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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002
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 [I.R.S. Employer
jurisdiction Identification No.]
of incorporation or
organization]
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
May 13, 2002 was 47,837,194
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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
March 31, 2002 and December 31, 2001 3
Consolidated Statements of Operations and Comprehensive
Loss (Unaudited)for the three months ended
March 31, 2002 and 2001 4
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the three months ended March 31, 2002 and 2001 5
Notes to Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings Not Applicable
Item 2. Changes in Securities and Use of Proceeds 27
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 27
Exhibit Index Not Applicable
Signatures 28
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands except per share amounts)
(unaudited)
ASSETS
MARCH 31, DECEMBER 31,
2002 2001
------------ ------------
Current assets:
Cash and cash equivalents $ 4,169 $ 5,710
Accounts receivable, net of allowance for
doubtful accounts of $414 and $501,
respectively 7,686 10,313
Inventories 9,175 8,589
Other current assets 756 1,063
----------- ------------
Total current assets 21,786 25,675
Property and equipment, net 9,658 10,118
Goodwill and intangible assets, net 1,372 1,400
Other assets 443 564
----------- ------------
Total assets $ 33,259 $ 37,757
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,050 $ 4,263
Accrued liabilities 4,809 6,302
Deferred revenue 349 343
Line of credit 6,026 5,737
Current portion of capital lease obligations 76 104
Current portion of long-term debt 471 711
----------- ------------
Total current liabilities 16,781 17,460
Capital lease obligations, net of current portion 52 57
Long-term debt, net of current portion 1,940 2,052
Deferred revenue and other long-term liabilities 1,021 1,022
----------- ------------
Total liabilities 19,794 20,591
----------- ------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, 25,000,000
shares authorized; none issued or outstanding - -
Common stock, $.001 par value, 75,000,000 shares
authorized; 47,824,194 and 47,842,198 shares
issued and outstanding, respectively 48 48
Additional paid-in capital 211,591 211,589
Deferred compensation (637) (681)
Accumulated other comprehensive loss (483) (627)
Accumulated deficit (197,054) (193,163)
----------- ------------
Total stockholders' equity 13,465 17,166
----------- ------------
Total liabilities and stockholders' equity $ 33,259 $ 37,757
=========== ============
See accompanying notes to consolidated financial statements
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share amounts)
(unaudited)
THREE MONTHS ENDED
MARCH 31,
--------------------------------
2002 2001
------------ ------------
Revenue:
Products, net of sales returns and allowance $ 9,921 $ 10,314
Research, development and other 244 613
------------ ------------
Total revenues 10,165 10,927
Cost of products sold 5,899 6,214
------------ ------------
4,266 4,713
------------ ------------
Operating expenses:
Selling and marketing 3,177 3,558
Research and development 2,916 3,455
General and administrative 1,720 2,096
Amortization of goodwill and intangible assets 15 68
Restructuring expenses and other 236 -
------------ ------------
Total operating expenses 8,064 9,177
------------ ------------
Loss from operations (3,798) (4,464)
Other (expense), net (93) (108)
------------ ------------
Net loss $ (3,891) $ (4,572)
============ ============
Basic and diluted net loss per share $ (0.08) $ (0.12)
============ ============
Shares used to compute basic and diluted
net loss per share 47,835 37,029
============ ============
See accompanying notes to consolidated financial statements
HESKA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
THREE MONTHS ENDED
MARCH 31,
----------------------------------
2002 2001
------------ ------------
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net cash used in operating activities $ (1,399) $ (5,323)
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of marketable securities - 2,500
Proceeds from disposition of property and equipment 52 -
Purchase of property and equipment (97) (300)
----------- ------------
Net cash (used in) provided by investing activities (45) 2,200
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 2 5,332
Proceeds from borrowings 288 -
Repayments of debt and capital lease obligations (386) (567)
------------ ------------
Net cash (used in) provided by financing activities (96) 4,765
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (2) (109)
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,542) 1,533
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 5,710 3,176
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,168 $ 4,709
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 90 $ 140
============ ============
See accompanying notes to consolidated financial statements
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(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 and delivery of diagnostic services to veterinarians. The Company
currently conducts its operations through two reportable segments. Through its
Companion Animal Health segment, the Company sells pharmaceutical, vaccine and
diagnostic products and veterinary diagnostic and patient monitoring
instruments, offers diagnostic services, and performs a variety of research and
development activities. The operations of this segment are carried out through
the Company's facilities in Fort Collins, Colorado, and its wholly owned Swiss
subsidiary, Heska AG. Through its Food Animal Health segment, the Company
manufactures food animal vaccine and pharmaceutical products that are marketed
and distributed by third parties. The operations of this segment are carried
out through the Company's wholly owned subsidiary Diamond Animal Health, Inc.
("Diamond"), located in Des Moines, Iowa.
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 revenue 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, 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
Heska AG (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.
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 March 31, 2002 have totaled $197.1
million. During the three months ended March 31, 2002, the Company incurred a
loss of approximately $3.9 million and used cash of approximately $1.4 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.
Our financial plan for 2002 indicates that our available cash and cash
equivalents, together with cash from operations, borrowings we expect to be
available under our revolving line of credit facility and other sources, should
be sufficient to satisfy our projected cash requirements through 2002 and into
2003. However, our actual results may differ from this plan and, we may need to
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) obtaining new
loans secured by unencumbered assets; (2) sale of various products or marketing
rights; (3) licensing of technology; (4) sale of various assets; and (5) sale of
additional equity or debt securities. If we cannot raise the additional funds
through these options on acceptable terms or with the necessary timing,
management could also reduce discretionary spending to decrease our cash burn
rate and extend the currently available cash and cash equivalents, and available
borrowings.
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 March 31, 2002, the statements of
operations for the three months ended March 31, 2002 and 2001 and the statements
of cash flows for the three months ended March 31, 2002 and 2001 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. 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, 2001, included in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission on April 1, 2002.
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. Included in these amounts were Japanese yen with a
value in U.S. dollars of approximately $126,000 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. Changes in the fair value of the yen are
recorded in current earnings.
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
common stock equivalents (such as stock options and warrants) determined using
the treasury stock method. Since inception, due to the Company's net losses,
all potentially dilative securities are anti-dilutive and as a result, basic and
net loss per share is the same as diluted net loss per share for all periods
presented. At March 31, 2002 and 2001, outstanding options and warrants to
purchase 6,001,378 and 5,306,284 shares, respectively, of the Company's common
stock have been excluded from diluted net loss per share because they are anti-
dilutive.
3. MAJOR CUSTOMERS
The Company had no single customer who accounted for 10% or more of total
revenues for the three months ended March 31, 2002, or 10% or more of total net
accounts receivable at March 31, 2002. One customer, who purchased vaccines
from Diamond, accounted for approximately 10% of total revenues for the three
months ended March 31, 2001 and total net accounts receivable as of March 31,
2001.
4. RESTRUCTURING EXPENSES
The Company recorded a restructuring charge during the first quarter of
2002. The charge to operations of approximately $566,000 related primarily to
personnel severance costs for 32 individuals and the costs associated with
disposal of leased vehicles and other costs for certain of the employees.
In the fourth quarter of 2001, the Company recorded a $1.5 million
restructuring charge related to a strategic change in its distribution model and
the consolidation of its European operations into one facility. This expense
related to personnel severance costs, costs to adjust the Company's products to
align with the new distribution model and the cost to close a leased facility in
Europe. During the first quarter of 2002, the Company revised its cost
estimates related to the restructuring charge recorded in the fourth quarter of
2001 as certain liabilities were favorably settled. This change in estimate was
approximately $330,000 and was offset against the restructuring charge recorded
in the first quarter of 2002 as described above.
Shown below is a reconciliation of restructuring costs for the three months
ended March 31, 2002 (in thousands):
ADDITIONS FOR THE PAYMENTS/CHARGES
THREE MONTHS FOR THE THREE
BALANCE AT ENDED MONTHS ENDED BALANCE AT
DECEMBER 31, MARCH 31, MARCH 31, MARCH 31,
2001 2002 2002 OTHER 2002
------------ -------------- -------------- -------------- ------------
Severance pay and benefits $ 378 $ 466 $ (432) $ (6) $ 406
Leased facility closure costs 50 - (41) - 9
Products and other 1,100 100 (81) (324) 795
--------- --------- ---------- --------- ---------
Total $ 1,528 $ 566 $ (554) $ (330) $ 1,210
========= ========= ========== ========= =========
5. GOODWILL AND INTANGIBLES
The Company adopted SFAS No. 141, "Business Combinations" and SFAS No. 142,
"Goodwill and Other Intangible Assets" effective as of January 1, 2002. SFAS
No. 141 requires that all business combinations initiated after June 30, 2001 be
accounted for using the purchase accounting method. SFAS No. 142 states that
goodwill is no longer subject to amortization over its useful life. Rather,
goodwill will be subject to an annual assessment for impairment and be written
down to its fair value only if the carrying amount is greater than the fair
value. In addition, intangible assets will be separately recognized if the
benefit of the intangible asset is obtained through contractual or other legal
rights, or if the intangible asset can be sold, transferred, licensed, rented or
exchanged, regardless of the acquirer's intent to do so. The amount and timing
of non-cash charges related to intangibles acquired in business combinations
will change significantly from prior practice.
The Company's recorded goodwill relates to the acquisition in 1997 of
Heska AG, and beginning in fiscal 2002 it is no longer amortized on a periodic
basis. The balance at March 31, 2002 is approximately $650,000 and it will
be tested for impairment in the second quarter of 2002. No impairment was
recognized and there were no other changes to the goodwill balance during the
three months ended March 31, 2002. This goodwill is included in the assets
of the Companion Animal Health segment.
The Company has net intangible assets related to capitalized patent costs
totaling approximately $725,000 as of March 31, 2002. These costs are being
amortized over an average life of 15 years. Amortization expense for the three
months ended March 31, 2002, was approximately $17,000. There are no additional
intangible assets not being amortized on a periodic basis. These intangible
assets are included in the assets of the Companion Animal Health segment.
The following reflects the impact on the Company's financial results of
amortization expense for goodwill and other intangible assets during the prior
three fiscal years. There was no material impact for the three months ended
March 31, 2002. (In thousands except per share amounts):
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
2001 2000 1999
--------------- --------------- ---------------
Reported net loss $ (18,691) $ (21,870) $ (35,836)
Add back: Goodwill amortization 210 209 241
Add back: Patent amortization 98 60 60
------------ ------------ -------------
Adjusted net loss $ (18,383) $ (21,601) $ (35,535)
============ ============ =============
Basic and diluted earnings per share:
Reported net loss $ (0.48) $ (0.65) $ (1.31)
Goodwill amortization 0.01 0.01 0.01
Patent amortization - - -
------------ ------------ -------------
Adjusted net loss $ (0.47) $ (0.64) $ (1.30)
============ ============ =============
6. SEGMENT REPORTING
The Company's business is comprised of two reportable segments, Companion
Animal Health and Food Animal Health. Within the Companion Animal Health
segment products include pharmaceuticals, vaccines and diagnostics and
veterinary diagnostic and patient monitoring instruments. These products are
sold through operations in Fort Collins, Colorado and Europe. Within the Food
Animal Health segment, products include food animal vaccines and
pharmaceuticals. Food Animal Health products are manufactured at, and sold
by, the Company's Diamond Animal Health subsidiary in Des Moines, Iowa.
Non-product revenues are generated from sponsored research and development
projects for third parties, licensing of technology and royalties. These
sponsored research and development projects are performed for both companion
animal and food animal purposes.
Summarized financial information concerning the Company's reportable
segments is shown in the following table (in thousands).
COMPANION FOOD
ANIMAL ANIMAL
HEALTH HEALTH OTHER TOTAL
------------ ------------- ----------- -------------
THREE MONTHS ENDED
MARCH 31, 2002:
Revenue $ 7,832 $ 2,921 $ (588) $ 10,165
Operating income (loss) (4,032) 234 - (3,798)
Total assets 48,368 22,017 (37,126) 33,259
Capital expenditures 97 - - 97
Depreciation and
amortization 316 311 - 627
THREE MONTHS ENDED
MARCH 31, 2001:
Revenue $ 8,112 $ 3,362 $ (547) $ 10,927
Operating income (loss) (4,555) 91 - (4,464)
Total assets 51,080 17,744 (30,923) 37,901
Capital expenditures 103 197 - 300
Depreciation and 565 397 - 962
amortization
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 and Diamond. Revenues earned in Europe are primarily attributable to
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).
NORTH
AMERICA EUROPE OTHER TOTAL
------------ ------------ ------------- -----------
THREE MONTHS ENDED
MARCH 31, 2002:
Revenue $ 10,146 $ 607 $ (588) $ 10,165
Operating income (loss) (3,830) 32 - (3,798)
Total assets 68,450 1,935 (37,126) 33,259
Capital expenditures 96 1 - 97
Depreciation and amortization 582 45 - 627
THREE MONTHS ENDED
MARCH 31, 2001:
Revenue $ 10,882 $ 592 $ (547) $ 10,927
Operating income (loss) (4,398) (66) - (4,464)
Total assets 66,504 2,320 (30,923) 37,901
Capital expenditures 300 - - 300
Depreciation and amortization 955 7 - 962
7. CREDIT FACILITY
In March 2002, 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 $2.5 million during 2002. The Company had
borrowed approximately $6.0 million under its revolving line of credit as of
March 31, 2002, which includes approximately $300,000 of additional borrowings
during the three months ended March 31, 2002. As of March 31, 2002, the
Company's remaining available borrowing capacity was approximately $300,000.
The credit facility expires on May 31, 2003.
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. Total comprehensive income and the components
of comprehensive income follow (in thousands):
THREE MONTHS ENDED
MARCH 31,
------------------------------
2002 2001
----------- -----------
Net loss per Consolidated Statements of Operations $ (3,891) $ (4,572)
Foreign currency translation adjustments 134 157
Changes in unrealized gains (losses) on forward contracts,
net of realized gains (losses) 10 -
Changes in unrealized loss on marketable securities - (45)
--------- ---------
Comprehensive loss $ (3,747) $ (4,460)
========= =========
Accumulated gains and losses from derivative contracts is as follows:
2002
------------
Accumulated derivative gains (losses) December 31, 2001 $ (24)
Unrealized losses on forward contracts -
Realized losses on forward contracts reclassified to current earnings 10
--------
Accumulated derivative gains (losses), March 31, 2002 $ (14)
========
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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-Q, particularly in "Factors that
May Affect Results," that could cause actual results to differ materially from
those projected. The forward-looking statements set forth in this Form 10-Q are
as of the date of this filing, and we undertake no duty to update this
information.
CORPORATE OVERVIEW
We discover, develop, manufacture and market companion animal health
products, principally for dogs, cats and horses. We employ approximately 60
scientists, of whom over one quarter hold doctoral degrees, with expertise in
several disciplines including microbiology, immunology, genetics, biochemistry,
molecular biology, parasitology and veterinary medicine. This scientific
expertise is focused on the development of a broad range of pharmaceutical,
vaccine and diagnostic products for companion animals. We also sell veterinary
diagnostic and patient monitoring instruments and offer diagnostic services to
veterinarians in the United States and Europe, principally for companion
animals. In addition to manufacturing companion animal health products for
marketing and sale by Heska, our Diamond Animal Health subsidiary manufactures
food animal vaccines and other food animal products that are marketed and
distributed by other animal health companies.
OUR BUSINESS
We currently market our products in the United States to veterinarians
through approximately 20 independent third-party distributors and through a
direct sales force. Nearly one-half of these domestic distributors purchase the
full line of our pharmaceutical, vaccine, diagnostic and instrumentation
products. We have recently begun to rely on distributors for a greater portion
of our sales.
Our business is comprised of two reportable segments, Companion Animal
Health and Food Animal Health. Within the Companion Animal Health segment, our
products include pharmaceuticals, vaccines and diagnostics and veterinary
diagnostic and patient monitoring instruments. These products are sold through
our operations in Fort Collins, Colorado and Europe. Within the Food Animal
Health segment, we sell food animal vaccine and pharmaceutical products. We
manufacture these food animal products at our Diamond Animal Health subsidiary,
located in Des Moines, Iowa.
Additionally, we generate non-product revenues from sponsored research and
development projects for third parties, licensing of technology and royalties.
We perform these sponsored research and development projects for both companion
animal and food animal purposes.
CRITICAL ACCOUNTING POLICIES
The Company's discussion and analysis of its financial condition and
results of operations is based upon the consolidated financial statements, which
have been prepared in accordance with U.S. generally accepted accounting
principles ("GAAP"). The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent assets
and liabilities as of the date of the financial statements, and the reported
amounts of revenue and expenses during the periods. These estimates are based
on historical experience and various other assumptions that we believe to be
reasonable under the circumstances. Actual results may differ materially from
these estimates under different assumptions or conditions. Our critical
accounting policies include:
* We generate our revenues through sale of products, licensing of
technology and sponsored research and development. Revenue is accounted
for in accordance with the guidelines provided by Staff Accounting
Bulletin 101 "Revenue Recognition in Financial Statements" (SAB 101).
Our policy is to recognize revenue when the applicable revenue
recognition criteria have been met, which generally include the
following:
- Persuasive evidence of an arrangement exists;
- Delivery has occurred or services rendered;
- Price is fixed or determinable; and
- Collectibility is reasonably assured.
Revenue from the sale of products is generally recognized after both the
goods are shipped to the customer and acceptance has been received with
an appropriate provision for returns and allowances. The terms of the
customer arrangements generally pass title and risk of ownership to the
customer at the time of shipment. Certain customer arrangements provide
for acceptance provisions. Revenue for these arrangements is not
recognized until the acceptance has been received or the acceptance
period has lapsed.
In addition to its direct sales force, we utilize third-party
distributors to sell our products. Distributors purchase goods from us,
take title to those goods and resell them to their customers in the
distributors' territory.
License revenues under arrangements to sell product rights or technology
rights are recognized upon the sale and completion by us of all
obligations under the agreement. Royalties are recognized as products
are sold to customers.
We recognize revenue from sponsored research and development over the
life of the contract as research activities are performed. The revenue
recognized is the lesser of revenue earned under a percentage of
completion method based on total expected revenues or actual non-
refundable cash received to date under the agreement.
* Inventories. Inventories are stated at the lower of cost or market,
cost being determined on the first-in, first-out method. Inventories
are written down if the estimated net realizable value is less than the
recorded value.
* Foreign currency translation. The financial position and results of
operations of our foreign subsidiaries are measured using local currency
as the functional currency. Assets and liabilities of each foreign
subsidiary are translated at the rate of exchange in effect at the end
of the period. Revenues and expenses are translated at the average
exchange rate for the period. Foreign currency translation gains and
losses not impacting cash flows are credited to or charged against other
comprehensive income (loss). Foreign currency translation gains and
losses arising from cash transactions are credited to or charged against
current earnings.
RESULTS OF OPERATIONS
Revenues
Total revenues, which include product revenue as well as research,
development and other revenue decreased 7% to $10.2 million in the first quarter
of 2002 compared to $10.9 million for the first quarter of 2001.
Product revenues for the first three months of 2002 in our Companion Animal
Health segment grew by 1% to $7.6 million from $7.5 million in same period of
2001. Product revenues from this segment of our business include
pharmaceuticals, vaccines, diagnostics and medical instrumentation. This growth
was driven by increased sales of our SpotChem(TM) EZ clinical chemistry system,
growth in sales of medical instrument reagents and consumables, and sales of
our two most recent product introductions-the E.R.D.-Screen(TM) test for early
renal disease in dogs, and our Allercept(TM) E-Screen(TM) test for allergy
diagnosis in dogs. We also saw an increase in export sales due primarily to
sales of our heartworm diagnostic tests to Novartis for distribution in Japan.
We recently implemented a new distribution model and began to rely on
distributors for a greater portion of our sales. We believe this model will,
over time, allow us to grow our business more effectively and in the near term
lower our operating costs. We were pleased to see even modest sales growth in
our Companion Animal products during this time of transition.
Product revenues in the first quarter of 2002 from the Food Animal Health
segment of the business declined 17% to $2.3 million from $2.8 million in the
first quarter of last year. We believe that this is a timing issue with the
release of customer orders. Diamond's business has always been seasonal, with
the majority of revenue coming in the second half of the year. It appears that
this seasonality is becoming even more exaggerated, as a larger proportion of
the annual sales to some of our largest customers at Diamond are scheduled for
the second half of 2002.
Revenues from research, development and other sources were down slightly in
the first quarter of 2002 as compared to the first quarter of 2001, due
primarily to non-recurring revenue from a sponsored product development project
recorded in last year's first quarter.
Cost of Products Sold
Cost of products sold totaled $5.9 million in the first quarter of 2002
compared to $6.2 million in the first quarter of 2001. Gross profit as a
percentage of product sales increased to 40.6% in the first quarter of 2002
compared to 39.8% in the same quarter last year. The improvement in gross
profit reflects the increase in sales of our proprietary PVD products,
increased sales of instrument reagents and consumables and improved margins
at Diamond. 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.
Operating Expenses
Selling and marketing expenses decreased to $3.2 million in the first
quarter of 2002 compared to $3.6 million in the first quarter of 2001 due
primarily to lower personnel costs. 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 $2.9 million in the first
quarter of 2002 from $3.5 million in the first quarter of 2001 due primarily to
lower personnel costs. 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 decreased to $1.7 million in the first
quarter of 2002 compared to $2.1 million in the first quarter of 2001. 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 and
continue our disciplined management of operating expenses.
Restructuring Expenses and Other
During the first quarter of 2002, we recorded a restructuring charge
related to personnel severance costs and other related expenses which
totaled $566,000. Also during the same quarter we revised previous
estimates related to the early termination of certain supply contracts
and recorded a credit to restructuring expenses of $330,000. These previous
estimates were recorded as restructuring expenses in the fourth quarter of 2001.
Net Loss
For the quarter ended March 31, 2002, our net loss declined to $3.9 million
from $4.6 million in the first quarter of the prior year. This represents a 15%
improvement over results reported in the prior year. The net loss per common
share in the first quarter of 2002 was $0.08, compared with a net loss per
common share of $0.12 in the first quarter of the prior year.
LIQUIDITY AND CAPITAL RESOURCES
We have incurred negative cash flow from operations since inception in
1988. Our negative operating cash flows have been funded primarily through the
sale of common stock and borrowings. At Mach 31, 2002, we had cash and cash
equivalents of $4.2 million.
We recently amended our credit agreement with our lender to set the
financial covenants for 2002 and extend the maturity date of the loans an
additional year to May 31, 2003. If our lender imposes additional loan
covenants or other credit requirements that would prevent us from accessing the
full amount of our line of credit, we would need to raise additional capital to
fund any shortfall from our borrowings expected to be available under the
revolving line of credit. We anticipate that any additional capital would be
raised through one or more of the following:
* obtaining new loans secured by unencumbered assets;
* sale of various products or marketing rights;
* licensing of technology;
* sale of various assets; and
* sale of additional equity or debt securities.
At March 31, 2002, we had outstanding obligations for long-term debt and
capital leases totaling $2.9 million primarily related to two term loans with
Wells Fargo Business Credit. One of these two term loans is secured by real
estate at Diamond and had an outstanding balance at March 31, 2002 of $1.7
million due in monthly installments of $17,658 plus interest, with a balloon
payment of approximately $1.5 million due on May 31, 2003. The other term loan
is secured by machinery and equipment at Diamond and had an outstanding balance
at March 31, 2002 of approximately $632,000 payable in installments of $18,667
plus interest, with a balloon payment of approximately $370,000 due on May 31,
2003. Both loans have a stated interest rate of prime plus 1.25%. In addition,
Diamond has promissory notes to the Iowa Department of Economic Development and
the City of Des Moines with outstanding balances at March 31, 2002 of $41,000
and $49,000, respectively, due in annual and monthly installments through June
2004 and May 2004, respectively. Both promissory notes have a stated interest
rate of 3.0% and an imputed interest rate of 9.5%. The notes are secured by
first security interests in essentially all of Diamond's assets and both lenders
have subordinated their first security interest to Wells
Fargo. We also had $240,000 of equipment financing which was paid in full in
January 2002. Our capital lease obligations totaled $128,000 at March 31, 2002.
We also have a $10.0 million asset-based revolving line of credit with
Wells Fargo Business Credit. Available borrowings under this line of credit are
based upon percentages of our eligible domestic accounts receivable and domestic
inventories. Interest is charged at a stated rate of prime plus 1% and is
payable monthly. Our ability to borrow under this facility varies based upon
available cash, eligible accounts receivable and eligible inventory. The line
of credit has a maturity date of May 31, 2003. At March 31, 2002, our
outstanding borrowings under the line of credit were $6.0 million and we had
remaining available borrowing capacity of $300,000.
Net cash used in operating activities was $1.4 million for the first three
months of 2002, compared to $5.3 million for the same period in 2001. The
improvement was primarily due to the lower net loss and increases in accounts
receivable collections.
Net cash flows from investing activities used $45,000 during the first
quarter of 2002, compared to providing $2.2 million in 2001. The cash provided
in 2001 resulted from the sale of our marketable securities offset by capital
expenditures for the year.
Net cash flows from financing activities used $96,000 during the first
three months of 2002 compared to providing $4.8 million for the same period last
year. The cash provided in 2001 was the result of approximately $5.3 million
of net proceeds from a private placement of our common stock offset by debt
repayments.
Our primary short-term needs for capital, which are subject to change, are
for our continuing research and development efforts, our sales, marketing and
administrative activities, working capital associated with increased product
sales and capital expenditures relating to developing and expanding our
manufacturing operations. Our future liquidity and capital requirements will
depend on numerous factors, including the extent to which our present and future
products gain market acceptance, the extent to which products or technologies
under research or development are successfully developed, the timing of
regulatory actions regarding our products, the costs and timing of expansion of
sales, marketing and manufacturing activities, the cost, timing and business
management of current and potential acquisitions and contingent liabilities
associated with such acquisitions, the procurement and enforcement of patents
important to our business and the results of competition.
Our financial plan for 2002 indicates that our available cash and cash
equivalents, together with cash from operations, borrowings expected to be
available under our revolving line of credit and other sources, should be
sufficient to fund our operations through 2002 and into 2003. However, our
actual results may differ from this plan, and we may need to raise additional
capital in the future. If necessary, we expect to raise these additional funds
through one or more of the following: (1) obtaining new loans secured by
unencumbered assets; (2) sale of various products or marketing rights; (3)
licensing of technology; (4) sale of various assets; and (5) sale of additional
equity or debt securities. If we cannot raise the additional funds through
these options on acceptable terms or with the necessary timing, management could
also reduce discretionary spending to decrease our cash burn rate and extend the
currently available cash and cash equivalents, and available borrowings. See
"Factors that May Affect Results."
A summary of our contractual obligations at March 31, 2002 is shown below
(amounts in thousands).
PAYMENTS DUE BY PERIOD
--------------------------------------------------------------------------
LESS THAN 1-3 4-5 AFTER
TOTAL 1 YEAR YEARS YEARS 5 YEARS
------------ ------------ ------------ ------------ ------------
CONTRACTUAL OBLIGATIONS
Long-Term Debt $ 2,411 $ 471 $ 1,940 $ - $ -
Capital Lease Obligations 128 76 52 - -
Line of Credit 6,026 - 6,026 - -
Operating Leases 2,403 674 1,729 - -
Unconditional Purchase Obligations 2,339 38 1,655 646 -
Other Long-Term Obligations 137 - - - 137
---------- -------- --------- -------- --------
Total Contractual Cash Obligations $ 13,444 $ 1,259 $ 11,402 $ 646 $ 137
========== ======== ========= ======== ========
RECENT ACCOUNTING PRONOUNCEMENTS
The Company adopted SFAS No. 141, "Business Combinations" and SFAS No. 142,
"Goodwill and Other Intangible Assets" effective as of January 1, 2002. SFAS
No. 141 requires that all business combinations initiated after June 30, 2001 be
accounted for using the purchase accounting method. SFAS No. 142 states that
goodwill is no longer subject to amortization over its useful life. Rather,
goodwill will be subject to an annual assessment for impairment and be written
down to its fair value only if the carrying amount is greater than the fair
value. In addition, intangible assets will be separately recognized if the
benefit of the intangible asset is obtained through contractual or other legal
rights, or if the intangible asset can be sold, transferred, licensed, rented or
exchanged, regardless of the acquirer's intent to do so. The amount and timing
of non-cash charges related to intangibles acquired in business combinations
will change significantly from prior practice.
FACTORS THAT MAY AFFECT RESULTS
Our future operating results may vary substantially from period to period
due to a number of factors, many of which are beyond our control. The following
discussion highlights these factors and the possible impact of these factors on
future results of operations. If any of the following factors actually occur,
our business, financial condition or results of operations could be harmed. In
that case, the price of our common stock could decline, and you could experience
losses on your investment.
WE ANTICIPATE FUTURE LOSSES AND MAY NOT BE ABLE TO ACHIEVE PROFITABILITY.
We have incurred net losses since our inception in 1988 and, as of March
31, 2002, we had an accumulated deficit of $197.1 million. We anticipate that
we will continue to incur additional operating losses in the near term. These
losses have resulted principally from expenses incurred in our research and
development programs and from sales and marketing and general and administrative
expenses. Even if we achieve profitability, we may not be able to sustain or
increase profitability on a quarterly or annual basis. If we cannot achieve or
sustain profitability, we may not be able to fund our expected cash needs or
continue our operations.
WE ARE NOT GENERATING POSITIVE CASH FLOW AND MAY NEED ADDITIONAL CAPITAL AND
ANY REQUIRED CAPITAL MAY NOT BE AVAILABLE ON ACCEPTABLE TERMS OR AT ALL.
We have incurred negative cash flow from operations since inception in
1988. Our financial plan for 2002 indicates that our cash on hand, together
with borrowings expected to be available under our revolving line of credit and
other sources, should be sufficient to fund our operations through 2002 and into
2003. However, should our actual results achieved this year fall below those
reflected in our forecast, or if we are unable to borrow the funds we expect to
be available, we may need to raise additional capital.
We recently amended our credit agreement with our lender to set the
financial covenants for 2002 and extend the maturity date of the loans an
additional year to May 31, 2003. If our lender imposes additional loan
covenants or other credit requirements that would prevent us from accessing the
full amount of our line of credit, we would need to raise additional capital to
fund any shortfall from our borrowings expected to be available under the
revolving line of credit. We anticipate that any additional capital would be
raised through one or more of the following:
* obtaining new loans secured by unencumbered assets;
* sale of various products or marketing rights;
* licensing of technology;
* sale of various assets; and
* sale of additional equity or debt securities.
Additional capital may not be available on acceptable terms, if at all.
The public markets may remain unreceptive to equity financings, and we may not
be able to obtain additional private equity financing. Furthermore, amounts we
expect to be available under our existing revolving credit facility may not be
available, and other lenders could refuse to provide us with additional debt
financing. Furthermore, any additional equity financing would likely be
dilutive to stockholders, and additional debt financing, if available, may
include restrictive covenants which may limit our currently planned operations
and strategies. If adequate funds are not available, we may be required to
curtail our operations significantly and reduce discretionary spending to extend
the currently available cash resources, or to obtain funds by entering into
collaborative agreements or other arrangements on unfavorable terms, all of
which would likely have a material adverse effect on our business, financial
condition and our ability to continue as a going concern.
WE MUST MAINTAIN VARIOUS FINANCIAL AND OTHER COVENANTS UNDER OUR REVOLVING
LINE OF CREDIT AGREEMENT.
Under our revolving line of credit agreement with Wells Fargo Business
Credit, we are required to comply with various financial and non-financial
covenants, and we have made various representations and warranties. Among the
financial covenants are requirements for monthly minimum book net worth, minimum
quarterly net income and minimum cash balances or liquidity levels. We have
obtained modifications and a waiver of these covenants in the past.
Failure to comply with any of the covenants, representations or warranties
could result in our being in default under the loan and could cause all
outstanding amounts to become immediately due and payable or impact our ability
to borrow under the agreement. All amounts due under the credit facility mature
on May 31, 2003. We intend to rely on available borrowings under the credit
agreement to fund our operations through 2002 and into 2003. If we are unable
to borrow funds under this agreement, we will need to raise additional capital
to fund our cash needs and continue our operations.
OUR COMMON STOCK COULD BE DELISTED FROM THE NATIONAL NASDAQ MARKET.
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, including a minimum bid price requirement of $1.00. The minimum bid
price of our common stock is currently below $1.00, and if it remains below
$1.00 for 30 consecutive trading days, our common stock could be delisted from
the Nasdaq National Market.
The result of delisting from the Nasdaq National Market could be a
reduction in the liquidity of any investment in our common stock and may have an
adverse effect on the trading price of our common stock. As a result, the
ability for investors to resell shares of our common stock could be adversely
affected. This lack of liquidity would make it more difficult for us to raise
capital in the future.
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 any issued patents that 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. The sole remaining claim in the lawsuit is expected
to be scheduled for trial before the end of 2002.
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, or USPTO, to
determine the priority of inventions. The defense and prosecution of
intellectual property suits, USPTO interference proceedings, and related legal
and administrative proceedings are 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 HAVE LIMITED RESOURCES TO DEVOTE TO PRODUCT DEVELOPMENT AND
COMMERCIALIZATION. IF WE ARE NOT ABLE TO DEVOTE ADEQUATE RESOURCES TO PRODUCT
DEVELOPMENT AND COMMERCIALIZATION, WE MAY NOT BE ABLE TO DEVELOP OUR PRODUCTS.
Our strategy is to develop a broad range of products addressing companion
animal healthcare. We believe that our revenue growth and profitability, if
any, will substantially depend upon our ability to:
* improve market acceptance of our current products;
* complete development of new products; and
* successfully introduce and commercialize new products.
We have introduced some of our products only recently and many of our
products are still under development. Among our recently introduced products
are SOLO STEP CH Batch Test Strips for testing heartworm infection in dogs,
E.R.D.-SCREEN Urine Test for detecting albumin in canine urine, ALLERCEPT E-
SCREEN Test for assessing allergies in dogs, and SPOTCHEMT EZ, a compact system
for measuring animal blood chemistry. We currently have under development or in
preliminary clinical trials a number of products, including a gene based therapy
for canine cancer. Because we have limited resources to devote to product
development and commercialization, any delay in the development of one product
or reallocation of resources to product development efforts that prove
unsuccessful may delay or jeopardize the development of our other product
candidates. If we fail to develop new products and bring them to market, our
ability to generate revenues will decrease.
In addition, our products may not achieve satisfactory market acceptance,
and we may not successfully commercialize them on a timely basis, or at all. If
our products do not achieve a significant level of market acceptance, demand for
our products will not develop as expected and it is unlikely that we ever will
become profitable.
WE MAY BE UNABLE TO SUCCESSFULLY MARKET AND DISTRIBUTE OUR PRODUCTS AND HAVE
RECENTLY MODIFIED OUR DISTRIBUTION STRATEGY.
The market for companion animal healthcare products is highly fragmented,
with discount stores and specialty pet stores accounting for a substantial
percentage of sales of certain products. Because our proprietary products are
available only by prescription and our medical instruments require technical
training, we sell our companion animal health products only to veterinarians.
Therefore, we may fail to reach a substantial segment of the potential market.
We currently market our products in the United States to veterinarians
through approximately 20 independent third-party distributors and through a
direct sales force. Nearly one-half of these domestic distributors carry the
full line of our pharmaceutical, vaccine, diagnostic and instrumentation
products. We have recently begun to rely on distributors for a greater portion
of our sales and therefore need to increase our training efforts directed at the
sales personnel of our distributors. To be successful, we will have to continue
to develop and train our direct sales force as well as sales personnel of our
distributors and rely on other arrangements with third parties to market,
distribute and sell our products. In addition, most of our distributor
agreements can be terminated on 60 days' notice and we believe IDEXX, our
largest competitor, prohibits its distributors from selling competitors'
products, including ours. For example, one of our largest distributors recently
informed us that they would no longer carry our heartworm diagnostic products or
our chemistry or hematology instruments because they wish to carry products from
one of our competitors.
We may not successfully develop and maintain marketing, distribution or
sales capabilities, and we may not be able to make arrangements with third
parties to perform these activities on satisfactory terms. If our marketing and
distribution strategy is unsuccessful, our ability to sell our products will be
negatively impacted and our revenues will decrease. Furthermore, the recent
change in our distribution strategy and our expected increase in sales from
distributors and decrease in direct sales may have a negative impact on our
gross margins.
WE MUST OBTAIN AND MAINTAIN COSTLY REGULATORY APPROVALS IN ORDER TO MARKET
OUR PRODUCTS.
Many of the products we develop and market are subject to extensive
regulation by one or more of the USDA, the FDA, the EPA and foreign regulatory
authorities. These regulations govern, among other things, the development,
testing, manufacturing, labeling, storage, pre-market approval, advertising,
promotion, sale and distribution of our products. Satisfaction of these
requirements can take several years and time needed to satisfy them may vary
substantially, based on the type, complexity and novelty of the product.
Our Flu AVERT I.N. Vaccine, SOLO STEP CH, SOLO STEP FH and SOLO STEP Batch
Test Strips each have received regulatory approval in the United States by the
USDA. In addition, the Flu AVERT I.N. Vaccine has been approved in Canada by
the CFIA. SOLO STEP CH and SOLO STEP Batch Test Strips are pending approval by
the CFIA. SOLO STEP CH has also been approved by the Japanese Ministry of
Agriculture, Forestry and Fisheries. In addition, our Trivalent
Intranasal/Intraocular Vaccine has also received United States regulatory
approval. U.S. regulatory approval by the USDA is currently pending for our
Feline ImmuCheck Assay, Canine Cancer Gene Therapy, Giardia + Crypto-Screen
Fecal Test and Trivalent Intranasal/Intraocular Vaccine - Second Generation
products.
The effect of government regulation may be to delay or to prevent marketing
of our products for a considerable period of time and to impose costly
procedures upon our activities. We have experienced in the
past, and may experience in the future, difficulties that could delay or prevent
us from obtaining the regulatory approval or license necessary to introduce or
market our products. For example, the Flu AVERT I.N. vaccine for equine
influenza was not approved until six months after the date on which we expected
approval. This delay caused us to miss the initial primary selling season for
equine influenza vaccines, and we believe it delayed the initial market
acceptance of this product. Regulatory approval of our products may also impose
limitations on the indicated or intended uses for which our products may be
marketed.
Among the conditions for certain regulatory approvals is the requirement
that our manufacturing facilities or those of our third party manufacturers
conform to current Good Manufacturing Practices or other manufacturing
regulations, which include requirements relating to quality control and quality
assurance as well as maintenance of records and documentation. The USDA, FDA
and foreign regulatory authorities strictly enforce manufacturing regulatory
requirements through periodic inspections. If any regulatory authority
determines that our manufacturing facilities or those of our third party
manufacturers do not conform to appropriate manufacturing requirements, we or
the manufacturers of our products may be subject to sanctions, including warning
letters, product recalls or seizures, injunctions, refusal to permit products to
be imported into or exported out of the United States, refusals of regulatory
authorities to grant approval or to allow us to enter into government supply
contracts, withdrawals of previously approved marketing applications, civil
fines and criminal prosecutions.
FACTORS BEYOND OUR CONTROL MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE, AND
SINCE MANY OF OUR EXPENSES ARE FIXED, THIS FLUCTUATION COULD CAUSE OUR STOCK
PRICE TO DECLINE.
We believe that our future operating results will fluctuate on a quarterly
basis due to a variety of factors, including:
* results from Diamond;
* the introduction of new products by us or by our competitors;
* our recent change in distribution strategy;
* market acceptance of our current or new products;
* regulatory and other delays in product development;
* product recalls;
* competition and pricing pressures from competitive products;
* manufacturing delays;
* shipment problems;
* product seasonality; and
* changes in the mix of products sold.
We have high operating expenses for personnel, new product development and
marketing. Many of these expenses are fixed in the short term. If any of the
factors listed above cause our revenues to decline, our operating results could
be substantially harmed.
Our operating results in some quarters may not meet the expectations of
stock market analysts and investors. In that case, our stock price probably
would decline.
OUR LARGEST CUSTOMER ACCOUNTED FOR OVER 15% OF OUR REVENUES FOR THE PREVIOUS
TWO YEARS, AND THE LOSS OF THAT CUSTOMER OR OTHER CUSTOMERS COULD HARM OUR
OPERATING RESULTS.
We currently derive a substantial portion of our revenues from sales by our
subsidiary, Diamond, which manufactures several of our products and products for
other companies in the animal health industry. Revenues from one contract
between Diamond and Agri Laboratories, Ltd., comprised approximately 16% of our
total revenues in 2001 and 17% of our total revenues in 2000. In May 2002,
Diamond signed a seven-year contract
extension with Agri Laboratories. However, if Agri Laboratories does not
continue to purchase from Diamond and if we fail to replace the lost revenue
with revenues from other customers, our business could be substantially harmed.
In addition, sales from our next three largest customers accounted for an
aggregate of approximately 12% of our revenues in 2001. If we are unable to
maintain our relationships with one or more of these customers, our sales may
decline.
WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY, WHICH COULD RENDER OUR PRODUCTS
OBSOLETE OR SUBSTANTIALLY LIMIT THE VOLUME OF PRODUCTS THAT WE SELL. THIS WOULD
LIMIT OUR ABILITY TO COMPETE AND ACHIEVE PROFITABILITY.
We compete with independent animal health companies and major
pharmaceutical companies that have animal health divisions. Companies with a
significant presence in the animal health market, such as Wyeth, Bayer, IDEXX,
Intervet, Merial, Novartis, Pfizer, Pharmacia and Schering Plough, have
developed or are developing products that compete with our products or would
compete with them if developed. These competitors may have substantially
greater financial, technical, research and other resources and larger, better-
established marketing, sales, distribution and service organizations than us.
In addition, we believe that IDEXX prohibits its distributors from selling
competitors' products, including our SOLO STEP heartworm diagnostic products and
medical diagnostic instruments. Our competitors frequently offer broader
product lines and have greater name recognition than we do. Our competitors may
develop or market technologies or products that are more effective or
commercially attractive than our current or future products or that would render
our technologies and products obsolete. Further, additional competition could
come from new entrants to the animal healthcare market. Moreover, we may not
have the financial resources, technical expertise or marketing, distribution or
support capabilities to compete successfully. If we fail to compete
successfully, our ability to achieve profitability will be limited.
OUR TECHNOLOGY AND THAT OF OUR COLLABORATORS MAY BECOME THE SUBJECT OF LEGAL
ACTION.
We license technology from a number of third parties, including Quidel
Corporation, Genzyme Corporation, Diagnostic Chemicals, Ltd., Valentis, Inc.,
Corixa Corporation, Roche, New England Biolabs, Inc. and Hybritech Inc., as well
as a number of research institutions and universities. 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 agencies 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 HAVE GRANTED THIRD PARTIES SUBSTANTIAL MARKETING RIGHTS TO CERTAIN OF OUR
EXISTING PRODUCTS AS WELL AS PRODUCTS UNDER DEVELOPMENT. IF THE THIRD PARTIES
ARE NOT SUCCESSFUL IN MARKETING OUR PRODUCTS OUR SALES MAY NOT INCREASE.
Our agreements with our corporate marketing partners generally contain no
minimum purchase requirements in order for them to maintain their exclusive or
co-exclusive marketing rights. Currently, Novartis Agro K.K. markets and
distributes SOLO STEP CH in Japan, and Novartis Animal Health Canada, Inc.
distributes our FLU AVERT I.N. vaccine in Canada. In addition, we have entered
into agreements with Novartis and Eisai Inc. to market or co-market certain of
the products that we are currently developing. Also, Nestle Purina Petcare has
exclusive rights to license our technology for nutritional applications for dogs
and cats. One or more of these marketing partners may not devote sufficient
resources to marketing our products. Furthermore, there is nothing to prevent
these partners from pursuing alternative technologies or products that may
compete with our products. In the future, third-party marketing assistance may
not be available on reasonable terms, if at all. If any of these events occur,
we may not be able to commercialize our products and our sales will decline.
WE 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 several of our proposed products, we are dependent on collaborative
partners to successfully and timely perform research and development activities
on our behalf. For example, we jointly developed several point-of-care
diagnostic products with Quidel Corporation, and Quidel manufactures these
products. We license DNA delivery and manufacturing technology from Valentis
Inc. and distribute chemistry analyzers for Arkray, Inc. We also have worked
with i-STAT Corporation to develop portable clinical analyzers for dogs and
Diagnostic Chemicals, Ltd. to develop the E.R.D.-SCREEN Urine Test, and we are
working with 3-Dimensional Pharmaceuticals, Inc. to develop pharmaceutical
products. One or more of our 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.
IF RECENT CHANGES IN OUR SENIOR MANAGEMENT ARE NOT SUCCESSFUL, WE WILL NOT BE
ABLE TO ACHIEVE OUR GOALS.
Our President and Chief Operating Officer and Chief Financial Officer have
both recently retired. We have appointed a new Chief Financial Officer and Dr.
Grieve, our Chief Executive Officer, will assume the duties of the President and
Chief Operating Officer. These changes may place a strain on our resources and
planning and management processes during this transition period. If these
changes are not successful, we will not be able to implement our business
strategy. In addition, we will not be able to increase revenues or control
costs unless we continue to improve our operational, financial and managerial
controls and reporting systems and procedures.
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, particularly Dr. Robert B. Grieve, our Chairman
and Chief Executive Officer. 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. Although we have an
employment agreement with Dr. Grieve, he is an at-will employee, which means
that either party may terminate his employment at any time without prior notice.
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 do
not maintain key person life insurance for any of our key personnel.
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 SALES COULD DECLINE.
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 CLEAN UP COSTS OR OTHERWISE 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 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 public 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 $1.47. 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.
THE REGISTRATION OF SHARES FROM OUR RECENT PRIVATE PLACEMENT WILL INCREASE
THE NUMBER OF SHARES AVAILABLE FOR RESALE IN THE PUBLIC MARKET.
We recently filed a registration statement on Form S-3 with the SEC to
register the shares sold in a private offering in December 2001. The sale into
the public market of the common stock sold in the offering could adversely
affect the market price of our common stock. Most of our shares of common stock
outstanding are eligible for immediate and unrestricted sale in the public
market at any time. Once the registration statement on Form S-3 is declared
effective, the 7,792,768 shares of common stock covered by the Form S-3 will be
eligible for immediate and unrestricted resale into the public market. The
presence of these additional shares of common stock in the public market may
further depress our stock price.
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. During 2001, we entered into a series of forward contracts for the
purchase of Japanese yen to be used for the purchase of inventory. As of
December 31, 2001, all of these forward contracts had been settled.
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, is affected by
changes in market interest rates. At March 31, 2002, approximately $8.4 million
was outstanding on these lines of credit and other borrowings with a weighted
average interest rate of 5.82%. 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 June 30, 2002, we would experience an increase in interest expense
of approximately $82,000 based on our outstanding balances as of March 31,
2002.
FOREIGN CURRENCY RISK
At December 31, 2001, 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 completed
a foreign currency exchange risk sensitivity analysis on an assumed 1% increase
in foreign currency exchange rates. If foreign currency exchange rates
increase/decrease by 1% during the three months ended June 30, 2002, 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 fiscal year ended March 31, 2002.
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 March 31, 2002.
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: May 15, 2002 By /s/ Robert B. Grieve
------------------------------
ROBERT B. GRIEVE
Chief Executive Officer and Chairman of the Board
(on behalf of the Registrant and as the
Registrant's Principal Executive Officer)
Date: May 15, 2002 By /s/ Michael A. Bent
------------------------------
MICHAEL A. BENT
Vice President, Controller
(on behalf of the Registrant and as the
Registrant's Principal Accounting Officer)