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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, 2001
Or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________
to _________________
COMMISSION FILE NUMBER: 0-22427
HESKA CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0192527
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
1613 PROSPECT PARKWAY 80525
FORT COLLINS, COLORADO
(ADDRESS OF PRINCIPAL EXECUTIVE (ZIP CODE))
OFFICES)
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 in 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 $40,287,365 as of
March 26, 2002 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.
47,845,112 shares of the Registrant's Common Stock, $.001 par
value, were outstanding at March 26, 2002.
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 filed with the Securities and Exchange Commission in
connection with the solicitation of proxies for the Registrant's
2002 Annual Meeting of Stockholders.
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TABLE OF CONTENTS
Page
PART I 1
Item 1. Business. 1
Item 2. Properties. 12
Item 3. Legal Proceedings. 12
Item 4. Submission of Matters to a Vote of Security Holders. 13
PART II 14
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters. 14
Item 6. Selected Consolidated Financial Data. 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 16
Item 7A. Quantitative and Qualitative Disclosures about Market Risk. 34
Item 8. Financial Statements and Supplementary Data. 35
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure. 65
PART III 65
Item 10. Directors and Executive Officers of the Registrant. 65
Item 11. Executive Compensation. 66
Item 12. Security Ownership of Certain Beneficial Owners and
Management. 66
Item 13. Certain Relationships and Related Transactions. 66
PART IV 67
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K. 67
ALLERCEPT, AVERT, E.R.D.-SCREEN, E-SCREEN, HESKA, SOLO STEP, VET/ECG,
VET/E-Sig, VET/IV, and VET/OX are trademarks of Heska Corporation. This 10-K
also refers to trademarks and trade names of other organizations.
PART I
This Form 10-K contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended and Section 21E of the
Securities Exchange Act of 1934, as amended. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates,"
variations of such words and similar expressions are intended to identify such
forward- looking statements. These statements are not guarantees of future
performance and are subject to certain risks, uncertainties and assumptions that
are difficult to predict. Therefore, actual results could differ materially
from those expressed or forecasted in any such forward-looking statements as a
result of certain factors, including those set forth in "Factors that May
Affect Results," "Management's Discussion and Analysis of Financial Condition
and Results of Operations," "Business" and elsewhere in this Form 10-K.
Although we believe that expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. 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. These forward-looking statements apply only as of
the date of this Form 10-K.
ITEM 1. BUSINESS.
We discover, develop, manufacture and market companion animal health
products principally for dogs, cats and horses. We employ approximately 80
scientists, of whom over one quarter hold doctoral degrees, with expertise in
several disciplines including microbiology, immunology, genetics, biochemistry,
molecular biology, parasitology and veterinary medicine. This scientific
expertise is focused on the development of a broad range of pharmaceutical,
vaccine and diagnostic products for companion animals. We also sell veterinary
diagnostic and patient monitoring instruments and offer diagnostic services to
veterinarians in the United States and Europe principally for companion animals.
Our Diamond Animal Health subsidiary manufactures food animal vaccines as well
as other food animal products that are marketed and distributed by other animal
health companies. In addition, Diamond manufactures certain companion animal
health products for marketing and sale by Heska.
We currently market our products in the United States to veterinarians
through approximately 20 independent third-party distributors and through a
direct sales force, complemented by an internal telesales group. Nearly one-
half of our domestic distributors provide sales services for the full line of
our pharmaceutical, vaccine, diagnostic and instrumentation products. Late in
2001, we made a shift in our product distribution strategy and expect to rely on
independent distributors for a greater portion of our domestic sales. Outside
the United States, we rely primarily on third-party distributors and, for
certain of our products, have granted our corporate partners exclusive
distribution rights. See "Sales, Marketing and Distribution" below.
Our principal executive offices are located at 1613 Prospect Parkway, Fort
Collins, Colorado 80525 and our telephone number is (970) 493-7272. We were
incorporated in California in 1988, and we reincorporated in Delaware in 1997.
Our business is comprised of two reportable segments, Companion Animal
Health and Food Animal Health. Within the Companion Animal Health segment there
are two major product groups, which we define as pharmaceuticals, vaccines and
diagnostics (PVD) and veterinary diagnostic and patient monitoring instruments.
These products are sold through our operations in Fort Collins, Colorado and
Europe. Within the Food Animal Health segment, there is one major product
group, food animal vaccine and pharmaceutical products. We manufacture these
food animal products at our Diamond Animal Health subsidiary located in Des
Moines, Iowa.
COMPANION ANIMAL HEALTH PRODUCTS
We presently sell a variety of companion animal health products, among the
most significant of which are the following:
DIAGNOSTICS
Heartworm Diagnostic Products. 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 that live in the pulmonary arteries and heart of
the host, where they can cause serious cardiovascular, pulmonary, liver and
kidney disease. Our canine and feline heartworm diagnostic tests use monoclonal
antibodies or a recombinant heartworm antigen, respectively, to detect heartworm
antigens or antibodies circulating in the blood of an infected animal. These
tests were introduced into the marketplace over the last several years.
We currently market and sell heartworm diagnostic products for both cats
and dogs. SOLO STEP FH for cats and SOLO STEP CH for dogs are available in both
point-of-care versions that can be used by veterinarians on site, as well as
tests that can be sent to our veterinary diagnostic laboratory at our Fort
Collins facility. In 2000, we introduced SOLO STEP CH Batch Test Strips, which
is a rapid and simple point-of-care antigen detection test for dogs that allows
veterinarians in larger practices to run multiple samples at the same time.
Novartis Agro K.K. (Novartis Animal Health K.K. Tokyo) has been appointed our
exclusive distributor of SOLO STEP CH and SOLO STEP FH in Japan. SOLO STEP CH
received regulatory approval from the Japanese Ministry of Agriculture, Forestry
and Fisheries, or MAFF, in September 2001 and was first sold in Japan in
November 2001.
Allergy Testing and Diagnostic Products. 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 can be painful, subjective
and inconvenient. The effectiveness of the immunotherapy that is prescribed to
treat allergic disease is inherently limited by inaccuracies in the diagnostic
process.
Heska markets two complementary in vitro tests for the detection of IgE,
the antibody involved in most allergic reactions:
* The ALLERCEPT E-Screen Test, introduced in 2001, is a rapid in-clinic
test that detects the presence of allergen-specific IgE, an antibody
associated with allergic disease. Dogs testing positive for allergen-
specific IgE are candidates for further evaluation using our ALLERCEPT
Definitive Allergen Panels to determine the specific allergens to
which the dog is allergic.
* The ALLERCEPT Definitive Allergen Panels, introduced in 1997, provide
the most accurate determination of the specific allergens to which a
dog is reacting. The panels use a highly specific 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, insect
and mite allergens. The test results often serve as the basis for
prescription ALLERCEPT Allergy Treatment Sets.
Early Renal Disease. Renal disease is the second leading cause of death in
dogs and often goes undetected until it is too late. It is estimated that 70%
to 80% of kidney function is already destroyed before veterinarians can detect
renal disease using existing tests. Early detection is key to the introduction
of dietary or therapeutic regimens that could significantly slow the progression
of the disease and add quality years to a dog's life. Our E.R.D.-SCREEN Test,
introduced in March 2002, is a rapid in-clinic immunoassay that detects trace
amounts of albumin in urine. The persistent presence of albumin in urine is
believed to be associated with the early stages of renal disease.
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 believe that approximately half of the six million
horses in the United States currently 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 U.S. equine vaccine market at $50
million. We believe that other currently available vaccines for equine
influenza are of limited efficacy.
We have developed a unique vaccine for equine influenza, our Flu AVERT I.N.
vaccine, which we believe has improved efficacy and duration of immunity
compared to existing products. This product was approved by the United States
Department of Agriculture, or USDA, in November 1999 and was first sold to
veterinarians in December 1999. In February 2001, we granted Novartis Animal
Health Canada exclusive distribution rights for Flu AVERT I.N. vaccine in
Canada. The vaccine received regulatory approval from the Canadian Food
Inspection Agency, or CFIA, in August 200l and was first sold in Canada in
September 2001.
Allergy Treatment Sets. Veterinarians who use our ALLERCEPT Definitive
Allergen Panels often purchase ALLERCEPT Allergy Treatment Sets for those
animals with positive test results. These prescription immunotherapy treatment
sets are formulated specifically for each allergic animal and contain only the
allergens to which the animal has 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 products.
Feline Respiratory Disease Vaccine. In 1997, we introduced in the United
States HESKA Trivalent Intranasal/Intraocular Vaccine, a three-way modified live
vaccine to prevent disease caused by the three most common respiratory viruses
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 vaccine avoids injection site side
effects, and we believe it is very efficacious. We anticipate the introduction
of a second generation of this product in 2003.
PHARMACEUTICALS
Nutritional Supplements. In 1998, we developed and introduced in the
United States a novel fatty acid supplement, HESKA F.A. Granules. The 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 mediators. The HESKA 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 offer a broad line of veterinary diagnostic, monitoring and other
instruments which are described below. We also market and sell consumable
supplies and reagents for these instruments. We entered this line of business
in March 1998, when we acquired Sensor Devices, Inc., a manufacturer and
marketer of patient monitoring and diagnostic instruments. Following that
acquisition, we completed the development of various other instruments and
entered into agreements for the distribution of additional instruments to
veterinarians.
Diagnostic Instruments. Our line of veterinary diagnostic instruments
includes the following:
* The i-STAT Portable Clinical Analyzer is 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.
* The HESKA Vet ABC-Diff Hematology Analyzer is 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.
* The SPOTCHEM EZ is a compact desktop system used to measure common
blood chemistry components that are vital to veterinary medical diagnosis.
It provides veterinarians with an easy-to-use, flexible and economical
in-clinic chemistry system.
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. Our line of
monitoring instruments includes:
* The VET/OX 4404 monitor and the VET/OX 4800 monitor, the centerpieces
of our monitoring instrument product line, are oxygen saturation monitors
designed for monitoring animals under anesthesia. Each monitor includes
a variety of additional parameters, such as pulse rate and strength, body
temperature, respiration and ECG.
* The VET/E-Sig probe is used for monitoring ECG, temperature and heart and
breath sounds of anesthetized dogs.
* The VET/IV 2.2 infusion pump is a compact, affordable IV pump that allows
veterinarians to easily provide regulated infusion of fluids, drugs 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 services including polymerase chain reaction (PCR) based tests for
certain infectious diseases. Our Fort Collins veterinary diagnostic laboratory
is currently staffed by 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.
FOOD ANIMAL HEALTH PRODUCTS
In addition to manufacturing companion animal health products for marketing
and sale by Heska, Diamond Animal Health, our wholly-owned subsidiary, has
developed its own line of food animal vaccines that were licensed by the USDA in
the United States in 1998 and 1999. In 1998, Diamond entered into an agreement
with a food animal products distributor, Agri Laboratories, Ltd., or AGRILABS,
for the exclusive marketing and sale of these vaccines worldwide. AGRILABS
currently has an arrangement with Intervet International B.V., a division of
Akzo Nobel, for the exclusive distribution of these vaccines worldwide. Certain
annual contract minimums must be met by AGRILABS in order to maintain worldwide
exclusivity. The agreement expires in December 2004 and is automatically
renewed for additional one-year terms thereafter, unless either party gives
prior written notice that it does not wish to renew the agreement. We do not
currently intend to terminate this agreement and have not received any such
notice from AGRILABS. We are currently in negotiations with AGRILABS to modify
and extend this agreement. Diamond is the sole manufacturer of these products.
Diamond also manufactures biological and pharmaceutical products for a
number of other food animal health companies. This activity ranges from
providing complete turnkey services which include research, licensing,
production, labeling and packaging of products to providing any one of these
services as needed by their customers.
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 that
consist of microbiologists, immunologists, geneticists, biochemists, molecular
biologists, parasitologists and veterinarians, as appropriate.
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.
In the past, we have collaborated with a number of third parties on the
development of various pharmaceutical, vaccine and diagnostic products. We have
collaborated with numerous university veterinary specialists and practicing
veterinarians to test products in development and to validate the utility of our
existing products in the marketplace. In addition, we have collaborated with
the following institutions and companies to develop critical components of our
products:
* Quidel Corporation, Genzyme Corporation and Diagnostic Chemicals, Ltd.
with respect to the development of certain of our rapid, in-clinic
diagnostics tests,
* Valentis, Inc. and National Jewish Medical and Research Center on the
development of an intratumor gene therapy for the treatment of solid
tumors in dogs, and
* Researchers at the University of Pittsburgh on the development of our
Flu Avert I.N. vaccine.
We have also collaborated with several third parties on the development of
our veterinary medical instrument product line, including:
* i-STAT Corporation, for the development of veterinary applications for
the i-STAT Portable Clinical Analyzer and the cartridges used with this
instrument,
* Arkray, Inc., for the development of veterinary applications for the
SPOTCHEM EZ clinical biochemistry analyzer and associated reagents, and
* scil GmbH, for the development of veterinary applications for the Heska
Vet ABC-Diff Hematology Analyzer and associated reagents.
Our product pipeline currently includes numerous products in various stages
of development. Products under development include several point-of-care
diagnostic products, vaccines and pharmaceutical products for allergy, cancer,
heartworm control, pain management and flea control. We currently have under
development the following products which we expect to introduce in 2002 and
2003:
* A screening test for the parasites, Giardia and Cryptosporidium;
* A second generation vaccine for feline respiratory disease;
* A diagnostic product to determine if cats remain protected against
common respiratory viral diseases; and
* A gene-based medicine that stimulates a dog's own immune system to
attack tumors.
The vast majority of all our research and development resources are
directed toward the development of new companion animal health products. We
incurred expenses of $13.6 million, $14.9 million and $17.0 million in the years
ended December 31, 2001, 2000, and 1999, respectively in support of our research
and development activities.
SALES, MARKETING AND DISTRIBUTION
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.
During the past year, we sold our products to approximately 14,000 such clinics
in the United States.
We currently market our products in the United States to veterinarians
through independent third- party distributors, a direct sales force, a telephone
sales force, trade shows and print advertising. Prior to 2001, our distribution
strategy relied upon the use of third-party sales agents who would market
Heska's products on consignment. During 2001, we modified our distribution
strategy and entered into distribution agreements with over 20 third-party
veterinary distributors. These distributors market our products utilizing their
direct sales forces. Nearly one-half of these domestic distributors carry the
full line of our pharmaceutical, vaccine, diagnostic and instrumentation
products. We believe that these relationships will provide for more complete
market penetration. Internationally, we market our products to veterinarians
primarily through third-party distributors and corporate partners.
Given the shift in our product distribution strategy, we expect that a
greater portion of our sales will come from distributors rather than our direct
sales force. An important factor in successfully implementing this strategy
will be to retain sufficient independent distributors to market and sell our
products. We believe that one of our largest competitors, IDEXX, prohibits its
distributors from selling competitors' products, including our SOLO STEP
heartworm diagnostic products and medical diagnostic instruments. To be
successful, we will need to continue to attract and retain sufficient
independent distributors and train the sales personnel of our distributors about
the Heska products.
We have granted third parties substantial marketing rights to certain of
our existing products as well as products under development. 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. Currently, Novartis Agro K.K. markets and distributes SOLO
STEP CH in Japan, and Novartis Animal Health Canada, Inc. distributes our Flu
AVERT I.N. vaccine in Canada. In addition, we have entered into agreements with
Novartis, Nestle Purina Petcare Company and Eisai Inc. to market or co-market
certain of the products that we are currently developing.
MANUFACTURING
Our products are manufactured by our Fort Collins, Des Moines and Fribourg,
Switzerland facilities and/or by third-party manufacturers. Diamond's facility
is a USDA, Food and Drug Administration, or FDA, and Drug Enforcement Agency, or
DEA, 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. Heska AG
manufactures its allergy diagnostic products at its facility in Fribourg,
Switzerland. Quidel Corporation and Diamond manufacture our heartworm point-of-
care diagnostic products. Centaq, Inc. manufactures our immunotherapy treatment
products. Third parties manufacture our veterinary diagnostic and patient
monitoring instruments, including our various analyzers and veterinary sensors.
In addition to manufacturing certain of 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 vaccine 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. Diamond also offers support to its customers
through research services, regulatory compliance services, validation support
and distribution services.
COLLABORATIVE AGREEMENTS
Novartis. We have entered into several collaborative agreements with
various subsidiaries and/or divisions of Novartis AG.
* Screening and Development Agreement. We entered into this agreement
with Ciba-Geigy Limited, now known as Novartis AG, in April 1996.
Under the agreement the parties may undertake joint research and
development activities related to both companion animal and food
animal health. If the parties decide not to perform joint research
activities, then Novartis has the right to use our materials to
develop food animal or companion animal products. Novartis would pay
royalties on any such products developed by it. There are currently
no joint research programs underway and no products being sold that
were developed under this agreement. This Agreement is effective
until December 31, 2005.
* Marketing Agreements. In April 1996, we entered into marketing
agreements with Ciba-Geigy Limited (Novartis AG) and Ciba-Geigy
Corporation, now known as Novartis Animal Health US, Inc. Under
these agreements, these entities were granted various rights to
manufacture and market flea control vaccine or feline heartworm
control vaccine products developed by us for which USDA prelicensing
serials are completed on or before December 31, 2005. We have
co-exclusive rights to market these products under our own trade
names throughout the world, subject to certain other marketing rights,
and we share revenues on those sales. These agreements are in force
until December 2010 or for as long as Novartis is selling the products.
No products have yet been developed or commercialized under these
agreements.
* Right of First Refusal Agreements.
- In April 1996 we entered into an agreement with Ciba-Geigy
Limited (Novartis AG) under which we, prior to granting
licenses to any third party to products or technology
developed or acquired by us for either companion animal or
food animal applications, subject to certain other rights,
must first notify and offer Novartis such rights. This
agreement terminates in December 2005. To date, Novartis AG
is not developing or marketing any products offered to it
under this agreement, except for a Leishmania vaccine that
is currently in development at Novartis.
- In August 1998, we entered into an agreement with Novartis Agro
K.K. ("NAH-Japan") and Novartis Animal Health, Inc. ("NAH") under
which both entities, prior to granting licenses to any third party
to certain products or technology offered to NAH-Japan or NAH by
any third party or by any NAH affiliate for either companion animal
or food animal applications, must first notify and offer us such
rights. This agreement terminates in December 2005. To date,
Heska is not developing or marketing any products under this
agreement.
* Exclusive Distribution Agreements.
- In August 1998, we entered into an agreement with Novartis Agro K.K.
(Novartis Animal Health K.K. Tokyo) to be our exclusive distributor
for SOLO STEP CH and SOLO STEP FH heartworm diagnostic products and
our feline Bivalent/Trivalent Intranasal/Intraocular Vaccines in
Japan upon obtaining regulatory approval in Japan for such products,
at Novartis' expense. This right continues until December 2006.
There are no minimum purchase obligations contained in this
agreement. Sales of SOLO STEP CH began in November 2001.
- In February 2001, we entered into an agreement with Novartis Animal
Health Canada, Inc. to be our exclusive distributor for Flu AVERT,
I.N. our equine influenza vaccine in Canada until December 2006,
subject to Novartis meeting certain minimum purchase requirements.
Products are marketed under the HESKA brand name. Product sales
began in November 2001.
Nestle Purina PetCare Company. We have a strategic alliance with Nestle
Purina PetCare Company, formerly Ralston Purina Company. Nestle holds exclusive
rights to license our discoveries, know-how and technologies for innovative
diets for dogs and cats. The first product from this strategic alliance was
introduced under the Purina name in July 2000. A second related product was
introduced in 2001. These products are specialty diets for the nutritional
management of feline diabetes mellitus. We receive a royalty from Nestle on
sales of these products.
i-STAT Corporation. Under the terms of an Amended and Restated
Distribution Agreement dated as of February 1999, we have been granted exclusive
rights to market and sell the i-STAT portable blood analyzer and cartridges in
the U.S. and major international markets, including Europe. We also have a
right to market certain products developed by i-STAT. The term of this
agreement is currently until December 2002. It is automatically renewed
thereafter for additional 12 months terms unless either party gives at least
9 months prior written notice to the other that it does not wish to renew the
agreement.
Agri Laboratories, Ltd. In July 1998, our wholly owned subsidiary, Diamond
Animal Health, Inc. entered into a Bovine Vaccine Distribution Agreement. Under
the terms of this agreement, Diamond has agreed to manufacture and sell certain
bovine vaccines to AGRILABS for distribution worldwide, with certain exceptions.
Certain minimum purchase requirements apply to this agreement. This agreement
expires in December 2004 and is automatically renewed thereafter for additional
one year terms unless either party gives prior written notice to the other that
it does not wish to renew the agreement. We are currently in negotiations with
AGRILABS to modify and extend this agreement.
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.
We actively seek patent protection both in the United States and abroad.
As of December 31, 2001, we owned, co-owned or had rights to 138 issued U.S.
patents and 110 pending U.S. patent applications. Our issued U.S. patents
primarily relate to allergy, flea control, heartworm control, infectious disease
vaccines, nutrition, instrumentation, diagnostics or vaccine delivery
technologies. Our pending patent applications primarily relate to allergy, flea
control, heartworm control, infectious disease vaccines, diagnostics, nutrition,
cancer, vaccine delivery, immunomodulators or medical instrument technologies.
Applications corresponding to pending U.S. applications have been or will be
filed in other countries. Our patent portfolio also includes 132 issued patents
and 209 pending applications in various foreign 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 and Heska AG are primarily
protected through trade secret protection of, for example, their manufacturing
processes.
The biotechnology and pharmaceutical industries have been characterized by
extensive litigation relating to patents and other intellectual property rights.
In 1998, Synbiotics Corporation filed a lawsuit against us alleging infringement
of a Synbiotics patent relating to heartworm diagnostic technology. See "Item
3. Legal Proceedings."
SEASONALITY
Certain portions of our business are subject to seasonality, including our
SOLO STEP heartworm diagnostic products, which are principally sold starting in
the fourth quarter and continuing through the second quarter of the year; our
Flu AVERT I.N. vaccine for equine influenza, which is principally sold in the
first and fourth quarters of the year; our veterinary medical instrument
products, sales of which are higher in the fourth quarter of the year; and our
food animal vaccine products, which are sold principally in the second half of
the year.
GOVERNMENT REGULATION
Most of the products that we develop are subject to extensive regulation by
governmental authorities in the United States, including the USDA and the FDA,
and by similar agencies in other countries. These regulations govern, among
other things, the development, testing, manufacturing, labeling, storage, pre-
market approval, advertising, promotion, sale and distribution of our products.
Satisfaction of these requirements can take several years and time needed to
satisfy them may vary substantially, based on the type, complexity and novelty
of the product. Any product that we develop must receive all relevant
regulatory approval or clearances, if required, before it may be marketed in a
particular country. The following summarizes the U.S. government agencies that
regulate animal health products:
* USDA. Vaccines and certain point-of-care diagnostics are considered
veterinary biologics and are therefore regulated by the Center for
Veterinary Biologics, or CVB, of the USDA. Industry data indicate
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, at 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 manufactured, information on the efficacy
and safety of the product in laboratory animal studies and information
on performance of the product in field conditions.
* FDA. Pharmaceutical products, which generally include synthetic
compounds, are approved and monitored by the Center for Veterinary
Medicine of the FDA. Industry data indicate that developing a new
drug for animals requires approximately 11 years from commencement
of research to market introduction and costs approximately $5.5 million.
Of this time, approximately three years is spent in animal studies and
the regulatory review process. However, unlike human drugs, neither
preclinical studies nor a sequential phase system of studies are
required. Rather, for animal drugs, studies 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 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 production animals, as
food safety issues relating to tissue residue levels are not
present.
* EPA. Products that are applied topically to animals or to premises
to control external parasites are regulated by the Environmental
Protection Agency, or EPA.
After we have received regulatory licensing or approval for our
pharmaceutical products, numerous regulatory requirements apply. Among the
conditions for certain regulatory approvals is the requirement that our
manufacturing facilities or those of our third-party manufacturers conform to
current Good Manufacturing Practices or other manufacturing regulations, which
include requirements relating to quality control and quality assurance as well
as maintenance of records and documentation. The USDA, FDA and foreign
regulatory authorities strictly enforce manufacturing regulatory requirements
through periodic inspections.
A number of our animal health products are not regulated. For example,
certain assays for use in a veterinary diagnostic laboratory, such as ALLERCEPT,
E-SCREEN and E.R.D.-SCREEN Urine Test, do not have to be licensed by either the
USDA or FDA. Similarly, none of our veterinary diagnostic and patient
monitoring instruments require regulatory approval to be marketed and sold.
Additionally, various botanically derived products, various nutritional products
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.
We have pursued regulatory approval outside the United States based on
market demographics of foreign countries. For marketing outside the United
States, we are also subject to foreign regulatory requirements governing
regulatory licensing and approval for many of our products. The requirements
governing product licensing and approval vary widely from country to country.
Licensing and approval by comparable regulatory authorities of foreign countries
must be obtained before we can market products in those countries. The approval
process varies from country to country and the time required for such approvals
may differ substantially from that required in the United States. We cannot be
certain that approval of any of our products in one country will result in
approvals in any other country. To date, we or our distributors have sought
regulatory approval for certain of our products in Canada, which is governed by
the Canadian Food Inspection Agency, or CFIA, and in Japan, which is governed by
the Japanese Ministry of Agriculture, Forestry and Fisheries, or MAFF.
The status of regulatory approval for our major products and products in
development both in the United States and elsewhere is summarized below.
CURRENT MAJOR PRODUCTS COUNTRY REGULATED AGENCY STATUS
- ---------------------------------------- -------------- ----------------------- ---------- -----------
ALLERCEPT E-SCREEN Test United States No
EU No - in most countries
ALLERCEPT Definitive Allergen Panels Unites States No
EU No
E.R.D.-SCREEN Urine Test United States No
EU No - in most countries
Flu AVERT I.N. Vaccine United States Yes USDA Licensed
Canada Yes CFIA Licensed
HESKA F.A. Granules United States No
SOLO STEP CH United States Yes USDA Licensed
Canada Yes CFIA Pending
Japan Yes MAFF Licensed
SOLO STEP FH United States Yes USDA Licensed
SOLO STEP Batch Test Strips United States Yes USDA Licensed
Canada Yes CFIA Pending
Trivalent Intranasal/Intraocular Vaccine United States Yes USDA Licensed
Veterinary Medical Instrumentation United States No
EU No
PRODUCTS IN DEVELOPMENT COUNTRY REGULATED AGENCY STATUS
- ---------------------------------------- -------------- ---------------------- ----------- ------------
Feline ImmuCheck Assay United States Yes USDA Pending
EU No-in most countries
Canine Cancer Gene Therapy United States Yes USDA Pending
Giardia + Crypto-Screen Fecal Test United States Yes USDA Pending
EU No-in most countries
Trivalent Intranasal/Intraocular Vaccine- United States Yes USDA Pending
Second Generation
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
animal health market, such as Wyeth (formerly American Home Products), Bayer AG,
IDEXX Laboratories, Inc., Intervet International B.V., Merial Ltd., Novartis AG,
Pfizer Inc., Pharmacia Corporation and Schering-Plough Corporation are marketing
or are developing products that 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 we do. Novartis is our
marketing partner, but its agreement with us does not restrict its ability to
develop and market competing products. In addition, we believe that IDEXX
prohibits its distributors from selling competitors' products, including our
SOLO STEP heartworm diagnostic products and medical diagnostic instruments.
The food animal 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 may have more established marketing, sales, distribution and service
organizations than AGRILABS.
ENVIRONMENTAL REGULATION
In connection with our product development activities and manufacturing of
our biological, pharmaceutical and diagnostic products, we are subject to
federal, state and local laws, rules, regulations and policies governing the
use, generation, manufacture, storage, handling and disposal of certain
materials, biological specimens and wastes. Although we believe that we have
complied with these laws, regulations and policies in all material respects and
have not been required to take any significant action to correct any
noncompliance, we may be required to incur significant costs to comply with
environmental and health and safety regulations in the future. Although we
believe that our safety procedures for handling and disposing of such materials
comply with the standards prescribed by state and federal regulations, the risk
of accidental contamination or injury from these materials cannot be eliminated.
In the event of such an accident, we could be held liable for any damages that
result and any such liability could exceed our resources.
EMPLOYEES
As of December 31, 2001, we and our subsidiaries employed 336 full-time
persons, of whom 107 were in manufacturing, quality control, shipping and
receiving, and materials management, 90 were in research, development,
intellectual property and regulatory affairs, 57 were in management, finance,
administration, legal, information systems, human resources and facilities
management, 67 were in sales, marketing and customer service and 15 were in the
diagnostic laboratories. We believe that our ability to attract and retain
skilled personnel is critical to our success. None of our employees is covered
by a collective bargaining agreement, and we believe our employee relations are
good.
ITEM 2. PROPERTIES.
Our principal administrative and research and development activities are
located in Fort Collins, Colorado. We currently lease an aggregate of
approximately 64,000 square feet of administrative and laboratory space in four
buildings located in Fort Collins 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. Our principal manufacturing facility,
Diamond, located in Des Moines, Iowa, consists of 168,000 square feet of
buildings on 34 acres of land, which we own. We also own a 175-acre farm used
principally for research purposes located in Carlisle, Iowa. Our European
subsidiaries lease their facilities.
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. 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 related to the one
remaining claim. In September 2000, the U.S. District Court hearing the case
granted our request for a partial summary judgment, holding two of the
Synbiotics patent claims to be invalid, leaving only the one remaining claim in
the lawsuit. The one remaining claim is currently scheduled for trial in 2002.
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.
No matters were submitted to a vote of stockholders during the fourth
quarter of the year ended December 31, 2001.
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
-------------- -------------
2000
First Quarter $ 5.563 $ 2.063
Second Quarter 4.375 1.500
Third Quarter 4.469 1.750
Fourth Quarter 2.938 0.594
2001
First Quarter 1.563 0.656
Second Quarter 1.440 0.950
Third Quarter 1.310 0.500
Fourth Quarter 1.100 0.500
2002
First Quarter (through March 26) 1.470 1.019
On March 26, 2002, the last reported sale price of our common stock was
$1.10 per share. As of March 26, 2002, there were approximately 358 holders of
record of our common stock and approximately 4,658 beneficial stockholders. We
have never declared or paid cash dividends on our capital stock and do not
anticipate paying any cash dividends in the near future. In addition, we are
restricted from paying dividends, other then dividends payable solely in stock,
under the terms of our credit facility. We currently intend to retain future
earnings for the development of our business.
On December 18, 2001, we issued 7,792,768 shares of common stock for an
aggregate purchase price of approximately $5.7 million, net of issuance costs,
to accredited investors. The issuance of these shares was made in reliance on
the exemptions from registration set forth in Section 4(2) of the Securities Act
of 1933, as amended. We made no public solicitation in connection with the
issuance of the above-mentioned securities. We relied on representations from
the recipients of the securities that they purchased the securities for
investment only and not with a view to any distribution thereof and that they
were aware of our business affairs and financial condition and had sufficient
information to reach an informed and knowledgeable decision regarding their
purchase of the securities.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The following statement of operations and balance sheet data have been
derived from our consolidated financial statements. The information set forth
below is not necessarily indicative of the results of future operations and
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,
--------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
----------------- ---------------- ----------------- ---------------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues:
Products, net:
Pharmaceuticals, vaccines
and diagnostics $ 16,704 $ 13,961 $ 12,716 $ 5,406 $ 2,587
Veterinary medical instruments 16,018 14,194 12,106 6,709 5,690
Food animal products 13,664 18,203 12,086 12,234 11,083
Sold businesses and other - 3,191 13,383 14,102 7,365
--------- --------- --------- --------- ---------
Total product revenues 46,386 49,549 50,291 38,451 26,725
Research, development and other 1,897 3,126 885 1,321 2,578
--------- --------- --------- --------- ---------
Total revenues 48,283 52,675 51,176 39,772 29,303
--------- --------- --------- --------- ---------
Cost of products sold 28,655 33,299 36,386 29,087 20,077
--------- --------- --------- --------- ---------
19,628 19,376 14,790 10,685 9,226
--------- --------- --------- --------- ---------
Operating expenses:
Selling and marketing 13,981 14,788 15,073 13,188 9,954
Research and development 13,565 14,929 17,042 25,126 20,343
General and administrative 7,882 9,457 11,231 11,939 13,192
Amortization of intangible assets
and deferred compensation 299 903 2,228 2,745 2,500
Purchased research and
development - - - - 2,399
Loss on sale of assets - 204 2,593 1,287 -
Restructuring expenses and other 2,023 435 1,210 2,356 -
--------- --------- --------- -------- ---------
Total operating expenses 37,750 40,716 49,377 56,641 48,388
--------- --------- --------- -------- ---------
Loss from operations (18,122) (21,340) (34,587) (45,956) (39,162)
--------- --------- --------- --------) ---------
Other income (expense) (569) (530) (1,249) 1,682 298
Net loss $ (18,691) $ (21,870) $ (35,836) $ 44,274) $ (38,864)
========= ========= ========= ======== =========
Basic net loss per share $ (0.48) $ (0.65) $ (1.31) $ (1.79)
========= ========= ========= ========
Unaudited pro forma basic net
loss per share(1) $ (2.42)
=========
Shares used to compute basic net
loss per share and Unaudited pro
forma basic net loss per share 38,919 33,782 27,290 24,693 16,042
DECEMBER 31,
--------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------------ ---------------- ----------------- ---------------- ---------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and
marketable securities $ 5,710 $ 5,658 $ 23,981 $ 51,930 $ 28,752
Working capital 8,215 13,308 28,234 51,947 31,461
Total assets 37,757 39,160 71,168 98,054 69,020
Line of credit 5,737 - 917 1,749 667
Long-term obligations 3,131 3,819 5,346 11,367 10,754
Accumulated deficit (193,163) (174,472) (152,602) (116,766) (72,492)
Total stockholders' equity 17,166 25,100 45,439 67,114 43,850
(1) All shares of convertible preferred stock were automatically
converted to common stock upon closing of the Company's initial
public offering in July 1997. The Company has reflected the
conversion of convertible preferred stock into 11,289 shares of
common stock on a pro forma basis as if the shares had been
outstanding during 1997.
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 forward-looking statements that involve risks and
uncertainties. 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, but not limited to, those
discussed below and elsewhere in this Form 10-K, particularly in "Factors that
May Affect Results," that could cause actual results to differ materially from
those projected. The forward-looking statements set forth in this Form 10-K are
as of April 1, 2002, and we undertake no duty to update this information.
CORPORATE OVERVIEW
We discover, develop, manufacture and market companion animal health
products, principally for dogs, cats and horses. We employ approximately 80
scientists, of whom over one quarter hold doctoral degrees, with expertise in
several disciplines including microbiology, immunology, genetics, biochemistry,
molecular biology, parasitology and veterinary medicine. This scientific
expertise is focused on the development of a broad range of pharmaceutical,
vaccine and diagnostic products for companion animals. We also sell veterinary
diagnostic and patient monitoring instruments and offer diagnostic services to
veterinarians in the United States and Europe, principally for companion
animals. In addition to manufacturing companion animal health products for
marketing and sale by Heska, our Diamond Animal Health subsidiary manufactures
food animal vaccines and other food animal products that are marketed and
distributed by other animal health companies.
OUR BUSINESS
We currently market our products in the United States to veterinarians
through approximately 20 independent third-party distributors and through a
direct sales force. Nearly one-half of these domestic distributors purchase the
full line of our pharmaceutical, vaccine, diagnostic and instrumentation
products. We have recently begun to rely on distributors for a greater portion
of our sales.
Our business is comprised of two reportable segments, Companion Animal
Health and Food Animal Health. Prior to June 30, 2000, we also had a third
reportable segment, Allergy Treatment, which represented the operations of a
subsidiary sold as of June 23, 2000. Within the Companion Animal Health segment
there are two major product groupings which we define as pharmaceuticals,
vaccines and diagnostics (PVD) and veterinary diagnostic and patient monitoring
instruments. These products are sold through our operations in Fort Collins,
Colorado and Europe. Within the Food Animal Health segment, there is one major
product grouping, food animal vaccine and pharmaceutical products. We
manufacture these food animal products at our Diamond Animal Health subsidiary,
located in Des Moines, Iowa.
Additionally, we generate non-product revenues from sponsored research and
development projects for third parties, licensing of technology and royalties.
We perform these sponsored research and development projects for both companion
animal and food animal purposes.
ACQUISITIONS AND DISPOSITIONS
In 1996, we expanded into a fully-integrated research, development,
manufacturing and marketing company by acquiring Diamond Animal Health, a
licensed pharmaceutical and biological manufacturing facility in Des Moines,
Iowa, accounted for as a purchase. We acquired Center Laboratories, an FDA and
USDA licensed manufacturer of allergy immunotherapy products located in New York
in 1997, accounted for as a purchase. Center was sold effective June 23, 2000.
Also in 1997, we expanded internationally with the acquisitions of Heska UK, a
veterinary diagnostic laboratory in England and Heska AG (formerly Centre
Medical des Grand'Places S.A.) in Switzerland, which manufactures and markets
allergy diagnostic products for use in veterinary and human medicine, primarily
in Europe, accounted for as a purchase. Heska UK was sold effective January 31,
2000. In 1998, we acquired Sensor Devices, Inc., a manufacturer and marketer of
patient monitoring devices located in Waukesha, Wisconsin, accounted for as a
pooling. These operations were consolidated with our existing operations in
Fort Collins, Colorado and Des Moines, Iowa as of December 31, 1999 and the
facility was closed.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are more fully described in Note 2 to
our consolidated financial statements. However, certain of our accounting
policies are particularly important to the understanding of our financial
position and results of operations and require the application of significant
judgment by our management; as a result they are subject to an inherent degree
of uncertainty. In applying those policies, our management uses its judgment to
determine the appropriate assumptions to be used in the determination of certain
estimates. Those estimates are based on our historical experience, terms of
existing contracts, our observance of trends in the industry, information
provided by our customers and information available from other outside sources,
as appropriate. Our significant accounting policies include:
* The Company generates its revenues through sale of products, licensing
of technology and sponsored research and development. Revenue is
accounted for in accordance with the guidelines provided by Staff
Accounting Bulletin 101 "Revenue Recognition in Financial Statements"
(SAB 101). The Company's policy is to recognize revenue when the
applicable revenue recognition criteria have been met, which generally
include the following:
- Persuasive evidence of an arrangement exists;
- Delivery has occurred or services rendered;
- Price is fixed or determinable; and
- Collectibility is reasonably assured.
Revenue from the sale of products is generally recognized
after both the goods are shipped to the customer and
acceptance has been received with an appropriate provision for
returns and allowances. The terms of the customer
arrangements generally pass title and risk of ownership to the
customer at the time of shipment. Certain customer
arrangements provide for acceptance provisions. Revenue for
these arrangements is not recognized until the acceptance has
been received or the acceptance period has lapsed.
In addition to its direct sales force, the Company utilizes
third-party distributors to sell its products. Distributors
purchase goods from the Company, take title to those goods and
resell them to their customers in the distributors'
territory.
License revenues under arrangements to sell product rights or
technology rights are recognized upon the sale and completion
by the Company of all obligations under the agreement.
Royalties are recognized as products are sold to customers.
The Company recognizes revenue from sponsored research and
development over the life of the contract as research
activities are performed. The revenue recognized is the
lesser of revenue earned under a percentage of completion
method based on total expected revenues or actual non-
refundable cash received to date under the agreement.
* Inventories. Inventories are stated at the lower of cost or market,
cost being determined on the first-in, first-out method. Inventories
are written down if the estimated net realizable value is less than the
recorded value.
* Foreign currency translation. The financial position and results of
operations of our foreign subsidiaries are measured using local currency
as the functional currency. Assets and liabilities of each foreign
subsidiary are translated at the rate of exchange in effect at the end
of the period. Revenues and expenses are translated at the average
exchange rate for the period. Foreign currency translation gains and
losses not impacting cash flows are credited to or charged against
other comprehensive income (loss). Foreign currency translation gains
and losses arising from cash transactions are credited to or charged
against current earnings.
RESULTS OF OPERATIONS
The following table summarizes our operations for our three most recent
fiscal years.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
2001 2000 1999
------------------- ------------------- ------------------
(IN THOUSANDS)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Products, net:
Pharmaceuticals, vaccines and diagnostics $ 16,704 $ 13,961 $ 12,716
Veterinary medical instruments 16,018 14,194 12,106
Food animal products 13,664 18,203 12,086
Sold businesses and other - 3,191 13,383
------------ ----------- ----------
Total product revenues 46,386 49,549 50,291
Research, development and other 1,897 3,126 885
------------ ----------- ----------
Total revenues 48,283 52,675 51,176
Cost of products sold 28,655 33,299 36,386
------------ ----------- ----------
19,628 19,376 14,790
------------ ----------- ----------
Operating expenses:
Selling and marketing 13,981 14,788 15,073
Research and development 13,565 14,929 17,042
General and administrative 7,882 9,457 11,231
Amortization of intangible assets and deferred compensation 299 903 2,228
Loss on sale of assets - 204 2,593
Restructuring expenses and other 2,023 435 1,210
----------- ----------- ----------
Total operating expenses 37,750 40,716 49,377
----------- ----------- ----------
Loss from operations (18,122) (21,340) (34,587)
Other income (expense) (569) (530) (1,249)
----------- ----------- ----------
Net loss $ (18,691) $ (21,870) $ (35,836)
=========== =========== ==========
Basic net loss per share $ (0.48) $ (0.65) $ (1.31)
=========== =========== ==========
REVENUES
Total revenues, which include product revenues, sponsored research and
development and other revenues, decreased 8% to $48.3 million in 2001 compared
to $52.7 million in 2000. The 2000 total revenues of $52.7 million increased 3%
compared to $51.2 million in 1999. The total reported revenue included
approximately $3.2 million in 2000 and $13.4 million in 1999 from businesses
sold and non-strategic product lines discontinued during those years. In 2000,
we recorded $1.3 million in non-recurring revenue related to the sale of the
worldwide rights to one of our products. Sales to one customer, AGRILABS,
represented 16% and 17% of total revenues in 2001 and 2000, respectively, and
sales to another customer, Bayer, represented 12% of total revenues in 1999. We
expect our total 2002 revenues to be higher than 2001 for all product groups as
we introduce our new canine early renal disease diagnostic and record full-year
revenues for products introduced in the prior year.
Product revenues decreased 6% to $46.4 million in 2001 compared to $49.5
million in 2000. Product revenues decreased 2% to $49.5 million in 2000
compared to $50.3 million in 1999.
Our PVD product group had increased revenues of 20% in 2001 and 10% in 2000
on a year-to-year basis. Both of these annual increases were driven primarily
by higher domestic sales of our heartworm diagnostic products and equine
influenza vaccine, as well as growth in our export sales of both products. We
introduced the equine influenza vaccine in 2000 and in 2001 we introduced our E-
SCREEN allergy product. In 2002, we introduced our E.R.D.-SCREEN Urine Test
canine renal product. We expect PVD product revenues to increase in 2002 due
primarily to this introduction.
Revenues from the Instruments product group increased 12% to $16.0 million
in 2001 and 17% to $14.2 million in 2000 over the respective prior year. The
2001 increase is primarily attributable to the introduction of our new blood
chemistry instrument and solid growth in consumables and reagents as more
instruments have been placed in service each year. During 2000 we experienced
significant growth in the sales of our portable analyzer and hematology
instrument and the related consumables and reagents. Instrument product
revenues in 2002 should continue to grow at a rate equal to or greater than 2001
due to a full year of sales for our blood chemistry instrument introduced in
2001 and increased sales for consumables and reagents with more instruments
placed in service.
Diamond Animal Health reported 25% lower revenues in 2001 declining to
$13.6 million versus the prior year revenues of $18.2 million due to reduced
orders from a significant vaccine customer. Revenues at Diamond increased 51%
in 2000 over the 1999 total of $12.1 million due to increases in contract
vaccine manufacturing for food animals. We expect higher sales at Diamond in
2002 with growth primarily in our bovine vaccine products.
Revenues from sponsored research and development and other decreased 39% to
$1.9 million in 2001 from $3.1 million in 2000. Included in the total for 2000
is $1.3 million of revenue from the sale of our worldwide rights to the
PERIOceutic Gel product. Revenues from sponsored research and development and
other increased 244% to $3.1 million in 2000 from $900,000 in 1999 due to the
sale of the product rights and an increase in the number of funded research
projects. Our revenues from sponsored research and development are anticipated
to be significantly lower in 2002 due to fewer large research projects for third
parties.
COST OF PRODUCTS SOLD
Cost of products sold totaled $28.7 million in 2001 compared to $33.3
million in 2000, and the resulting gross profit from product sales for 2001
increased to $17.7 million from $16.3 million in 2000. Our gross margin
percentage on products sold was 38% in 2001, compared to 33% in 2000. During
2001, our gross margin improved as our product mix included a higher percentage
of our proprietary PVD products with higher gross margins. Also during fiscal
2000 we sold businesses and eliminated various product lines that did not meet
gross profit expectations.
Cost of goods sold totaled $33.3 million in 2000 compared to $36.4 million
in 1999, and the resulting gross profit from product sales for 2000 increased to
$16.3 million from $13.9 million in 1999. Our gross margin percentage was 33%
in 2000, compared to 28% in 1999. During 2000, our gross margin improved as our
product mix included a higher percentage of proprietary products with higher
gross margins. Also during fiscal 2000 and late in fiscal 1999, we sold
businesses and eliminated various product lines that did not meet gross profit
expectations.
We expect our gross margin percentage to continue to increase in 2002 as we
sell more higher-margin PVD products plus reagents and consumables related to
the increased number of instruments in use in the marketplace. We also expect
to benefit from an improved cost structure at Diamond. This expected gross
margin percentage increase will be at a slower pace than prior years because, in
part, it will be somewhat offset by the recent change in our distribution
strategy which incorporates a larger reliance on third-party distributors for
the sale of our products.
OPERATING EXPENSES
Selling and marketing expenses decreased over 5% to $14.0 million in 2001
as compared to $14.8 million in 2000, due to the sale of certain businesses.
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 lower
selling and marketing expenses in 2002 as we rely more heavily on third-party
distributors rather than our own direct sales force to generate sales of our
products to veterinarians. Selling and marketing expenses remained relatively
flat with $14.8 million in 2000 as compared to $15.1 million in 1999, due to the
sale of certain businesses offset by the introduction and marketing costs for
new products.
Research and development expenses decreased nearly 9% to $13.6 million in
2001 from $14.9 million in 2000 and $17.0 million in 1999. The decreases are
due to a greater focus on companion animal product opportunities and tight cost
control. We expect a similar decrease in these expenses in 2002 for the same
reasons.
General and administrative expenses decreased 17% to $7.9 million in 2001
from $9.5 million in 2000 and $11.2 million in 1999. The year-over-year
decreases are due to the sale of certain businesses and tight cost control at
all operations. We expect general and administrative expenses to continue to
decrease in 2002 with continued tight cost control.
The amortization of goodwill and other intangibles resulted in a non-cash
charge to operations of $270,000, $255,000 and $1.6 million in 2001, 2000 and
1999, respectively. The decrease after 1999 is due to the sale of Heska UK and
the write-down of goodwill and certain intangible assets in 1999. The
amortization of deferred compensation resulted in a non-cash charge to
operations in 2001 of approximately $29,000 compared to $648,000 and $629,000 in
2000 and 1999, respectively. The 2000 and 1999 amortization of deferred
compensation represents current period costs associated with options issued to
employees during 1996 and 1997 in which the deemed value of the common stock for
accounting purposes on the date of grant exceeded the exercise price of the
options. The compensation costs were recognized over the service period and the
related deferred compensation was fully amortized as of December 31, 2000. We
have adopted SFAS 142 and therefore, will no longer be amortizing the goodwill
associated with our purchase of CMG. During fiscal 2001, we recognized $210,000
of amortization related to this goodwill.
The loss on sale of assets in 2000 reflects the write-down to net book
value of certain assets held for sale, offset by the gain on the sale of Center
of approximately $151,000.
We recorded a restructuring charge of approximately $1.5 million in the
fourth quarter of 2001 related to the change in our distribution strategy and to
the consolidation of our European operations into one facility. We also
recognized approximately $500,000 of non-recurring expenses resulting from
management's decision to not pursue a strategic transaction after extensive
evaluation.
During the first quarter of 2000, we recorded a $435,000 restructuring
charge related to the rationalization of our business operations at Diamond.
Diamond reduced the size of its workforce and vacated a warehouse and
distribution facility no longer needed when we decided to discontinue
manufacturing of certain low margin human healthcare products.
OTHER
Interest income decreased to $324,000 in 2001 as compared to $1.0 million
in 2000 and $1.6 million in 1999 as we continued to fund our operations with
available cash. Interest income is expected to continue to decrease in the
future as we continue to use cash to fund our business operations. Interest
expense decreased to $587,000 in 2001 from $1.2 million in 2000 and $1.9 million
as we reduced our debt and capital leases from $17.1 million at the beginning of
1999 to less than $8.7 million at the end of fiscal 2001.
Other expense decreased to $306,000 from $361,000 in 2000 and nearly $1.0
million in 1999. The higher losses in 1999 were primarily due to losses
realized on the sale of certain long-term interest-bearing government securities
during that year.
NET LOSS
Our net loss decreased to $18.7 million in 2001 compared to $21.9 million
in 2000 and $35.8 million in 1999. The improvement is the result of
significantly higher gross margin percentages on product sales from year-to-
year, a $11.6 million reduction in operating expenses including certain
unprofitable businesses that were sold and tight cost control in all areas of
our business. We are expecting a net loss in 2002 substantially lower than the
net loss in 2001 as we anticipate revenue growth in each of our primary product
groups, slightly higher gross profit margins on product sales and continued
disciplined management of our operating expenses.
LIQUIDITY AND CAPITAL RESOURCES
We have incurred negative cash flow from operations since inception in
1988. For the year ended December 31, 2001, we had total revenues of $48.3
million and a net loss of $18.7 million. Our negative operating cash flows have
been funded primarily through the sale of common stock and borrowings. At
December 31, 2001, we had cash and cash equivalents of $5.7 million.
We recently amended our credit agreement with our lender to obtain a waiver
of certain covenants under our revolving line of credit as of December 31, 2001,
set the financial covenants for 2002 and extend the maturity date of the loans
an additional year to May 31, 2003. If our lender imposes loan covenants or
other credit requirements that would prevent us from accessing the full amount
of our line of credit, we would need to raise additional capital to fund any
shortfall from our borrowings expected to be available under the revolving line
of credit. We anticipate that any additional capital would be raised through
one or more of the following:
* obtaining new loans secured by unencumbered assets;
* sale of various products or marketing rights;
* licensing of technology;
* sale of various assets; and
* sale of additional equity or debt securities.
At December 31, 2001, we had outstanding obligations for long-term debt and
capital leases totaling $2.9 million primarily related to two term loans with
Wells Fargo Business Credit. One of these two term loans is secured by real
estate at Diamond and had an outstanding balance at December 31, 2001 of
$1.8 million due in monthly installments of $17,658 plus interest, with a
balloon payment of approximately $1.5 million due on May 31, 2003. The other
term loan is secured by machinery and equipment at Diamond and had an
outstanding balance at December 31, 2001 of approximately $688,000 payable in
installments of $18,667 plus interest, with a balloon payment of approximately
$370,000 due on May 31, 2003. Both loans have a stated interest rate of prime
plus 1.25%. In addition, Diamond has promissory notes to the Iowa Department of
Economic Development and the City of Des Moines with outstanding balances at
year-end of $41,000 and $54,000, respectively, due in annual and monthly
installments through June 2004 and May 2004, respectively. Both promissory
notes have a stated interest rate of 3.0% and an imputed interest rate of 9.5%.
The notes are secured by first security interests in essentially all of
Diamond's assets and both lenders have subordinated their first security
interest to Wells Fargo. We also had $240,000 of equipment financing which was
paid in full in January 2002. Our capital lease obligations totaled $161,000 at
year-end 2001.
We also have a $10.0 million asset-based revolving line of credit with
Wells Fargo Business Credit. Available borrowings under this line of credit are
based upon percentages of our eligible domestic accounts receivable and domestic
inventories. Interest is charged at a stated rate of prime plus 1% and is
payable monthly. Our ability to borrow under this facility varies based upon
available cash, eligible accounts receivable and eligible inventory. On March
13, 2002, we negotiated our covenants for 2002 and obtained a waiver of certain
financial covenants at December 31, 2001. The line of credit has a maturity
date of May 31, 2003. At December 31, 2001, our outstanding borrowings under
the line of credit were $5.7 million and we had remaining available borrowing
capacity of $2.2 million.
Net cash used in operating activities was $14.1 million in 2001, compared
to $15.9 million in 2000. Accounts payable and accrued liabilities increased by
$2.9 million in 2001 related to the $2.0 million of restructuring expense and
other, as well as increases in accrued commissions, royalties and incentive
compensation. Accounts receivable increased by $2.0 million compared to the
fourth quarter of 2000 due to the 29% increase in revenues during the fourth
quarter of 2001. Net cash used in operating activities in 1999 was $33.2
million compared to $14.1 million in 2001. This significant decrease when
compared to the current year is primarily due to a $17.1 million decrease in the
net loss over the past two fiscal years.
Net cash flows from investing activities provided us with $1.9 million
during 2001, compared to $25.2 million and $20.3 million of cash provided in
2000 and 1999, respectively. The cash provided in 2001 resulted from the sale
of our marketable securities offset by capital expenditures for the year. The
cash provided in 2000 resulted primarily from the sale of $20.0 million of
marketable securities and the sale of Center Laboratories for approximately $6.0
million. This cash was used to fund our fiscal 2000 operations and debt
repayments. The cash provided in 1999 was from proceeds from the sale of
marketable securities offset by the purchase of marketable securities and
capital expenditures. This cash was used to fund operations in 1999 and debt
repayments. Expenditures for property and equipment totaled $840,000,
$1.2 million and $3.3 million in 2001, 2000 and 1999, respectively. We
currently expect to spend approximately $500,000 in 2002 for capital equipment,
including expenditures to upgrade certain manufacturing operations to improve
efficiencies and to assure ongoing compliance with regulatory requirements. We
also expect to begin a major renovation of the roof at our Diamond manufacturing
facility with an estimated cost of $1.0-$1.5 million. We expect to finance
these expenditures through available cash, equipment leases and secured debt
facilities.
Net cash flows from financing activities provided $14.8 million in cash in
2001, used $7.6 million in 2000 and provided $8.4 million in 1999. Our primary
sources of cash from financing activities in 2001 were two private placements of
our common stock in February and December with net proceeds of approximately
$11.0 million and borrowings under our credit facility of $5.7 million. We
repaid debt and capital lease obligations totaling $2.0 million in 2001. Our
primary use of cash in 2000 was the repayment of debt and capital lease
obligations totaling nearly $8.5 million. 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.
Our financial plan for 2002 indicates that our cash on hand, together with
up to $9.1 million of borrowings expected to be available under our revolving
line of credit, should be sufficient to fund our operations through 2002 and
into 2003. However, our actual results may differ from this plan, and we may
need to raise additional capital in the future. If necessary, we expect to
raise these additional funds through one or more of the following: (1)
obtaining new loans secured by unencumbered assets; (2) sale of various products
or marketing rights; (3) licensing of technology; (4) sale of various assets;
and (5) sale of additional equity or debt securities. If we cannot raise the
additional funds through these options on acceptable terms or with the necessary
timing, management could also reduce discretionary spending to decrease our cash
burn rate and extend the currently available cash and cash equivalents, and
available borrowings. See "Factors that May Affect Results."
A summary of our contractual obligations at December 31, 2001 is shown
below.
PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------------------------
TOTAL LESS THAN 1-3 4-5 AFTER
--------------- 1 YEAR YEARS YEARS 5 YEARS
--------------- --------------- --------------- ---------------
CONTRACTUAL OBLIGATIONS
Long-Term Debt $ 2,763 $ 711 $ 2,052 $ - $ -
Capital Lease Obligations 161 104 57 - -
Line of Credit 5,737 - 5,737 - -
Operating Leases 2,580 887 1,607 86 -
Unconditional Purchase 2,392 91 1,655 646 -
Obligations
Other Long-Term Obligations 125 - - - 125
---------- ---------- ---------- ---------- ---------
Total Contractual Cash $ 13,758 $ 1,793 $ 11,108 $ 732 $ 125
Obligations ========== ========== ========== ========== =========
NET OPERATING LOSS CARRYFORWARDS
As of December 31, 2001, we had a net operating loss carryforward, or NOL,
of approximately $164.5 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 2021.
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 research and
development tax credits to offset taxes payable. We believe that this
limitation may affect the eventual utilization of our total NOL carryforwards.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other
Intangible Assets." These statements prohibit pooling-of-interests accounting
for transactions initiated after June 30, 2001, require the use of the purchase
method of accounting for all combinations after June 30, 2001, and establish a
new accounting standard for goodwill acquired in a business combination. These
continue to require recognition of goodwill as an asset, but do not permit
amortization of goodwill as previously required by APB Opinion No. 17,
"Intangible Assets." Furthermore, certain intangible assets that are not
separable from goodwill will also not be amortized. However, goodwill and other
intangible assets will be subject to periodic (at least annual) tests for
impairment, and recognition of impairment losses in the future could be required
based on a new methodology for measuring impairments prescribed by these
pronouncements. The revised standards include transition rules and requirements
for identification, valuation and recognition of a much broader list of
intangibles as part of business combinations than prior practice, most of which
will continue to be amortized. The potential prospective impact of these
pronouncements on the Company's financial statements may significantly affect
the results of future periodic tests for impairment. The amount and timing of
non-cash charges related to intangibles acquired in business combinations will
change from prior practice. The Company recorded $211,000 of amortization
expense during the year ended December 31, 2001 relating to goodwill that will
not be amortized beginning January 1, 2002. Furthermore, the Company will be
required to conduct an annual impairment test of its goodwill. The Company has
not yet quantified the impact, if any, that this impairment test will have on
the results of its operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement establishes accounting standards for
recognition and measurement of a liability for an asset retirement obligation
and the associated asset retirement cost. It requires an entity to recognize
the fair value of a liability for an asset retirement obligation in the period
in which it is incurred if a reasonable estimate can be made. The Company is
required to adopt this statement in its fiscal year 2003. The Company does not
believe that this statement will materially impact its results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement supersedes SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed of" and the accounting and reporting provisions of APB
Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." This statement applies to recognized long-
lived assets of an entity to be held and used, or to be disposed of. This
statement does not apply to goodwill, intangible assets not being amortized,
financial instruments, and deferred tax assets. This statement requires an
impairment loss to be recorded for assets to be held and used when the carrying
amount of a long-lived asset is not recoverable and exceeds its fair value. An
asset that is classified as held for sale shall be recorded at the lower of its
carrying amount or fair value less cost to sell. The Company is required to
adopt this statement for the first quarter of 2002. The Company does not
believe that this statement will materially impact its results of operations.
FACTORS THAT MAY AFFECT RESULTS
Our future operating results may vary substantially from period to period
due to a number of factors, many of which are beyond our control. The following
discussion highlights these factors and the possible impact of these factors on
future results of operations. If any of the following factors actually occur,
our business, financial condition or results of operations could be harmed. In
that case, the price of our common stock could decline, and you could experience
losses on your investment.
WE ANTICIPATE FUTURE LOSSES AND MAY NOT BE ABLE TO ACHIEVE PROFITABILITY IN
THE FUTURE.
We have incurred net losses since our inception in 1988 and, as of December
31, 2001, we had an accumulated deficit of $193.2 million. We anticipate that
we will continue to incur additional operating losses in the near term. These
losses have resulted principally from expenses incurred in our research and
development programs and from sales and marketing and general and administrative
expenses. Even if we achieve profitability, we may not be able to sustain or
increase profitability on a quarterly or annual basis. If we cannot achieve or
sustain profitability, we may not be able to fund our expected cash needs or
continue our operations.
WE ARE NOT GENERATING POSITIVE CASH FLOW AND MAY NEED ADDITIONAL CAPITAL IN
THE FUTURE AND ANY REQUIRED CAPITAL MAY NOT BE AVAILABLE ON ACCEPTABLE TERMS OR
AT ALL.
We have incurred negative cash flow from operations since inception in
1988. For the year ended December 31, 2001, we had total revenues of $48.3
million and a net loss of $18.7 million. Our financial plan for 2002 indicates
that our cash on hand, together with up to $9.1 million of borrowings expected
to be available under our revolving line of credit should be sufficient to fund
our operations through 2002 and into 2003. However, our actual results may
differ from this plan, and we may need to raise additional capital in the
future.
We recently amended our credit agreement with our lender to obtain a waiver
of certain covenants under our revolving line of credit as of December 31, 2001,
set the financial covenants for 2002 and extend the maturity date of the loans
an additional year to May 31, 2003. If our lender imposes loan covenants or
other credit requirements that would prevent us from accessing the full amount
of our line of credit, we would need to raise additional capital to fund any
shortfall from our borrowings expected to be available under the revolving line
of credit. We anticipate that any additional capital would be raised through
one or more of the following:
* obtaining new loans secured by unencumbered assets;
* sale of various products or marketing rights;
* licensing of technology;
* sale of various assets; and
* sale of additional equity or debt securities.
Additional capital may not be available on acceptable terms, if at all.
The public markets may remain unreceptive to equity financings, and we may not
be able to obtain additional private equity financing. Furthermore, amounts we
expect to be available under our existing revolving credit facility may not be
available, and other lenders could refuse to provide us with additional debt
financing. Furthermore, any additional equity financing would likely be
dilutive to stockholders, and additional debt financing, if available, may
include restrictive covenants which may limit our currently planned operations
and strategies. If adequate funds are not available, we may be required to
curtail our operations significantly and reduce discretionary spending to extend
the currently available cash resources, or to obtain funds by entering into
collaborative agreements or other arrangements on unfavorable terms, all of
which would likely have a material adverse effect on our business, financial
condition and our ability to continue as a going concern.
WE MUST MAINTAIN VARIOUS FINANCIAL AND OTHER COVENANTS UNDER OUR REVOLVING
LINE OF CREDIT AGREEMENT.
Under our revolving line of credit agreement with Wells Fargo Business
Credit, we are required to comply with various financial and non-financial
covenants, and we have made various representations and warranties. Among the
financial covenants are requirements for monthly minimum book net worth, minimum
quarterly net income and minimum cash balances or liquidity levels. We have
obtained modifications and a waiver of these covenants in the past.
Failure to comply with any of the covenants, representations or warranties
could result in our being in default under the loan and could cause all
outstanding amounts to become immediately due and payable or impact our ability
to borrow under the agreement. All amounts due under the credit facility mature
on May 31, 2003. We intend to rely on available borrowings under the credit
agreement to fund our operations through 2002 and into 2003. If we are unable
to borrow funds under this agreement, we will need to raise additional capital
to fund our cash needs and continue our operations.
WE HAVE LIMITED RESOURCES TO DEVOTE TO PRODUCT DEVELOPMENT AND
COMMERCIALIZATION. IF WE ARE NOT ABLE TO DEVOTE ADEQUATE RESOURCES TO PRODUCT
DEVELOPMENT AND COMMERCIALIZATION, WE MAY NOT BE ABLE TO DEVELOP OUR PRODUCTS.
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:
* improve market acceptance of our current products;
* complete development of new products; and
* successfully introduce and commercialize new products.
We have introduced some of our products only recently and many of our
products are still under development. Among our recently introduced products
are SOLO STEP CH Batch Test Strips for testing heartworm infection in dogs,
E.R.D.-SCREEN Urine Test for detecting albumin in canine urine, ALLERCEPT E-
SCREEN Test for assessing allergies in dogs, and SPOTCHEMT EZ, a compact system
for measuring animal blood chemistry. We currently have under development or in
preliminary clinical trials a number of products, including a gene based therapy
for canine cancer. 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
ability to generate revenues will decrease.
In addition, our products may not achieve satisfactory market acceptance,
and we may not successfully commercialize them on a timely basis, or at all. If
our products do not achieve a significant level of market acceptance, demand for
our products will not develop as expected and it is unlikely that we ever will
become profitable.
WE MUST OBTAIN AND MAINTAIN COSTLY REGULATORY APPROVALS IN ORDER TO MARKET
OUR PRODUCTS.
Many of the products we develop and market are subject to extensive
regulation by one or more of the USDA, the FDA, the EPA and foreign regulatory
authorities. These regulations govern, among other things, the development,
testing, manufacturing, labeling, storage, pre-market approval, advertising,
promotion, sale and distribution of our products. Satisfaction of these
requirements can take several years and time needed to satisfy them may vary
substantially, based on the type, complexity and novelty of the product.
Our Flu AVERT I.N. Vaccine, SOLO STEP CH, SOLO STEP FH and SOLO STEP Batch
Test Strips each have received regulatory approval in the United States by the
USDA. In addition, the Flu AVERT I.N. Vaccine has been approved in Canada by
the CFIA. SOLO STEP CH and SOLO STEP Batch Test Strips are pending approval by
the CFIA. SOLO STEP CH has also been approved by the Japanese Ministry of
Agriculture, Forestry and Fisheries. In addition, our Trivalent
Intranasal/Intraocular Vaccine has also received United States regulatory
approval. U.S. regulatory approval by the USDA is currently pending for our
Feline ImmuCheck Assay, Canine Cancer Gene Therapy, Giardia + Crypto-Screen
Fecal Test and Trivalent Intranasal/Intraocular Vaccine - Second Generation
products.
The effect of government regulation may be to delay or to prevent marketing
of our products for a considerable period of time and to impose costly
procedures upon our activities. We have experienced in the past, and may
experience in the future, difficulties that could delay or prevent us from
obtaining the regulatory approval or license necessary to introduce or market
our products. For example, the Flu AVERT I.N. vaccine for equine influenza was
not approved until six months after the date on which we expected approval.
This delay caused us to miss the initial primary selling season for equine
influenza vaccines, and we believe it delayed the initial market acceptance of
this product. Regulatory approval of our products may also impose limitations
on the indicated or intended uses for which our products may be marketed.
Among the conditions for certain regulatory approvals is the requirement
that our manufacturing facilities or those of our third party manufacturers
conform to current Good Manufacturing Practices or other manufacturing
regulations, which include requirements relating to quality control and quality
assurance as well as maintenance of records and documentation. The USDA, FDA
and foreign regulatory authorities strictly enforce manufacturing regulatory
requirements through periodic inspections. If any regulatory authority
determines that our manufacturing facilities or those of our third party
manufacturers do not conform to appropriate manufacturing requirements, we or
the manufacturers of our products may be subject to sanctions, including warning
letters, product recalls or seizures, injunctions, refusal to permit products to
be imported into or exported out of the United States, refusals of regulatory
authorities to grant approval or to allow us to enter into government supply
contracts, withdrawals of previously approved marketing applications, civil
fines and criminal prosecutions.
FACTORS BEYOND OUR CONTROL MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE, AND
SINCE MANY OF OUR EXPENSES ARE FIXED, THIS FLUCTUATION COULD CAUSE OUR STOCK
PRICE TO DECLINE.
We believe that our future operating results will fluctuate on a quarterly
basis due to a variety of factors, including:
* results from Diamond;
* the introduction of new products by us or by our competitors;
* our recent change in distribution strategy;
* market acceptance of our current or new products;
* regulatory and other delays in product development;
* product recalls;
* competition and pricing pressures from competitive products;
* manufacturing delays;
* shipment problems;
* product seasonality; and
* 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.
Our operating results in some quarters may not meet the expectations of
stock market analysts and investors. In that case, our stock price probably
would decline.
OUR LARGEST CUSTOMER ACCOUNTED FOR OVER 15% OF OUR REVENUES FOR THE PREVIOUS
TWO YEARS, AND THE LOSS OF THAT CUSTOMER OR OTHER CUSTOMERS COULD HARM OUR
OPERATING RESULTS.
We currently derive a substantial portion of our revenues from sales by our
subsidiary, Diamond, which manufactures several of our products and products for
other companies in the animal health industry. Revenues from one contract
between Diamond and Agri Laboratories, Ltd., comprised approximately 16% of our
total revenues in 2001 and 17% of our total revenues in 2000. That contract
expires in 2004 and is automatically renewed unless either party does not wish
to renew. We are currently in negotiations with Agri Laboratories to modify and
extend this agreement, but there is no assurance we will be successful. If Agri
Laboratories does not continue to purchase from Diamond and if we fail to
replace the lost revenue with revenues from other customers, our business could
be substantially harmed. In addition, sales from our next three largest
customers accounted for an aggregate of approximately 12% of our revenues in
2001. If we are unable to maintain our relationships with one or more of these
customers, our sales may decline.
WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY, WHICH COULD RENDER OUR PRODUCTS
OBSOLETE OR SUBSTANTIALLY LIMIT THE VOLUME OF PRODUCTS THAT WE SELL. THIS WOULD
LIMIT OUR ABILITY TO COMPETE AND ACHIEVE PROFITABILITY.
We compete with 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 Wyeth, Bayer, IDEXX,
Intervet, Merial, Novartis, Pfizer, Pharmacia and Schering Plough, 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.
In addition, we believe that IDEXX prohibits its distributors from selling
competitors' products, including our SOLO STEP heartworm diagnostic products
and medical diagnostic instruments. Our competitors frequently offer broader
product lines and have greater name recognition than we do. Our competitors may
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. Further, additional competition could
come from new entrants to the animal healthcare market. Moreover, we may not
have the financial resources, technical expertise or marketing, distribution or
support capabilities to compete successfully. If we fail to compete
successfully, our ability to achieve profitability will be limited.
WE MAY BE UNABLE TO SUCCESSFULLY MARKET AND DISTRIBUTE OUR PRODUCTS AND HAVE
RECENTLY MODIFIED OUR DISTRIBUTION STRATEGY.
The market for companion animal healthcare products is highly fragmented,
with discount stores and specialty pet stores accounting for a substantial
percentage of sales of certain products. Because our proprietary products are
available only by prescription and our medical instruments require technical
training, we sell our companion animal health products only to veterinarians.
Therefore, we may fail to reach a substantial segment of the potential market.
We currently market our products in the United States to veterinarians
through approximately 20 independent third party distributors and through a
direct sales force. Nearly one-half of these domestic distributors carry the
full line of our pharmaceutical, vaccine, diagnostic and instrumentation
products. We have recently begun to rely on distributors for a greater portion
of our sales and therefore need to increase our training efforts directed at the
sales personnel of our distributors. To be successful, we will have to continue
to develop and train our direct sales force as well as sales personnel of our
distributors and rely on other arrangements with third parties to market,
distribute and sell our products. In addition, most of our distributor
agreements can be terminated on 60 days' notice and IDEXX, our largest
competitor, prohibits its distributors from selling competitors' products,
including ours. For example, one of our largest distributors recently informed
us that they would no longer carry our heartworm diagnostic products or our
chemistry or hematology instruments because they wish to carry products from one
of our competitors.
We may not successfully develop and maintain marketing, distribution or
sales capabilities, and we may not be able to make arrangements with third
parties to perform these activities on satisfactory terms. If our marketing and
distribution strategy is unsuccessful, our ability to sell our products will be
negatively impacted and our revenues will decrease. Furthermore, the recent
change in our distribution strategy and our expected increase in sales from
distributors and decrease in direct sales may have a negative impact on our
gross margins.
WE HAVE GRANTED THIRD PARTIES SUBSTANTIAL MARKETING RIGHTS TO CERTAIN OF OUR
EXISTING PRODUCTS AS WELL AS PRODUCTS UNDER DEVELOPMENT. IF THE THIRD PARTIES
ARE NOT SUCCESSFUL IN MARKETING OUR PRODUCTS OUR SALES MAY NOT INCREASE.
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. Currently, Novartis Agro K.K. markets and
distributes SOLO STEP CH in Japan, and Novartis Animal Health Canada, Inc.
distributes our FLU AVERT I.N. vaccine in Canada. In addition, we have entered
into agreements with Novartis and Eisai Inc. to market or co-market certain of
the products that we are currently developing. Also, Nestle Purina Petcare has
exclusive rights to license our technology for nutritional applications for dogs
and cats. One or more of these marketing partners may not devote sufficient
resources to marketing our products. Furthermore, there is nothing to prevent
these partners from pursuing alternative technologies or products that may
compete with our products. In the future, third party marketing assistance may
not be available on reasonable terms, if at all. If any of these events occur,
we may not be able to commercialize our products and our sales will decline.
WE MAY FACE COSTLY INTELLECTUAL PROPERTY DISPUTES.
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