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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-22427
HESKA CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 77-0192527
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[State or other [I.R.S. Employer
jurisdiction Identification No.]
of incorporation or
organization]
1613 Prospect Parkway
Fort Collins, Colorado 80525
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[Address of principal [Zip Code]
executive 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 to Part
III of this Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of
the Registrant was approximately $44,318,000 as of March 23, 2001
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.
38,656,745 shares of the Registrant's Common Stock, $.001 par value,
were outstanding at March 23, 2001.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10 (as to directors), 11, 12 and 13 of Part III incorporate by
reference information from the Registrant's Proxy Statement to be
filed with the Securities and Exchange Commission in connection with
the solicitation of proxies for the Registrant's 2001 Annual Meeting
of Stockholders.
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PART I
This Form 10-K contains forward-looking statements. These statements
relate to our, and in some cases our partners', future plans, objectives,
expectations, intentions and financial performance, and assumptions that
underlie these statements. When used in this Form 10-K, terms such as
"anticipates," "believes," "continue," "could," "estimates," "expects,"
"intends," "may," "plans," "potential," "predicts," "should," or "will" or the
negative of those terms or other comparable terms may identify forward-looking
statements. These statements involve known and unknown risks, uncertainties and
other factors that may cause industry trends or our actual results, level of
activity, performance or achievements to be materially different from any future
results, levels of activity, performance or achievements expressed or implied by
these statements. These factors include those listed under "Factors that May
Affect Results," "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and "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. We have a sophisticated scientific effort devoted to applying
biotechnology to create a broad range of pharmaceutical, vaccine and diagnostic
products for the large and growing companion animal health market. In addition
to our pharmaceutical, vaccine and diagnostic products, we also sell veterinary
diagnostic and patient monitoring instruments and offer diagnostic services in
the United States and Europe to veterinarians. Our primary manufacturing
subsidiary, Diamond Animal Health, Inc., or Diamond, manufactures some of our
companion animal products and food animal vaccine and pharmaceutical products
which are marketed and distributed by third parties.
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. We reincorporated in Delaware in 1997.
ALLERCEPT, ALLERCEPT E-SCREEN, FLU AVERT I.N., HESKA, VET/OX, VET/E-Sig,
VET/ECG, VET/IV, CHEM-ELITE and SOLO STEP are trademarks of Heska Corporation.
This 10-K also refers to trademarks and trade names of other organizations.
ANIMAL HEALTH PRODUCTS
We presently sell a variety of companion animal health products, among the
most significant of which are the following.
DIAGNOSTICS
Heartworm Diagnostics
Heartworm infections of dogs and cats are caused by the parasite,
Dirofilaria immitis. This parasitic worm is transmitted in larval form to dogs
and cats through the bite of an infected mosquito. Larvae develop into adult
worms which live in the pulmonary arteries and heart of the host, where they can
cause serious cardiovascular, pulmonary, liver and kidney disease.
In 1997, we developed a diagnostic test for heartworm infection in dogs.
This test uses monoclonal antibodies reactive with heartworm antigens to detect
the presence of these antigens in the blood of the infected dog. This test was
first offered through our own veterinary diagnostic laboratory. A simple,
rapid, and easy to use point-of-care version of this test, SOLO STEP CH, was
introduced in Italy in 1998. In January 1999, we received regulatory clearance
to sell SOLO STEP CH in the United States and introduced this product in the
United States shortly thereafter. In March 2000, we received regulatory
clearance to sell a batch test version of this product, SOLO STEP CH Batch Test
Strips, and introduced this product in the United States shortly thereafter.
In 1997, we introduced a new test in our veterinary diagnostic laboratory
for heartworm infections of cats which allowed veterinarians for the first time
to accurately establish the prevalence of feline heartworm exposure in their
practices. This test is highly sensitive and accurate, and identifies
antibodies in cat serum that react with a recombinant heartworm antigen. In
1997, we introduced a rapid, point-of-care version of this test in Italy. After
receiving regulatory clearance, we introduced this point-of-care feline
heartworm test, SOLO STEP FH, in the United States in 1998.
Allergy
Allergy is common in companion animals, and it is estimated to affect
approximately 10% to 15% of dogs. Clinical symptoms of allergy are variable,
but are often manifested as persistent and serious skin disease in dogs and
cats. Clinical management of allergic disease is problematic, as there are a
large number of allergens that may give rise to these conditions. Although skin
testing is often regarded as the most accurate diagnostic procedure, such tests
are painful, subjective and inconvenient. The effectiveness of the
immunotherapy that is prescribed to treat allergic disease is inherently limited
by inaccuracies in the diagnostic process.
We have developed the HESKA ALLERCEPT Definitive Allergen Panels, a more
accurate in vitro technology, to detect IgE, the antibody involved in most
allergic reactions. This technology permits the design of tests that, in
contrast to other in vitro tests, more accurately identify the animal's allergic
responses to particular allergens. During 1997, we adapted this technology to
our canine allergy tests. The ALLERCEPT Definitive Allergen Panels use a
recombinant version of the natural IgE receptor to screen the serum of
potentially allergic animals for IgE directed against a panel of known
allergens. A typical test panel consists primarily of various pollen, grass,
mold and insect allergens.
We have also developed the HESKA ALLERCEPT E-SCREEN Test, a rapid and
highly accurate screen for certain antibodies commonly associated with allergic
disease. This product, which utilizes our proprietary patented technology, is
designed to enable veterinarians to do point-of-care screens of dogs with
allergic symptoms. In January 2001, we entered into a distribution agreement
with Novartis Animal Health granting exculsive distribution rights for the E-
Screen Test product in Europe.
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 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 USDA in
November 1999 and was first sold to veterinarians in December 1999. In March
2001, we granted Novartis Animal Health Canada exclusive distribution rights for
FLU AVERT I.N. vaccine in Canada.
Allergy Immunotherapy
Veterinarians who use our in vitro allergy testing services often purchase
immunotherapy treatment sets for those animals with positive test results.
These prescription treatment sets are formulated specifically for each allergic
animal and contain only the allergens to which the animal has 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
In 1997, we introduced in the United States a three-way modified live
vaccine (HESKA Trivalent Intranasal/Intraocular Vaccine) for the three most
common viral diseases of cats: calicivirus, rhinotracheitis virus and
panleukopenia virus. This vaccine is administered without needle injection by
dropping the liquid preparation into the eyes and nostrils of cats. While there
is one competitive non-injectable two-way vaccine, all other competitive
products are injectable formulations. The use of injectable vaccines in cats
has become controversial due to the frequency of injection site-associated side
effects. The most serious of these side effects are injection site sarcomas,
tumors which, if untreated, are nearly always fatal. Our vaccines avoid
injection site side effects and we believe they are very efficacious.
PHARMACEUTICALS
Canine Thyroid Supplement
Canine hypothyroidism is a serious disease that is usually caused by
abnormalities of the thyroid gland. It is estimated that 3% to 4% of all dogs
require thyroid hormone replacement therapy. Common clinical signs include dry,
coarse, thin hair, possibly with patches of hair loss and pigment changes. The
disease can affect multiple organ systems and cause recurrent infections.
In 1997, we introduced a chewable tablet for the treatment of
hypothyroidism in dogs in the United States. These chewable tablets, which are
administered daily for the life of the dog, provide levothyroxine sodium, a
replacement therapy for the hormone normally produced by the dog.
Nutritional Supplements
Arising partly from our allergy expertise, in 1998, we developed and
introduced in the United States a novel fatty acid supplement, HESKA 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 entered this line of business in
March 1998, when we acquired 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 diagnostic instruments includes the i-STAT Portable Clinical
Analyzer, 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. This past year we have
introduced new i-STAT capability for measuring additional blood analytes and
expanding the versatility of the instrument for veterinarians. In the United
States we also market the Heska Vet Diff ABC Hematology Analyzer, an easy to use
blood analyzer that measures such key parameters as white blood cell count, red
blood cell count, platelet count and hemoglobin levels in animals. We also
offer the Reflovet Clinical Analyzer, an easy to operate, cost effective blood
chemistry analyzer that measures a broad range of animal blood analytes, such as
amylase, creatinine, uric acid, bilirubin and glucose. Consumable supplies for
the i-STAT, Vet ABC Hematology Analyzer and Reflovet are also provided to
veterinarians through Heska sales and distribution channels.
In January 2001, we announced the introduction of our new Chem-Elite
Advanced Chemistry System. The Chem-Elite System is a micro-processor
controlled, programmable liquid chemistry analyzer designed for use in high
volume veterinary practices. It gives veterinarians the ability to run
individual tests, pre-programmed batteries of tests or customized profiles.
We also announced the introduction in March 2001 of the SPOTCHEM EZ
Automated Chemistry Analyzer. The SPOTCHEM EZ is a compact desktop system used
to measure all 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. The centerpiece of our monitoring instrument product
line are oxygen saturation monitors designed for monitoring animals under
anesthesia: the VET/OX 4404 monitor and the VET/OX 4800 monitor, each of which
includes a variety of additional monitoring parameters, such as pulse rate and
strength, body temperature, respiration and ECG. We offer a proprietary
esophageal ECG sensor, VET/E-Sig probe, for monitoring ECG, temperature and
heart and breath sounds of anesthetized dogs. Our monitoring line also includes
the VET/ECG 2000, a hand-held ECG monitor. We also offer the VET/IV 2.2
infusion pump, a compact, affordable IV pump that allows veterinarians to easily
provide regulated infusion of blood or nutritional products for their patients.
VETERINARY DIAGNOSTIC LABORATORY
We have a veterinary diagnostic laboratory at our Fort Collins facility.
This diagnostic laboratory currently offers our allergy diagnostics, canine and
feline heartworm diagnostics and flea bite allergy assays, in addition to other
diagnostic services. 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 PRODUCTS
In addition to manufacturing companion animal health products for marketing
and sale by Heska, Diamond has completed the development of new food animal
vaccines that were licensed by the USDA in the United States in 1998 and 1999.
Diamond has entered into an agreement with a food animal products distributor,
Agri Laboratories, Ltd., 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 distribution of these
vaccines worldwide. Diamond is the sole manufacturer of these products.
Diamond also manufactures vaccine products for a number of other animal
health companies. This activity ranges from providing bulk vaccine antigens
which are included in the vaccines which are manufactured by other companies to
filling and finishing final products using bulk antigens provided by other
animal health companies.
PRODUCT CREATION
We are committed to creating innovative products to address significant
unmet health needs of companion animals. We create products both through
internal research and development and through external collaborations. Internal
research is managed by multidisciplinary product-associated project teams
consisting of veterinarians, biologists, molecular and cellular biologists,
biochemists and immunologists. We believe that we have one of the most
sophisticated scientific efforts in the world devoted to applying biotechnology
to the creation of companion animal products.
We are also committed to identifying external product opportunities and
creating business and technical collaborations that lead to the creation of
other products. We believe that our active participation in scientific networks
and our reputation for investing in research enhances our ability to acquire
external product opportunities.
Our product pipeline currently includes numerous products in various stages
of development. Products under development include several point-of-care
diagnostic products, vaccines for infectious diseases in cats, dogs and horses
and pharmaceutical products for allergy, cancer, osteoarthritis and flea
control.
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 $14.9 million, $17.0 million and $25.1 million in the years
ended December 31, 2000, 1999 and 1998, respectively in support of our research
and development activities.
SALES AND MARKETING
We presently market our products in the United States directly to
veterinarians through the use of our field sales force, inside customer
service/tele-sales force and veterinary distributors acting as contract sales
agents. As of December 31, 2000, we had approximately 35 field sales
representatives and field sales supervisors and 13 customer service/tele-sales
representatives and supervisors. We have entered into sales agency
relationships with 16 veterinary distributors and six direct sales distributors,
although some of these distributors do not sell all of our products. In October
1999, we entered into an agreement with a third party to provide a contract
sales force for the sale of our products to equine veterinarians. This
agreement was terminated in November 2000. Internationally, we market our
products to veterinarians primarily through distributors.
We estimate that there are approximately 30,000 veterinarians in the United
States whose practices are devoted principally to small animal medicine. Those
veterinarians practice in approximately 20,000 clinics in the United States. We
market our products to these clinics primarily through the use of our field and
telephone sales force, sales agents, direct sales distributors, trade shows and
print advertising. During the past year, we sold our products to approximately
14,000 such clinics in the United States.
Some of the products which we have under research and development, if
completed, may be marketed partially or wholly by third parties with whom we
have collaborative agreements.
MANUFACTURING
Our products are manufactured by our Fort Collins, Diamond and CMG
facilities and/or by third party manufacturers. Diamond's facility is a USDA
and FDA licensed biological and pharmaceutical manufacturing facility in Des
Moines, Iowa. We expect that we will manufacture most or all of our biological
products at this facility, as well as most or all of our recombinant proteins
and other proprietary reagents for our diagnostic products. CMG manufactures
its allergy diagnostic products at its facility in Fribourg, Switzerland.
Diamond's facility is subject to regulation and inspection by the USDA and the
FDA. Our heartworm point-of-care diagnostic products are manufactured by Quidel
Corporation and Diamond. Our canine and feline allergy immunotherapy treatment
products are manufactured by Centaq, Inc. Our veterinary diagnostic and patient
monitoring instruments, including our clinical and hematology analyzers and
veterinary sensors, are manufactured by third party manufacturers.
In addition to manufacturing our proprietary products, Diamond manufactures
animal health vaccine products for marketing and sale by other companies.
Diamond currently has the capacity to manufacture more than 50 million doses of
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. In addition, Diamond offers to support its customers through
research services, regulatory compliance services, validation support and
distribution services.
COLLABORATIVE AGREEMENTS
Novartis
We have entered into several collaborative agreements with Novartis Animal
Health. Novartis has various rights to manufacture and market any flea control
vaccine or feline heartworm control vaccine product developed by us. In
addition, we entered into a screening and development agreement under which we
may undertake joint research and development activities in various fields and
under which Novartis has the right to use certain of our materials on an
exclusive or co-exclusive basis. We also entered into a right of first refusal
agreement under which, prior to granting licenses to any third party to any
products or technology developed or acquired by us for either companion animal
or food animal applications, we must first notify and offer Novartis such
rights. The screening and development agreement and right of first refusal
agreement each terminate in 2005. We also entered into additional research and
development agreements in specific areas.
Novartis has the exclusive right to distribute certain of our products in
Japan, including our in-clinic feline and canine heartworm diagnostic products
and feline viral vaccines, upon obtaining regulatory approval in Japan for such
products. Novartis also granted us a right of first refusal to evaluate for
possible development and marketing worldwide various new product technologies
for the veterinary market as they may become available from Novartis. Novartis
also has the exclusive right to distribute our ALLERCEPT E-Screen test in Europe
and our FLU AVERT I.N. equine influenza vaccine in Canada.
Ralston Purina Company
We have a strategic alliance with Ralston Purina Company, the world's
largest manufacturer of dry dog foods and dry and soft-moist cat foods. Ralston
Purina holds exclusive rights to license our discoveries, know-how and
technologies for innovative diets for dogs and cats. The first product from
this strategic alliance was introduced by Ralston Purina in July 2000. This new
product is a specialty diet for the nutritional management of feline diabetes
mellitus. We receive a royalty from Ralston Purina on sales of this product.
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, 2000, we owned, co-owned or had rights to 105 issued U.S.
patents and 127 pending U.S. patent applications. Our issued U.S. patents
primarily relate to allergy, flea control, heartworm, diagnostics or vaccine
delivery technologies. Our pending patent applications primarily relate to
allergy, flea control, heartworm, diagnostics, nutrition, cancer vaccine
delivery or medical instrument technologies. Applications corresponding to
pending U.S. applications have been or will be filed in other countries.
We also have obtained exclusive and non-exclusive licenses for numerous
other patents held by academic institutions and biotechnology and pharmaceutical
companies. The proprietary technologies of Diamond and CMG are primarily
protected through trade secret protection of, for example, their manufacturing
processes. In general, the intellectual property of Diamond's customers belongs
to such customers.
GOVERNMENT REGULATION
Most of our products being developed will require licensing or approval by
a governmental agency before marketing. In the United States, governmental
regulation of animal health products is primarily provided by two agencies: the
USDA and the FDA. Vaccines and point-of-care diagnostics for animals are
considered veterinary biologics and are regulated by the Center for Veterinary
Biologics, or CVB, of the USDA under the auspices of the Virus-Serum-Toxin Act.
Alternatively, animal drugs, which generally include all synthetic compounds,
are approved and monitored by the Center for Veterinary Medicine of the FDA
under the auspices of the Federal Food, Drug and Cosmetic Act. A third agency,
the Environmental Protection Agency, has jurisdiction over various products
applied topically to animals or to premises to control external parasites.
Industry data indicates that it takes approximately four years and
$1.0 million to license a conventional vaccine for animals from basic research
through licensing. In contrast to vaccines, point-of-care diagnostics can
typically be licensed by the USDA in about a year, with considerably less cost.
However, vaccines or diagnostics that use innovative materials such as those
resulting from recombinant DNA technology usually require additional time to
license. The USDA licensing process involves the submission of several data
packages. These packages include information on how the product will be
manufactured, information on the efficacy and safety of the product in
laboratory animal studies and information on performance of the product in field
conditions.
Industry data indicates that it takes about 11 years and $5.5 million to
develop a new drug for animals, from commencement of research to market
introduction. Of this time, approximately three years is spent in animal
studies and 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 producing animals, as food safety
issues relating to tissue residue levels are not present.
After we have received regulatory licensing or approval for our products,
numerous regulatory requirements apply. These include complying with the Good
Manufacturing Practice regulations, which require us or our third party of
manufacturers to follow elaborate testing, control, documentation and other
quality assurance procedures. These regulations cover the manufacturing
process, labeling requirements, the general prohibition against promoting
products for unapproved or "off-label" uses and reporting of adverse events.
A number of animal health products are not regulated. For example, assays
for use in a veterinary diagnostic laboratory and various medical instruments do
not have to be licensed by either the USDA or FDA. Additionally, various
botanically derived products, various nutritional products and grooming and
supportive care products are exempt from significant regulation as long as they
do not bear a therapeutic claim that represents the product as a drug.
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 marketing of those
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.
COMPETITION
The market in which we compete is intensely competitive. Our competitors
include independent animal health companies and major pharmaceutical companies
that have animal health divisions. Companies with a significant presence in the
companion animal health market, such as American Home Products, Bayer, IDEXX
Laboratories, Inc., Intervet International B.V., Merial Ltd., Novartis, Pfizer
Inc., Pharmacia Animal Health and Schering-Plough Corporation have developed or
are developing products that do or would compete with our products.
These competitors may have substantially greater financial, technical, research
and other resources and larger, more established marketing, sales, distribution
and service organizations than us. Moreover, such competitors may offer broader
product lines and have greater name recognition than us. Novartis is our
marketing partner and its agreement with us does not restrict its ability to
develop and market competing products. In addition, IDEXX, which has products
that compete with our heartworm diagnostic products, prohibits its distributors
from selling competitiors' products, including ours. The market for companion
animal health care products is highly fragmented, with discount stores and
specialty pet stores accounting for a substantial percentage of such sales. As
we currently distribute our products primarily through veterinarians, a
substantial segment of the potential market may not be reached and we may not be
able to offer our products at prices which are competitive with those of
companies that distribute their products through retail channels.
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 more established marketing, sales, distribution and service
organizations than AgriLabs.
EMPLOYEES
As of December 31, 2000, 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. None of our employees is covered by a collective
bargaining agreement, and we believe our employee relations are good.
EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and their ages as of March 20, 2001 are as follows:
NAME AGE POSITION
- ---- --- --------
Robert B. Grieve, Ph.D. 49 Chairman of the Board and
Chief Executive Officer
James H. Fuller 56 President and Chief Operating
Officer
Ronald L. Hendrick 55 Executive Vice President,
Chief Financial Officer and
Secretary
Guiseppe Miozzari, Ph.D. 54 Managing Director, Heska AG (Europe)
Dan T. Stinchcomb, Ph.D. 47 Executive Vice President,
Research and Development
Carol Talkington Verser, Ph.D. 48 Executive Vice President, Intellectual
Property and Business Development
Robert B. Grieve, Ph.D., one of our founders, currently serves as Chief
Executive Officer and Chairman of the Board. Dr. Grieve was named Chief
Executive Officer effective January 1, 1999, Vice Chairman effective March 1992
and Chairman of the Board effective May 2000. Dr. Grieve also served as Chief
Scientific Officer from December 1994 to January 1999 and Vice President,
Research and Development, from March 1992 to December 1994. He has been a
member of our Board of Directors since 1990. He holds a Ph.D. degree from the
University of Florida and M.S. and B.S. degrees from the University of Wyoming.
James H. Fuller has served as President and Chief Operating Officer since
January 1999. Prior to joining us, Mr. Fuller served as Corporate Vice
President of Allergan, Inc., a leading specialty pharmaceutical company, from
1994 through 1998. Prior to 1994, Mr. Fuller served in a number of sales and
marketing positions at Allergan since 1974. He holds M.S. and B.S. degrees from
the University of Southern California.
Ronald L. Hendrick serves as Executive Vice President, Chief Financial
Officer and Secretary. He joined us in December 1998. From 1995 until December
1998, Mr. Hendrick was Executive Vice President and Chief Financial Officer of
Xenometrix, Inc., a human biotechnology concern. From 1993 until 1995,
Mr. Hendrick served as Vice President and Corporate Controller at Alexander &
Alexander Services, Inc., a NYSE financial services firm, and before that he
held a number of finance and accounting positions at Adolph Coors Company. He
holds a M.B.A. from the University of Colorado and a B.A. degree from Michigan
State University.
Giuseppe Miozzari, Ph.D., joined as Managing Director, Heska AG (Europe) in
March 1997. From 1980 to March 1997, Dr. Miozzari served in senior research
positions with Novartis, most recently as the Head of Research of the Animal
Health Sector and prior to that, from 1980 to 1983, as Head of the Molecular
Biology Research Unit in the Pharmaceuticals Division. Dr. Miozzari also served
as Novartis' designate on our Board of Directors from April 1996 to March 1997.
Dr. Miozzari holds Ph.D. and Dipl. Sc. Nat. degrees from the Federal Institute
of Technology (ETH) in Zurich, Switzerland.
Dan T. Stinchcomb, Ph.D., was appointed Executive Vice President, Research
and Deveoplement, in December 1999. Dr. Stinchcomb previously served as Vice
President, Research from December 1998 to November 1999, and as Vice President,
Biochemistry and Molecular Biology from May 1996 until December 1998. From July
1993 until May 1996, Dr. Stinchcomb was employed by Ribozyme Pharmaceuticals,
Inc., most recently as Director of Biology Research. From 1988 until April
1993, Dr. Stinchcomb held various positions with Synergen, Inc. Prior to
joining Synergen, Dr. Stinchcomb was an Associate Professor in Cellular and
Developmental Biology at Harvard University. He holds a Ph.D. degree from
Stanford University and a B.A. degree from Harvard University.
Carol Talkington Verser, Ph.D., was appointed Executive Vice President,
Intellectual Property and Business Development in February 2001. From June 2000
until January 2001 she was Vice President, Intellectual Property and Business
Development. From July 1996 to May 2000, she served us as Vice President,
Intellectual Property. From July 1995 to June 1996, Dr. Verser served us as
Director, Intellectual Property. From July 1991 to June 1995, Dr. Verser was a
Patent Agent and Technical Specialist at Sheridan, Ross and McIntosh, an
intellectual property law firm. Prior to July 1991, she was Director,
Scientific Development and Laboratory Director at Biogrowth, Inc., currently a
subsidiary of Insmed Inc. Dr. Verser holds a Ph.D. in cellular and
developmental biology from Harvard University and a B.S. in biological sciences
from the University of Southern California.
ITEM 2. PROPERTIES.
We currently lease an aggregate of approximately 64,000 square feet of
administrative and laboratory space in four buildings located in Fort Collins,
Colorado under leases expiring through 2005, with options to extend through 2010
for the larger facilities. We believe that our present Fort Collins facilities
are adequate for our current and planned activities and that suitable additional
or replacement facilities in the Fort Collins area are readily available on
commercially reasonable terms should such facilities be needed in the future.
Diamond's principal manufacturing facility in Des Moines, Iowa, consisting of
166,000 square feet of buildings on 34 acres of land, is owned by Diamond.
Diamond also owns a 160-acre farm used principally for research purposes located
in Carlisle, Iowa. Our European subsidiaries lease their facilities. We also
currently lease approximately 19,500 square feet of office and manufacturing
space in Waukesha, Wisconsin which we have vacated and are currently seeking to
sublease.
ITEM 3. LEGAL PROCEEDINGS.
In November 1998, Synbiotics Corporation filed a lawsuit against us in the
United States District Court for the Southern District of California in which it
alleges that we infringe a patent owned by Synbiotics relating to heartworm
diagnostic technology. No trial date has been set. We have obtained legal
opinions from our outside patent counsel that our heartworm diagnostic products
do not infringe the Synbiotics patent and that the patent is invalid. The
opinions of non-infringement are consistent with the results of our internal
evaluations 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 one remaining claim.
While we believe that we have valid defenses to Synbiotics' allegations and
intend to defend the action vigorously, there can be no assurance that an
adverse result or settlement would not have a material adverse effect on our
financial position, results of operations or cash flow.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
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
----- -----
1999
First Quarter $ 6.000 $ 3.000
Second Quarter 5.125 2.250
Third Quarter 3.938 2.000
Fourth Quarter 2.938 1.375
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 (through March 23) 1.563 0.656
On March 23, 2001, the last reported sale price of our common stock was
$1.469 per share. As of February 28, 2001, there were approximately 285 holders
of record of our common stock and approximately 4,062 beneficial stockholders.
We have never declared or paid cash dividends on our capital stock and do not
anticipate paying any cash dividends in the foreseeable future. We currently
intend to retain future earnings for the development of our business.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The data set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements and related Notes included as Items 7 and
8 in this Form 10-K.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Products, net $ 49,549 $ 50,291 $ 38,451 $ 26,725 $ 15,570
Research, development and other 3,126 885 1,321 2,578 1,946
---------- --------- ---------- --------- --------
Total revenues 52,675 51,176 39,772 29,303 17,516
Costs: ---------- --------- ---------- --------- --------
Cost of goods sold 33,299 36,386 29,087 20,077 12,002
---------- --------- ---------- --------- --------
19,376 14,790 10,685 9,226 5,514
---------- --------- ---------- --------- --------
- - -
Operating Expenses:
Selling and marketing 14,788 15,073 13,188 9,954 4,168
Research and development 14,929 17,042 25,126 20,343 14,513
General and administrative 9,457 11,231 11,939 13,192 5,514
Amortization of intangible assets and
deferred compensation 903 2,228 2,745 2,500 1,289
Purchased research and development - - - 2,399 -
Loss on sale of assets 204 2,593 1,287 - -
Restructuring expenses 435 1,210 2,356 - -
---------- --------- ---------- --------- --------
Total operating expenses 40,716 49,377 56,641 48,388 25,484
---------- --------- ---------- --------- --------
Loss from operations (21,340) (34,587) (45,956) (39,162) (19,970)
Other income (expense) (530) (1,249) 1,682 298 721
---------- --------- ---------- --------- --------
Net loss $ (21,870) $ (35,836) $ (44,274) $ (38,864) $ (19,249)
========== ========= ========== ========= =========
Basic net loss per share $ (0.65) $ (1.31) $ (1.79)
========== ========== ==========
Unaudited pro forma basic net loss per share(1) $ (2.42) $ (1.53)
========= ========
Shares used to compute basic net loss per
share and unaudited pro forma basic net loss 33,782 27,290 24,693 16,042 12,609
per share
DECEMBER 31,
-------------------------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities $ 5,658 $ 23,981 $ 51,930 $ 28,752 $ 23,721
Working capital 13,308 28,234 51,947 31,461 24,224
Total assets 39,160 71,168 98,054 69,020 45,651
Long-term obligations 3,819 5,346 11,367 10,754 5,077
Accumulated deficit (174,472) (152,602) (116,766) (72,492) (33,628)
Total stockholders' equity 25,100 45,439 67,114 43,850 32,671
(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 and 1996.
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, particulary in "Factors that
May Affect Results," that could cause actual results to differ materially from
those projected.
OVERVIEW
We discover, develop, manufacture and market companion animal health
products. We have a sophisticated scientific effort devoted to applying
biotechnology to create a broad range of pharmaceutical, vaccine and diagnostic
products for the large and growing companion animal health market. In addition
to our pharmaceutical, vaccine and diagnostic products, we also sell veterinary
diagnostic and patient monitoring instruments and offer diagnostic services in
the United States and Europe to veterinarians. Our primary manufacturing
subsidiary, Diamond Animal Health, Inc., or Diamond, manufactures some of our
companion animal products and food animal vaccine and pharmaceutical products
which are marketed and distributed by third parties.
From our inception in 1988 until early 1996, our operating activities
related primarily to research and development activities, entering into
collaborative agreements, raising capital and recruiting personnel. Prior to
1996, we had not received any revenues from the sale of products. During 1996,
we grew from being primarily a research and development concern to a fully-
integrated research, development, manufacturing and marketing company. We
accomplished this by acquiring Diamond, a licensed pharmaceutical and biological
manufacturing facility in Des Moines, Iowa, hiring key employees and support
staff, establishing marketing and sales operations to support our products
introduced in 1996, and designing and implementing more sophisticated operating
and information systems. We also expanded the scope and level of our scientific
and business development activities, increasing the opportunities for new
products. In 1997, we introduced 13 additional products and expanded in the
United States through the acquisition of Center, an FDA and USDA licensed
manufacturer of allergy immunotherapy products located in New York, and
internationally through the acquisitions of Heska UK, a veterinary diagnostic
laboratory in England and CMG in Switzerland, which manufactures and markets
allergy diagnostic products for use in veterinary and human medicine, primarily
in Europe. Each of our acquisitions during this period was accounted for under
the purchase method of accounting and accordingly, our financial statements
reflect the operations of these businesses only for the periods subsequent to
the acquisitions. In July 1997, we established a new subsidiary, Heska AG,
located near Basel, Switzerland, for the purpose of managing our European
operations.
During the first quarter of 1998 we acquired a manufacturer and marketer of
patient monitoring devices. The financial results of this entity have been
consolidated with ours under the pooling-of-interests accounting method for all
periods presented. These operations were consolidated with our existing
operations in Fort Collins, Colorado and Des Moines, Iowa as of December 31,
1999, and our facility in Waukesha, Wisconsin was closed.
We sold our subsidiary in the United Kingdom, Heska UK, in March 2000. In
June 2000, we completed the sale of Center.
We have incurred net losses since our inception and anticipate that we will
continue to incur additional net losses in the near term as we introduce new
products, expand our sales and marketing capabilities and continue our research
and development activities. Cumulative net losses from inception in 1988
through December 31, 2000 have totaled $174.5 million.
Our ability to achieve profitable operations will depend primarily upon our
ability to successfully market our existing products, commercialize products
that are currently under development and develop new products. Most of our
products are subject to long development and regulatory approval cycles, and we
may not successfully develop, manufacture or market these products. We also may
not attain profitability or, if achieved, may not remain profitable on a
quarterly or annual basis in the future. Until we attain positive cash flow, we
may continue to finance operations with additional equity and debt financing.
Such financing may not be available when required or may not be obtained under
favorable terms. See the discussion later in this section titled "Factors That
May Affect Results" for a more in-depth explanation of risks faced by us.
RESULTS OF OPERATIONS
Years Ended December 31, 2000 and 1999
Total revenues, which include product revenues, sponsored research and
development and other revenues, increased 3% to $52.7 million in 2000 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 2000. Sales to one customer, AgriLabs,
represented 17% of total revenues in 2000.
Product revenues decreased 2% to $49.5 million in 2000 compared to $50.3
million in 1999. For the year ended December 31, 2000, product revenue from our
continuing core business increased 26%. This continuing core business consists
of the following business components: pharmaceutical, vaccine and diagnostic
(PVD) products, veterinary monitoring and diagnostic instrumentation and Diamond
Animal Health, our manufacturing subsidiary. The fiscal 2000 increase was
attributable to strong growth in our veterinary medical instrument products and
to increases in our proprietary pharmaceuticals, vaccines and diagnostics.
Diamond also posted solid revenue growth during the year.
Revenues from sponsored research and development and other increased to
$3.1 million in 2000 from $900,000 in 1999. Included in the total for 2000 is
revenue from the sale of our worldwide rights to the PERIOceutic Gel product.
Revenues from sponsored research and development increased due to an increase in
the number of funded research projects.
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.
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.
Selling and marketing expenses consist primarily of salaries, commissions and
benefits for sales and marketing personnel, commissions paid to contract sales
personnel and expenses of product advertising and promotion. We expect selling
and marketing expenses to increase as sales volumes increase and new products
are introduced to the marketplace, but to decrease as a percentage of total
revenues in future years.
Research and development expenses decreased to $14.9 million in 2000 from
$17.0 million in 1999. The decrease is due to additional focus on companion
animal product opportunities and tight cost control. Research and development
expenses are expected to decrease as a percentage of total revenues in future
years.
General and administrative expenses decreased to $9.5 million in 2000 from
$11.2 million in 1999. The decrease in 2000 is due to the sale of certain
businesses and tight cost control at all operations. General and administrative
expenses are expected to decrease as a percentage of total revenues in future
years.
Amortization of intangible assets and deferred compensation decreased to
$903,000 in 2000 from $2.2 million in 1999. The amortization of intangibles
resulted in a non-cash charge to operations of $255,000 and $1.6 million in 2000
and 1999, respectively. The decrease is due to the sale of Heska UK and the
write-down of certain intangible assets in 1999. The amortization of deferred
compensation resulted in a non-cash charge to operations in 2000 of
approximately $648,000 compared to $629,000 in 1999. The deferred compensation
represents the difference between the exercise price of options issued to
employees during 1996 and 1997 and the deemed value of the common stock for
accounting purposes on the date of grant. Compensation costs, equal to the fair
value of the options on the date of grant, were recognized over the service
period. The deferred compensation has been fully amortized as of December 31,
2000.
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.
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 discontine
manufacturing of certain low margin human healthcare products.
Interest income decreased to just under $1.0 million in 2000 as compared to
$1.6 million in 1999 as we continued to fund our operations with available cash.
Interest income is expected to decrease in the future as we continue to use cash
to fund our business operations. Interest expense decreased to $1.2 million in
2000 from $1.9 million in 1999 as we reduced our debt and capital leases by
nearly $8.5 million during the year. Other expense decreased to $400,000 in
2000 from nearly $1.0 million in 1999 due primarily to lower losses realized on
the sale of certain long-term interest-bearing government securities during the
current year.
Years Ended December 31, 1999 and 1998
Total revenues, which include product revenues, sponsored research and
development and other revenues, increased 29% to $51.2 million in 1999 compared
to $39.8 million in 1998. Product revenues increased 31% to $50.3 million in
1999 compared to $38.5 million in 1998. The growth in revenues during 1999 was
primarily due to sales of new products introduced during 1999 and increased
sales of our existing products. Sales to one customer, Bayer, represented 12%
of total revenues in 1999 pursuant to a take-or-pay contract with Bayer that
expired in February 2000. A portion of these sales were replaced under an
agreement with AgriLabs.
Revenues from sponsored research and development and other decreased to
$900,000 in 1999 from $1.3 million in 1998. Fluctuations in revenues from
sponsored research and development are generally the result of changes in the
number of funded research projects.
Cost of goods sold totaled $36.4 million in 1999 compared to $29.1 million
in 1998, and the resulting gross profit from product sales for 1999 increased to
$13.9 million from $9.4 million in 1998. Our gross margin percentage was 28% in
1999, compared to 24% in 1998. During 1999, the gross profit margin improved as
our product mix included a higher percentage of proprietary products with higher
gross profit margins. Also during fiscal 1999, we eliminated various product
lines that did not meet gross profit expectations.
Research and development expenses decreased to $17.0 million in 1999 from
$25.1 million in 1998. The decrease in 1999 was primarily due to reductions in
our internal research and development activities, resulting from our
restructuring in December 1998, and our decision to eliminate or defer research
projects which appeared to have greater long-term risk or lower market
potential.
Selling and marketing expenses increased to $15.1 million in 1999 from
$13.2 million in 1998. This increase reflects primarily the expansion of our
sales and marketing organization and costs associated with the introduction and
marketing of new products.
General and administrative expenses decreased to $11.2 million in 1999 from
$11.9 million in 1998. The decrease in 1999 was primarily due to reductions in
staffing and expenditures, resulting from our restructuring in December 1998.
Amortization of intangible assets and deferred compensation decreased to
$2.2 million in 1999 from $2.7 million in 1998. Intangible assets resulted
primarily from our 1997 and 1996 business acquisitions and are being amortized
over lives of 2 to 10 years. The amortization of deferred compensation resulted
in a non-cash charge to operations in 1999 of approximately $629,000 compared to
$736,000 in 1998.
The loss on assets held for disposition of $2.6 million recorded in 1999
reflects the write-down of certain tangible and intangible assets to their
expected net realizable values. Included in the loss was $1.0 million related
to the sale of Heska UK, a write-off of $580,000 in book value of assets held
for sale resulting from our decision to discontinue contract manufacturing of
certain low margin human healthcare products for third parties at Diamond and a
write-off of $1.0 million in book value of certain intangible and tangible
assets no longer considered strategic and held for sale or other disposition.
During the third quarter of 1999, we recognized a charge to operations of
approximately $1.2 million related to our decision to consolidate the operations
of our Waukesha, Wisconsin facility into our existing operations in Fort
Collins, Colorado and Des Moines, Iowa. The charge was primarily for personnel
severance costs and the cost of closing the facility in Waukesha, Wisconsin.
Interest income decreased to $1.6 million in 1999 from $3.2 million in 1998
as a result of reduced cash available for investment as we funded our business
operations. Interest income is expected to decline in the future as we continue
to use cash to fund our business operations. Interest expense decreased
slightly to $1.9 million in 1999 from $2.0 million in 1998. Other expense of
nearly $1.0 million in 1999 is due primarily to the loss realized on the sale of
certain long-term, interest-bearing government securities.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity at December 31, 2000 was $5.7 million in
cash, cash equivalents and marketable securities and our asset-based revolving
line of credit. In June 2000, we entered into the two-year credit facility with
Wells Fargo Business Credit, an affiliate of Wells Fargo Bank. This credit
facility requires us to maintain various minimum financial covenants including
book net worth, net income and cash balances or liquidity levels. In March
2001, we negotiated new covenants under this line of credit. At March 27, 2001,
our available borrowing capacity was approximately $5.0 million. In February
2001, we sold 4,573,000 shares of our common stock through a private placement
offering and received net proceeds of $5.3 million.
Net cash used in operating activities was $15.9 million in 2000, compared
to $33.2 million in 1999. Accounts payable decreased by $2.6 million in 2000
primarily due to the lower inventory levels. Inventory levels decreased by $2.4
million in 2000, due to a program to reduce inventory levels at Diamond.
Net cash flows from investing activities provided us with $25.2 million
during 2000, compared to $20.3 million of cash provided in 1999. The cash
provided in 2000 resulted primarily from the sale of $20.0 million of marketable
securities and the sale of Center for approximately $6.0 million. It was used
to fund our current year operations and debt repayments. Expenditures for
property and equipment totaled $1.2 million for 2000 compared to $3.3 million in
1999. We have historically used, and anticipate that we will continue to use,
capital equipment lease and debt facilities to finance equipment purchases and,
if possible, leasehold improvements. We currently expect to spend approximately
$1.5 million in 2001 for capital equipment, including expenditures to upgrade
certain manufacturing operations to improve efficiencies and to assure ongoing
compliance with regulatory requirements. We expect to finance these
expenditures through available cash, equipment leases and secured debt
facilities.
Net cash flows from financing activities used $7.6 million in cash in 2000,
compared to generating $8.4 million in 1999. 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.
We believe that our available cash, cash equivalents and marketable
securities, together with cash from operations, available borrowings and
borrowings we expect to be available under our revolving line of credit facility
will be sufficient to satisfy our projected cash requirements into 2002,
although we may raise additional funds at or before such time. If necessary, we
expect to raise these additional funds through one or more of the following:
(1) sale of additional securities; (2) sale of various assets; (3) licensing of
technology; and (4) sale of various products or marketing rights. 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, cash
equivalents, marketable securities and available borrowings. See "Factors that
May Affect Results."
On February 6, 2001, we sold 4,573,000 shares of common stock through a
private placement offering and received net proceeds of approximately $5.3
million.
NET OPERATING LOSS CARRYFORWARDS
As of December 31, 2000, we had a net operating loss carryforward, or NOL,
of approximately $154.6 million and approximately $3.1 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 2020.
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 December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, Revenue Recognition. SAB 101 clarifies the SEC
staff's views in applying generally accepted accounting principles to selected
revenue recognition issues. We adopted SAB 101 during the quarter ended
December 31, 2000. The adoption of SAB 101 did not have a material impact on
our financial statements, and therefore, did not result in the recording of a
cumulative effect of change in accounting principles as if SAB 101 had been
adopted on January 1, 2000, or the restatement of the previously reported
quarterly results for 2000.
We do not expect the adoption of any other standards recently issued by the
Financial Accounting Standards Board or the Securities and Exchange Commission
to have a material impact on our financial position or results of operations.
FACTORS THAT MAY AFFECT RESULTS
We have a history of losses and may never achieve profitability.
We have incurred net losses since our inception in 1988 and, as of December
31, 2000, we had an accumulated deficit of $174.5 million. We anticipate that
we will continue to incur additional operating losses in the near term. These
losses have resulted principally from expenses incurred in our research and
development programs and from general and administrative and sales and marketing
expenses. Even if we achieve profitability, we may not be able to sustain or
increase profitability on a quarterly or annual basis.
We may need additional capital in the future.
We have incurred negative cash flow from operations since inception in
1988. We do not expect to generate positive cash flow sufficient to fund our
operations in the near term. Moreover, based on our current projections, we may
need to raise additional capital in the future. If necessary, we expect to
raise this additional capital through one or more of the following:
* sale of additional securities;
* sale of various assets;
* licensing of technology; and
* sale of various products or marketing
rights.
Additional capital may not be available on acceptable terms, if at all.
Furthermore, any additional equity financing would likely be dilutive to
stockholders, and additional debt financing, if available, may include
restrictive covenants which may limit our currently planned operations and
strategies. If adequate funds are not available, we may be required to curtail
our operations significantly 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. If we fail
to generate adequate funding on acceptable terms when we need to, our business
could be substantially harmed.
We have limited resources to devote to product development and
commercialization. If we are not able to devote 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. 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 United States Department of Agriculture, or
USDA, the Food and Drug Administration, or FDA, the Environmental Protection
Agency, or EPA, and foreign regulatory authorities. These regulations govern,
among other things, the development, testing, manufacturing, labeling, storage,
premarket 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. 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. 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 regulatory approval is the requirement that our
manufacturing facilities or those of our third party manufacturers conform to
current Good Manufacturing Practices. The FDA and foreign regulatory
authorities strictly enforce Good Manufacturing Practices requirements through
periodic inspections. We can provide no assurance that any regulatory authority
will determine that our manufacturing facilities or those of our third party
manufacturers will conform to Good Manufacturing Practices requirements.
Failure to comply with applicable regulatory requirements can result in
sanctions being imposed on us or the manufacturers of our products, 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:
* the introduction of new products by us or by our
competitors;
* 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.
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, Inc., 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. Failure to
comply with any of the covenants, representations or warranties would negatively
impact our ability to borrow under the agreement. Our inability to borrow to
fund our operations could materially harm our business.
A small number of large customers account for a large percentage of our
revenues, and the loss of any of them could harm our operating results.
We currently derive a substantial portion of our revenues from sales by our
subsidiary Diamond, which manufactures various of our products and products for
other companies in the animal health industry. Revenues from Diamond customers,
AgriLabs and Bayer, comprised approximately 17% and 12% of our total revenues
for the years ended December 31, 2000 and 1999, respectively. If we are not
successful in maintaining our relationships with our customers and obtaining new
customers, our business and results of operations will suffer.
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 American Home
Products, Bayer, IDEXX Laboratories, Inc., Intervet International B.V., Merial
Ltd., Novartis, Pfizer Inc., Pharmacia Animal Health and Schering Plough
Corporation, 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, IDEXX, which has products that compete with
our heartworm diagnostic products, prohibits its distributors from selling
competitors' products, including ours. 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 have limited experience in marketing our products, and may be unable to
commercialize our products.
The market for companion animal healthcare products is highly fragmented,
with discount stores and specialty pet stores accounting for a substantial
percentage of sales. Because we sell our companion animal health products only
to veterinarians, we may fail to reach a substantial segment of the potential
market, and we may not be able to offer our products at prices which are
competitive with those of companies that distribute their products through
retail channels. We currently market our products to veterinarians through a
direct sales force and through third parties. To be successful, we will have to
continue to develop and train our direct sales force or rely on marketing
partnerships or other arrangements with third parties to market, distribute and
sell our products. We 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 we
fail to develop a successful marketing strategy, our ability to commercialize
our products and generate revenues will decrease.
We have granted third parties substantial marketing rights to our products under
development. If our current third party marketing agreements are not
successful, or if we are unable to develop our own marketing capabilities or
enter into additional marketing agreements in the future, we may not be able to
develop and commercialize our products.
Our agreements with our corporate marketing partners generally contain no
minimum purchase requirements in order for them to maintain their exclusive or
co-exclusive marketing rights. Novartis, Eisai or Ralston Purina or any other
collaborative party may not devote sufficient resources to marketing our
products. Furthermore, there is nothing to prevent Novartis, Eisai or Ralston
Purina or any other collaborative party from pursuing alternative technologies
or products that may compete with our products. If we fail to develop and
maintain our own marketing capabilities, we may find it necessary to continue to
rely on potential or actual competitors for third party marketing assistance.
Third party marketing assistance may not be available in the future on
reasonable terms, if at all. If any of these events occur, we may not be able
to develop and commercialize our products and our revenues will decline.
We may face costly intellectual property disputes.
Our ability to compete effectively will depend in part on our ability to
develop and maintain proprietary aspects of our technology and either to operate
without infringing the proprietary rights of others or to obtain rights to
technology owned by third parties. We have United States and foreign-issued
patents and are currently prosecuting patent applications in the United States
and with various foreign countries. Our pending patent applications may not
result in the issuance of any patents or that any issued patents will offer
protection against competitors with similar technology. Patents we receive may
be challenged, invalidated or circumvented in the future or the rights created
by those patents may not provide a competitive advantage. We also rely on trade
secrets, technical know-how and continuing invention to develop and maintain our
competitive position. Others may independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to our trade
secrets.
The biotechnology and pharmaceutical industries have been characterized by
extensive litigation relating to patents and other intellectual property rights.
In 1998, Synbiotics Corporation filed a lawsuit against us alleging infringement
of a Synbiotics patent relating to heartworm diagnostic technology, and this
litigation remains ongoing. We may become subject to additional patent
infringement claims and litigation in the United States or other countries or
interference proceedings conducted in the United States Patent and Trademark
Office to determine the priority of inventions. The defense and prosecution of
intellectual property suits, USPTO interference proceedings, and related legal
and administrative proceedings are costly, time-consuming and distracting. We
may also need to pursue litigation to enforce any patents issued to us or our
collaborative partners, to protect trade secrets or know-how owned by us or our
collaborative partners, or to determine the enforceability, scope and validity
of the proprietary rights of others. Any litigation or interference proceeding
will result in substantial expense to us and significant diversion of the
efforts of our technical and management personnel. Any adverse determination in
litigation or interference proceedings could subject us to significant
liabilities to third parties. Further, as a result of litigation or other
proceedings, we may be required to seek licenses from third parties which may
not be available on commercially reasonable terms, if at all.
We license technology from a number of third parties. The majority of
these license agreements impose due diligence or milestone obligations on us,
and in some cases impose minimum royalty and/or sales obligations on us, in
order for us to maintain our rights under these agreements. Our products may
incorporate technologies that are the subject of patents issued to, and patent
applications filed by, others. As is typical in our industry, from time to time
we and our collaborators have received, and may in the future receive, notices
from third parties claiming infringement and invitations to take licenses under
third party patents. It is our policy that when we receive such notices, we
conduct investigations of the claims they assert. With respect to the notices
we have received to date, we believe, after due investigation, that we have
meritorious defenses to the infringement claims asserted. Any legal action
against us or our collaborators may require us or our collaborators to obtain
one or more licenses in order to market or manufacture affected products or
services. However, we cannot assure you that we or our collaborators will be
able to obtain licenses for technology patented by others on commercially
reasonable terms, that we will be able to develop alternative approaches if
unable to obtain licenses, or that the current and future licenses will be
adequate for the operation of our businesses. Failure to obtain necessary
licenses or to identify and implement alternative approaches could prevent us
and our collaborators from commercializing our products under development and
could substantially harm our business.
We have limited manufacturing experience and capacity and rely substantially on
third party manufacturers. The loss of any third party manufacturers could
limit our ability to launch our products in a timely manner, or at all.
To be successful, we must manufacture, or contract for the manufacture of,
our current and future products in compliance with regulatory requirements, in
sufficient quantities and on a timely basis, while maintaining product quality
and acceptable manufacturing costs. In order to increase our manufacturing
capacity, we acquired Diamond in April 1996.
We currently rely on third parties to manufacture those products we do not
manufacture at our Diamond facility. We currently have supply agreements with
Quidel Corporation for various manufacturing services relating to our point-of-
care diagnostic tests, with Centaq, Inc. for the manufacture of our own allergy
immunotherapy treatment products and with various manufacturers for the supply
of our veterinary diagnostic and patient monitoring instruments. Our
manufacturing strategy presents the following risks:
* Delays in the scale-up to quantities needed for product
development could delay regulatory submissions and
commercialization of our products in development;
* Our manufacturing facilities and those of some of our third
party manufacturers are subject to ongoing periodic
unannounced inspection by regulatory authorities, including
the FDA, USDA and other federal and state agency's for
compliance with strictly enforced Good Manufacturing
Practices regulations and similar foreign standards, and we
do not have control over our third party manufacturers'
compliance with these regulations and standards;
* If we need to change to other commercial manufacturing
contractors for certain of our products, additional
regulatory licenses or approvals must be obtained for these
contractors prior to our use. This would require new
testing and compliance inspections. Any new manufacturer
would have to be educated in, or develop substantially
equivalent processes necessary for the production of our
products;
* If market demand for our products increases suddenly, our
current manufacturers might not be able to fulfill our
commercial needs, which would require us to seek new
manufacturing arrangements and may result in substantial
delays in meeting market demand; and
* We may not have intellectual property rights, or may have to
share intellectual property rights, to any improvements in
the manufacturing processes or new manufacturing processes
for our products.
Any of these factors could delay commercialization of our products under
development, interfere with current sales, entail higher costs and result in our
being unable to effectively sell our products.
Our agreements with various suppliers of the veterinary medical instruments
require us to meet minimum annual sales levels to maintain our position as the
exclusive distributor of these instruments. We may not meet these minimum sales
levels in the future, and maintain exclusivity over the distribution and sale of
these products. If we are not the exclusive distributor of these products,
competition may increase.
We depend on partners in our research and development activities. If our
current partnerships and collaborations are not successful, we may not be able
to develop our technologies or products.
For various of our proposed products, we are dependent on collaborative
partners to successfully and timely perform research and development activities
on our behalf. These collaborative partners may not complete research and
development activities on our behalf in a timely fashion, or at all. If our
collaborative partners fail to complete research and development activities, or
fail to complete them in a timely fashion, our ability to develop technologies
and products will be impacted negatively and our revenues will decline.
We depend on key personnel for our future success. If we lose our key personnel
or are unable to attract and retain additional personnel, we may be unable to
achieve our goals.
Our future success is substantially dependent on the efforts of our senior
management and scientific team. The loss of the services of members of our
senior management or scientific staff may
significantly delay or prevent the achievement of product development and other
business objectives. Because of the specialized scientific nature of our
business, we depend substantially on our ability to attract and retain qualified
scientific and technical personnel. There is intense competition among major
pharmaceutical and chemical companies, specialized biotechnology firms and
universities and other research institutions for qualified personnel in the
areas of our activities. If we lose the services of, or fail to recruit, key
scientific and technical personnel, the growth of our business could be
substantially impaired.
We may face product returns and product liability litigation and the extent of
our insurance coverage is limited. If we become subject to product liability
claims resulting from defects in our products, we may fail to achieve market
acceptance of our products and our business could be harmed.
The testing, manufacturing and marketing of our current products as well as
those currently under development entail an inherent risk of product liability
claims and associated adverse publicity. Following the introduction of a
product, adverse side effects may be discovered. Adverse publicity regarding
such effects could affect sales of our other products for an indeterminate time
period. To date, we have not experienced any material product liability claims,
but any claim arising in the future could substantially harm our business.
Potential product liability claims may exceed the amount of our insurance
coverage or may be excluded from coverage under the terms of the policy. We may
not be able to continue to obtain adequate insurance at a reasonable cost, if at
all. In the event that we are held liable for a claim against which we are not
indemnified or for damages exceeding the $10 million limit of our insurance
coverage or which results in significant adverse publicity against us, we may
lose revenue and fail to achieve market acceptance.
We may be held liable for the release of hazardous materials, which could result
in extensive costs which would harm our business.
Our products and development programs involve the controlled use of
hazardous and biohazardous materials, including chemicals, infectious disease
agents and various radioactive compounds. Although we believe that our safety
procedures for handling and disposing of such materials comply with the
standards prescribed by applicable local, state and federal regulations, we
cannot completely eliminate the risk of accidental contamination or injury from
these materials. In the event of such an accident, we could be held liable for
any fines, penalties, remediation costs or other damages that result. Our
liability for the release of hazardous materials could exceed our resources,
which could lead to a shut down of our operations. In addition, we may incur
substantial costs to comply with environmental regulations as we expand our
manufacturing capacity.
We expect to experience volatility in our stock price, which may affect our
ability to raise capital in the future or make it difficult for investors to
sell their shares.
The securities markets have from time to time experienced significant price
and volume fluctuations that are unrelated to the operating performance of
particular companies. The market prices of securities of many publicly-held
biotechnology companies have in the past been, and can in the future be expected
to be, especially volatile. For example, in the last twelve months our closing
stock price has ranged from a low of $0.59375 to a high of $4.50. Fluctuations
in the trading price or liquidity of our common stock may adversely affect our
ability to raise capital through future equity financings. Factors that may
have a significant impact on the market price and marketability of our common
stock include:
* announcements of technological innovations or new products by us or by
our competitors;
* our quarterly operating results;
* releases of reports by securities analysts;
* developments or disputes concerning patents or proprietary rights;
* regulatory developments;
* developments in our relationships with collaborative partners;
* changes in regulatory policies;
* litigation;
* economic and other external factors; and
* general market conditions.
In the past, following periods of volatility in the market price of a company's
securities, securities class action litigation has often been instituted. If a
securities class action suit is filed against us, we would incur substantial
legal fees and our management's attention and resources would be diverted from
operating our business in order to respond to the litigation.
If we fail to meet Nasdaq National Market listing requirements, our common stock
will be delisted and become illiquid.
Our common stock is currently listed on the Nasdaq National Market. Nasdaq
has requirements we must meet in order to remain listed on the Nasdaq National
Market. If we continue to experience losses from our operations or we are
unable to raise additional funds, we might not be able to maintain the standards
for continued quotation on the Nasdaq National Market, including a minimum bid
price requirement of $1.00. If the minimum bid price of our common stock were
to remain below $1.00 for 30 consecutive trading days, or if we were unable to
continue to meet Nasdaq's standards for any other reason, our common stock could
be delisted from the Nasdaq National Market.
If as a result of the application of these listing requirements, our common
stock were delisted from the Nasdaq National Market, our stock would become
harder to buy and sell. Further, our stock could be subject to what are known
as the "penny stock" rules. The penny stock rules place additional requirements
on broker-dealers who sell or make a market in such securities. Consequently,
if we were removed from the Nasdaq National Market, the ability or willingness
of broker-dealers to sell or make a market in our common stock might decline.
As a result, the ability for investors to resell shares of our common stock
could be adversely affected.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk represents the risk of loss that may impact the financial
position, results of operations or cash flows due to adverse changes in
financial and commodity market prices and rates. We are exposed to market risk
in the areas of changes in United States and foreign interest rates and changes
in foreign currency exchange rates as measured against the United States dollar.
These exposures are directly related to our normal operating and funding
activities. Historically, and as of December 31, 2000, we have not used
derivative instruments or engaged in hedging activities.
Interest Rate Risk
The interest payable on certain of our lines of credit and other borrowings
is variable based on the United States prime rate, or LIBOR, and, therefore,
affected by changes in market interest rates. At December 31, 2000,
approximately $2.9 million was outstanding on these lines of credit and other
borrowings with a weighted average interest rate of 10.75%. We manage interest
rate risk by investing excess funds principally in cash equivalents or
marketable securities which bear interest rates that reflect current market
yields. Additionally, we monitor interest rates and at December 31, 2000 had
sufficient cash balances to pay off the lines-of-credit should interest rates
increase significantly. As a result, we do
not believe that reasonably possible near-term changes in interest rates
will result in a material effect on our future earnings, financial position or
cash flows.
Foreign Currency Risk
At December 31, 2000, we had a wholly-owned subsidiary located in
Switzerland. Sales from these operations are denominated in Swiss Francs or
Euros, thereby creating exposures to changes in exchange rates. The changes in
the Swiss/U.S. exchange rate or Euro/U.S. exchange rate may positively or
negatively affect our sales, gross margins and retained earnings. We do not
believe that reasonably possible near-term changes in exchange rates will result
in a material effect on future earnings, fair values or cash flows, and
therefore, have chosen not to enter into foreign currency hedging instruments.
Such an approach may not be successful, especially in the event of a significant
and sudden decline in the value of the Swiss Franc or Euro.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public Accountants 31
Consolidated Balance Sheets as of December 31, 2000 and 1999 32
Consolidated Statements of Operations and Comprehensive Loss for
the years
ended December 31, 2000, 1999, and 1998 33
Consolidated Statements of Stockholders' Equity for the years
ended
December 31, 2000, 1999 and 1998 34
Consolidated Statements of Cash Flows for the years ended
December 31, 2000,
1999 and 1998 35
Notes to Consolidated Financial Statements 36
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Heska Corporation:
We have audited the accompanying consolidated balance sheets of Heska
Corporation (a Delaware corporation) and subsidiaries as of December 31, 2000
and 1999, and the related consolidated statements of operations and
comprehensive loss, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Heska Corporation and
subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule of valuation and qualifying
accounts is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audit of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
/s/ Arthur Andersen LLP
Denver, Colorado,
January 31, 2001, except with
respect to the matters
discussed in Note 15, as to
which the dates are February 6,
2001 and March 27, 2001.
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
ASSETS
DECEMBER 31,
-----------------
2000 1999
---- ----
Current assets:
Cash and cash equivalents $ 3,176 $ 1,499
Marketable securities 2,482 22,482
Accounts receivable, net of allowance for doubtful
accounts of $431 and $188, respectively 8,433 9,652
Inventories, net 8,716 13,957
Other current assets 742 1,027
-------- --------
Total current assets 23,549 48,617
Property and equipment, net 12,901 19,574
Intangible assets, net 1,457 1,629
Restricted marketable securities and other assets 1,253 1,348
-------- --------
Total assets $ 39,160 $ 71,168
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,370 $ 6,928
Accrued liabilities 4,258 4,369
Deferred revenue 467 930
Current portion of capital lease obligations 584 604
Current portion of long-term debt 1,562 7,552
-------- --------
Total current liabilities 10,241 20,383
Capital lease obligations, net of current portion 138 718
Long-term debt, net of current portion 2,670 4,428
Deferred revenue and other long-term liabilities 1,011 200
-------- --------
Total liabilities 14,060 25,729
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, 25,000,000 shares
authorized; none outstanding - -
Common stock, $.001 par value, 40,000,000 shares
authorized; 34,072,640 and 33,436,669 shares issued 34 33
and outstanding, respectively
Additional paid-in capital 199,789 199,156
Deferred compensation - (648)
Stock subscription receivable from officers - (124)
Accumulated other comprehensive income (251) (376)
Accumulated deficit (174,472) (152,602)
---------- ---------
Total stockholders' equity 25,100 45,439
---------- ---------
Total liabilities and stockholders' equity $ 39,160 $ 71,168
========= =========
See accompanying notes to consolidated financial statements
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share amounts)
YEAR ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
--------- --------- ---------
Revenues:
Products, net $ 49,549 $ 50,291 $ 38,451
Research, development and other 3,126 885 1,321
--------- --------- ---------
Total revenues 52,675 51,176 39,772
Cost of goods sold 33,299 36,386 29,087
--------- --------- ---------
19,376 14,790 10,685
--------- --------- ---------
Operating expenses:
Selling and marketing 14,788 15,073 13,188
Research and development 14,929 17,042 25,126
General and administrative 9,457 11,231 11,939
Amortization of intangible assets
and deferred compensation 903 2,228 2,745
Loss on sale of assets 204 2,593 1,287
Restructuring expenses 435 1,210 2,356
-------- -------- ---------
Total operating expenses 40,716 49,377 56,641
-------- --------- ---------
Loss from operations (21,340) (34,587) (45,956)
-------- -------- ---------
Other income
Interest income 986 1,611 3,183
Interest expense (1,155) (1,857) (2,009)
Other, net (361) (1,003) 508
--------- --------- ---------
Net loss (21,870) (35,836) (44,274)
-------- -------- --------
Other comprehensive income (loss):
Foreign currency translation adjustments (121) (88) 2
Unrealized gain (loss) on marketable securities 246 (376) 85
--------- -------- --------
Other comprehensive income (loss) 125 (464) 87
--------- -------- --------
Comprehensive loss $(21,745) $(36,300) $(44,187)
========= ======== ========
Basic and diluted net loss per share $ (0.65) $ (1.31) $ (1.79)
========= ========= ========
Shares used to compute basic and diluted
net loss per share 33,782 27,290 24,693
See accompanying notes to consolidated financial statements
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except per share data)
COMMON STOCK ADDITIONAL
---------------- PAID-IN DEFERRED
SHARES AMOUNT CAPITAL COMPENSATION
------ ------ ---------- ------------
Balances, December 31, 1997 19,491 $ 19 $ 118,447 $ (1,967)
Issuance of common stock for cash 3 - 6 -
Issuance of common stock upon the Company's
follow-on public offering, net 5,250 5 48,595 -
Issuance of common stock and warrants for cash 1,165 1 14,999 -
Issuance of common stock in exchange for assets
and in repayment of debt 206 - 2,262 -
Issuance of common stock for services 32 - 461 -
Cashless exercise of warrants to purchase common
stock 5 - - -
Issuance of common stock related to options, the
ESPP and other 306 1 347 -
Deferred compensation related to stock options - - 46 (46)
Amortization of deferred compensation - - - 736
Interest on stock subscription receivable - - - -
Payments received on stock subscription
receivable - - - -
Foreign currency translation adjustments - - - -
Unrealized gain on marketable securities - - - -
Net loss - - - -
------ ----- ----------- --------
Balances, December 31, 1998 26,458 26 185,163 (1,277)
Issuance of common stock for services 17 - 116 -
Cashless exercise of warrants to purchase common
stock 5 - - -
Issuance of common stock upon the Company's
follow-on public offering, net 6,500 7 13,282 -
Issuance of common stock related to options, the
ESPP 457 - 595 -
and other
Amortization of deferred compensation - - - 629
Interest on stock subscription receivable - - - -
Payments received on stock subscription
receivable - - - -
Foreign currency translation adjustments - - - -
Unrealized loss on marketable securities - - - -
Net loss - - - -
------ ----- ----------- --------
Balances, December 31, 1999 33,437 33 199,156 (648)
Issuance of common stock related to options, the
ESPP and other 636 1 633 -
Amortization of deferred compensation - - - 648
Interest/payments on stock subscription
receivable - - - -
Foreign currency translation adjustments - - - -
Unrealized gain on marketable securities - - - -
Net loss - - - -
------ ----- ----------- -------
Balances, December 31, 2000 34,073 $ 34 $ 199,789 $ -
ACCUMULATED
STOCK OTHER TOTAL
SUBSCRIPTION COMPREHENSIVE ACCUMULATED STOCKHOLDERS'
RECEIVABLE INCOME DEFICIT EQUITY
------------ ------------- ----------- -------------
Balances, December 31, 1997 $ (158) $ 1 $ (72,492) $ 43,850
Issuance of common stock for cash - - - 6
Issuance of common stock upon the Company's
follow-on public offering, net - - - 48,600
Issuance of common stock and warrants for cash - - - 15,000
Issuance of common stock in exchange for assets
and in repayment of debt - - - 2,262
Issuance of common stock for services - - - 461
Cashless exercise of warrants to purchase common
stock - - - -
Issuance of common stock related to options, the
ESPP and other - - - 348
Deferred compensation related to stock options - - - -
Amortization of deferred compensation - - - 736
Interest on stock subscription receivable (13) - - (13)
Payments received on stock subscription
receivable 51 - - 51
Foreign currency translation adjustments - 2 - 2
Unrealized gain on marketable securities - 85 - 85
Net loss - - (44,274) (44,274)
-------- ------- ----------- ---------
Balances, December 31, 1998 (120) 88 (116,766) 67,114
Issuance of common stock for services - - - 116
Cashless exercise of warrants to purchase common
stock - - - -
Issuance of common stock upon the Company's
follow-on public offering, net - - - 13,289
Issuance of common stock related to options, the
ESPP and other - - - 595
Amortization of deferred compensation - - - 629
Interest on stock subscription receivable (7) - - (4)
Payments received on stock subscription
receivable 3 - - -
Foreign currency translation adjustments - (88) - (88)
Unrealized loss on marketable securities - (376) - (376)
Net loss - - (35,836) (35,836)
-------- ------- ----------- ---------
Balances, December 31, 1999 (124) (376) (152,602) 45,439
Issuance of common stock related to options, the
ESPP and other - - - 634
Amortization of deferred compensation - - - 648
Interest/payments on stock subscription
receivable 124 - - 124
Foreign currency translation adjustments - (121) - (121)
Unrealized gain on marketable securities - 246 - 246
Net loss - - (21,870) (21,870)
-------- ------- ----------- ---------
Balances, December 31, 2000 $ - $ (251) $ (174,472) $ 25,100
See accompanying notes to consolidated financial statements
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net loss $ (21,870) $ (35,836) $ (44,274)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation and amortization 4,066 3,864 3,600
Amortization of intangible assets and
deferred compensation 903 2,228 2,745
Loss on disposition of assets 445 2,215 2
Changes in operating assets and liabilities:
Accounts receivable, net 155 (2,993) (1,177)
Inventories, net 2,380 (1,760) (1,608)
Other long-term assets (229) (1,092) -
Other assets 18 (293) 406
Accounts payable (2,551) (614) 1,189
Accrued liabilities 449 498 896
Deferred revenue (463) 274 502
Other - 194 (365)
Other long-term liabilities 811 124 (37)
--------- --------- ---------
Net cash used in operating activities (15,886) (33,191) (38,121)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash withdrawn from restricted cash account - 238 -
Additions to intangible assets - - (549)
Purchase of marketable securities - (21,229) (123,842)
Proceeds from sale of marketable securities 20,000 44,300 96,248
Proceeds from sale of subsidiary 6,000 - -
Proceeds from disposition of property and
equipment 406 262 -
Purchases of property and equipment (1,207) (3,296) (6,470)
--------- --------- ---------
Net cash provided by (used in)
investing activities 25,199 20,275 (34,613)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 634 13,884 64,505
Proceeds from stock subscription receivable 124 3 51
Proceeds from borrowings 136 971 10,171
Repayments of debt and capital lease obligations (8,484) (6,464) (6,804)
--------- --------- ----------
Net cash provided by (used in)
financing activities (7,590) 8,394 67,923
--------- --------- ----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (46) 100 53
--------- --------- ----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,677 (4,422) (4,758)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,499 5,921 10,679
--------- --------- ----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 3,176 $ 1,499 $ 5,921
========= ========= ==========
See accompanying notes to consolidated financial statements
1. ORGANIZATION AND BUSINESS
Heska Corporation ("Heska" or the "Company") is primarily focused on the
discovery, development, manufacturing and marketing of companion animal health
products. In addition to manufacturing certain of Heska's companion animal
health products, the Company's primary manufacturing subsidiary, Diamond Animal
Health, Inc. ("Diamond"), manufactures food animal vaccine and pharmaceutical
products that are marketed and distributed by third parties. The Company also
offers diagnostic services to veterinarians at its Fort Collins, Colorado and
CMG-Heska Allergy Products S.A. ("CMG"), a Swiss corporation, locations.
From the Company's inception in 1988 until early 1996, the Company's
operating activities related primarily to research and development activities,
entering into collaborative agreements, raising capital and recruiting
personnel. Prior to 1996, the Company had not received any revenues from the
sale of products. During 1996, Heska grew from being primarily a research and
development concern to a fully-integrated research, development, manufacturing
and marketing company. The Company accomplished this by acquiring Diamond, a
licensed pharmaceutical and biological manufacturing facility in Des Moines,
Iowa, hiring key employees and support staff, establishing marketing and sales
operations to support new Heska products, and designing and implementing more
sophisticated operating and information systems. The Company also expanded the
scope and level of its scientific and business development activities,
increasing the opportunities for new products. In 1997, the Company introduced
additional products and expanded in the United States through the acquisition of
Center, a Food and Drug Administration ("FDA") and United States Department of
Agriculture ("USDA") licensed manufacturer of allergy immunotherapy products
located in Port Washington, New York, and internationally through the
acquisitions of Heska UK Limited ("Heska UK", formerly Bloxham Laboratories
Limited), a veterinary diagnostic laboratory in Teignmouth, England and CMG
(formerly Centre Medical des Grand'Places S.A.) in Fribourg, Switzerland, which
manufactures and markets allergy diagnostic products for use in veterinary and
human medicine, primarily in Europe. Each of the Company's acquisitions during
this period was accounted for under the purchase method of accounting and
accordingly, the Company's financial statements reflect the operations of these
businesses only for the periods subsequent to the respective acquisitions. In
July 1997, the Company established a new subsidiary, Heska AG, located near
Basel, Switzerland, for the purpose of managing its European operations.
During the first quarter of 1998 the Company acquired Heska Waukesha
(formerly Sensor Devices, Inc.), a manufacturer and marketer of patient
monitoring devices used in both animal health and human applications. The
financial results of Heska Waukesha have been consolidated with those of the
Company under the pooling-of-interests accounting method for all periods
presented.
During 1999 and 2000, the Company restructured and refocused its business.
The operations of Heska Waukesha were combined with existing operations in Fort
Collins, Colorado and Des Moines, Iowa during the fourth quarter of 1999. The
Heska Waukesha facility was closed in December 1999. In March 2000, the Company
sold Heska UK. The Company recorded a loss on disposition of approximately $1.0
million during 1999 for this sale. In June 2000, the Company sold Center. The
Company recognized a gain on the sale of approximately $151,000.
The Company has incurred net losses since its inception and anticipates
that it will continue to incur additional net losses in the near term as it
introduces new products, expands its sales and marketing capabilities and
continues its research and development activities. Cumulative net losses from
inception of the Company in 1988 through December 31, 2000 have totaled $174.5
million. During the year ended December 31, 2000, the Company incurred a loss
of approximately $21.9 million and used cash of approximately $15.9 million for
operations.
The Company's primary short-term needs for capital, which are subject to
change, are for its continuing research and development efforts, its sales,
marketing and administrative activities, working capital associated with
increased product sales and capital expenditures relating to developing and
expanding its manufacturing operations. The Company's ability to achieve
profitable operations will depend primarily upon its ability to successfully
market its products, commercialize products that are currently under
development and develop new products. Most of the Company's products are subject
to long development and regulatory approval cycles and there can be no guarantee
that the Company will successfully develop, manufacture or market these
products. There can also be no guarantee that the Company will attain
profitability or, if achieved, will remain profitable on a quarterly or annual
basis in the future. Until the Company attains positive cash flow, the Company
may continue to finance operations with additional equity and debt financing.
There can be no guarantee that such financing will be available when required or
will be obtained under favorable terms.
The Company believes that its available cash, cash equivalents and
marketable securities, together with cash from operations, available borrowings
and borrowings expected to be available under its revolving line of credit
facility will be sufficient to satisfy projected cash requirements into 2002,
although it may raise additional funds at or before such time. Thereafter, if
cash generated from operations is insufficient to satisfy its cash requirements,
the Company will need to raise additional captial to continue its business
operations. If necessary, the Company expects to raise these additional funds
through one or more of the following: (1) sale of additional securities; (2)
sale of various assets; (3) licensing of technology; and (4) sale of various
products or marketing rights. If the Company cannot raise the additional funds
through these options on acceptable terms or with the necessary timing,
management could also reduce discretionary spending to decrease the Company's
cash burn rate and extend the currently available cash, cash equivalents,
marketable securities and available borrowings. See Note 15.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
the Company and of its wholly-owned subsidiaries since their respective dates of
acquisitions when accounted for under the purchase method of accounting, and for
all periods presented when accounted for under the pooling-of-interests method
of accounting. All material intercompany transactions and balances have been
eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents are stated at cost, which approximates market,
and include short-term highly liquid investments with original maturities of
less than three months.
Marketable Securities and Restricted Investments
The Company classifies its marketable securities as "available-for-sale"
and, accordingly, carries such securities at aggregate fair value. Unrealized
gains or losses, if material, are included as a component of accumulated other
comprehensive income.
At December 31, 2000 these securities, consisting entirely of U.S.
government agency obligations, had an aggregate amortized cost, using specific
identification, of $2.8 million, with a maximum maturity of approximately three
years. At December 31, 1999 these securities had an aggregate amortized cost,
using specific identification, of $23.1 million, a maximum maturity of
approximately 4 years and consisted of $7.8 million of U.S. government agency
obligations and $15.3 million of U.S. corporate commercial paper. The fair
market value of marketable securities at December 31, 2000 and 1999 was
approximately $2.8 million and $22.8 million, respectively. Marketable
securities at both December 31, 2000 and 1999 included approximately $281,000 of
restricted investments held as collateral for capital leases (See Note 4) and
$2.5 million and $22.5 million of short-term marketable securities,
respectively. The Company realized losses on the sale of certain marketable
securities of $111,000 and $943,000 in 2000 and 1999, respectively, and a gain
of $216,000 in 1998.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to a
concentration of credit risk consist of cash and cash equivalents, marketable
securities and accounts receivable. The Company maintains the majority of its
cash, cash equivalents and marketable securities with financial institutions
that management believes are creditworthy in the form of demand deposits, U.S.
government agency obligations and U.S. corporate commercial paper. The Company
has no significant off-balance sheet concentrations of credit risk such as
foreign exchange contracts, options contracts or other foreign hedging
arrangements. Its accounts receivable balances are due primarily from domestic
veterinary clinics and individual veterinarians, and both domestic and
international corporations.
Fair Value of Financial Instruments
The Company's financial instruments consist of cash and cash equivalents,
short-term trade receivables and payables, notes receivable and notes payable.
The carrying values of cash and cash equivalents and short-term trade
receivables and payables approximate fair value. The fair value of notes
payable is estimated based on current rates available for similar debt with
similar maturities and collateral, and at December 31, 2000, approximates the
carrying value.
Inventories, net
Inventories are stated at the lower of cost or market using the first-in,
first-out method. If the cost of inventories exceeds fair market value,
provisions are made for the difference between cost and fair market value.
Inventories, net of provisions, consist of the following (in thousands):
DECEMBER 31,
-----------------------
2000 1999
------- ------
Raw materials $ 2,596 $ 3,436
Work in process 2,904 6,640
Finished goods 3,822 4,191
Less reserves for losses (606) (310)
--------- ---------
$ 8,716 $ 13,957
========= =========
Derivative Instruments and Hedging Activities
During 2001, the Company will adopt the provisions of SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. The Statement
establishes accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at fair value. The Statement requires that changes in the derivative's
fair value be recognized currently in earnings unless specific hedging criteria
are met. The Company does not expect that the adoption of this Statement will
have a material impact on its reported earnings or comprehensive income.
Property, Equipment and Intangible Assets
Property and equipment are recorded at cost and depreciated on a straight-
line or declining balance basis over the estimated useful lives of the related
assets. Amortization of assets acquired under capital leases is included with
depreciation expense on owned assets.
Leasehold improvements are amortized over the applicable lease period or
their estimated useful lives, whichever is shorter. Maintenance and repairs are
charged to expense when incurred, and major renewals and improvements are
capitalized.
Intangible assets primarily consist of various assets arising from business
combinations and are amortized using the straight-line method over the period of
expected benefit.
The Company periodically reviews the appropriateness of the remaining life
of its property, equipment and intangible assets considering whether any events
have occurred or conditions have developed which may indicate that the remaining
life requires adjustment. After reviewing the appropriateness of the remaining
life and the pattern of usage of these assets, the Company then assesses their
overall recoverability by determining if the net book value can be recovered
through undiscounted future operating cash flows. Absent any unfavorable
findings, the Company continues to amortize and depreciate its property,
equipment and intangible assets based on the existing estimated life. During
2000, the Company's review of property, equipment and intangible assets
determined that a write-down to fair market value of $355,000 for equipment was
needed. In 1999, the Company's review of property, equipment and intangible
assets determined that a write-down to fair market value of $1.0 million for
equipment and $372,000 for intangible assets was needed. These amounts were
recorded as part of the loss on sale of assets in the accompanying statement of
operations.
Property and equipment consist of the following (in thousands):
ESTIMATED DECEMBER 31,
USEFUL ------------
LIFE 2000 1999
--------- ---- ---- --
Land N/A $ 377 $ 435
Building 10 to 20 years 2,677 4,154
Machinery and equipment 3 to 15 years 19,426 22,503
Leasehold improvements 7 to 15 years 4,066 3,482
-------- --------
26,546 30,574
Less accumulated depreciation and
amortization (13,645) (11,000)
-------- --------
$ 12,901 $ 19,574
======== ========
Depreciation and amortization expense for property and equipment was $4.1
million, $3.9 million and $3.6 million for the years ended December 31, 2000,
1999 and 1998, respectively.
Intangible assets consist of the following (in thousands):
ESTIMATED DECEMBER 31,
USEFUL ----------------
LIFE 2000 1999
--------- ---- ----
Customer lists and market presence 7 years $ 1,705 $ 2,848
Other intangible assets 2 to 5 years 793 394
-------- --------
2,498 3,242
Less accumulated amortization (1,041) (1,613)
-------- --------
$ 1,457 $ 1,629
======== ========
The customer lists and market presence resulted from the Company's 1997
acquisition of CMG. The remaining intangible assets resulted primarily from the
acquisitions of certain assets in 1998. Amortization expense for intangible
assets was $255,000, $1.6 million and $2.0 million for the years ended December
31, 2000, 1999 and 1998, respectively.
Revenue Recognition
Product revenues are recognized at the time goods are shipped to the
customer with an appropriate provision for returns and allowances.
License revenues received under arrangements to license patent rights or
technology rights are deferred and amortized over the life of the related
arrangement. 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. In connection with these sponsored research and
development agreements, the Company has recognized $1.4 million, $900,000 and
$1.3 million of research and development revenue for the years ended
December 31, 2000, 1999 and 1998, respectively.
In addition to its direct sales force, the Company utilizes both
distributors and sales agency organizations to sell its products. Distributors
purchase goods from the Company, take title to those goods and resell them to
their customers in the distributors' territory. Sales agents maintain
inventories of goods on consignment from the Company and sell these goods on
behalf of the Company to customers in the sales agents' territory. The Company
recognizes revenue at the time goods are sold to the customers by the sales
agents. Sales agents are paid a fee for their services, which include
maintaining product inventories, sales activities, billing and collections.
Fees earned by sales agents are netted against revenues generated by these
entities.
In December 1999, the SEC issued SAB No. 101, Revenue Recognition. SAB 101
clarifies the SEC staff's views in applying generally accepted accounting
principles to selected revenue recognition issues. We adopted SAB 101 during
the quarter ended December 31, 2000. The adoption of SAB 101 did not have a
material impact on our financial statements, and therefore, did not result in
the recording of a cumulative effect of change in an accounting principle as if
SAB 101 had been adopted on January 1, 2000, or the restatement of the
previously reported quarterly results for 2000.
Cost of Sales
Royalties payable in connection with certain research, development and
licensing agreements (See Note 9) are reflected in cost of sales as incurred.
Basic and Diluted Net Loss Per Share
Basic net loss per common share is computed using the weighted average
number of common shares outstanding during the period. Diluted net loss per
share is computed using the sum of the weighted average number of shares of
common stock outstanding and, if not anti-dilutive, the effect of outstanding
stock options and warrants determined using the treasury stock method. At
December 31, 2000, securities that have been excluded from diluted net loss per
share because they would be anti-dilutive are outstanding options to purchase
3,964,668 shares of the Company's common stock and warrants to purchase
1,165,000 shares of the Company's common stock.
Foreign Currency Translation
The functional currency of the Company's international subsidiaries is the
Swiss Franc ("CHF"). Assets and liabilities of the Company's international
subsidiaries are translated using the exchange rate in effect at the balance
sheet date. Revenue and expense accounts are translated using an average of
exchange rates in effect during the period. Cumulative translation gains and
losses, if material, are shown in the consolidated balance sheets as a separate
component of stockholders' equity. Exchange gains and losses arising from
transactions denominated in foreign currencies (i.e., transaction gains and
losses) are recognized in current operations. The Company does not generally
enter into any forward contracts or hedging transactions.
3. BUSINESS ACQUISITION
Acquisition of Heska Waukesha. In March 1998 the Company completed its
acquisition of all of the outstanding shares of Heska Waukesha, a manufacturer
and marketer of medical sensor products, in a
transaction valued at approximately $8.9 million using the pooling-of-interests
accounting method. The Company issued 639,622 shares of its common stock and
also reserved an additional 147,898 shares of its common stock for issuance in
connection with outstanding Heska Waukesha options that were assumed by the
Company in the merger. Accordingly, in 1998, the consolidated financial
statements of the Company were restated to include the accounts of Heska
Waukesha for all prior periods presented. There were no adjustments required to
the net assets or previously reported results of operations of the Company or
Heska Waukesha as a result of the adoption of the same accounting practices by
the respective entities.
4. CAPITAL LEASE OBLIGATIONS
The Company has entered into certain capital lease agreements for
laboratory equipment, office equipment, machinery and equipment, and computer
equipment and software. For the years ended December 31, 2000 and 1999, the
Company had capitalized machinery and equipment under capital leases with a
gross value of approximately $2.5 million and $2.5 million and net book value of
approximately $740,000 and $1.2 million, respectively. The capitalized cost of
the equipment under capital leases is included in the accompanying balance
sheets under the respective asset classes. Under the terms of the Company's
lease agreements, the Company is required to make monthly payments of principal
and interest through the year 2004, at interest rates ranging from 4.05% to
20.00% per annum. The equipment under the capital leases serves as security for
the leases.
The Company has a capital lease with a commercial bank which requires the
Company to pledge cash or investments as additional collateral for the lease.
The lease agreement, which has a borrowing limit of $2.0 million calls for a
collateral balance equal to 25% of the borrowed amount when the Company's annual
revenues reach $28.0 million. The lease also requires the Company to maintain
minimum levels of cash and cash equivalent balances throughout the term of the
lease. At both December 31, 2000 and 1999, the Company was in compliance with
all covenants of the master lease and held restricted U.S. Treasury Bonds of
approximately $281,000 as additional collateral under the lease.
The future annual minimum required payments under capital lease obligations
as of December 31, 2000 were as follows (in thousands):
YEAR ENDING
DECEMBER 31,
--------
2001 $ 615
2002 111
2003 40
2004 6
-------
Total minimum lease payments 772
Less amount representing interest (50)
-------
Present value of net minimum lease payments 722
Less current portion (584)
-------
Total long-term capital lease obligations $ 138
=======
5. RESTRUCTURING EXPENSES
During the first quarter of fiscal 2000, the Company initiated a cost
reduction and restructuring plan at its Diamond subsidiary. The restructuring
resulted from the rationalization of Diamond's business including a reduction in
the size of its workforce and the Company's decision to vacate a leased
warehouse and distribution facility no longer needed after the Company's
decision to discontinue contract manufacturing of certain low margin human
healthcare products. The charge to operations of approximately $435,000 related
primarily to personnel severance costs for 12 individuals and the costs
associated with closing the leased facility, terminating the lease and
abandoning certain leasehold improvements. The facility was closed in April
2000.
In August 1999, the Company announced plans to consolidate its Heska
Waukesha operations with existing operations in Fort Collins, Colorado and Des
Moines, Iowa. This consolidation was based on the Company's determination that
significant operating efficiencies could be achieved through the combined
operations. The Company recognized a charge to operations of approximately $1.2
million for this consolidation. These expenses related primarily to personnel
severance costs for 40 individuals and the costs associated with facilities
being closed and excess equipment, primarily at the Company's Waukesha,
Wisconsin location. This facility was closed in December 1999.
Shown below is a reconciliation of restructuring costs for the year ended
December 31, 2000 (in thousands):
Additions Payments/
Balance for the Charges Balance
at Fiscal Year through at
December Ended December December
31, December 31, 31,
1999 31, 2000 2000 2000
-------- ---------- --------- --------
Severance pay, benefits and relocation
expenses $ 429 $ 121 $ (550) $ -
Noncancellable leased facility closure costs 694 314 (832) 176
--------- --------- --------- - -----
Total $ 1,123 $ 435 $ (1,382) $ 176
========= ========= ========= ========
The balance of $176,000 and $1.1 million is included in accrued liabilities
in the accompanying consolidated balance sheets as of December 31, 2000 and
1999, respectively.
6. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
DECEMBER 31,
------------
2000 1999
---- ----
Heska, Diamond, Center and Heska Waukesha obligations:
Equipment financing due in monthly installments through
November 2001, and final payments due March 2001 through
January 2002, with stated interest rates between
2.7% and 17.9%, secured by certain equipment and fixtures $ 1,218 $ 3,642
Center obligations:
Promissory note to former owner of Center due in July 2000,
with quarterly interest payments at a stated interest rate
of prime (8.5% at December 1999) plus 0.75%, paid in full
in June 2000 - 3,464
Diamond obligations:
Promissory note to the Iowa Department of Economic Development
("IDED"), due in annual installments through June 2004,
with a stated interest rate of 3.0% and a 9.5% imputed
interest rate, net 54 67
Promissory note to the City of Des Moines, due in monthly
installments through May 2004, with a stated interest rate of
3% and a 9.5% imputed interest rate, net 75 97
$2,500 commercial bank line of credit, due September 2001, with
monthly interest payments at prime (8.5% at December 1999)
plus 1.75%, replaced by corporate line of credit in April 2000 - 917
Real estate mortgage loan with a commercial bank, due in
monthly installments through September 2003, with a stated
interest rate of prime (9.5% and 8.5% at December 2000 and 1999,
respectively) plus 1.25% at December 2000 and 1.75% at
December 1999 1,973 2,175
Term loan with a commercial bank, secured by machinery and
equipment, due in monthly installments through December 2004,
with a stated interest rate of prime plus 1.25% at
December 31, 2000 (10.75%) and prime plus 1.75% at
December 31, 1999 (10.25%) 912 1,200
Heska UK obligations:
Real estate mortgage due in monthly principal payments and
quarterly interest payments through December 2006, with a
stated interest rate of a bank's base rate (8.5% at
December 1999) plus 2.75%, denominated in pounds sterling,
transferred in the sale of Heska UK - 142
CMG obligations:
CHF150 commercial bank line of credit, due upon demand, with
quarterly interest payments, with a stated interest rate of
5.5%, plus 0.25% per quarter, cancelled in January 2000 - 145
CHF400 commercial bank line of credit, due upon demand, with
quarterly interest payments, with a stated interest rate of
6.0%, plus 0.25% per quarter - 131
-------- --------
4,232 11,980
Less installments due within one year (1,562) (7,552)
-------- --------
$ 2,670 $ 4,428
======== ========
In June 2000, the Company entered into a two-year expanded credit facility
with Wells Fargo Business Credit, Inc., an affiliate of Wells Fargo Bank. The
credit facility includes an asset-based revolving line of credit. Under the
agreement, the Company is required to comply with certain financial and non-
financial covenants. Among the financial covenants are requirements for monthly
minimum book net worth, quarterly minimum net income and minimum cash balances
or liquidity levels. The Company was in compliance with all financial covenants
at December 31, 2000. See Note 15.
Amounts due under the Company's equipment term loan, real estate mortgage
loan and revolving credit facility are payable to a commercial bank and are
secured by a first security interest in essentially all of the Company's assets.
The IDED and City of Des Moines promissory notes are secured by a first
security interest in essentially all assets of Diamond except assets acquired
through capital leases and are included as cross-collateralized obligations by
the respective lenders. The IDED has subordinated all of its security interest
in these assets to a commercial bank providing credit to the Company. The City
of Des Moines has subordinated up to $15 million of its security interest in
these assets to the same commercial bank. These notes were assumed as a result
of the 1996 Diamond acquisition.
The Company's other debt instruments are secured by the assets of the
respective subsidiaries and general corporate guarantees by Heska Corporation.
Maturities of long-term debt as of December 31, 2000 were as follows (in
thousands):
YEAR ENDING
DECEMBER 31,
------------
2001 $ 1,562
2002 727
2003 463
2004 456
2005 228
Thereafter 796
---------
$ 4,232
=========
7. ACCRUED PENSION LIABILITY
Diamond has a noncontributory defined benefit pension plan covering all
employees who have met the eligibility requirements. The plan provides monthly
benefits based on years of service which are subject to certain reductions if
the employee retires before reaching age 65. Diamond's funding policy is to
make the minimum annual contribution that is required by applicable regulations.
Effective October 1992, Diamond froze the plan, restricting new participants and
benefits for future service.
The following table sets forth the plan's funded status and amounts
recognized in the accompanying balance sheets (in thousands):
DECEMBER 31,
-----------------------
2000 1999
------ ------
Change in benefit obligation:
Benefit obligation, beginning $ 1,171 $ 1,126
Service cost - -
Interest cost 80 76
Actuarial loss (39) 31
Benefits paid (85) (62)
------- -------
Benefit obligation, ending 1,127 1,171
------- -------
Change in plan assets:
Fair value of plan assets,
beginning 971 1,050
Actual return on plan assets 68 (17)
Employer contribution - -
Benefits paid (85) (62)
------- -------
Fair value of plan assets, ending 954 971
------- -------
Funded status (173) (200)
Unrecognized net actuarial loss 234 274
------- -------
Prepaid benefit cost $ 61 $ 74
======= =======
Additional minimum liability disclosures:
Accrued benefit liability $ (173) $ (200)
======= =======
Components of net periodic benefit costs:
Service cost $ - $ -
Interest cost 80 77
Expected return on plan assets (73) (79)
Recognized net actuarial loss 7 2
------- -------
Net periodic benefit cost $ 14 $ -
======= =======
Assumptions used by Diamond in the determination of the pension plan
information consisted of the following:
DECEMBER 31,
-----------------
2000 1999
------ ------
Discount rate 7.00% 7.00%
Expected long-term rate of return on plan assets 7.75% 7.75%
8. INCOME TAXES
As of December 31, 2000 the Company had approximately $154.6 million of net
operating loss ("NOL") carryforwards for income tax purposes and approximately
$3.1 million of research and development tax credits available to offset future
federal income tax, subject to limitations for alternative minimum tax. The NOL
and credit carryforwards are subject to examination by the tax authorities and
expire in various years from 2003 through 2020. The Tax Reform Act of 1986
contains provisions that may limit the NOL and credit carryforwards available
for use in any given year upon the occurrence of certain events, including
significant changes in ownership interest. A change in ownership
of a company of greater than 50% within a three-year period results in an annual
limitation on the Company's ability to utilize its NOL carryforwards from tax
periods prior to the ownership change. The acquisition of Diamond in April 1996
resulted in such a change of ownership and the Company estimates that the
resulting NOL carryforward limitation will be approximately $4.7 million per
year for periods subsequent to April 19, 1996. The Company believes that this
limitation may affect the eventual utilization of its total NOL carryforwards.
The Company's NOL's represent a previously unrecognized tax benefit.
Recognition of these benefits requires future taxable income, the attainment of
which is uncertain, and therefore, a valuation allowance has been established
for the entire tax benefit and no benefit for income taxes has been recognized
in the accompanying consolidated statements of operations.
The components of net loss were as follows (in thousands):
Year Ended
December 31,
-------------------------
2000 1999
------- -------
Domestic $ (20,642) $ (32,087)
Foreign (1,228) (3,749)
---------- ----------
$ (21,870) $ (35,836)
=========== ==========
Temporary differences that give rise to the components of deferred tax
assets are as follows (in thousands):
December 31,
--------------------
2000 1999
------ ------
Current deferred tax assets (liabilities):
Inventory valuation and reserves $ 268 $ 281
Accrued compensation 121 111
Restructuring reserve 254 430
Other 182 51
------- -------
825 873
Valuation allowance (825) (873)
------- -------
Total current deferred tax assets
(liabilities) - -
======= =======
Noncurrent deferred tax assets (liabilities):
Research and development credits 3,126 2,744
Deferred revenue 17 268
Pension liability 19 77
Amortization of intangible assets 314 711
Loss on assets held for sale (35) 594
Property and equipment (875) (511)
Net operating loss carryforwards 58,874 48,786
-------- --------
61,440 52,669
Valuation allowance (61,440) (52,669)
-------- --------
Total noncurrent deferred tax assets
(liabilities) $ - $ -
======== ========
The components of the income tax expense (benefit) are as follows (in
thousands):
Year Ended
December 31,
-------------------
2000 1999
------ ------
Deferred income tax benefit:
Federal $ (7,265) $ (10,886)
State (969) (1,452)
Foreign (490) (735)
--------- ----------
Total benefit (8,724) (13,073)
Valuation allowance 8,724 13,073
--------- ----------
Total income tax expense (benefit) $ - $ -
========= ==========
The Company's income tax benefit relating to losses, respectively, for the
periods presented differ from the amounts that would result from applying the
federal statutory rate to those losses as follows:
Year Ended
December 31,
----------------------
2000 1999
---- ----
Statutory federal tax rate (34%) (34%)
State income taxes, net of federal benefit (4%) (4%)
Amortization of deferred compensation 1% 1%
Change in valuation allowance 37% 37%
------- -------
Effective income tax rate 0% 0%
======= =======
9. COMMITMENTS AND CONTINGENCIES
In November 1998, Synbiotics Corporation ("Synbiotics") filed a lawsuit
against the Company in the United States District Court for the Southern
District of California in which it alleges that the Company infringed a patent
owned by Synbiotics relating to heartworm diagnostic technology. The Company
has answered the complaint and no trial date has been set. The Company has
obtained legal opinions from outside patent counsel that its 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
the Company's internal evaluations. In September 2000, the U.S. District Court
hearing the case granted the Company's request for a partial summary judgment,
holding two of the Synbiotics patent claims to be invalid, leaving only one
remaining claim. While management believes that the Company
has valid defenses to Synbiotics' allegations and intends to defend the
action vigorously, there can be no assurance that an adverse result or
settlement would not have a material adverse effect on the Company's financial
position, its results of operations or cash flow.
The Company holds certain rights to market and manufacture all products
developed or created under certain research, development and licensing
agreements with various entities. In connection with such agreements, the
Company has agreed to pay the entities royalties on net product sales. In the
years ended December 31, 2000, 1999 and 1998, royalties of $931,000, $1.0
million and $52,000 became payable under these agreements, respectively.
The Company contracts with various parties that conduct research and
development on the Company's behalf. In return, the Company generally receives
the right to commercialize any products resulting from these contracts. In the
event the Company licenses any technology developed under these contracts, the
Company will generally be obligated to pay royalties at specified percentages of
future sales of products utilizing the licensed technology.
The Company has entered into operating leases for its office and research
facilities and certain equipment with future minimum payments as of December 31,
2000 as follows (in thousands):
YEAR ENDING
DECEMBER 31,
------------
2001 $ 878
2002 878
2003 799
2004 666
2005 108
---------
$ 3,329
=========
The Company had rent expense of $1.0 million, $1.1 million and $1.4 million
in 2000, 1999 and 1998, respectively.
10. CAPITAL STOCK
Common Stock
In February 2001, the Company completed a private placement of 4.57 million
shares of common stock at a price of $1.247 per share, providing the Company
with net proceeds of approximately $5.3 million.
In December 1999, the Company completed a public offering of 6.5 million
shares of common stock at a price of $2.063 per share, providing the Company
with net proceeds of approximately $13.3 million.
In July 1998, the Company issued 1.165 million shares of the Company's
common stock to Ralston Purina Company, for $14.75 million in cash, and also
issued, for an additional cash payment of $250,000, warrants to purchase an
additional 1.165 million shares of the Company's common stock. The exercise
price of the warrants was $12.67 for the first year of the warrants, increasing
by 20% per year for each of the second and third years of the warrants. The
warrants were exercisable immediately as of July 30, 1998 and expire in three
years with respect to any unexercised shares.
In July 1998, the Company issued 205,619 shares of common stock to Bayer
Corporation ("Bayer") in consideration for the acquisition by Diamond of certain
assets, including land and buildings formerly leased by Diamond from Bayer, and
as repayment in full of certain indebtedness of Diamond to Bayer, in a
transaction valued at approximately $2.3 million.
In March 1998, the Company completed its follow-on public offering of
5,750,000 shares of common stock (including 500,000 shares offered by a
stockholder of the Company and an underwriters' over-allotment option exercised
for 750,000 shares) at a price of $9.875 per share, providing the Company with
net proceeds of approximately $48.6 million.
Stock Option Plans
The Company has a stock option plan which authorizes granting of stock
options and stock purchase rights to employees, officers, directors and
consultants of the Company to purchase shares of common stock. In 1997, the
board of directors adopted the 1997 Stock Incentive Plan and terminated two
prior option plans. However, options granted and unexercised under the prior
plans are still outstanding. All shares remaining available for grant under the
terminated plans were rolled into the 1997 Plan. In addition, all shares which
are subsequently cancelled under the prior plans are rolled into the 1997 Plan
on a quarterly basis. The number of shares reserved for issuance under the 1997
Plan increases automatically on January 1 of each year by a number equal to the
lesser of (a) 1,500,000 shares or (b) 5% of the shares of common stock
outstanding on the immediately preceding December 31. The number of shares
reserved for issuance under all plans as of January 1, 2001 was 7,643,853.
The stock options granted by the board of directors may be either incentive
stock options ("ISOs") or non-qualified stock options ("NQs"). The purchase
price for options under all of the plans may be no less than 100% of fair market
value for ISOs or 85% of fair market value for NQs. Options granted will expire
no later than the tenth anniversary subsequent to the date of grant or three
months following termination of employment, except in cases of death or
disability, in which case the options will remain exercisable for up to twelve
months. Under the terms of the 1997 Plan, in the event the Company is sold or
merged, options granted will either be assumed by the surviving corporation or
vest immediately.
SFAS No. 123 ("SFAS 123")
SFAS 123, Accounting for Stock-Based Compensation, defines a fair value
based method of accounting for employee stock options, employee stock purchases,
or similar equity instruments. However, SFAS 123 allows the continued
measurement of compensation cost for such plans using the intrinsic value based
method prescribed by APB Opinion No. 25, Accounting for Stock Issued to
Employees ("APB 25"), provided that pro forma disclosures are made of net income
or loss, assuming the fair value based method of SFAS 123 had been applied.
The Company has elected to account for its stock-based compensation plans under
APB 25; accordingly, for purposes of the pro forma disclosures presented below,
the Company has computed the fair values of all options granted during 2000,
1999 and 1998, using the Black-Scholes pricing model and the following weighted
average assumptions:
2000 1999 1998
---- ---- ----
Risk-free interest rate 6.26% 5.63% 5.28%
Expected lives 7.59 years 3.5 years 3.8 years
Expected volatility 94% 91% 89%
Expected dividend yield 0% 0% 0%
To estimate expected lives of options for this valuation, it was assumed
options will be exercised at varying schedules after becoming fully vested
dependent upon the income level of the option holder. For measurement purposes,
options have been segregated into three income groups, and estimated exercise
behavior of option recipients varies from six months to one and one half years
from the date of vesting, dependent on income group (less highly compensated
employees are expected to have shorter holding periods). All options are
initially assumed to vest. Cumulative compensation cost recognized in pro forma
basic net income or loss with respect to options that are forfeited prior to
vesting is adjusted as a reduction of pro forma compensation expense in the
period of forfeiture. Fair value computations are highly sensitive to the
volatility factor assumed; the greater the volatility, the higher the computed
fair value of the options granted.
The total fair value of options granted was computed to be approximately
$1.7 million, $3.8 million and $8.8 million for the years ended December 31,
2000, 1999 and 1998, respectively. The amounts are amortized ratably over the
vesting periods of the options. Pro forma stock-based compensation, net of the
effect of forfeitures, was $2.2 million, $3.6 million and $3.9 million for 2000,
1999 and 1998, respectively.
A summary of the Company's stock option plans is as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------
2000 1999 1998
--------------------- -------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- --------- ---------- --------- ---------- -----------
Outstanding at beginning of period 4,246,183 $ 4.6994 3,209,317 $ 5.1203 2,570,533 $ 1.9053
Granted 753,700 $ 3.3453 1,725,480 $ 3.4876 1,304,443 $ 10.6166
Cancelled (600,228) $ 6.5438 (329,820) $ 6.6815 (315,543) $ 5.9544
Exercised (434,967) $ 1.0904 (358,794) $ 0.8148 (350,116) $ 1.2188
--------- --------- ---------
Outstanding at end of period 3,964,668 $ 4.4979 4,246,183 $ 4.6994 3,209,317 $ 5.1203
========= ========= =========
Exercisable at end of period 2,274,489 $ 4.6293 1,973,349 $ 4.1737 1,531,895 $ 2.9417
========= ========= =========
The weighted average estimated fair value of options granted during the
years ended December 31, 2000, 1999 and 1998 were $2.3277, $2.1814 and $6.7635,
respectively.
In 1998 the Company also granted stock options to non-employees in exchange
for consulting services, recording deferred compensation of $46,000 based on the
estimated fair value of the options at the date of grant. Deferred compensation
was amortized over the applicable service periods. The amortization of deferred
compensation resulted in a non-cash charge to operations of $648,000, $629,000
and $736,000 in the years ended December 31, 2000, 1999 and 1998, respectively.
The following table summarizes information about stock options outstanding
and exercisable at December 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- --------------------------
NUMBER OF NUMBER OF
OPTIONS WEIGHTED OPTIONS
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
AT REMAINING AVERAGE AT AVERRAGE
DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 2000 LIFE IN YEARS PRICE 2000 PRICE
------------ -------------- ------------ ------------- ----------
$0.25 - $0.35 223,066 4.23 $ 0.3381 223,066 $ 0.3381
$1.20 - $1.20 557,766 5.61 $ 1.2000 551,046 $ 1.2000
$1.31 - $2.00 613,815 8.77 $ 1.9478 174,817 $ 1.8678
$2.06 - $3.37 432,465 8.13 $ 3.0018 211,766 $ 3.0108
$3.69 - $3.88 535,644 9.02 $ 3.6969 136,421 $ 3.7144
$3.94 - $5.25 549,743 7.76 $ 5.0084 282,824 $ 5.0507
$5.37 - $11.75 500,313 7.86 $ 6.5105 283,837 $ 6.9641
$11.88 - $15.00 551,856 7.07 $ 11.9659 410,712 $ 11.9736
--------- ---------
$0.25 - $15.00 3,964,668 7.55 $ 4.4979 2,274,489 $ 4.6293
========= =========
Employee Stock Purchase Plan (the "ESPP")
Under the 1997 Employee Stock Purchase Plan, the Company is authorized to
issue up to 750,000 shares of common stock to its employees. Employees of the
Company and its U.S. subsidiaries who are expected to work at least 20 hours per
week and five months per year are eligible to participate. Under the terms of
the plan, employees can choose to have up to 10% of their annual base earnings
withheld to purchase the Company's common stock. The purchase price of the
stock is 85% of the lower of its beginning-of-enrollment period or end-of-
measurement period market price. Each enrollment period is two years, with six
month measurement periods ending June 30 and December 31.
For the years ended December 31, 2000, 1999 and 1998, the weighted-average
fair value of the purchase rights granted was $0.91, $1.24 and $4.57 per share,
respectively. Pro forma stock-based compensation, net of the effect of
adjustments, was approximately $112,462, $96,000 and $268,000 in 2000, 1999 and
1998, respectively, for the ESPP.
Pro Forma Basic Net Loss per Share under SFAS 123
If the Company had accounted for all of its stock-based compensation plans
in accordance with SFAS 123, the Company's net loss would have been reported as
follows (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
--------- -------- ---------
Net loss:
As reported $ (21,870) $ (35,836) $ (44,274)
========= ========= =========
Pro forma (24,143) $ (39,564) $ (48,442)
========= ======== =========
Basic net loss per share:
As reported $ (0.65) $ (1.31) $ (1.79)
========= ========= ========
Pro forma $ (0.71) $ (1.45) $ (1.96)
========= ========= ========
Stock Warrants
In July 1998, the Company issued warrants to purchase 1.165 million shares
of the Company's common stock in connection with the private placement with
Ralston Purina described previously. The exercise price of the warrants was
$12.67 for the first year of the warrants, increasing by 20% per year for each
of the second and third years of the warrants. The warrants were exercisable
immediately as of July 30, 1998 and expire in three years with respect to any
unexercised shares.
11. MAJOR CUSTOMERS
The Company had sales of greater than 10% of total revenue to only one
customer during the years ended December 31, 2000, 1999 and 1998. The customer
which represented 17% of total revenues in 2000, and a different customer which
represented 12% and 15% of total revenues in 1999 and 1998, respectively,
purchased vaccines from Diamond.
12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
YEAR ENDED DECEMBER 31,
-------------------------
2000 1999 1998
------- ------- -------
(IN THOUSANDS)
Cash paid for interest $ 1,155 $ 1,857 $ 1,999
Non-cash investing and financing activities:
Issuance of common stock in exchange for assets and as
repayment of debt - - 2,262
Purchase of assets under direct capital lease financing 45 193 86
13. SEGMENT REPORTING
The Company divides its operations into three reportable segments.
Companion Animal Health includes the operations of Heska, Heska Waukesha
(through 1999), CMG and Heska AG. Food Animal Health includes the operations of
Diamond Animal Health. Allergy Treatment includes the operations of Center,
which was sold in June 2000.
Summarized financial information concerning the Company's reportable
segments is shown in the following table (in thousands). The "Other" column
includes the elimination of intercompany transactions and other items as noted.
COMPANION FOOD
ANIMAL ANIMAL ALLERGY
HEALTH HEALTH TREATMENT OTHER TOTAL
--------- -------- --------- -------- ----------
2000:
Revenues $ 31,684 $ 19,907 $ 3,353 $ (2,269) $ 52,675
Operating income (loss) (22,065) 1,539 (24) (790) (a) (21,340)
Total assets 53,109 17,533 - (31,482) 39,160
Capital expenditures 724 483 - - 1,207
Depreciation and amortization 2,277 1,577 212 - 4,066
________
(a) Includes the write-down of certain fixed assets to their expected
net realizable values, resulting in a loss of $355,000 and
restructuring expenses of $435,000 (See Note 5).
COMPANION FOOD
ANIMAL ANIMAL ALLERGY
HEALTH HEALTH TREATMENT OTHER TOTAL
--------- -------- --------- --------- ---------
1999:
Revenues $ 29,282 $ 18,149 $ 7,105 $ (3,360) $ 51,176
Operating income (loss) (27,878) (2,534) (372) (3,803 (b) (34,587)
Total assets 89,199 22,185 6,376 (46,592) 71,168
Capital expenditures 743 2,368 185 - 3,296
Depreciation and amortization 2,155 1,294 415 - 3,864
________
(b) Includes the write-down of certain tangible and
intangible assets to their expected net realizable values,
resulting from a loss on assets held for disposition of $2.6
million and restructuring expenses of $1.2 million (See Note 5).
COMPANION FOOD
ANIMAL ANIMAL ALLERGY
HEALTH HEALTH TREATMENT OTHER TOTAL
--------- -------- --------- ----------- ---------
1998:
Revenues $ 18,610 $ 18,250 $ 7,374 $ (4,462) $ 39,772
Operating income (loss) (39,196) 86 (672) (6,174) (c) (45,956)
Total assets 102,895 21,884 6,682 (33,407) 98,054
Capital expenditures 1,995 3,686 789 - 6,470
Depreciation and amortization 2,406 890 304 - 3,600
________
(c) Includes the write-down of certain tangible and intangible
assets to their expected net realizable values, resulting from
a loss on assets held for disposition of $1.3 million,
restructuring expenses of $2.4 million (See Note 5) and
inventory write-downs of $1.5 million.
The Company manufactures and markets its products in two major geographic
areas, North America and Europe. The Company's primary manufacturing facilities
are located in North America. Revenues earned in North America are attributable
to Heska, Diamond, Heska Waukesha (through 1999) and Center (through June 2000).
Revenues earned in Europe are primarily attributable to Heska UK (through
January 2000), CMG and Heska AG. There have been no significant exports from
North America or Europe.
During each of the years presented, European subsidiaries purchased
products from North America for sale to European customers. Transfer prices to
international subsidiaries are intended to allow the North American companies to
produce profit margins commensurate with their sales and
marketing efforts. Certain information by geographic area is shown in the
following table (in thousands). The "Other" column includes the elimination of
intercompany transactions.
NORTH
AMERICA EUROPE OTHER TOTAL
--------- --------- --------- -------
2000:
Revenues $ 52,580 $ 2,364 $ (2,269) $ 52,675
Operating income (loss) (20,444) (896) - (21,340)
Total assets 68,130 2,512 (31,482) 39,160
Capital expenditures 1,082 125 - 1,207
Depreciation and amortization 3,956 110 - 4,066
1999
Revenues $ 50,336 $ 4,200 $ (3,360) $ 51,176
Operating income (loss) (27,431) (3,353) (3,803) (34,587)
Total assets 114,165 3,595 (46,592) 71,168
Capital expenditures 3,292 4 - 3,296
Depreciation and amortization 3,701 163 - 3,864
1998
Revenues $ 40,573 $ 3,661 $ (4,462) $ 39,772
Operating income (loss) (37,386) (2,396) (6,174) (45,956)
Total assets 127,004 4,457 (33,407) 98,054
Capital expenditures 6,190 280 - 6,470
Depreciation and amortization 3,009 591 - 3,600
14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following summarizes selected quarterly financial information for each
of the two years in the period ended December 31, 2000 (amounts in thousands
except per share data).
Q1 Q2 Q3 Q4 TOTAL
--------- --------- --------- --------- --------
2000:
Total revenues $ 14,363 $ 14,243 $ 12,708 $ 11,362 $ 52,675
Gross profit from product sales 4,001 4,250 3,944 4,055 16,250
Net loss (5,929) (5,703) (4,731) (5,507) (21,870)
Net loss per share - basic and diluted (0.18) (0.17) (0.14) (0.16) (0.65)
1999:
Total revenues $ 11,051 $ 12,878 $ 13,067 $ 14,180 $ 51,176
Gross profit from product sales 3,301 4,267 4,213 2,124 13,905
Net loss (7,883) (6,931) (8,323) (12,699) (35,836)
Net loss per share - basic and diluted (0.30) (0.26) (0.31) (0.44) (1.31)
15. SUBSEQUENT EVENTS
On February 6, 2001, the Company sold 4,573,000 shares of common stock
through a private placement offering with net proceeds to the Company of
approximately $5.3 million. The Company has agreed to register the shares
issued under the private placement as soon as practicable.
On March 23, 2001, the Company re-negotiated the covenants under its
revolving line of credit facility. The Company's ability to borrow under this
agreement varies based upon available cash, eligible accounts receivable and
eligible inventory. The minimum liquidity (cash plus excess capacity) required
to be maintained has been reduced to $3 million during 2001. As of March 23,
2001, the Company's available borrowing capacity was approximately $5 million.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
Certain information required by Part III is incorporated by reference to
our definitive Proxy Statement to be filed with the Securities and Exchange
Commission in connection with the solicitation of proxies for our 2001 Annual
Meeting of Stockholders.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this section is incorporated by reference to
the information in the sections entitled "Election of Directors-Directors and
Nominees for Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement. The required information concerning our
executive officers is contained in the section entitled "Executive Officers of
the Registrant" in Part I of this Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this section is incorporated by reference to
the information in the sections entitled "Election of Directors-Directors'
Compensation" and "Executive Compensation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this section is incorporated by reference to
the information in the section entitled "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this section is incorporated by reference to
the information in the section entitled "Certain Transactions and Relationships"
in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Form 10-K.
(1) FINANCIAL STATEMENTS:
Reference is made to the Index to Consolidated Financial Statements
under Item 8 in Part II of this Form 10-K.
(2) FINANCIAL STATEMENT SCHEDULES:
Schedule II - Valuation and Qualifying Accounts.
SCHEDULE II
HESKA CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
BALANCE CHARGED
AT TO BALANCE
BEGINNING COSTS AND AT
OF YEAR EXPENSES OTHER END OF
--------- --------- ADDITIONS DEDUCTIONS YEAR
--------- ---------- --------
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Year ended:
December 31, 2000 $ 188 $ 320 - $ (77) (a) $ 431
December 31, 1999 $ 93 $ 122 - $ (27) (a) $ 188
December 31, 1998 $ 96 $ 9 - $ (12) (a) $ 93
ALLOWANCE FOR RESTRUCTURING CHARGES
Year ended:
December 31, 2000 $ 1,123 $ 435 - (1,382) (a) $ 176
December 31, 1999 $ 1,631 $ 1,210 - $ (1,718) (a) $ 1,123
December 31, 1998 - $ 2,356 - $ (725) (a) $ 1,631
________
(a) Write-offs of uncollectible accounts and payments for personnel
severance costs and facility closing costs.
3) EXHIBITS:
The exhibits listed below are required by Item 601 of Regulation S-K.
Each management contract or compensatory plan or arrangement required
to be filed as an exhibit to this Form 10-K has been identified.
Exhibit
Number
- -------
Notes Description of Document
----- -----------
3(i)(d) (9) Restated Certificate of Incorporation of the
Registrant
3(ii) Bylaws of the Registrant
4.2 (1) First Amended Investors' Rights Agreement by and
among Registrant and certain stockholders of
Registrant dated as of April 12, 1996.
4.2(a) (6) Waiver and Amendment to first Amended Investors'
Rights Agreement among the Company and certain
other parties.
4.2(b) (6) Second Waiver and Amendment to first Amended
Investors' Rights Agreement among the Company and
certain other parties.
4.2(c) (6) Third Waiver and Amendment to first Amended
Investors' Rights Agreement among the Company and
certain other parties.
4.3 (1) Form of warrant to purchase Series C Preferred
Stock.
4.4 (1) Form of warrant to purchase Series D Preferred
Stock.
4.5 (5) Company Stock Warrant Purchase Agreement dated as
of July 29, 1998 between the Company and Ralston
Purina Company.
10.1H (1) Collaborative Agreement between Registrant and
Eisai Co., Ltd. dated January 25, 1993.
10.2H (1) Canine Heartworm Cooperation Agreement between
Registrant and Bayer AG dated as of June 10, 1994.
10.3H (1) Feline Toxoplasmosis Cooperation Agreement between
Registrant and Bayer AG dated as of June 10, 1994.
10.5H (1) Screening and Development Agreement between Ciba-
Geigy Limited and Registrant, dated as of April 12,
1996.
10.6 (1) Right of First Refusal Agreement between Ciba-Geigy
Limited and Registrant, dated as of April 12, 1996.
10.7 (1) Marketing Agreement between Registrant and Ciba-
Geigy Limited dated as of April 12, 1996.
10.8H (1) Marketing Agreement between Registrant and Ciba-
Geigy Corporation dated as of April 12, 1996.
10.9H (1) Manufacturing and Supply Agreement between and
among Diamond Animal Health, Inc., Agrion
Corporation, Diamond Scientific Co. and Miles Inc.
dated December 31, 1993 and Amendment and Extension
thereto dated September 1, 1995.
10.9(a)H (5) Second Amendment to Manufacturing and Supply
Agreement between Diamond Animal Health, Inc. and
Bayer Corporation dated February 26, 1998.
10.10* (1) Employment Agreement between Registrant and Robert
B. Grieve dated January 1, 1994, as amended March
4, 1997.
10.10(a) * Amended and Restated Employment Agreement with
Robert B. Grieve dated as of February 22, 2000.
10.14H (2) Supply Agreement between Registrant and Quidel
Corporation dated July 3, 1997.
10.18* (1) Form of Indemnification Agreement entered into
between Registrant and its directors and certain
officers.
10.19* (1) 1997 Incentive Stock Plan of Registrant.
10.20* (1) Forms of Option Agreement.
10.21* (1) 1997 Employee Stock Purchase Plan of Registrant.
10.22 (1) Lease Agreement dated March 8, 1994 between Sharp
Point Properties, LLC and Registrant.
10.23 (1) Lease Agreement dated as of June 27, 1996 between
GB Ventures and Registrant.
10.24 (1) Lease Agreement dated as of July 11, 1996 between
GB Ventures and Registrant.
10.26* (3) Employment Agreement between Registrant and
Giuseppe Miozzari dated July 1, 1997.
10.26(a) * Amended and Restated Employment Agreement between
Registrant and Giuseppe Miozzari dated June 9,
2000.
10.28* (7) Employment Agreement between Registrant and Ronald
L. Hendrick dated December 1, 1998.
10.29* (7) Employment Agreement between Registrant and James
H. Fuller dated January 18, 1999.
10.30* (7) Separation Agreement between Registrant and Fred M.
Schwarzer dated December 14, 1998.
10.31* (7) Consulting Services and Confidentiality Agreement
between Registrant and Fred M. Schwarzer dated
December 14, 1998.
10.34H (7) Exclusive Distribution Agreement dated as of August
18, 1998 between the Company and Novartis Agro K.K.
10.35 (7) Right of First Refusal Agreement dated as of August
18, 1998 between the Company and Novartis Animal
Health, Inc.
10.37* (8) Consultant Services and Confidentiality Agreement
between Registrant and Seward Pharm, LLC dated
December 1, 1999.
10.39 (9) Second Amended and Restated Credit and Security
Agreement by and between Heska Corporation, Diamond
Animal Health, Inc., Center Laboratories, Inc. and
Wells Fargo Business Credit, Inc., dated as of June
14, 2000.
10.40* (9) Employment agreement by and between Registrant and
Dan T. Stinchcomb dated as of May 1, 2000.
10.41* (9) Employment agreement by and between Registrant and
Carol Talkington Verser dated as of May 1, 2000.
10.42* Management Incentive Compensation Plan
21.1 Subsidiaries of the Company.
23.1 Consent of Arthur Andersen LLP.
24.1 Power of Attorney (See page 60 of this Form 10-K).
Notes
- -----
* Indicates management contract or compensatory plan or arrangement.
H Confidential treatment has been granted with respect to
certain portions of these agreements.
(1) Filed with Registrant's Registration Statement on Form S-1
(File No. 333-25767).
(2) Filed with the Registrant's Form 10-Q for the quarter ended
September 30, 1997.
(3) Filed with Registrant's Registration Statement on Form S-1
(File No. 333-44835).
(4) Filed with the Registrant's Form 10-K for the year ended
December 31, 1998.
(5) Filed with the Registrant's Form 10-Q for the quarter ended
March 31, 1998.
(6) Filed with the Registrant's Form 10-Q for the quarter ended
September 30, 1998.
(7) Filed with the Registrant's Form 10-Q for the quarter ended
June 30, 1999.
(8) Filed with the Registrant's Form 10-K for the year ended
December 31, 1999.
(9) Filed with the Registrant's Form 10-Q for the quarter ended
June 30, 2000.
(b) Reports on Form 8-K:
There were no Reports on Form 8-K filed by the Company during the quarter
ended December 31, 2000.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 23, 2001.
HESKA CORPORATION
By /s/ ROBERT B. GRIEVE
Robert B. Grieve
Chairman of the Board and
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Robert B. Grieve, Ronald L. Hendrick,
Michael A. Bent and A. Lynn DeGeorge, and each of them, his or her true and
lawful attorneys-in-fact, each with full power of substitution, for him or her
in any and all capacities, to sign any amendments to this report on Form 10-K
and to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact or their substitute or
substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated:
Name Title Date
- ---- ----- ----
/s/ Robert B. Grieve Chairman of the Board March 23, 2001
- -------------------------- and Chief Executive
Robert B. Grieve Officer (Principal
Executive Officer)
and Director
/s/ Ronald L. Hendrick Chief Financial Officer, March 23, 2001
- -------------------------- Executive Vice President
Ronald L. Hendrick and Secretary (Principal
Financial and Accounting
Officer)
/s/ Fred M. Schwarzer Director March 23, 2001
- --------------------------
Fred M. Schwarzer
/s/ A. Barr Dolan Director March 23, 2001
- --------------------------
A. Barr Dolan
/s/ Lyle A. Hohnke Director March 23, 2001
- --------------------------
Lyle A. Hohnke
/s/ Edith W. Martin Director March 23, 2001
- --------------------------
Edith W. Martin
/s/ William A. Aylesworth Director March 23, 2001
- --------------------------
William A. Aylesworth
s/ Lynnor B. Stevenson Director March 23, 2001
- --------------------------
Lynnor B. Stevenson
/s/ John F. Sasen, Sr. Director March 23, 2001
- --------------------------
John F. Sasen, Sr.