Gross Margin, i.e. gross profit
divided by total revenue, increased to 36.6% for the three months ended March 31, 2009 as
compared to 35.3% in the corresponding period in 2008. Product mix and improved
pricing were key factors in the margin increase. This was somewhat offset by significantly lower
margins in our OVP segment where our fixed costs were spread over a significantly lower revenue base.
We expect Gross Margin to be flat or down slightly for 2009 as compared to 2008.
Operating Expenses
Total operating expenses decreased 20% to $6.4 million in the three months ended March 31, 2009 as compared to $8.0 million in the prior year period.
Selling and marketing expenses decreased 24% to $3.8 million in the three months ended March 31, 2009 as compared to $4.9 million in the corresponding period in 2008. Key factors in the decline were lower spending related to product launches and lower commissions.
Research and development expenses were $446 thousand for the three months ended March 31, 2009, a decline of approximately $93 thousand as compared to $539 thousand in the corresponding period in 2008. A key factor in the decline was lower spending on research and development resources, such as laboratory supplies.
General and administrative expenses were $2.2 million in the three months ended March 31, 2009, down 14% from $2.5 million in the prior year period. A factor in the change was savings resulting from our year-end restructuring.
We expect
2009 operating expenses will be lower than in 2008.
Interest and Other Expense, Net
Interest
and other expense, net was $165 thousand in the three months ended March 31, 2009, a slight decrease as
compared to $166 thousand in the prior year period. Interest and other expense, net can be broken into
two components: net interest expense and net foreign currency gain (or loss). Net interest expense was
$139 thousand in the three months ended March 31, 2009, a decrease
of $49 thousand from $188 thousand in the prior year period. Lower loan balances and lower
interest rates, somewhat offset by an increased interest rate spread negotiated with our bank in
December, were responsible for the decline. In the three months ended March 31, 2009, net
foreign currency loss was $26 thousand, a change of $48 thousand from a net foreign
currency gain of $22 thousand in the prior year period.
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)
Income
tax expense was $392 thousand in the three months ended March 31, 2009, a $555 thousand
increase as compared to a tax benefit of $163 thousand in the prior year period. In both periods,
the tax entry was primarily non-cash and offsetting either an increase or decrease in our deferred
tax assets. The tax benefit recorded in the prior year period was due to an anticipated future
tax benefit from the loss occurring in that period and increased our deferred tax assets.
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.
Net Income
Net income
was $460 thousand in the three months ended March 31, 2009, an increase of approximately $686 thousand
compared to net loss of $226 thousand in the prior year period. As discussed above, the increase was
primarily due to lower operating expenses.
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 and Capital Resources
We have incurred net cumulative negative cash flow from operations since our inception in 1988. For the three months ended March 31 2009, we had a net income of $460 thousand. During the three months ended March 31, 2009, our operations provided cash of approximately $981 thousand. At March 31, 2009, we had $4.4 million of cash and cash equivalents, $10.1 million of working capital,
$10.0 million of outstanding borrowings under our revolving line of credit, discussed below, and $957 thousand of other debt.
Net cash
provided by operating activities was approximately $981 thousand for the three months ended March 31, 2009
as compared to $597 thousand of cash used in operating activities in the prior year period, an improvement
of approximately $1.6 million. Major factors in the change were a $1.7 million increase in
cash provided by inventory as we reduced our overall inventory levels, an increase of $1.5 million in cash
provided by accounts payable which was somewhat offset by $595 thousand in cash used for
accrued liabilities, an increase in net income of $686 thousand, a reduction in cash used for deferred revenue and other
liabilities of $673 thousand and a $563 thousand increase in cash provided related to deferred tax
expense. These factors were somewhat offset by a $2.6 million increase in cash used
for accounts receivable as we recognized a relatively large portion of revenue late in the
three months ended March 31, 2009.
Net cash
flows from investing activities used cash of $22 thousand in the three months ended March 31, 2009,
a decline of nearly $500 thousand compared to $518 thousand during the corresponding period in 2008.
All expenditures were for the purchase of property and equipment in both cases.
Net cash
flows used in financing activities was $1.2 million during the three months ended March 31, 2009, a $2.4 million
change as compared to providing $1.2 million during the corresponding period in 2008. The primary reason
for the change is a $2.3 million change related to our revolving line of credit with Wells
Fargo, where we borrowed an additional $1.3 million in the three months ended
March 31, 2008 and repaid nearly $1 million in the three months ended March 31, 2009. In addition,
proceeds from the issuance of common stock declined by $68 thousand as a result of option exercises
which occurred in the three months ended March 31, 2008, but not 2009.
At March 31, 2009, we had a $15.0 million asset-based revolving line of credit with Wells Fargo which has a maturity date of June 30, 2011 as part of our credit and security agreement with Wells Fargo. At March 31, 2009, $10.0 million was outstanding under this line of credit. Our ability to borrow under this facility varies based upon available cash, eligible accounts receivable and
eligible inventory. On March 31, 2009, 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 to become immediately due and payable or impact our ability to borrow under the agreement. Any default under the Wells Fargo agreement could also accelerate the repayment of our other borrowings. We were in compliance with all financial covenants as of March 31, 2009. At March 31, 2009, we
had $2.2 million borrowing capacity based upon eligible accounts receivable and eligible inventory under our revolving line of credit.
At
March 31, 2009, we also had outstanding obligations for long-term debt totaling approximately
$957 thousand related to three term loans with Wells Fargo. One term loan is secured by real
estate in Iowa and had an outstanding balance at March 31, 2009 of approximately $216 thousand due in
monthly installments of $17,658 plus interest. The term loan had a stated interest rate of
prime plus 2.50% on March 31, 2009 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, respectively (the "Equipment Notes").
The Equipment Notes
had an outstanding balance at March 31, 2009 of approximately $741 thousand with principal payments on the
Equipment Notes of $46,296 plus interest due in monthly installments. The Equipment Notes had a stated
interest rate of prime plus 2.50% as of March 31, 2009 and are to be paid in full in August 2010.
At March 31, 2009, we had deferred revenue and other long-term liabilities, net of current portion, of approximately $3.7 million. Included in this total is approximately $3.4 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 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 and sell our products, are successful in increasing
revenue, competition, the extent to which currently planned products and/or technologies are successfully developed,
launched and sold, changes required 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. However, our actual results may differ from this plan, and we may be required to consider alternative strategies. We may be
required to raise additional capital in the future. If necessary, we expect to raise these additional funds through the sale of equity 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.
Recent Accounting Pronouncements
None.
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact the financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk in the areas of changes in United States and foreign interest rates and changes in foreign currency exchange rates as measured against the United States dollar and
against other foreign currency exchange rates. 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 March 31, 2009, approximately $11 million was outstanding on these lines of credit and other borrowings with a weighted average interest rate of 5.75%. We also had approximately $4.4 million of
cash and cash equivalents at March 31, 2009, the majority of which was invested in liquid interest bearing accounts. We had no interest rate hedge transactions in place on March 31, 2009. 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 net interest expense of approximately
$66 thousand based on our outstanding balances as of March 31, 2009.
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 customers and suppliers 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 March 31, 2009.
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 results of
operations for the most recent 12 months, 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 $735 thousand.
Item 4.
CONTROLS AND PROCEDURES
(a)
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 end of the period covered by this Quarterly Report on
Form 10-Q. Based on this evaluation, our chief executive officer and our 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 SEC's 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 required disclosure.
(b)
Changes in Internal Control over Financial Reporting
. There was no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1.
|
Legal Proceedings
|
From time to time, we may be involved in litigation relating to claims arising out of our operations. As of March 31, 2009, we were not a party to any legal proceedings that are expected, individually or in the aggregate, to have a material effect on our business, financial condition or operating results.
Our future operating results may vary substantially from period to period due to a number of factors, many of which are beyond our control. The following discussion highlights 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. We recently received notice
that one of our major third-party suppliers has decided to cancel our agreement and we expct to lose
access to the corresponding product line in November 2009.
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 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.
Currently,
the largest of these suppliers is Abbott Point of Care Inc. ("APOC"), formerly known as
i-STAT Corporation, a unit of Abbott Laboratories. Approximately 18% of our trailing 12-month revenue
is related to the proprietary products manufactured by APOC (the "iSTAT Products"). On May 1, 2009,
APOC informed us that they were canceling our contractual agreement as of November 1, 2009. Under our
agreement with APOC, our rights became non-exclusive upon receipt of such notice. We subsequently
learned through an 8-K filing with the SEC that Abaxis, Inc. ("Abaxis"), one of our major competitors,
had signed an agreement with APOC to distribute certain iSTAT Products into the animal health market and
that such rights are to be exclusive outside of Japan on November 1, 2009. Through November 1, we may
face severe competition to service the customers who purchase iSTAT Products, including the currently
existing base of users and customers who purchase our other products, which could significantly lower our
revenue and gross margin and increase our sales and marketing and other expenses. After November 1, our
ability to compete in this area will be severely hampered as we do not expect to have access to iSTAT Products
to sell to our installed base of customers and thus anticipate a significant decline in revenue and gross
margin related to iSTAT Products as a result. There can be no assurance we will be able to find an
alternative product to the iSTAT Products, that any such product could compete effectively against the
iSTAT Products, directly or in a niche, or that any such product will be available in a timely and
economic manner. In addition, under our contract with APOC, we may only sell inventory for a given
period after contract termination, so that we could face significant inventory reserves and losses if
we do not sell iSTAT Products as currently expected.
Other major suppliers
who sell us proprietary products which are responsible for more than 5% of our trailing 12-month
revenue are Arkray Global Business, Inc., Boule Medical AB, FUJIFILM Corporation and Quidel Corporation. None of
these suppliers sell us proprietary products
which are responsible for more than 15% of our revenue, although the proprietary
products of two are 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. Although we believe we have
arrangements to ensure supply of our other major product offerings other than the iSTAT Products
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
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 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. The loss of distribution rights for products or failure to gain access
to new products may cause damage to our reputation and adversely affect our business and future prospects.
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 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 distributor's 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 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 segment's 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,
recently launched a canine heartworm diagnostic test competitive with ours. On May 1, 2009, APOC informed
us that they were canceling our contratual agreement as of November 1, 2009. Under our agreement with
APOC, our rights became non-exclusive upon receipt of such notice. We subsequently learned through an
8-K filing with the SEC that Abaxis had signed an agreement with APOC to distribute certain iSTAT Products
into the animal health market and that such rights are to be exclusive outside of Japan on November 1, 2009.
Through November 1, we may face severe competition to service the customers who purchase iSTAT Products,
including the currently existing base of users and customers who purchase our other products, which could
significantly lower our revenue and gross margin and increase our sales and marketing and other expenses.
After November 1, our ability to compete in this area will be severly hampered as we do not expect to have
access to iSTAT Products to sell to our installed base of customers and thus anticipate a significant
decline in revenue and gross margin related to iSTAT Products as a result. There can be no assurance
we will be able to find an alternative product to the iSTAT Products, that any such product could compete
effectively against the iSTAT Products, directly or in a niche, or that any such product will be
available in a timely and economic manner.
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.
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.
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.
The loss
of significant customers could harm our operating results.
Sales to SPAH
accounted for 12% of total revenue for the three months ended March 31, 2009. Sales to no single customer
accounted for more than 10% of our consolidated revenue for the three months ended
March 31, 2008. SPAH accounted for 16% and 14% of our consolidated accounts receivable at
March 31, 2009 and 2008, respectively. 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.
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.
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.
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 Corporation. 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 March 31, 2009, we had an
accumulated deficit of $173.6 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.
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 price enforcement until July 20, 2009, when the compliance process will be reinstated;
we are to have 180 calendar days from July 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. 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;
|
|
•
|
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.
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 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 $1.51. 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;
|
|
•
|
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 company's 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 management's attention and resources would be diverted from operating our business in order to respond to the
litigation.
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 product's 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 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 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.
Item 2.
|
Unregistered Sales of Equity Securities and Use of Proceeds
|
Item 3.
|
Defaults upon Senior Securities
|
Item 4.
|
Submission of Matters to a Vote of Security Holders
|
Item 5.
|
Other Information
|
Item 6. Exhibits
|
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.
|
HESKA CORPORATION
SIGNATURES
Pursuant to the requirements 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.
Date:
|
May 11, 2009
|
By
|
/s/ Robert B. Grieve
|
|
|
|
ROBERT B. GRIEVE
|
|
|
|
Chairman of the Board and Chief Executive Officer
(on behalf of the Registrant and as the Registrant's Principal Executive Officer)
|
|
|
|
|
Date:
|
May 11, 2009
|
By
|
/s/ Jason A. Napolitano
|
|
|
|
JASON A. NAPOLITANO
|
|
|
|
Executive Vice President and Chief Financial Officer
(on behalf of the Registrant and as the Registrant's Principal Financial Officer)
|
Heska (NASDAQ:HSKA)
Historical Stock Chart
From May 2024 to Jun 2024
Heska (NASDAQ:HSKA)
Historical Stock Chart
From Jun 2023 to Jun 2024