UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ____________
Commission file number 000-22427
HESKA CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 77-0192527
[State or other jurisdiction of [I.R.S. Employer
incorporation or organization] Identification No.]
1613 PROSPECT PARKWAY
FORT COLLINS, COLORADO 80525
(Address of principal executive offices)
(970) 493-7272
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
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.
[ X ] Yes [ ] No
The number of shares of the Registrant's Common Stock, $.001 par
value, outstanding at
November 9, 2001 was 39,895,601
HESKA CORPORATION
FORM 10-Q
QUARTERLY REPORT
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets (Unaudited) as of
September 30, 2001 and December 31, 2000 3
Consolidated Statements of Operations (Unaudited)
for the three and nine months ended
September 30, 2001 and 2000 4
Condensed Consolidated Statements of Cash Flows
(Unaudited) for the nine months ended
September 30, 2001 and 2000 5
Notes to Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings Not Applicable
Item 2. Changes in Securities and Use of Proceeds 29
Item 3. Defaults Upon Senior Securities Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders Not Applicable
Item 5. Other Information Not Applicable
Item 6. Exhibits and Reports on Form 8-K 29
Exhibit Index 29
Signatures 30
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands except per share amounts)
(unaudited)
ASSETS
SEPTEMBER 30, DECEMBER 31,
2001 2000
-------------- ---------------
Current assets:
Cash and cash equivalents $ 2,906 $ 3,176
Marketable securities - 2,482
Accounts receivable, net of allowance of $279 and $431, respectively 8,597 8,433
Inventories, net of reserve of $578 and $606, respectively 9,593 8,716
Other current assets 1,440 742
-------------- --------------
Total current assets 22,536 23,549
Property and equipment, net of accumulated depreciation of $16,066 and
$13,645, respectively 10,594 12,901
Intangible assets, net of accumulated amortization of $1,296 and
$1,041, respectively 1,482 1,457
Restricted marketable securities and other assets 634 1,253
-------------- --------------
Total assets $ 35,246 $ 39,160
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,851 $ 3,370
Accrued liabilities 3,339 4,258
Deferred revenue and other 1,261 467
Line of credit 4,345 912
Current portion of capital lease obligations 137 584
Current portion of long-term debt 762 650
-------------- --------------
Total current liabilities 14,695 10,241
Capital lease obligations, net of current portion 69 138
Long-term debt, net of current portion 2,258 2,670
Other long-term liabilities 924 1,011
-------------- --------------
Total liabilities 17,946 14,060
-------------- --------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, 25,000,000 shares authorized;
none outstanding - -
Common stock, $.001 par value, 75,000,000 shares authorized; 38,838,214
and 34,072,640 shares issued and outstanding, respectively 39 34
Additional paid-in capital 205,228 199,789
Accumulated other comprehensive loss (364) (251)
Accumulated deficit (187,603) (174,472)
-------------- --------------
Total stockholders' equity 17,300 25,100
-------------- --------------
Total liabilities and stockholders' equity $ 35,246 $ 39,160
============== ==============
See accompanying notes to consolidated financial statements
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2001 2000 2001 2000
---- ---- ---- ----
Revenues:
Products, net $ 11,035 $ 12,396 $ 32,048 $ 38,533
Research, development and other 720 312 1,571 2,781
-------- -------- -------- --------
Total revenues 11,755 12,708 33,619 41,314
Cost of products sold 6,920 8,452 20,124 26,338
-------- -------- -------- --------
4,835 4,256 13,495 14,976
-------- -------- -------- --------
Operating expenses:
Selling and marketing 3,349 3,275 10,491 11,486
Research and development 3,236 3,605 9,809 11,406
General and administrative 1,883 1,888 5,773 7,217
Amortization of intangible assets and
deferred compensation 67 207 200 623
Gain on sale of assets - - - (151)
Restructuring expense - - - 435
-------- -------- -------- --------
Total operating expenses 8,535 8,975 26,273 31,016
-------- -------- -------- --------
Loss from operations (3,700) (4,719) (12,778) (16,040)
Other (expense), net (194) (12) (352) (322)
-------- -------- -------- --------
Net loss $ (3,894) $ (4,731) $(13,130) $(16,362)
======== ======== ======== ========
Basic and diluted net loss per share $ (0.10) $ (0.14) $ (0.34) $ (0.49)
======== ======== ======== ========
Shares used to compute basic and diluted
net loss per share 38,838 33,872 38,187 33,735
======== ======== ======== ========
See accompanying notes to consolidated financial statements
HESKA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
NINE MONTHS
ENDED
SEPTEMBER 30,
-------------
2001 2000
---- ----
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net cash used in operating activities $ (10,300) $ (14,244)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of marketable securities 2,500 15,546
Proceeds from sale of subsidiary - 6,000
Proceeds from disposition of property and equipment 317 406
Purchase of property and equipment (790) (889)
--------- ---------
Net cash provided by investing activities 2,027 21,063
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 5,444 495
Proceeds from borrowings 4,345 136
Repayments of debt and capital lease obligations (1,733) (6,758)
--------- ---------
Net cash provided by (used in) financing activities 8,056 (6,127)
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (53) (148)
--------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (270) 544
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,176 1,499
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,906 $ 2,043
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 447 $ 1,006
========= =========
See accompanying notes to consolidated financial statements
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
(UNAUDITED)
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 some of Heska's companion animal health
products, the Company's primary manufacturing subsidiary, Diamond Animal Health,
Inc. ("Diamond"), manufactures food animal vaccines and pharmaceutical products
that are marketed and distributed by third parties. The Company also offers
diagnostic services to veterinarians at its Fort Collins, Colorado location and
through its subsidiary, CMG-Heska Allergy Products S.A. ("CMG"), a Swiss
corporation.
From the Company's inception in 1988 until early 1996, the Company's
operations 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 (1) 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 (2) 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.
In 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 the first quarter of
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 September 30, 2001 have totaled $187.6
million.
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 our 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 will 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's primary sources of liquidity at September 30, 2001 were the
$2.9 million in cash and cash equivalents and the asset-based revolving line of
credit. At September 30, 2001, the Company had borrowed $4.3 million under its
revolving line of credit facility and had available additional borrowing
capacity of approximately $2.5 million. The Company believes that its
available cash and cash equivalents, 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 through the end of 2001. The Company will need to raise
additional capital to continue its business operations in 2002. The Company
expects to raise these additional funds through one or more of the following:
(1) sale of additional equity or debt 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 will
need to take actions to conserve its cash balances, including reducing
capital expenditures, reducing operating expenses, eliminating personnel
and curtailing certain operations, all of which would likely have a material
adverse affect on the Company's business, financial condition and results
of operations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. The balance sheet as of September 30, 2001, the
statements of operations for the three and nine months ended September 30, 2001
and 2000 and the statements of cash flows for the nine months ended September
30, 2001 and 2000 are unaudited but include, in the opinion of management, all
adjustments (consisting of normal recurring adjustments) which the Company
considers necessary for a fair presentation of its financial position, operating
results and cash flows for the periods presented. The consolidated financial
statements include the accounts of the Company and its wholly owned subsidiaries
since the dates of their respective acquisitions when accounted for under the
purchase method of accounting, and for all periods presented when accounted for
under the pooling-of-interests method of accounting. All material intercompany
transactions and balances have been eliminated in consolidation. Although the
Company believes that the disclosures in these financial statements are adequate
to make the information presented not misleading, certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission.
Results for any interim period are not necessarily indicative of results
for any future interim period or for the entire year. The accompanying
financial statements and related disclosures have been prepared with the
presumption that users of the interim financial information have read or have
access to the audited financial statements for the preceding fiscal year.
Accordingly, these financial statements should be read in conjunction with the
audited financial statements and the related notes thereto for the year ended
December 31, 2000, included in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission on March 29, 2001.
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
The Company had $2.9 million of cash and cash equivalents as of September
30, 2001. Included in these amounts were Japanese yen with a value in U.S.
dollars of approximately $504,000 which were held in an interest-bearing multi-
currency account of a non-U.S. bank. The Company values its Japanese yen at the
spot market rate as of the balance sheet date. These yen resulted from
settlement of forward contracts entered into for purchases of inventory
throughout fiscal 2001 (See Note 8). Changes in the fair value of the yen are
recorded in current earnings. The Company recognized a loss from devaluation of
the yen of approximately $6,000 during the three months ended September 30,
2001. The Company had no Japanese yen at December 31, 2000.
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 consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------ -----------
Raw materials $ 2,699 $ 2,596
Work in process 3,529 2,904
Finished goods 3,943 3,822
Less reserves for losses (578) (606)
--------- ---------
$ 9,593 $ 8,716
========= =========
Derivative Financial Instruments
The Company utilizes derivative financial instruments to reduce financial
market risks. These instruments may be used to hedge foreign currency, interest
rate and certain equity market exposures of underlying assets, liabilities and
other obligations. The Company does not use derivative financial instruments
for speculative or trading purposes. The Company accounts for its derivative
instruments in accordance with the Statement of Financial Accounting Standards
("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities,"
as amended by SFAS No. 138. This standard requires that all derivative
instruments be recorded on the balance sheet at fair value and establishes
criteria for designation and effectiveness of hedging relationships. The
Company's accounting policies for these instruments are based on whether they
meet the Company's criteria for designation as hedging transactions. The
criteria the Company uses for designating an instrument as a hedge includes the
instrument's effectiveness in risk reduction and one-to-one matching of
derivative instruments to underlying transactions. Gains and losses on currency
forward contracts, and options that are designated and effective as hedges of
anticipated transactions, for which a firm commitment has been attained, are
deferred and recognized in income in the same period that the underlying
transactions are settled. Gains and losses on currency forward contracts,
options and swaps that are designated and effective as hedges of existing
transactions are recognized in income in the same period as losses and gains on
the underlying transactions are recognized and generally offset. Gains and
losses on any instruments not meeting the above criteria are recognized in
income in the current period. If an underlying hedged transaction is terminated
earlier than initially anticipated, the offsetting gain or loss on the related
derivative instrument would be recognized in each period until the instrument
matures, is terminated or is sold.
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 under arrangements to sell product rights or technology
rights are recognized upon the sale and completion by the Company of all
obligations under the agreement. Royalties are recognized as products are sold
to customers.
The Company recognizes revenue from sponsored research and development over
the life of the contract as research activities are performed. The revenue
recognized is the lesser of revenue earned under a percentage of completion
method based on total expected revenues or actual non-refundable cash received
to date under the agreement.
In addition to its direct sales force, the Company utilizes both
distributors and a limited number of 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.
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 and September 30, 2001, outstanding options to purchase
3,964,668 and 3,934,076 shares, respectively, of the Company's common stock and
warrants to purchase 1,165,592 and zero shares of the Company's common stock as
of each date, have been excluded from diluted net loss per share because they
would be anti-dilutive.
Foreign Currency Translation
The functional currency of the Company's international subsidiaries is the
Swiss Franc. 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 are
included in accumulated other comprehensive income in the consolidated balance
sheets. Exchange gains and losses arising from transactions denominated in
foreign currencies (i.e., transaction gains and losses) are recognized in
current operations.
Reclassifications
Certain prior period results have been reclassified to conform to the
current year's presentation.
Recently Issued Accounting Pronouncements
During June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143 "Accounting for
Asset Retirement Obligations". This statement establishes accounting standards
for recognition and measurement of a liability for an asset retirement
obligation and the associated asset retirement cost. It requires an entity to
recognize the fair value of a liability for an asset retirement obligation in
the period in which it is incurred if a reasonable estimate can be made. The
Company is required to adopt this statement in its fiscal year 2003. The
Company does not believe that this statement will materially impact its results
of operations.
During August 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 144 "Accounting
for the Impairment or Disposal of Long-Lived Assets." This statement supersedes
SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to Be Disposed of" and the accounting and reporting provisions of
APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" for segments to be disposed of.
This statement applies to recognized long-lived assets of an entity to be held
and used or to be disposed of. This statement does not apply to goodwill,
intangible assets not being amortized, financial instruments, and deferred tax
assets. This statement requires an impairment loss to be recorded for assets to
be held and used when the carrying amount of a long-lived asset is not
recoverable and exceeds its fair value. An asset that is classified as held for
sale shall be recorded at the lower of its carrying amount or fair value less
cost to sell. The Company is required to adopt this statement for the first
quarter of 2002. The Company does not believe that this statement will
materially impact its results of operations.
3. MAJOR CUSTOMERS
One customer in 2001 and two customers in 2000 accounted for approximately
15% and 41% of total revenue during the three months ended September 30, 2001
and 2000, respectively. These same customers accounted for 12% and 28% of total
revenue for the nine months ended September 30, 2001 and 2000, respectively. At
September 30, 2001, one customer accounted for approximately 19% of accounts
receivable. These customers purchased vaccines from Diamond.
4. SEGMENT REPORTING
The Company divides its operations into three reportable segments.
Companion Animal Health includes the operations of Heska, 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
--------- ------ --------- ----- -----
THREE MONTHS ENDED
SEPTEMBER 30, 2001:
Revenues $ 7,869 $ 4,278 $ - $ (392) $ 11,755
Operating income (loss) (4,240) 540 - - (3,700)
Total assets 48,258 20,435 - (33,447) 35,246
Capital expenditures 169 181 - - 350
Depreciation and
amortization 495 394 - - 889
THREE MONTHS ENDED
SEPTEMBER 30, 2000:
Revenues $ 6,332 $ 6,807 $ - $ (431) $ 12,708
Operating income (loss) (5,761) 1,042 - - (4,719)
Total assets 56,036 20,415 - (31,913) 44,538
Capital expenditures 67 83 - - 150
Depreciation and
amortization 556 649 - - 1,205
COMPANION FOOD
ANIMAL ANIMAL ALLERGY
HEALTH HEALTH TREATMENT OTHER TOTAL
--------- ------ --------- ----- -----
NINE MONTHS ENDED
SEPTEMBER 30, 2001:
Revenues $ 24,333 $ 10,833 $ - $ (1,547) $ 33,619
Operating income (loss) (13,505) 727 - - (12,778)
Total assets 48,258 20,435 - (33,447) 35,246
Capital expenditures 373 417 - - 790
Depreciation and
amortization 1,623 1,157 - - 2,780
NINE MONTHS ENDED
SEPTEMBER 30, 2000:
Revenues $ 23,483 $ 16,382 $ 3,353 $ (1,904) $ 41,314
Operating income (loss) (17,219) 1,637 (23) (435)(a) (16,040)
Total assets 56,036 20,415 - (31,913) 44,538
Capital expenditures 597 292 - - 889
Depreciation and
amortization 1,686 1,423 212 - 3,321
--------------
(a) Includes restructuring expenses of $435,000 (See Note 3).
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 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 the three and nine months ended September 30, 2001 and 2000,
European subsidiaries purchased products from the Company's North American
facilities for sale to European customers. Transfer prices to international
subsidiaries are intended to allow the North American companies to earn 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
-------- ------ ----- -----
THREE MONTHS ENDED
SEPTEMBER 30, 2001:
Revenues $ 11,861 $ 286 $ (392) $ 11,755
Operating income (loss) (3,597) (103) - (3,700)
Total assets 66,668 2,025 (33,447 35,246
Capital expenditures 285 65 - 350
Depreciation and
amortization 824 65 - 889
THREE MONTHS ENDED
SEPTEMBER 30, 2000:
Revenues $ 12,720 $ 419 $ (431) $ 12,708
Operating income (loss) (4,384) (335) - (4,719)
Total assets 73,712 2,739 (31,913) 44,538
Capital expenditures 153 (3) - 150
Depreciation and
amortization 1,192 13 - 1,205
NORTH
AMERICA EUROPE OTHER TOTAL
------- ------ ----- -----
NINE MONTHS ENDED
SEPTEMBER 30, 2001:
Revenues $ 33,835 $ 1,331 $ (1,547) $ 33,619
Operating income (loss) (12,467) (311) - (12,778)
Total assets 66,668 2,025 (33,447) 35,246
Capital expenditures 755 35 - 790
Depreciation and
amortization 2,692 88 - 2,780
NINE MONTHS ENDED
SEPTEMBER 30, 2000:
Revenues $ 41,312 $ 1,906 $ (1,904) $ 41,314
Operating income (loss) (14,831) (774) (435)(a) (16,040)
Total assets 73,712 2,739 (31,913) 44,538
Capital expenditures 838 51 - 889
Depreciation and
amortization 3,260 61 - 3,321
--------------
(a) Includes restructuring expenses of $435,000 (See Note 3).
5. SALE OF COMMON STOCK
In February 2001, the Company sold 4,573,000 shares of common stock through
a private placement with net proceeds of approximately $5.3 million, and filed a
registration statement covering resales of these shares. The Company intends to
keep the registration statement effective until April 5, 2003, or such earlier
date of the disposition of these shares, subject to the Company's right to
suspend the use of the registration statement.
6. CREDIT FACILITY
In March 2001, the Company entered into an amendment to 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 borrowing base) required to be
maintained has been reduced to $3.0 million during 2001. The Company had
borrowed approximately $4.3 million under its revolving line of credit at
September 30, 2001. As of September 30, 2001, the Company's remaining available
borrowing capacity was approximately $2.5 million. During the three months
ended September 30, 2001, the Company borrowed $1.6 million against this
facility.
7. HEDGING ACTIVITIES
In April 2001, the Company entered into a series of forward contracts to
purchase Japanese yen at various dates throughout the remainder of the year.
The yen will be used to purchase inventory from a Japanese manufacturer
throughout fiscal 2001. These derivative instruments have been designated and
qualify as cash flow hedging instruments under the definition provided by SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities". The
forward contracts were entered into with settlement dates, and for amounts, that
approximately correspond with the Company's projected needs to purchase
inventory with the hedged currency. All of these forward contracts will be
settled and the associated inventory purchased by December 31, 2001. These
derivative instruments were consistent with the Company's risk management
policy, which allows for the hedging of risk associated with fluctuations in
foreign currency for anticipated future transactions. These instruments have
been determined to be fully effective as a hedge in reducing the risk of the
underlying transaction. An unrealized loss of approximately $24,000 has been
recorded in Other Comprehensive Income during the nine months ended September
30, 2001 (See Note 9). These unrealized gains or losses will be reclassified to
cost of products sold and recognized as the purchased inventory is sold to
customers. The Company has recognized a loss of approximately $21,000 and
$22,000 in cost of products sold during the three months and nine months
ended September 30, 2001, respectively.
8. COMPREHENSIVE INCOME
Comprehensive income includes net income (loss) plus the results of certain
stockholders' equity changes not reflected in the Consolidated Statements of
Operations. Such changes include foreign currency items, unrealized gains and
losses on certain investments in marketable securities and unrealized gains and
losses on derivative instruments. During the nine months ended September 30,
2001, the Company realized a loss of approximately $22,000 on the sale of
marketable securities. Total comprehensive income and the components of
comprehensive income follow (in thousands):
THREE MONTHS ENDED
SEPTEMBER 30,
---------------------
2001 2000
--------- ---------
Net loss per Consolidated
Statements of Operations $ (3,894) $ (4,731)
Foreign currency translation adjustments 9 (131)
Changes in unrealized gains (losses) on
forward contracts, net of realized
gains (losses) 44 -
Changes in unrealized loss on
marketable securities - 71
-------- --------
Comprehensive loss $ (3,841) $ (4,791)
======== ========
NINE MONTHS ENDED
SEPTEMBER 30,
2001 2000
--------- ---------
Net loss per Consolidated
Statements of Operations $(13,130) $(16,362)
Foreign currency translation adjustments (134) (229)
Changes in unrealized gains (losses) on
forward contracts, net of realized
gains (losses) (24) -
Changes in unrealized loss on
marketable securities 44 75
-------- --------
Comprehensive loss $(13,244) $(16,516)
======== ========
Accumulated gains and losses from derivative contracts is as follows:
2001
------
Accumulated derivative gains (losses), December 31, 2000 $ -
Unrealized losses on forward contracts (46)
Realized losses on forward contracts reclassified to
current earnings 22
-----
Accumulated derivative gains (losses), September 30, 2001 $ (24)
=====
9. SUBSEQUENT EVENT
In September 2001, the Company offered its current employees the
opportunity to exchange all options outstanding with exercise prices greater
than $3.90 per share under the 1997 Stock Incentive Plan for shares of
restricted stock. The tender offer closed on September 28, 2001 with options
to purchase 1,044,900 shares of common stock exchanged for 1,044,900 shares
of restricted stock. The restricted stock vests over 48 months from its
issuance on October 1, 2001.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion contains, in addition to historical information,
forward-looking statements that involve risks and uncertainties. Our actual
results and the timing of certain events could differ materially from the
results discussed in the forward-looking statements. When used in this
discussion the words "expects," "anticipates," "believes," "continue," "could,"
"may," "will" and similar expressions are intended to identify forward-looking
statements. Such statements, which include statements concerning future revenue
sources and concentration, gross margins, research and development expenses,
selling and marketing expenses, general and administrative expenses, capital
resources, additional financings or borrowings and additional losses, are
subject to risks and uncertainties, including those set forth below under
"Factors that May Affect Results" that could cause actual results to differ
materially from those projected. These forward-looking statements speak only as
of the date hereof. We expressly disclaim any obligation or undertaking to
release publicly any updates or revisions to any forward-looking statements
contained herein to reflect any change in our expectations with regard thereto
or any change in events, conditions, or circumstances on which any such
statement is based.
OVERVIEW
We 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 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.
In 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 the first
quarter of 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 September 30, 2001 have totaled $187.6 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
will 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 discussions later in this section titled "Liquidity
and Capital Resources" and "Factors That May Affect Results" for a more in-depth
explanation of risks faced by us.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2001 and 2000
Total revenues, which include product, research and development and other
revenues, decreased 7% to $11.8 million in the third quarter of 2001 compared to
$12.7 million for the third quarter of 2000.
Product revenues decreased 11% to $11.0 million in the third quarter of
2001 compared to $12.4 million for the same period in 2000, primarily as a
result of a $2.6 million decrease in sales at Diamond. Gross profit margins on
products sold improved 5.5 percentage points over the third quarter of the prior
year, as the sales mix contained a larger percentage of high margin Heska
proprietary products. In addition, total operating expenses for the 2001 third
quarter declined by $440,000 from third quarter 2000 levels. Our net loss was
reduced by over $800,000, or 18%, for the third quarter of 2001 as compared to
the same quarter in 2000.
Total reported product revenues during the quarter were derived from the
three components of our continuing core business. These revenue components are
as follows:
PHARMACEUTICALS, VACCINES AND DIAGNOSTIC PRODUCTS (PVD). This group
of products includes our heartworm diagnostic products, equine influenza
vaccine, allergy products, feline vaccines and other such products for the
companion animal health market. During the third quarter of 2001, PVD product
revenue increased approximately 15% over the comparable quarter of 2000, to $3.2
million, primarily relating to strong sales of our Flu Avert (TM) I.N. vaccine
for equine influenza and of our feline trivalent vaccine, which increased by
135% and 112%, respectively, from prior year levels. In addition, our new
E-Screen allergy test introduced in the third quarter also contributed to the
increase in our PVD product revenue.
VETERINARY MEDICAL INSTRUMENTATION PRODUCTS. This group of products
includes all of our veterinary medical instrumentation, as well as the reagents,
consumables, parts and accessories for these instruments, which are for the
companion animal health market. During the third quarter of 2001, medical
instrumentation product revenue increased by approximately 25% from the
comparable quarter of 2000, to $4.0 million, primarily attributable to our
SPOTCHEM (TM) clinical chemistry system that we introduced earlier this year
and our i-STAT (R) portable clinical analyzer and associated reagents.
DIAMOND ANIMAL HEALTH PRODUCTS. This group of products is comprised
principally of vaccines and other biological products for cattle and other non-
companion animals. In addition, Diamond also manufactures some of our PVD
products and serves as our primary product distribution center. During the
third quarter of 2001, Diamond's product revenue declined by approximately 40%
from the comparable quarter of 2000, to $3.8 million. The decline in third
quarter revenue at Diamond was principally due to cancelled and delayed orders
from customers.
Cost of products sold totaled $6.9 million in the third quarter of 2001
compared to $8.5 million in the third quarter of 2000. Gross profit as a
percentage of product sales increased to 37.3% in the third quarter of 2001
compared to 31.8% in the same quarter last year. The improvement in gross
profit as a percentage of product sales in the third quarter of 2001 compared to
2000 reflects the increase in sales of our proprietary PVD products. We expect
gross profit as a percentage of product sales to continue to improve as we
increase the sales of our higher margin proprietary PVD products and the
increased sales of instrument reagents and consumables.
Selling and marketing expenses were unchanged at $3.3 million in the third
quarter of 2001 compared to $3.3 million in the third quarter of 2000. We
expect selling and marketing expense as a percentage of total sales to decrease
in the future as we continue to increase sales from our business.
Research and development expenses decreased to $3.2 million in the third
quarter of 2001 from $3.6 million in the third quarter of 2000. Fluctuations in
research and development expenses are generally the result of the number of
research projects in progress. We expect research and development expense as a
percentage of total sales to decrease in the future as we continue to increase
sales from our business.
General and administrative expenses were unchanged at $1.9 million in the
third quarter of 2001 compared to $1.9 million in the third quarter of 2000.
We expect general and administrative expense as a percentage of total sales to
decrease in the future as we continue to increase sales from our business.
For the quarter ended September 30, 2001, our net loss declined to $3.9
million from $4.7 million in the third quarter of the prior year. This
represents an 18% improvement over results reported in the prior year. The net
loss per common share in the third quarter of 2001 was $0.10, compared with a
net loss per common share of $0.14 in the third quarter of the prior year.
Nine Months Ended September 30, 2001 and 2000
Total revenues, which include product, research and development and other
revenues, decreased 19% to $33.6 million in the first nine months of 2001
compared to $41.3 million for the same period of 2000. Product revenues
decreased 17% to $32.0 million this period in 2001 compared to $38.5 million in
2000 primarily as a result of lower sales at Diamond, which fell $5.9 million,
or 39% from the comparable period in 2000. The total reported revenue for the
nine months ended September 30, 2000 included approximately $3.2 million from
businesses sold in fiscal 2000 and approximately $1.25 million attributable to
the sale of worldwide rights to our PERIOceutic (TM) Gel product.
Product revenue from our continuing core business (excluding sold
businesses and discontinued product lines) declined by 9% in the first nine
months of 2001 compared to the same period of the prior year. Gross profit
margins on products sold improved by 5.5 percentage points over the first nine
months of the prior year, as the sales mix contained a larger percentage of high
margin Heska proprietary products. In addition, total operating expenses
declined by $4.7 million from 2000 levels. Our net loss was reduced by
$3.3 million for the first nine months of 2001 as compared to the same period in
2000.
Total reported product revenues are derived from the three components of
our continuing core business, plus revenues from sold businesses and
discontinued products. These revenue components are as follows:
PHARMACEUTICALS, VACCINES AND DIAGNOSTIC PRODUCTS (PVD). This group
of products includes our heartworm diagnostic products, equine influenza
vaccine, allergy products, feline vaccines and other such products for the
companion animal health market. During the first nine months of 2001, PVD
product revenue increased approximately 19% over the comparable period of 2000,
to $11.6 million, primarily due to an increase in heartworm diagnostic product
line sales of 11% and an increase in equine influenza vaccine sales of over
91% year-to-date.
VETERINARY MEDICAL INSTRUMENTATION PRODUCTS. This group of products
includes all of our veterinary medical instrumentation, as well as the reagents,
consumables, parts and accessories for these instruments, which are for the
companion animal health market. During the first nine months of 2001, medical
instrumentation product revenue increased by approximately 7% from the
comparable period of 2000, to $11.3 million, primarily attributable to our
SPOTCHEM (TM) clinical chemistry system that we introduced earlier this year
and our i-STAT (R) portable clinical analyzer and associated reagents.
DIAMOND ANIMAL HEALTH PRODUCTS. Revenue reported from this group of
products is comprised principally of vaccines and other biological products for
cattle and other non-companion animals. In addition, Diamond also manufactures
some of our PVD products and serves as our primary product distribution center.
During the first nine months of 2001, Diamond's product revenue declined by
approximately 39% from the comparable period of 2000, to $9.1 million. The
decline in revenue at Diamond was principally due to cancelled and delayed
orders from customers.
SOLD BUSINESSES AND DISCONTINUED PRODUCTS. During 2000, we engaged in
a number of activities to restructure our business, including the sale of Heska
UK, effective January 31, 2000 and the sale of Center, effective June 23, 2000.
Our total reported product revenue in 2000 includes the revenue from these sold
businesses prior to the dates of sale. The revenue attributable to these sold
businesses in the first nine months of 2000 was approximately $3.2 million.
Cost of products sold totaled $20.1 million in the first nine months of
2001 compared to $26.3 million in the same period of 2000. Gross profit as a
percentage of product sales increased to 37.2% in the first nine months of 2001
compared to 31.7% for the same period last year. The improvement in gross
profit as a percentage of product sales in 2001 compared to 2000 reflects the
increase in sales of our proprietary PVD products and the increased sales of
instrument reagents and consumables. We expect gross profit as a percentage
of product sales to continue to improve as we increase the sales of our
higher margin proprietary PVD products.
Selling and marketing expenses decreased to $10.5 million in the first nine
months of 2001 from $11.5 million in the same period of 2000. This decrease
reflects primarily the costs associated with the introduction and marketing of
new products in the first half of 2000, as well as the sale of Center and Heska
UK in 2000. We expect selling and marketing expense as a percentage of total
sales to decrease in the future as we continue to increase sales from our
continuing core business.
Research and development expenses decreased to $9.8 million in the first
nine months of 2001 from $11.4 million in the same period of 2000. Fluctuations
in research and development expenses are generally the result of the number of
research projects in progress. We expect research and development expense as a
percentage of total sales to decrease in the future as we continue to increase
sales from our continuing core business.
General and administrative expenses decreased to $5.8 million in the first
nine months of 2001 from $7.2 million in the same period of 2000. This decrease
is due to tighter expense control at all locations and the sale of Center and
Heska UK in 2000. We expect general and administrative expense as a percentage
of total sales to decrease in the future as we continue to increase sales from
our continuing core business.
During the first quarter of fiscal 2000, we initiated a cost reduction and
restructuring plan at Diamond. The restructuring resulted from the
rationalization of Diamond's business including a reduction in the size of its
workforce and our decision to vacate a leased warehouse and distribution
facility no longer needed after our decision to discontinue contract
manufacturing of certain low margin human health care 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.
For the nine months ended September 30, 2001, our net loss declined to
$13.1 million from $16.4 million in the same period of the prior year. This
represents a 20% improvement over results reported in the prior year. The net
loss per common share in the first nine months of 2001 was $0.34, compared with
a net loss per common share of $0.49 in the same period of the prior year.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity at September 30, 2001 was our $2.9 million
in cash and cash equivalents and, our asset-based revolving line of credit. At
September 30, 2001, we had borrowed $4.3 million under the revolving line of
credit facility and had an additional $2.5 million of borrowing capacity
available. Our credit facility requires us to maintain various financial
covenants including monthly minimum book net worth, minimum quarterly net income
and minimum cash balances or liquidity levels. In March 2001, we negotiated new
covenants under this line of credit which lowered our minimum liquidity
requirements.
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.
Cash used in operating activities was $10.3 million in the first nine
months of 2001, compared to $14.2 million in the same period of 2000. The
decrease in cash used in operating activities is attributable primarily to the
decrease of $3.2 million in our net loss for the first nine months of 2001
compared to the prior year.
Our investing activities provided cash of $2.0 million in the first nine
months of 2001, compared to $21.1 million during the same period of 2000. Cash
provided by investing activities was primarily related to the sale of marketable
securities to fund our business operations. Expenditures for property and
equipment were approximately $790,000 for the first nine months of 2001 compared
to approximately $889,000 in the first nine months of 2000. We have
historically used capital equipment lease and debt facilities to finance
equipment purchases and, if possible, leasehold improvements. We currently
expect to spend approximately $900,000 in 2001 for capital equipment, including
expenditures for the upgrading of manufacturing operations to improve
efficiencies as well as various enhancements to assure ongoing compliance with
regulatory requirements.
Our financing activities provided $8.1 million in the first nine months of
2001 compared to $6.1 million used in the first nine months of 2000. This 2001
cash was provided principally by our sale of 4,573,000 shares of our common
stock in a private placement in February 2001 with net proceeds to us of
approximately $5.3 million and net borrowings from our revolving credit facility
of $3.4 million.
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 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 available cash and cash equivalents, together with cash from
operations, available borrowings and borrowings expected to be available under
our revolving line of credit facility will be sufficient to satisfy projected
cash requirements through the end of 2001. We will need to raise additional
capital to continue our business operations in 2002. If necessary, we expect to
raise these additional funds through one or more of the following: (1) sale of
additional equity or debt 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 will need to take actions to conserve its
cash balances, including reducing capital expenditures, reducing operating
expenses, eliminating personnel and curtailing certain operations, all of which
would likely have a material adverse affect on our business, financial condition
and results of operations. Consequently, any projections of future cash needs
and cash flows are subject to substantial uncertainty.
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 on various dates
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.
Approximately $4.7 million of NOLs per year will be available to offset future
taxable income 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
During June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143 "Accounting for
Asset Retirement Obligations". This statement establishes accounting standards
for recognition and measurement of a liability for an asset retirement
obligation and the associated asset retirement cost. It requires an entity to
recognize the fair value of a liability for an asset retirement obligation in
the period in which it is incurred if a reasonable estimate can be made. The
Company is required to adopt this statement in its fiscal year 2003. The
Company does not believe that this statement will materially impact its results
of operations.
During August 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 144 "Accounting
for the Impairment or Disposal of Long-Lived Assets." This statement supersedes
SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to Be Disposed of" and the accounting and reporting provisions of
APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" for segments to be disposed of.
This statement applies to recognized long-lived assets of an entity to be held
and used or to be disposed of. This statement does not apply to goodwill,
intangible assets not being amortized, financial instruments, and deferred tax
assets. This statement requires an impairment loss to be recorded for assets to
be held and used when the carrying amount of a long-lived asset is not
recoverable and exceeds its fair value. An asset that is classified as held for
sale shall be recorded at the lower of its carrying amount or fair value less
cost to sell. The Company is required to adopt this statement for the first
quarter of 2002. The Company does not believe that this statement will
materially impact its results of operations.
FACTORS THAT MAY AFFECT RESULTS
We will need additional capital to fund continued business operations in 2002
and we cannot be sure that additional financing will be available.
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 2002. Moreover, based on our current projections, we will need to
raise additional capital in the near future. We expect to raise this additional
capital through one or more of the following:
* sale of additional equity or debt 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 will have to curtail our
operations significantly and reduce discretionary spending to extend the
currently available cash resources, or to obtain funds by entering into
collaborative agreements or other arrangements on unfavorable terms, all of
which would likely have a material adverse effect on our business, financial
condition and our ability to reduce losses or generate profits.
We anticipate future losses and negative cash flow.
We have incurred net losses since our inception in 1988 and, as of
September 30, 2001, we had an accumulated deficit of $187.6 million. We
anticipate that we may 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. If we cannot
achieve or sustain profitability, we may not be able to meet our working capital
expenditures, which would have a material adverse effect on our business.
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:
* results from our Diamond Animal Health subsidiary;
* 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 one Diamond
customer in 2001, AgriLabs, and two Diamond customers in 2000, AgriLabs and
Alpharma, comprised approximately 15% and 41% of our total revenues for the
three months ended September 30, 2001 and 2000, respectively, and 12% and 28% of
our total revenues for the nine months ended September 30, 2001 and 2000,
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 or our collaborators may not be able to obtain licenses
for technology patented by others on commercially reasonable terms, we may not
be able to develop alternative approaches if unable to obtain licenses, or
current and future licenses may not 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 shutdown 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 experienced significant price and volume
fluctuations and 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 $0.50 to a high of $2.938. 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. Nasdaq has suspended these
requirements until January 2, 2002.
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 3.
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. In April 2001, we entered into a series of forward contracts for
the purchase of Japanese yen to be used for the purchase of inventory.
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 and, therefore, affected by
changes in market interest rates. At September 30, 2001, approximately $6.9
million was outstanding on these borrowings with a weighted average interest
rate of 7.09%. 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. We completed an interest rate risk
sensitivity analysis of these borrowings based on an assumed 1% increase in
interest rates. If market rates increase by 1% during the three months ended
December 31, 2001, we would experience an increase in interest expense of
approximately $17,000 based on the outstanding borrowing balances at September
30, 2001.
Foreign Currency Risk
At September 30, 2001, we had wholly-owned subsidiaries 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 completed
a foreign currency exchange rate risk sensitivity analysis on an assumed 1%
change in foreign currency exchange rates. If the foreign currency exchange
rates change by 1% during the three months ended December 31, 2001, we would
experience an increase/decrease in our foreign currency gain/loss of
approximately $100,000 based on the investment in foreign subsidiaries as of and
for the three months ended September 30, 2001.
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
None.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter
ended September 30, 2001.
HESKA CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HESKA CORPORATION
Date: November 13, 2001 By /s/ Ronald L. Hendrick
-------------------------
RONALD L. HENDRICK
Executive Vice President and Chief Financial Officer
(on behalf of the Registrant and as the Registrant's
Principal Financial and Accounting Officer)