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UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
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ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended December 31, 2008
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OR
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
Commission file number: 0-22427
HESKA
CORPORATION
(Exact
name of registrant as specified in its charter)
Delaware
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77-0192527
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(State
or other jurisdiction of
incorporation or organization)
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(I.R.S.
Employer
Identification Number)
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3760 Rocky Mountain Avenue
Loveland, Colorado
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80538
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(Address
of principal executive offices)
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(Zip
Code)
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Registrants
telephone number, including area code:
(970) 493-7272
Securities registered
pursuant to Section 12(b) of the Act:
Common Stock, $.001
par value
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Nasdaq Capital Market
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(Title
of Class)
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(Name
of Each Exchange on Which Registered)
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Securities registered
pursuant to Section 12(g) of the Act:
None
Indicate by
check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes
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No
x
Indicate by
check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act.
Yes
o
No
x
Indicate by
check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes
x
No
o
Indicate by
check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of the registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
o
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of large accelerated filer, accelerated filer,
and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large
accelerated filer
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Accelerated
filer
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Non-accelerated
filer
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Smaller
reporting company
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(Do not check if a smaller
reporting company)
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Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act).
Yes
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No
x
The aggregate
market value of voting common stock held by non-affiliates of the Registrant
was approximately $60,480,577 as of June 30, 2008 based upon the closing
price on the Nasdaq Capital Market reported for such date. This calculation does not reflect a
determination that certain persons are affiliates of the Registrant for any
other purpose.
52,010,928
shares of the Registrants Common Stock, $.001 par value, were outstanding at
March 13, 2009.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10 (as to directors),
11, 12, 13 and 14 of Part III incorporate by reference information from
the Registrants Proxy Statement to be filed with the Securities and Exchange
Commission in connection with the solicitation of proxies for the Registrants
2009 Annual Meeting of Stockholders.
Table of Contents
TABLE OF CONTENTS
DRI-CHEM is a registered
trademark of FUJIFILM Corporation.
i-STAT is a registered trademark of Abbott Laboratories. SPOTCHEM is a trademark of
Arkray, Inc. TRI-HEART is a
registered trademark of Schering-Plough Animal Health Corporation (SPAH) in
the United States and is a trademark of Heska Corporation in other countries. HESKA, ALLERCEPT,
AVERT, E.R.D.-HEALTHSCREEN, E-SCREEN, FELINE ULTRANASAL, HEMATRUE,
SOLO STEP, THYROMED and VET/OX are registered trademarks and CBC-DIFF,
G2 DIGITAL and VET/IV are registered trademarks of Heska Corporation in
the United States and/or other countries.
This Form 10-K also refers to trademarks and trade names of other
organizations.
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Statement
Regarding Forward Looking Statements
This Form 10-K contains
forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended and Section 21E of the Securities
Exchange Act of 1934, as amended. For
this purpose, any statements contained herein that are not statements of
current or historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as
anticipates, expects, intends,
plans, believes, seeks, estimates, variations of such words and similar
expressions are intended to identify such forward-looking statements. These statements are not guarantees of future
performance and are subject to certain risks, uncertainties and assumptions
that are difficult to predict.
Therefore, actual results could differ materially from those expressed
or forecasted in any such forward-looking statements as a result of certain
factors, including those set forth in Risk Factors, Managements Discussion
and Analysis of Financial Condition and Results of Operations, Business and
elsewhere in this Form 10-K.
Readers are cautioned not to place undue reliance on these
forward-looking statements.
Although we believe that
expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. We expressly disclaim any
obligation or undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any change in our expectations
with regard thereto or any change in events, conditions or circumstances on
which any such statement is based. These
forward-looking statements apply only as of the date of this Form 10-K or
for statements incorporated by reference from the 2009 definitive proxy
statement on Schedule 14A, as of the date of the Schedule 14A.
Internet
Site
Our Internet address is
www.heska.com. Because we believe it
provides useful information in a cost-effective manner to interested investors,
via a link on our website our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and amendments to
those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 are publicly available free
of charge and we believe are available as soon as reasonably practical after we
electronically file such material with, or furnish it to, the Securities
Exchange Commission. Information
contained on our website is not a part of this annual report on Form 10-K.
Where You
Can Find Additional Information
You may review a copy of
this annual report on Form 10-K, including exhibits and any schedule filed
therewith, and obtain copies of such materials at prescribed rates, at the
Securities and Exchange Commissions Public Reference Room in Room 1580,
100 F Street, NE, Washington, D.C. 20549-0102.
You may obtain information on the operation of the Public Reference
Room by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission
maintains a website (http://www.sec.gov) that contains reports, proxy and
information statements and other information regarding registrants, such as
Heska Corporation, that file electronically with the Securities and Exchange
Commission.
PART I
Item
1. Business.
We develop, manufacture,
market, sell and support veterinary products.
Our core focus is on the canine and feline companion animal health
markets where we strive to provide high value products.
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Our business is comprised of
two reportable segments, Core Companion Animal Health and Other Vaccines,
Pharmaceuticals and Products. The Core
Companion Animal Health segment (CCA) includes diagnostic instruments and
supplies as well as single use diagnostic and other tests, vaccines and
pharmaceuticals, primarily for canine and feline use. These products are sold directly by us as
well as through independent third-party distributors and other distribution
relationships. The Other Vaccines,
Pharmaceuticals and Products segment (OVP) includes private label vaccine and
pharmaceutical production, primarily for cattle but also for other animals
including small mammals and fish. All OVP
products are sold by third parties under third party labels.
Our principal executive
offices are located at 3760 Rocky Mountain Avenue, Loveland, Colorado 80538,
our telephone number is (970) 493-7272 and our internet address is
www.heska.com. We originally
incorporated in California in 1988, and we subsequently incorporated in
Delaware in 1997.
Background
We were incorporated as
Paravax, Inc. in 1988 and conducted research on vaccines to prevent
infections by parasites. In 1991, we
moved our headquarters from California to northern Colorado in order to be
located closer to the research facilities of the College of Veterinary Medicine
and Biomedical Sciences of Colorado State University. In 1995, we changed our name to Heska
Corporation. We completed our initial
public offering in July 1997.
Between 1996 and 1998, we expanded our business, making several
acquisitions and significantly increasing our sales and marketing activities. During 1999 and 2000, we restructured and
refocused our business, making several divestitures. We continued to be a research and
development-focused company, devoting substantial resources to the research and
development of innovative products for the companion animal health market. In 2001 and 2002, we took further steps to
lower our expense base, largely in internal research and development but also
in other areas, and to rationalize and further focus our business. In the years since 2003, we have continued to
concentrate our efforts on operating improvements, such as enhancing the
effectiveness of our sales and marketing efforts and pursuing cost
efficiencies, and seeking new product opportunities with third parties.
Core
Companion Animal Health Segment
We presently sell a variety
of companion animal health products and services, among the most significant of
which are the following:
Veterinary Instruments
We offer a line of
veterinary diagnostic and other instruments which are described below. We also market and sell consumable supplies
for these instruments. Our line of veterinary instruments includes the
following:
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Handheld Blood
Analysis.
The i-STAT 1 Handheld Clinical Analyzer,
introduced in January 2007, is a handheld instrument that provides quick,
easy analysis of critical electrolyte, blood gas, chemistry and basic
hematology results with whole blood. In
addition, we continue to service and support the similar, less expensive
original i-STAT Handheld Clinical Analyzer.
We are supplied new instruments and affiliated cartridges and supplies
of these products under a contractual agreement with Abbott Point of Care Inc.
(APOC), formerly known as i-STAT Corporation, a unit of Abbott Laboratories.
·
Blood Chemistry.
The DRI-CHEM 4000 Veterinary Chemistry
Analyzer, introduced in November 2007, is a robust system that uses dry
slide technology for blood chemistry and electrolyte analysis and has the
ability to run 22 tests at a time with a single blood sample. Test slides are available as both
pre-packaged panels as well as individual slides. The instrument has
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an
additional feature allowing simple, fully automated sample dilution and results
calculations. We are supplied this instrument and affiliated test slides and
supplies under a contractual agreement with FUJIFILM Corporation (FUJIFILM). In addition, we continue to service and
support our previous chemistry instrument for which we are supplied affiliated
test strips and supplies under a contractual agreement with Arkray Global
Business, Inc. (Arkray).
·
Hematology.
The HEMATRUE Veterinary Hematology Analyzer,
introduced in July 2007, is an easy-to-use blood analyzer that measures
such key parameters as white blood cell count, red blood cell count, platelet
count and hemoglobin levels in animals. In addition, we continue to
service and support our previous hematology instrument, the HESKA CBC-DIFF
Veterinary Hematology System. We are
supplied new instruments and affiliated reagents and supplies of these products
under a contractual agreement with Boule Medical AB (Boule).
·
IV Pumps.
The VET/IV 2.2 infusion pump is
a compact, affordable IV pump that allows veterinarians to easily provide
regulated infusion of fluids, drugs or nutritional products for their patients.
Point-of-Care Diagnostic and Other Tests
Heartworm
Diagnostic Products
. Heartworm infections of dogs and cats are
caused by the parasite
Dirofilaria immitis
. This parasitic worm is transmitted in larval
form to dogs and cats through the bite of an infected mosquito. Larvae develop into adult worms that live in
the pulmonary arteries and heart of the host, where they can cause serious
cardiovascular, pulmonary, liver and kidney disease. Our canine and feline heartworm diagnostic
tests use monoclonal antibodies or a recombinant heartworm antigen, respectively,
to detect heartworm antigens or antibodies circulating in the blood of an
infected animal.
We currently market and sell
heartworm diagnostic tests for both dogs and cats. SOLO STEP CH for dogs and SOLO STEP FH for
cats are available in point-of-care, single use formats that can be used by
veterinarians on site. We also offer
SOLO STEP CH Batch Test Strips, a rapid and simple point-of-care antigen
detection test for dogs that allows veterinarians in larger practices to run
multiple samples at the same time. We
obtain SOLO STEP CH, SOLO STEP FH and SOLO STEP Batch Test Strips under a
contractual agreement with Quidel Corporation (Quidel).
Early
Renal Damage Detection Products
. Renal damage is a leading
cause of death in both dogs and cats.
Several inflammatory, infectious or neoplastic diseases can damage an
animals kidneys. It is estimated that
70% to 80% of kidney function is already destroyed before veterinarians can
detect renal damage using traditional tests.
Early detection is key to eliminate the causes and to mitigate the
effects of kidney damage. Identification and treatment of the underlying cause
of kidney damage can slow the progression of disease and add quality years to
an animals life.
Our E.R.D.-HEALTHSCREEN
Canine Urine Test and our E.R.D.-HEALTHSCREEN Feline Urine Test are rapid
in-clinic immunoassay tests designed to detect microalbuminuria, the most
sensitive indicator of renal damage.
Veterinary Diagnostic Laboratory Products and Services
Allergy
Diagnostic Products and Services.
Allergy is common in companion animals, and it has been estimated to
affect approximately 10% to 15% of dogs.
Clinical symptoms of allergy are variable, but are often manifested as
persistent and serious skin disease in dogs and cats. Clinical management of allergic disease is
problematic, as there are a large number of allergens that may give rise to
these conditions. Although skin testing
is often regarded as the most accurate diagnostic procedure, such tests can be
painful,
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subjective and
inconvenient. The effectiveness of the
immunotherapy that is prescribed to treat allergic disease is inherently limited
by inaccuracies in the diagnostic process.
Our ALLERCEPT Definitive
Allergen Panels provide the most accurate determination of which we are aware
of the specific allergens to which an animal, such as a dog, cat or horse, is
reacting. The panels use a highly
specific recombinant version of the natural IgE receptor to test the serum of
potentially allergic animals for IgE directed against a panel of known
allergens. A typical test panel consists
primarily of various pollen, grass, mold, insect and mite allergens. The test results serve as the basis for
prescription ALLERCEPT Allergy Treatment Sets, discussed later in this
document.
Outside of the United
States, we sell kits to conduct blood testing using our ALLERCEPT Definitive
Allergen Panels to third-party veterinary diagnostic laboratories. We also sell products to screen for the
presence of allergen-specific IgE to third party veterinary diagnostic
laboratories outside of the United States we sell kits to conduct preliminary
blood testing using products based on our ALLERCEPT Definitive Allergen Panels
as well as a similar test requiring less technical sophistication, our
ALLERCEPT E-SCREEN Test.
We have veterinary
diagnostic laboratories in Loveland, Colorado and Fribourg, Switzerland which both
offer blood testing using our ALLERCEPT Definitive Allergen Panels. In our Fribourg veterinary diagnostic
laboratory, we also offer preliminary blood testing to screen for the presence
of allergen-specific IgE using products based on our ALLERCEPT Definitive
Allergen Panels. Animals testing
positive for allergen-specific IgE are candidates for further evaluation using
our ALLERCEPT Definitive Allergen Panels.
Other
Products and Services.
We sell ERD Reagent Packs used to detect
microalbuminuria, the most sensitive indicator of renal damage, to Antech
Diagnostics, the laboratory division of VCA Antech, Inc., for use in its
veterinary diagnostic laboratories.
Our Loveland veterinary
diagnostic laboratory currently also offers testing using our canine and feline
heartworm, renal damage, immune status and flea bite allergy assays as well as
other diagnostic services including polymerase chain reaction, or PCR, based
tests for certain infectious diseases.
Our Loveland diagnostic laboratory is currently staffed by medical
technologists experienced in animal disease and several additional technical
staff. We intend to continue to use our
Loveland veterinary diagnostic laboratory both as a stand-alone service center
for our customers and as an adjunct to our product development efforts.
Pharmaceuticals and Supplements
Heartworm
Prevention
. We have an agreement with Schering-Plough
Animal Health Corporation (SPAH), the worldwide animal health care business
of Schering-Plough Corporation, granting SPAH the distribution and marketing
rights in the United States for TRI-HEART Plus Chewable Tablets, our canine
heartworm prevention product. TRI-HEART
Plus Chewable Tablets (ivermectin/pyrantel) are indicated for use as a monthly
preventive treatment of canine heartworm infection and for treatment and
control of ascarid and hookworm infections.
We manufacture TRI-HEART Plus Chewable Tablets at our Des Moines, Iowa
production facility.
Nutritional
Supplements
. We sell a novel fatty acid supplement, HESKA
F.A. Granules. The source of the fatty
acids in this product, flaxseed oil, leads to high omega-3:omega-6 ratios of
fatty acids. Diets high in omega-3 fatty
acids are believed to lead to lower levels of inflammatory mediators. The HESKA F.A. Granules include vitamins and
are formulated in a palatable flavor base that makes the product convenient and
easy to administer.
Hypothyroid
Treatment
. We sell a chewable thyroid supplement,
THYROMED Chewable Tablets, for treatment of hypothyroidism in dogs. Hypothyroidism is one of the most common
endocrine disorders
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diagnosed in older dogs,
treatment of which requires a daily hormone supplement for the lifetime of the
animal. THYROMED Chewable Tablets
contain the active ingredient
Levothyroxine
Sodium
, which is a clinically proven replacement for the naturally
occurring hormone secreted by the thyroid gland. The chewable formulation makes this daily
supplement convenient and easy to administer.
Vaccines and other Biologicals
Allergy
Treatment
. Veterinarians who use our ALLERCEPT
Definitive Allergen Panels often purchase ALLERCEPT Allergy Treatment Sets for
those animals with positive test results.
These prescription immunotherapy treatment sets are formulated
specifically for each allergic animal and contain only the allergens to which
the animal has significant levels of IgE antibodies. The prescription formulations are
administered in a series of injections, with doses increasing over several
months, to ameliorate the allergic condition of the animal. Immunotherapy is generally continued for an
extended time. We offer canine, feline
and equine immunotherapy treatment products.
Feline
Respiratory Disease
. The use of injectable vaccines in cats has
become controversial due to the frequency of injection site-associated side
effects. The most serious of these side
effects are injection site sarcomas, tumors which, if untreated, are nearly
always fatal. While there is one
competitive non-injectable two-way vaccine, all other competitive products are
injectable formulations.
We sell the FELINE
ULTRANASAL FVRCP Vaccine, a three-way modified live vaccine combination to prevent
disease caused by the three most common respiratory viruses of cats: calicivirus, rhinotracheitis virus and
panleukopenia virus. Our two-way
modified live vaccine combination, FELINE ULTRANASAL FVRC, prevents disease
caused by calicivirus and rhinotracheitis.
These vaccines are administered without needle injection by dropping the
liquid preparation into the nostrils of cats.
Our vaccines avoid injection site side effects, and we believe they are
very efficacious.
Other
Vaccines, Pharmaceuticals and Products Segment
We have developed our own
line of bovine vaccines that are licensed by the United States Department of
Agriculture (USDA). We have a
long-term agreement with a distributor, Agri Laboratories, Ltd., (AgriLabs), for
the marketing and sale of certain of these vaccines which are sold primarily
under the Titanium® and MasterGuard® brands registered trademarks of
AgriLabs. AgriLabs has rights to sell
these bovine vaccines in the United States, Africa and Mexico into
December 2013. AgriLabs rights in
these regions will be exclusive into December 2009. We have the right to sell these bovine
vaccines to any party of our choosing in other regions of the world. We also
manufacture other bovine products not covered under the agreement with
AgriLabs.
We manufacture biological
and pharmaceutical products for a number of other animal health companies. We manufacture products for animals including
small mammals. Our offerings range from
providing complete turnkey services which include research, licensing,
production, labeling and packaging of products to providing any one of these
services as needed by our customers as well as validation support and
distribution services.
Marketing,
Sales and Customer Support
We estimate that there are approximately
46,000 veterinarians in the United States whose practices are devoted
principally to small animal medicine.
Those veterinarians practice in approximately 20,000 clinics in the
United States. In 2008, our products
were sold to approximately 14,500 such clinics in the United States. Veterinarians may obtain our products
directly from us or indirectly from others, such as independent third-party
distributors. All our Core Companion
Animal Health products are predominately
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sold to or through
veterinarians ultimately. In many cases,
veterinarians will markup their costs to the end user. The acceptance of our products by
veterinarians is critical to our success.
We currently market our Core
Companion Animal Health products in the United States to veterinarians through an
outside field organization, a telephone sales force, independent third-party
distributors, as well as through trade shows and print advertising and through
other distribution relationships, such as SPAH in the case of our heartworm
preventive. Our outside field
organization currently consists of 38 individuals for activities in various parts
of the United States. Our inside sales
force consists of 20 persons.
Our independent third-party
distributors in the U.S. purchase and market our Core Companion Animal Health
products utilizing their direct sales forces.
We currently have agreements with 16 regional distributors with
approximately 676 field representatives.
We believe that one of our largest competitors, IDEXX
Laboratories, Inc. (IDEXX), in effect prohibits its distributors from
selling competitive products, including our diagnostic instruments and
heartworm diagnostic tests. As a result,
11 of these 16 regional distributors with approximately 135 field
representatives carry our full distribution product line. We believe the IDEXX restrictions limit our
ability to engage national independent third party distributors to sell our
full distribution line of products.
We have a staff dedicated to
customer and product support in our Core Companion Animal Health segment
including veterinarians, technical support specialists and service
technicians. Individuals from our
product development group may also be used as a resource in responding to
certain product inquiries.
Internationally, we market
our Core Companion Animal Health products to veterinarians primarily through
third-party veterinary diagnostic laboratories, independent third-party
distributors and Novartis Agro K.K., Tokyo (Novartis Japan). These entities typically provide customer
support. Novartis Japan exclusively
markets and distributes SOLO STEP CH and our line of E.R.D. HEALTHSCREEN urine
test products in Japan.
All OVP products are
marketed and sold by third parties under third party labels. AgriLabs currently has exclusive sales and
marketing rights to certain of our bovine vaccines, which are sold primarily
under the Titanium® and MasterGuard® labels, in the United States, Africa and
Mexico.
We grant third parties
rights to our intellectual property as well as our products, with our
compensation often taking the form of royalties and/or milestone payments. For example, we have an agreement with Nestlé
Purina PetCare Company (Purina), a unit of Nestlé S.A., under which Purina
pays royalties on certain pet food products it markets based on our
patent-protected science.
Manufacturing
The majority of our product
revenue is from proprietary products manufactured by third parties. Third parties manufacture our veterinary
instruments, including affiliated consumables and supplies, as well as other
products including our heartworm point-of-care diagnostic tests, our allergy
treatment products and our E.R.D.-HEALTHSCREEN Urine Tests. Our handheld blood analysis instruments and
affiliated supplies are manufactured under contract with APOC, our chemistry
instruments and affiliated supplies are manufactured under contract with
FUJIFILM, test strips and supplies affiliated with our previous chemistry
instrument are manufactured under contract with Arkray and our hematology
instruments and affiliated supplies are manufactured under contract with Boule. Our immunotherapy treatment products are
manufactured under contract with ALK-Abelló, Inc. Our E.R.D. Reagent Packs and our E.R.D.-
HEALTHSCREEN Urine Tests are manufactured under contract with Genzyme
Diagnostics P.E.I., Inc., formerly known as Diagnostic Chemicals Limited. Our heartworm point-of-care diagnostic tests
are
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manufactured under a
contract with Quidel. We manufacture and
supply Quidel with certain critical raw materials for our heartworm
point-of-care tests.
Our facility in Des Moines,
Iowa is a USDA, Food and Drug Administration (FDA), and Drug Enforcement
Agency (DEA) licensed biological and pharmaceutical manufacturing
facility. This facility currently has
the capacity to manufacture more than 50 million doses of vaccine each
year. We expect that we will manufacture
most or all of our biological and pharmaceutical products at this facility, as
well as most or all of our recombinant proteins and other proprietary reagents
for our diagnostic tests. We currently
manufacture our canine heartworm prevention product, our FELINE ULTRANASAL
Vaccines and all our OVP segment products at this facility. Our OVP segments customers purchase products
in both finished and bulk format, and we perform all phases of manufacturing,
including growth of the active bacterial and viral agents, sterile filling,
lyophilization and packaging at this facility.
We manufacture our various allergy diagnostic products at our Des Moines
facility, our Loveland facility and our Fribourg facility. We believe the raw materials for products we
manufacture are available from several sources.
Product
Development
We are committed to
providing innovative products to address latent health needs of companion
animals. We may obtain such products
from external sources, external collaboration or internal research and
development.
We are committed to
identifying external product opportunities and creating business and technical
collaborations that lead to high value veterinary products. We believe that our active participation in
scientific networks and our reputation for investing in research enhances our
ability to acquire external product opportunities. We have collaborated, and intend to continue
to do so, with a number of companies and universities. Examples of such collaborations include:
·
Quidel for the development of SOLO STEP CH
Cassettes, SOLO STEP CH Batch Test Strips and SOLO STEP FH Cassettes;
·
Boule for the development of veterinary
applications for the HEMATRUE Veterinary Hematology Analyzer and associated
reagents;
·
FUJIFILM for the development of veterinary
applications for the DRI-CHEM 4000 Veterinary Chemistry Analyzer and associated
slides and supplies.
We are currently
collaborating with FUJIFILM on a line extension of our chemistry instrument
offering. We expect to complete
development and sell the resulting new instrument prior to year end.
Internal research and
development is managed on a case-by-case basis.
We employ individuals with microbiology, immunology, genetics,
biochemistry, molecular biology, parasitology as well as veterinary expertise
and will form multidisciplinary product-associated teams as appropriate. We incurred expenses of $3.5 million, $2.7
million and $2.0 million in the years ended December 31, 2006, 2007
and 2008, respectively, in support of our research and development activities.
Intellectual
Property
We believe that patents,
trademarks, copyrights and other proprietary rights are important to our
business. We also rely upon trade
secrets, know-how, continuing technological innovations and licensing
opportunities to develop and maintain our competitive position. The proprietary technologies of our OVP
segment are primarily protected through trade secret protection of, for
example, our manufacturing processes in this area.
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We actively seek patent
protection both in the United States and abroad. Our issued and pending patent portfolios
primarily relate to heartworm control, flea control, allergy, infectious
disease vaccines, diagnostic and detection tests, immunomodulators,
instrumentation, nutrition, pain control and vaccine delivery
technologies. As of December 31,
2008, we owned, co-owned or had rights to 176 issued U.S. patents and 35
pending U.S. patent applications expiring at various dates from February 2011
to August 2024. Applications
corresponding to pending U.S. applications have been or will be filed in other
countries. Our corresponding foreign
patent portfolio as of December 31, 2008 included 80 issued patents and 35
pending applications in various foreign countries.
We have entered into a
number of out-licensing agreements to realize additional value in certain of
our intellectual property assets in fields outside of our core focus. For example, in 1998 we obtained rights from ImmuLogic
Pharmaceutical Corporation to an intellectual property portfolio including a
number of major allergens and the genes that encode them for use in veterinary
as well as human allergy applications.
In order to realize additional value from that portfolio, we granted
licenses and options for licenses to several companies for the use of those
allergens in the fields of diagnosis and treatment of human allergy. In December 2006, we sold this
intellectual property portfolio to Allergopharma Joachim Ganzer KG and obtained
an exclusive license to veterinary rights for this intellectual property
portfolio as part of the agreement.
We also have obtained
exclusive and non-exclusive licenses for numerous other patents held by
academic institutions and biotechnology and pharmaceutical companies.
Seasonality
We expect to experience less
seasonality than we have in the past due to factors including increased
instrument consumable revenue, which does not tend to be seasonal, and changes
in the timing of certain product promotions. At this point, we do not
anticipate a large seasonal effect on our consolidated financial results.
Government
Regulation
Although the majority of our
product revenue is from the sale of unregulated items, many of our products or
products that we may develop are, or may be, subject to extensive regulation by
governmental authorities in the United States, including the USDA and the FDA,
and by similar agencies in other countries.
These regulations govern, among other things, the development, testing,
manufacturing, labeling, storage, pre-market approval, advertising, promotion,
sale and distribution of our products.
Satisfaction of these requirements can take several years to achieve and
the time needed to satisfy them may vary substantially, based on the type,
complexity and novelty of the product.
Any product that we develop must receive all relevant regulatory
approval or clearances, if required, before it may be marketed in a particular
country. The following summarizes the
major U.S. government agencies that regulate animal health products:
·
USDA
.
Vaccines and certain single use, point-of-care diagnostics are
considered veterinary biologics and are therefore regulated by the Center for
Veterinary Biologics, or CVB, of the USDA.
Industry data indicate that it takes approximately four years and $1.0
million to license a conventional vaccine for animals from basic research
through licensing. In contrast to
vaccines, single use, point-of-care diagnostics can typically be licensed by
the USDA in about two years, at considerably less cost. However, vaccines or diagnostics that use
innovative materials, such as those resulting from recombinant DNA technology,
usually require additional time to license.
The USDA licensing process involves the submission of several data
packages. These packages include
information on how the product will be manufactured, information on the
efficacy and safety of the product in laboratory and target animal studies and
information on performance of the product in field conditions.
8
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·
FDA
.
Pharmaceutical products, which typically include synthetic compounds,
are approved and monitored by the Center for Veterinary Medicine of the
FDA. Industry data indicate that
developing a new drug for animals requires approximately 11 years from
commencement of research to market introduction and costs approximately $5.5
million. Of this time, approximately
three years is spent in animal studies and the regulatory review process. However, unlike human drugs, neither
preclinical studies nor a sequential phase system of studies are required. Rather, for animal drugs, studies for safety
and efficacy may be conducted immediately in the species for which the drug is
intended. Thus, there is no required
phased evaluation of drug performance, and the Center for Veterinary Medicine
will review data at appropriate times in the drug development process. In addition, the time and cost for developing
companion animal drugs may be significantly less than for drugs for livestock
animals, as food safety issues relating to tissue residue levels are not
applicable.
·
EPA
.
Products that are applied topically to animals or to premises to control
external parasites are regulated by the Environmental Protection Agency, or
EPA.
After we have received
regulatory licensing or approval for our products, numerous regulatory
requirements typically apply. Among the
conditions for certain regulatory approvals is the requirement that our
manufacturing facilities or those of our third-party manufacturers conform to
current Good Manufacturing Practices or other manufacturing regulations, which
include requirements relating to quality control and quality assurance as well
as maintenance of records and documentation.
The USDA, FDA and foreign regulatory authorities strictly enforce
manufacturing regulatory requirements through periodic inspections and/or
reports.
A number of our animal
health products are not regulated. For
example, certain products such as our E.R.D.-HEALTHSCREEN Urine Tests and our
ALLERCEPT panels, as well as other reference lab tests, are not regulated by
either the USDA or FDA. Similarly, none
of our veterinary instruments requires regulatory approval to be marketed and
sold in the United States.
We have pursued regulatory
approval outside the United States based on market demographics of foreign
countries. For marketing outside the
United States, we are subject to foreign regulatory requirements governing
regulatory licensing and approval for many of our products. Licensing and approval by comparable
regulatory authorities of foreign countries must be obtained before we can
market products in those countries.
Product licensing approval processes and requirements vary from country
to country and the time required for such approvals may differ substantially
from that required in the United States.
We cannot be certain that approval of any of our products in one country
will result in approvals in any other country.
To date, we or our distributors have sought regulatory approval for
certain of our products in Canada, which is governed by the Canadian Food Inspection
Agency, or CFIA; in Japan, which is governed by the Japanese Ministry of
Agriculture, Forestry and Fisheries, or MAFF; and in certain European and other
Asian countries requiring such approval.
9
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Core Companion Animal Health
products previously discussed which have received regulatory approval in the
United States and/or elsewhere are summarized below.
Products
|
|
Country
|
|
Regulated
|
|
Agency
|
|
Status
|
E.R.D.-HEALTHSCREEN Canine Urine Test
|
|
United States
|
|
No
|
|
|
|
|
|
|
EU
|
|
No-in most countries
|
|
|
|
|
|
|
Canada
|
|
No
|
|
|
|
|
|
|
Japan
|
|
Yes
|
|
MAFF
|
|
Licensed
|
|
|
|
|
|
|
|
|
|
E.R.D.-HEALTHSCREEN Feline Urine Test
|
|
United States
|
|
No
|
|
|
|
|
|
|
EU
|
|
No-in most countries
|
|
|
|
|
|
|
Canada
|
|
No
|
|
|
|
|
|
|
Japan
|
|
Yes
|
|
MAFF
|
|
Licensed
|
|
|
|
|
|
|
|
|
|
FELINE ULTRANASAL FVRC Vaccine
|
|
United States
|
|
Yes
|
|
USDA
|
|
Licensed
|
|
|
Canada
|
|
Yes
|
|
CFIA
|
|
Licensed
|
|
|
|
|
|
|
|
|
|
FELINE ULTRANASAL FVRCP Vaccine
|
|
United States
|
|
Yes
|
|
USDA
|
|
Licensed
|
|
|
Canada
|
|
Yes
|
|
CFIA
|
|
Licensed
|
|
|
|
|
|
|
|
|
|
SOLO STEP CH
|
|
United States
|
|
Yes
|
|
USDA
|
|
Licensed
|
|
|
EU
|
|
No-in most countries
|
|
|
|
|
|
|
Canada
|
|
Yes
|
|
CFIA
|
|
Licensed
|
|
|
Japan
|
|
Yes
|
|
MAFF
|
|
Licensed
|
|
|
|
|
|
|
|
|
|
SOLO STEP CH Batch Test Strips
|
|
United States
|
|
Yes
|
|
USDA
|
|
Licensed
|
|
|
Canada
|
|
Yes
|
|
CFIA
|
|
Licensed
|
|
|
|
|
|
|
|
|
|
SOLO STEP FH
|
|
United States
|
|
Yes
|
|
USDA
|
|
Licensed
|
|
|
|
|
|
|
|
|
|
TRI-HEART Plus Heartworm Preventive
|
|
United States
|
|
Yes
|
|
FDA
|
|
Licensed
|
|
|
Japan
|
|
Yes
|
|
MAFF
|
|
Licensed
|
|
|
South Korea
|
|
Yes
|
|
NVRQS
|
|
Licensed
|
Competition
Our market is intensely
competitive. Our competitors include
independent animal health companies and major pharmaceutical companies that
have animal health divisions. We also
compete with independent, third-party distributors, including distributors who
sell products under their own private labels.
In the point-of-care diagnostic testing market, our major competitors
include IDEXX, Abaxis, Inc. and Synbiotics Corporation. The products manufactured by our OVP segment
for sale by third parties compete with similar products offered by a number of
other companies, some of which have substantially greater financial, technical,
research and other resources than us and may have more established marketing,
sales, distribution and service organizations than our OVP segments
customers. Companies with a significant
presence in the animal health market such as Bayer AG, CEVA Santé Animale,
Merial Limited, Novartis AG, Pfizer Inc., Schering-Plough Corporation, Vétoquinol
S.A., Virbac S.A. and Wyeth may be marketing or developing products that
compete with our products or would compete with them if successfully
developed. These and other competitors
and potential competitors may have substantially greater financial, technical,
research and other resources and larger, more established marketing, sales,
distribution and service organizations than we do. Our competitors may offer broader product
lines and have greater name recognition than we do.
Environmental
Regulation
In connection with our
product development activities and manufacturing of our biological,
pharmaceutical and diagnostic and detection products, we are subject to
federal, state and local laws, rules, regulations and policies governing the use,
generation, manufacture, storage, handling and disposal of certain materials,
biological specimens and wastes.
Although we believe that we have complied with these laws,
10
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regulations and policies in
all material respects and have not been required to take any significant action
to correct any noncompliance, we may be required to incur significant costs to
comply with environmental and health and safety regulations in the future. Although we believe that our safety
procedures for handling and disposing of such materials comply with the
standards prescribed by state and federal regulations, the risk of accidental
contamination or injury from these materials cannot be eliminated. In the event of such an accident, we could be
held liable for any damages that result and any such liability could exceed our
resources.
Employees
As of December 31,
2008, we and our subsidiaries employed 312 people, of whom 138 were focused in
production and technical and logistical services, including instrumentation
service, 108 in sales, marketing and customer support, 56 in general
administrative services, such as accounting, and 10 in product
development. We believe that our ability
to attract and retain skilled personnel is critical to our success. None of our employees is covered by a
collective bargaining agreement, and we believe our employee relations are
good.
Executive
Officers
Our executive officers and
their ages as of March 16, 2009 are as follows:
Name
|
|
Age
|
|
Position
|
Robert B. Grieve, Ph.D.
|
|
57
|
|
Chairman of the Board and
Chief Executive Officer
|
Michael J. McGinley, Ph.D.
|
|
48
|
|
President and Chief
Operating Officer
|
Jason A. Napolitano
|
|
40
|
|
Executive Vice President,
Chief Financial Officer and Secretary
|
Michael A. Bent
|
|
54
|
|
Vice President, Principal
Accounting Officer and Controller
|
G. Lynn Snodgrass
|
|
39
|
|
Vice President, Sales
|
Robert B.
Grieve, Ph.D.
, one of
our founders, currently serves as Chief Executive Officer and Chairman of the
Board. Dr. Grieve was named Chief
Executive Officer effective January 1, 1999, Vice Chairman effective March 1992
and Chairman of the Board effective May 2000. Dr. Grieve also served as Chief
Scientific Officer from December 1994 to January 1999 and Vice
President, Research and Development, from March 1992 to December 1994. He has been a member of our Board of
Directors since 1990. He holds a Ph.D.
degree from the University of Florida and M.S. and B.S. degrees from the
University of Wyoming.
Michael J.
McGinley, Ph.D.
was
appointed President and Chief Operating Officer effective January 1,
2009. He previously served as Vice
President, Global Operations from April through December 2008, Vice
President, Operations and Technical Affairs and General Manager, Heska Des
Moines from January 2002 to April 2008 and in other positions
beginning in June 1997. Prior to
joining Heska, Dr. McGinley held positions with Bayer Animal Health and Fort
Dodge Laboratories. He holds Doctorate and M.S. degrees in Immunobiology
from Iowa State University.
Jason A.
Napolitano
was
appointed Executive Vice President and Chief Financial Officer in May 2002. He was appointed our Secretary in February 2009.
He also served as our Secretary from May 2002
to December 2006. Prior to joining
us formally, he was a financial consultant.
From 1990 to 2001, Mr. Napolitano held various positions at Credit
Suisse First Boston, an investment bank, including Vice President in health
care investment banking and Director in mergers and acquisitions. He holds a B.S. degree from Yale University.
11
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Michael A.
Bent
was appointed
Vice President, Principal Accounting Officer and Controller in May 2002. From September 1999 until April 2002,
he was Corporate Controller. From November 1993
until September 1999, Mr. Bent was Director, Accounting Operations at
Coors Brewing Company. Mr. Bent
holds a B.S. in accounting from the University of Wyoming. Mr. Bent is a CPA in Colorado and
Wyoming.
G. Lynn
Snodgrass
was
appointed Vice President, Sales in January 2007. From January 2005 to December 2006,
he was Senior Director, Sales for Heska Corporation. He held various
sales positions at Heska from August 1999 through December 2004.
Prior to joining Heska, he held various sales positions with Luitpold
Pharmaceuticals, GPC Incorporated, Merck and Company and TV Fanfare, Inc.
Mr. Snodgrass holds a B.S. in Biomedical Science from Texas A&M
University.
Item
1A. Risk Factors
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 some of these factors and the possible impact
of these factors on future results of operations. The risks and uncertainties described below
are not the only ones we face.
Additional risks or uncertainties not presently known to us or that we
deem to be currently immaterial also may impair our business 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 rely substantially on third-party suppliers. The loss of products or delays in product
availability from one or more third-party supplier could substantially harm our
business.
To be successful, we must
contract for the supply of, or manufacture ourselves, current and future
products of appropriate quantity, quality and cost. Such products must be available on a timely
basis and be in compliance with any regulatory requirements. Failure to do so could substantially harm our
business.
We rely on third party
suppliers to manufacture those products we do not manufacture ourselves. Proprietary products provided by these
suppliers represent a majority of our product revenue. We currently rely on these suppliers for our
veterinary instruments and consumable supplies for these instruments, for our
point-of-care diagnostic and other tests, for the manufacture of our allergy
immunotherapy treatment products as well as for the manufacture of other
products. Major suppliers who sell us
proprietary products which are responsible for more than 5% of our trailing
12-month product revenue are APOC, Arkray, Boule, FUJIFILM and Quidel. None of these suppliers sell us proprietary
products which are responsible for more than 20% of our trailing 12-month
product revenue, although the proprietary products of one is responsible for
more than 15% of our revenue and one other is responsible for more than 10% of
our revenue. We often purchase products
from our suppliers under agreements that are of limited duration or potentially
can be terminated on an annual basis. In
the case of our veterinary diagnostic instruments, we are typically entitled to
non-exclusive access to consumable supplies for a defined period upon
expiration of exclusive rights, which could subject us to competitive pressures
in the period of non-exclusive access.
For example, APOC has the right to cancel our agreement with notice to
us and if APOC does so, we believe we have the contractual right to purchase
consumable supplies from APOC for six months and sell consumable supplies for
at least nine months following such notice on a non-exclusive basis. Although we believe we have arrangements to
ensure supply of our other major product offerings in the marketplace through
at least the end of 2009, there can be no assurance that our suppliers will
meet their obligations under any agreements we may have in place with them or
that we will be able to compel them to do so.
Risks of relying on suppliers include:
·
The loss of product rights
upon expiration or termination of an existing agreement.
Unless we are able to find an alternate supply of a similar product, we
would not be able to continue to offer our customers the same breadth of
products and our sales and operating results would likely suffer. In the case of an instrument supplier, we
could also potentially suffer the loss of sales of consumable supplies, which
would be significant in cases where we have built a significant installed base,
further harming our sales prospects and opportunities. Even if we were able to
12
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find
an alternate supply for a product to which we lost rights, we would likely face
increased competition from the product whose rights we lost being marketed by a
third party or the former supplier and it may take us additional time and
expense to gain the necessary approvals and launch an alternative product.
·
Loss of exclusivity.
In
the case of our veterinary diagnostic instruments, if we are entitled to
non-exclusive access to consumable supplies for a defined period upon
expiration of exclusive rights, we may face increased competition from a third
party with similar non-exclusive access or our former supplier, which could
cause us to lose customers and/or significantly decrease our margins and could
significantly affect our financial results.
In addition, current agreements, or agreements we may negotiate in the
future, with suppliers may require us to meet minimum annual sales levels to
maintain our position as the exclusive distributor of these products. We may not meet these minimum sales levels
and maintain exclusivity over the distribution and sale of these products. If we are not the exclusive distributor of
these products, competition may increase significantly, reducing our revenues
and/or decreasing our margins.
·
High switching costs.
In our
diagnostic instrument products we could face significant competition and lose
all or some of the consumable revenues from the installed base of those
instruments if we were to switch to a competitive instrument. If we need to change to other commercial
manufacturing contractors for certain of our regulated products, additional
regulatory licenses or approvals must be obtained for these contractors prior
to our use. This would require new
testing and compliance inspections prior to sale thus resulting in potential
delays. Any new manufacturer would have
to be educated in, or develop substantially equivalent processes necessary for
the production of our products. We
likely would have to train our sales force, distribution network employees and
customer support organization on the new product and spend significant funds
marketing the new product to our customer base.
·
Inability to meet minimum
obligations.
Current agreements, or agreements we may
negotiate in the future, may commit us to certain minimum purchase or other
spending obligations. It is possible we
will not be able to create the market demand to meet such obligations, which
could create a drain on our financial resources and liquidity. Some such agreements may require minimum
purchases and/or sales to maintain product rights and we may be significantly
harmed if we are unable to meet such requirements and lose product rights.
·
The involuntary or
voluntary discontinuation of a product line.
Unless we are able to find an
alternate supply of a similar product in this or similar circumstances with any
product, we would not be able to continue to offer our customers the same breadth
of products and our sales would likely suffer.
Even if we are able to identify an alternate supply, it may take us
additional time and expense to gain the necessary approvals and launch an
alternative product, especially if the product is discontinued unexpectedly. An example of such a situation arose in 2006
when Dolphin Medical Inc. (a majority-owned subsidiary of OSI Systems, Inc.)
discontinued production of our VET/OX G2 DIGITAL Monitor as part of an
agreement with Masimo Corporation to settle a patent dispute.
·
Inconsistent or inadequate
quality control.
We may not be able to control or adequately
monitor the quality of products we receive from our suppliers. Poor quality items could damage our
reputation with our customers.
·
Limited capacity or ability
to scale capacity.
If market demand for our products increases
suddenly, our current suppliers 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. If we consistently generate more demand for a
product than a given
13
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supplier
is capable of handling, it could lead to large backorders and potentially lost
sales to competitive products that are readily available. This could require us to seek or fund new
sources of supply, which may be difficult to find unless it is under terms that
are less advantageous.
·
Regulatory risk.
Our
manufacturing facility and those of some of our third party suppliers 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 suppliers compliance
with these regulations and standards.
Violations could potentially lead to interruptions in supply that could
cause us to lose sales to readily available competitive products.
·
Developmental delays.
We
may experience delays in the scale-up quantities needed for product development
that could delay regulatory submissions and commercialization of our products
in development, causing us to miss key opportunities.
·
Limited intellectual
property rights.
We typically do not have intellectual
property rights, or may have to share intellectual property rights, to the
products themselves and any improvements to the manufacturing processes or new
manufacturing processes for our products.
Potential problems with
suppliers such as those discussed above could substantially decrease sales,
lead to higher costs, and/or damage our reputation with our customers due to
factors such as poor quality goods or delays in order fulfillment, resulting in
our being unable to sell our products effectively and substantially harm our
business.
We may be unable to successfully market and sell our products.
We may not successfully
develop and maintain marketing and/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
sales strategy is unsuccessful, our ability to sell our products will be
negatively impacted and our revenues will decrease.
We believe the recent worldwide
economic weakness has had a negative effect on our business, and this may
continue in the future. This is
particularly notable in the sale of new instruments, which is a capital
expenditure many, if not most, veterinarians may choose to defer in times of
perceived economic weakness. Even if the
overall economy begins to grow in the future, there may be a lag before
veterinarians display confidence such growth will continue and return to
historical capital expenditure purchasing patterns. As the vast majority of cash flow to
veterinarians ultimately is funded by pet owners without private insurance or
government support, our business may be more susceptible to severe economic
downturns than other health care businesses which rely less on individual
consumers.
The market for companion
animal healthcare products is highly fragmented. Because our Core Companion Animal Health
proprietary products are generally available only to veterinarians or by
prescription and our medical instruments require technical training to operate,
we predominately sell all our Core Companion Animal Health products to or
through veterinarians ultimately. The
acceptance of our products by veterinarians is critical to our success. Changes in our ability to obtain or maintain
such acceptance or changes in veterinary medical practice could significantly
decrease our anticipated sales.
We currently market and sell
most of our Core Companion Animal Health products in the United States to
veterinarians through an outside field organization of approximately 38
individuals, an inside sales force of approximately 20 individuals,
approximately 11 independent third-party distributors who carry our full
distribution product line and approximately 5 independent third-party distributors
who carry portions of our
14
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distribution product line,
as well as through trade shows and print advertising. To be successful in these endeavors, we will
have to effectively market our products and continue to develop and train our
direct sales force as well as the sales personnel of our independent
third-party distributors.
Independent third-party distributors
may be effective in increasing sales of our products to veterinarians, although
we would expect a corresponding lower gross margin as such distributors
typically buy products from us at a discount to end user prices. It is possible new or existing independent
third-party distributors could cannibalize our direct sales efforts and lower
our total gross margin. For us to be
effective when working with an independent third-party distributor, the
distributor must agree to market and/or sell our products and we must provide
proper economic incentives to the distributor as well as contend effectively
for the distributors time and focus given other products the distributor may
be carrying, potentially including those of our competitors. If we fail to be effective with new or
existing independent third-party distributors, our financial performance may
suffer. In addition, most of our
independent third-party distributor agreements can be terminated on 60 days
notice and we believe that IDEXX, one of our largest competitors, in effect
prohibits its distributors from selling competitive products, including our
diagnostic instruments and heartworm diagnostic tests. We believe this restriction limits our
ability to engage national independent third-party distributors to sell our
full distribution line of products and has caused large distributors of our
products in the past to no longer carry our instruments and heartworm
diagnostic tests upon commencing distribution of the IDEXX product line.
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 maintain sustained profitability.
The market in which we
compete is intensely competitive. Our
competitors include independent animal health companies and major
pharmaceutical companies that have animal health divisions. We also compete with independent, third-party
distributors, including distributors who sell products under their own private
labels. In the point-of-care diagnostic
testing market, our major competitors include IDEXX, Abaxis, Inc. and
Synbiotics Corporation. The products
manufactured by our OVP segment for sale by third parties compete with similar
products offered by a number of other companies, some of which have
substantially greater financial, technical, research and other resources than
us and may have more established marketing, sales, distribution and service
organizations than our OVP segments customers.
Competitors may have facilities with similar capabilities to our OVP
segment, which they may operate and sell at a lower unit price to customers
than our OVP segment does, which could cause us to lose customers. Companies with a significant presence in the
companion animal health market, such as Bayer AG, CEVA Santé Animale, Merial
Limited (a company jointly owned by Merck & Co., Inc. and Sanofi-Aventis),
Novartis AG, Pfizer Inc., Schering-Plough Corporation, Vétoquinol S.A., Virbac
S.A. and Wyeth, may be marketing or developing products that compete with our
products or would compete with them if developed. These and other competitors and potential
competitors may have substantially greater financial, technical, research and
other resources and larger, more established marketing, sales and service
organizations than we do. Our
competitors may 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 health care market. Moreover, we
may not have the financial resources, technical expertise or marketing, sales
or support capabilities to compete successfully. We believe that one of our largest
competitors, IDEXX, in effect prohibits its distributors from selling competitive
products, including our diagnostic instruments and heartworm diagnostic
tests. Another of our competitors,
Abaxis, Inc. recently launched a canine heartworm diagnostic test
competitive with ours. If we fail to
compete successfully, our ability to achieve sustained profitability will be limited
and sustained profitability, or profitability at all, may not be possible.
15
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If the third parties to whom we granted substantial marketing rights
for certain of our existing products or future products under development are
not successful in marketing those products, then our sales and financial
position may suffer.
Our agreements with our
corporate marketing partners generally contain no or small minimum purchase
requirements in order for them to maintain their exclusive or co-exclusive
marketing rights. We are party to an
agreement with SPAH which grants distribution and marketing rights in the U.S.
for our canine heartworm preventive product, TRI-HEART Plus Chewable
Tablets. AgriLabs has the exclusive
right to sell certain of our bovine vaccines in the United States, Africa and
Mexico. Novartis Japan markets and
distributes our SOLO STEP CH heartworm test and our E.R.D. Healthscreen urine
test products in Japan under an exclusive arrangement. One or more of these marketing partners may
not devote sufficient resources to marketing our products. For example, on March 9, 2009, Merck &
Co., Inc. (Merck) and Schering-Plough Corporation (SGP) announced
plans to merge. SGP is the parent
company of SPAH. Merck owns 50% of
Merial Limited, a company which sells a canine heartworm preventive competitive
with ours. If Merck and SGP are required
to divest or cease operations related to our heartworm preventive in order to
complete their merger, our sales could decline significantly and our business
could be damaged. Similarly, if SPAH
personnel are distracted or experience turmoil as a result of the announced
merger between Merck and SGP, our sales could decline significantly. Furthermore, there may be nothing to prevent
these partners from pursuing alternative technologies or products that may
compete with our products in current or future agreements. For example, we believe a unit of SPAH has
obtained FDA approval for a canine heartworm preventive product with additional
claims compared with our TRI-HEART Plus Chewable Tablets. Should SPAH decide to emphasize sales and
marketing efforts of this product rather than our TRI-HEART Plus Chewable
Tablets or cancel our agreement regarding canine heartworm preventive
distribution and marketing, our sales could decline significantly. 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. In addition, both our agreement with AgriLabs
requires us to potentially pay penalties if we are unable to supply product
over an extended period of time.
We have historically not consistently generated positive cash flow from
operations, may need additional capital and any required capital may not be
available on reasonable terms or at all.
If our actual performance
deviates from our operating plan, we may be required to raise additional
capital in the future. If necessary, we
expect to raise these additional funds by the sale of equity securities
or refinancing loans currently outstanding on assets with historical
appraised values in excess of related debt.
There is no guarantee that additional capital will be available from
these sources on reasonable terms, if at all, and certain of these sources may
require approval by existing lenders.
The public markets may be unreceptive to equity financings and we may
not be able to obtain additional private equity or debt financing. Any equity financing would likely be dilutive
to stockholders and additional debt financing, if available, may include
restrictive covenants and increased interest rates that would limit our
currently planned operations and strategies.
Additionally, funds we expect to be available under our existing
revolving line of credit may not be available and other lenders could refuse to
provide us with additional debt financing.
We believe the credit markets are particularly restrictive and difficult
to obtain funding in versus recent history.
Furthermore, even if additional capital is available, it may not be of
the magnitude required to meet our needs under these or other scenarios. If additional funds are required and are not
available, it would likely have a material adverse effect on our business,
financial condition and our ability to continue as a going concern.
Our common stock is listed on the Nasdaq Capital Market and we may not
be able to maintain that listing, which may make it more difficult for you to
sell your shares.
Our common stock is listed
on the Nasdaq Capital Market. The Nasdaq
has several quantitative and qualitative requirements companies must comply
with to maintain this listing, including a $1.00 minimum bid price. We are currently not in compliance with the
$1.00 minimum bid price and we have received a communication from Nasdaq so
advising us. Nasdaq has announced a
temporary suspension of minimum bid
16
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price enforcement until April 20,
2009, when the compliance process will be reinstated; we are to have 180 calendar
days from April 20, 2009 to regain compliance with the minimum bid price
requirement, which requires our stock to have a minimum closing bid price of
$1.00 for at least 10 consecutive trading days.
If we fail to regain compliance with the minimum bid price requirement
within 180 days, Nasdaq has informed us we will be eligible for an additional
180 calendar day compliance period if we satisfy the Nasdaq Capital Market
initial listing criteria other than the minimum bid price requirement at that
time. There can be no assurance we will
meet these criteria at that point, that Nasdaq will interpret these criteria in
the same manner we do if we believe we meet the criteria, or that Nasdaq will
not change such criteria to include requirements we do not meet in the future,
any of which could cause us to fail to obtain the additional 180 day compliance
period. In addition, we may be delisted
before April 20, 2009 if we fail to comply with certain other Nasdaq
Capital Markets listing requirements. If
we are delisted from the Nasdaq Capital Market, our common stock may be
considered a penny stock under the regulations of the SEC and would therefore
be subject to rules that impose additional sales practice requirements on
broker-dealers who sell our securities.
The additional burdens imposed upon broker-dealers may discourage
broker-dealers from effecting transactions in our common stock, which could
severely limit market liquidity of the common stock and your ability to sell
our securities in the secondary market.
This lack of liquidity would also make it more difficult for us to raise
capital in the future.
Many of our expenses are fixed and if factors beyond our control cause
our revenue to fluctuate, this fluctuation could cause greater than expected
losses, cash flow and liquidity shortfalls.
We believe that our future
operating results will fluctuate on a quarterly basis due to a variety of
factors which are generally beyond our control, including:
·
supply of products from third-party suppliers
or termination, cancellation or expiration of such relationships;
·
the introduction of new products by our
competitors or by us;
·
competition and pricing pressures from
competitive products;
·
our ability to maintain relationships with
independent third-party distributors;
·
large customers failing to purchase at
historical levels, including changes in independent third-party distributor
purchasing patterns and inventory levels;
·
fundamental shifts in market demand;
·
manufacturing delays;
·
shipment problems;
·
information technology problems, which may
prevent us from conducting our business effectively, or at all, and may also
raise our costs;
·
regulatory and other delays in product
development;
·
product recalls or other issues which may
raise our costs;
·
changes in our reputation and/or market
acceptance of our current or new products; and
·
changes in the mix of products sold.
We have high operating
expenses, including those related to personnel.
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.
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We often depend on third parties for products we intend to introduce in
the future. If our current relationships
and collaborations are not successful, we may not be able to introduce the
products we intend to in the future.
We are often dependent on
third parties and collaborative partners to successfully and timely perform
research and development activities to successfully develop new products. For example, we jointly developed
point-of-care diagnostic products with Quidel.
In other cases, we have discussed Heska marketing in the veterinary
market an instrument being developed by a third party for use in the human
health care market. In the future, one
or more of these third parties or collaborative partners may not complete
research and development activities in a timely fashion, or at all. Even if these third parties are successful in
their research and development activities, we may not be able to come to an
economic agreement with them. If these
third parties or collaborative partners fail to complete research and
development activities, fail to complete them in a timely fashion, or if we are
unable to negotiate economic agreements with such third parties or
collaborative partners, our ability to introduce new products will be impacted
negatively and our revenues may decline.
We are currently collaborating with FUJIFILM on a line extension of our
chemistry instrument offering. We expect
to complete and sell the resulting new instrument prior to year end. If FUJIFILM fails to complete the anticipated
development activities in a timely fashion, we will not generate any sales of
this new instrument prior to year end and our 2009 revenue will likely be lower
than our current expectations as a result.
We may not be able to continue to achieve sustained profitability or
increase profitability on a quarterly or annual basis.
Prior to 2005, we incurred
net losses on an annual basis since our inception in 1988 and, as of December 31,
2008, we had an accumulated deficit of $174.0 million. We have achieved only one quarter with income
before income taxes greater than $1.5 million.
Accordingly, relatively small differences in our performance metrics may
cause us to lose money in future periods.
Our ability to continue to be profitable in future periods will depend,
in part, on our ability to increase sales in our Core Companion Animal Health
segment, including maintaining and growing our installed base of instruments
and related consumables, to maintain or increase gross margins and to limit the
increase in our operating expenses to a reasonable level as well as avoid or
effectively manage any unanticipated issues.
We may not be able to generate, sustain or increase profitability on a
quarterly or annual basis. If we cannot
achieve or sustain profitability for an extended period, we may not be able to
fund our expected cash needs, including the repayment of debt as it comes due,
or continue our operations.
If we are unable to maintain various financial and other covenants required
by our credit facility agreement we will be unable to borrow any funds under
the agreement and fund our operations.
Under our credit and
security agreement with Wells Fargo Bank, National Association (Wells Fargo)
we are required to comply with various financial and non-financial covenants in
order to borrow under the agreement. The availability of borrowings under
this agreement is essential to continue to fund our operations. Among the
financial covenants is a requirement to maintain minimum liquidity (cash plus
excess borrowing base) of $1.5 million. Additional requirements include
covenants for minimum capital monthly and minimum net income quarterly.
Although we believe we will be able to maintain compliance with all these
covenants and any covenants we may negotiate in the future, there can be no
assurance thereof. We have not always been able to maintain compliance
with all covenants under our credit and security agreement in the past.
Although Wells Fargo granted us a waiver of non-compliance in each case, there
can be no assurance we will be able to obtain similar waivers or other
modifications if needed in the future on economic terms, if at all.
Failure to comply with any
of the covenants, representations or warranties, or failure to modify them to
allow future compliance, could result in our being in default and could cause
all outstanding borrowings under our credit and security agreement to become
immediately due and payable, or impact our ability to borrow under the
agreement. In addition, Wells Fargo has discretion in setting the advance
rates which we may borrow against eligible assets. We intend to rely on available borrowings
under the credit and security agreement to fund our operations in the
future. If we are unable to borrow funds under this agreement, we will
need to raise additional capital from other sources to continue our operations,
which capital may not be available on acceptable terms, or at all.
Our future revenues depend on successful product development,
commercialization and/or market acceptance, any of which can be slower than we
expect or may not occur.
The product development and
regulatory approval process for many of our potential products is extensive and
may take substantially longer than we anticipate. Research projects may fail. New products that we may be developing for
the veterinary marketplace may not perform up to our expectations. 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 other product
candidates. If we fail to successfully
develop new products and bring them to market in a timely manner, our ability
to generate additional revenue will decrease.
Even if we are successful in
the development of a product or obtain rights to a product from a third-party
supplier, we may experience delays in commercialization and/or market
acceptance of the product. For example,
veterinarians may be slow to adopt a product or there may be delays in
producing large volumes of a product.
The former is particularly likely where there is no comparable product
available or historical use of such a product.
For example, while we believe our E.R.D.-HEALTHSCREEN urine tests for
dogs and cats represent a significant scientific breakthrough in companion animal
annual health examinations, these
18
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products have achieved
significantly lower market acceptance than we anticipated. The ultimate adoption of a new product by
veterinarians, the rate of such adoption and the extent veterinarians choose to
integrate such a product into their practice are all important factors in the
economic success of one of our new products and are factors that we do not control
to a large extent. If our products do
not achieve a significant level of market acceptance, demand for our products
will not develop as expected and our revenues will be lower than we anticipate.
Our stock price has historically experienced high volatility, which may
increase in the future, and which could 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 microcap and smallcap companies have in the past been, and
can in the future be expected to be, especially volatile. During the past 12 months, our closing stock
price has ranged from a low of $0.17 to a high of $1.60. 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:
·
stock sales by large stockholders or by insiders;
·
changes in the outlook for our business, including any changes in our
earnings guidance;
·
our quarterly operating results, including as compared to our revenue,
earnings or other guidance and in comparison to historical results;
·
termination, cancellation or expiration of our third-party supplier
relationships;
·
announcements of technological innovations or new products by our
competitors or by us;
·
litigation;
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·
regulatory developments, including delays in product introductions;
·
developments or disputes concerning patents or proprietary rights;
·
availability of our revolving line of credit and compliance with debt
covenants;
·
releases of reports by securities analysts;
·
changes in regulatory policies;
·
economic and other external factors; and
·
general market conditions.
In the past, following
periods of volatility in the market price of a companys securities, securities
class action litigation has often been instituted. If a securities class action suit is filed
against us, it is likely we would incur substantial legal fees and our
managements attention and resources would be diverted from operating our
business in order to respond to the litigation.
The loss of significant customers could harm our operating results.
Sales to no single customer
accounted for more than 10% of our consolidated revenue for the periods ended December 31,
2008, 2007 and 2006. No single customer accounted for more than 10% of
accounts receivable at December 31, 2008 or 2007. The loss of
significant customers who, for example, are historically large purchasers or
who are considered leaders in their field could damage our business and
financial results.
Obtaining and maintaining regulatory approvals in order to market our
regulated products may be costly and delay the marketing and sales of our
products.
Many of the products we
develop, market or manufacture may subject us to extensive regulation by one or
more of the USDA, the FDA, the EPA and foreign and other regulatory
authorities. These regulations govern,
among other things, the development, testing, manufacturing, labeling, storage,
pre-market approval, advertising, promotion and sale of some of our
products. Satisfaction of these
requirements can take several years and time needed to satisfy them may vary
substantially, based on the type, complexity and novelty of the product.
The effect of government
regulation may be to delay or to prevent marketing of our products for a
considerable period of time and to impose costly procedures upon our
activities. We have experienced in the
past, and may experience in the future, difficulties that could delay or
prevent us from obtaining the regulatory approval or license necessary to
introduce or market our products. Such
delays in approval may cause us to forego a significant portion of a new
products sales in its first year due to seasonality and advanced booking
periods associated with certain products.
Regulatory approval of our products may also impose limitations on the
indicated or intended uses for which our products may be marketed.
Among the conditions for
certain regulatory approvals is the requirement that our facilities and/or the
facilities of our third party manufacturers conform to current Good
Manufacturing Practices and other requirements.
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, but not limited to, warning letters, manufacturing
suspensions, 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. In addition, certain of our agreements
require us to pay penalties if we are unable to
20
Table
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supply products, including
for failure to maintain regulatory approvals.
Any of these events, alone or in unison, could damage our business.
Interpretation of existing legislation, regulations and rules or
implementation of future legislation, regulations and rules could cause
our costs to increase or could harm us in other ways.
The Sarbanes-Oxley Act of
2002 (Sarbanes-Oxley) has increased our required administrative actions and
expenses as a public company. The
increase in general and administrative costs of complying with Sarbanes-Oxley
will depend on how it is interpreted over time.
Of particular concern are the level of standards for internal control
evaluation and reporting adopted under Section 404 of Sarbanes-Oxley. If our regulators and/or auditors adopt or
interpret more stringent standards than we anticipate, we and/or our auditors
may be unable to conclude that our internal controls over financial reporting
are designed and operating effectively, which could adversely affect investor
confidence in our financial statements.
Even if we and our auditors are able to conclude that our internal
controls over financial reporting are designed and operating effectively in such
a circumstance, our general and administrative costs are likely to increase in
such a circumstance. In addition,
actions by other entities, such as enhanced rules to maintain our listing
on the Nasdaq Capital Market, could also increase our general and
administrative costs or have other adverse effects on us, as could further
legislative, regulatory or rule-making action or more stringent interpretations
of existing legislation, regulations and rules.
We may face costly legal disputes, including related to our
intellectual property or technology or that of our suppliers or collaborators.
We may face legal disputes
related to our business. Even if
meritless, these disputes may require significant expenditures on our part and
could entail a significant distraction to members of our management team or
other key employees. A legal dispute
leading to an unfavorable ruling or settlement could have significant material
adverse consequences on our business.
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 likely to be costly, time-consuming
and distracting. As is typical in our
industry, from time to time we and our collaborators and suppliers have
received, and may in the future receive, notices from third parties claiming
infringement and invitations to take licenses under third party patents. Any legal action against us or our
collaborators or suppliers may require us or our collaborators or suppliers to
obtain one or more licenses in order to market or manufacture affected products
or services. However, we or our
collaborators or suppliers may not be able to obtain licenses for technology
patented by others on commercially reasonable terms, or at all, may not be able
to develop alternative approaches if unable to obtain licenses or current and
future licenses may not be adequate, any of which could substantially harm our
business. An example of such a situation
arose in 2006 when Dolphin Medical Inc. (a majority-owned subsidiary of OSI
Systems, Inc.) discontinued production of our VET/OX G2 DIGITAL Monitor as
part of an agreement with Masimo Corporation to settle a patent dispute.
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 likely 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.
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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 other key
personnel. The loss of the services of
members of our senior management or other key personnel may significantly delay
or prevent the achievement of our business objectives. Although we have an employment agreement with
many of these individuals, all are at-will employees, which means that either
the employee or Heska may terminate employment at any time without prior
notice. If we lose the services of, or
fail to recruit, key personnel, the growth of our business could be
substantially impaired. We do not
maintain key person life insurance for any of our senior management or key
personnel.
Changes to financial accounting standards may affect our results of
operations and cause us to change our business practices.
We prepare our financial
statements in conformance with United States generally accepted accounting
principles, or GAAP. These accounting
principles are established by and are subject to interpretation by the SEC, the
Financial Accounting Standards Board, the American Institute of Certified
Public Accountants, and others who interpret and create accounting
policies. A change in those policies can
have a significant effect on our reported results and may affect our reporting
of transactions completed before a change is made effective. Such changes may adversely affect our
reported financial results or the way we conduct our business.
We may face product returns and product liability litigation in excess
of or not covered by our insurance coverage or indemnities and/or warranties
from our suppliers. 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 substantially
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, be required to
make substantial payments which could exceed our financial capacity and/or lose
or 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.
Certain of our products and
development programs produced at our Des Moines, Iowa facility involve the
controlled use of hazardous and biohazardous materials, including chemicals and
infectious disease agents. 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, significant remediation costs
and potential legal liability. In
addition, we may incur substantial costs to comply with environmental
regulations if we choose to expand our manufacturing capacity.
22
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Item
1B. Unresolved Staff Comments.
Not applicable.
Item
2. Properties.
Our principal administrative
and research and development activities are located in Loveland, Colorado. We currently lease approximately 60,000
square feet at a facility in Loveland, Colorado under an 18-year lease
agreement which expires in 2023. Our
principal production facility located in Des Moines, Iowa, consists of 168,000
square feet of buildings on 34 acres of land, which we own. We also own a 175-acre farm used principally
for testing products, located in Carlisle, Iowa. Our European facility in Fribourg,
Switzerland is leased under an agreement which expires in 2012.
Item
3. Legal Proceedings.
None.
Item
4. Submission of Matters to a Vote of
Security Holders.
No matters were submitted to
a vote of stockholders during the fourth quarter ended December 31, 2008.
23
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PART II
Item
5. Market for Registrants Common
Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is quoted
on the Nasdaq Capital Market under the symbol HSKA. The following table sets forth the high and
low closing prices for our common stock as reported by the Nasdaq Capital
Market for the periods indicated below:
|
|
High
|
|
Low
|
|
2007
|
|
|
|
|
|
First Quarter
|
|
$
|
1.73
|
|
$
|
1.56
|
|
Second Quarter
|
|
2.54
|
|
1.67
|
|
Third Quarter
|
|
2.90
|
|
1.88
|
|
Fourth Quarter
|
|
2.34
|
|
1.57
|
|
2008
|
|
|
|
|
|
First Quarter
|
|
2.10
|
|
1.30
|
|
Second Quarter
|
|
1.60
|
|
1.20
|
|
Third Quarter
|
|
1.23
|
|
0.65
|
|
Fourth Quarter
|
|
0.61
|
|
0.18
|
|
2009
|
|
|
|
|
|
First Quarter
(through March 13)
|
|
0.35
|
|
0.17
|
|
|
|
|
|
|
|
|
|
As of March 13, 2009,
there were approximately 293 holders of record of our common stock and
approximately 2,559 beneficial stockholders.
We have never declared or paid cash dividends on our capital stock and
do not anticipate paying any cash dividends in the near future. In addition, we are restricted from paying
dividends, other than dividends payable solely in stock, under the terms of our
credit facility. We currently intend to
retain future earnings, if any, for the development of our business.
Equity
Compensation Plan Information
The following table sets
forth information about our common stock that may be issued upon exercise of
options and rights under all of our equity compensation plans as of December 31,
2008, including the 1988 Stock Option Plan, the 1997 Stock Incentive Plan, the
2003 Stock Incentive Plan and the 1997 Employee Stock Purchase Plan. Our stockholders have approved all of these
plans.
Plan Category
|
|
(a) Number of Securities
to be Issued Upon
Exercise of Outstanding
Options and Rights
|
|
(b) Weighted-Average
Exercise Price of
Outstanding Options
and Rights
|
|
(c) Number of Securities
Remaining Available for Future
Issuance Under Equity
Compensation Plans (excluding
securities reflected in column (a))
|
|
Equity
Compensation Plans Approved by Stockholders
|
|
12,835,269
|
|
$
|
1.28
|
|
3,198,436
|
|
Equity
Compensation Plans Not Approved by Stockholders
|
|
None
|
|
None
|
|
None
|
|
Total
|
|
12,835,269
|
|
$
|
1.28
|
|
3,198,436
|
|
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STOCK PRICE PERFORMANCE GRAPH
The following graph provides
a comparison over the five-year period ended December 31, 2008 of the
cumulative total stockholder return from a $100 investment in the Companys
common stock with the Center for Research in Securities Prices Total Return
Index for Nasdaq Medical Devices, Instruments and Supplies, Manufacturers and
Distributors Stocks (the Nasdaq Medical Devices Index), the CRSP Total Return
Index for Nasdaq Pharmaceutical Stocks (the Nasdaq Pharmaceutical Index) and
the CRSP Total Return Index for the Nasdaq Stock Market (U.S. and Foreign) (the
Nasdaq U.S. & Foreign Index).
Comparison of Cumulative Total Return Among Heska
Corporation,
the Nasdaq Medical
Devices Index, the Nasdaq Pharmaceutical Index and the Nasdaq U.S. and
Foreign Index
25
Table
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Item
6. Selected Consolidated Financial Data.
The following consolidated
statement of operations and consolidated balance sheet data have been derived
from our consolidated financial statements.
The information set forth below is not necessarily indicative of the
results of future operations and should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of Operations and
the Consolidated Financial Statements and related Notes included as Items 7 and
8 in this Form 10-K.
|
|
Year Ended December 31,
|
|
|
|
2004
|
|
2005
|
|
2006
|
|
2007
|
|
2008
|
|
|
|
(in thousands, except per share amounts)
|
|
Consolidated
Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
Products, net of
sales returns and allowances
|
|
$
|
65,687
|
|
$
|
67,549
|
|
$
|
71,815
|
|
$
|
80,807
|
|
$
|
80,331
|
|
Research,
development and other
|
|
2,004
|
|
1,888
|
|
3,245
|
|
1,528
|
|
1,322
|
|
Total revenue
|
|
67,691
|
|
69,437
|
|
75,060
|
|
82,335
|
|
81,653
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products
sold
|
|
42,253
|
|
42,515
|
|
43,000
|
|
48,874
|
|
52,478
|
|
Cost of
research, development and other
|
|
729
|
|
1,095
|
|
1,414
|
|
274
|
|
331
|
|
Total cost of
revenue
|
|
42,982
|
|
43,610
|
|
44,414
|
|
49,148
|
|
52,809
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
24,709
|
|
25,827
|
|
30,646
|
|
33,187
|
|
28,844
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
Selling and
marketing
|
|
15,616
|
|
14,020
|
|
14,356
|
|
16,109
|
|
17,640
|
|
Research and
development
|
|
5,891
|
|
3,749
|
|
3,483
|
|
2,679
|
|
1,951
|
|
General and
administrative
|
|
7,442
|
|
7,187
|
|
9,887
|
|
8,925
|
|
8,917
|
|
Restructuring
expenses
|
|
|
|
|
|
|
|
|
|
785
|
|
Other
|
|
|
|
|
|
(155
|
)
|
(47
|
)
|
232
|
|
Total operating
expenses
|
|
28,949
|
|
24,956
|
|
27,571
|
|
27,666
|
|
29,525
|
|
Income (loss)
from operations
|
|
(4,240
|
)
|
871
|
|
3,075
|
|
5,521
|
|
(681
|
)
|
Interest and
other expense, net
|
|
575
|
|
774
|
|
1,041
|
|
588
|
|
640
|
|
Income (loss)
before income taxes
|
|
(4,815
|
)
|
97
|
|
2,034
|
|
4,933
|
|
(1,321
|
)
|
Income tax
expense (benefit)
|
|
|
|
(185
|
)
|
206
|
|
(29,875
|
)
|
(471
|
)
|
Net income
(loss)
|
|
$
|
(4,815
|
)
|
$
|
282
|
|
$
|
1,828
|
|
$
|
34,808
|
|
$
|
(850
|
)
|
Basic net income
(loss) per share
|
|
$
|
(0.10
|
)
|
$
|
0.01
|
|
$
|
0.04
|
|
$
|
0.68
|
|
$
|
(0.02
|
)
|
Diluted net
income (loss) per share
|
|
$
|
(0.10
|
)
|
$
|
0.01
|
|
$
|
0.03
|
|
$
|
0.63
|
|
$
|
(0.02
|
)
|
Shares used for basic
net income (loss) per share
|
|
49,029
|
|
49,650
|
|
50,347
|
|
51,097
|
|
51,674
|
|
Shares used for
diluted net income (loss) per share
|
|
49,029
|
|
50,438
|
|
52,932
|
|
55,509
|
|
51,674
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents
|
|
$
|
4,982
|
|
$
|
5,231
|
|
$
|
5,275
|
|
$
|
5,524
|
|
$
|
4,705
|
|
Total current
assets
|
|
28,442
|
|
26,845
|
|
30,652
|
|
35,127
|
|
31,290
|
|
Total assets
|
|
38,724
|
|
36,784
|
|
38,495
|
|
75,591
|
|
70,438
|
|
Line of credit
|
|
10,375
|
|
9,453
|
|
8,022
|
|
12,614
|
|
11,042
|
|
Current portion
of long-term debt and capital leases
|
|
302
|
|
1,263
|
|
1,275
|
|
776
|
|
770
|
|
Total current
liabilities
|
|
23,269
|
|
20,722
|
|
21,980
|
|
25,195
|
|
22,228
|
|
Long-term debt
and capital leases
|
|
1,466
|
|
2,703
|
|
1,927
|
|
1,151
|
|
381
|
|
Long-term
deferred revenue and other
|
|
11,410
|
|
10,126
|
|
7,840
|
|
6,362
|
|
5,306
|
|
Total
stockholders equity
|
|
2,579
|
|
3,233
|
|
6,748
|
|
42,883
|
|
42,523
|
|
26
Table
of Contents
Item
7. Managements Discussion and Analysis
of Financial Condition and Results of Operations.
The following discussion and
analysis of our financial condition and results of operations should be read in
conjunction with Selected Consolidated Financial Data and the Consolidated
Financial Statements and related Notes included in Items 6 and 8 of this Form 10-K.
This discussion contains
forward-looking statements that involve risks and uncertainties. Such statements, which include statements
concerning future revenue sources and concentration, gross 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-K,
particularly in 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-K are as of March 16, 2009, and we undertake no duty to
update this information.
Overview
We develop, manufacture,
market, sell and support veterinary products.
Our business is comprised of two reportable segments, Core Companion
Animal Health, which represented 83% of 2008 product revenue, and Other
Vaccines, Pharmaceuticals and Products which represented 17% of 2008 product
revenue.
The Core Companion Animal
Health segment (CCA) includes diagnostic and other instruments and supplies
as well as single use diagnostic and other tests, pharmaceuticals and vaccines,
primarily for canine and feline use.
Diagnostic and other
instruments and supplies represented approximately 48% of our 2008 product revenue. Many products in this area involve placing an
instrument with a customer and generating future revenue from consumables,
including items such as supplies and service, as that instrument is used. Approximately 34% of our 2008 product revenue
resulted from the sale of such consumables to an installed base of instruments
and approximately 14% of our product revenue was from new hardware sales. A loss of or disruption in supply of
consumables we are selling to an installed base of instruments could substantially
harm our business. All products in this
area 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
handheld blood analysis instrument, our chemistry instrument and our hematology
instrument and their affiliated operating consumables. Revenue from products in these three areas,
including revenue from consumables, represented approximately 44% of our 2008
product revenue.
Single use diagnostic and
other tests, pharmaceuticals and vaccines and other products represented
approximately 35% of our 2008 product revenue.
Since items in this area are single use by their nature, our 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 in this area include our heartworm diagnostic tests, our
heartworm preventive, our allergy test kits, our allergy immunotherapy and our
allergy diagnostic tests. Combined
revenue from heartworm-related products and allergy-related products
represented approximately 32% of 2008 product revenue.
We consider the Core
Companion Animal Health 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 are in the Core Companion
Animal
27
Table
of Contents
Health segment. The majority of our research and development
spending is dedicated to this segment, as well.
All our Core Companion
Animal Health products predominately are sold to or through veterinarians
ultimately. In many cases, veterinarians
will mark up their costs to the end user.
The acceptance of our products by veterinarians is critical to our
success. Core Companion Animal Health
products are sold directly by us as well as through independent third-party
distributors and other distribution relationships, such as our corporate
agreement with SPAH and the sale of kits to conduct blood testing to
third-party veterinary diagnostic laboratories.
Revenue from direct sales, independent third-party distributors and
other distribution relationships represented approximately 51%, 29% and 20% of
Core Companion Animal Health 2008 product revenue, respectively.
Independent third-party
distributors may be effective in increasing sales of our products to
veterinarians, although we would expect a corresponding lower gross margin as
such distributors typically buy products from us at a discount to end user
prices. To be effective when working
with an independent third-party distributor, the distributor must agree to
market and/or sell our products and we must provide proper economic incentives
to the distributor as well as contend effectively for the distributors time
and focus given other products the distributor may be carrying, potentially
including those of our competitors. We
believe that one of our largest competitors, IDEXX, in effect prohibits its
distributors from selling competitive products, including our diagnostic
instruments and heartworm diagnostic tests.
We believe the IDEXX restrictions limit our ability to engage national
distributors to sell our full distribution line of products.
We intend to return to and
sustain profitability through a combination of revenue growth, gross margin
improvement and expense control.
Accordingly, we closely monitor product revenue growth trends in our
Core Companion Animal Health segment.
Product revenue in this segment grew 2% in 2008 as compared to 2007 and
has grown at a compounded annual growth rate of 16% since 1998, our first full
year as a public company.
The Other Vaccines,
Pharmaceuticals and Products segment (OVP) includes our 168,000 square foot
USDA- and FDA-licensed production facility in Des Moines, Iowa. We view this facility as a strategic asset
which will allow us to control our cost of goods on any vaccines and
pharmaceuticals that we may commercialize in the future. We are increasingly integrating this facility
with our operations elsewhere. For
example, virtually all our U.S. inventory is now stored at this facility and
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 Core Companion Animal Health segment.
Our OVP segment includes
private label vaccine and pharmaceutical production, primarily for cattle but
also for other animals such as small mammals.
All OVP products are sold by third parties under third party labels.
We have developed our own
line of bovine vaccines that are licensed by the USDA. We have a long-term agreement with a
distributor, Agri Laboratories, Ltd., (AgriLabs), for the marketing and sale
of certain of these vaccines which are sold primarily under the Titanium® and
MasterGuard® brands which are registered trademarks of AgriLabs. This agreement generates a significant
portion of our OVP segments revenue.
AgriLabs has the exclusive right to sell the aforementioned bovine
vaccines in the United States, Africa and Mexico until December 2009. Our OVP segment also produces vaccines and
pharmaceuticals for other third parties.
28
Table of Contents
Additionally, we generate
non-product revenues from licensing of technology, royalties and sponsored
research and development projects for third parties. We perform these sponsored research and
development projects for both companion animal and livestock product purposes.
Critical
Accounting Policies and Estimates
Our discussion and analysis
of our 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 expense during the periods. These estimates are based on historical
experience and various other assumptions that we believe to be reasonable under
the circumstances. We have identified
those critical accounting policies used in reporting our financial position and
results of operations based upon a consideration of those accounting policies
that involve the most complex or subjective decisions or assessment. We consider the following to be our critical
policies.
Revenue
Recognition
We
generate our revenue through the sale of products, licensing of technology product
rights, royalties and sponsored research and development. 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 recognized after both the goods are shipped to the
customer and acceptance has been received, if required, with an appropriate
provision for estimated returns and allowances.
We do not permit general returns of products sold. Certain of our products have expiration
dates. Our policy is to exchange certain
outdated, expired product with the same product. We record an accrual for the estimated cost
of replacing the expired product expected to be returned in the future, based
on our historical experience, adjusted for any known factors that reasonably
could be expected to change historical patterns, such as regulatory actions
which allow us to extend the shelf life of our products. Revenue from both direct sales to
veterinarians and sales to independent third-party distributors are generally
recognized when goods are shipped. Our
products are shipped complete and ready to use by the customer. 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. We reduce our product revenue by the
estimated cost of any rebates, allowances or similar programs, which are used
as promotional programs.
Recording
revenue from the sale of products involves the use of estimates and management
judgment. We must make a determination
at the time of sale whether the customer has the ability to make payments in
accordance with arrangements. While we
do utilize past payment history, and, to the extent available for new
customers, public credit information in making our assessment, the
determination of whether collectibility is reasonably assured is ultimately a
judgment decision that must be made by management. We must also make estimates regarding our
future obligation relating to returns, rebates, allowances and similar other
programs.
29
Table
of Contents
License
revenue under arrangements to sell or license product rights or technology
rights is recognized as obligations under the agreement are satisfied, which
generally occurs over a period of time.
Generally, licensing revenue is deferred and recognized over the
estimated life of the related agreements, products, patents or technology. Nonrefundable licensing fees, marketing
rights and milestone payments received under contractual arrangements are deferred
and recognized over the remaining contractual term using the straight-line
method. Revenue from licensing
technology and product rights is reported in our research, development and
other revenue line item. An example of
the former, i.e. licensing technology, is a patent we own under which we grant
a third-party exclusive rights to the human healthcare market for the life of
the patent in exchange for an upfront payment and royalty payments on sales of
any product based on the patent. The
upfront payment will be amortized over the life of the patent and reported
along with any affiliated royalty payments in our research, development and
other revenue line item. An example of
the latter, i.e. product rights, is our July 2002 agreement to license
Intervet Inc. certain rights to patents, trademarks and know-how for our Flu
AVERT I.N. equine influenza vaccine, the worlds first intranasal influenza
vaccine for horses. As we had no further
rights to manufacture, market or sell this vaccine without Intervet Inc.s
permission under this agreement, we are reporting the amortization of the
upfront payment we received in this agreement along with any affiliated royalty
payments in our research, development and other revenue line item. The upfront payment is being amortized over
the estimated life of the product.
Recording
revenue from license arrangements involves the use of estimates. The primary estimate made by management is
determining the useful life of the related agreement, product, patent or
technology. We evaluate all of our
licensing arrangements by estimating the useful life of either the product or
the technology, the length of the agreement or the legal patent life and defer
the revenue for recognition over the appropriate period.
Occasionally
we enter into arrangements that include multiple elements. Such arrangements may include the licensing
of technology and manufacturing of product.
In these situations we must determine whether the various elements meet
the criteria to be accounted for as separate elements. If the elements cannot be separated, revenue
is recognized once revenue recognition criteria for the entire arrangement have
been met or over the period that our obligations to the customer are fulfilled,
as appropriate. If the elements are
determined to be separable, the revenue is allocated to the separate elements
based on relative fair value and recognized separately for each element when
the applicable revenue recognition criteria have been met. In accounting for these multiple element
arrangements, we must make determinations about whether elements can be
accounted for separately and make estimates regarding their relative fair
values.
Allowance for Doubtful Accounts
We
maintain an allowance for doubtful accounts receivable based on client-specific
allowances, as well as a general allowance.
Specific allowances are maintained for clients which are determined to
have a high degree of collectibility risk based on such factors, among others,
as: (i) the aging of the accounts receivable balance; (ii) the clients
past payment experience; (iii) a deterioration in the clients financial
condition, evidenced by weak financial condition and/or continued poor
operating results, reduced credit ratings, and/or a bankruptcy filing. In addition to the specific allowance, the
Company maintains a general allowance for credit risk in its accounts
receivable which is not covered by a specific allowance. The general allowance is established based on
such factors, among others, as: (i) the total balance of the outstanding
accounts receivable, including considerations of the aging categories of those
accounts receivable; (ii) past history of uncollectible accounts
receivable write-offs; and (iii) the overall creditworthiness of the
client base. A considerable amount of
judgment is required in assessing the realizability of accounts
receivable. Should any of the factors
considered in determining the adequacy of the
30
Table
of Contents
overall
allowance change, an adjustment to the provision for doubtful accounts
receivable may be necessary.
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 of an inventory item is
less than its recorded value. We review
the carrying cost of our inventories by product each quarter to determine the
adequacy of our reserves for obsolescence.
In accounting for inventories we must make estimates regarding the
estimated net realizable value of our inventory. This estimate is based, in part, on our
forecasts of future sales and shelf life of product.
Capitalized Patent Costs
In
the year ended December 31, 2006, we deferred and capitalized certain
costs, including payments to third-party law firms for patent prosecution to
expand the scope of our patents, related to the technology or patents
underlying a variety of long-term licensing agreements. We owned a portfolio of patents not then
utilized in our product development or manufacture. Several entities paid upfront licensing fees
to utilize the technology supported by these patents in their own product development
and commercialization efforts. Because
we believed that we had an obligation to protect the underlying patents, we
deferred the revenue associated with these long-term agreements and the direct
and incremental costs of prosecuting the patents that supported the
agreements. We use the term patent
prosecution in this context in the narrow sense often used by intellectual
property professionals to describe activities where we seek to expand the
scope of existing patents such as geographically, where we may look to expand
patent protection into new countries, or for broader applications, such as for
newly contemplated uses or expanded claim breadth coverage of the technology
defined by those licensing our technology within existing geographies. A situation where a third party has violated
our intellectual property rights by using our patented technology without
permission and we have filed a corresponding lawsuit would not meet this
definition of patent prosecution and we would therefore expense the
corresponding legal expenses as incurred.
In accordance with SFAS No. 95, paragraph 17(c), we classified
patent prosecution expenditures which were capitalized as cash used for
investing activities since, like a capital expenditure to improve a building or
add a piece of equipment, the cost is a necessary investment into a productive
asset to maintain our future revenue process.
No internal costs were capitalized. These capitalized costs were
amortized over the same period as the licensing revenue related to those
patents was recognized. Costs in excess of the amount of remaining
related deferred licensing revenue were not capitalized, but expensed as
incurred. We capitalized approximately
$292 thousand for the year ended December 31, 2006 and amortized
approximately $334 thousand for the same period. In December 2006, we sold all patents
for which we had capitalized patent costs and, accordingly, we have no
capitalized patent costs on our balance sheet as of December 31, 2008,
2007 and 2006. We do not expect to
capitalize any patent costs in the future.
31
Table
of Contents
Deferred Tax Assets Valuation Allowance
Our
deferred tax assets, such as a net operating loss carryforward (NOL), are
reduced by an offsetting valuation allowance based on judgmental assessment of
available evidence if we are unable to conclude that it is more likely than not
that some or all of the related deferred tax assets will be realized. If we are able to conclude it is more likely
than not that we will realize a future benefit from a deferred tax asset, we
will reduce the related valuation allowance by an amount equal to the estimated
quantity of income taxes we would pay in cash if we were not to utilize the
deferred tax asset in the future. The
first time this occurs in a given jurisdiction, it will result in a net
deferred tax asset on our balance sheet and an income tax benefit of equal magnitude
in our statement of operations at the time we make the determination. In future periods, we will then recognize as
income tax expense the estimated quantity of income taxes we would have paid in
cash had we not utilized the related deferred tax asset. The corresponding journal entry will be a
reduction of our deferred tax asset. If
there is a change regarding our tax position in the future, we will make a
corresponding adjustment to the related valuation allowance.
Results of
Operations
The following table
summarizes our results of operations for the three most recent fiscal years:
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
|
|
(in thousands except per share amounts)
|
|
Consolidated
Statement of Operations Data:
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
Product revenue,
net:
|
|
|
|
|
|
|
|
Core companion
animal health
|
|
$
|
59,936
|
|
$
|
65,910
|
|
$
|
67,021
|
|
Other vaccines,
pharmaceuticals and products
|
|
11,879
|
|
14,897
|
|
13,310
|
|
Total product
revenue, net
|
|
71,815
|
|
80,807
|
|
80,331
|
|
Research,
development and other
|
|
3,245
|
|
1,528
|
|
1,322
|
|
Total revenue,
net
|
|
75,060
|
|
82,335
|
|
81,653
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
Cost of products
sold
|
|
43,000
|
|
48,874
|
|
52,478
|
|
Cost of
research, development and other
|
|
1,414
|
|
274
|
|
331
|
|
Total cost of
revenue
|
|
44,414
|
|
49,148
|
|
52,809
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
30,646
|
|
33,187
|
|
28,844
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
Selling and
marketing
|
|
14,356
|
|
16,109
|
|
17,640
|
|
Research and
development
|
|
3,483
|
|
2,679
|
|
1,951
|
|
General and
administrative
|
|
9,887
|
|
8,925
|
|
8,917
|
|
Restructuring
expenses
|
|
|
|
|
|
785
|
|
Other
|
|
(155
|
)
|
(47
|
)
|
232
|
|
Total operating
expenses
|
|
27,571
|
|
27,666
|
|
29,525
|
|
Income (loss)
from operations
|
|
3,075
|
|
5,521
|
|
(681
|
)
|
Interest and
other expense, net
|
|
1,041
|
|
588
|
|
640
|
|
Income (loss)
before income taxes
|
|
2,034
|
|
4,933
|
|
(1,321
|
)
|
Income tax
expense (benefit)
|
|
206
|
|
(29,875
|
)
|
(471
|
)
|
Net income (loss)
|
|
$
|
1,828
|
|
$
|
34,808
|
|
$
|
(850
|
)
|
Basic net income
(loss) per share
|
|
$
|
0.04
|
|
$
|
0.68
|
|
$
|
(0.02
|
)
|
Diluted net
income (loss) per share
|
|
$
|
0.03
|
|
$
|
0.63
|
|
$
|
(0.02
|
)
|
32
Table
of Contents
Revenue
Total revenue, which
includes product revenue, research and development and other revenue, decreased
1% to $81.7 million in 2008 compared to $82.3 million in 2007. Total revenue for 2007 increased 10% to $82.3
million from $75.1 million in 2006.
Product revenue decreased 1% to $80.3 million in 2008 compared to $80.8
million in 2007. Product revenue
increased 13% to $80.8 million in 2007 compared to $71.8 million in 2006.
Core Companion Animal Health
segment product revenue increased 2% to $67.0 million in 2008 compared to
$65.9 million in 2007. Key factors in
the increase were greater sales of our chemistry instrument, which was launched
in November 2007, our instrument consumables and our heartworm diagnostic
tests, somewhat offset by lower sales of our handheld blood analysis
instruments and our heartworm preventive, both internationally and
domestically.
2007 product revenue from
our Core Companion Animal Health segment increased 10% to $65.9 million
compared to $59.9 million in 2006. Key
factors in the increase were higher sales of our instrument consumables, our
hematology instruments, our handheld blood analysis instruments, our IV pumps,
international sales of our heartworm preventive, our microalbumin laboratory
packs and our allergy diagnostic kits.
Other Vaccines,
Pharmaceuticals and Products segment (OVP) product revenue decreased 11% to
$13.3 million in 2008 compared to $14.9 million in 2007. The largest factor in the decrease was
approximately $1.6 million in revenue (the United Revenue) recognized in 2007
upon receipt of a payment for product previously shipped and take or pay
minimums for 2005 and 2006 which previously had not been paid as part of a now
settled dispute with United Vaccines, Inc. (UV), a former customer. As UV had ceased operations, we did not
generate any corresponding revenue from UV in 2008, nor do we expect to generate
any revenue from UV in the future. This
decrease was somewhat offset by an increase in sales of bovine vaccines under
our contract with AgriLabs.
2007 product revenue from
OVP increased 25% to $14.9 million compared to $11.9 million in 2006. Key factors in the increase were greater
sales of fish vaccines, the United Revenue and an increase in sales of bovine
vaccines under our contract with AgriLabs.
Decreases in sales of our bulk bovine biologicals and our equine
influenza vaccine somewhat offset increased sales in other areas. We licensed Intervet Inc. exclusive rights to
our equine influenza vaccine in July 2002, and our last shipment of this
product prior to Intervet Inc. producing the product themselves occurred in the
third quarter of 2006.
Revenue from research and
development and other revenue decreased by 13% to $1.3 million in 2008 from
$1.5 million in 2007. The primary factor
in the decrease was $250 thousand in revenue recognized from a service contract
in 2007, with no corresponding revenue recognized in 2008 as the service
contract was completed in 2007. The
service contract was related to a worldwide patent portfolio covering a number
of major allergens and the genes that encode them (the Allergopharma Portfolio)
and was with the buyer of the Allergopharma Portfolio, which we sold in December 2006.
Revenue from research and
development and other revenue decreased by 53% to $1.5 million in 2007 from
$3.2 million in 2006. The decrease
is primarily due to revenue from the acceleration of approximately
$1.5 million in previously deferred licensing fees recognized upon
completion of the sale of the Allergopharma Portfolio in December 2006,
with no corresponding revenue recognized in 2007.
We expect total revenue to
decline slightly when compared to 2008.
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Cost of Revenue
Cost of revenue consists of
two components: 1) cost of products sold and 2) cost of research, development
and other revenue, both of which correspond to their respective revenue
categories. Cost of revenue totaled $52.8 million for the twelve
months ended December 31, 2008, a 7% increase as compared to $49.1 million
for the corresponding period in 2007. Gross profit decreased 13% to $28.8
million for 2008 as compared to $33.2 million in 2007. Gross Margin,
i.e. gross profit divided by total revenue, decreased to 35.3% for 2008 as
compared to 40.3% in 2007. Cost of revenue totaled $49.1 million for
2007, an 11% increase as compared to $44.4 million for 2006. Gross profit
increased 8% to $33.2 million for 2007 as compared to $30.6 million in
2006. Gross Margin decreased to 40.3% for 2007 as compared to 40.8% in
2006.
Cost of products sold
increased 7% to $52.5 million in the twelve months ended December 31, 2008
from $48.9 million in 2007. Gross profit on product revenue
decreased 13% to $27.9 million for 2008 from $31.9 million in the prior
year. Product Gross Margin, i.e. gross profit on product revenue divided
by product revenue, decreased to 34.7% in 2008 as compared to 39.5% in
2007. The largest factor in the decrease was recognition of the United
Revenue in 2007 for which the affiliated Cost of products sold had been
recognized in prior periods and for which no corresponding revenue or gross
profit was recognized in 2008. In
addition, product mix and increased reserves taken against inventory we expect
to expire prior to sale, primarily related to consumables for our new chemistry
instrument and our handheld diagnostic instruments, were factors in the
decrease. Cost of products sold
increased 14% to $48.9 million in 2007 as compared to $43.0 million in
2006. Gross profit on product revenue increased 11% to $31.9 million
for 2007 from $28.8 million in 2006. Product Gross Margin decreased to
39.5% in 2007 as compared to 40.1% in 2006. Product mix was a key factor
in the decrease, including sales of our diagnostic instruments, which
represented a larger share of overall sales than in 2006. Our diagnostic instruments tend to be
relatively lower margin sales and certain instruments experienced lower gross
margins in 2007 than in 2006 due to aggressive sales and marketing programs in
2007. This was somewhat offset by recognition
of the United Revenue for which the affiliated cost of products sold had been
recognized in prior periods.
Cost of research,
development and other revenue increased 21% to $331 thousand in the twelve
months ended December 31, 2008 as compared to $274 thousand in 2007.
Gross profit on research, development and other revenue decreased 21% to $1.0
million for 2008 from $1.3 million in 2007. Other Gross Margin, i.e.
gross profit on research, development and other revenue divided by research,
development and other revenue, decreased to 75.0% for 2008 as compared to 82.1%
in 2007. A factor in the decline was lower margins on sponsored research
and development revenue. Cost of
research, development and other revenue decreased 81% to $274 thousand in 2007
as compared to $1.4 million in 2006. Gross profit on research,
development and other revenue decreased 32% to $1.3 million for the twelve
months ended December 31, 2007 from $1.8 million in 2006. Other
Gross Margin increased to 82.1% for 2007 as compared to 56.4% in 2006.
The primary reason for the increase in gross margin was revenue related to the
Allergopharma Portfolio from deferred licensing fees for which a corresponding
capitalized patent cost was amortized, which occurred in 2006, but not in
2007. This was somewhat offset by the
acceleration of certain previously deferred upfront licensing fees which were
recognized in 2006 due to the sale of the Allergopharma Portfolio in December 2006.
We expect Gross Margin to be
flat or down slightly for 2009 as compared to 2008.
Operating Expenses
Selling and marketing
expenses increased by 10% to $17.6 million in 2008 compared to
$16.1 million in 2007. Key factors
in the change were an increase in personnel and increased expenditures on
market research. Selling and marketing
expenses increased by 12% to $16.1 million in 2007 as compared to
$14.4 million in 2006. A key factor
in the increase was cost related to new product launches.
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Research and development
expenses decreased by $728 thousand to $2.0 million in 2008 from
$2.7 million in 2007. A key factor
in the change was less space at our corporate headquarters being used for
research and development activities. In
late 2007, we implemented a plan to move and expand space for certain
activities within our corporate headquarters, which reduced the space dedicated
to research and development activities. Research
and development expenses decreased by $804 thousand to $2.7 million in
2007 from $3.5 million in 2006. A factor
in the decline was a decrease in accrued expenses related to our Management
Incentive Program (MIP) recognized in 2007 as compared to 2006.
General and administrative
expenses were $8.9 million in 2008, a slight decrease as compared to 2007. A factor in the decline was no MIP payouts
were earned in 2008 while there was some corresponding MIP payout earned in
2007. General and administrative
expenses decreased by 10% to $8.9 million in 2007 from $9.9 million in
2006. Key factors in the decline were
lower incentive compensation, including compensation related to our MIP, in
2007 as compared to 2006, and lower legal fees, primarily related to our
litigation with UV in 2006.
In 2008, we recorded
restructuring expenses of approximately $785 thousand, consisting of
approximately $621 thousand related primarily to personnel severance and other
costs for certain individuals affected by our restructuring in December 2008
and $164 thousand related to inventory of discontinued products, including a
monitoring product the manufacturer has informed us it no longer intends to
support. We recorded no restructuring
expenses in 2007 or 2006.
Other operating expenses of
approximately $232 thousand in 2008 relate to an asset impairment charge
related to certain rental instruments we own.
In 2007, we recognized a gain of approximately $47 thousand on the
sale of certain patents we held net of costs on this line. In 2006, we recognized a gain of
approximately $155 thousand on the sale of the Allergopharma Portfolio on this
line. The gain is equal to the sales
price less the net book value of the Allergopharma Portfolio, which included
all of our unamortized capitalized patent costs.
We expect 2009 operating
expenses will be lower than in 2008, primarily as a result of our restructuring
at the end of 2008.
Interest and Other Expense, Net
Interest and other expense,
net was $640 thousand in 2008, as compared to $588 thousand in 2007 and $1.0
million in 2006. This line item includes
interest expense, interest income and foreign currency gains and losses. The largest factor in the increase in 2008 as
compared to 2007 was greater borrowings under our revolving line of credit with
Wells Fargo, somewhat offset by lower market interest rates. The largest factor in the decrease from 2006
to 2007 was lower borrowings under our credit and security agreement with Wells
Fargo along with the fact that we repaid $500 thousand in subordinated debt in May 2007. Another factor was lower interest rate
spreads to Prime on our borrowings with Wells Fargo resulting from our
achievement of negotiated milestones.
We expect interest and other
expense, net to decrease in 2009 as compared to 2008 based on lower market
interest rates and lower average borrowings, somewhat offset by an increase in
our interest rate spread.
Income Tax Expense (Benefit)
In general, income tax
expense (or benefit) can be broken into two categories: current and
deferred. Valuation allowance
adjustments and net operating loss usage have been components of deferred
income tax expense (benefit) in all years presented.
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Current income tax expense
generally consists of taxes payable on tax returns for a given year. These primarily relate to domestic federal
alternative minimum tax payments required, although state taxes are also
included in this category. We have
typically not had to pay much in cash taxes when we have generated taxable
income due to our NOL in Switzerland and in the United States.
A valuation allowance
adjustment is due to a change in circumstances that causes a change in judgment
about the realizability of the related deferred tax asset in future years. Based on the profitable operating performance
of our subsidiary in Switzerland, in the fourth quarter of 2005 we concluded
that our NOL in Switzerland was realizable on a more-likely-than-not
basis. We reduced the related valuation
allowance in the fourth quarter of 2005.
This resulted in a net deferred tax asset equal to the estimated
quantity of income taxes we would have recognized in our future statements of
operations as income tax expense that we would not have to actually pay in cash
assuming our estimate of our NOL usage in Switzerland was exactly correct.
We subsequently obtained
agreements from the tax authorities in the canton of Fribourg (the Tax
Agreements) regarding the determination of our taxable income which reduced
our taxable income in Switzerland in 2005 and 2006 from previous estimates for
financial reporting purposes and we expected to reduce our taxable income, and
thus our tax obligation, in future years as compared to prior
expectations. Given our corresponding
lower income expectations in Switzerland, we no longer believed we would
utilize all of our NOL in Switzerland before it was scheduled to expire at the
end of 2008. Accordingly, we reduced our
net deferred tax asset related to this NOL via an increase in the related
valuation allowance which is reported as a valuation allowance adjustment
income tax expense of $69 thousand in the fourth quarter of 2006. We did not generate sufficient taxable income
in 2008 to fully utilize our Swiss net deferred tax asset, which expired at the
end of 2008, and made an associated reduction in the deferred tax asset and
recorded a corresponding income tax expense journal entry of $10 thousand in
the fourth quarter of 2008.
Net operating loss usage
represents the tax we would have paid had we not had an NOL in a given
jurisdiction, but did not pay. We had
net operating loss usage in Switzerland of $32 thousand, $17 thousand and $79
thousand in 2008, 2007 and 2006, respectively.
The amount decreased from 2006 to 2007 due to the Tax Agreements. The amount increased from 2007 to 2008 due to
the expiration of a tax holiday from canton, municipal and church income
taxes in the canton of Fribourg in August 2007.
In the fourth quarter of
2007, based on the Companys profitable domestic operating performance, we
concluded that a portion of our domestic deferred tax assets, which primarily
consist of our domestic NOL, was realizable on a more-likely-than-not basis and
the related valuation allowance was, resulting in an income tax benefit of $30
million, reported as a valuation allowance adjustment income tax benefit. This resulted in a net deferred tax asset of
$30 million for our domestic deferred tax assets.
In 2008, domestic deferred
income tax benefits related to our loss before income taxes was the primary
reason we recorded a $471 thousand income tax benefit. In 2007, the $30 million valuation allowance
adjustment related to our domestic NOL discussed above was the primary reason
for the $29.9 million income tax benefit recorded. In 2006, deferred tax expenses discussed
above related to our Swiss subsidiary were the primary components of $206
thousand in income tax expense.
In 2009, we expect current
income tax expense as compared to an income tax benefit in 2008 as we expect to
generate income before income taxes as opposed to the loss before income taxes
we experienced in 2008.
36
Table
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or benefit in 2009 and
expect to record valuation allowance adjustment income tax expense or benefit
infrequently, if at all, in future years.
Net Income (Loss)
Our 2008 net loss was $850
thousand as compared to net income of $34.8 million in 2007 and
$1.8 million in 2006. The decline in 2008 as compared to 2007 was
due to the large valuation allowance adjustment related to our domestic NOL
recognized in 2007, but not 2008. Lower
total revenue, lower Gross Margin and higher operating expenses for 2008 as
compared to 2007 also contributed to the change. A large valuation allowance income tax
benefit was the primary reason for the increase from 2006 to 2007, although
increased revenue also contributed to the improvement.
In 2009, we expect to generate net income as opposed
to the net loss we reported in 2008, primarily as a result of lower operating
expenses.
Liquidity,
Capital Resources and Financial Condition
We have incurred net
cumulative negative cash flow from operations since inception in 1988. For the year ended December 31, 2008, we
had total revenue of $81.7 million and net loss of $850 thousand. In 2008, net cash provided by operations was $1.7
million. At December 31, 2008, we
had $4.7 million of cash and cash equivalents, working capital of $9.1 million,
$11.0 million of outstanding borrowings under our revolving line of credit,
discussed below, and $1.2 million of other debt and capital leases.
Net cash flows from
operating activities provided cash of $1.7 million in 2008 as compared to using
cash of $1.7 million in 2007 and providing cash of $1.1 million in 2006. The major factors in the improvement in 2008
versus 2007 were a $7.4 million improvement in cash provided by inventory as we
lowered our inventory levels at year end 2008 compared to year end 2007, a $1.9
million improvement in cash provided by accrued liabilities and other related
items primarily due to a relatively large cash payout for our 2006 MIP in early
2007, a $1.2 million improvement in cash provided by accounts receivable
primarily due to lower fourth quarter sales and $1.1 million greater
depreciation and amortization primarily related to full versus partial year
depreciation on rental instruments we capitalized in 2007. This was somewhat offset by a $35.7 million
decrease in net income, partially mitigated by a $29.4 million decrease in
deferred tax benefit primarily due to the $30 million valuation allowance
adjustment related to our domestic NOL recorded in 2007, as well as a $2.6
million increase in cash used for accounts payable which primarily relates to
lower inventory received but not paid for at year end 2008 as compared to 2007. The major factors in the use of cash in 2007
as compared to providing cash of $1.1 million in 2006 were an increase in cash
used for inventories of $5.4 million due primarily to the non-cash transfer of
inventory to property and equipment related to 2007 rental programs on certain
of our diagnostic instruments as well as greater overall inventory levels,
decreases in cash provided from accrued liabilities and other related items of
$3.7 million primarily due to decreases in accrued management incentive plan
payouts, somewhat offset by a $33.0 million improvement in our net income
which was mostly offset by a corresponding deferred tax benefit change of $30.1
million, a $2.5 million improvement in cash provided by accounts receivable
resulting from a lower days outstanding accounts receivable balance and a $1.2
million improvement in cash provided by accounts payable related to increased
spending.
Net cash flows from
investing activities used cash of $554 thousand in 2008 as compared to using
cash of $2.3 million in 2007 and providing cash of $159 thousand in 2006. Expenditures for property and equipment
totaled approximately $554 thousand, $2.4 million and $1.2 million in
2008, 2007 and 2006, respectively. The
cash used in 2008 was entirely for purchases of property and equipment, which
decreased from $1.8 million as compared to 2007. A factor in the decrease was the launch of
three major instruments in 2007 for which we capitalized demonstration and
other units, with no corresponding instrument launches in 2008. The cash used in 2007 was entirely for
purchases of property and equipment, which increased from 2006 due to the
purchases of demonstration units for the three new diagnostic instruments we
launched in 2007 and increased purchases related to our Des Moines
manufacturing operations in 2007 as compared to 2006. In 2006, the sale of certain intellectual
property generated cash, after related costs, of approximately
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Table
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$1.6 million which was
slightly larger than approximately $1.5 million in capital expenditures and
capitalized patent costs.
Net cash flows from
financing activities used cash of $2.0 million in 2008 as compared to providing
$4.2 million in 2007 and using $1.4 million in 2006. In 2008 we used cash to reduce our borrowings
under our line of credit by $1.6 million and repay principal on term debt of
$776 thousand which was partially offset by proceeds from the issuance of common
stock upon option exercises and in our Employee Stock Purchase Plan totaling $372
thousand. In 2007, we increased our line
of credit borrowings by $4.6 million and received $851 thousand from the
issuance of common stock upon option exercises and in our Employee Stock
Purchase Plan. These cash inflows were
somewhat offset by the repayment of principal on term debt of
$1.3 million. In 2006, we reduced
our line of credit borrowings by $1.4 million and repaid principal on term debt
of $763 thousand which was somewhat offset by $766 thousand in proceeds from
the issuance of common stock upon option exercises and in our Employee Stock
Purchase Plan. Proceeds from the
issuance of common stock decreased in 2008 as compared to 2007 and 2006
primarily due to lower proceeds from option exercises. We repaid approximately $500 thousand more
term debt in 2007 than in 2008 and 2006 because a $500 thousand term loan from
a customer matured and was repaid in 2007.
At December 31, 2008,
we had a $15.0 million asset-based revolving line of credit with Wells Fargo
which has a maturity date of June 30, 2011. At December 31, 2008, $11.0 million was
outstanding under this line of credit.
Our ability to borrow under this line of credit varies based upon
available cash, eligible accounts receivable and eligible inventory. On December 31, 2008, interest was
charged at a stated rate of prime plus 2.50% and was payable monthly. We are required to comply with various
financial and non-financial covenants, and we have made various representations
and warranties. Among the financial
covenants is a requirement to maintain a minimum liquidity (cash plus excess
borrowing base) of $1.5 million.
Additional requirements include covenants for minimum capital monthly
and minimum net income quarterly.
Failure to comply with any of the covenants, representations or
warranties could result in our being in default on the loan and could cause all
outstanding amounts payable to Wells Fargo, including those discussed below, to
become immediately due and payable or impact our ability to borrow under the
agreement. We were in compliance with
all financial covenants as of December 31, 2008. At December 31, 2008, our remaining
available borrowing capacity based upon eligible accounts receivable and
eligible inventory under our revolving line of credit was approximately
$448 thousand.
At December 31, 2008,
we also had outstanding obligations for long-term debt and capital leases
totaling approximately $1.2 million primarily related to three term loans
with Wells Fargo. One term loan is
secured by real estate in Iowa and had an outstanding balance at December 31,
2008 of approximately $269 thousand due in monthly installments of $17,658
plus interest. The term loan had a
stated interest rate of prime plus 2.50% on December 31, 2008 and is to be
paid in full in April 2010. The
other two term loans are secured by machinery and equipment at our Des Moines,
Iowa and Loveland, Colorado locations (the Equipment Notes). Principal payments on the Equipment Notes of
$46,296 plus interest are due monthly.
The Equipment Notes had a stated interest rate of prime plus 2.50% on December 31,
2008 and are to be paid in full in August 2010. Our capital lease obligations totaled
approximately $2 thousand at December 31, 2008.
At December 31, 2008,
we had deferred revenue and other long term liabilities, net of current
portion, of approximately $5.3 million.
Included in this total is approximately $3.8 million of deferred revenue
related to up-front fees that have been received for certain product rights and
technology rights out-licensed. These
deferred amounts are being recognized on a straight-line basis over the
remaining lives of the agreements, products, patents or technology.
Our primary short-term need
for capital, which is subject to change, is to fund our operations, which
consist of continued sales and marketing, general and administrative and
research and development efforts, working capital associated with increased
product sales and capital expenditures relating to maintaining and
38
Table
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developing our manufacturing
operations. Our future liquidity and
capital requirements will depend on numerous factors, including the extent to
which our marketing and selling efforts, as well as those of third parties who
market, sell and distribute our products, are successful in increasing our
revenue, the extent to which currently planned products and/or technologies
under development are successfully developed and achieve market acceptance,
changes required by us by regulatory bodies to maintain our operations and
other factors.
Our financial plan for 2009
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 through 2009 and into
2010. Our financial plan for 2009 expects
that we will have positive cash flow from operations. However, our actual results may differ from
this plan, and we may be required to consider alternative strategies, such as
further reductions in our personnel costs.
We may be required to raise additional capital in the future. If necessary, we expect to raise these
additional funds through the sale of equity securities or refinancing loans
currently outstanding on assets with historical appraised values significantly
in excess of related 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. 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 through actions such as delaying or canceling
budgeted research activities or marketing plans. These actions would likely extend the then
available cash and cash equivalents, and then available borrowings to some
degree. See Risk Factors in Item 1A of
this Form 10-K for a discussion of some of the factors that affect our capital raising
alternatives.
A summary of our contractual
obligations at December 31, 2008 is shown below:
|
|
Payments Due by Period (in thousands)
|
|
|
|
Total
|
|
Less Than
1 Year
|
|
1-3
Years
|
|
4-5
Years
|
|
After
5 Years
|
|
Contractual
Obligations
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt
|
|
$
|
1,149
|
|
$
|
768
|
|
$
|
381
|
|
$
|
|
|
$
|
|
|
Capital lease
obligations
|
|
2
|
|
2
|
|
|
|
|
|
|
|
Interest
payments on debt
|
|
57
|
|
50
|
|
7
|
|
|
|
|
|
Line of credit
|
|
11,042
|
|
11,042
|
|
|
|
|
|
|
|
Operating leases
|
|
29,829
|
|
2,045
|
|
5,697
|
|
1,869
|
|
20,218
|
|
Unconditional
purchase obligations
|
|
2,741
|
|
2,741
|
|
|
|
|
|
|
|
Total
contractual cash obligations
|
|
$
|
44,820
|
|
$
|
16,648
|
|
$
|
6,085
|
|
$
|
1,869
|
|
$
|
20,218
|
|
In addition to those
agreements considered above where our contractual obligation is fixed, we are
party to commercial agreements which may require us to make milestone payments
under certain circumstances. All
milestone obligations which we believe are likely to be triggered but are not
yet paid are included in Unconditional Purchase Obligations in the table
above. We do not believe other potential
milestone obligations, some of which we consider to be of remote likelihood of
ever being triggered, will have a material impact on our liquidity, capital
resources or financial condition in the foreseeable future.
Net
Operating Loss Carryforwards
As of December 31,
2008, we had a net domestic operating loss carryforward, or NOL, of
approximately
$166.4 million, a domestic alternative minimum tax
credit of approximately $129 thousand and a domestic research and development
tax credit carryforward of approximately $312 thousand. Our NOL is scheduled to expire in various
years beginning in 2010 and ending in 2028, with the majority scheduled to
expire in 2018 or later. The NOL and tax
credit carryforwards are subject to alternative minimum tax limitations and to
examination by the tax authorities. In
addition, we had a change of ownership as defined under the provisions of Section 382
of the Internal Revenue Code of 1986, as amended (an Ownership Change). We believe the latest Ownership Change
occurred at the time of our initial public offering in July 1997.
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We do not believe this
Ownership Change will place a significant restriction on our ability to utilize
our NOLs in the future.
Recent
Accounting Pronouncements
In September 2006, the
Financial Accounting Standards Board issued Statement of Financial Standards No. 157,
Fair Value Measurements (SFAS 157). SFAS
157 defines fair value, establishes a framework for measuring fair value in
accordance with accounting principles generally accepted in the Untied States,
and expands disclosures about fair value measurements. This statement does not require any new fair
value measurements; rather, it applies under other accounting pronouncements
that require or permit fair value measurements.
The provisions of SFAS 157 are effective for fiscal years beginning
after November 15, 2007 (beginning in 2008 for calendar year-end
entities). In February 2008, FSP
157-2 was issued which delayed application of SFAS No. 157 for
non-recurring nonfinancial assets and nonfinancial liabilities, except for
items that are recognized or disclosed at fair value in the financial statements
on a recurring basis (at least annually), until fiscal years beginning after November 15,
2008, and interim periods within those fiscal years (beginning in 2009 for
calendar year-end entities). The
adoption of the provisions of FSP 157-2 for non-recurring nonfinancial assets
and nonfinancial liabilities will impact how those balances are measured, for
example in the case of assessing impairment.
The adoption of SFAS No. 157 related to non-recurring,
non-financial fair value measurements is not expected to have a material
impact on the Companys results of operations or financial position.
In December 2007, the
FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS No. 141(R)). Under SFAS No. 141(R), an entity is
required to recognize the assets acquired, liabilities assumed, contractual
contingencies and contingent consideration at their fair value on the
acquisition date. It further requires
that acquisition-related costs are recognized separately from the acquisition
and expensed as incurred, restructuring costs generally be expensed in periods
subsequent to the acquisition date, and changes in accounting for deferred tax
asset valuation allowances and acquired income tax uncertainties after the
measurement period impact income tax expense.
The adoption of SFAS No.141(R) will change the accounting treatment
for business combinations on a prospective basis beginning in 2009 for calendar
year-end entities. The effects are
presumed to be material to the accounting for future business acquisitions, if any,
and will also increase future income statement volatility upon consummation of
future business acquisitions.
In December 2007, the
FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements an amendment of ARB No. 51 (SFAS No. 160). SFAS No. 160 changes the accounting and
reporting for minority interests, which will be recharacterized as
non-controlling interests and classified as a component of equity. SFAS No. 160 is effective for business
combinations with an acquisition date beginning in the first quarter of fiscal
year 2009. The adoption of SFAS No. 160
is not expected to have an impact on the Companys consolidated financial
statements.
In March 2008, the FASB
issued SFAS No. 161, Disclosure about Derivative Instruments and Hedging
Activities, an amendment of SFAS No. 133, (SFAS 161). SFAS No. 161 changes the disclosure
requirements for derivative instruments and hedging activities. Entities are required to provide enhanced
disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under
Statement 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entitys financial position,
financial performance and cash flows.
SFAS No. 161 is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008
(beginning in 2009 for calendar year-end entities) with early application
encouraged. The adoption of SFAS No. 161
is not expected to have a material impact on the Companys results of
operations or financial position.
40
Table of Contents
Item 7A. Quantitative
and Qu
alitative 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.
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 December 31,
2008, approximately $12.2 million was outstanding on these lines of credit and
other borrowings with a weighted average interest rate of 5.75%. We also had approximately $4.7 million of
cash and cash equivalents at December 31, 2008, the majority of which was
invested in liquid interest bearing accounts.
We had no interest rate hedge transactions in place on December 31,
2008. We completed an interest rate risk
sensitivity analysis based on the above and an assumed one-percentage point
increase/decrease in interest rates. If
market rates increase/decrease by one percentage point, we would experience an
increase/decrease in annual interest expense of approximately $75 thousand
based on our outstanding balances as of December 31, 2008.
Foreign Currency Risk
Our
investment in foreign assets consists primarily of our investment in our
European subsidiary. Foreign currency
risk may impact our results of operations.
In cases where we purchase inventory in one currency and sell
corresponding products in another, our gross margin percentage is typically at
risk based on foreign currency exchange rates.
In addition, in cases where we may be generating operating income in
foreign currencies, the magnitude of such operating income when translated into
U.S. dollars will be at risk based on foreign currency exchange rates. Our agreements with suppliers and customers
vary significantly in regard to the existence and extent of currency adjustment
and other currency risk sharing provisions.
We had no foreign currency hedge transactions in place on December 31,
2008.
We
have a wholly-owned subsidiary in Switzerland which uses the Swiss Franc as its
functional currency. We purchase
inventory in foreign currencies, primarily Japanese Yen and Euros, and sell
corresponding products in U.S. dollars.
We also sell products in foreign currencies, primarily Japanese Yen and
Euros, where our inventory costs are in U.S. dollars. Based on our 2008 results of operations, if
foreign currency exchange rates were to strengthen/weaken by 25% against the
dollar, we would expect a resulting pre-tax loss/gain of approximately $900
thousand.
41
Table of Contents
Item 8. Financial
Statements and Sup
plementary
Data.
HESKA CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
42
Table of Contents
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
The
Board of Directors and Stockholders
Heska
Corporation:
We
have audited the accompanying consolidated balance sheets of Heska Corporation
and its subsidiaries as of December 31, 2007 and 2008, and the related
consolidated statements of operations, stockholders equity and cash flows for
each of the three years in the period ended December 31, 2008. In connection with our audit of these
consolidated financial statements, we also have audited the financial statement
schedule of valuation and qualifying accounts for the years ended December 31,
2006, 2007 and 2008. We also have
audited the Companys internal control over financial reporting based on
criteria established in
Internal
Control-Integrated Framework
issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO Criteria). The
Companys management is responsible for these financial statements and schedule,
for maintaining effective internal control over financial reporting, and for
its assessment of the effectiveness of internal control over financial
reporting included in the accompanying managements report. Our
responsibility is to express an opinion on these financial statements and the
effectiveness of the Companys internal control over financial reporting based
on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of the financial statements included examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. Our audit of internal control included obtaining an
understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audits provide a reasonable basis for
our opinions.
A
companys internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles.
A companys internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In
our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Heska Corporation
and its subsidiaries as of December 31, 2007 and 2008, and the results of
their operations and their cash flows for each of the three years in the period
ended
43
Table
of Contents
December 31, 2008 in
conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, the
related consolidated financial statement schedule of valuation and qualifying
accounts, for the years ended December 31, 2006, 2007 and 2008, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth
therein. Also in our opinion, Heska
Corporation and subsidiaries maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2008 based on
the COSO Criteria.
|
/S/ Ehrhardt
Keefe Steiner & Hottman PC
|
Denver,
Colorado
March 16,
2009
44
Table of Contents
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share amounts)
|
|
December 31,
|
|
|
|
2007
|
|
2008
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
Cash and cash
equivalents
|
|
$
|
5,524
|
|
$
|
4,705
|
|
Accounts
receivable, net of allowance for doubtful accounts of $96 and $209,
respectively
|
|
11,064
|
|
9,514
|
|
Inventories, net
|
|
16,395
|
|
15,249
|
|
Current portion
of deferred tax asset
|
|
1,260
|
|
869
|
|
Other current
assets
|
|
884
|
|
953
|
|
Total current
assets
|
|
35,127
|
|
31,290
|
|
Property and
equipment, net
|
|
10,669
|
|
8,509
|
|
Goodwill
|
|
834
|
|
890
|
|
Deferred tax
asset, net of current portion
|
|
28,776
|
|
29,749
|
|
Other assets
|
|
185
|
|
|
|
Total assets
|
|
$
|
75,591
|
|
$
|
70,438
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
Accounts payable
|
|
$
|
5,653
|
|
$
|
3,904
|
|
Accrued
liabilities
|
|
2,309
|
|
2,574
|
|
Accrued
compensation
|
|
866
|
|
554
|
|
Accrued
restructuring
|
|
|
|
578
|
|
Current portion
of deferred revenue
|
|
2,977
|
|
2,806
|
|
Line of credit
|
|
12,614
|
|
11,042
|
|
Current portion
of capital lease obligations
|
|
9
|
|
2
|
|
Current portion
of long-term debt
|
|
767
|
|
768
|
|
Total current
liabilities
|
|
25,195
|
|
22,228
|
|
Capital lease
obligations, net of current portion
|
|
2
|
|
|
|
Long-term debt,
net of current portion
|
|
1,149
|
|
381
|
|
Deferred
revenue, net of current portion, and other
|
|
6,362
|
|
5,306
|
|
Total
liabilities
|
|
32,708
|
|
27,915
|
|
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; 51,447,663 and 52,010,928
shares issued and outstanding, respectively
|
|
51
|
|
52
|
|
Additional
paid-in capital
|
|
215,685
|
|
216,463
|
|
Accumulated
other comprehensive income
|
|
335
|
|
46
|
|
Accumulated
deficit
|
|
(173,188
|
)
|
(174,038
|
)
|
Total
stockholders equity
|
|
42,883
|
|
42,523
|
|
Total
liabilities and stockholders equity
|
|
$
|
75,591
|
|
$
|
70,438
|
|
See accompanying notes to consolidated financial statements.
45
Table of Contents
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
OPERATIONS
(in thousands, except per share amounts)
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
Revenue:
|
|
|
|
|
|
|
|
Product revenue,
net:
|
|
|
|
|
|
|
|
Core companion
animal health
|
|
$
|
59,936
|
|
$
|
65,910
|
|
$
|
67,021
|
|
Other vaccines,
pharmaceuticals and products
|
|
11,879
|
|
14,897
|
|
13,310
|
|
Total product
revenue, net
|
|
71,815
|
|
80,807
|
|
80,331
|
|
Research,
development and other
|
|
3,245
|
|
1,528
|
|
1,322
|
|
Total revenue,
net
|
|
75,060
|
|
82,335
|
|
81,653
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
Cost of products
sold
|
|
43,000
|
|
48,874
|
|
52,478
|
|
Cost of
research, development and other
|
|
1,414
|
|
274
|
|
331
|
|
Total cost of
revenue
|
|
44,414
|
|
49,148
|
|
52,809
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
30,646
|
|
33,187
|
|
28,844
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
Selling and
marketing
|
|
14,356
|
|
16,109
|
|
17,640
|
|
Research and
development
|
|
3,483
|
|
2,679
|
|
1,951
|
|
General and
administrative
|
|
9,887
|
|
8,925
|
|
8,917
|
|
Restructuring
expenses
|
|
|
|
|
|
785
|
|
Other
|
|
(155
|
)
|
(47
|
)
|
232
|
|
Total operating
expenses
|
|
27,571
|
|
27,666
|
|
29,525
|
|
Income (loss)
from operations
|
|
3,075
|
|
5,521
|
|
(681
|
)
|
Interest and
other expense, net
|
|
1,041
|
|
588
|
|
640
|
|
Income (loss)
before income taxes
|
|
2,034
|
|
4,933
|
|
(1,321
|
)
|
Income tax
expense (benefit)
|
|
206
|
|
(29,875
|
)
|
(471
|
)
|
Net income
(loss)
|
|
$
|
1,828
|
|
$
|
34,808
|
|
$
|
(850
|
)
|
|
|
|
|
|
|
|
|
Basic net income
(loss) per share
|
|
$
|
0.04
|
|
$
|
0.68
|
|
$
|
(0.02
|
)
|
Diluted net
income (loss) per share
|
|
$
|
0.03
|
|
$
|
0.63
|
|
$
|
(0.02
|
)
|
Weighted average
outstanding shares used to compute basic net income (loss) per share
|
|
50,347
|
|
51,097
|
|
51,674
|
|
Weighted average
outstanding shares used to compute diluted net income (loss) per share
|
|
52,932
|
|
55,509
|
|
51,674
|
|
See accompanying notes to consolidated financial statements.
46
Table of Contents
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS EQUITY
(in thousands)
|
|
Common Stock
|
|
Additional
Paid-in
|
|
Accumulated
Other
Comprehensive
|
|
Accumulated
|
|
Total
Stockholders
|
|
|
|
Shares
|
|
Amount
|
|
Capital
|
|
Income (Loss)
|
|
Deficit
|
|
Equity
|
|
Balances,
January 1, 2006
|
|
50,042
|
|
$
|
50
|
|
$
|
213,054
|
|
$
|
(47
|
)
|
$
|
(209,824
|
)
|
$
|
3,233
|
|
Issuance of
common stock related to options, ESPP and other
|
|
722
|
|
1
|
|
765
|
|
|
|
|
|
766
|
|
Recognition of
stock based compensation
|
|
|
|
|
|
782
|
|
|
|
|
|
782
|
|
Comprehensive net
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
1,828
|
|
1,828
|
|
Minimum pension
liability adjustments
|
|
|
|
|
|
|
|
(89
|
)
|
|
|
(89
|
)
|
Unrealized (loss)
on available for sale investments
|
|
|
|
|
|
|
|
(5
|
)
|
|
|
(5
|
)
|
Foreign currency
translation adjustments
|
|
|
|
|
|
|
|
233
|
|
|
|
233
|
|
Comprehensive net
income
|
|
|
|
|
|
|
|
|
|
|
|
1,967
|
|
Balances,
December 31, 2006
|
|
50,764
|
|
51
|
|
214,601
|
|
92
|
|
(207,996
|
)
|
6,748
|
|
Issuance of
common stock related to options, ESPP and other
|
|
684
|
|
|
|
851
|
|
|
|
|
|
851
|
|
Recognition of
stock based compensation
|
|
|
|
|
|
233
|
|
|
|
|
|
233
|
|
Comprehensive net
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
34,808
|
|
34,808
|
|
Minimum pension
liability adjustments
|
|
|
|
|
|
|
|
53
|
|
|
|
53
|
|
Unrealized gain
on available for sale investments
|
|
|
|
|
|
|
|
5
|
|
|
|
5
|
|
Foreign currency
translation adjustments
|
|
|
|
|
|
|
|
185
|
|
|
|
185
|
|
Comprehensive net
income
|
|
|
|
|
|
|
|
|
|
|
|
35,051
|
|
Balances,
December 31, 2007
|
|
51,448
|
|
51
|
|
215,685
|
|
335
|
|
(173,188
|
)
|
42,883
|
|
Issuance of
common stock related to options, ESPP and other
|
|
563
|
|
1
|
|
416
|
|
|
|
|
|
417
|
|
Recognition of
stock based compensation
|
|
|
|
|
|
362
|
|
|
|
|
|
362
|
|
Comprehensive net
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss)
|
|
|
|
|
|
|
|
|
|
(850
|
)
|
(850
|
)
|
Minimum pension
liability adjustments
|
|
|
|
|
|
|
|
(444
|
)
|
|
|
(444
|
)
|
Unrealized (loss)
on available for sale investments
|
|
|
|
|
|
|
|
(9
|
)
|
|
|
(9
|
)
|
Foreign currency
translation adjustments
|
|
|
|
|
|
|
|
164
|
|
|
|
164
|
|
Comprehensive net
(loss)
|
|
|
|
|
|
|
|
|
|
|
|
(1,139
|
)
|
Balances,
December 31, 2008
|
|
52,011
|
|
$
|
52
|
|
$
|
216,463
|
|
$
|
46
|
|
$
|
(174,038
|
)
|
$
|
42,523
|
|
See accompanying notes to consolidated financial statements.
47
Table of Contents
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH
FLOWS
(in thousands)
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
CASH FLOWS
PROVIDED BY (USED IN) OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
Net income
(loss)
|
|
$
|
1,828
|
|
$
|
34,808
|
|
$
|
(850
|
)
|
Adjustments to
reconcile net income (loss) to cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
Depreciation and
amortization
|
|
1,671
|
|
2,183
|
|
3,266
|
|
Amortization of
intangible assets
|
|
334
|
|
|
|
|
|
Deferred tax
(benefit) expense
|
|
148
|
|
(29,983
|
)
|
(536
|
)
|
Stock based
compensation
|
|
782
|
|
233
|
|
362
|
|
Loss (gain) on
disposition of assets
|
|
(155
|
)
|
(47
|
)
|
|
|
Unrealized gain
on foreign currency translation
|
|
(161
|
)
|
(19
|
)
|
80
|
|
Changes in
operating assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
(2,200
|
)
|
308
|
|
1,550
|
|
Inventories
|
|
(1,419
|
)
|
(6,840
|
)
|
599
|
|
Other current
assets
|
|
84
|
|
19
|
|
(77
|
)
|
Other long-term
assets
|
|
|
|
4
|
|
57
|
|
Accounts payable
|
|
(349
|
)
|
804
|
|
(1,749
|
)
|
Accrued
liabilities and other
|
|
2,421
|
|
(1,320
|
)
|
530
|
|
Income taxes
payable
|
|
58
|
|
(58
|
)
|
|
|
Deferred revenue
and other
|
|
(1,917
|
)
|
(1,822
|
)
|
(1,542
|
)
|
Net cash
provided by (used in) operating activities
|
|
1,125
|
|
(1,730
|
)
|
1,690
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM
INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
Proceeds from
sale of assets, net of related costs
|
|
1,640
|
|
47
|
|
|
|
Purchases of
property and equipment
|
|
(1,189
|
)
|
(2,357
|
)
|
(554
|
)
|
Capitalized
patent costs
|
|
(292
|
)
|
|
|
|
|
Net cash
provided by (used in) investing activities
|
|
159
|
|
(2,310
|
)
|
(554
|
)
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM
FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Proceeds from
issuance of common stock
|
|
766
|
|
851
|
|
372
|
|
Proceeds from
(repayments of) line of credit borrowings, net
|
|
(1,431
|
)
|
4,591
|
|
(1,572
|
)
|
Repayments of
debt and capital lease obligations
|
|
(763
|
)
|
(1,275
|
)
|
(776
|
)
|
Net cash
provided by (used in) financing activities
|
|
(1,428
|
)
|
4,167
|
|
(1,976
|
)
|
|
|
|
|
|
|
|
|
EFFECT OF
EXCHANGE RATE CHANGES ON CASH
|
|
188
|
|
122
|
|
21
|
|
|
|
|
|
|
|
|
|
INCREASE
(DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
44
|
|
249
|
|
(819
|
)
|
|
|
|
|
|
|
|
|
CASH AND CASH
EQUIVALENTS, BEGINNING OF YEAR
|
|
5,231
|
|
5,275
|
|
5,524
|
|
|
|
|
|
|
|
|
|
CASH AND CASH
EQUIVALENTS, END OF YEAR
|
|
$
|
5,275
|
|
$
|
5,524
|
|
$
|
4,705
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for
interest
|
|
$
|
1,178
|
|
$
|
774
|
|
$
|
622
|
|
|
|
|
|
|
|
|
|
Non-cash
transfer of inventory to property and equipment
|
|
$
|
15
|
|
$
|
3,565
|
|
$
|
547
|
|
See accompanying notes to consolidated financial statements.
48
Table
of Contents
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
ORGANIZATION AND BUSINESS
Heska Corporation (Heska
or the Company) develops, manufactures, markets, sells and supports
veterinary products. Heskas core focus
is on the canine and feline companion animal health markets.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of
Presentation
The accompanying
consolidated financial statements include the accounts of the Company and of
its wholly-owned subsidiaries since their respective dates of
acquisitions. All material intercompany
transactions and balances have been eliminated in consolidation.
Use of
Estimates
The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States of America 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/obsolete inventory, in determining the period over which
the Companys obligations are fulfilled under agreements to license product
rights and/or technology rights, evaluating long-lived assets for impairment,
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.
Trade
Accounts Receivable
Trade accounts receivable
are recorded at the invoiced amount. The
allowance for doubtful accounts is the Companys best estimate of the amount of
probable credit losses in the Companys existing accounts receivable. The Company determines the allowance based on
historical write-off experience. The
Company reviews its allowance for doubtful accounts monthly. Past due balances over 90 days and over a
specified amount are reviewed individually for collectibility. Account balances are charged against the
allowance after all means of collection have been exhausted and the potential
for recovery is considered remote. The
Company does not have any off-balance-sheet credit exposure related to its
customers.
Concentration
of Credit Risk
Financial instruments that
potentially subject the Company to a concentration of credit risk consist of
cash and cash equivalents and accounts receivable. The Company maintains the majority of its
cash and cash equivalents with financial institutions that management believes
are creditworthy in the form of demand deposits, U.S. government agency
obligations and U.S. corporate commercial paper. The Company has no significant
off-balance-sheet concentrations of credit risk such as foreign exchange
contracts, options contracts or other foreign currency hedging arrangements. Its accounts receivable balances are due
primarily from domestic veterinary clinics and individual veterinarians, and
both domestic and international corporations.
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. The Company valued its European Euro and
Japanese Yen cash accounts at the spot market foreign exchange rate as of each
balance
49
Table
of Contents
HESKA CORPORATION AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
sheet date, with changes due
to foreign exchange fluctuations recorded in current earnings. The Company held 415,931 and 888,310 Euros at
December 31, 2007 and 2008, respectively.
The Company held 57,730,441 and 15,778,546 Yen at December 31, 2007
and 2008, respectively. The Company held
667,506 and 132,890 Swiss Francs at December 31, 2007 and 2008,
respectively. The Company held 1,348 and
zero British Pounds at December 31, 2007 and 2008, respectively.
Fair Value
of Financial Instruments
The Companys financial
instruments consist of cash and cash equivalents, short-term trade receivables
and payables and notes payable, including the revolving line of credit. The carrying values of cash and cash
equivalents and short-term trade receivables and payables approximate fair value. The fair value of notes payable is estimated
based on current rates available for similar debt with similar maturities and
collateral, and at December 31, 2007 and 2008, approximates the carrying
value due primarily to the floating rate of interest on such debt instruments.
Inventories
Inventories are stated at
the lower of cost or market using the first-in, first-out method. Inventory manufactured by the Company
includes the cost of material, labor and overhead. If the cost of inventories exceeds estimated
fair value, provisions are made to reduce the carrying value to estimated fair
value.
Inventories, net consist of
the following (in thousands):
|
|
December 31,
|
|
|
|
2007
|
|
2008
|
|
Raw materials
|
|
$
|
4,865
|
|
$
|
6,893
|
|
Work in process
|
|
3,138
|
|
2,957
|
|
Finished goods
|
|
8,969
|
|
6,370
|
|
Allowance for
excess or obsolete inventory
|
|
(577
|
)
|
(971
|
)
|
|
|
$
|
16,395
|
|
$
|
15,249
|
|
Property
and Equipment
Property and equipment are
recorded at cost and depreciated on a straight-line basis over the estimated
useful lives of the related assets.
Leasehold improvements are amortized over the applicable lease period or
their estimated useful lives, whichever is shorter. Maintenance and repairs are charged to
expense when incurred, and major renewals and improvements are capitalized.
Property and equipment
consist of the following (in thousands):
|
|
Estimated
|
|
December 31,
|
|
|
|
Useful Life
|
|
2007
|
|
2008
|
|
Land
|
|
N/A
|
|
$
|
377
|
|
$
|
377
|
|
Building
|
|
10 to 20 years
|
|
2,678
|
|
2,678
|
|
Machinery and
equipment
|
|
3 to 15 years
|
|
24,918
|
|
25,831
|
|
Leasehold and
building improvements
|
|
7 to 15 years
|
|
5,282
|
|
5,314
|
|
|
|
|
|
33,255
|
|
34,200
|
|
Less accumulated
depreciation and amortization
|
|
|
|
(22,586
|
)
|
(25,691
|
)
|
|
|
|
|
$
|
10,669
|
|
$
|
8,509
|
|
From time to time, the
Company utilizes marketing programs whereby its instruments in inventory may be
placed in a customers location on a rental basis. The cost of these instruments is transferred
to machinery and equipment and depreciated, typically over a four year
period. During 2006, 2007 and 2008,
50
Table
of Contents
HESKA CORPORATION AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
total costs transferred from
inventory were approximately $15 thousand, $3.6 million and $547 thousand,
respectively.
Depreciation and
amortization expense for property and equipment was $1.7 million, $2.2 million
and $3.3 million for the years ended December 31, 2006, 2007 and 2008,
respectively.
Realizability
of Long-Lived Assets
The Company continually
evaluates whether events and circumstances have occurred that indicate the
remaining estimated useful life of long-lived assets may warrant revision, or
that the remaining balance of these assets may not be recoverable. When deemed necessary, the Company completes
this evaluation by comparing the carrying amount of the assets with the
estimated undiscounted future cash flows associated with them. If such evaluations indicate that the future
undiscounted cash flows of amortizable long-lived assets are not sufficient to
recover the carrying value of such assets, the assets are adjusted to their
estimated fair values. The Company
identified certain long-lived assets where the estimated fair value was less
than carrying value as of December 31, 2008 and therefore the Company
recorded an impairment charge of approximately $232 thousand. The Company
determined the estimated fair value based on undiscounted future cash flows
related to these long-lived assets.
Goodwill
and Other Intangible Assets
Goodwill is subject to an
annual assessment for impairment.
Impairment is indicated when the carrying amount of the related
reporting unit is greater than its estimated fair value.
The Companys recorded
goodwill relates to the 1997 acquisition of Heska AG, the Companys Swiss
subsidiary. This goodwill is reviewed at
least annually for impairment. At December 31,
2007 and 2008, goodwill was approximately $834 thousand and $890 thousand,
respectively, and is included in the assets of the Core Companion Animal Health
segment. The Company completed its
annual analysis of the estimated fair value of its goodwill at December 31,
2008 and determined there was no indicated impairment of its goodwill. The change in carrying value of the goodwill
between years was solely due to foreign currency rate changes. There can be no assurance that future
goodwill impairments will not occur.
There are no other intangible assets that are not being amortized on a
periodic basis.
Revenue
Recognition
The Company generates its
revenues through sale of products and services, licensing of product and
technology rights, and research and development services. Revenue is accounted for in accordance with
the guidelines provided by SEC Codification of Staff Accounting Bulletins,
Topic 13: Revenue Recognition. The Companys 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, if required, with an appropriate
provision for estimated returns and other 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. The Company maintains an allowance for sales
returns based upon its customer policies
51
Table
of Contents
HESKA CORPORATION AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
and historical
experience. Shipping and handling costs
charged to customers is included as revenue, and the related costs are recorded
as a component of cost of products sold.
In addition to its direct
sales force, the Company utilizes independent third-party distributors to sell
its products. Distributors purchase
goods from the Company, take title to those goods and resell them to their
customers in the distributors territory.
Upfront payments received by
the Company under arrangements for product, patent or technology rights in
which the Company retains an interest in the underlying product, patent or
technology are initially deferred, and revenue is subsequently recognized over
the estimated life of the agreement, product, patent or technology. The Company received approximately $395
thousand, $325 thousand and $0 thousand of such payments in 2006, 2007 and
2008, respectively. Revenue from
royalties is recognized based upon historical experience or as the Company is
informed of sales on which it is entitled to royalties.
For multiple-element
arrangements that are not subject to a higher level of authoritative
literature, the Company follows the guidelines of the Financial Accounting
Standards Boards (FASB) Emerging Issues Task Force (EITF) Issue No. 00-21,
Accounting for Revenue Arrangements with Multiple Deliverables (EITF 00-21),
in determining the separate units of accounting. For those arrangements subject to the
separation criteria of EITF 00-21, the Company must determine whether the
various elements meet the criteria to be accounted for as separate
elements. If the elements cannot be
separated, revenue is recognized once revenue recognition criteria for the
entire arrangement have been met or over the period that the Companys
obligations to the customer are fulfilled, as appropriate. If the elements are determined to be
separable, the revenue is allocated to the separate elements based on relative
fair value and recognized separately for each element when the applicable
revenue recognition criteria have been met.
In accounting for these multiple element arrangements, the Company must
make determinations about whether elements can be accounted for separately and
make estimates regarding their relative fair values.
Cost of
Products Sold
Royalties payable in
connection with certain licensing agreements (see Note 10) are reflected in
cost of products sold as incurred.
Stock-Based
Compensation
Effective January 1, 2006, the Company adopted
Statement of Financial Accounting Standards No. 123 (revised 2004) Share-Based
Payment (SFAS No. 123R). During the
years ended December 31, 2006 and 2007, the Companys income from operations,
income before income taxes and net income were reduced by $782 thousand and $233
thousand, respectively. Basic and
diluted earnings per share were reduced by $0.02 and $0.01 per share for 2006
and $0.01 and $0.00 per share for 2007.
During the year ended December 31, 2008, the Companys loss from
operations and loss before income taxes was increased by $362 thousand, net
loss was increased by $219 thousand and basic and diluted loss per share were
not impacted. For all years presented,
there was no material impact on cash flow from operations and cash flow from
financing activities. At December 31,
2008, the Company had two stock-based compensation plans. See Note 7 for a description of these plans
and additional disclosures regarding the plans.
Restructuring and Other Expenses
The Company recorded net
restructuring expenses of $785 thousand for the year ended December 31,
2008 (See Note 8). At December 31,
2008, approximately $578 thousand of accrued restructuring expenses remained on
the Companys balance sheet.
52
Table
of Contents
HESKA CORPORATION AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Restructuring expenses were
approximately $621 thousand related primarily to personnel severance and other
costs for 24 individuals and $164 thousand related to inventory of discontinued
products, including a monitoring product the manufacturer has informed the
Company it no longer intends to support.
The Company recorded $232
thousand in impairment expense in the year ended December 31, 2008. This charge was related to certain
instruments the Company purchased from Abbott Point of Care Inc. (APOC),
formerly known as i-STAT Corporation and a unit of Abbott Laboratories, which
the Company had capitalized as rental units (the Rental Units) for use by the
Companys customers. The majority of the
Rental Units were being depreciated over a four year life. APOC has the right to cancel the agreement
under which the Company purchases affiliated cartridges and supplies for the
Rental Units prior to year end 2009, which would prevent the Company from
obtaining a future benefit from Rental Unit usage of these items if APOC
refused to sell the Company cartridges and supplies beyond its contractual
obligation and the Company sold all its remaining inventory of these
items. Accordingly, the Company
concluded that the appropriate depreciation period for the Rental Units was
through year end 2009. Based on average
usage assumptions for these instruments, the Company calculated the future
undiscounted cash flows associated with usage of the Rental Units through year
end 2009 and recorded an impairment to reduce the carrying amount of the Rental
Units to this level.
In the year ended December 31,
2007, the Company recognized a gain of $47 thousand on the sale of certain
patents the Company held, net of costs.
In the year ended December 31, 2006, the Company recognized a gain
of $155 thousand on the sale of a worldwide patent portfolio covering a number
of major allergens and the genes that encode them (the Allergopharma Portfolio). The gain on sale is equal to the sales price
less the net book value of the Allergopharma Portfolio, which included all
unamortized capitalized patent costs.
Advertising
Costs
The Company expenses
advertising costs as incurred.
Advertising expenses were $443 thousand, $654 thousand and $705 thousand
for the years ended December 31, 2006, 2007 and 2008, respectively.
Income
Taxes
The Company records a
current provision for income taxes based on estimated amounts payable or
refundable on tax returns filed or to be filed each year. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates, in each tax jurisdiction,
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in operations in the period
that includes the enactment date. The
overall change in deferred tax assets and liabilities for the period measures
the deferred tax expense or benefit for the period. Deferred tax assets are reduced by a
valuation allowance based on judgmental assessment of available evidence if the
Company is unable to conclude that it is more likely than not that some or all
of the deferred tax assets will be realized.
Basic and
Diluted Net Income (Loss) Per Share
Basic net income (loss) per
common share is computed using the weighted average number of common shares
outstanding during the period. Diluted
net income 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.
Due to the Companys net loss in 2008, all outstanding common stock
equivalents are considered anti-dilutive for fiscal 2008. At December 31, 2006, 2007 and 2008,
securities that have been
53
Table
of Contents
HESKA CORPORATION AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
excluded from diluted net
income per share because they would be anti-dilutive are outstanding options to
purchase 3,721,800, 1,616,886 and 12,835,269 shares, respectively, of the
Companys common stock. Securities
included in the diluted net income per share calculation at December 31,
2006 and 2007, using the treasury stock method, were outstanding options to
purchase approximately 2.6 million and 4.4 million shares of the Companys
common stock, respectively.
Comprehensive
Income (Loss)
Comprehensive income (loss),
as shown in the Consolidated Statement of Stockholders Equity, includes net
income adjusted for the results of certain stockholders equity changes. Such changes include foreign currency items
and minimum pension liability adjustments. At December 31, 2008,
Accumulated Other Comprehensive Income (Loss) consists of $507 thousand gain
for cumulative translation adjustments, $479 thousand for unrealized pension
liability and $18 thousand of unrealized gain on available for sale investments. At December 31, 2007, Accumulated Other
Comprehensive Income consists of $344 thousand gain for cumulative translation
adjustments, $36 thousand for unrealized pension liability and $27 thousand of
unrealized gain on available for sale investments. At December 31, 2006, Accumulated Other
Comprehensive Income consists of $159 thousand gain for cumulative translation
adjustments, $89 thousand for unrealized pension liability and
$22 thousand of unrealized gain on available for sale investments.
Foreign Currency
Translation
The functional currency of
the Companys Swiss subsidiary is the Swiss Franc. Assets and liabilities of the Companys Swiss
subsidiary are translated using the exchange rate in effect at the balance
sheet date. Revenue and expense accounts
and cash flows are translated using an average of exchange rates in effect
during the period. Cumulative
translation gains and losses are shown in the consolidated balance sheets as a
separate component of stockholders equity.
Exchange gains and losses arising from transactions denominated in
foreign currencies (i.e., transaction gains and losses) are recognized as a
component of other income (expense) in current operations, as are exchange
gains and losses on intercompany transactions expected to be settled in the
near term.
New
Accounting Pronouncements
In September 2006, the
Financial Accounting Standards Board issued Statement of Financial Standards No. 157,
Fair Value Measurements (SFAS 157).
SFAS 157 defines fair value, establishes a framework for measuring fair
value in accordance with accounting principles generally accepted in the Untied
States, and expands disclosures about fair value measurements. This statement does not require any new fair
value measurements; rather, it applies under other accounting pronouncements
that require or permit fair value measurements.
The provisions of SFAS 157 are effective for fiscal years beginning
after November 15, 2007 (beginning in 2008 for calendar year-end
entities). In February 2008, FSP 157-2
was issued which delayed application of SFAS No. 157 for non-recurring
nonfinancial assets and nonfinancial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a
recurring basis (at least annually), until fiscal years beginning after November 15,
2008, and interim periods within those fiscal years (beginning in 2009 for
calendar year-end entities). The
adoption of the provisions of FSP 157-2 for non-recurring nonfinancial assets
and nonfinancial liabilities will impact how those balances are measured, for
example in the case of assessing impairment.
The adoption of SFAS No. 157 related to non-recurring,
non-financial fair value measurements is not expected to have a material
impact on the Companys results of operations or financial position.
In December 2007, the
FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS No. 141(R)). Under SFAS No. 141(R), an entity is
required to recognize the assets acquired, liabilities assumed, contractual
contingencies and contingent consideration at their fair value on the
acquisition date. It further requires
that acquisition-related costs are recognized separately from the acquisition
and expensed as incurred, restructuring costs generally be expensed in periods
subsequent to the
54
Table
of Contents
HESKA CORPORATION AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
acquisition date, and
changes in accounting for deferred tax asset valuation allowances and acquired
income tax uncertainties after the measurement period impact income tax
expense. The adoption of SFAS No.141(R) will
change the accounting treatment for business combinations on a prospective
basis beginning in 2009 for calendar year-end entities. The effects are presumed to be material to
the accounting for future business acquisitions and will also increase future
income statement volatility upon consummation of future business acquisitions.
In December 2007, the
FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements an amendment of ARB No. 51 (SFAS No. 160). SFAS No. 160 changes the accounting and
reporting for minority interests, which will be recharacterized as
non-controlling interests and classified as a component of equity. SFAS No. 160 is effective for business
combinations with an acquisition date beginning in the first quarter of fiscal
year 2009. The adoption of SFAS No. 160
is not expected to have an impact on the Companys consolidated financial
statements.
In March 2008, the FASB
issued SFAS No. 161, Disclosure about Derivative Instruments and Hedging
Activities, an amendment of SFAS No. 133, (SFAS 161). SFAS No. 161 changes the disclosure
requirements for derivative instruments and hedging activities. Entities are required to provide enhanced
disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under
Statement 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entitys financial position,
financial performance and cash flows.
SFAS No. 161 is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008
(beginning in 2009 for calendar year-end entities) with early application
encouraged. The adoption of SFAS No. 161
is not expected to have a material impact on the Companys results of
operations or financial position.
3.
CAPITAL LEASE OBLIGATIONS
The Company has entered into
certain capital lease agreements for laboratory equipment, office equipment,
machinery and equipment, and computer equipment and software. At December 31, 2007 and 2008, the
Company had capitalized machinery and equipment under capital leases with a
gross value of approximately $38 thousand and $24 thousand, respectively, and
net book value of approximately $9 thousand and $2 thousand,
respectively. The capitalized cost of
the equipment under capital leases is included in the accompanying consolidated
balance sheets under the respective asset classes. Under the terms of the Companys lease
agreements, the Company is required to make monthly payments of principal and
interest through the year 2009, at an interest rate of approximately 11.3% per
annum. The equipment under the capital
leases serves as security for the leases.
55
Table
of Contents
HESKA CORPORATION AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The future annual minimum
required payments under capital lease obligations as of December 31, 2008
were as follows (in thousands):
Year Ending December 31,
|
|
|
|
|
2009
|
|
$
|
2
|
|
Total future
minimum lease payments
|
|
2
|
|
Less amount
representing interest
|
|
|
|
Present value of
future minimum lease payments
|
|
2
|
|
Less current
portion
|
|
2
|
|
Total long-term
capital lease obligations
|
|
$
|
|
|
4.
LONG-TERM DEBT
Long-term debt consists of
the following (in thousands):
|
|
December 31,
|
|
|
|
2007
|
|
2008
|
|
Real estate
mortgage loan with a commercial bank, due in monthly installments, with a
stated interest rate of prime at December 31, 2007 and prime plus 2.5%
at December 31, 2008 (7.25% and 5.75%).
|
|
$
|
481
|
|
$
|
269
|
|
Term loan with a
commercial bank, secured by machinery and equipment, due in monthly
installments, with a stated interest rate of prime at December 31, 2007
and prime plus 2.5% at December 31, 2008 (7.25% and 5.75%).
|
|
1,148
|
|
704
|
|
Term loan with a
commercial bank, secured by machinery and equipment, due in monthly
installments, with a stated interest rate of prime at December 31, 2007
and prime plus 2.5% at December 31, 2008 (7.25% and 5.75%).
|
|
287
|
|
176
|
|
|
|
1,916
|
|
1,149
|
|
Less
installments due within one year
|
|
(767
|
)
|
(768
|
)
|
|
|
$
|
1,149
|
|
$
|
381
|
|
The Company has a credit and
security agreement with Wells Fargo Bank, National Association which expires June 30,
2011. The agreement includes the real
estate mortgage loan and term loans above, and a $15.0 million asset-based
revolving line of credit with a stated interest rate at December 31, 2008
of prime plus 2.5% (5.75%). Amounts due
under the credit facility are secured by a first security interest in
essentially all of the Companys assets.
Under the agreement, the Company is required to comply with certain
financial and non-financial covenants. Among
the financial covenants are requirements for monthly minimum capital, quarterly
minimum net income and monthly minimum liquidity. The amount available for borrowings under the
line of credit varies based upon available cash, eligible accounts receivable
and eligible inventory. As of December 31,
2008, approximately $11.0 million was outstanding on the line of credit and
there was $448 thousand available capacity for additional borrowings under
the line of credit agreement.
Maturities of long-term debt
as of December 31, 2008 were as follows (in thousands):
Year Ending December 31,
|
|
|
|
|
2009
|
|
$
|
768
|
|
2010
|
|
381
|
|
|
|
$
|
1,149
|
|
56
Table
of Contents
HESKA CORPORATION AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
5.
SUPPLEMENTAL DISCLOSURE OF INTEREST AND OTHER EXPENSE
(INCOME) INFORMATION
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
|
|
(in thousands)
|
|
Interest and
other expense (income):
|
|
|
|
|
|
|
|
Interest income
|
|
$
|
(69
|
)
|
$
|
(87
|
)
|
$
|
(66
|
)
|
Interest expense
|
|
1,244
|
|
721
|
|
624
|
|
Other, net
|
|
(134
|
)
|
(46
|
)
|
82
|
|
|
|
$
|
1,041
|
|
$
|
588
|
|
$
|
640
|
|
6.
INCOME TAXES
As of December 31,
2008, the Company had a domestic net operating loss carryforward (NOL), of
approximately
$166.4 million, a domestic alternative minimum tax
credit of approximately $129 thousand and a domestic research and development
tax credit carryforward of approximately $312 thousand. The Companys domestic NOL is scheduled to
expire in various years beginning in 2010 and ending in 2028, with the majority
scheduled to expire in 2018 or later.
The NOL and tax credit carryforwards are subject to alternative minimum
tax limitations and to examination by the tax authorities. In addition, the Company had a change of
ownership as defined under the provisions of Section 382 of the Internal
Revenue Code of 1986, as amended (an Ownership Change). The Company believes the latest Ownership
Change occurred at the time of its initial public offering in July 1997. The Company does not believe this Ownership
Change will place a significant restriction on its ability to utilize its NOL
in the future.
The Company reduces its
deferred tax assets by an offsetting valuation allowance if, based on
judgmental assessment of available evidence, the Company is unable to conclude
that it is more likely than not that some or all of the related deferred tax
assets will be realized. The Company
maintained a full, offsetting valuation allowance for all deferred tax assets
prior to 2005. The Company records a
valuation allowance adjustment income tax benefit or expense due to a change in
circumstances that causes a change in judgment about the realizability of the related
deferred tax asset in future years.
Based on the profitable operating performance of Heska AG, the Companys
evaluation determined that its NOL in Switzerland was realizable on a
more-likely-than-not basis and the related valuation allowance was released in
the fourth quarter of 2005. The Company
subsequently obtained agreements from the tax authorities in the canton of
Fribourg (the Tax Agreements) regarding the Companys determination of
taxable income. The Company anticipated
the Tax Agreements would reduce the Companys taxable income and therefore tax
obligation in Switzerland in future years as compared to prior
expectations. In addition, the Tax
Agreements reduced the Companys taxable income in Switzerland in 2005 and 2006
from previous estimates for financial reporting purposes. Accordingly, due to the Companys lower
income expectations in Switzerland related to the Tax Agreements, the Company
no longer believed it would be able to utilize all of its NOL in Switzerland
before it fully expired and made an associated reduction in its net deferred
tax asset in the fourth quarter of 2006 via an increase of $69 thousand in the
related valuation allowance along with a corresponding income tax expense
journal entry. As a result of the Tax Agreements,
the Company had a smaller net deferred tax asset, lower foreign taxable income,
and greater domestic taxable income than the Company estimated when it reported
its results for the year ended December 31, 2005. The Company did not generate sufficient
taxable income in 2008 to fully utilize its Swiss deferred tax asset, which
expired at the end of 2008, and made an associated reduction in its net
deferred tax asset in the fourth quarter of 2008 via an decrease of $10
thousand in the related valuation allowance along with a corresponding income
tax expense journal entry. Based on the
Companys profitable domestic operating performance, the Companys evaluation
determined that a portion of its NOL in the United States was realizable on a
more-likely-than-not basis and the related valuation allowance was released in
the fourth quarter of 2007, resulting in an income tax benefit of $30 million
and a corresponding net deferred tax asset of $30 million on December 31,
2007.
57
Table
of Contents
HESKA CORPORATION AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The Company is 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. In the United States, the tax years 2005
2007 remain open to examination by the federal Internal Revenue Service and the
tax years 2004 2007 remain open for various state taxing authorities.
The components of income
(loss) before income taxes were as follows (in thousands):
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
|
|
|
|
|
|
|
|
Domestic
|
|
$
|
1,976
|
|
$
|
4,802
|
|
$
|
(1,451
|
)
|
Foreign
|
|
58
|
|
131
|
|
130
|
|
|
|
$
|
2,034
|
|
$
|
4,933
|
|
$
|
(1,321
|
)
|
Temporary differences that
give rise to the components of deferred tax assets are as follows (in
thousands):
|
|
December 31,
|
|
|
|
2007
|
|
2008
|
|
Current deferred
tax assets
|
|
|
|
|
|
Inventory
|
|
$
|
191
|
|
$
|
337
|
|
Accrued
compensation
|
|
69
|
|
171
|
|
Net operating
loss carryforwards domestic
|
|
649
|
|
809
|
|
Net operating
loss carryforwards foreign
|
|
36
|
|
|
|
Other
|
|
315
|
|
658
|
|
|
|
1,260
|
|
1,975
|
|
Valuation
allowance
|
|
|
|
(1,106
|
)
|
Total current
deferred tax assets
|
|
$
|
1,260
|
|
$
|
869
|
|
|
|
|
|
|
|
Noncurrent
deferred tax assets
|
|
|
|
|
|
Research and
development
|
|
$
|
307
|
|
$
|
312
|
|
Alternative
minimum tax credit
|
|
146
|
|
129
|
|
Deferred revenue
|
|
3,655
|
|
3,060
|
|
Property and
equipment
|
|
1,151
|
|
1,276
|
|
Net operating
loss carryforwards domestic
|
|
62,318
|
|
62,666
|
|
Net operating
loss carryforwards foreign
|
|
|
|
|
|
|
|
67,577
|
|
67,443
|
|
Valuation
allowance
|
|
(38,801
|
)
|
(37,694
|
)
|
Total noncurrent
deferred tax assets (liabilities)
|
|
$
|
28,776
|
|
$
|
29,749
|
|
58
Table
of Contents
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The components of the
income tax expense (benefit) are as follows (in thousands):
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
|
|
|
|
|
|
|
|
Current income
tax expense (benefit):
|
|
|
|
|
|
|
|
Federal
|
|
$
|
58
|
|
$
|
81
|
|
$
|
|
|
State
|
|
|
|
27
|
|
|
|
Foreign
|
|
|
|
|
|
|
|
Total current
expense (benefit)
|
|
58
|
|
108
|
|
|
|
Deferred income
tax expense (benefit):
|
|
|
|
|
|
|
|
Federal
|
|
|
|
(26,667
|
)
|
(450
|
)
|
State
|
|
|
|
(3,333
|
)
|
(63
|
)
|
Foreign
|
|
148
|
|
17
|
|
42
|
|
Total deferred
benefit
|
|
148
|
|
(29,983
|
)
|
(471
|
)
|
Valuation
allowance
|
|
|
|
|
|
|
|
Total income tax
expense (benefit)
|
|
$
|
206
|
|
$
|
(29,875
|
)
|
$
|
(471
|
)
|
The Companys income tax
expense (benefit) relating to income (loss) for the periods presented differ
from the amounts that would result from applying the federal statutory rate to
that income (loss) as follows:
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
|
|
|
|
|
|
|
|
Statutory
federal tax rate
|
|
35
|
%
|
33
|
%
|
34
|
%
|
State income
taxes, net of federal benefit
|
|
4
|
%
|
4
|
%
|
5
|
%
|
Other permanent
differences
|
|
9
|
%
|
4
|
%
|
(4
|
)%
|
Domestic NOL
utilization
|
|
|
|
(38
|
)%
|
|
|
Foreign rate
difference
|
|
2
|
%
|
|
|
1
|
%
|
Current year
impact of foreign tax holiday
|
|
(1
|
)%
|
|
|
|
|
Loss of foreign
NOL benefit under new tax rate agreement
|
|
7
|
%
|
|
|
|
|
Swiss NOL
carryforward
|
|
(1
|
)%
|
|
|
|
|
Change in
valuation allowance
|
|
(50
|
)%
|
(608
|
)%
|
|
|
Other
|
|
5
|
%
|
(1
|
)%
|
|
|
Effective income
tax rate
|
|
10
|
%
|
(606
|
)%
|
36
|
%
|
7.
CAPITAL STOCK
Stock
Option Plans
The Company has two stock
option plans which authorize granting of stock options and stock purchase
rights to employees, officers, directors and consultants of the Company to
purchase shares of common stock. In
1997, the board of directors adopted the 1997 Stock Incentive Plan and
terminated two prior option plans. All
shares that remained available for grant under the terminated plans were
incorporated into the 1997 Plan. In addition,
all shares subsequently cancelled under the prior plans are added back to the
1997 Plan on a quarterly basis as additional options available to grant. In May 2003, the stockholders approved a
new plan, the 2003 Stock Incentive Plan, which allows for the granting of
options for up to 2,390,500 shares of the Companys common stock. The number of shares reserved for issuance
under all plans as of January 1, 2009 was 3,198,436.
The stock options granted by
the board of directors may be either incentive stock options (ISOs) or
non-qualified stock options (NQs). The
exercise price for options under all of the plans may be no less than 100% of
the fair value of the underlying common stock for ISOs or 85% of fair value for
NQs. Options granted will expire no
later than the tenth anniversary subsequent to the date of grant or three
months
59
Table
of Contents
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
following termination of
employment, except in cases of death or disability, in which case the options
will remain exercisable for up to twelve months. Under the terms of the 1997 Plan, in the
event the Company is sold or merged, outstanding options will either be assumed
by the surviving corporation or vest immediately.
There are four key inputs to
the Black-Scholes model which the Company uses to estimate fair value for
options which it issues: expected term, expected volatility, risk-free interest
rate and expected dividends, all of which require the Company to make
estimates. The Companys estimates for
these inputs may not be indicative of actual future performance and changes to
any of these inputs can have a material impact on the resulting estimated fair
value calculated for the option. The
Companys expected term input was estimated based on the Companys historical
experience for time from option grant to option exercise for all employees in
2008, 2007 and 2006; the Company treated all employees in one grouping in all
three years. The Companys expected
volatility input was estimated based on the Companys historical stock price
volatility in 2008, 2007 and 2006. The Companys
risk-free interest rate input was determined based on the U.S. Treasury yield
curve at the time of option issuance in 2008, 2007 and 2006. The Companys expected dividends input was
zero in 2008, 2007 and 2006. Weighted
average assumptions used in 2008, 2007 and 2006 for each of these four key
inputs are listed in the following table:
|
|
2006
|
|
2007
|
|
2008
|
|
Risk-free
interest rate
|
|
4.81%
|
|
3.46%
|
|
1.89%
|
|
Expected lives
|
|
2.8 years
|
|
3.0 years
|
|
2.9 years
|
|
Expected
volatility
|
|
65%
|
|
60%
|
|
56%
|
|
Expected
dividend yield
|
|
0%
|
|
0%
|
|
0%
|
|
A summary of the Companys
stock option plans is as follows:
|
|
Year Ended December 31,
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
|
|
Options
|
|
Weighted
Average
Exercise
Price
|
|
Options
|
|
Weighted
Average
Exercise
Price
|
|
Options
|
|
Weighted
Average
Exercise
Price
|
|
Outstanding at
beginning of period
|
|
11,989,582
|
|
$
|
1.3251
|
|
11,818,823
|
|
$
|
1.3575
|
|
12,118,417
|
|
$
|
1.3979
|
|
Granted at
Market
|
|
1,078,891
|
|
$
|
1.5175
|
|
980,835
|
|
$
|
1.9305
|
|
1,575,268
|
|
$
|
0.7694
|
|
Cancelled
|
|
(681,377
|
)
|
$
|
1.3042
|
|
(122,746
|
)
|
$
|
2.9538
|
|
(573,898
|
)
|
$
|
2.5005
|
|
Exercised
|
|
(568,273
|
)
|
$
|
1.0418
|
|
(558,495
|
)
|
$
|
1.1348
|
|
(284,518
|
)
|
$
|
0.8526
|
|
Outstanding at
end of period
|
|
11,818,823
|
|
$
|
1.3575
|
|
12,118,417
|
|
$
|
1.3979
|
|
12,835,269
|
|
$
|
1.2836
|
|
Exercisable at
end of period
|
|
11,792,445
|
|
$
|
1.3585
|
|
11,340,083
|
|
$
|
1.3675
|
|
11,042,716
|
|
$
|
1.3360
|
|
The total estimated fair
value of stock options granted during the years ended December 31, 2008,
2007 and 2006 were computed to be approximately $452 thousand, $810 thousand
and $718 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 years ended December 31, 2008, 2007 and 2006
was computed to be approximately $0.29, $0.83 and $0.68, respectively. The total intrinsic value of options
exercised during the years ended December 31, 2008, 2007 and 2006 was $137
thousand, $557 thousand and $251 thousand, respectively. The cash proceeds from options exercised
during the years ended December 31, 2008, 2007 and 2006 were $243
thousand, $634 thousand and $592 thousand.
60
Table of Contents
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The following table
summarizes information about stock options outstanding and exercisable at December 31,
2008:
|
|
Options Outstanding
|
|
Options Exercisable
|
|
Exercise Prices
|
|
Number of
Options
Outstanding
at
December 31,
2008
|
|
Weighted
Average
Remaining
Contractual
Life in
Years
|
|
Weighted
Average
Exercise
Price
|
|
Number of
Options
Exercisable
at
December 31,
2008
|
|
Weighted
Average
Exercise
Price
|
|
$ 0.34 - $0.87
|
|
2,885,953
|
|
6.25
|
|
$
|
0.5655
|
|
1,808,877
|
|
$
|
0.6402
|
|
$ 0.88 - $1.06
|
|
2,765,194
|
|
5.12
|
|
$
|
0.9393
|
|
2,746,444
|
|
$
|
0.9394
|
|
$ 1.07 - $1.25
|
|
2,444,123
|
|
5.34
|
|
$
|
1.2166
|
|
2,444,123
|
|
$
|
1.2166
|
|
$ 1.27 - $1.82
|
|
2,279,602
|
|
6.72
|
|
$
|
1.5879
|
|
2,148,768
|
|
$
|
1.5966
|
|
$ 1.83 - $5.37
|
|
2,460,397
|
|
5.52
|
|
$
|
2.2973
|
|
1,894,504
|
|
$
|
2.4340
|
|
$ 0.34 - $5.37
|
|
12,835,269
|
|
5.78
|
|
$
|
1.2836
|
|
11,042,716
|
|
$
|
1.3360
|
|
As
of December 31, 2008, there was $732 thousand of total unrecognized
compensation expense related to outstanding stock options. That cost is expected to be recognized over a
weighted-average period of 2.4 years with all cost to be recognized by the end
of November 2012, assuming all options vest according to the vesting
schedules in place at December 31, 2008.
As of December 31, 2008, the aggregate intrinsic value of
outstanding options was $0 and the aggregate intrinsic value of exercisable
options was $0.
Employee
Stock Purchase Plan (the ESPP)
Under the 1997 Employee
Stock Purchase Plan, the Company is authorized to issue up to 2,750,000 shares
of common stock to its employees, of which 2,601,190 had been issued as of December 31,
2008. Employees of the Company and its
U.S. subsidiaries who are expected to work at least 20 hours per week and five
months per year are eligible to participate.
Under the terms of the plan, employees can choose to have up to 10% of
their annual base earnings withheld to purchase the Companys common
stock. Each offering period is five
years, with six-month accumulation periods ending June 30 and December 31. The purchase price of the stock for June 30
and December 31 was 85% of the end-of-measurement-period market price.
For the years ended December 31,
2006, 2007 and 2008, the weighted-average fair value of the purchase rights
granted was $0.36, $0.50 and $0.26 per share, respectively.
8.
RESTRUCTURING EXPENSES
In the fourth quarter of
2008, the Company recorded restructuring charges of $621 thousand for personnel
severance and other costs related to 24 individuals and $164 thousand related
to inventory costs of discontinued products, including a monitoring product the
manufacturer has informed the Company it no longer intends to support.
Shown below is a
reconciliation of restructuring costs for the year ended December 31, 2008
(in thousands):
|
|
Balance at
December 31,
|
|
Year Ended
December 31, 2008
|
|
Balance at
December 31,
|
|
|
|
2007
|
|
Costs Incurred
|
|
Payments/Settlements
|
|
2008
|
|
Severance pay,
benefits and other
|
|
$
|
|
|
$
|
621
|
|
$
|
(43
|
)
|
$
|
578
|
|
Products and
other
|
|
|
|
164
|
|
(164
|
)
|
|
|
Total
|
|
$
|
|
|
$
|
785
|
|
$
|
(207
|
)
|
$
|
578
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
61
Table
of Contents
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The balance of $578 thousand
is included in accrued restructuring in the accompanying consolidated balance
sheets as of December 31, 2008 and is expected to be paid in full by July 31,
2009.
The Company had no customers
in 2006, 2007 and 2008 to whom sales represented 10% or more of total
revenue. No customer represented 10% or
more of total accounts receivable at December 31, 2007 or 2008.
10.
|
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 the years ended December 31,
2008, 2007 and 2006, royalties of $580 thousand, $559 thousand and $722
thousand became payable under these agreements, respectively.
The Company has a contract
with one supplier for unconditional annual minimum inventory purchases totaling
approximately $2.7 million in fiscal 2009.
The Company has entered into
operating leases for its office and research facilities and certain equipment
with future minimum payments as of December 31, 2008 as follows (in
thousands):
Year Ending December 31,
|
|
|
|
|
2009
|
|
$
|
2,045
|
|
2010
|
|
1,908
|
|
2011
|
|
1,873
|
|
2012
|
|
1,916
|
|
2013
|
|
1,869
|
|
Thereafter
|
|
20,218
|
|
|
|
$
|
29,829
|
|
The Company had rent expense
of $1.8 million, $1.9 million and $2.1 million in 2006, 2007 and 2008,
respectively.
From time to time, the
Company may be involved in litigation relating to claims arising out of its
operations. At December 31, 2008,
the Company had no material litigation pending.
The Companys 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 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
Companys warranty reserve on December 31, 2008 was $201 thousand.
The Companys licensing
arrangements generally include a product indemnification provision that will
indemnify and defend a licensee in actions brought against the licensee that
claim the Companys patents infringe upon a copyright, trade secret or valid patent. Historically, the Company has not incurred
any significant costs related to product indemnification claims, and as a
result, does not maintain a reserve for such exposure.
62
Table of Contents
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11.
SEGMENT REPORTING
The Company is comprised of
two reportable segments, Core Companion Animal Health (CCA) and Other
Vaccines, Pharmaceuticals and Products (OVP).
The Core Companion Animal Health segment includes diagnostic instruments
and supplies, as well as single use diagnostic and other tests, pharmaceuticals
and vaccines, primarily for canine and feline use. 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 segments assets are transferred at cost and are not
recorded as revenue for the OVP segment.
The Other Vaccines, Pharmaceuticals and Products segment includes
private label vaccine and pharmaceutical production, primarily for cattle, but
also for other animals including small mammals and fish. All OVP products are sold by third parties
under third-party labels.
Additionally, the Company
generates non-product revenue from research and development projects for third
parties, licensing of technology and royalties.
The Company performs these research and development projects for both
companion animal and livestock purposes.
63
Table of Contents
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Summarized financial
information concerning the Companys reportable segments is shown in the
following table (in thousands):
|
|
Core
Companion
Animal
Health
|
|
Other Vaccines,
Pharmaceuticals
and Products
|
|
Total
|
|
2006:
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
62,968
|
|
$
|
12,092
|
|
$
|
75,060
|
|
Operating income
|
|
2,780
|
|
295
|
|
3,075
|
|
Interest expense
|
|
809
|
|
435
|
|
1,244
|
|
Total assets
|
|
26,112
|
|
12,383
|
|
38,495
|
|
Net assets
|
|
4,410
|
|
2,338
|
|
6,748
|
|
Capital
expenditures
|
|
810
|
|
379
|
|
1,189
|
|
Depreciation and
amortization
|
|
765
|
|
906
|
|
1,671
|
|
Amortization of
intangible assets
|
|
334
|
|
|
|
334
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Core
Companion
Animal
Health
|
|
Other Vaccines,
Pharmaceuticals
and Products
|
|
Total
|
|
2007:
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
67,279
|
|
$
|
15,056
|
|
$
|
82,335
|
|
Operating income
|
|
1,862
|
|
3,659
|
|
5,521
|
|
Interest expense
|
|
429
|
|
292
|
|
721
|
|
Total assets
|
|
62,414
|
|
13,177
|
|
75,591
|
|
Net assets
|
|
35,666
|
|
7,217
|
|
42,883
|
|
Capital
expenditures
|
|
1,416
|
|
941
|
|
2,357
|
|
Depreciation and
amortization
|
|
1,295
|
|
888
|
|
2,183
|
|
Amortization of
intangible assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Core
Companion
Animal
Health
|
|
Other Vaccines,
Pharmaceuticals
and Products
|
|
Total
|
|
2008:
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
68,140
|
|
$
|
13,513
|
|
$
|
81,653
|
|
Operating income
(loss)
|
|
(2,220
|
)
|
1,539
|
|
(681
|
)
|
Interest expense
|
|
474
|
|
150
|
|
624
|
|
Total assets
|
|
58,581
|
|
11,857
|
|
70,438
|
|
Net assets
|
|
34,602
|
|
7,921
|
|
42,523
|
|
Capital
expenditures
|
|
216
|
|
338
|
|
554
|
|
Depreciation and
amortization
|
|
2,341
|
|
925
|
|
3,266
|
|
Amortization of
intangible assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
64
Table
of Contents
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Total
revenue by principal geographic area was as follows (in thousands):
|
|
For the Years Ended December 31,
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
63,828
|
|
$
|
69,389
|
|
$
|
69,062
|
|
Europe
|
|
5,974
|
|
4,088
|
|
4,413
|
|
Other
International
|
|
5,258
|
|
8,858
|
|
8,178
|
|
Total
|
|
$
|
75,060
|
|
$
|
82,335
|
|
$
|
81,653
|
|
Total assets by principal
geographic areas were as follows (in thousands):
|
|
December 31,
|
|
|
|
2006
|
|
2007
|
|
2008
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
33,395
|
|
$
|
72,585
|
|
$
|
67,207
|
|
Europe
|
|
5,100
|
|
3,006
|
|
3,231
|
|
Other
International
|
|
|
|
|
|
|
|
Total
|
|
$
|
38,495
|
|
$
|
75,591
|
|
$
|
70,438
|
|
12. QUARTERLY FINANCIAL INFORMATION (unaudited)
The following summarizes
selected quarterly financial information for each of the two years in the
periods ended December 31, 2007 and 2008 (amounts in thousands, except per
share data).
|
|
Q1
|
|
Q2
|
|
Q3
|
|
Q4
|
|
Total
|
|
2007:
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
22,715
|
|
$
|
20,087
|
|
$
|
19,491
|
|
$
|
20,042
|
|
$
|
82,335
|
|
Gross profit
|
|
10,360
|
|
8,301
|
|
7,608
|
|
6,918
|
|
33,187
|
|
Operating income
|
|
2,650
|
|
1,210
|
|
1,133
|
|
528
|
|
5,521
|
|
Net income
|
|
2,394
|
|
1,033
|
|
1,012
|
|
30,369
|
|
34,808
|
|
Net income per
share basic
|
|
0.05
|
|
0.02
|
|
0.02
|
|
0.59
|
|
0.68
|
|
Net income per
share diluted
|
|
0.04
|
|
0.02
|
|
0.02
|
|
0.55
|
|
0.63
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008:
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
21,918
|
|
$
|
22,615
|
|
$
|
21,686
|
|
$
|
15,434
|
|
$
|
81,653
|
|
Gross profit
|
|
7,736
|
|
8,571
|
|
8,196
|
|
4,341
|
|
28,844
|
|
Operating income
(loss)
|
|
(223
|
)
|
1,386
|
|
1,098
|
|
(2,942
|
)
|
(681
|
)
|
Net income
(loss)
|
|
(226
|
)
|
666
|
|
577
|
|
(1,867
|
)
|
(850
|
)
|
Net income
(loss) per share basic
|
|
(0.00
|
)
|
0.01
|
|
0.01
|
|
(0.04
|
)
|
(0.02
|
)
|
Net income
(loss) per share diluted
|
|
(0.00
|
)
|
0.01
|
|
0.01
|
|
(0.04
|
)
|
(0.02
|
)
|
65
Table of Contents
Item 9.
|
Changes
in and Disagreements with Accountants on Accounting and Financial Disclosure.
|
None.
Item 9A.
|
Controls and Procedures.
|
Evaluation of Disclosure Controls and Procedures
.
Our management, with the
participation of our chief executive officer and our chief financial officer,
evaluated the effectiveness of our disclosure controls and procedures, as
defined by Rule 13a-15 of the Exchange Act, as of the period covered by
this Annual Report on Form 10-K.
Based on this evaluation, our chief executive officer and chief
financial officer have concluded that our disclosure controls and procedures
are adequate to provide reasonable assurance that information we are required
to disclose in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SECs rules and forms and that such information is accumulated and
communicated to our management, including our chief executive officer and chief
financial officer, as appropriate, to allow timely decisions regarding
disclosure.
Managements Report on Internal Control Over Financial Reporting.
Our management is
responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under
the Exchange Act. Under the supervision
and with the participation of our management, including our chief executive
officer and chief financial officer, the Company conducted an evaluation of the
effectiveness of its internal control over financial reporting based on
criteria outlined in the COSO Internal Control over Financial Reporting
Guidance for Smaller Public Companies, a supplemental implementation guide
issued in 2007 which modified criteria established in the framework in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
Based on this evaluation, the Companys management has concluded that
the Companys internal control over financial reporting was effective as of December 31,
2008.
Because of its inherent
limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to
future periods are subject to the risks that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate. Accordingly, even an effective system
of internal control will provide only reasonable assurance that the objectives
of the internal control system are met.
The effectiveness of our
internal control over financial reporting as of December 31, 2008, has
been audited by Ehrhardt Keefe Steiner & Hottman PC, an independent
registered public accounting firm, as stated in their report, which is included
herein.
Changes in Internal Control over Financial Reporting
.
There has been no change in our
internal control over financial reporting during the fourth fiscal quarter
covered by this Form 10-K that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
Item 9B.
|
Other
Information.
|
None.
66
Table
of Contents
PART III
Certain information required
by Part III is incorporated by reference to our definitive Proxy Statement
filed with the Securities and Exchange Commission in connection with the
solicitation of proxies for our 2008 Annual Meeting of Stockholders.
Item
10. Directors and Executive Officers of
the Registrant.
Executive
Officers
The information required by
this item with respect to executive officers is incorporated by reference to
Item 1 of this report and can be found under the caption Executive Officers.
Directors
The information required by
this section with respect to our directors will be incorporated by reference to
the information in the sections entitled Election of Directors and Section 16(a) Beneficial
Ownership Reporting Compliance in the Proxy Statement.
Code of
Ethics
Our Board of Directors has
adopted a code of ethics for our senior executive and financial officers
(including our principal executive officer, principal financial officer and
principal accounting officer). The code
of ethics is available on our website at www.heska.com. We intend to disclose any amendments to or
waivers from the code of ethics at that location.
Audit Committee
The information required by
this section with respect to our Audit Committee will be incorporated by
reference to the information in the section entitled Directors and Executive
Officers in the Proxy Statement.
Section 16(a) Beneficial
Ownership Reporting Compliance
The information required by
this item is incorporated by reference to the information in the section
entitled Section 16(a) Beneficial Ownership Reporting Compliance in the
Proxy Statement.
Item
11. Executive Compensation.
The information required by
this section will be incorporated by reference to the information in the
sections entitled Director Compensation and Executive Compensation in the
Proxy Statement.
Item
12. Security Ownership of Certain
Beneficial Owners and Management.
The information required by
this section will be incorporated by reference to the information in the
section entitled Common Stock Ownership of Certain Beneficial Owners and
Management in the Proxy Statement.
67
Table of Contents
Item
13. Certain Relationships and Related
Transactions.
The
information required by this section will be incorporated by reference to the
information in the sections entitled Executive CompensationEmployment,
Severance and Change of Control Agreements, Certain Transactions and
Relationships and Directors and Executive Officers in the Proxy Statement.
Item 14.
Principal Accountant Fees and Services.
The information required by
this section will be incorporated by reference to the information in the
section entitled Auditor Fees and Services in the Proxy Statement.
The information required by Part III
to the extent not set forth herein, will be incorporated herein by reference to
our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders.
68
Table of Contents
PART IV
Item
15. Exhibits and Financial Statement
Schedules.
(a) The following documents are filed as a part of this Form 10-K.
(1) Financial Statements:
Reference
is made to the Index to Consolidated Financial Statements under Item 8 in Part II
of this Form 10-K.
(2) Financial Statement Schedules:
Schedule
II Valuation and Qualifying Accounts.
SCHEDULE II
HESKA CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(amounts
in thousands)
|
|
Balance at
Beginning
of Year
|
|
Additions
Charged to
Costs and
Expenses
|
|
Other
Additions
|
|
Deductions
|
|
Balance at
End of Year
|
|
Allowance
for doubtful accounts
|
|
|
|
|
|
|
|
|
|
|
|
Year ended:
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2006
|
|
$
|
88
|
|
$
|
46
|
|
|
|
$
|
(36
|
)(a)
|
$
|
98
|
|
December 31,
2007
|
|
$
|
98
|
|
$
|
26
|
|
|
|
$
|
(28
|
)(a)
|
$
|
96
|
|
December 31,
2008
|
|
$
|
96
|
|
$
|
137
|
|
|
|
$
|
(24
|
)(a)
|
$
|
209
|
|
(a)
Write-offs of
uncollectible accounts.
69
Table of Contents
(3) Exhibits:
The exhibits listed below
are required by Item 601 of Regulation S-K.
Each management contract or compensatory plan or arrangement required to
be filed as an exhibit to this Form 10-K has been identified.
Exhibit
Number
|
|
Notes
|
|
Description of Document
|
3(i)
|
|
(2)
|
|
Restated
Certificate of Incorporation of the Registrant.
|
3(ii)
|
|
(4)
|
|
Bylaws
of the Registrant.
|
10.1*
|
|
(12)
|
|
1997 Incentive Stock Plan
of Registrant, as amended and restated.
|
10.2*
|
|
(12)
|
|
1997 Incentive Stock Plan
Employees and Consultants Option Agreement.
|
10.3*
|
|
(12)
|
|
1997 Incentive Stock Plan
Outside Directors Option Agreement.
|
10.4*
|
|
|
|
2003 Equity Incentive
Plan, as amended and restated.
|
10.5*
|
|
|
|
2003 Equity Incentive Plan
Option Agreement.
|
10.6*
|
|
(15)
|
|
1997 Employee Stock
Purchase Plan of Registrant, as amended.
|
10.7*
|
|
(11)
|
|
Management
Incentive Plan Master Document.
|
10.8*
|
|
(17)
|
|
2009 Management Incentive
Plan.
|
10.9*
|
|
(13)
|
|
Director Compensation
Policy, effective January 1, 2007.
|
10.10*
|
|
(14)
|
|
Form of
Indemnification Agreement entered into between Registrant and its directors
and certain officers.
|
10.11*
|
|
(10)
|
|
Amended and Restated
Employment Agreement with Robert B. Grieve, dated March 29, 2006.
|
10.12*
|
|
(14)
|
|
Amendment to Employment
Agreement between Registrant and Robert B. Grieve, dated effective as of
January 1, 2008.
|
10.13*
|
|
(12)
|
|
Employment Agreement
between Registrant and Michael McGinley, dated May 1, 2000.
|
10.14*
|
|
(14)
|
|
Amendment to Employment
Agreement between Registrant and Michael McGinley, dated effective as of
January 1, 2008.
|
10.15*
|
|
(6)
|
|
Employment Agreement
between Registrant and Jason Napolitano, dated May 6, 2002.
|
10.16*
|
|
(14)
|
|
Amendment to Employment
Agreement between Registrant and Jason Napolitano, dated effective as of
January 1, 2008.
|
10.17*
|
|
(6)
|
|
Employment Agreement
between Registrant and Michael Bent, dated May 1, 2000.
|
10.18*
|
|
(14)
|
|
Amendment to Employment
Agreement between Registrant and Michael Bent, dated effective as of
January 1, 2008.
|
10.19
|
|
(8)
|
|
Net Lease Agreement
between Registrant and CCMRED 40, LLC, dated May 24, 2004.
|
10.20
|
|
(9)
|
|
First Amendment to Net
Lease Agreement and Development Agreement between Registrant and CCMRED 40,
LLC, dated February 11, 2005.
|
10.21
|
|
(9)
|
|
Second Amendment to Net
Lease Agreement between Registrant and CCMRED 40, LLC, dated July 14,
2005.
|
10.22+
|
|
(12)
|
|
Third Amended and Restated
Credit and Security Agreement between Registrant, Diamond Animal
Health, Inc. and Wells Fargo Business Credit, Inc., dated
December 30, 2005.
|
10.23+
|
|
(14)
|
|
First Amendment to Third
Amended and Restated Credit and Security Agreement between Registrant,
Diamond Animal Health, Inc. and Wells Fargo Bank, National Association,
dated December 5, 2006.
|
10.24+
|
|
(14)
|
|
Second Amendment to Third
Amended and Restated Credit and Security Agreement between Registrant,
Diamond Animal Health, Inc. and Wells Fargo Bank, National Association,
dated July 20, 2007.
|
10.25
|
|
(14)
|
|
Third Amendment to Third
Amended and Restated Credit and Security Agreement between Registrant,
Diamond Animal Health, Inc. and Wells Fargo Bank, National Association,
dated December 21, 2007.
|
70
Table
of Contents
Exhibit
Number
|
|
Notes
|
|
Description of Document
|
10.26+
|
|
(16)
|
|
Fourth and Fifth
Amendments to Third Amended and Restated Credit and Security Agreement
between Registrant, Diamond Animal Health, Inc. and Wells Fargo Bank,
National Association, dated October 16, 2008.
|
10.27+
|
|
|
|
Sixth Amendment to Third
Amended and Restated Credit and Security Agreement between Registrant,
Diamond Animal Health, Inc. and Wells Fargo Bank, National Association,
dated December 30, 2008.
|
10.28+
|
|
(1)
|
|
Product Supply Agreement
between Registrant and Quidel Corporation, dated July 3, 1997.
|
10.29+
|
|
(3)
|
|
First Amendment to Product
Supply Agreement between Registrant and Quidel Corporation, dated
March 15, 1999.
|
10.30
|
|
|
|
Letter Amendment to
Product Supply Agreement between Registrant and Quidel Corporation dated
July 7, 2004.
|
10.31+
|
|
(5)
|
|
Amended and Restated
Bovine Vaccine Distribution Agreement between Diamond Animal
Health, Inc. and Agri Laboratories, Ltd., dated September 30, 2002.
|
10.32+
|
|
(7)
|
|
First Amendment to Amended
and Restated Bovine Vaccine Distribution Agreement between Diamond Animal
Health, Inc. and Agri Laboratories, Ltd., dated September 20, 2004.
|
10.33+
|
|
(12)
|
|
Second Amendment to
Amended and Restated Bovine Vaccine Distribution Agreement between Diamond
Animal Health, Inc. and Agri Laboratories, Ltd., dated December 10,
2004.
|
10.34+
|
|
(12)
|
|
Third Amendment to Amended
and Restated Bovine Vaccine Distribution Agreement between Diamond Animal
Health, Inc. and Agri Laboratories, Ltd., dated May 26, 2006.
|
10.35+
|
|
(14)
|
|
Fourth Amendment to
Amended and Restated Bovine Vaccine Distribution Agreement between Diamond
Animal Health, Inc. and Agri Laboratories, Ltd., dated as of
November 16, 2007.
|
10.36+
|
|
(12)
|
|
Supply and Distribution
Agreement between Registrant and Boule Medical AB, dated June 17, 2003,
Letter Amendment to Supply and Distribution Agreement between Registrant and
Boule Medical AB, dated June 1, 2004 and Letter Amendment to Supply and
Distribution Agreement between Registrant and Boule Medical AB, dated
December 31, 2004.
|
10.37+
|
|
(16)
|
|
Letter Amendment to Supply
and Distribution Agreement between Registrant and Boule Medical AB, dated
July 12, 2005; Letter Amendment to Supply and Distribution Agreement
between Registrant and Boule Medical AB, dated March 20, 2007; Letter
Amendment to Supply and Distribution Agreement between Registrant and Boule
Medical AB, dated January 23, 2008; and Sixth Amendment to Supply and
Distribution Agreement between Registrant and Boule Medical AB, dated
October 1, 2008.
|
10.38+
|
|
(12)
|
|
Supply and License
Agreement between Registrant and Schering-Plough Animal Health Corporation,
dated as of August 1, 2003.
|
10.39+
|
|
|
|
Amendment No. 1 to
Supply and License Agreement between Registrant and Schering-Plough Animal
Health Corporation, dated August 31, 2005.
|
10.40+
|
|
(12)
|
|
Distribution Agreement
between Registrant and i-STAT Corporation, dated October 1, 2004.
|
10.41+
|
|
|
|
Amendment to Distribution
Agreement between Registrant and Abbott Point of Care, Abbott
Laboratories, Inc. (i-Stat), dated February 5, 2007.
|
10.42+
|
|
(12)
|
|
Distribution Agreement
between Registrant and Arkray Global Business, Inc. dated
November 1, 2004.
|
10.43+
|
|
(14)
|
|
Clinical Chemistry
Analyzer Agreement between Registrant and FUJIFILM Corporation dated as of
January 30, 2007.
|
21.1
|
|
|
|
Subsidiaries of the
Company.
|
71
Table
of Contents
Exhibit
Number
|
|
Notes
|
|
Description of Document
|
23.1
|
|
|
|
Consent of Ehrhardt
Keefe Steiner & Hottman PC, Independent Registered Public Accounting
Firm.
|
24.1
|
|
|
|
Power of Attorney (See Signature
Page of this Form 10-K).
|
31.1**
|
|
|
|
Certification of Chief
Executive Officer Pursuant to Rule 13a-14(a) and
Rule 15d-14(a) of the Securities Exchange Act, as amended.
|
31.2**
|
|
|
|
Certification of Chief
Financial Officer Pursuant to Rule 13a-14(a) and
Rule 15d-14(a) of the Securities Exchange Act, as amended.
|
32.1**
|
|
|
|
Certification of Chief
Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
Notes
*
|
|
Indicates
management contract or compensatory plan or arrangement.
|
+
|
Portions
of the exhibit have been omitted pursuant to a request for confidential
treatment.
|
**
|
|
Furnished herewith.
|
(1)
|
|
Filed with the Registrants Form 10-Q for the quarter ended
September 30, 1997.
|
(2)
|
|
Filed
with the Registrants Form 10-Q for the quarter ended June 30,
2000.
|
(3)
|
|
Filed
with the Registrants Form 10-K for the year ended December 31,
2001.
|
(4)
|
|
Filed
with the Registrants Form 10-Q for the quarter ended June 30,
2002.
|
(5)
|
|
Filed
with the Registrants Form 10-Q for the quarter ended September 30,
2002.
|
(6)
|
|
Filed
with the Registrants Form 10-K for the year ended December 31,
2002.
|
(7)
|
|
Filed
with the Registrants Form 10-Q for the quarter ended September 30,
2004.
|
(8)
|
|
Filed
with the Registrants Form 10-K for the year ended December 31,
2004.
|
(9)
|
|
Filed
with the Registrants Form 10-Q for the quarter ended June 30,
2005.
|
(10)
|
|
Filed
with the Registrants Form 10-K for the year ended December 31,
2005.
|
(11)
|
|
Filed
with the Registrants Form 10-Q for the quarter ended March 31,
2006.
|
(12)
|
|
Filed
with the Registrants Form 10-K for the year ended December 31,
2006.
|
(13)
|
|
Filed
with the Registrants Form 8-K dated March 5, 2007.
|
(14)
|
|
Filed
with the Registrants Form 10-K for the year ended December 31,
2007.
|
(15)
|
|
Filed
with the Registrants Form 10-Q for the quarter ended June 30,
2008.
|
(16)
|
|
Filed
with the Registrants Form 10-Q for the quarter ended September 30,
2008.
|
(17)
|
|
Filed
with the Registrants Form 8-K dated November 10, 2008.
|
72
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of
the Securities Exchange Act of 1934, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized, on March 16,
2009.
|
HESKA
CORPORATION
|
|
|
|
By:
|
/s/
ROBERT B. GRIEVE
|
|
|
Robert
B. Grieve
|
|
|
Chairman
of the Board and Chief Executive Officer
|
POWER
OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person
whose signature appears below constitutes and appoints Robert B. Grieve, Jason
A. Napolitano and Michael A. Bent, and each of them, his or her true and lawful
attorneys-in-fact, each with full power of substitution, for him or her in any
and all capacities, to sign any amendments to this report on Form 10-K and
to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact or their substitute or
substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities and
Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated:
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
/s/ ROBERT B. GRIEVE
|
|
Chairman of the Board
and Chief Executive
|
|
|
Robert
B. Grieve
|
|
Officer (Principal
Executive Officer) and Director
|
|
March 16,
2009
|
|
|
|
|
|
/s/ JASON A. NAPOLITANO
|
|
Executive Vice
President, Chief Financial Officer
|
|
March 16,
2009
|
Jason
A. Napolitano
|
|
and Secretary
(Principal Financial Officer)
|
|
|
|
|
|
|
|
/s/ MICHAEL A. BENT
|
|
Vice President,
Controller (Principal Accounting
|
|
March 16,
2009
|
Michael
A. Bent
|
|
Officer)
|
|
|
|
|
|
|
|
/s/ WILLIAM A.
AYLESWORTH
|
|
Director
|
|
March 16,
2009
|
William
A. Aylesworth
|
|
|
|
|
|
|
|
|
|
/s/ PETER EIO
|
|
Director
|
|
March 16,
2009
|
Peter
Eio
|
|
|
|
|
|
|
|
|
|
/s/ G. IRWIN GORDON
|
|
Director
|
|
March 16,
2009
|
G.
Irwin Gordon
|
|
|
|
|
|
|
|
|
|
/s/ LOUISE L. McCORMICK
|
|
Director
|
|
March 16,
2009
|
Louise
L. McCormick
|
|
|
|
|
|
|
|
|
|
/s/ JOHN F.
SASEN, Sr.
|
|
Director
|
|
March 16,
2009
|
John
F. Sasen, Sr.
|
|
|
|
|
73
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