartis also granted us a right of first refusal to evaluate for
possible development and marketing worldwide certain new product technologies
for the veterinary market as they may become available from Novartis.
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Bayer
We currently have a research agreement with Bayer providing for funding of
research by Bayer on a canine heartworm vaccine. Bayer has the option to obtain
an exclusive, royalty-bearing license to sell this vaccine in all countries
except in those in which Eisai has rights. If Bayer exercises this option, we
will negotiate license and distribution agreements. We have the first option to
manufacture any products sold pursuant to any such distribution agreement. The
research agreement will terminate upon completion of the research program. Bayer
may terminate the research agreement prior to completion, but would not have any
rights to market the vaccine (unless it terminated due to our breach), although
it would have non-exclusive access to technology developed in the research
program for use other than in similar vaccines. In the event Bayer elects to
terminate the research agreement (other than due to our breach), we would
recover the right to market the vaccine, subject to certain royalties to Bayer
intended to repay certain amounts Bayer paid under the research agreement. We
also had a research agreement with Bayer with respect to a recombinant feline
toxoplasmosis vaccine which has been terminated.
Eisai
We have an agreement with Eisai, a leading Japanese pharmaceutical company,
pursuant to which Eisai has the exclusive right to market our feline and canine
heartworm vaccines and flea control vaccine in Japan and most other countries in
East Asia. We received an up-front license fee and research funding for the
development of these products. We have the right to manufacture any such
products pursuant to a supply agreement to be negotiated. The agreement will
terminate in January 2008, unless extended or earlier terminated by either party
for material breach of the agreement or by Eisai pursuant to certain early
termination rights.
Ralston Purina Company
We have a strategic alliance with Ralston Purina Company, the world's
largest manufacturer of dry dog foods and dry and soft-moist cat foods. Ralston
Purina holds exclusive rights to license our discoveries, know-how and
technologies for innovative diets for dogs and cats. We are jointly developing
therapeutic diets. We believe that the combination of our expertise in companion
animal disease physiology with Ralston Purina's expertise in formulation and
diet testing will lead to the development of novel nutritional products. Testing
of experimental formulations is ongoing. In the event any products that are the
subject of the collaboration are commercialized by Ralston Purina, Ralston
Purina will pay us a royalty on products incorporating our technology.
Quidel
We have a development agreement with Quidel under which we jointly
developed our Solo Step(TM) CH, Solo Step(TM) CH Batch Test Strips and Solo
Step(TM) FH point-of-care diagnostic products using Quidel's rapid in-clinic
test technology. We also have a supply agreement under which Quidel manufactures
these products.
INTELLECTUAL PROPERTY
We believe that patents, trademarks, copyrights and other proprietary
rights are important to our business. We also rely upon trade secrets, know-how,
continuing technological innovations and licensing opportunities to develop and
maintain our competitive position.
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We actively seek patent protection both in the United States and abroad. As
of December 31, 1999, we owned or co-owned 57 issued U.S. patents and 131
pending U.S. patent applications. Our issued U.S. patents primarily relate to
proprietary allergy, flea control, heartworm, trichinosis and diagnostic and
vaccine delivery technology. Our pending patent applications primarily relate to
proprietary allergy, flea control, heartworm, equine influenza, diagnostic,
vaccine delivery and patient monitoring instrument technologies. Applications
corresponding to pending U.S. applications have been or will be filed in other
countries.
We also have obtained exclusive and non-exclusive licenses for numerous
other patents held by academic institutions and biotechnology and pharmaceutical
companies. The proprietary technologies of Diamond, Center and CMG are primarily
protected through trade secret protection of, for example, their manufacturing
processes. In general, the intellectual property of Diamond's customers belongs
to such customers.
As patent applications in the United States are maintained in secrecy until
patents issue and as publication of discoveries in the scientific or patent
literature often lags behind the actual discoveries, we cannot be certain that
we were the first to make the inventions covered by each of our pending patent
applications or that we were the first to file patent applications for such
inventions. Furthermore, the patent positions of biotechnology and
pharmaceutical companies are highly uncertain and involve complex legal and
factual questions, and, therefore, the breadth of claims allowed in
biotechnology and pharmaceutical patents or their enforceability cannot be
predicted. There can be no assurance that patents will issue from any of our
patent applications or, should patents issue, that we will be provided with
adequate protection against potentially competitive products. Furthermore, there
can be no assurance that should patents issue, they will be of commercial value
to us, or that the United States Patent and Trademark Office or private parties,
including competitors, will not successfully challenge our patents or circumvent
our patent position. For example, we are currently in litigation with Synbiotics
Corporation over a patent relating to heartworm diagnostic technology.
Pursuant to the terms of the Uruguay Round Agreements Act, patents issuing
from applications filed on or after June 8, 1995 have a term of 20 years from
the date of such filing, irrespective of the period of time it may take for such
patent to ultimately issue. This method of patent term calculation can result in
a shorter period of patent protection afforded to our products compared to the
prior method of term calculation (17 years from the date of issue) as patent
applications in the biopharmaceutical sector often take considerable time to
issue. Under the Drug Price Competition and Patent Term Restoration Act of 1984
and the Generic Animal Drug and Patent Term Restoration Act, a patent which
claims a product, use or method of manufacture covering drugs and certain other
products may be extended for up to five years to compensate the patent holder
for a portion of the time required for FDA review of the product. There can be
no assurance that we will be able to take advantage of the patent term extension
provisions of this law.
GOVERNMENT REGULATION
Most of our products being developed will require licensing by a
governmental agency before marketing. In the United States, governmental
oversight of animal health products is primarily provided by two agencies: the
USDA and the FDA. Vaccines and point-of-care diagnostics for animals are
considered veterinary biologics and are regulated by the Center for Veterinary
Biologics of the USDA under the auspices of the Virus-Serum-Toxin Act.
Alternatively, animal drugs, which generally include all synthetic compounds,
are approved and monitored by the Center for Veterinary Medicine of the FDA
under the auspices of the Federal Food, Drug and Cosmetic Act. A third agency,
the Environmental
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Protection Agency, has jurisdiction over certain products applied topically to
animals or to premises to control external parasites. In the United States,
governmental oversight of human health products is provided exclusively by the
FDA.
Many of our regulated products presently under development will be
regulated by the USDA. The purpose of the Virus-Serum-Toxin Act is to ensure
that veterinary biologics sold in the United States are safe and efficacious.
Pre-market testing is performed by the manufacturer and the CVB prior to
approval of the product for sale, as well as on each new lot. Although the
procedures for licensing products by the USDA are formalized, the acceptable
standards of performance for any product are agreed upon between the
manufacturer and the CVB. For novel products that are unlike others already
licensed, the agreement on expected performance standards is typically reached
through a dialogue between the CVB and the manufacturer. The formal
demonstration of acceptable efficacy of the product is typically done in
carefully controlled laboratory trials. This is normally a much more efficient
and reliable process than demonstration of efficacy in clinical trials using
client-owned animals.
Industry data indicates that it takes approximately four years and $1.0
million to license a conventional vaccine for animals from basic research
through licensing. In contrast to vaccines, point-of-care diagnostics can
typically be licensed by the USDA in about a year, with considerably less cost.
However, vaccines or diagnostics that use innovative materials such as those
resulting from recombinant DNA technology usually require additional time to
license. The USDA licensing process involves the submission of several data
packages. These packages include information on how the product will be
prepared, information on the performance and safety of the product in laboratory
studies and information on performance of the product in field conditions.
However, the submission and review of these data packages is not staged, so that
one must be completed before beginning the next.
Industry data indicates that it takes about 11 years and $5.5 million to
develop a new drug for animals, from commencement of research to market
introduction. Of this time, approximately three years is spent in the clinical
trial and review process. However, unlike human drugs, neither preclinical
studies in model systems nor a sequential phase system of clinical trials are
required. Rather, for animal drugs, clinical trials for safety and efficacy may
be conducted immediately in the species for which the drug is intended. Thus,
there is no required phased evaluation of drug performance, and the Center for
Veterinary Medicine will review data at appropriate and productive times in the
drug development process. In addition, the time and cost for developing
companion animal drugs may be significantly less than for drugs for food
producing animals, as food safety issues relating to tissue residue levels are
not present.
A number of animal health products are not regulated. For example, assays
for use in a veterinary diagnostic laboratory and certain medical instruments do
not have to be licensed by either the USDA or FDA. Additionally, certain
botanically derived products, certain nutritional products and grooming and
supportive care products are exempt from significant regulation as long as they
do not bear a therapeutic claim that represents the product as a drug.
The European Union has centralized the regulatory process for companion
animal drugs and biologics for member states. In addition, both the USDA and the
FDA are working with the European Union and Japan via the Veterinary
International Cooperation on Harmonization initiative to harmonize the
regulatory requirements for companion animal health products. Thus, in the
future, it is hoped that a single set of requirements will be in place to
streamline the licensing of veterinary products in the major companion animal
markets.
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Delays in obtaining or failure to obtain any necessary regulatory approvals
for our products could harm our future product sales and operations. Heska has
experienced delays in the past and could incur additional delays in the future.
Any acquisitions of new products and technologies may subject us to additional
government regulation.
COMPETITION
The market in which we compete is intensely competitive. Our competitors
include independent animal health companies and major pharmaceutical companies
that have animal health divisions. Companies with a significant presence in the
companion animal health market, such as American Home Products, Bayer, Merial
Ltd., Novartis, Pfizer Inc., Schering-Plough Corp., Pharmacia & Upjohn, Inc. and
IDEXX Laboratories, Inc., have developed or are developing products that do or
would compete with our products. These competitors may have substantially
greater financial, technical, research and other resources and larger, more
established marketing, sales, distribution and service organizations than us.
Moreover, such competitors may offer broader product lines and have greater name
recognition than us. Novartis and Bayer are our marketing partners and their
agreements with us do not restrict their ability to develop and market competing
products. 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 we intend to distribute our products
primarily through veterinarians, a substantial segment of the potential market
may not be reached and we may not be able to offer our products at prices which
are competitive with those of companies that distribute their products through
retail channels.
Center's human allergy immunotherapy products compete with similar products
offered by a number of other companies, some of which have substantially greater
financial, technical, research and other resources than Center and more
established marketing, sales, distribution and service organizations than Center
Pharmaceuticals, Inc. The bovine vaccines sold by Diamond to AgriLabs compete
with similar products offered by a number of other companies, some of which have
substantially greater financial, technical, research and other resources than
Diamond and more established marketing, sales, distribution and service
organizations than AgriLabs.
EMPLOYEES
As of December 31, 1999, we and our subsidiaries employed 463 full-time
persons, of whom 165 were in manufacturing, quality control, shipping and
receiving, and materials management, 92 were in research, development and
regulatory affairs, 73 were in management, finance, administration, legal,
information systems, human resources and facilities management, 89 were in
sales, marketing and customer service and 44 were in the diagnostic
laboratories. None of our employees is covered by a collective bargaining
agreement, and we believe employee relations are good.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company and their ages as of March 20, 2000
are as follows:
NAME AGE POSITION
- ---- --- --------
Robert B. Grieve, Ph.D. 48 Vice Chairman and Chief Executive Officer
James H. Fuller 55 President and Chief Operating Officer
Ronald L. Hendrick 54 Executive Vice President, Chief Financial Officer and Secretary
Paul S. Hudnut 41 Executive Vice President
Guiseppe Miozzari, Ph.D. 53 Managing Director, Heska Europe
Dan T. Stinchcomb, Ph.D. 46 Executive Vice President, Research and Development
Robert B. Grieve, Ph.D., a founder of the Company, currently serves as
Chief Executive Officer and Vice Chairman of the Board of Directors. Dr. Grieve
was named Chief Executive Officer effective January 1, 1999 and Vice Chairman
effective March 1992. Dr. Grieve also served as Chief Scientific Officer from
December 1994 to January 1999 and Vice President, Research and Development, from
March 1992 to December 1994. He has been a member of the Company's Board of
Directors since 1990. He holds a Ph.D. degree from the University of Florida and
M.S. and B.S. degrees from the University of Wyoming.
James H. Fuller is President and Chief Operating Officer of the Company. He
joined the Company in January 1999. Prior to joining the Company, Mr. Fuller
served as Corporate Vice President of Allergan, Inc., a leading specialty
pharmaceutical company, from 1994 through 1998. Prior to that, Mr. Fuller served
in a number of sales and marketing positions at Allergan since 1974. He holds
M.S. and B.S. degrees from the University of Southern California.
Ronald L. Hendrick is Executive Vice President, Chief Financial Officer and
Secretary of the Company. He joined the Company in December 1998. Prior to
joining the Company, Mr. Hendrick was Executive Vice President and Chief
Financial Officer of Xenometrix, Inc., a human biotechnology concern, from 1995
until December 1998. Prior to that, Mr. Hendrick served as Vice President and
Corporate Controller at Alexander & Alexander Services, Inc., a NYSE financial
services firm, from 1993 until 1995, and before that he was Vice President and
Corporate Controller, Adolph Coors Company. Mr. Hendrick is a Certified Public
Accountant. He holds a M.B.A. from the University of Colorado and a B.A. degree
from Michigan State University.
Paul S. Hudnut is Executive Vice President of the Company. He was elected
Executive Vice President in September 1998, and prior to that was Vice President
of Business Development of the Company since June 1996. Prior to joining the
Company in June 1996, Mr. Hudnut was a General Manager at US WEST Media Group
and held various positions in management and business development at
subsidiaries of US WEST, Inc. from February 1988. Prior to joining US WEST, Mr.
Hudnut was an associate with the Denver, Colorado law firm of Davis, Graham and
Stubbs. He holds a J.D. degree from the University of Virginia and a B.A. degree
from The Colorado College.
Giuseppe Miozzari, Ph.D., joined the Company as Managing Director, Heska
Europe in March 1997. From 1980 to March 1997, Dr. Miozzari served in senior
research positions with Novartis, most recently as the Head of Research of the
Animal Health Sector and prior to that, from 1980 to 1983, as Head of the
Molecular Biology Research Unit in the Pharmaceuticals Division. Dr. Miozzari
also served as Novartis' designate on the Board of Directors of the Company from
April 1996 to March 1997.
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Dr. Miozzari holds Ph.D. and Dipl. Sc. Nat. degrees from the Federal Institute
of Technology (ETH) in Zurich, Switzerland.
Dan T. Stinchcomb, Ph.D., was appointed Executive Vice President, Research
and Development in December 1999. He previously was appointed Vice President,
Research, in December 1998. He joined Heska in May 1996 as Vice President,
Biochemistry and Molecular Biology. Prior to joining the Company, from July 1993
until May 1996, Dr. Stinchcomb was employed by Ribozyme Pharmaceuticals, Inc.,
most recently as Director of Biology Research. From 1988 until 1993, Dr.
Stinchcomb held various positions with Synergen, Inc. Prior to joining Synergen,
Dr. Stinchcomb was an Associate Professor in Cellular and Developmental Biology
at Harvard University. He holds a Ph.D. degree from Stanford University and a
B.A. degree from Harvard University.
ITEM 2. PROPERTIES.
We currently lease an aggregate of approximately 64,000 square feet of
administrative and laboratory space in four buildings located in Fort Collins,
Colorado under leases expiring through 2005, with options to extend through 2010
for the larger facilities. We believe that our present Fort Collins facilities
are adequate for our current and planned activities and that suitable additional
or replacement facilities in the Fort Collins area are readily available on
commercially reasonable terms should such facilities be needed in the future.
Diamond's principal manufacturing facility in Des Moines, Iowa, consisting of
166,000 square feet of buildings on 34 acres of land, is owned by Diamond.
Diamond also owns a 160-acre farm used principally for research purposes located
in Carlisle, Iowa. Center owns its approximately 27,000 square foot facility in
Port Washington, New York. The Company's European subsidiaries lease their
facilities. We also currently lease approximately 19,500 square feet of office
and manufacturing space in Waukesha, Wisconsin which we have vacated and are
currently seeking to sublease.
ITEM 3. LEGAL PROCEEDINGS.
In November 1998, Synbiotics Corporation filed a lawsuit against us in the
United States District Court for the Southern District of California in which it
alleges that we infringe a patent owned by Synbiotics relating to heartworm
diagnostic technology. Discovery continues, and no trial date has been set. We
have obtained legal opinions from our outside patent counsel that our heartworm
diagnostic products do not infringe the Synbiotics patent and that the patent is
invalid. The opinions of non-infringement are consistent with the results of our
internal evaluations. While we believe that we have valid defenses to
Synbiotics' allegations and intend to defend the action vigorously, there can be
no assurance that an adverse result or settlement would not have a material
adverse effect on our financial position, results of operations or cash flow.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Our common stock is quoted on the Nasdaq National Market under the symbol
"HSKA." The following table sets forth the intraday high and low prices for our
common stock as reported by the Nasdaq National Market, for the periods
indicated below.
HIGH LOW
--------- ---------
1998
First Quarter...................... $ 14.875 $ 9.25
Second Quarter..................... 16.75 8.75
Third Quarter...................... 11.938 5.125
Fourth Quarter..................... 7.625 3.00
1999
First Quarter...................... 6.00 3.00
Second Quarter..................... 5.125 2.25
Third Quarter...................... 3.938 2.00
Fourth Quarter..................... 2.938 1.375
2000
First Quarter (through March 20)... 6.00 2.063
On March 20, 2000, the last reported sale price of our common stock was
$4.75 per share. As of February 29, 2000, there were approximately 285 holders
of record of our common stock and approximately 4,062 beneficial stockholders.
We have never declared or paid cash dividends on our capital stock and do not
anticipate paying any cash dividends in the foreseeable future. We currently
intend to retain future earnings for the development of our business.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The data set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements and related Notes included as Items 7 and
8 in this Form 10-K.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Products, net ..................................... $ 4,719 $ 15,570 $ 26,725 $ 38,451 $ 50,291
Research and development .......................... 2,230 1,946 2,578 1,321 885
-------- -------- -------- -------- --------
Total revenues ................................ 6,949 17,516 29,303 39,772 51,176
Costs and operating expenses:
Cost of goods sold ................................ 2,842 12,002 20,077 29,087 36,386
Research and development .......................... 6,412 14,513 20,343 25,126 17,042
Selling and marketing ............................. 902 4,168 9,954 13,188 15,073
General and administrative ........................ 1,442 5,514 13,192 11,939 11,231
Amortization of intangible assets and deferred
compensation .................................. 278 1,289 2,500 2,745 2,228
Purchased research and development ................ -- -- 2,399 -- --
Loss on assets held for disposition ............... -- -- -- 1,287 2,593
Restructuring expense ............................. -- -- -- 2,356 1,210
-------- -------- -------- -------- --------
Total costs and operating expenses ............ 11,876 37,486 68,465 85,728 85,763
-------- -------- -------- -------- --------
Loss from operations ..................................... (4,927) (19,970) (39,162) (45,956) (34,587)
Other income (expense) ................................... 19 721 298 1,682 (1,249)
-------- -------- -------- -------- --------
Net loss ................................................. $ (4,908) $(19,249) $(38,864) $(44,274) $(35,836)
======== ======== ======== ======== ========
Basic net loss per share ................................. $ (1.79) $ (1.31)
======== ========
Unaudited pro forma basic net loss per share(1) .......... $ (1.53) $ (2.42)
======== ========
Shares used to compute basic net loss per share and
unaudited pro forma basic net loss per share ...... 12,609 16,042 24,693 27,290
DECEMBER 31,
---------------------------------------------------------------------
1995 1996 1997 1998 1999
--------- --------- --------- --------- ---------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities .... $ 6,849 $ 23,721 $ 28,752 $ 51,930 $ 23,981
Working capital ..................................... 6,843 24,224 31,461 51,947 28,234
Total assets ........................................ 11,291 45,651 69,020 98,054 71,168
Long-term obligations ............................... 903 5,077 10,754 11,367 5,346
Accumulated deficit ................................. (14,379) (33,628) (72,492) (116,766) (152,602)
Total stockholders' equity .......................... 7,414 32,671 43,850 67,114 45,439
- -----------
(1) See Note 2 of Notes to Consolidated Financial Statements for information
concerning the computation of pro forma basic net loss per share.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with "Selected Consolidated
Financial Data" and the Consolidated Financial Statements and related Notes
included in Items 6 and 8 of this Form 10-K.
This discussion contains, in addition to historical information,
forward-looking statements that involve risks and uncertainties. Our actual
results and the timing of certain events could differ materially from the
results discussed in the forward-looking statements. When used in this
discussion, the words "expects," "anticipates," "estimates" and similar
expressions are intended to identify forward-looking statements. Such
statements, which include statements concerning future revenue sources and
concentration, gross margins, research and development expenses, selling and
marketing expenses, general and administrative expenses, capital resources,
additional financings or borrowings and additional losses, are subject to risks
and uncertainties, including those set forth below under "--Factors that May
Affect Results" that could cause actual results to differ materially from those
projected. These forward-looking statements speak only as of the date hereof. We
expressly disclaim any obligation or undertaking to release publicly any updates
or revisions to any forward-looking statements contained herein to reflect any
change in our expectations with regard thereto or any change in events,
conditions, or circumstances on which any such statement is based.
OVERVIEW
We are primarily focused on the discovery, development and marketing of
companion animal health products. In addition to manufacturing certain of our
companion animal products, our primary manufacturing subsidiary, Diamond also
manufactures bovine vaccine products and pharmaceutical products that are
marketed and distributed by third parties. In addition to manufacturing
veterinary allergy products for marketing and sale by us, our subsidiaries,
Center and CMG, also manufacture and sell human allergy products. We also offer
diagnostic services to veterinarians at our Fort Collins, Colorado location.
From our inception in 1988 until early 1996, our operating activities
related primarily to research and development activities, entering into
collaborative agreements, raising capital and recruiting personnel. Prior to
1996, we had not received any revenues from the sale of products. During 1996,
we grew from being primarily a research and development concern to a
fully-integrated research, development, manufacturing and marketing company. We
accomplished this by acquiring Diamond, a licensed pharmaceutical and biological
manufacturing facility in Des Moines, Iowa, hiring key employees and support
staff, establishing marketing and sales operations to support our products
introduced in 1996, and designing and implementing more sophisticated operating
and information systems. We also expanded the scope and level of our scientific
and business development activities, increasing the opportunities for new
products. In 1997, we introduced 13 additional products and expanded in the
United States through the acquisition of Center, an FDA and USDA licensed
manufacturer of allergy immunotherapy products located in New York, and
internationally through the acquisitions of Heska UK, a veterinary diagnostic
laboratory in England and CMG in Switzerland, which manufactures and markets
allergy diagnostic products for use in veterinary and human medicine, primarily
in Europe. Each of our acquisitions during this period was accounted for under
the purchase method of accounting and accordingly, our financial statements
reflect the operations of these businesses only for the periods subsequent to
the acquisitions. In July 1997, we established a new subsidiary, Heska AG,
located near Basel, Switzerland, for the purpose of managing our European
operations.
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During the first quarter of 1998 we acquired a manufacturer and marketer of
patient monitoring devices. The financial results of this entity have been
consolidated with ours under the pooling-of-interests accounting method for all
periods presented. These operations were consolidated with our existing
operations in Fort Collins, Colorado and Des Moines, Iowa as of December 31,
1999, and our facility in Waukesha, Wisconsin was closed.
In December 1999, we announced our intent to sell our subsidiary in the
United Kingdom, Heska UK. The sale was completed in March 2000. In 1999, we
recorded a loss on disposition of approximately $1.0 million related to the sale
of Heska UK.
We have incurred net losses since our inception and anticipate that we will
continue to incur additional net losses in the near term as we introduce new
products, expand our sales and marketing capabilities and continue our research
and development activities. Cumulative net losses from inception in 1988 through
December 31, 1999 have totaled $152.6 million.
Our ability to achieve profitable operations will depend primarily upon our
ability to successfully market our products, commercialize products that are
currently under development and develop new products. Most of our products are
subject to long development and regulatory approval cycles, and there can be no
assurance that we will successfully develop, manufacture or market these
products. There can also be no assurance that we will attain profitability or,
if achieved, will remain profitable on a quarterly or annual basis in the
future. Until we attain positive cash flow, we may continue to finance
operations with additional equity and debt financing. There can be no assurance
that such financing will be available when required or will be obtained under
favorable terms. See the discussion later in this section titled "Factors That
May Affect Results" for a more in-depth explanation of risks faced by us.
RESULTS OF OPERATIONS
Year Ended December 31, 1999
Total revenues, which include product and research and development
revenues, increased 29% to $51.2 million in 1999 compared to $39.8 million in
1998. Product revenues increased 31% to $50.3 million in 1999 compared to $38.5
million in 1998. The growth in revenues during 1999 was primarily due to sales
of new products introduced during 1999 and increased sales of our existing
products. Sales to one customer, Bayer, represented 12% of total revenues in
1999 and are expected to decline in future years due to the expiration in
February 2000 of a take-or-pay contract with Bayer. It is expected that a
portion of these sales will be replaced under an agreement for the sale of
certain new vaccines to AgriLabs for distribution by Bayer and others.
Revenues from sponsored research and development decreased to $900,000 in
1999 from $1.3 million in 1998. Fluctuations in revenues from sponsored research
and development are generally the result of changes in the number of funded
research projects as well as the timing and performance of contract milestones.
We may engage in additional sponsored research if such projects become available
and are consistent with our research priorities.
Cost of goods sold totaled $36.4 million in 1999 compared to $29.1 million
in 1998, and the resulting gross profit from product sales for 1999 increased to
$13.9 million from $9.4 million in 1998. Our gross margin percentage was 28% in
1999, compared to 24% in 1998. During 1999, the gross profit margin improved as
our product mix included a higher percentage of proprietary products with higher
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gross profit margins. Also during fiscal 1999, we eliminated certain product
lines that did not meet gross profit expectations. We believe that gross profit
margins as a percentage of revenues will improve in future years, as more of our
proprietary diagnostic, vaccine and pharmaceutical products are approved by the
applicable regulatory bodies and achieve market acceptance.
Research and development expenses decreased to $17.0 million in 1999 from
$25.1 million in 1998. The decrease in 1999 was primarily due to reductions in
our internal research and development activities, resulting from our
restructuring in December 1998, and our decision to eliminate or defer research
projects which appeared to have greater long-term risk or lower market
potential. Research and development expenses are expected to decrease as a
percentage of total revenues in future years.
Selling and marketing expenses increased to $15.1 million in 1999 from
$13.2 million in 1998. This increase reflects primarily the expansion of our
sales and marketing organization and costs associated with the introduction and
marketing of new products. Selling and marketing expenses consist primarily of
salaries, commissions and benefits for sales and marketing personnel,
commissions paid to contract sales personnel and expenses of product advertising
and promotion. We expect selling and marketing expenses to increase as sales
volumes increase and new products are introduced to the marketplace, but to
decrease as a percentage of total revenues in future years.
General and administrative expenses decreased to $11.2 million in 1999 from
$11.9 million in 1998. The decrease in 1999 was primarily due to reductions in
staffing and expenditures, resulting from our restructuring in December 1998.
General and administrative expenses are expected to decrease as a percentage of
total revenues in future years.
Amortization of intangible assets and deferred compensation decreased to
$2.2 million in 1999 from $2.7 million in 1998. Intangible assets resulted
primarily from our 1997 and 1996 business acquisitions and are being amortized
over lives of 2 to 10 years. The amortization of deferred compensation resulted
in a non-cash charge to operations in 1999 of approximately $629,000 compared to
$736,000 in 1998. In connection with the grant of certain stock options in 1997
and 1996, we recorded deferred compensation representing the difference between
the deemed value of the common stock for accounting purposes and the exercise
price of such options at the date of grant. Compensation costs, equal to the
fair value of the options on the date of grant, will be recognized over the
service period. We expect to incur a non-cash charge to operations as a result
of option grants outstanding at December 31, 1999 of approximately $574,000 and
$74,000 per year for 2000 and 2001, respectively, for amortization of deferred
compensation.
The loss on assets held for disposition of $2.6 million recorded in 1999
reflects the write-down of certain tangible and intangible assets to their
expected net realizable values. Included in the loss was $1.0 million related to
the sale of Heska UK, a write-off of $580,000 in book value of assets held for
sale resulting from our decision to discontinue contract manufacturing of
certain low margin human healthcare products for third parties at Diamond and a
write-off of $1.0 million in book value of certain intangible and tangible
assets no longer considered strategic and held for sale or other disposition.
During the third quarter of 1999, we recognized a charge to operations of
approximately $1.2 million related to our decision to consolidate the operations
of our Waukesha, Wisconsin facility into our existing operations in Fort
Collins, Colorado and Des Moines, Iowa. The charge was primarily for personnel
severance costs and the cost of closing the facility in Waukesha, Wisconsin.
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Interest income decreased to $1.6 million in 1999 from $3.2 million in 1998
as a result of reduced cash available for investment as we funded our business
operations. Interest income is expected to decline in the future as we continue
to use cash to fund our business operations. Interest expense decreased slightly
to $1.9 million in 1999 from $2.0 million in 1998. Other expense of nearly $1.0
million in 1999 is due primarily to the loss realized on the sale of certain
long-term, interest-bearing government securities.
Year Ended December 31, 1998
Total revenues, which include product and research and development
revenues, increased 36% to $39.8 million in 1998 compared to $29.3 million in
1997. Product revenues increased 44% to $38.5 million in 1998 compared to $26.7
million in 1997. The growth in revenues during 1998 was primarily due to sales
of new products introduced during 1998, increased sales of our existing products
and from consolidating revenues of Center and CMG subsequent to their
acquisitions in July 1997 and September 1997, respectively. Sales to one
customer, Bayer, represented 15% of total revenues in 1998.
Revenues from sponsored research and development decreased to $1.3 million
in 1998 from $2.6 million in 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.
Cost of goods sold totaled $29.1 million in 1998 compared to $20.1 million
in 1997, and the resulting gross profit from product sales for 1998 increased to
$9.4 million from $6.6 million in 1997. Our gross margin percentage was 24% in
1998, compared to 25% in 1997. Gross profit margins in 1998 were adversely
affected by inventory write-downs of approximately $1.5 million during the year.
Without these inventory write-downs, gross profit margins would have been 28%.
Research and development expenses increased to $25.1 million in 1998 from
$20.3 million in 1997. The increase in 1998 was primarily due to increases in
the level and scope of our internal research and development activities,
expenses related to new collaborative agreements and licenses to support
research efforts for potential products to be developed by us.
Selling and marketing expenses increased to $13.2 million in 1998 from
$10.0 million in 1997. This increase reflects primarily the expansion of our
sales and marketing organization and costs associated with the introduction and
marketing of new products.
General and administrative expenses decreased to $11.9 million in 1998 from
$13.2 million in 1997. The decrease in 1998 was primarily due to a one-time
charge in 1997 relating to a supply agreement termination fee.
Amortization of intangible assets and deferred compensation increased to
$2.7 million in 1998 from $2.5 million in 1997. Intangible assets resulted
primarily from our 1997 and 1996 business acquisitions and are being amortized
over lives of 2 to 10 years. The amortization of deferred compensation resulted
in a non-cash charge to operations in 1998 of approximately $736,000 compared to
$645,000 in 1997. In connection with the grant of certain stock options in 1997
and 1996, we deferred compensation representing the difference between the
deemed value of the common stock for accounting purposes and the exercise price
of such options at the date of grant. In 1998, we also granted stock options to
non-employees in exchange for consulting services. Compensation costs, equal to
the fair value of the options on the date of grant, will be recognized over the
service period.
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The loss on assets held for sale recorded in 1998 reflects the write-down
of certain tangible and intangible assets to their expected net realizable
values.
In December 1998, we completed a cost reduction and restructuring plan. The
restructuring was based on our determination that, while revenues had been
increasing steadily, we believed that reducing expenses was necessary in order
to accelerate our efforts to reach profitability. In connection with the
restructuring, we recognized a charge to operations in 1998 of approximately
$2.4 million. These expenses primarily related to personnel severance costs and
costs associated with excess facilities and equipment.
Interest income increased to $3.2 million in 1998 from $1.6 million in 1997
as a result of increased cash available for investment arising from the proceeds
from our IPO in July 1997, the follow-on offering completed in March 1998 and
the private placement of common stock in July 1998. Interest expense increased
to $2.0 million in 1998 from $1.4 million in 1997 due to increases in debt
financing for laboratory and manufacturing equipment and debt related to our
1997 business acquisitions.
Year Ended December 31, 1997
Total revenues, which include product and research and development
revenues, increased 67% to $29.3 million in 1997 compared to $17.5 million in
1996. Product revenues increased 71% to $26.7 million in 1997 compared to $15.6
million in 1996. The growth in revenues during 1997 was primarily due to new
product introductions, increased sales of our existing products and from
consolidating revenues of Diamond, Center and CMG subsequent to their
acquisitions in April 1996, July 1997 and September 1997, respectively. Sales to
one customer, Bayer, represented 21% of total revenues in 1997.
Revenues from sponsored research and development increased to $2.6 million
in 1997 from $1.9 million in 1996. Fluctuations in revenues from sponsored
research and development are generally the result of changes in the number of
funded research projects as well as the timing and performance of contract
milestones.
Cost of goods sold totaled $20.1 million in 1997 compared to $12.0 million
in 1996, and the resulting gross profit for 1997 increased to $6.6 million from
$3.6 million in 1996. Our gross profit margin from product sales was 25% in
1997, compared to 23% in 1996.
Research and development expenses increased to $20.3 million in 1997 from
$14.5 million in 1996. The increase in 1997 was primarily due to increases in
the level and scope of our internal research and development activities,
expenses related to new collaborative agreements and licenses to support
research efforts for potential products to be developed by us.
Selling and marketing expenses increased to $10.0 million in 1997 from $4.2
million in 1996. This increase reflects primarily the expansion of our sales and
marketing organization and costs associated with the introduction and marketing
of new products.
General and administrative expenses increased to $13.2 million in 1997 from
$5.5 million in 1996. The increase in 1997 primarily resulted from the growth of
accounting and finance, human resources, legal, administrative, information
systems and facilities operations to support our increased
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business, financing and financial reporting requirements. General and
administrative expenses for 1997 include a one-time charge of $750,000 for the
termination of a supply agreement.
Amortization of intangible assets and deferred compensation increased to
$2.5 million in 1997 from $1.3 million in 1996. Intangible assets resulted
primarily from our 1997 and 1996 business acquisitions and are being amortized
over lives of 2 to 10 years. The amortization of deferred compensation resulted
in a non-cash charge to operations in 1997 of approximately $645,000 compared to
$188,000 in 1996. In connection with the grant of certain stock options in 1997
and 1996, we recorded deferred compensation representing the difference between
the deemed value of the common stock for accounting purposes and the exercise
price of such options at the date of grant.
Purchased research and development expenses of $2.4 million for 1997
reflect a one-time non-cash charge related to the acquisition in May 1997 of a
development stage company.
Interest income increased to $1.6 million in 1997 from $1.4 million in 1996
as a result of increased cash available for investment resulting from the
proceeds from our IPO. Interest expense increased to $1.4 million in 1997 from
$500,000 in 1996 due to increases in debt financing for laboratory and
manufacturing equipment and debt related to our 1996 and 1997 business
acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity at December 31, 1999 was $24.0 million in
cash, cash equivalents and marketable securities. The source of these funds was
primarily attributable to our public offering of common stock in December 1999,
which provided us with net proceeds of approximately $13.3 million, our
follow-on public offering of common stock in March 1998 and the July 1998
private placement of common stock, which provided us with net proceeds of
approximately $48.6 million and $15.0 million, respectively. As additional
sources of liquidity, we and our subsidiaries have secured lines of credit
totaling approximately $2.9 million, against which borrowings of approximately
$1.2 million were outstanding at December 31, 1999. These financing facilities
are secured by our assets and those of our respective subsidiaries, and by
corporate guarantees of Heska. We expect to seek additional asset-based
borrowing facilities.
Net cash used in operating activities was $33.2 million in 1999, compared
to $38.1 million in 1998. Accounts receivable increased by $3.0 million in 1999
as a result of the increase in product sales. Inventory levels increased by $1.8
million in 1999, primarily to support increased sales of existing products and
inventory build-up in anticipation of new product introductions.
Net cash flows from investing activities provided us with $20.3 million
during 1999, compared to a use of $34.6 million in 1998. The cash provided in
1999 resulted from the sale of marketable securities and was used to fund our
current year operations. Expenditures for property and equipment totaled $3.3
million for 1999 compared to $6.5 million in 1998. We have historically used,
and anticipate that we will continue, to use capital equipment lease and debt
facilities to finance equipment purchases and, if possible, leasehold
improvements. We currently expect to spend approximately $2.0 million in 2000
for capital equipment, including expenditures to upgrade certain manufacturing
operations to improve efficiencies and to assure ongoing compliance with
regulatory requirements. We expect to finance these expenditures through
equipment leases and secured debt facilities, where possible.
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Net cash flows from financing activities generated $8.4 million in cash in
1999, compared to $67.9 million in 1998. The primary source of cash in 1999 was
the public offering of common stock in December which provided us with net
proceeds of approximately $13.3 million. We also borrowed an additional $971,000
under our available credit facilities. We used cash to repay $6.5 million of
debt and capital lease obligations.
Our primary short-term needs for capital, which are subject to change, are
for our continuing research and development efforts, our sales, marketing and
administrative activities, working capital associated with increased product
sales and capital expenditures relating to developing and expanding our
manufacturing operations. Our future liquidity and capital requirements will
depend on numerous factors, including the extent to which our present and future
products gain market acceptance, the extent to which products or technologies
under research or development are successfully developed, the timing of
regulatory actions regarding our products, the costs and timing of expansion of
sales, marketing and manufacturing activities, the cost, timing and business
management of current and potential acquisitions and contingent liabilities
associated with such acquisitions, the procurement and enforcement of patents
important to our business and the results of competition.
We believe that our available cash, cash from operations and available
borrowings will be sufficient to satisfy our projected cash requirements 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 our cash requirements, we will need to raise additional capital to
continue our business operations. There can be no assurance that such additional
capital will be available on terms acceptable to us, if at all. Furthermore, any
additional equity financing would likely be dilutive to stockholders and debt
financing, if available, may include restrictive covenants which may limit our
operations and strategies.
As of December 31, 1999, one of the Company's wholly-owned subsidiaries,
Diamond, did not meet certain financial covenants contained in its existing
$2,500,000 line of credit agreement. The commercial bank who provides the line
of credit waived the covenant non-compliance as of December 31, 1999. The
Company has reflected the $917,000 outstanding under the existing agreement as
current in its financial statements. The Company has received a proposal for a
new, larger corporate line of credit with the same commercial bank. The
commitment is subject to a number of closing conditions. Management believes
that such conditions will be satisfactorily met, however there can be no
assurance the new line of credit facility will close. Under the terms and
covenants of the proposed facility, the Company would have been in compliance as
of December 31, 1999.
NET OPERATING LOSS CARRYFORWARDS
As of December 31, 1999, we had a net operating loss carryforward of
approximately $127.5 million and approximately $2.7 million of research and
development tax credits available to offset future federal income taxes. The NOL
and tax credit carryforwards, which are subject to alternative minimum tax
limitations and to examination by the tax authorities, expire from 2003 to 2019.
Our acquisition of Diamond resulted in a "change of ownership" under the
provisions of Section 382 of the Internal Revenue Code of 1986, as amended. As
such, we will be limited in the amount of NOL's incurred prior to the merger
that we may utilize to offset future taxable income. This limitation will total
approximately $4.7 million per year for periods subsequent to the Diamond
acquisition. Similar limitations also apply to utilization of R&D tax credits to
offset taxes payable. We believe that this limitation may affect the eventual
utilization of our total NOL carryforwards.
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RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the SEC issued SAB No. 101, Revenue Recognition. SAB 101
clarifies the SEC staff's views in applying generally accepted accounting
principles to selected revenue recognition issues. The guidance in SAB 101 must
be implemented by our first fiscal quarter of fiscal 2000. We are currently
reviewing the guidelines provided in SAB 101, and believe that SAB 101 will not
significantly affect our results of operations.
We do not expect the adoption of any standards recently issued by the
Financial Accounting Standards Board or the Securities and Exchange Commission
to have a material impact on our financial position or results of operations.
FACTORS THAT MAY AFFECT RESULTS
We have a history of losses and may never achieve profitability.
We have incurred net losses since our inception. At December 31, 1999, our
accumulated deficit was $152.6 million. We anticipate that we will continue to
incur additional operating losses in the near term. These losses have resulted
principally from expenses incurred in our research and development programs and
from general and administrative and sales and marketing expenses. We cannot
assure you that we will attain profitability or, if we do, that we will remain
profitable on a quarterly or annual basis in the future.
We have limited resources to devote to product development and
commercialization.
Our strategy is to develop a broad range of products addressing companion
animal healthcare. We believe that our revenue growth and profitability, if any,
will substantially depend upon our ability to:
o improve market acceptance of our current products;
o complete development of new products; and
o successfully introduce and commercialize new products.
We have introduced some of our products only recently and many of our
products are still under development. Because we have limited resources to
devote to product development and commercialization, any delay in the
development of one product or reallocation of resources to product development
efforts that prove unsuccessful may delay or jeopardize the development of our
other product candidates. If we fail to develop new products and bring them to
market, our business could be substantially harmed.
We may experience difficulty in commercializing our products.
Because several of our current products, as well as a number of products
under development, are novel, we may need to expend substantial efforts in order
to educate our customers about the uses of our products and to convince them of
the need for our products. We cannot assure you that any of our products will
achieve satisfactory market acceptance or that we will successfully
commercialize them on a timely basis, or at all. If any of our products do not
achieve a significant level of market acceptance, our business could be
substantially harmed.
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We must obtain costly regulatory approvals in order to bring our products to
market.
Many of the products we develop and market are subject to regulation by one
or more of the USDA, FDA, EPA and foreign regulatory authorities. The
development and regulatory approval activities necessary to bring new products
to market are time-consuming and costly. We have experienced in the past, and
may experience in the future, difficulties that could delay or prevent us from
obtaining the regulatory approvals necessary to introduce new products or to
market them. We cannot assure you that the USDA, FDA, EPA or foreign regulatory
authorities will issue regulatory clearance or new product approvals on a timely
basis, or at all. Any acquisitions of new products and technologies may subject
us to additional government regulation. If we do not secure the necessary
regulatory approvals for our products, our business could be substantially
harmed.
Factors beyond our control may cause our operating results to fluctuate and many
of our expenses are fixed.
We believe that our future operating results will fluctuate on a quarterly
basis due to a variety of factors, including:
o the introduction of new products by us or by our competitors;
o market acceptance of our current or new products;
o regulatory and other delays in product development;
o product recalls;
o competition and pricing pressures from competitive products;
o manufacturing delays;
o shipment problems;
o product seasonality; and
o changes in the mix of products sold.
We have high operating expenses for personnel, new product development and
marketing. Many of these expenses are fixed in the short term. If any of the
factors listed above cause our revenues to decline, our operating results could
be substantially harmed.
We may need to seek additional financing in the future.
We have incurred negative cash flow from operations since inception. We do
not expect to generate positive cash flow sufficient to fund our operations in
the near term. We believe that our available cash, cash from operations and
available borrowings will be sufficient to satisfy our projected cash
requirements for at least the next 12 months, assuming no significant uses of
cash in acquisition activities. Thus, we may need to raise additional capital to
fund our research and development, manufacturing, sales and marketing
activities. Our future liquidity and capital requirements will depend on
numerous factors, including:
o the extent to which our present and future products gain market
acceptance;
o the extent to which we successfully develop products from technologies
under research or development;
o the timing of regulatory actions concerning our products;
o the costs and timing of expansions of our sales, marketing and
manufacturing activities;
o the cost, timing and business management of recent and potential
acquisitions and contingent liabilities associated with acquisitions;
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o the procurement and enforcement of important patents, and
o the results of competition.
We cannot assure you that additional capital will be available on
acceptable terms, if at all. Furthermore, any additional equity financing would
likely be dilutive to stockholders, and debt financing, if available, may
include restrictive covenants which may limit our currently planned operations
and strategies. If adequate funds are not available, we may be required to
curtail our operations significantly or to obtain funds by entering into
collaborative agreements or other arrangements on unfavorable terms. If we fail
to raise capital on acceptable terms when we need to, our business could be
substantially harmed.
A small number of large customers account for a large percentage of our
revenues.
We currently derive a substantial portion of our revenues from Diamond,
which manufactures certain of our products and products for other companies in
the animal health industry. Revenues from one Diamond customer comprised
approximately 12% of total revenues in 1999 under the terms of a take-or-pay
contract that expired in February 2000. If this customer does not continue to
purchase from Diamond and if we fail to replace the lost revenues with revenues
from other customers, our business could be substantially harmed.
We have limited experience in marketing our products.
The market for companion animal healthcare products is highly fragmented,
with discount stores and specialty pet stores accounting for a substantial
percentage of sales. Because we sell our companion animal health products only
to veterinarians, we may fail to reach a substantial segment of the potential
market, and we may not be able to offer our products at prices which are
competitive with those of companies that distribute their products through
retail channels. We currently market our products to veterinarians through a
direct sales force and through third parties. To be successful, we will have to
continue to develop and train our direct sales force or rely on marketing
partnerships or other arrangements with third parties to market, distribute and
sell our products. We cannot assure you that we will successfully develop and
maintain marketing, distribution or sales capabilities, or that we will be able
to make arrangements with third parties to perform these activities on
satisfactory terms. If we fail to develop a successful marketing strategy, our
business could be substantially harmed.
We operate in a highly competitive industry.
The market in which we operate is intensely competitive. Our competitors
include independent animal health companies and major pharmaceutical companies
that have animal health divisions. Companies with a significant presence in the
animal health market, such as American Home Products, Bayer, Merial Ltd.,
Novartis, Pfizer Inc., Schering Plough Corporation, Pharmacia & Upjohn, Inc. and
IDEXX Laboratories, Inc., have developed or are developing products that compete
with our products or would compete with them if developed. These competitors may
have substantially greater financial, technical, research and other resources
and larger, better-established marketing, sales, distribution and service
organizations than us. Our competitors offer broader product lines and have
greater name recognition than we do. We cannot assure you that our competitors
will not develop or market technologies or products that are more effective or
commercially attractive than our current or future products, or that would
render our technologies and products obsolete. Moreover, we cannot assure you
that we will have the financial resources, technical expertise or marketing,
distribution or support
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capabilities to compete successfully. If we fail to compete successfully, our
business could be substantially harmed.
We have granted third parties substantial marketing rights to our products under
development.
We have granted marketing rights to certain products under development to
third parties, including Novartis, Bayer, Eisai and Ralston Purina. Novartis has
the right to manufacture and market throughout the world (except in countries
where Eisai has such rights) under the Novartis trade name any flea control
vaccine or feline heartworm vaccine we develop on or before December 31, 2005.
We have retained the right to co-exclusively manufacture and market these
products throughout the world under our own trade names. Accordingly, we and
Novartis may become direct competitors, with each party sharing revenues on the
other's sales. We have also granted Novartis a right of first refusal pursuant
to which, prior to granting rights to any third party for any products or
technology we develop or acquire for either companion animal or food animal
applications, we must first offer Novartis such rights. In Japan, Novartis also
has the exclusive right, upon regulatory approval, to distribute our (a)
heartworm diagnostics, (b) trivalent and bivalent feline vaccines and (c)
certain other Heska products. Bayer has exclusive marketing rights to our canine
heartworm vaccine, except in countries where Eisai has such rights. Eisai has
exclusive rights in Japan and most countries in East Asia to market our feline
and canine heartworm vaccines, our feline and canine flea control vaccine and
our feline toxoplasmosis vaccine. In addition, we granted Ralston Purina the
exclusive rights to develop and commercialize our discoveries, know-how and
technologies in various pet food products.
Our agreements with our corporate marketing partners generally contain no
minimum purchase requirements in order for them to maintain their exclusive or
co-exclusive marketing rights. We cannot assure you that Novartis, Bayer, Eisai
or Ralston Purina or any other collaborative party will devote sufficient
resources to marketing our products. Furthermore, there is nothing to prevent
Novartis, Bayer, Eisai or Ralston Purina or any other collaborative party from
pursuing alternative technologies or products that may compete with our
products. If we fail to develop and maintain our own marketing capabilities, we
may find it necessary to continue to rely on potential or actual competitors for
third-party marketing assistance. Third party marketing assistance may not be
available in the future on reasonable terms, if at all.
We may face costly intellectual property disputes.
Our ability to compete effectively will depend in part on our ability to
develop and maintain proprietary aspects of our technology and either to operate
without infringing the proprietary rights of others or to obtain rights to
technology owned by third parties. We have United States and foreign-issued
patents and are currently prosecuting patent applications in the United States
and with various foreign patent offices. We cannot assure you that any of our
pending patent applications will result in the issuance of any patents or that
any issued patents will offer protection against competitors with similar
technology. We cannot assure you that any patents we receive will not be
challenged, invalidated or circumvented in the future or that the rights created
by those patents will provide a competitive advantage. We also rely on trade
secrets, technical know-how and continuing invention to develop and maintain our
competitive position. We cannot assure you that others will not independently
develop substantially equivalent proprietary information and techniques or
otherwise gain access to our trade secrets.
The biotechnology and pharmaceutical industries have been characterized by
extensive litigation relating to patents and other intellectual property rights.
In 1998, Synbiotics Corporation filed a lawsuit
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against us alleging infringement of a Synbiotics patent relating to heartworm
diagnostic technology and this litigation remains ongoing. We cannot assure you
that we will not become subject to additional patent infringement claims and
litigation in the United States or other countries or interference proceedings
conducted in the United States Patent and Trademark Office to determine the
priority of inventions. The defense and prosecution of intellectual property
suits, USPTO interference proceedings, and related legal and administrative
proceedings are costly, time-consuming and distracting. We may also need to
pursue litigation to enforce any patents issued to us or our collaborative
partners, to protect trade secrets or know-how owned by us or our collaborative
partners, or to determine the enforceability, scope and validity of the
proprietary rights of others. Any litigation or interference proceeding will
result in substantial expense to us and significant diversion of the efforts of
our technical and management personnel. Any adverse determination in litigation
or interference proceedings could subject us to significant liabilities to third
parties. Further, as a result of litigation or other proceedings, we may be
required to seek licenses from third parties which may not be available on
commercially reasonable terms, if at all.
We license technology from a number of third parties. The majority of these
license agreements impose due diligence or milestone obligations on us, and in
some cases impose minimum royalty and/or sales obligations on us, in order for
us to maintain our rights under these agreements. Our products may incorporate
technologies that are the subject of patents issued to, and patent applications
filed by, others. As is typical in our industry, from time to time we and our
collaborators have received, and may in the future receive, notices from third
parties claiming infringement and invitations to take licenses under third-party
patents. It is our policy that when we receive such notices, we conduct
investigations of the claims they assert. With respect to the notices we have
received to date, we believe, after due investigation, that we have meritorious
defenses to the infringement claims asserted. Any legal action against us or our
collaborators may require us or our collaborators to obtain one or more licenses
in order to market or manufacture affected products or services. However, we
cannot assure you that we or our collaborators will be able to obtain licenses
for technology patented by others on commercially reasonable terms, that we will
be able to develop alternative approaches if unable to obtain licenses, or that
the current and future licenses will be adequate for the operation of our
businesses. Failure to obtain necessary licenses or to identify and implement
alternative approaches could prevent us and our collaborators from
commercializing certain of our products under development and could
substantially harm our business.
We have limited manufacturing experience and capacity and rely substantially on
third-party manufacturers.
To be successful, we must manufacture, or contract for the manufacture of,
our current and future products in compliance with regulatory requirements, in
sufficient quantities and on a timely basis, while maintaining product quality
and acceptable manufacturing costs. In order to increase our manufacturing
capacity, we acquired Diamond in April 1996 and certain assets of Center in July
1997. We must complete significant improvements in our manufacturing
infrastructure in order to scale up for the manufacturing of our new products.
We cannot assure you that we can complete such work successfully or on a timely
basis.
We currently rely on third parties to manufacture those products we do not
manufacture at our Diamond or Center facilities. We currently have supply
agreements with Atrix Laboratories, Inc. for our canine periodontal disease
therapeutic and with Quidel Corporation for certain manufacturing services
relating to our point-of-care diagnostic tests. Third parties also manufacture
our patient monitoring instruments and associated consumable products. We cannot
assure you that these partners will
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manufacture products to regulatory standards and our specifications in a
cost-effective and timely manner. If one or more of our suppliers experiences
delays in scaling up commercial manufacturing, fails to produce a sufficient
quantity of products to meet market demand, or requests renegotiation of
contract prices, our business could be substantially harmed. While we typically
retain the right to manufacture products ourselves or contract with an
alternative supplier in the event of a manufacturer's breach, any transfer of
production would cause significant production delays and additional expense to
us to scale up production at a new facility and to apply for regulatory
licensure at that new facility. In addition, we cannot assure you that suitable
manufacturing partners or alternative suppliers will be available for our
products under development if present arrangements are not satisfactory.
Our manufacturing facilities are subject to governmental regulation.
Our manufacturing facilities and those of any third-party manufacturers we
may use are subject to the requirements of and periodic regulatory inspections
by one or more of the FDA, USDA and other federal, state and foreign regulatory
agencies. We cannot assure you that we or our contractors will continue to
satisfy these regulatory requirements. Any failure to do so could substantially
harm our business, financial condition or results of operations. We cannot
assure you that we will not incur significant costs to comply with laws and
regulations in the future or that new laws and regulations will not
substantially harm our business.
We depend on partners in our research and development activities.
For certain of our proposed products, we are dependent on collaborative
partners to successfully and timely perform research and development activities
on our behalf. We cannot assure you that these collaborative partners will
complete research and development activities on our behalf in a timely fashion,
or at all. If our collaborative partners fail to complete research and
development activities, or fail to complete them in a timely fashion, our
business could be substantially harmed.
We depend on key personnel for our future success.
Our future success is substantially dependent on the efforts of our senior
management and scientific team. The loss of the services of members of our
senior management or scientific staff may significantly delay or prevent the
achievement of product development and other business objectives. Because of the
specialized scientific nature of our business, we depend substantially on our
ability to attract and retain qualified scientific and technical personnel.
There is intense competition among major pharmaceutical and chemical companies,
specialized biotechnology firms and universities and other research institutions
for qualified personnel in the areas of our activities. If we lose the services
of, or fail to recruit, key scientific and technical personnel, our business
could be substantially harmed.
We must manage our growth effectively.
We anticipate that our business will grow as we develop and commercialize
new products, and that this growth will result in an increase in
responsibilities for both existing and new management personnel. In order to
manage growth effectively, we will need to continue to implement and improve our
operational, financial and management information systems, to train, motivate
and manage our current employees and to hire new employees. We cannot assure you
that we will be able to manage our expansion effectively. Failure to do so could
substantially harm our business.
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We may face product liability litigation and the extent of our insurance
coverage is limited.
The testing, manufacturing and marketing of our current products as well as
those currently under development entail an inherent risk of product liability
claims and associated adverse publicity. To date, we have not experienced any
material product liability claims, but any claim arising in the future could
substantially harm our business. Potential product liability claims may exceed
the amount of our insurance coverage or may be excluded from coverage under the
terms of the policy. We cannot assure you that we will be able to continue to
obtain adequate insurance at a reasonable cost, if at all. In the event that we
are held liable for a claim against which we are not indemnified or for damages
exceeding the limits of our insurance coverage or which results in significant
adverse publicity against us, our business could be substantially harmed.
Side effects of our products may generate adverse publicity.
Following the introduction of a product, adverse side effects may be
discovered that make a product no longer commercially viable. Publicity
regarding such adverse effects could affect sales of our other products for an
indeterminate time period. We are dependent on the acceptance of our products by
both veterinarians and pet owners. If we fail to engender confidence in our
products and services, our ability to attain and sustain market acceptance of
our products could be substantially harmed.
We may be held liable for the release of hazardous materials.
Our products and development programs involve the controlled use of
hazardous and biohazardous materials, including chemicals, infectious disease
agents and various radioactive compounds. Although we believe that our safety
procedures for handling and disposing of such materials comply with the
standards prescribed by applicable local, state and federal regulations, we
cannot completely eliminate the risk of accidental contamination or injury from
these materials. In the event of such an accident, we could be held liable for
any damages or fines that result. Our liability for the release of hazardous
materials could exceed our resources. We may incur substantial costs to comply
with environmental regulations as we expand our manufacturing capacity.
We expect to experience volatility in our stock price.
The securities markets have from time to time experienced significant price
and volume fluctuations that are unrelated to the operating performance of
particular companies. The market prices of securities of many publicly-held
biotechnology companies have in the past been, and can in the future be expected
to be, especially volatile. The market price of our common stock may fluctuate
substantially due to factors such as:
o announcements of technological innovations or new products by us or by
our competitors;
o releases of reports by securities analysts;
o developments or disputes concerning patents or proprietary rights;
o regulatory developments;
o changes in regulatory policies;
o economic and other external factors; and
o quarterly fluctuations in our financial results.
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Our directors, executive officers and entities affiliated with them have
substantial control over our affairs.
Our directors, executive officers and entities affiliated with them own
approximately 39% of our outstanding common stock. Three of our major
stockholders, Charter Ventures, Novartis and Volendam, who together own
approximately 33% of our outstanding common stock, have entered into a voting
agreement dated as of April 12, 1996 whereby each agreed to collectively vote
its shares in such a manner so as to ensure that each major stockholder was
represented by one member on our Board of Directors. The voting agreement
terminates on December 31, 2005 unless prior to that date any of the investors
ceases to beneficially hold 2,000,000 shares of our voting stock, at which time
the voting agreement will terminate. Our major stockholders, acting together,
could substantially influence matters requiring approval by our stockholders,
including the election of directors and the approval of mergers or other
business combination transactions. These stockholders may have interests
different from, or in addition to, those of non-affiliated stockholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk represents the risk of loss that may impact the financial
position, results of operations or cash flows due to adverse changes in
financial and commodity market prices and rates. We are exposed to market risk
in the areas of changes in United States and foreign interest rates and changes
in foreign currency exchange rates as measured against the United States dollar.
These exposures are directly related to our normal operating and funding
activities. Historically and as of December 31, 1999, we have not used
derivative instruments or engaged in hedging activities.
Interest Rate Risk
The interest payable on certain of our lines of credit and other borrowings
is variable based on the United States prime rate, or LIBOR, and, therefore,
affected by changes in market interest rates. At December 31, 1999,
approximately $5.6 million was outstanding on these lines of credit and other
borrowings with a weighted average interest rate of 9.6%. The lines of credit
mature from January 2000 through September 2001 and are subject to annual
renewal. We may pay the balance in full at any time without penalty. We manage
interest rate risk by investing excess funds principally in cash equivalents or
marketable securities which bear interest rates that reflect current market
yields. Additionally, we monitor interest rates and at December 31, 1999 had
sufficient cash balances to pay off the lines-of-credit should interest rates
increase significantly. As a result, we do not believe that reasonably possible
near-term changes in interest rates will result in a material effect on our
future earnings, financial position or cash flows.
Foreign Currency Risk
At December 31, 1999, we had wholly-owned subsidiaries located in England,
Switzerland and France. Sales from these operations are denominated in British
Pounds, Swiss Francs, French Francs or Euros, thereby creating exposures to
changes in exchange rates. The changes in the British/U.S. exchange rate,
Swiss/U.S. exchange rate, French/U.S. exchange rate or Euro/U.S. exchange rate
may positively or negatively affect our sales, gross margins and retained
earnings. We do not believe that reasonably possible near-term changes in
exchange rates will result in a material effect on future earnings, fair values
or cash flows, and therefore, have chosen not to enter into foreign currency
hedging instruments. There can be no assurance that such an approach will be
successful, especially in the event of a significant and sudden decline in the
value of the British Pound, Swiss Franc, French Franc or Euro. In March 2000, we
sold our wholly-owned subsidiary in England.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
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Report of Independent Public Accountants.......................................................................... 33
Consolidated Balance Sheets as of December 31, 1998 and 1999...................................................... 34
Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 1997,
1998 and 1999................................................................................................. 35
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1998 and 1999.............. 36
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999........................ 37
Notes to Consolidated Financial Statements........................................................................ 38
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Heska Corporation:
We have audited the accompanying consolidated balance sheets of Heska
Corporation (a Delaware corporation) and subsidiaries as of December 31, 1998
and 1999, and the related consolidated statements of operations and
comprehensive loss, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Heska Corporation and
subsidiaries as of December 31, 1998 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Denver, Colorado
January 28, 2000.
33
34
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
ASSETS
DECEMBER 31,
------------------------
1998 1999
--------- ---------
Current assets:
Cash and cash equivalents ............................................................. $ 5,921 $ 1,499
Marketable securities ................................................................. 46,009 22,482
Accounts receivable, net of allowance for doubtful accounts of $93 and
$188, respectively .................................................................. 6,659 9,652
Inventories, net ...................................................................... 12,197 13,957
Other current assets .................................................................. 734 1,027
--------- ---------
Total current assets ............................................................. 71,520 48,617
Property and equipment, net ................................................................... 21,226 19,574
Intangible assets, net ........................................................................ 4,311 1,629
Restricted marketable securities and other assets ............................................. 997 1,348
--------- ---------
Total assets ..................................................................... $ 98,054 $ 71,168
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ...................................................................... $ 7,542 $ 6,928
Accrued liabilities .................