HESKA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except shares and per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
December 31,
|
|
|
2017
|
|
2016
|
|
|
(unaudited)
|
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
3,727
|
|
|
$
|
10,794
|
|
Accounts receivable, net of allowance for doubtful accounts of
$267 and $237, respectively
|
|
14,459
|
|
|
20,857
|
|
Due from – related parties
|
|
21
|
|
|
100
|
|
Inventories, net
|
|
26,068
|
|
|
20,395
|
|
Other current assets
|
|
3,713
|
|
|
3,127
|
|
Total current assets
|
|
47,988
|
|
|
55,273
|
|
Property and equipment, net
|
|
16,159
|
|
|
16,581
|
|
Goodwill
|
|
26,706
|
|
|
26,647
|
|
Other intangible assets, net
|
|
2,152
|
|
|
2,346
|
|
Deferred tax asset, net
|
|
21,052
|
|
|
21,122
|
|
Other non-current assets
|
|
12,352
|
|
|
8,875
|
|
Total assets
|
|
$
|
126,409
|
|
|
$
|
130,844
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
Current liabilities:
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
7,410
|
|
|
$
|
7,154
|
|
Accrued liabilities
|
|
4,668
|
|
|
6,469
|
|
Current portion of deferred revenue
|
|
3,424
|
|
|
3,439
|
|
Obligation to purchase minority interest
|
|
—
|
|
|
14,602
|
|
Line of credit and other short-term borrowings
|
|
4,033
|
|
|
750
|
|
Total current liabilities
|
|
19,535
|
|
|
32,414
|
|
Deferred revenue, net of current portion, and other
|
|
10,299
|
|
|
11,455
|
|
Total liabilities
|
|
29,834
|
|
|
43,869
|
|
Commitments and contingencies (Note 11)
|
|
|
|
|
|
|
Stockholders' equity:
|
|
|
|
|
|
|
Preferred stock, $.01 par value, 2,500,000 shares authorized,
none issued or outstanding
|
|
—
|
|
|
—
|
|
Traditional common stock, $.01 par value, 10,000,000 shares authorized,
none issued or outstanding
|
|
—
|
|
|
—
|
|
Public common stock, $.01 par value, 10,000,000 shares authorized,
7,195,623 and 7,026,051 shares issued and outstanding, respectively
|
|
72
|
|
|
70
|
|
Additional paid-in capital
|
|
240,621
|
|
|
238,635
|
|
Accumulated other comprehensive income
|
|
267
|
|
|
97
|
|
Accumulated deficit
|
|
(144,385
|
)
|
|
(151,827
|
)
|
Total stockholders' equity
|
|
96,575
|
|
|
86,975
|
|
Total liabilities and stockholders' equity
|
|
$
|
126,409
|
|
|
$
|
130,844
|
|
See accompanying notes to condensed consolidated financial statements.
HESKA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
Core companion animal health
|
|
$
|
27,021
|
|
|
$
|
24,464
|
|
|
$
|
51,629
|
|
|
$
|
47,898
|
|
Other vaccines, pharmaceuticals and products
|
|
7,315
|
|
|
5,501
|
|
|
13,089
|
|
|
9,213
|
|
Total revenue, net
|
|
34,336
|
|
|
29,965
|
|
|
64,718
|
|
|
57,111
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
19,407
|
|
|
17,283
|
|
|
36,580
|
|
|
32,987
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
14,929
|
|
|
12,682
|
|
|
28,138
|
|
|
24,124
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
5,993
|
|
|
5,386
|
|
|
12,093
|
|
|
11,005
|
|
Research and development
|
|
445
|
|
|
523
|
|
|
975
|
|
|
1,098
|
|
General and administrative
|
|
3,931
|
|
|
3,217
|
|
|
7,722
|
|
|
6,495
|
|
Total operating expenses
|
|
10,369
|
|
|
9,126
|
|
|
20,790
|
|
|
18,598
|
|
Operating income
|
|
4,560
|
|
|
3,556
|
|
|
7,348
|
|
|
5,526
|
|
Interest and other expense (income), net
|
|
(118
|
)
|
|
34
|
|
|
(180
|
)
|
|
(99
|
)
|
Income before income taxes
|
|
4,678
|
|
|
3,522
|
|
|
7,528
|
|
|
5,625
|
|
Income tax expense:
|
|
|
|
|
|
|
|
|
|
|
|
Current income tax expense
|
|
10
|
|
|
87
|
|
|
17
|
|
|
161
|
|
Deferred income tax expense
|
|
1,529
|
|
|
693
|
|
|
69
|
|
|
1,275
|
|
Total income tax expense
|
|
1,539
|
|
|
780
|
|
|
86
|
|
|
1,436
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
3,139
|
|
|
2,742
|
|
|
7,442
|
|
|
4,189
|
|
Net income (loss) attributable to non-controlling interest
|
|
(194
|
)
|
|
220
|
|
|
(498
|
)
|
|
482
|
|
Net income attributable to Heska Corporation
|
|
$
|
3,333
|
|
|
$
|
2,522
|
|
|
$
|
7,940
|
|
|
$
|
3,707
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share attributable
to Heska Corporation
|
|
$
|
0.47
|
|
|
$
|
0.38
|
|
|
$
|
1.14
|
|
|
$
|
0.56
|
|
Diluted earnings per share attributable
to Heska Corporation
|
|
$
|
0.44
|
|
|
$
|
0.35
|
|
|
$
|
1.05
|
|
|
$
|
0.51
|
|
|
|
|
|
|
|
|
|
|
Weighted average outstanding shares used to compute basic earnings per share attributable to Heska Corporation
|
|
7,069
|
|
|
6,695
|
|
|
6,967
|
|
|
6,641
|
|
Weighted average outstanding shares used to compute diluted earnings per share attributable to Heska Corporation
|
|
7,632
|
|
|
7,249
|
|
|
7,570
|
|
|
7,206
|
|
See accompanying notes to condensed consolidated financial statements.
HESKA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
3,139
|
|
|
$
|
2,742
|
|
|
$
|
7,442
|
|
|
$
|
4,189
|
|
Other comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
Sale of equity investment
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(90
|
)
|
Foreign currency translation
|
|
114
|
|
|
(47
|
)
|
|
170
|
|
|
42
|
|
Comprehensive income
|
|
3,253
|
|
|
2,695
|
|
|
7,612
|
|
|
4,141
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss) attributable to non-controlling interest
|
|
(194
|
)
|
|
220
|
|
|
(498
|
)
|
|
482
|
|
Comprehensive income attributable to Heska Corporation
|
|
$
|
3,447
|
|
|
$
|
2,475
|
|
|
$
|
8,110
|
|
|
$
|
3,659
|
|
See accompanying notes to condensed consolidated financial statements.
HESKA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
|
2017
|
|
2016
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
Net income
|
|
$
|
7,442
|
|
|
$
|
4,189
|
|
Adjustments to reconcile net income to cash provided by operating activities:
|
|
|
|
|
|
|
Depreciation and amortization
|
|
2,192
|
|
|
2,211
|
|
Deferred tax expense
|
|
69
|
|
|
1,275
|
|
Stock based compensation
|
|
1,386
|
|
|
1,112
|
|
Unrealized benefit on foreign currency translation
|
|
20
|
|
|
(2
|
)
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
Accounts receivable
|
|
6,398
|
|
|
1,764
|
|
Inventories
|
|
(5,391
|
)
|
|
(3,691
|
)
|
Other current assets
|
|
(567
|
)
|
|
363
|
|
Accounts payable
|
|
255
|
|
|
(1,725
|
)
|
Accrued liabilities and other
|
|
(1,801
|
)
|
|
(367
|
)
|
Other non-current assets
|
|
(3,661
|
)
|
|
(2,889
|
)
|
Deferred revenue and other
|
|
(917
|
)
|
|
(1,962
|
)
|
Net cash provided by operating activities
|
|
5,425
|
|
|
278
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
Proceeds from sale of equity investment
|
|
—
|
|
|
115
|
|
Purchase of minority interest
|
|
(13,757
|
)
|
|
—
|
|
Purchases of property and equipment
|
|
(1,865
|
)
|
|
(1,368
|
)
|
Proceeds from disposition of property and equipment
|
|
—
|
|
|
405
|
|
Net cash used in investing activities
|
|
(15,622
|
)
|
|
(848
|
)
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
Proceeds from issuance of common stock
|
|
1,571
|
|
|
649
|
|
Repurchase of equity instruments
|
|
(860
|
)
|
|
—
|
|
Distributions to non-controlling interest members
|
|
(954
|
)
|
|
—
|
|
Proceeds from line of credit borrowings
|
|
26,051
|
|
|
15,886
|
|
Repayments of line of credit borrowings
|
|
(22,690
|
)
|
|
(16,028
|
)
|
Repayments of other debt
|
|
(79
|
)
|
|
(180
|
)
|
Net cash provided by financing activities
|
|
3,039
|
|
|
327
|
|
EFFECT OF EXCHANGE RATE CHANGES ON CASH
|
|
91
|
|
|
22
|
|
DECREASE IN CASH AND CASH EQUIVALENTS
|
|
(7,067
|
)
|
|
(221
|
)
|
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
|
|
10,794
|
|
|
6,890
|
|
CASH AND CASH EQUIVALENTS, END OF PERIOD
|
|
$
|
3,727
|
|
|
$
|
6,669
|
|
See accompanying notes to condensed consolidated financial statements.
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Heska Corporation and its wholly-owned subsidiaries ("Heska", the "Company", "we" or "our") sell advanced veterinary diagnostic and specialty products. Our offerings include blood testing instruments and supplies, digital imaging products, software and services, vaccines, local and cloud-based data services, allergy testing and immunotherapy, and single-use offerings such as in-clinic diagnostic tests and heartworm preventive products. Our core focus is on supporting veterinarians in the canine and feline healthcare space.
In the opinion of management, the accompanying unaudited Condensed Consolidated Financial Statements contain all adjustments, consisting of normal, recurring adjustments, necessary to present fairly the financial position of the Company at
June 30, 2017
, and the results of our operations for the
three and six
months ended
June 30, 2017
and 2016 and cash flows for the
six
months ended
June 30, 2017
and
2016
.
The unaudited Condensed Consolidated Financial Statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") have been condensed or omitted pursuant to such rules and regulations. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 and other financial information filed with the SEC.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP 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. Significant estimates are required when establishing the allowance for doubtful accounts and the provision for excess or obsolete inventory, in determining the period over which our obligations are fulfilled under agreements to license product rights and/or technology rights, evaluating long-lived and intangible assets for impairment, determining the allocation of purchase price under purchase accounting, estimating the expense associated with the granting of stock options, and in determining the need for, and the amount of, a valuation allowance on deferred tax assets.
Critical Accounting Policies
Our accounting policies are described in our audited Consolidated Financial Statements and Notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2016.
Recent Accounting Pronouncements
In May 2017, the FASB issued ASU 2017-09, “Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting.” ASU 2017-09 was issued to provide clarity and reduce both 1) diversity in practice and 2) cost and complexity when applying the guidance in Topic 718 to a change in the terms or conditions of a share-based payment award. ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting under Topic 718. The amendments in ASU 2017-09 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period. The amendments in ASU 2017-09 should be applied prospectively to an award modified on or after
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
the adoption date. Heska adopted the new guidance in its second quarter of fiscal year 2017 and will apply the guidance to any future changes to the terms or conditions of its share-based payment awards.
In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment,” to simplify financial reporting by eliminating the need to determine the fair value of individual assets and liabilities of a reporting unit to measure goodwill impairment. Under ASU 2017-04, an entity should perform its goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, up to the amount of goodwill allocated to that reporting unit. The new guidance effectively eliminates “Step 2” from the previous goodwill impairment test. ASU 2017-04 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption is permitted for goodwill impairment tests performed on testing dates after January 1, 2017. Heska plans to adopt the new guidance in its fourth quarter of fiscal year 2017 when it performs its annual goodwill impairment test as of December 15, 2017. Heska does not expect the adoption of ASU 2017-04 to have a significant impact on the results of its goodwill impairment testing.
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)", which supersedes ASC 840, Leases, and creates a new topic, ASC 842, Leases. This update requires lessees to recognize a lease liability and a lease asset for all leases, including operating leases, with a term greater than 12 months on its balance sheet. The update also expands the required quantitative and qualitative disclosures surrounding leases. This update is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, with early adoption permitted. This update will be applied using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. We are currently evaluating the effect of this update on our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” and has subsequently issued several supplemental and/or clarifying ASUs (collectively “ASC 606”). ASC 606 prescribes a single common revenue standard that replaces most existing U.S. GAAP revenue recognition guidance. ASC 606 outlines a five-step model, under which Heska will recognize revenue as performance obligations within a customer contract are satisfied. ASC 606 is intended to provide more consistent interpretation and application of the principles outlined in the standard across filers in multiple industries and within the same industries compared to current practices, which should improve comparability.
Adoption of ASC 606 is required for annual reporting periods beginning after December 15, 2017, including interim periods within the reporting period. Upon adoption, Heska must elect to adopt either retrospectively to each prior reporting period presented (full retrospective method) or using the cumulative effect transition method with the cumulative effect of initial adoption recognized at the date of initial application (modified retrospective method). Based on evaluation of the accounting impact of ASC 606 on our revenue streams, Heska has elected to adopt the modified retrospective method.
Heska assessed the impact that the future adoption of ASC 606 is expected to have on its Consolidated Financial Statements by analyzing its current portfolio of customer contracts and various revenue streams, including a review of historical accounting policies and practices to identify potential differences in applying the guidance of ASC 606. Heska is also performing a comprehensive review of its current processes and systems to determine and implement changes required to support the adoption of ASC 606 on January 1, 2018.
Based on Heska’s review of its customer contracts, Heska has determined that the timing of revenue recognition on the majority of its customer contracts will continue to be recognized as they are currently, generally upon shipment of products, consistent with Heska’s current revenue recognition model. While
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
Heska believes that the timing of revenue recognition is consistent with current practice, we are still evaluating the allocation of the standalone selling price of goods and services and this could have an impact on the amount of revenue recognized at a point in time versus over time. As such, Heska believes the adoption of ASC 606 will have an impact on both the timing of revenue recognition and various line items within the Consolidated Balance Sheet.
Heska generally expenses costs to obtain contracts (i.e. sales commissions) as a period expense for all contracts, despite the length of the arrangement. ASC 606, states that "an asset recognized in accordance with the incremental costs of obtaining a contract shall be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates." Because a significant number of Heska’s customers are under noncancelable contracts for periods extending beyond one year with the delivery of goods and services occurring throughout the duration, Heska anticipates recording an asset related to the prepayment of such contract acquisition costs.
In addition, ASC 606 will require more comprehensive disclosures about revenue streams and contracts with customers, including significant judgments required. Heska is currently evaluating potential changes to its processes for preparing required disclosures and to information systems that support the financial reporting process.
In addition, Heska is evaluating implications to the Company’s system of internal controls, relative to revenue recognition and the related revenue disclosures.
2. ACQUISITIONS AND RELATED PARTY ITEMS
Cuattro Veterinary, LLC
On May 31, 2016, the Company closed a transaction (the "Merger") to acquire Cuattro Veterinary, LLC ("Cuattro International") from Kevin S. Wilson, and all of the members of Cuattro International (the "Members"). Pursuant to the Merger, the Company issued
175,000
shares of the Company’s common stock,
$.01
par value per share (the "Common Stock"), to the Members on the Closing Date, at an aggregate value equal to approximately
$6.3 million
based on the adjusted closing price per share of the Common Stock as reported on the Nasdaq Stock Market on the Merger closing date. These shares were issued to the Members in a private placement in reliance upon an exemption from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(a)(2) thereof and the safe harbor provided by Rule 506 of Regulation D promulgated thereunder. In addition, the Company assumed approximately
$1.5 million
in debt as part of the transaction.
Mr. Wilson is a founder of Cuattro International, Cuattro, LLC, Cuattro Software, LLC and Cuattro Medical, LLC. Mr. Wilson, Mrs. Wilson and trusts for the benefit of Mr. and Mrs. Wilson’s children and family own a
100%
interest in Cuattro, LLC and a majority interest in Cuattro Medical, LLC. Cuattro, LLC owns a
100%
interest in Cuattro Software, LLC and, prior to the Merger, owned a majority interest in Cuattro International.
The Company recorded assets acquired and liabilities assumed at their estimated fair values. Intangible assets were valued based on a report from an independent third party.
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
The following summarizes the aggregate consideration paid by the Company and the allocation of the purchase price (in thousands):
|
|
|
|
|
Common stock issued - 175,000 shares
|
$
|
6,347
|
|
Debt assumed
|
1,535
|
|
Total fair value of consideration transferred
|
$
|
7,882
|
|
|
|
Accounts receivable
|
$
|
222
|
|
Inventories
|
39
|
|
Due from Cuattro, LLC
|
963
|
|
Property and equipment
|
80
|
|
Other tangible assets
|
164
|
|
Deferred tax asset
|
56
|
|
Intangible assets
|
2,521
|
|
Goodwill
|
5,783
|
|
Accounts payable
|
(112
|
)
|
Deferred tax liability
|
(905
|
)
|
Other assumed liabilities
|
(929
|
)
|
Total fair value of consideration transferred
|
$
|
7,882
|
|
Intangible assets acquired, amortization method and estimated useful lives as of May 31, 2016 was as follows (dollars in thousands):
|
|
|
|
|
|
|
|
Useful Life
|
|
Amortization Method
|
|
Fair Value
|
Customer relationships
|
6.67
|
|
Straight-line
|
|
$2,521
|
Cuattro International is a provider to international markets of digital radiography technologies for veterinarians. As a leading provider of advanced veterinary diagnostic and specialty products, we made the acquisition in an effort to combine Cuattro International's international reach with our domestic success in the imaging and blood testing markets in the United States. International markets represent a significant portion of worldwide veterinary revenues for which we intend to compete.
As of the closing date of the Merger, Cuattro International was renamed Heska Imaging International, LLC, and the Company's interest in both Heska Imaging International, LLC ("International Imaging") and Heska Imaging US, LLC ("US Imaging") was transferred to the Company's wholly-owned subsidiary, Heska Imaging Global, LLC ("Global Imaging").
Cuattro Veterinary USA, LLC
On February 24, 2013, the Company acquired a
54.6%
interest in Cuattro Veterinary USA, LLC, which was subsequently renamed Heska Imaging US, LLC. The remaining minority position
(45.4%)
in US Imaging was subject to purchase by Heska under performance-based puts and calls following the audit of our financial statements for 2016 and 2017. The required performance criteria were met in 2016, we considered notice given on March 3, 2017 that the put option was being exercised and on May 31, 2017, we delivered
$13.8 million
in cash to obtain the remaining minority position in US Imaging.
Prior to the purchase of the minority position (the "Imaging Minority"), Shawna M. Wilson, Clint Roth, DVM, Steven M. Asakowicz, Rodney A. Lippincott, Kevin S. Wilson and Cuattro, LLC owned approximately
29.75%
,
8.39%
,
4.09%
,
3.07%
,
0.05%
and
0.05%
of US Imaging, respectively. Kevin S.
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
Wilson is the Chief Executive Officer and President of the Company and the spouse of Shawna M. Wilson. Steven M. Asakowicz serves as Executive Vice President, Companion Animal Health Sales for the Company. Rodney A. Lippincott serves as Executive Vice President, Companion Animal Health Sales for the Company. On April 3, 2017, and in accordance with the terms of its Operating Agreement, US Imaging distributed
$2.1 million
based on past operating performance, including
$1.0 million
to its minority interest members.
On June 1, 2017, the Company consolidated its assets and liabilities in the US Imaging and International Imaging companies into Global Imaging, which was re-named Heska Imaging, LLC ("Heska Imaging").
Related Party Activities
Cuattro, LLC charged Heska Imaging
$8.6 million
during
the six months ended June 30, 2017
, primarily related to digital imaging products, for which there is an underlying supply contract with minimum purchase obligations, software and services as well as other operating expenses; Heska Corporation charged Heska Imaging
$2.9 million
during the five months ended May 31, 2017, prior to the purchase of the Imaging Minority on June 1, 2017, primarily related to sales expenses; and Heska Corporation charged Cuattro, LLC
$67 thousand
during
the six months ended June 30, 2017
, primarily related to facility usage and other services.
As of June 30, 2017, Heska Corporation had receivables from Cuattro, LLC of
$21 thousand
, which is included in "Due from – related parties" on the Company's consolidated balance sheet.
3. INCOME TAXES
Our total income tax expense and the effective tax rate for our income before income taxes were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Income before income taxes
|
|
$
|
4,678
|
|
|
$
|
3,522
|
|
|
$
|
7,528
|
|
|
$
|
5,625
|
|
Total income tax expense
|
|
1,539
|
|
|
780
|
|
|
86
|
|
|
1,436
|
|
Effective tax rate
|
|
32.9
|
%
|
|
22.1
|
%
|
|
1.1
|
%
|
|
25.5
|
%
|
We are subject to income taxes in the U.S. federal jurisdiction, and various foreign, state and local jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply.
During interim periods, the Company generally utilizes the estimated annual effective tax rate method which involves the use of forecasted information. Under this method, the provision is calculated by applying an estimate of the annual effective tax rate for the full fiscal year to “ordinary” income or loss (pretax income or loss excluding unusual or infrequently occurring discrete items) for the reporting period. The Company’s effective tax rate increased to
32.9%
for the three months ended
June 30, 2017
, compared to
22.1%
for the three months ended
June 30, 2016
, which included the early adoption of ASU 2016-09. As discussed further below, the increase in rate was primarily attributable to recording a partial valuation allowance against our deferred tax assets (“DTAs”) as of
June 30, 2017
to partially offset the tax impact of various stock compensation-related tax benefits.
As of
June 30, 2017
, the Company assessed whether the reduction of taxable income due to large benefits created by stock option exercises and vesting of restricted stock and the excess tax benefits resulting
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
from the application of ASU 2016-09 would cause a larger portion of our DTAs to likely expire unrealized. The Company assessed its ability to realize the DTAs by evaluating all available positive and negative evidence, including (1) cumulative results of operations in recent years, (2) sources of recent pre-tax losses, (3) estimates of future taxable income, and (4) the length of Net Operating Loss ("NOL") carryforward periods. Additionally, the Company considered the length of NOL carryforward periods and an objectively verifiable estimate of future income based on operating results from the Company’s recent history, as well as an estimate of future income that incorporates the Company's forecasted operating results for fiscal 2017. Due to the significant amount of additional stock based compensation excess tax deduction generated, the Company determined that the negative evidence outweighed the positive evidence and that it is not more-likely-than-not that sufficient taxable income will be generated to realize all of the DTAs as of June 30, 2017. As such, an additional $1.8 million was recorded to the current partial valuation allowance against the Company’s DTAs as of June 30, 2017. The Company will continue to closely monitor the need for an additional valuation allowance against its DTAs in each subsequent reporting period which can be impacted by actual operating results compared to the Company's forecast.
There were
$144 thousand
cash payments for income taxes for
the three months ended June 30, 2017
and there were
$57 thousand
cash paid for income taxes for the three month period ended
June 30, 2016
.
There were
$144 thousand
cash payments for income taxes for
the six months ended June 30, 2017
and there were
$62 thousand
cash paid for income taxes for the six month period ended
June 30, 2016
.
4. EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing net income attributable to Heska by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that the numerator is increased to exclude charges that would not have been incurred, and the denominator is increased to include the number of additional common shares that would have been outstanding (using the if-converted and treasury stock methods), if securities containing potentially dilutive common shares (stock options and restricted stock units but excluding options to purchase fractional shares resulting from the Company's December 2010 1-for-
10
reverse stock split) had been converted to common shares, and if such assumed conversion is dilutive.
The following is a reconciliation of the weighted-average shares outstanding used in the calculation of basic and diluted earnings per share for the three and six months ended
June 30, 2017
and
2016
(in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Net income attributable to Heska
|
$
|
3,333
|
|
|
$
|
2,522
|
|
|
$
|
7,940
|
|
|
$
|
3,707
|
|
|
|
|
|
|
|
|
|
Basic weighted-average common shares outstanding
|
7,069
|
|
|
6,695
|
|
|
6,967
|
|
|
6,641
|
|
Assumed exercise of dilutive stock options and restricted stock units
|
563
|
|
|
554
|
|
|
603
|
|
565
|
|
Diluted weighted-average common shares outstanding
|
7,632
|
|
|
7,249
|
|
|
7,570
|
|
|
7,206
|
|
|
|
|
|
|
|
|
|
Basic earnings per share attributable to Heska
|
$
|
0.47
|
|
|
$
|
0.38
|
|
|
$
|
1.14
|
|
|
$
|
0.56
|
|
Diluted earnings per share attributable to Heska
|
$
|
0.44
|
|
|
$
|
0.35
|
|
|
$
|
1.05
|
|
|
$
|
0.51
|
|
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
The following stock options and restricted units were excluded from the computation of diluted earnings per share because they would have been anti-dilutive (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Stock options
|
25
|
|
|
138
|
|
|
132
|
|
|
138
|
|
5. GOODWILL AND OTHER INTANGIBLES
The following summarizes the change in goodwill during
the six months ended June 30, 2017
(in thousands):
|
|
|
|
|
Carrying amount, December 31, 2016
|
$
|
26,647
|
|
Foreign currency adjustments
|
59
|
|
Carrying amount, June 30, 2017
|
$
|
26,706
|
|
Other intangibles consists of the following as of
June 30, 2017
and
December 31, 2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
December 31,
|
|
2017
|
|
2016
|
Gross carrying amount
|
$
|
3,309
|
|
|
$
|
3,309
|
|
Accumulated amortization
|
(1,157
|
)
|
|
(963
|
)
|
Net carrying amount
|
$
|
2,152
|
|
|
$
|
2,346
|
|
Amortization expense relating to other intangibles was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Amortization expense
|
$
|
97
|
|
|
$
|
34
|
|
|
$
|
194
|
|
|
$
|
37
|
|
Estimated amortization expense related to intangibles for each of the five years from 2017 (remaining) through 2021 and thereafter is as follows (in thousands):
|
|
|
|
|
Year Ending December 31,
|
|
2017 (remaining)
|
194
|
|
2018
|
388
|
|
2019
|
388
|
|
2020
|
388
|
|
2021
|
384
|
|
Thereafter
|
410
|
|
|
$
|
2,152
|
|
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
6. PROPERTY AND EQUIPMENT
Property and equipment, net consists of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
December 31,
|
|
2017
|
|
2016
|
Land
|
$
|
377
|
|
|
$
|
377
|
|
Building
|
2,868
|
|
|
2,868
|
|
Machinery and equipment
|
37,488
|
|
|
36,588
|
|
Leasehold and building improvements
|
8,126
|
|
|
7,662
|
|
Construction in progress
|
1,869
|
|
|
1,655
|
|
|
50,728
|
|
|
49,150
|
|
Less accumulated depreciation
|
(34,569
|
)
|
|
(32,569
|
)
|
Total property and equipment, net
|
$
|
16,159
|
|
|
$
|
16,581
|
|
The Company has utilized marketing programs whereby its instruments in inventory may be placed in a customer's location on a rental basis. The cost of these instruments is transferred to machinery and equipment and depreciated, typically over a
five
to
seven
year period depending on the circumstance under which the instrument is placed with the customer. Total costs transferred from inventory were approximately
$0.3 million
and
$1.8 million
for the six months ended June 30, 2017 and the annual period ended December 31, 2016, respectively.
The Company has sold certain customer rental contracts and underlying assets to third parties under agreements that once the customer has met its obligations under the contract, ownership of the assets underlying the contract would be returned to the Company. The Company enters a debit to cash and a corresponding credit to deferred revenue at the time of these sales. Since the Company anticipates it will regain ownership of the assets underlying these sales, it reports these assets as part of property and equipment and depreciates these assets in accordance with its depreciation policies. The Company had
$0.3 million
of net property and equipment related to these transactions as of both
June 30, 2017
and December 31, 2016, all related to Heska Imaging.
Depreciation expense for property and equipment was
$1.0 million
and
$1.1 million
for
the three months ended June 30, 2017
and 2016, respectively. Depreciation expense was
$2.0 million
and
$2.2 million
for
the six months ended June 30, 2017
and 2016, respectively.
7. INVENTORIES
Inventories are stated at the lower of cost or net realizable value using the first-in, first-out method. Inventory we manufacture includes the cost of material, labor and overhead. If the cost of inventories exceeds estimated net realizable value, provisions are made to reduce the carrying value to estimated net realizable value.
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
Inventories, net consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
December 31,
|
|
|
2017
|
|
2016
|
Raw materials
|
|
$
|
12,551
|
|
|
$
|
10,807
|
|
Work in process
|
|
4,413
|
|
|
3,820
|
|
Finished goods
|
|
10,508
|
|
|
7,087
|
|
Allowance for excess or obsolete inventory
|
|
(1,404
|
)
|
|
(1,319
|
)
|
Total inventory, net
|
|
$
|
26,068
|
|
|
$
|
20,395
|
|
8. ACCRUED LIABILITIES
Accrued liabilities consists of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
June 30,
2017
|
|
December 31,
2016
|
Accrued payroll and employee benefits
|
$
|
1,457
|
|
|
$
|
2,166
|
|
Accrued property taxes
|
522
|
|
|
748
|
|
Accrued purchases
|
—
|
|
|
664
|
|
Other
|
2,689
|
|
|
2,891
|
|
Total accrued liabilities
|
$
|
4,668
|
|
|
$
|
6,469
|
|
Other accrued liabilities consist of items that are individually less than 5% of total current liabilities.
9. CAPITAL STOCK
Stock Option Plans
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option- pricing model with the following weighted average assumptions for options granted in the
six
months ended
June 30,
2017
and
2016
.
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Risk-free interest rate
|
1.75%
|
|
1.17%
|
|
1.75%
|
|
1.19%
|
Expected lives
|
4.9 years
|
|
4.5 years
|
|
4.9 years
|
|
4.5 years
|
Expected volatility
|
41%
|
|
41%
|
|
41%
|
|
41%
|
Expected dividend yield
|
0%
|
|
0%
|
|
0%
|
|
0%
|
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
A summary of our stock option plans, excluding options to purchase fractional shares resulting from our December 2010 1-for-
10
reverse stock split, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
Year Ended
December 31,
|
|
2017
|
|
2016
|
|
Options
|
|
Weighted Average Exercise Price
|
|
Options
|
|
Weighted Average Exercise Price
|
Outstanding at beginning of period
|
829,617
|
|
|
$
|
23.203
|
|
|
940,610
|
|
|
$
|
14.163
|
|
Granted at Market
|
24,950
|
|
|
$
|
98.794
|
|
|
129,855
|
|
|
$
|
67.706
|
|
Canceled
|
(3,343
|
)
|
|
$
|
46.181
|
|
|
(463
|
)
|
|
$
|
14.881
|
|
Exercised
|
(144,407
|
)
|
|
$
|
10.657
|
|
|
(240,385
|
)
|
|
$
|
11.886
|
|
Outstanding at end of period
|
706,817
|
|
|
$
|
28.326
|
|
|
829,617
|
|
|
$
|
23.203
|
|
Exercisable at end of period
|
456,476
|
|
|
$
|
15.304
|
|
|
532,703
|
|
|
$
|
12.140
|
|
The total estimated fair value of stock options granted during
the six months ended June 30, 2017
and
2016
was computed to be approximately
$932 thousand
and
$267 thousand
, respectively. The amounts are amortized ratably over the vesting periods of the options. The weighted average estimated fair value of options granted during
the six months ended June 30, 2017
and
2016
was computed to be approximately
$37.37
and
$13.83
, respectively. The total intrinsic value of options exercised during
the six months ended June 30, 2017
and
2016
was
$12.4 million
and
$1.6 million
, respectively. The cash proceeds from options exercised during
the six months ended June 30, 2017
and
2016
was
$1.3 million
and
$660 thousand
, respectively.
The following table summarizes information about stock options outstanding and exercisable at
June 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
Options Exercisable
|
Exercise Prices
|
|
Number of
Options
Outstanding
at
June 30,
2017
|
|
Weighted
Average
Remaining
Contractual
Life in Years
|
|
Weighted
Average
Exercise
Price
|
|
Number of
Options
Exercisable
at
June 30,
2017
|
|
Weighted
Average
Exercise
Price
|
$ 4.40 - $ 6.90
|
|
97,973
|
|
|
3.20
|
|
$
|
5.406
|
|
|
97,605
|
|
|
$
|
5.403
|
|
$ 6.91 - $ 7.36
|
|
140,266
|
|
|
6.39
|
|
$
|
7.360
|
|
|
120,875
|
|
|
$
|
7.360
|
|
$ 7.37 - $18.13
|
|
166,553
|
|
|
6.55
|
|
$
|
13.317
|
|
|
130,005
|
|
|
$
|
12.030
|
|
$18.14 - $39.76
|
|
169,201
|
|
|
7.57
|
|
$
|
35.054
|
|
|
94,911
|
|
|
$
|
32.025
|
|
$39.77 - $108.25
|
|
132,824
|
|
|
9.58
|
|
$
|
77.623
|
|
|
13,080
|
|
|
$
|
73.803
|
|
$ 4.40 - $108.25
|
|
706,817
|
|
|
6.87
|
|
$
|
28.326
|
|
|
456,476
|
|
|
$
|
15.304
|
|
As of
June 30, 2017
, there was approximately
$4.5 million
in total unrecognized compensation cost related to outstanding stock options. That cost is expected to be recognized over a weighted average period of
1.81
years, with all cost to be recognized by the end of May 2021, assuming all options vest according to the vesting schedules in place at
June 30, 2017
. As of
June 30, 2017
, the aggregate intrinsic value of outstanding options was approximately
$52.1 million
and the aggregate intrinsic value of exercisable options was approximately
$39.6 million
.
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
Employee Stock Purchase Plan (the "ESPP")
For
the three months ended June 30, 2017
and
2016
, we issued
2,339
and
4,497
shares under the ESPP, respectively. For the six months ended
June 30,
2017
and
2016
, we issued
5,543
and
10,382
shares under the ESPP, respectively.
For the three and six months ended
June 30, 2017
and
2016
, we estimated the fair values of stock purchase rights granted under the ESPP using the Black-Scholes pricing model. The weighted average assumptions used for the periods presented were as follows:
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Risk-free interest rate
|
0.70%
|
|
0.55%
|
|
0.67%
|
|
0.53%
|
Expected lives
|
1.2 years
|
|
1.2 years
|
|
1.2 years
|
|
1.2 years
|
Expected volatility
|
45%
|
|
43%
|
|
45%
|
|
42%
|
Expected dividend yield
|
0%
|
|
0%
|
|
0%
|
|
0%
|
For
the three months ended June 30, 2017
and 2016, the weighted-average fair value of the purchase rights granted was
$18.67
and
$7.64
per share, respectively. For
the six months ended June 30, 2017
and
2016
, the weighted-average fair value of the purchase rights granted was
$15.63
and
$6.87
per share, respectively.
Restricted Stock Issuance
On March 26, 2014, we issued
110,000
shares to Mr. Wilson pursuant to an employment agreement between Mr. Wilson and the Company effective as of March 26, 2014 (the "Wilson Employment Agreement"). The shares were issued in
four
equal tranches and subject to time-based vesting and other provisions outlined in the Wilson Employment Agreement. As of March 26, 2017, all tranches have vested.
On March 17, 2015, the Company issued unvested shares to certain Executive Officers related to performance-based restricted stock grants (the "Performance Grants"). The Company issued
52,956
shares under the Performance Grants. The Performance Grants have met the underlying performance condition based on the Company's 2015 financial performance and are to cliff vest on March 17, 2018, subject to other vesting provisions in the underlying restricted stock grant agreement.
On March 2, 2016, the Company issued
15,000
unvested shares to certain Executive Officers related to performance-based restricted stock grants as part of the Company’s 2016 Management Incentive Plan (the "2016 MIP Grants"). Of these,
14,629
vested,
371
were forfeited, and
4,133
were withheld for tax. The 2016 MIP Grants vested during the three months ended March 31, 2017.
On May 1, 2017, the Company issued
2,720
shares of our Common Stock to the Company's non-employee directors. These grants are to vest (the "Vesting Time") in full on the latter of (i) the one year anniversary of the date of grant and (ii) the Company’s Annual Meeting of Stockholders for the year following the year of grant for the award (the "Vesting Meeting"), subject to (i) the non-employee director's continued service to the Company through the Vesting Time, unless the non-employee director’s current term expires at the Vesting Meeting in which case vesting is subject to the non-employee director’s service to the Vesting Meeting and (ii) the non-employee director not engaging in “competition”, as defined in a restricted stock grant agreement executed by the non-employee director, to the Vesting Time.
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
On May 31, 2017, the Company issued
23,700
unvested performance-based restricted stock shares to certain key employees. The vesting of these shares is subject to the achievement of certain Company performance and market conditions that must be met on or before
May 30, 2024
.
On June 15, 2017, the Company issued
6,594
unvested restricted shares to certain Executive Officers related to performance-based restricted stock grants as part of the Company’s 2017 Management Incentive Plan (the "2017 MIP Grants"). The 2017 MIP Grants have a one year vesting period from date of grant, subject to the Company’s achievement of certain financial goals and other vesting provisions in the underlying restricted stock grant agreement.
Restrictions on the transfer of Company stock
The Company's Restated Certificate of Incorporation, as amended (the "Certificate of Incorporation"), places restrictions (the "Transfer Restrictions") on the transfer of the Company's stock that could adversely affect the Company's ability to utilize its domestic Federal Net Operating Loss Position. In particular, the Transfer Restrictions prevent the transfer of shares without the approval of the Company's Board of Directors if, as a consequence of such transfer, an individual, entity or groups of individuals or entities would become a 5-percent holder under Section 382 of the Internal Revenue Code of 1986, as amended, and the related Treasury regulations, and also prevents any existing
5
-percent holder from increasing his or her ownership position in the Company without the approval of the Company's Board of Directors. Any transfer of shares in violation of the Transfer Restrictions (a "Transfer Violation") shall be void
ab initio
under the Certificate of Incorporation, and the Company's Board of Directors has procedures under the Certificate of Incorporation to remedy a Transfer Violation, including requiring the shares causing such Transfer Violation to be sold and any profit resulting from such sale to be transferred to a charitable entity chosen by the Company's Board of Directors in specified circumstances.
10. ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income consists of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minimum pension liability
|
|
Foreign currency translation
|
|
Total accumulated other comprehensive income
|
Balances at December 31, 2016
|
$
|
(501
|
)
|
|
$
|
598
|
|
|
$
|
97
|
|
Current period other comprehensive income
|
—
|
|
|
170
|
|
|
170
|
|
Balances at June 30, 2017
|
$
|
(501
|
)
|
|
$
|
768
|
|
|
$
|
267
|
|
11.
COMMITMENTS AND CONTINGENCIES
The Company holds certain rights to market and manufacture all products developed or created under certain research, development and licensing agreements with various entities. In connection with such agreements, the Company has agreed to pay the entities royalties on net product sales. In each of the
the three months ended June 30, 2017
and 2016, royalties of
$0.1 million
became payable under these agreements. In each of
the six months ended June 30, 2017
and 2016, royalties of
$0.2 million
became payable under these agreements.
The Company has contracts with suppliers for unconditional annual minimum inventory purchases and milestone obligations to third parties the Company believes are likely to be triggered currently totaling approximately
$0.3 million
for the remainder of
2017
and
$0.3 million
in
2018
.
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
From time to time, the Company may be involved in litigation relating to claims arising out of its operations. On March 12, 2015, a complaint was filed against us by Shaun Fauley in the United States District Court Northern District of Illinois alleging our transmittal of unauthorized faxes in violation of the federal Telephone Consumer Protection Act of 1991, as amended by the Junk Fax Prevention Act of 2005, as a class action seeking stated damages of the greater of actual monetary loss or five hundred dollars per violation. The Company intends to defend itself vigorously in this matter. As of
June 30,
2017, the Company was not a party to any other legal proceedings that were expected, individually or in the aggregate, to have a material adverse effect on its business, financial condition or operating results.
The Company's current terms and conditions of sale include a limited warranty that its products and services will conform to published specifications at the time of shipment and a more extensive warranty related to certain of its products. The Company also sells a renewal warranty for certain of its products. The typical remedy for breach of warranty is to correct or replace any defective product, and if not possible or practical, the Company will accept the return of the defective product and refund the amount paid. Historically, the Company has incurred minimal warranty costs. The Company's warranty reserve was
$0.4 million
at both
June 30, 2017
and
December 31, 2016
.
12. INTEREST AND OTHER INCOME, NET
Interest and other income, net consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Interest income
|
$
|
(43
|
)
|
|
$
|
(30
|
)
|
|
$
|
(81
|
)
|
|
$
|
(63
|
)
|
Interest expense
|
51
|
|
|
38
|
|
|
75
|
|
|
76
|
|
Other expense (income), net
|
(126
|
)
|
|
26
|
|
|
(174
|
)
|
|
(112
|
)
|
Total interest and other expense (income), net
|
$
|
(118
|
)
|
|
$
|
34
|
|
|
$
|
(180
|
)
|
|
$
|
(99
|
)
|
Cash paid for interest for
the three months ended June 30, 2017
and
2016
was
$32 thousand
and
$19 thousand
, respectively. Cash paid for interest for
the six months ended June 30, 2017
and
2016
was
$58 thousand
and
$37 thousand
, respectively.
13. CREDIT FACILITY
At
June 30, 2017
, we had a
$15.0 million
asset-based revolving line of credit with Wells Fargo which had a maturity date of
December 31, 2017
as part of our credit and security agreement with Wells Fargo. At
June 30, 2017
and
December 31, 2016
, we had
$4.0 million
and
$0.7 million
borrowings outstanding on this line of credit, respectively. We were in compliance with all financial covenants as of
June 30, 2017
and our available borrowing capacity under this revolving line of credit was approximately
$11.1 million
.
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
On July 27, 2017, we repaid all outstanding balances and closed the Credit Facility with Wells Fargo described above and entered into a Credit Agreement (the "Credit Agreement") with JP Morgan Chase Bank, N.A. ("Chase"), which provides for a new revolving credit facility of up to
$30.0 million
(the "Credit Facility"). The Credit Facility provides us with the ability to borrow up to
$30.0 million
, although the amount of the Credit Facility may be increased by an additional
$20.0 million
up to a total of
$50.0 million
subject to receipt of additional lender commitments and other conditions. Any interest on borrowings due is to be charged at either the (i) rate of interest per annum publicly announced from time to time by Chase as its prime rate in effect at its principal offices in New York City, subject to a floor, minus
1.65%
, or (ii) the interest rate per annum equal to (a) LIBOR for the interest period in effect multiplied by (b) Chase's Statutory Reserve Rate (as defined in the Credit Agreement), plus
1.10%
and payable monthly. There is an annual minimum interest charge of
$60 thousand
under the Credit Agreement. Borrowings under the Credit Facility are subject to certain financial and non-financial covenants and are available for various corporate purposes, including general working capital, capital investments, and certain permitted acquisitions. The Credit Agreement also permits us to issue letters of credit. The maturity date of the Credit Facility is July 27, 2020. The foregoing discussion of the new Credit Facility is a summary only and is qualified in its entirety by reference to the full text of the Credit Agreement, a copy of which has been filed as an exhibit to the Company's Current Report on Form 8-K filed with the SEC on August 2, 2017.
14. SEGMENT REPORTING
The Company consists of
two
reportable segments, Core Companion Animal Health ("CCA") and Other Vaccines, Pharmaceuticals and Products ("OVP"). The CCA segment includes diagnostic instruments and supplies, as well as single use diagnostic and other tests, pharmaceuticals and vaccines, primarily for canine and feline use. The CCA segment also includes digital radiography and ultrasound products along with embedded software and support, data hosting and other services from US Imaging and International Imaging. These products are sold directly by the Company as well as through independent third-party distributors and through other distribution relationships. CCA segment products manufactured at the Des Moines, Iowa production facility included in the OVP segment's assets are transferred at cost and are not recorded as revenue for the OVP segment. The OVP segment includes private label vaccine and pharmaceutical production, primarily for cattle, but also for other animals including small mammals. All OVP products are sold by third parties under third-party labels.
Summarized financial information concerning the Company's reportable segments is shown in the following table (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2017
|
|
Core
Companion
Animal Health
|
|
Other Vaccines, Pharmaceuticals and Products
|
|
Total
|
Total revenue
|
|
$
|
27,021
|
|
|
$
|
7,315
|
|
|
$
|
34,336
|
|
Operating income
|
|
2,581
|
|
|
1,979
|
|
|
4,560
|
|
Income before income taxes
|
|
2,683
|
|
|
1,995
|
|
|
4,678
|
|
Capital purchases
|
|
211
|
|
|
779
|
|
|
990
|
|
Depreciation and amortization
|
|
857
|
|
|
243
|
|
|
1,100
|
|
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2016
|
|
Core
Companion
Animal Health
|
|
Other Vaccines, Pharmaceuticals and Products
|
|
Total
|
Total revenue
|
|
$
|
24,464
|
|
|
$
|
5,501
|
|
|
$
|
29,965
|
|
Operating income
|
|
2,746
|
|
|
810
|
|
|
3,556
|
|
Income before income taxes
|
|
2,724
|
|
|
798
|
|
|
3,522
|
|
Capital purchases
|
|
82
|
|
|
381
|
|
|
463
|
|
Depreciation and amortization
|
|
915
|
|
|
200
|
|
|
1,115
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30, 2017
|
|
Core
Companion
Animal Health
|
|
Other Vaccines, Pharmaceuticals and Products
|
|
Total
|
Total revenue
|
|
$
|
51,628
|
|
|
$
|
13,090
|
|
|
$
|
64,718
|
|
Operating income
|
|
3,695
|
|
|
3,653
|
|
|
7,348
|
|
Income before income taxes
|
|
3,897
|
|
|
3,631
|
|
|
7,528
|
|
Capital purchases
|
|
655
|
|
|
1,210
|
|
|
1,865
|
|
Depreciation and amortization
|
|
1,702
|
|
|
490
|
|
|
2,192
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30, 2016
|
|
Core
Companion
Animal Health
|
|
Other Vaccines, Pharmaceuticals and Products
|
|
Total
|
Total revenue
|
|
$
|
47,898
|
|
|
$
|
9,213
|
|
|
$
|
57,111
|
|
Operating income
|
|
4,504
|
|
|
1,022
|
|
|
5,526
|
|
Income before income taxes
|
|
4,532
|
|
|
1,093
|
|
|
5,625
|
|
Capital purchases
|
|
479
|
|
|
889
|
|
|
1,368
|
|
Depreciation and amortization
|
|
1,812
|
|
|
399
|
|
|
2,211
|
|
Revenue is attributed to individual countries based on customer location. Total revenue by principal geographic area was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
United States
|
$
|
31,902
|
|
|
$
|
28,371
|
|
|
$
|
59,623
|
|
|
$
|
53,955
|
|
Europe
|
516
|
|
|
605
|
|
|
1,902
|
|
|
1,432
|
|
Canada
|
990
|
|
|
340
|
|
|
1,038
|
|
|
771
|
|
Other International
|
928
|
|
|
649
|
|
|
2,155
|
|
|
953
|
|
Total
|
$
|
34,336
|
|
|
$
|
29,965
|
|
|
$
|
64,718
|
|
|
$
|
57,111
|
|
Asset information by reportable segment as of
June 30, 2017
is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Core
Companion
Animal Health
|
|
Other Vaccines, Pharmaceuticals and Products
|
|
Total
|
Total assets
|
|
$
|
105,655
|
|
|
$
|
20,754
|
|
|
$
|
126,409
|
|
Net assets
|
|
74,041
|
|
|
22,534
|
|
|
96,575
|
|
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- (Continued)
Asset information by reportable segment as of December 31, 2016 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Core
Companion
Animal Health
|
|
Other Vaccines, Pharmaceuticals and Products
|
|
Total
|
Total assets
|
|
$
|
110,995
|
|
|
$
|
19,849
|
|
|
$
|
130,844
|
|
Net assets
|
|
68,072
|
|
|
18,903
|
|
|
86,975
|
|
Total assets by principal geographic areas were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
December 31,
|
|
2017
|
|
2016
|
United States
|
$
|
123,908
|
|
|
$
|
127,827
|
|
Europe
|
2,501
|
|
|
3,017
|
|
Total
|
$
|
126,409
|
|
|
$
|
130,844
|
|
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and related Notes included in Part I Item 1 of this Form 10-Q.
This discussion contains forward-looking statements that involve risks and uncertainties. Such statements, which include statements concerning future revenue sources and concentration, gross profit margins, selling and marketing expenses, research and development 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 Part II, Item 1A "Risk Factors," 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 close of business on August 2, 2017 and we undertake no duty and do not intend to update this information, except as required by applicable laws.
Overview
We sell advanced veterinary diagnostic and specialty products. Our offerings include blood testing instruments and supplies, digital imaging products, software and services, vaccines, local and cloud-based data services, allergy testing and immunotherapy, and single-use offerings such as in-clinic diagnostic tests and heartworm preventive products. Our core focus is on supporting veterinarians in the canine and feline healthcare space.
Our business consists of two reportable segments, Core Companion Animal Health ("CCA"), which represented 81% of our revenue for the twelve months ended June 30, 2017 (which we define as "LTM") and Other Vaccines, Pharmaceuticals and Products ("OVP"), which represented 19% of LTM revenue.
The CCA segment includes, primarily for canine and feline use, blood testing instruments and supplies, digital imaging products, software and services, local and cloud-based data services, allergy testing and immunotherapy, and single use offerings such as in-clinic diagnostic tests and heartworm preventive products.
Blood testing and other non-imaging instruments and consumable supplies represented approximately 40% of our LTM revenue. Many products in this area involve placing an instrument in the field and generating future revenue from consumables, including items such as supplies and service, as that instrument is used. Approximately 28% of our LTM revenue resulted from the sale of such consumables to an installed base of instruments and approximately 12% of our LTM revenue was from instrument revenue. A loss of, or disruption in, the supply of consumables we are selling to an installed base of instruments could substantially harm our business. All of our blood testing and other non-imaging instruments and supplies are supplied by third parties, who typically own the product rights and supply the product to us under marketing and/or distribution agreements. In many cases, we have collaborated with a third party to adapt a human instrument for veterinary use. Major products in this area include our instruments for chemistry, hematology, blood gas, and immunodiagnostic testing and their affiliated operating consumables. Revenue from products in these three areas, including revenues from consumables, represented approximately 37% of our LTM revenue.
Imaging hardware, software and services represented approximately 20% of LTM revenue. Digital radiography is the largest product offering in this area, which also includes ultrasound instruments. Digital radiography solutions typically consist of a combination of hardware and software placed with a customer, often combined with an ongoing service and support contract. We sell our imaging solutions both in the United States and internationally. Our experience has been that most of the revenue is generated at the time of sale in this area, in contrast to the blood testing category discussed above where ongoing consumable revenue is often a larger component of economic value as a given blood testing instrument is used.
Other CCA revenue, including single use diagnostic and other tests, pharmaceuticals and biologicals as well as research and development, licensing and royalty revenue, represented approximately 21% of our LTM revenue. Since items in this area are often single use by their nature, our typical aim is to build customer satisfaction and loyalty for each product, generate repeat annual sales from existing customers and expand our customer base in the future. Products in this area are both supplied by third parties and provided by us. Major products and services in this area include heartworm diagnostic tests and preventives, and allergy test kits, allergy immunotherapy and testing. Combined revenue from heartworm-related products and allergy-related products represented 20% of our LTM revenue.
We consider the CCA segment to be our core business and devote most of our management time and other resources to improving the prospects for this segment. Maintaining a continuing, reliable and economic supply of products we currently obtain from third parties is critical to our success in this area. Virtually all of our sales and marketing expenses occur in the CCA segment. The majority of our research and development spending is dedicated to this segment as well.
All of our CCA products are ultimately sold primarily to or through veterinarians. In many cases, veterinarians will mark up their costs to their customer. The acceptance of our products by veterinarians is critical to our success. CCA products are sold directly to end users by us as well as through distribution relationships, such as our agreement with Merck Animal Health, the sale of kits to conduct blood testing to third-party veterinary diagnostic laboratories and independent third-party distributors. Revenue from direct sales and distribution relationships represented approximately 58% and 42%, respectively, of CCA LTM revenue.
The OVP segment includes our 168,000 square foot USDA- and FDA-licensed production facility in Des Moines, Iowa. We view this facility as an asset which could allow us to control our cost of goods on any pharmaceuticals and vaccines that we may commercialize in the future. We have increased integration of this facility with our operations elsewhere. For example, virtually all our U.S. inventory, excluding our imaging products, is now stored at this facility and related fulfillment logistics are managed there. CCA segment products manufactured at this facility are transferred at cost and are not recorded as revenue for our OVP
segment. We view OVP reported revenue as revenue primarily to cover the overhead costs of the facility and to generate incremental cash flow to fund our CCA segment.
Our OVP segment includes private label vaccine and pharmaceutical production, primarily for cattle but also for other species including equine, porcine, avian, feline and canine. All OVP products are sold by third parties under third-party labels.
Historically, a significant portion of our OVP segment's revenue has been generated from the sale of certain bovine vaccines, which have been sold primarily under the Titanium® and MasterGuard® brands. We have an agreement with Eli Lilly and Company ("Eli Lilly") and its affiliates operating through Elanco for the production of these vaccines. Our OVP segment also produces vaccines and pharmaceuticals for other third parties.
Results of Operations
Our analysis presented below is organized to provide the information we believe will facilitate an understanding of our historical performance and relevant trends going forward.
The following table sets forth, for the periods indicated, certain data derived from our unaudited condensed consolidated statements of income (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Revenue
|
$
|
34,336
|
|
|
$
|
29,965
|
|
|
$
|
64,718
|
|
|
$
|
57,111
|
|
Gross profit
|
14,929
|
|
|
12,682
|
|
|
28,138
|
|
|
24,124
|
|
Operating expenses
|
10,369
|
|
|
9,126
|
|
|
20,790
|
|
|
18,598
|
|
Operating income
|
4,560
|
|
|
3,556
|
|
|
7,348
|
|
|
5,526
|
|
Interest and other expense (income), net
|
(118
|
)
|
|
34
|
|
|
(180
|
)
|
|
(99
|
)
|
Income before income taxes
|
4,678
|
|
|
3,522
|
|
|
7,528
|
|
|
5,625
|
|
Income tax expense
|
1,539
|
|
|
780
|
|
|
86
|
|
|
1,436
|
|
Net income
|
3,139
|
|
|
2,742
|
|
|
7,442
|
|
|
4,189
|
|
Net income (loss) attributable to non-controlling interest
|
(194
|
)
|
|
220
|
|
|
(498
|
)
|
|
482
|
|
Net income attributable to Heska
|
$
|
3,333
|
|
|
$
|
2,522
|
|
|
$
|
7,940
|
|
|
$
|
3,707
|
|
The following table sets forth, for the periods indicated, the percentage of sales represented by certain items reflected in our unaudited condensed consolidated statements of income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Revenue
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
Gross profit
|
43.5
|
%
|
|
42.3
|
%
|
|
43.5
|
%
|
|
42.2
|
%
|
Operating expenses
|
30.2
|
%
|
|
30.5
|
%
|
|
32.1
|
%
|
|
32.6
|
%
|
Operating income
|
13.3
|
%
|
|
11.9
|
%
|
|
11.4
|
%
|
|
9.7
|
%
|
Interest and other expense (income), net
|
(0.3
|
)%
|
|
0.1
|
%
|
|
(0.3
|
)%
|
|
(0.2
|
)%
|
Income before income taxes
|
13.6
|
%
|
|
11.8
|
%
|
|
11.6
|
%
|
|
9.8
|
%
|
Income tax expense
|
4.5
|
%
|
|
2.6
|
%
|
|
0.1
|
%
|
|
2.5
|
%
|
Net income
|
9.1
|
%
|
|
9.2
|
%
|
|
11.5
|
%
|
|
7.3
|
%
|
Net income (loss) attributable to non-controlling interest
|
(0.6
|
)%
|
|
0.7
|
%
|
|
(0.8
|
)%
|
|
0.8
|
%
|
Net income attributable to Heska
|
9.7
|
%
|
|
8.4
|
%
|
|
12.3
|
%
|
|
6.5
|
%
|
Revenue
Total revenue
increased
15%
to
$34.3 million
in
the three months ended June 30, 2017
, compared to
$30.0 million
in
the three months ended June 30, 2016
and
increased
13%
to
$64.7 million
in
the six months ended June 30, 2017
, compared to
$57.1 million
in
the six months ended June 30, 2016
.
CCA segment revenue
increased
10%
to
$27.0 million
the three months ended June 30, 2017
, compared to
$24.5 million
in
the three months ended June 30, 2016
. The increase was driven primarily by a 33% increase in revenue from core blood diagnostics subscriptions, equipment and consumables, partially offset by a 7% decease in revenue from sales of our imaging products. CCA segment revenue
increased
8%
to
$51.6 million
in
the six months ended June 30, 2017
, compared to
$47.9 million
in
the six months ended June 30, 2016
. The increase in the year to date period was driven primarily by a 27% increase in revenue from core blood diagnostics subscriptions, equipment and consumables, partially offset by a 17% decrease in revenue from sales of our imaging products.
OVP segment revenue
increased
33%
to
$7.3 million
in
the three months ended June 30, 2017
, compared to
$5.5 million
in
the three months ended June 30, 2016
and
increased
42%
to
$13.1 million
in
the six months ended June 30, 2017
, compared to
$9.2 million
in
the six months ended June 30, 2016
. The increase in both periods presented was driven primarily by increased revenue from sales under our agreement with Elanco.
Gross Profit
Gross profit
increased
18%
to
$14.9 million
in
the three months ended June 30, 2017
, compared to
$12.7 million
in
the three months ended June 30, 2016
. Gross margin, which is gross profit divided by total revenue,
increased
to
43.5%
in
the three months ended June 30, 2017
compared to
42.3%
in
the three months ended June 30, 2016
. The increase in gross profit was driven primarily by a 15% increase in overall sales, while the increase in gross margin percentage was driven primarily by favorable product mix in our OVP segment. Gross profit
increased
17%
to
$28.1 million
in
the six months ended June 30, 2017
, compared to
$24.1 million
in
the six months ended June 30, 2016
. Gross margin
increased
to
43.5%
in
the six months ended June 30, 2017
, compared to
42.2%
in
the six months ended June 30, 2016
. The increase in gross profit for the year to date period was driven primarily by an 13% increase in overall sales, while the increase in gross margin percentage was driven primarily by favorable product mix in our OVP segment.
Operating Expenses
Selling and marketing expenses
increased
11%
to
$6.0 million
in
the three months ended June 30, 2017
, compared to
$5.4 million
in
the three months ended June 30, 2016
. The increase was driven primarily by a $0.3 million increase in compensation and benefits related to the expansion of our sales force to support our market share growth, as well as smaller increases in stock compensation expense and travel. Selling and marketing expenses
increased
10%
to
$12.1 million
in
the six months ended June 30, 2017
compared to
$11.0 million
in
the six months ended June 30, 2016
. The increase was driven primarily by a $0.5 million increase in compensation and benefits and a $0.2 million increase in stock compensation.
Research and development expenses
decreased
15%
to $
0.4 million
in
the three months ended June 30, 2017
, compared to
$0.5 million
in
the three months ended June 30, 2016
. Research and development expenses
decreased
11%
to
$1.0 million
in
the six months ended June 30, 2017
compared to
$1.1 million
in
the six months ended June 30, 2016
. The decrease in both periods presented was driven primarily by a slight decline in the purchase of general supplies for development projects.
General and administrative expenses
increased
22%
to
$3.9 million
in
the three months ended June 30, 2017
, compared to
$3.2 million
in
the three months ended June 30, 2016
. The increase was driven primarily by a $0.3 million increase in compensation and benefits, a $0.2 million increase in general consulting and a $0.1 million increase in intangible amortization due to the acquisition of Cuattro Veterinary, LLC in the later part of the comparable period a year ago. General and administrative expenses
increased
19%
to
$7.7 million
in
the six months ended June 30, 2017
compared to
$6.5 million
in
the six months ended June 30, 2016
. The increase was driven primarily by a $0.4 million increase in compensation and benefits, a $0..3 million increase in general consulting and a $0.2 million increase in intangible amortization due to the acquisition mentioned above.
Interest and Other Expense (Income), net
Interest and other expense (income), net, was income of
$118 thousand
in
the three months ended June 30, 2017
, compared to expense of
$34 thousand
in
the three months ended June 30, 2016
. This increase in other income was driven primarily by an $113 thousand increase in net foreign currency gains. These gains are driven by the impact of exchange rates between the Euro and the Swiss Franc, which is the functional currency of our Swiss subsidiary.
Interest and other expense (income), net, was income of
$180 thousand
in
the six months ended June 30, 2017
, as compared to income of
$99 thousand
in
the six months ended June 30, 2016
. The increase in other income was driven primarily by a $107 thousand increase in net foreign currency gains.
Income Tax Expense
In
the three months ended June 30, 2017
, we had total income tax expense of
$1.5 million
, which was primarily
$1.5 million
of domestic deferred income tax expense, a non-cash item primarily related to our domestic NOL position. In
the three months ended June 30, 2016
, we had total income tax expense of
$0.8 million
, including
$0.7 million
of domestic deferred income tax expense and
$0.1 million
of current income tax expense. In
the six months ended June 30, 2017
we had a total income tax of
$86 thousand
, including
$69 thousand
of domestic deferred income tax expense and
$17 thousand
of current income tax expense. In
the six months ended June 30, 2016
, we had total income tax expense of
$1.4 million
, including
$1.3 million
of domestic deferred income tax expense and
$0.2 million
of current income tax expense.
As discussed further below, the increase in tax expense in both periods was primarily attributable to recording a partial valuation allowance against our deferred tax assets (“DTAs”) as of June 30, 2017 to partially offset the impact of various stock compensation-related tax benefits.
As of June 30, 2017, the Company assessed whether the reduction of taxable income due to large benefits created by stock option exercises and vesting of restricted stock and the excess tax benefits resulting from the application of ASU 2016-09 would cause a larger portion of our DTAs to likely expire unrealized. Due to the significant amount of additional stock based compensation excess tax deduction generated, the Company determined that the negative evidence outweighed the positive evidence and that it is not more-likely-than-not that sufficient taxable income will be generated to realize all of the DTAs as of June 30, 2017. As such, an additional $1.8 million was recorded to the current partial valuation allowance against the Company’s DTAs as of June 30, 2017. The Company will continue to closely monitor the need for an additional valuation allowance against its DTAs in each subsequent reporting period which can be impacted by actual operating results compared to the Company's forecast.
Net Income attributable to Heska
Net income attributable to Heska was
$3.3 million
for
the three months ended June 30, 2017
, compared to net income attributable to Heska of
$2.5 million
in the prior year period. Net income attributable to Heska was
$7.9 million
for
the six months ended June 30, 2017
, compared to net income attributable to Heska of
$3.7 million
in the prior year period. The difference between this line item and "Net Income" is the net income or loss attributable to our minority interest in US Imaging, which was a loss of
$0.2 million
in
the three months ended June 30, 2017
, compared to a gain of
$0.2 million
in
the three months ended June 30, 2016
and a loss of
$0.5 million
in
the six months ended June 30, 2017
compared to a gain of
$0.5 million
in
the six months ended June 30, 2016
.
Impact of Inflation
In recent years, inflation has not had a significant impact on our operations.
Liquidity, Capital Resources and Financial Condition
We believe that adequate liquidity and cash generation is important to the execution of our strategic initiatives. Our ability to fund our operations, acquisitions, capital expenditures, and product development efforts may depend on our ability to generate cash from operating activities, which is subject to future operating performance, as well as general economic, financial, competitive, legislative, regulatory, and other conditions, some of which may be beyond our control. Our primary sources of liquidity are our available cash, cash generated from current operations and availability under our credit facilities noted below.
For
the six months ended June 30, 2017
, we had net income of
$7.4 million
and net cash provided by operations of
$5.4 million
. At
June 30, 2017
, we had
$3.7 million
of cash and cash equivalents and working capital of
$28.5 million
.
At
June 30, 2017
, we had a
$15.0 million
asset-based revolving line of credit with Wells Fargo which had a maturity date of
December 31, 2017
as part of our credit and security agreement with Wells Fargo. At
June 30, 2017
and
December 31, 2016
, we had
$4.0 million
and
$0.7 million
borrowings outstanding on this line of credit, respectively. We were in compliance with all financial covenants as of
June 30, 2017
and our available borrowing capacity under this revolving line of credit was approximately
$11.1 million
.
On July 27, 2017, we repaid all outstanding balances and closed the Credit Facility with Wells Fargo described above and entered into a Credit Agreement (the "Credit Agreement") with JP Morgan Chase Bank, N.A. ("Chase"), which provides for a new revolving credit facility of up to
$30.0 million
(the "Credit Facility"). The Credit Facility provides us with the ability to borrow up to
$30.0 million
, although the amount of the Credit Facility may be increased by an additional
$20.0 million
up to a total of
$50.0 million
subject to receipt of additional lender commitments and other conditions. Any interest on borrowings due is to be charged at either the (i) rate of interest per annum publicly announced from time to time by Chase as its prime rate in effect at its principal offices in New York City, subject to a floor, minus
1.65%
, or (ii) the interest rate per annum equal to (a) LIBOR for the interest period in effect multiplied by (b) Chase's Statutory Reserve Rate (as defined in the Credit Agreement), plus
1.10%
and payable monthly. There is an annual minimum interest charge of
$60 thousand
under the Credit Agreement. Borrowings under the Credit Facility are subject to certain financial and non-financial covenants and are available for various corporate purposes, including general working capital, capital investments, and certain permitted acquisitions. The Credit Agreement also permits us to issue letters of credit. The maturity date of the Credit Facility is July 27, 2020. The foregoing discussion of the new Credit Facility is a summary only and is qualified in its entirety by reference to the full text of the Credit Agreement, a copy of which has been filed as an exhibit to the Company's Current Report on Form 8-K filed with the SEC on August 2, 2017.
A summary of our cash from operating, investing and financing activities is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
Net cash provided by operating activities
|
$
|
5,425
|
|
|
$
|
278
|
|
Net cash used in investing activities
|
(15,622
|
)
|
|
(848
|
)
|
Net cash provided by financing activities
|
3,039
|
|
|
327
|
|
Effect of currency translation on cash
|
91
|
|
|
22
|
|
Decrease in cash and cash equivalents
|
(7,067
|
)
|
|
(221
|
)
|
Cash and cash equivalents, beginning of the period
|
10,794
|
|
|
6,890
|
|
Cash and cash equivalents, end of the period
|
$
|
3,727
|
|
|
$
|
6,669
|
|
Net cash provided by operating activities was
$5.4 million
in
the six months ended June 30, 2017
, compared to net cash provided in operating activities of
$0.3 million
in
the six months ended June 30, 2016
, an
increase
of approximately
$5.1 million
. The increase in cash provided by operations was driven primarily by a $4.6 million increase in cash provided by accounts receivable, a $3.3 million increase in net income, a $2.0 million decrease in cash used for accounts payable, a $1.0 million increase in cash provided by deferred revenue and other and a $0.3 million increase in stock-based compensation, partially offset by a $1.7 million increase in cash used for inventory, a $1.4 million reduction of accrued liabilities and other, a $1.2 million decrease in deferred tax expense, a $0.9 million increase in cash used in other current assets and a $0.8 million increase in cash used in other non-current assets.
Net cash used in investing activities was
$15.6 million
in
the six months ended June 30, 2017
, compared to net cash used in investing activities of
$0.8 million
in
the six months ended June 30, 2016
, an
increase
of approximately
$14.8 million
. The increase was driven primarily by our purchase of the minority interest in Heska Imaging for $13.8 million and a $0.5 million increase in the purchase of property, plant and equipment, partially offset by $0.4 million of proceeds from the disposition of property and equipment and $0.1 million of cash generated by the sale of an equity investment that both occurred in the first quarter of 2016.
Net cash provided in financing activities was
$3.0 million
in
the six months ended June 30, 2017
, compared to net cash provided by financing activities of
$0.3 million
in
the six months ended June 30, 2016
, which represented a
$2.7 million
increase
in cash used in financing activities. The change was driven primarily by a
$0.9 million
increase in proceeds from issuance in common stock, a $3.3 million increase in borrowings, net of repayments, from our line of credit used to partially finance the purchase of the minority interest in Heska Imaging, offset by
$0.9 million
of stock repurchased to cover employee tax payments, $1.0 million of distributions to non-controlling interest members and the repayment of other debt.
Following and in connection with the closing of the purchase of the minority interest in US Imaging, on June 1, 2017, the Company consolidated its assets and liabilities in the US Imaging and International Imaging companies into Global Imaging, which was re-named Heska Imaging, LLC ("Heska Imaging").
At
June 30, 2017
, Heska Corporation had receivables from Cuattro, LLC of
$21 thousand
, which is included in "Due from – related parties" on the Company's consolidated balance sheets.
Our financial plan for 2017 indicates that our available cash and cash equivalents, together with cash from operations and borrowings expected to be available under our revolving line of credit, will be sufficient to fund our operations for the foreseeable future. Additionally, we would consider additional acquisitions if we felt they were consistent with our strategic direction. However, our actual results may differ from this plan and we may be required to consider alternative strategies. We may be required to raise additional capital in the future. If necessary, we expect to raise these additional funds through the increased sale of customer leases, the sale of equity securities or the issuance of new term debt. There is no guarantee that additional capital will be available from these sources on acceptable terms, if at all, and certain of these sources may require approval by existing lenders. See "Risk Factors" in Item 1A of this Form 10-Q for a discussion of some of the factors that affect our capital raising alternatives.
Effect of currency translation on cash
Net effect of foreign currency translations on cash changed
$69 thousand
to a $
91 thousand
positive impact in
the six months ended June 30, 2017
, compared to a $
22 thousand
positive impact in
the six months ended June 30, 2016
. These effects are related to changes in exchange rates between the United States dollar and the Swiss Franc, which is the functional currency of our Swiss subsidiary.
Off Balance Sheet Arrangements
We have no off balance sheet arrangements or variable interest entities.
Critical Accounting Policies and Estimates
The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires us to make judgments, assumptions and estimates that affect the amounts reported in the unaudited Condensed Consolidated Financial Statements and accompanying notes. Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2016 describes the
significant accounting policies and methods used in the preparation of these unaudited Condensed Consolidated Financial Statements. Our critical accounting estimates, discussed in the Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2016, include estimates for revenue recognition, allowances for doubtful accounts, accounting for income taxes, and assessing excess and obsolete inventories. Such accounting policies and estimates require significant judgments and assumptions to be used in the preparation of the unaudited Condensed Consolidated Financial Statements and actual results could differ materially from the amounts reported based on variability in factors affecting these estimates.