-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ip+hasbD69Nyy/u7Y8m4TppsvJ15BPCYVIFfKP8M8JtKr/Kf752kYlcbggn0hY7g DxwgqNTY9CAuowqo5A09qQ== 0001038133-01-500016.txt : 20010511 0001038133-01-500016.hdr.sgml : 20010511 ACCESSION NUMBER: 0001038133-01-500016 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010510 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HESKA CORP CENTRAL INDEX KEY: 0001038133 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 770192527 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 333-72155 FILM NUMBER: 1629062 BUSINESS ADDRESS: STREET 1: 1613 PROSPECT PARKWAY CITY: FORT COLLINS STATE: CO ZIP: 80525 BUSINESS PHONE: 9704937272 MAIL ADDRESS: STREET 1: 1825 SHARP POINT DR CITY: FORT COLLINS STATE: CO ZIP: 80525 10-Q 1 quarterly.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to ____________ Commission file number 000-22427 HESKA CORPORATION (Exact name of Registrant as specified in its charter)
Delaware 77-0192527 ---------------------- ----------------------- ---- [State or other [I.R.S. Employer jurisdiction Identification No.] of incorporation or organization]
1613 PROSPECT PARKWAY FORT COLLINS, COLORADO 80525 (Address of principal executive offices) (970) 493-7272 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [ X ] Yes [ ] No The number of shares of the Registrant's Common Stock, $.001 par value, outstanding at May 9, 2001 was 38,667,328 ================================================================================ HESKA CORPORATION FORM 10-Q QUARTERLY REPORT TABLE OF CONTENTS
PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Consolidated Balance Sheets (Unaudited) as of March 31, 2001 and December 31, 2000 3 Consolidated Statements of Operations (Unaudited) for the three months ended March 31, 2001 and 2000 4 Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2001 and 2000 5 Notes to Consolidated Financial Statements (Unaudited) 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk 23 PART II. OTHER INFORMATION Item 1. Legal Proceedings Not Applicable Item 2. Changes in Securities and Use of Proceeds 24 Item 3. Defaults Upon Senior Securities Not Applicable Item 4. Submission of Matters to a Vote of Security Holders Not Applicable Item 5. Other Information Not Applicable Item 6. Exhibits and Reports on Form 8-K 24 Exhibit Index 24 Signatures 25
HESKA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (dollars in thousands except per share data) (unaudited)
ASSETS MARCH 31, DECEMBER 31, 2001 2000 --------- ------------ Current assets: Cash and cash equivalents $ 4,709 $ 3,176 Marketable securities - 2,482 Accounts receivable, net 8,656 8,433 Inventories, net 9,079 8,716 Other current assets 612 742 -------- -------- Total current assets 23,056 23,549 Property and equipment, net 12,239 12,901 Intangible assets, net 1,462 1,457 Restricted marketable securities and other assets 1,144 1,253 -------- -------- Total assets $ 37,901 $ 39,160 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 3,361 $ 3,370 Accrued liabilities 3,046 4,258 Deferred revenue 361 467 Current portion of capital lease obligations 503 584 Current portion of long-term debt 1,199 1,562 -------- -------- Total current liabilities 8,470 10,241 Capital lease obligations, net of current portion 92 138 Long-term debt, net of current portion 2,595 2,670 Other long-term liabilities 996 1,011 -------- -------- Total liabilities 12,153 14,060 -------- -------- Commitments and contingencies Stockholders' equity: Preferred stock, $.001 par value, 25,000,000 shares authorized; none outstanding - - Common stock, $.001 par value, 75,000,000 shares authorized; 38,656,945 and 34,072,640 shares issued and outstanding, respectively 39 34 Additional paid-in capital 205,117 199,789 Accumulated other comprehensive income (363) (251) Accumulated deficit (179,045) (174,472) --------- --------- Total stockholders' equity 25,748 25,100 --------- --------- Total liabilities and stockholders' equity $ 37,901 $ 39,160 ========= ========
See accompanying notes to consolidated financial statements HESKA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) (unaudited)
THREE MONTHS ENDED MARCH 31, --------------------- 2001 2000 --------------------- Revenues: Products, net $ 10,314 $ 12,423 Research, development and other 613 1,940 -------- -------- Total revenues 10,927 14,363 Cost of products sold 6,214 8,422 -------- -------- 4,713 5,941 -------- -------- Operating expenses: Selling and marketing 3,558 4,288 Research and development 3,455 4,003 General and administrative 2,096 2,819 Amortization of intangible assets and deferred 68 194 compensation Restructuring expense - 435 -------- -------- Total operating expenses 9,177 11,739 -------- -------- Loss from operations (4,464) (5,798) Other income (expense), net (108) (131) -------- -------- Net loss $ (4,572) $ (5,929) ======== ======== Basic and diluted net loss per share $ (0.12)$ (0.18) ======== ======== Shares used to compute basic and diluted net loss per share 37,029 33,602 ======== ========
See accompanying notes to consolidated financial statements HESKA CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
THREE MONTHS ENDED MARCH 31, ------------------ 2001 2000 ------- ------- CASH FLOWS USED IN OPERATING ACTIVITIES: Net cash used in operating activities $ (5,323) $ (9,462) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of marketable securities 2,500 12,267 Proceeds from disposition of property and equipment - 165 Purchase of property and equipment (300) (534) -------- -------- Net cash provided by investing activities 2,200 11,898 -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 5,332 120 Proceeds from borrowings - 1,101 Repayments of debt and capital lease obligations (567) (1,226) -------- -------- Net cash provided (used in) by financing activities 4,765 (5) -------- -------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (109) (49) -------- -------- INCREASE IN CASH AND CASH EQUIVALENTS 1,533 2,382 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,176 1,499 -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,709 $ 3,881 ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest $ 140 $ 380
See accompanying notes to consolidated financial statements HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 (UNAUDITED) 1. ORGANIZATION AND BUSINESS Heska Corporation ("Heska" or the "Company") is primarily focused on the discovery, development, manufacturing and marketing of companion animal health products. In addition to manufacturing certain of Heska's companion animal health products, the Company's primary manufacturing subsidiary, Diamond Animal Health, Inc. ("Diamond"), manufactures food animal vaccine and pharmaceutical products that are marketed and distributed by third parties. The Company also offers diagnostic services to veterinarians at its Fort Collins, Colorado and CMG-Heska Allergy Products S.A. ("CMG"), a Swiss corporation, locations. From the Company's inception in 1988 until early 1996, the Company's operating activities related primarily to research and development activities, entering into collaborative agreements, raising capital and recruiting personnel. Prior to 1996, the Company had not received any revenues from the sale of products. During 1996, Heska grew from being primarily a research and development concern to a fully-integrated research, development, manufacturing and marketing company. The Company accomplished this by acquiring Diamond, a licensed pharmaceutical and biological manufacturing facility in Des Moines, Iowa, hiring key employees and support staff, establishing marketing and sales operations to support new Heska products, and designing and implementing more sophisticated operating and information systems. The Company also expanded the scope and level of its scientific and business development activities, increasing the opportunities for new products. In 1997, the Company introduced additional products and expanded in the United States through the acquisition of Center, a Food and Drug Administration ("FDA") and United States Department of Agriculture ("USDA") licensed manufacturer of allergy immunotherapy products located in Port Washington, New York, and internationally through the acquisitions of Heska UK Limited ("Heska UK", formerly Bloxham Laboratories Limited), a veterinary diagnostic laboratory in Teignmouth, England and CMG (formerly Centre Medical des Grand'Places S.A.) in Fribourg, Switzerland, which manufactures and markets allergy diagnostic products for use in veterinary and human medicine, primarily in Europe. Each of the Company's acquisitions during this period was accounted for under the purchase method of accounting and accordingly, the Company's financial statements reflect the operations of these businesses only for the periods subsequent to the respective acquisitions. In July 1997, the Company established a new subsidiary, Heska AG, located near Basel, Switzerland, for the purpose of managing its European operations. During the first quarter of 1998 the Company acquired Heska Waukesha (formerly Sensor Devices, Inc.), a manufacturer and marketer of patient monitoring devices used in both animal health and human applications. The financial results of Heska Waukesha have been consolidated with those of the Company under the pooling-of-interests accounting method for all periods presented. During 1999 and 2000, the Company restructured and refocused its business. The operations of Heska Waukesha were combined with existing operations in Fort Collins, Colorado and Des Moines, Iowa during the fourth quarter of 1999. The Heska Waukesha facility was closed in December 1999. In March 2000, the Company sold Heska UK. The Company recorded a loss on disposition of approximately $1.0 million during 1999 for this sale. In June 2000, the Company sold Center. The Company recognized a gain on the sale of approximately $151,000. The Company has incurred net losses since its inception and anticipates that it will continue to incur additional net losses in the near term as it introduces new products, expands its sales and marketing capabilities and continues its research and development activities. Cumulative net losses from inception of the Company in 1988 through March 31, 2001 have totaled $179.0 million. The Company's primary short-term needs for capital, which are subject to change, are for its continuing research and development efforts, its sales, marketing and administrative activities, working capital associated with increased product sales and capital expenditures relating to our manufacturing operations. The Company's ability to achieve profitable operations will depend primarily upon its ability to successfully market its products, commercialize products that are currently under development and develop new products. Most of the Company's products are subject to long development and regulatory approval cycles and there can be no guarantee that the Company will successfully develop, manufacture or market these products. There can also be no guarantee that the Company will attain profitability or, if achieved, will remain profitable on a quarterly or annual basis in the future. Until the Company attains positive cash flow, the Company may continue to finance operations with additional equity and debt financing. There can be no guarantee that such financing will be available when required or will be obtained under favorable terms. The Company believes that its available cash, cash equivalents and marketable securities, together with cash from operations, available borrowings and borrowings expected to be available under its revolving line of credit facility will be sufficient to satisfy projected cash requirements into 2002, although it may raise additional funds at or before such time. Thereafter, if cash generated from operations is insufficient to satisfy its cash requirements, the Company will need to raise additional capital to continue its business operations. If necessary, the Company expects to raise these additional funds through one or more of the following: (1) sale of additional securities; (2) sale of various assets; (3) licensing of technology; and (4) sale of various products or marketing rights. If the Company cannot raise the additional funds through these options on acceptable terms or with the necessary timing, management could also reduce discretionary spending to decrease the Company's cash burn rate and extend the currently available cash, cash equivalents, marketable securities and available borrowings. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The balance sheet as of March 31, 2001, the statements of operations and comprehensive loss for the three months ended March 31, 2001 and 2000 and the statements of cash flows for the three months ended March 31, 2001 and 2000 are unaudited but include, in the opinion of management, all adjustments (consisting of normal recurring adjustments) which the Company considers necessary for a fair presentation of its financial position, operating results and cash flows for the periods presented. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries since the dates of their respective acquisitions when accounted for under the purchase method of accounting, and for all periods presented when accounted for under the pooling-of-interests method of accounting. All material intercompany transactions and balances have been eliminated in consolidation. Although the Company believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying financial statements and related disclosures have been prepared with the presumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these financial statements should be read in conjunction with the audited financial statements and the related notes thereto for the year ended December 31, 2000, included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 27, 2001. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Inventories, net Inventories are stated at the lower of cost or market using the first-in, first-out method. If the cost of inventories exceeds fair market value, provisions are made for the difference between cost and fair market value. Inventories consist of the following (in thousands):
MARCH 31, DECEMBER 31, 2001 2000 --------- ------------ Raw materials $ 2,625 $ 2,596 Work in process 3,362 2,904 Finished goods 3,723 3,822 Less reserves for losses (631) (606) --------- ---------- $ 9,079 $ 8,716 ========= ==========
Revenue Recognition Product revenues are recognized at the time goods are shipped to the customer with an appropriate provision for returns and allowances. License revenues under arrangements to sell product rights or technology rights are recognized upon the sale and completion by the Company of all obligations under the agreement. Royalties are recognized as products are sold to customers. The Company recognizes revenue from sponsored research and development over the life of the contract as research activities are performed. The revenue recognized is the lesser of revenue earned under a percentage of completion method based on total expected revenues or actual non-refundable cash received to date under the agreement. In addition to its direct sales force, the Company utilizes both distributors and sales agency organizations to sell its products. Distributors purchase goods from the Company, take title to those goods and resell them to their customers in the distributors' territory. Sales agents maintain inventories of goods on consignment from the Company and sell these goods on behalf of the Company to customers in the sales agents' territory. The Company recognizes revenue at the time goods are sold to the customers by the sales agents. Sales agents are paid a fee for their services, which include maintaining product inventories, sales activities, billing and collections. Fees earned by sales agents are netted against revenues generated by these entities. Basic and Diluted Net Loss Per Share Basic net loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed using the sum of the weighted average number of shares of common stock outstanding and, if not anti-dilutive, the effect of outstanding stock options and warrants determined using the treasury stock method. At December 31, 2000 and March 31, 2001, securities that have been excluded from diluted net loss per share because they would be anti-dilutive are outstanding options to purchase 3,964,668 and 4,299,754 shares, respectively, of the Company's common stock and warrants to purchase 1,165,000 shares of the Company's common stock as of each date. Foreign Currency Translation The functional currency of the Company's international subsidiaries is the Swiss Franc. Assets and liabilities of the Company's international subsidiaries are translated using the exchange rate in effect at the balance sheet date. Revenue and expense accounts are translated using an average of exchange rates in effect during the period. Cumulative translation gains and losses are included in accumulated other comprehensive income in the consolidated balance sheets. Exchange gains and losses arising from transactions denominated in foreign currencies (i.e., transaction gains and losses) are recognized in current operations. 3. RESTRUCTURING EXPENSES During the first quarter of fiscal 2000, the Company initiated a cost reduction and restructuring plan at its Diamond subsidiary. The restructuring resulted from the rationalization of Diamond's business including a reduction in the size of its workforce and the Company's decision to vacate a leased warehouse and distribution facility no longer needed after the Company's decision to discontinue contract manufacturing of certain low margin human healthcare products. The charge to operations of approximately $435,000 related primarily to personnel severance costs for 12 individuals and the costs associated with closing the leased facility, terminating the lease and abandoning certain leasehold improvements. The facility was closed in April 2000. As of March 31, 2001, the Company had approximately $115,000 in accrued liabilities for a leased facility closed at the end of fiscal 1999. 4. MAJOR CUSTOMERS One customer accounted for approximately 10% of total revenue during the three months ended March 31, 2001 and 2000. One customer accounted for approximately 10% and 11% of total net accounts receivable at March 31, 2001 and December 31, 2000, respectively. The customer purchased vaccines from Diamond. 5. SEGMENT REPORTING The Company divides its operations into three reportable segments. Companion Animal Health includes the operations of Heska, CMG and Heska AG. Food Animal Health includes the operations of Diamond Animal Health. Allergy Treatment includes the operations of Center, which was sold in June 2000. Summarized financial information concerning the Company's reportable segments is shown in the following table (in thousands). The "Other" column includes the elimination of intercompany transactions and other items as noted.
COMPANION FOOD ANIMAL ANIMAL ALLERGY HEALTH HEALTH TREATMENT OTHER TOTAL --------- --------- --------- ------- -------- THREE MONTHS ENDED MARCH 31, 2001: Revenues $ 8,112 $ 3,362 $ - $ (547) $ 10,927 Operating income (loss) (4,555) 91 - - (4,464) Total assets 51,080 17,744 - (30,923) 37,901 Capital expenditures 103 197 - - 300 Depreciation and amortization 565 397 - - 962 THREE MONTHS ENDED MARCH 31, 2000: Revenues $ 9,172 $ 4,121 $ 1,757 $ (687) $ 14,363 Operating income (loss) (5,435) 25 47 (435)(a) (5,798) Total assets 70,070 22,419 6,610 (35,416) 63,683 Capital expenditures 342 87 105 - 534 Depreciation and amortization 573 624 110 - 1,307
-------------- (a) Includes restructuring expenses of $435,000 (See Note 3). The Company manufactures and markets its products in two major geographic areas, North America and Europe. The Company's primary manufacturing facilities are located in North America. Revenues earned in North America are attributable to Heska, Diamond and Center (through June 2000). Revenues earned in Europe are primarily attributable to Heska UK (through January 2000), CMG and Heska AG. There have been no significant exports from North America or Europe. During the three months ended March 31, 2001 and 2000, European subsidiaries purchased products from North America for sale to European customers. Transfer prices to international subsidiaries are intended to allow the North American companies to earn profit margins commensurate with their sales and marketing efforts. Certain information by geographic area is shown in the following table (in thousands). The "Other" column includes the elimination of intercompany transactions.
NORTH AMERICA EUROPE OTHER TOTAL --------- -------- ------- ------- THREE MONTHS ENDED MARCH 31, 2001: Revenues $ 10,883 $ 591 $ (547) $ 10,927 Operating income (loss) (4,398) (66) - (4,464) Total assets 66,505 2,320 (30,924) 37,901 Capital expenditures 332 (32) - 300 Depreciation and amortization 955 7 - 962 THREE MONTHS ENDED MARCH 31, 2000: Revenues $ 14,209 $ 841 $ (687) $ 14,363 Operating income (loss) (5,084) (279) (435)(a) (5,798) Total assets 95,815 3,285 (35,417) 63,683 Capital expenditures 491 43 - 534 Depreciation and amortization 1,290 17 - 1,307
-------------- (a) Includes restructuring expenses of $435,000 (See Note 3). 6. SALE OF COMMON STOCK In February 2001, the Company sold 4,573,000 shares of common stock through a private placement offering with net proceeds of approximately $5.3 million and filed a registration statement covering resales of these shares. The Company intends to keep the registration statement effective until April 5, 2003, or such earlier date of the disposition of these shares, subject to the Company's right to suspend the use of the registration statement. 7. CREDIT FACILITY In March 2001, the Company entered into an amendment to its revolving line of credit facility. The Company's ability to borrow under this agreement varies based upon available cash, eligible accounts receivable and eligible inventory. The minimum liquidity (cash plus excess borrowing base) required to be maintained has been reduced to $3.0 million during 2001. As of March 31, 2001, the Company's available borrowing capacity was approximately $7.1 million. 8. COMPREHENSIVE INCOME Comprehensive income includes net income (loss) plus the results of certain stockholders' equity changes not reflected in the Consolidated Statements of Operations. Such changes include foreign currency items and unrealized gains and losses on certain investments in marketable securities. During the three months ended March 31, 2001, we realized a loss of approximately $22,000 on the sale of marketable securities. Total comprehensive income and the components of comprehensive income follow (in thousands):
Three Months Ended March 31, ----------------------- 2001 2000 -------- -------- Net loss per Consolidated Statements of Operations $ (4,572) $ (5,929) Foreign currency translation adjustments 157 24 Changes in unrealized loss on marketable securities (45) (34) -------- -------- Comprehensive loss $ (4,460) $ (5,939) ======== ========
9. SUBSEQUENT EVENT In April 2001, the Company entered into a series of forward contracts for the purchase of Japanese yen to be used for the purchase of inventory. The Company has adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Our actual results and the timing of certain events could differ materially from the results discussed in the forward-looking statements. When used in this discussion the words "expects," "anticipates," "believes," "continue," "could," "may," "will" and similar expressions are intended to identify forward-looking statements. Such statements, which include statements concerning future revenue sources and concentration, gross margins, research and development expenses, selling and marketing expenses, general and administrative expenses, capital resources, additional financings or borrowings and additional losses, are subject to risks and uncertainties, including those set forth below under "Factors that May Affect Results" that could cause actual results to differ materially from those projected. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions, or circumstances on which any such statement is based. OVERVIEW We discover, develop, manufacture and market companion animal health products. We have a sophisticated scientific effort devoted to applying biotechnology to create a broad range of pharmaceutical, vaccine and diagnostic products for the large and growing companion animal health market. In addition to our pharmaceutical, vaccine and diagnostic products, we also sell veterinary diagnostic and patient monitoring instruments and offer diagnostic services in the United States and Europe to veterinarians. Our primary manufacturing subsidiary, Diamond Animal Health, Inc., or Diamond, manufactures some of our companion animal products and food animal vaccine and pharmaceutical products, which are marketed and distributed by third parties. From our inception in 1988 until early 1996, our operating activities related primarily to research and development activities, entering into collaborative agreements, raising capital and recruiting personnel. Prior to 1996, we had not received any revenues from the sale of products. During 1996, we grew from being primarily a research and development concern to a fully- integrated research, development, manufacturing and marketing company. We accomplished this by acquiring Diamond, a licensed pharmaceutical and biological manufacturing facility in Des Moines, Iowa, hiring key employees and support staff, establishing marketing and sales operations to support our products introduced in 1996, and designing and implementing more sophisticated operating and information systems. We also expanded the scope and level of our scientific and business development activities, increasing the opportunities for new products. In 1997, we introduced 13 additional products and expanded in the United States through the acquisition of Center, an FDA and USDA licensed manufacturer of allergy immunotherapy products located in New York, and internationally through the acquisitions of Heska UK, a veterinary diagnostic laboratory in England and CMG in Switzerland, which manufactures and markets allergy diagnostic products for use in veterinary and human medicine, primarily in Europe. Each of our acquisitions during this period was accounted for under the purchase method of accounting and accordingly, our financial statements reflect the operations of these businesses only for the periods subsequent to the acquisitions. In July 1997, we established a new subsidiary, Heska AG, located near Basel, Switzerland, for the purpose of managing our European operations. During the first quarter of 1998 we acquired a manufacturer and marketer of patient monitoring devices. The financial results of this entity have been consolidated with ours under the pooling-of-interests accounting method for all periods presented. These operations were consolidated with our existing operations in Fort Collins, Colorado and Des Moines, Iowa as of December 31, 1999, and our facility in Waukesha, Wisconsin was closed. We sold our subsidiary in the United Kingdom, Heska UK, in March 2000. In June 2000, we completed the sale of Center. We have incurred net losses since our inception and anticipate that we will continue to incur additional net losses in the near term as we introduce new products, expand our sales and marketing capabilities and continue our research and development activities. Cumulative net losses from inception in 1988 through March 31, 2001 have totaled $179.0 million. Our ability to achieve profitable operations will depend primarily upon our ability to successfully market our existing products, commercialize products that are currently under development and develop new products. Most of our products are subject to long development and regulatory approval cycles, and we may not successfully develop, manufacture or market these products. We also may not attain profitability or, if achieved, may not remain profitable on a quarterly or annual basis in the future. Until we attain positive cash flow, we may continue to finance operations with additional equity and debt financing. Such financing may not be available when required or may not be obtained under favorable terms. See the discussion later in this section titled "Factors That May Affect Results" for a more in-depth explanation of risks faced by us. RESULTS OF OPERATIONS Three Months Ended March 31, 2001 and 2000 Total revenues, which include product, research and development and other revenues, decreased 24% to $10.9 million in the first quarter of 2001 compared to $14.4 million for the first quarter of 2000. Product revenues decreased 17% to $10.3 million in the first quarter of 2001 compared to $12.4 million for the first quarter of 2000. The total reported revenue for first quarter 2000 included approximately $1.8 million from businesses sold in fiscal 2000 and approximately $1.3 million attributable to the sale of worldwide rights to our PERIOceutic (TM) Gel product. No similar sales occurred during the quarter ended March 31, 2001. Revenue from our continuing core business (excluding sold businesses and discontinued product lines) declided by 2.6% in the first quarter of 2001 compared to the same quarter of the prior year. Gross profit margins on products sold improved by more than seven full percentage points over the first quarter of the prior year, as the sales mix contained a larger percentage of high margin Heska proprietary products. In addition, total operating expenses declined by more than $2.5 million from first quarter 2000 levels. Our net loss was reduced by $1.4 million for the first quarter of 2001 as compared to the same quarter in 2000. Total reported product revenues are derived from the three components of our continuing core business, plus revenues from sold businesses and discontinued products. These revenue components are as follows: PHARMACEUTICALS, VACCINES AND DIAGNOSTIC PRODUCTS (PVD). This group of products includes our heartworm diagnostic products, equine influenza vaccine, allergy products, feline vaccines and other such products for the companion animal health market. During the first quarter of 2001, PVD product revenue increased approximately 20% over the comparable quarter of 2000, to $4.0 million. VETERINARY MEDICAL INSTRUMENTATION PRODUCTS. This group of products includes all of our veterinary medical instrumentation, as well as the reagents, consumables, parts and accessories for these instruments which are for the companion animal health market. During the first quarter of 2001, medical instrumentation product revenue declined by approximately 3% from the comparable quarter of 2000, to $3.6 million. This decline was attributable to a large non-recurring sale of veterinary medical instruments in Europe during the first quarter of 2000 in conjunction with the sale of our Heska UK business. DIAMOND ANIMAL HEALTH PRODUCTS. Revenue reported from this group of products is comprised principally of vaccines and other biological products for cattle and other non-companion animals. In addition, Diamond also manufactures some of our PVD products and serves as our primary product distribution center. During the first quarter of 2001, Diamond's product revenue declined by approximately 23% from the comparable quarter of 2000, to $2.8 million. The decline in first quarter revenue at Diamond was principally due to delays in obtaining certain raw materials needed to meet sales projections. SOLD BUSINESSES AND DISCONTINUED PRODUCTS. During 2000, we engaged in a number of activities to restructure our business, including the sale of Heska UK, effective January 31, 2000 and the sale of Center Laboratories, effective June 23, 2000. Our total reported product revenue in 2000 includes the revenue from these sold businesses prior to the dates of sale. The revenue attributable to these sold businesses in the first quarter of 2000 was approximately $1.8 million. Cost of products sold totaled $6.2 million in the first quarter of 2001 compared to $8.4 million in the first quarter of 2000. Gross profit as a percentage of product sales increased to 39.8% in the first quarter of 2001 compared to 32.2% in the same quarter last year. The improvement in gross profit as a percentage of product sales in the first quarter of 2001 compared to 2000 reflects the increase in sales of our proprietary PVD products. We expect gross profit as a percentage of product sales to continue to improve as we increase the sales of our higher margin proprietary PVD products. Selling and marketing expenses decreased to $3.6 million in the first quarter of 2001 from $4.3 million in the first quarter of 2000. This decrease reflects primarily the costs associated with the expansion of our sales and marketing organization and costs associated with the introduction and marketing of new products in the first quarter of 2000, as well as the sale of Center Laboratories and Heska UK. We expect selling and marketing expense as a percentage of total sales to decrease in the future as we continue to increase sales from our continuing core business. Research and development expenses decreased to $3.5 million in the first quarter of 2001 from $4.0 million in the first quarter of 2000. Fluctuations in research and development expenses are generally the result of the number of research projects in progress. We expect research and development expense as a percentage of total sales to decrease in the future as we continue to increase sales from our continuing core business. General and administrative expenses decreased to $2.1 million in the first quarter of 2001 from $2.8 million in the first quarter of 2000. This decrease is due to tighter expense control at all locations and the sale of Center Laboratories and Heska UK in 2000. We expect general and administrative expense as a percentage of total sales to decrease in the future as we continue to increase sales from our continuing core business. During the first quarter of fiscal 2000, we initiated a cost reduction and restructuring plan at Diamond. The restructuring resulted from the rationalization of Diamond's business including a reduction in the size of its workforce and our decision to vacate a leased warehouse and distribution facility no longer needed after our decision to discontinue contract manufacturing of certain low margin human health care products. The charge to operations of approximately $435,000 related primarily to personnel severance costs for 12 individuals and the costs associated with closing the leased facility, terminating the lease and abandoning certain leasehold improvements. The facility was closed in April 2000. For the quarter ended March 31, 2001, our net loss declined to $4.6 million from $5.9 million in the first quarter of the prior year. This represents a 23% improvement over results reported in the prior year. The net loss per common share in the first quarter of 2001 improved by 33% to $0.12, compared with a net loss per common share of $0.18 in the first quarter of the prior year. LIQUIDITY AND CAPITAL RESOURCES Our primary source of liquidity at March 31, 2001 was our $4.7 million in cash, cash equivalents and marketable securities and our asset-based revolving line of credit. Our credit facility requires us to maintain various financial covenants including monthly minimum book net worth, minimum quarterly net income and minimum cash balances or liquidity levels. In March 2001, we negotiated new covenants under this line of credit. At March 31, 2001, our available borrowing capacity was approximately $7.1 million. In February 2001, we sold 4,573,000 shares of our common stock through a private placement offering and received net proceeds of $5.3 million. Cash used in operating activities was $5.3 million in the first quarter of 2001, compared to $9.5 million in the first quarter of 2000. The decrease in cash used in operating activities is attributable primarily to the decrease of $1.4 million in our net loss for the first quarter of 2001 compared to the prior year and, an increase in the prior year's first quarter accounts receivable balance of $3.9 million offset by a decrease in the accounts payable balance of $1.3 million during the 2001 first quarter. Our investing activities provided cash of $2.2 million in the first quarter of 2001, compared to $11.9 million in cash provided by investing activities during the first quarter of 2000. Cash provided by investing activities was primarily related to the sale of marketable securities to fund our business operations. Expenditures for property and equipment were approximately $300,000 for the first quarter of 2001 compared to approximately $500,000 in the first quarter of 2000. We have historically used capital equipment lease and debt facilities to finance equipment purchases and, if possible, leasehold improvements. We currently expect to spend approximately $1.2 million in 2001 for capital equipment, including expenditures for the upgrading of certain manufacturing operations to improve efficiencies as well as various enhancements to assure ongoing compliance with certain regulatory requirements. Our financing activities provided $4.8 million in the first quarter of 2001 compared to $5,000 used in the first quarter of 2000. This 2001 cash was provided by our sale of 4,573,000 shares of our common stock in a private placement in February 2001 with net proceeds to us of approximately $5.3 million. Our primary short-term needs for capital, which are subject to change, are for our continuing research and development efforts, our sales, marketing and administrative activities, working capital associated with increased product sales and capital expenditures relating to our manufacturing operations. Our future liquidity and capital requirements will depend on numerous factors, including the extent to which our present and future products gain market acceptance, the extent to which products or technologies under research or development are successfully developed, the timing of regulatory actions regarding our products, the costs and timing of expansion of sales, marketing and manufacturing activities, the cost, timing and business management of current and potential acquisitions and contingent liabilities associated with such acquisitions, the procurement and enforcement of patents important to our business and the results of competition. We believe that our available cash, cash equivalents and marketable securities, together with cash from operations, available borrowings and borrowings we expect to be available under our revolving line of credit facility will be sufficient to satisfy our projected cash requirements into 2002, although we may raise additional funds at or before such time. If necessary, we expect to raise these additional funds through one or more of the following: (1) sale of additional securities; (2) sale of various assets; (3) licensing of technology; and (4) sale of various products or marketing rights. If we cannot raise the additional funds through these options on acceptable terms or with the necessary timing, management could also reduce discretionary spending to decrease our cash burn rate and extend the currently available cash, cash equivalents, marketable securities and available borrowings. See "Factors that May Affect Results." NET OPERATING LOSS CARRYFORWARDS As of December 31, 2000, we had a net operating loss carryforward, or NOL, of approximately $154.6 million and approximately $3.1 million of research and development tax credits available to offset future federal income taxes. The NOL and tax credit carryforwards, which are subject to alternative minimum tax limitations and to examination by the tax authorities, expire from 2003 to 2020. Our acquisition of Diamond resulted in a "change of ownership" under the provisions of Section 382 of the Internal Revenue Code of 1986, as amended. As such, we will be limited in the amount of NOL's incurred prior to the merger that we may utilize to offset future taxable income. This limitation will total approximately $4.7 million per year for periods subsequent to the Diamond acquisition. Similar limitations also apply to utilization of research and development tax credits to offset taxes payable. We believe that this limitation may affect the eventual utilization of our total NOL carryforwards. RECENT ACCOUNTING PRONOUNCEMENTS We do not expect the adoption of any standards recently issued by the Financial Accounting Standards Board or the Securities and Exchange Commission to have a material impact on our financial position or results of operations. FACTORS THAT MAY AFFECT RESULTS We have a history of losses and may never achieve profitability. We have incurred net losses since our inception in 1988 and, as of March 31, 2001, we had an accumulated deficit of $179.0 million. We anticipate that we will continue to incur additional operating losses in the near term. These losses have resulted principally from expenses incurred in our research and development programs and from general and administrative and sales and marketing expenses. Even if we achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. We may need additional capital in the future. We have incurred negative cash flow from operations since inception in 1988. We do not expect to generate positive cash flow sufficient to fund our operations in the near term. Moreover, based on our current projections, we may need to raise additional capital in the future. If necessary, we expect to raise this additional capital through one or more of the following:
* sale of additional securities; * sale of various assets; * licensing of technology; and * sale of various products or marketing rights.
Additional capital may not be available on acceptable terms, if at all. Furthermore, any additional equity financing would likely be dilutive to stockholders, and additional debt financing, if available, may include restrictive covenants which may limit our currently planned operations and strategies. If adequate funds are not available, we may be required to curtail our operations significantly and reduce discretionary spending to extend the currently available cash resources, or to obtain funds by entering into collaborative agreements or other arrangements on unfavorable terms. If we fail to generate adequate funding on acceptable terms when we need to, our business could be substantially harmed. We have limited resources to devote to product development and commercialization. If we are not able to devote resources to product development and commercialization, we may not be able to develop our products. Our strategy is to develop a broad range of products addressing companion animal healthcare. We believe that our revenue growth and profitability, if any, will substantially depend upon our ability to:
* improve market acceptance of our current products; * complete development of new products; and * successfully introduce and commercialize new products.
We have introduced some of our products only recently and many of our products are still under development. Because we have limited resources to devote to product development and commercialization, any delay in the development of one product or reallocation of resources to product development efforts that prove unsuccessful may delay or jeopardize the development of our other product candidates. If we fail to develop new products and bring them to market, our ability to generate revenues will decrease. In addition, our products may not achieve satisfactory market acceptance, and we may not successfully commercialize them on a timely basis, or at all. If our products do not achieve a significant level of market acceptance, demand for our products will not develop as expected and it is unlikely that we ever will become profitable. We must obtain and maintain costly regulatory approvals in order to market our products. Many of the products we develop and market are subject to extensive regulation by one or more of the United States Department of Agriculture, or USDA, the Food and Drug Administration, or FDA, the Environmental Protection Agency, or EPA, and foreign regulatory authorities. These regulations govern, among other things, the development, testing, manufacturing, labeling, storage, premarket approval, advertising, promotion, sale and distribution of our products. Satisfaction of these requirements can take several years and time needed to satisfy them may vary substantially, based on the type, complexity and novelty of the product. The effect of government regulation may be to delay or to prevent marketing of our products for a considerable period of time and to impose costly procedures upon our activities. We have experienced in the past, and may experience in the future, difficulties that could delay or prevent us from obtaining the regulatory approval or license necessary to introduce or market our products. Regulatory approval of our products may also impose limitations on the indicated or intended uses for which our products may be marketed. Among the conditions for regulatory approval is the requirement that our manufacturing facilities or those of our third party manufacturers conform to current Good Manufacturing Practices. The FDA and foreign regulatory authorities strictly enforce Good Manufacturing Practices requirements through periodic inspections. We can provide no assurance that any regulatory authority will determine that our manufacturing facilities or those of our third party manufacturers will conform to Good Manufacturing Practices requirements. Failure to comply with applicable regulatory requirements can result in sanctions being imposed on us or the manufacturers of our products, including warning letters, product recalls or seizures, injunctions, refusal to permit products to be imported into or exported out of the United States, refusals of regulatory authorities to grant approval or to allow us to enter into government supply contracts, withdrawals of previously approved marketing applications, civil fines and criminal prosecutions. Factors beyond our control may cause our operating results to fluctuate, and since many of our expenses are fixed, this fluctuation could cause our stock price to decline. We believe that our future operating results will fluctuate on a quarterly basis due to a variety of factors, including:
* the introduction of new products by us or by our competitors; * market acceptance of our current or new products; * regulatory and other delays in product development; * product recalls; * competition and pricing pressures from competitive products; * manufacturing delays; * shipment problems; * product seasonality; and * changes in the mix of products sold.
We have high operating expenses for personnel, new product development and marketing. Many of these expenses are fixed in the short term. If any of the factors listed above cause our revenues to decline, our operating results could be substantially harmed. Our operating results in some quarters may not meet the expectations of stock market analysts and investors. In that case, our stock price probably would decline. We must maintain various financial and other covenants under our revolving line of credit agreement. Under our revolving line of credit agreement with Wells Fargo Business Credit, Inc., we are required to comply with various financial and non-financial covenants, and we have made various representations and warranties. Among the financial covenants are requirements for monthly minimum book net worth, minimum quarterly net income and minimum cash balances or liquidity levels. Failure to comply with any of the covenants, representations or warranties would negatively impact our ability to borrow under the agreement. Our inability to borrow to fund our operations could materially harm our business. A small number of large customers account for a large percentage of our revenues, and the loss of any of them could harm our operating results. We currently derive a substantial portion of our revenues from sales by our subsidiary Diamond, which manufactures various of our products and products for other companies in the animal health industry. Revenues from one Diamond customer, AgriLabs, comprised approximately 10% of our total revenues for the three months ended March 31, 2001 and 2000, respectively. If we are not successful in maintaining our relationships with our customers and obtaining new customers, our business and results of operations will suffer. We operate in a highly competitive industry, which could render our products obsolete or substantially limit the volume of products that we sell. This would limit our ability to compete and achieve profitability. We compete with independent animal health companies and major pharmaceutical companies that have animal health divisions. Companies with a significant presence in the animal health market, such as American Home Products, Bayer, IDEXX Laboratories, Inc., Intervet International B.V., Merial Ltd., Novartis, Pfizer Inc., Pharmacia Animal Health and Schering Plough Corporation, have developed or are developing products that compete with our products or would compete with them if developed. These competitors may have substantially greater financial, technical, research and other resources and larger, better-established marketing, sales, distribution and service organizations than us. In addition, IDEXX, which has products that compete with our heartworm diagnostic products, prohibits its distributors from selling competitors' products, including ours. Our competitors frequently offer broader product lines and have greater name recognition than we do. Our competitors may develop or market technologies or products that are more effective or commercially attractive than our current or future products, or that would render our technologies and products obsolete. Further, additional competition could come from new entrants to the animal healthcare market. Moreover, we may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully. If we fail to compete successfully, our ability to achieve profitability will be limited. We have limited experience in marketing our products, and may be unable to commercialize our products. The market for companion animal healthcare products is highly fragmented, with discount stores and specialty pet stores accounting for a substantial percentage of sales. Because we sell our companion animal health products only to veterinarians, we may fail to reach a substantial segment of the potential market, and we may not be able to offer our products at prices which are competitive with those of companies that distribute their products through retail channels. We currently market our products to veterinarians through a direct sales force and through third parties. To be successful, we will have to continue to develop and train our direct sales force or rely on marketing partnerships or other arrangements with third parties to market, distribute and sell our products. We may not successfully develop and maintain marketing, distribution or sales capabilities, and we may not be able to make arrangements with third parties to perform these activities on satisfactory terms. If we fail to develop a successful marketing strategy, our ability to commercialize our products and generate revenues will decrease. We have granted third parties substantial marketing rights to our products under development. If our current third party marketing agreements are not successful, or if we are unable to develop our own marketing capabilities or enter into additional marketing agreements in the future, we may not be able to develop and commercialize our products. Our agreements with our corporate marketing partners generally contain no minimum purchase requirements in order for them to maintain their exclusive or co-exclusive marketing rights. Novartis, Eisai or Ralston Purina or any other collaborative party may not devote sufficient resources to marketing our products. Furthermore, there is nothing to prevent Novartis, Eisai or Ralston Purina or any other collaborative party from pursuing alternative technologies or products that may compete with our products. If we fail to develop and maintain our own marketing capabilities, we may find it necessary to continue to rely on potential or actual competitors for third party marketing assistance. Third party marketing assistance may not be available in the future on reasonable terms, if at all. If any of these events occur, we may not be able to develop and commercialize our products and our revenues will decline. We may face costly intellectual property disputes. Our ability to compete effectively will depend in part on our ability to develop and maintain proprietary aspects of our technology and either to operate without infringing the proprietary rights of others or to obtain rights to technology owned by third parties. We have United States and foreign-issued patents and are currently prosecuting patent applications in the United States and with various foreign countries. Our pending patent applications may not result in the issuance of any patents or that any issued patents will offer protection against competitors with similar technology. Patents we receive may be challenged, invalidated or circumvented in the future or the rights created by those patents may not provide a competitive advantage. We also rely on trade secrets, technical know-how and continuing invention to develop and maintain our competitive position. Others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets. The biotechnology and pharmaceutical industries have been characterized by extensive litigation relating to patents and other intellectual property rights. In 1998, Synbiotics Corporation filed a lawsuit against us alleging infringement of a Synbiotics patent relating to heartworm diagnostic technology, and this litigation remains ongoing. We may become subject to additional patent infringement claims and litigation in the United States or other countries or interference proceedings conducted in the United States Patent and Trademark Office to determine the priority of inventions. The defense and prosecution of intellectual property suits, USPTO interference proceedings, and related legal and administrative proceedings are costly, time-consuming and distracting. We may also need to pursue litigation to enforce any patents issued to us or our collaborative partners, to protect trade secrets or know-how owned by us or our collaborative partners, or to determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or interference proceeding will result in substantial expense to us and significant diversion of the efforts of our technical and management personnel. Any adverse determination in litigation or interference proceedings could subject us to significant liabilities to third parties. Further, as a result of litigation or other proceedings, we may be required to seek licenses from third parties which may not be available on commercially reasonable terms, if at all. We license technology from a number of third parties. The majority of these license agreements impose due diligence or milestone obligations on us, and in some cases impose minimum royalty and/or sales obligations on us, in order for us to maintain our rights under these agreements. Our products may incorporate technologies that are the subject of patents issued to, and patent applications filed by, others. As is typical in our industry, from time to time we and our collaborators have received, and may in the future receive, notices from third parties claiming infringement and invitations to take licenses under third party patents. It is our policy that when we receive such notices, we conduct investigations of the claims they assert. With respect to the notices we have received to date, we believe, after due investigation, that we have meritorious defenses to the infringement claims asserted. Any legal action against us or our collaborators may require us or our collaborators to obtain one or more licenses in order to market or manufacture affected products or services. However, we or our collaborators may not be able to obtain licenses for technology patented by others on commercially reasonable terms, we may not be able to develop alternative approaches if unable to obtain licenses, or current and future licenses may not be adequate for the operation of our businesses. Failure to obtain necessary licenses or to identify and implement alternative approaches could prevent us and our collaborators from commercializing our products under development and could substantially harm our business. We have limited manufacturing experience and capacity and rely substantially on third party manufacturers. The loss of any third party manufacturers could limit our ability to launch our products in a timely manner, or at all. To be successful, we must manufacture, or contract for the manufacture of, our current and future products in compliance with regulatory requirements, in sufficient quantities and on a timely basis, while maintaining product quality and acceptable manufacturing costs. In order to increase our manufacturing capacity, we acquired Diamond in April 1996. We currently rely on third parties to manufacture those products we do not manufacture at our Diamond facility. We currently have supply agreements with Quidel Corporation for various manufacturing services relating to our point-of- care diagnostic tests, with Centaq, Inc. for the manufacture of our own allergy immunotherapy treatment products and with various manufacturers for the supply of our veterinary diagnostic and patient monitoring instruments. Our manufacturing strategy presents the following risks:
* Delays in the scale-up to quantities needed for product development could delay regulatory submissions and commercialization of our products in development; * Our manufacturing facilities and those of some of our third party manufacturers are subject to ongoing periodic unannounced inspection by regulatory authorities, including the FDA, USDA and other federal and state agency's for compliance with strictly enforced Good Manufacturing Practices regulations and similar foreign standards, and we do not have control over our third party manufacturers' compliance with these regulations and standards; * If we need to change to other commercial manufacturing contractors for certain of our products, additional regulatory licenses or approvals must be obtained for these contractors prior to our use. This would require new testing and compliance inspections. Any new manufacturer would have to be educated in, or develop substantially equivalen processes necessary for the production of our products; * If market demand for our products increases suddenly, our current manufacturers might not be able to fulfill our commercial needs, which would require us to seek new manufacturing arrangements and may result in substantial delays in meeting market demand; and * We may not have intellectual property rights, or may have to share intellectual property rights, to any improvements in the manufacturing processes or new manufacturing processes for our products.
Any of these factors could delay commercialization of our products under development, interfere with current sales, entail higher costs and result in our being unable to effectively sell our products. Our agreements with various suppliers of the veterinary medical instruments require us to meet minimum annual sales levels to maintain our position as the exclusive distributor of these instruments. We may not meet these minimum sales levels in the future, and maintain exclusivity over the distribution and sale of these products. If we are not the exclusive distributor of these products, competition may increase. We depend on partners in our research and development activities. If our current partnerships and collaborations are not successful, we may not be able to develop our technologies or products. For various of our proposed products, we are dependent on collaborative partners to successfully and timely perform research and development activities on our behalf. These collaborative partners may not complete research and development activities on our behalf in a timely fashion, or at all. If our collaborative partners fail to complete research and development activities, or fail to complete them in a timely fashion, our ability to develop technologies and products will be impacted negatively and our revenues will decline. We depend on key personnel for our future success. If we lose our key personnel or are unable to attract and retain additional personnel, we may be unable to achieve our goals. Our future success is substantially dependent on the efforts of our senior management and scientific team. The loss of the services of members of our senior management or scientific staff may significantly delay or prevent the achievement of product development and other business objectives. Because of the specialized scientific nature of our business, we depend substantially on our ability to attract and retain qualified scientific and technical personnel. There is intense competition among major pharmaceutical and chemical companies, specialized biotechnology firms and universities and other research institutions for qualified personnel in the areas of our activities. If we lose the services of, or fail to recruit, key scientific and technical personnel, the growth of our business could be substantially impaired. We may face product returns and product liability litigation and the extent of our insurance coverage is limited. If we become subject to product liability claims resulting from defects in our products, we may fail to achieve market acceptance of our products and our business could be harmed. The testing, manufacturing and marketing of our current products as well as those currently under development entail an inherent risk of product liability claims and associated adverse publicity. Following the introduction of a product, adverse side effects may be discovered. Adverse publicity regarding such effects could affect sales of our other products for an indeterminate time period. To date, we have not experienced any material product liability claims, but any claim arising in the future could substantially harm our business. Potential product liability claims may exceed the amount of our insurance coverage or may be excluded from coverage under the terms of the policy. We may not be able to continue to obtain adequate insurance at a reasonable cost, if at all. In the event that we are held liable for a claim against which we are not indemnified or for damages exceeding the $10 million limit of our insurance coverage or which results in significant adverse publicity against us, we may lose revenue and fail to achieve market acceptance. We may be held liable for the release of hazardous materials, which could result in extensive costs which would harm our business. Our products and development programs involve the controlled use of hazardous and biohazardous materials, including chemicals, infectious disease agents and various radioactive compounds. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by applicable local, state and federal regulations, we cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for any fines, penalties, remediation costs or other damages that result. Our liability for the release of hazardous materials could exceed our resources, which could lead to a shut down of our operations. In addition, we may incur substantial costs to comply with environmental regulations as we expand our manufacturing capacity. We expect to experience volatility in our stock price, which may affect our ability to raise capital in the future or make it difficult for investors to sell their shares. The securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. The market prices of securities of many publicly-held biotechnology companies have in the past been, and can in the future be expected to be, especially volatile. For example, in the last twelve months our closing stock price has ranged from a low of $0.59375 to a high of $4.50. Fluctuations in the trading price or liquidity of our common stock may adversely affect our ability to raise capital through future equity financings. Factors that may have a significant impact on the market price and marketability of our common stock include:
* announcements of technological innovations or new products by us or by our competitors; * our quarterly operating results; * releases of reports by securities analysts; * developments or disputes concerning patents or proprietary rights; * regulatory developments; * developments in our relationships with collaborative partners; * changes in regulatory policies; * litigation; * economic and other external factors; and * general market conditions.
In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted. If a securities class action suit is filed against us, we would incur substantial legal fees and our management's attention and resources would be diverted from operating our business in order to respond to the litigation. If we fail to meet Nasdaq National Market listing requirements, our common stock will be delisted and become illiquid. Our common stock is currently listed on the Nasdaq National Market. Nasdaq has requirements we must meet in order to remain listed on the Nasdaq National Market. If we continue to experience losses from our operations or we are unable to raise additional funds, we might not be able to maintain the standards for continued quotation on the Nasdaq National Market, including a minimum bid price requirement of $1.00. If the minimum bid price of our common stock were to remain below $1.00 for 30 consecutive trading days, or if we were unable to continue to meet Nasdaq's standards for any other reason, our common stock could be delisted from the Nasdaq National Market. If as a result of the application of these listing requirements, our common stock were delisted from the Nasdaq National Market, our stock would become harder to buy and sell. Further, our stock could be subject to what are known as the "penny stock" rules. The penny stock rules place additional requirements on broker-dealers who sell or make a market in such securities. Consequently, if we were removed from the Nasdaq National Market, the ability or willingness of broker-dealers to sell or make a market in our common stock might decline. As a result, the ability for investors to resell shares of our common stock could be adversely affected. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk represents the risk of loss that may impact the financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk in the areas of changes in United States and foreign interest rates and changes in foreign currency exchange rates as measured against the United States dollar. These exposures are directly related to our normal operating and funding activities. In April 2001, we entered into a series of forward contracts for the purchase of Japanese yen to be used for the purchase of inventory. We have adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging 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, affected by changes in market interest rates. At March 31, 2001, approximately $2.8 million was outstanding on these borrowings with a weighted average interest rate of 9.25%. We manage interest rate risk by investing excess funds principally in cash equivalents or marketable securities which bear interest rates that reflect current market yields. We completed an interest rate risk sensitivity analysis of these borrowings based on an assumed 1% increase in interest rates. If market rates increase by 1% during the three months ended June 30, 2001, we would experience an increase in interest expense of approximately $7,000 based on the outstanding borrowing balances at March 31, 2001. Foreign Currency Risk At March 31, 2001, we had wholly-owned subsidiaries located in Switzerland. Sales from these operations are denominated in Swiss Francs or Euros, thereby creating exposures to changes in exchange rates. The changes in the Swiss/U.S. exchange rate or Euro/U.S. exchange rate may positively or negatively affect our sales, gross margins and retained earnings. We completed a foreign currency exchange rate risk sensitivity analysis on an assumed 1% change in foreign currency exchange rates. If the foreign currency exchange rates change by 1% during the three months ended June 30, 2001, we would experience an increase/decrease in our foreign currency gain/loss of approximately $70,000 based on the investment in foreign subsidiaries as of and for the three months ended March 31, 2001. PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On February 6, 2001, we issued 4,573,000 shares of common stock for an aggregate purchase price of approximately $5.7 million to a group of institutional investors, including our existing stockholders. The issuance of shares described above was made in reliance on the exemptions from registration set forth in Section 4(2) of the Securities Act of 1933 ("the Act"), as amended. We made no public solicitation in connection with the issuance of the above mentioned securities. We relied on representation from the recipients of the securities that they purchased the securities for investment only and not with a view to any distribution thereof and that they were aware of our business affairs and financial condition and had sufficient information to reach an informed and knowledgeable decision regarding their acquisition of the securities. In February 2001, we issued 4,681 shares of common stock to a consultant in consideration of services rendered in accordance with the terms of his consulting agreement. We relied upon the exemption provided by Section 4(2) of the Act. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) Exhibits See Exhibit Index on page 24. (b) Reports on Form 8-K On February 7, 2001, we filed a report on Form 8-K in connection with the sale of 4,573,000 shares of our common stock through a private placement. EXHIBIT INDEX
Exhibit Number Description of Document ------- ----------------------- 10.39(a) First Amendment To Second Amended and Restated Credit and - ---------- Security Agreement
HESKA CORPORATION SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
HESKA CORPORATION Date: May 10,2001 By /s/ Ronald L. Hendrick ---------------------- RONALD L. HENDRICK Executive Vice President and Chief Financial Officer (on behalf of the Registrant and as the Registrant's Principal Financial and Accounting Officer)
EX-10 2 exhibit.txt EXHIBIT FIRST AMENDMENT TO SECOND AMENDED AND RESTATED CREDIT AND SECURITY AGREEMENT This First Amendment, dated as of March 27, 2001, is made by and among HESKA CORPORATION, a Delaware corporation ("Heska"), DIAMOND ANIMAL HEALTH, INC., an Iowa corporation ("Diamond") (each of Heska and Diamond may be referred to herein individually as a "Borrower" and collectively as the "Borrowers"), and WELLS FARGO BUSINESS CREDIT, INC., f/k/a Norwest Business Credit, Inc., a Minnesota corporation (the "Lender"). Recitals -------- The Borrowers and the Lender have entered into a Second Amended and Restated Credit and Security Agreement dated as of June 14, 2000 (as amended to date and as the same may be hereafter amended from time to time, the "Credit Agreement"). Capitalized terms used in these recitals have the meanings given to them in the Credit Agreement unless otherwise specified. The Borrowers have requested that certain amendments be made to the Credit Agreement, which the Lender is willing to make pursuant to the terms and conditions set forth herein. NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, it is agreed as follows: 1. Defined Terms. Capitalized terms used in this Amendment which are defined in the Credit Agreement shall have the same meanings as defined therein, unless otherwise defined herein. In addition, Section 1.1 of the Credit Agreement is amended by adding or amending, as the case may be, the following definitions: "`Borrowing Base' for a Borrower means, at any time the lesser of: (a) the Maximum Line; or (b) subject to change from time to time in the Lender's sole discretion: (i) 80% of Eligible Accounts of such Borrower, plus (ii) the lesser of (A) the sum of (1) 30% of Eligible Inventory of such Borrower consisting of raw materials plus (2) 50% of Eligible Inventory of such Borrower consisting of finished goods, or (B) the difference of (1) $6,000,000 less (2) the aggregate amount of Advances made to all Borrowers other than such Borrower in reliance on Eligible Inventory, less (iii) for any Borrower other than Heska, the principal sum of all outstanding Advances made to Heska in reliance on such Borrower's Borrowing Base "Limited Diamond Borrowing Base" on a given date means the lesser of (A) Diamond's Availability as of such date or (B) the amount by which the Tangible Net Worth of Diamond on such date exceeds $2,000,000. 2. Eligible Accounts. Section 1.1 of the Credit Agreement is further amended by deleting subsection (i) of the definition of "Eligible Accounts" and replacing it with the following: "(i) That portion of Accounts with terms of 60 days or less that are over 60 days past due, and all other Accounts over 90 days past the invoice date; provided, however, that certain Accounts which are billed pursuant to dated term invoices with payment terms of not greater than 180 days from the invoice date ("Dated Term Accounts") which (A) do not remain unpaid more than 180 days from such Dated Term Account's invoice date, (B) are not more than 30 days past due, and (C) are approved by the Lender in its sole discretion, shall, despite the terms of this subsection (i), be deemed Eligible Accounts;" 3. Revolving Advances. Section 2.2 of the Credit Agreement is hereby amended by deleting the initial paragraph thereof in its entirety and replacing such initial paragraph with the following: "The Lender agrees, on the terms and subject to the conditions herein set forth, to make advances (the "Revolving Advances") to any Borrower from time to time from the date the Inactive Period ends (the "Funding Date") to the Termination Date, on the terms and subject to the conditions herein set forth. The Lender shall have no obligation to make a Revolving Advance to a Borrower if, after giving effect to such requested Revolving Advance, (a) the sum of the outstanding and unpaid Revolving Advances would exceed the Aggregate Borrowing Base, (b) the sum of the outstanding and unpaid Revolving Advances to Diamond exceed the Limited Diamond Borrowing Base, (c) the sum of the outstanding and unpaid Revolving Advances to Heska would exceed the Expanded Heska Borrowing Base, or (d) during any Default Period, the sum of the outstanding and unpaid Revolving Advances to Heska would exceed Heska's Borrowing Base. Each Borrower's obligation to pay the Revolving Advances shall be evidenced by such Borrower's Revolving Note and shall be secured by the Collateral as provided in Article III and the Mortgaged Property as defined in each of the Factory Mortgage and the Farm Mortgage. Within the limits set forth in this Section 2.2, each Borrower may borrow, prepay pursuant to Section 2.12 and reborrow. Each Borrower agrees to comply with the following procedures in requesting Revolving Advances under this Section 2.2:" 4. Issuance of Letters of Credit: Section 2.18(a)(i)(1) of the Credit Agreement is hereby amended by deleting the amount "$500,000" therein and replacing such amount with "$1,000,000". 5. Payment of Taxes and Other Claims; Payment of Past- Due Accounts. Section 6.5 of the Credit Agreement is hereby amended by deleting such section in its entirety and replacing it with the following: "Section 6.5 Payment of Taxes and Other Claims; Payment of Past-Due Accounts. Each Borrower will pay or discharge, when due, (a) all taxes, assessments and governmental charges levied or imposed upon it or upon its income or profits, upon any properties belonging to it (including, without limitation, the Collateral) or upon or against the creation, perfection or continuance of the Security Interest, prior to the date on which penalties attach thereto, (b) all federal, state and local taxes required to be withheld by it, and (c) all lawful claims for labor, materials and supplies which, if unpaid, might by law become a lien or charge upon any properties of such Borrower; provided, that no Borrower shall be required to pay any such tax, assessment, charge or claim whose amount, applicability or validity is being contested in good faith by appropriate proceedings and for which proper reserves have been made. Each Borrower will, (i) at all times, immediately pay all of its accounts payable that are 60 days or more past due and (ii) during any period for which any Revolving Advance is outstanding, immediately pay all accounts payable (except for accounts payable whose amount, applicability or validity is being contested in good faith by appropriate proceedings or methods) before such accounts become 60 days or more past due. Each Borrower will at all times maintain its accounts payable in accordance with the previous sentence." 6. Minimum Book Net Worth: Section 6.12 of the Credit Agreement is hereby amended by deleting such Section in its entirety and replacing it with the following: "Section 6.12 Minimum Book Net Worth. Heska will maintain, on a consolidated basis, as of each date listed below, its Book Net Worth at an amount not less than the amount set forth opposite such date:
Period Minimum Book Net Worth ------- ---------------------- March 31, 2001 $23,045,000 April 30, 2001 $21,049,000 May 31, 2001 $19,656,000 June 30, 2001 $18,719,000 July 31, 2001 $17,139,000 August 31, 2001 $16,165,000 September 30, 2001 $15,362,000 October 31, 2001 $14,329,000 November 30, 2001 $14,072,000 December 31, 2001 and the last day of each month thereafter $14,489,000"
7. Minimum Net Income: Section 6.13 of the Credit Agreement is hereby amended by deleting such Section in its entirety and replacing it with the following: "Section 6.13 Minimum Net Income. Heska will achieve, on a consolidated basis, during each period described below, Net Income in an amount not less than the amount set forth opposite such period (amounts in parentheses denote negative numbers):
Period Minimum Net Income ------ ------------------ Three months ending March 31, 2001 ($7,757,000) Six months ending June 30, 2001 ($12,082,000) Nine months ending September 30, 2001 ($15,439,000) Twelve months ending December 31, 2001 ($16,312,000)"
8. Minimum Cash Balance: Section 6.14 of the Credit Agreement is hereby amended by deleting such Section in its entirety and replacing it with the following: "Section 6.14 Minimum Cash Balance. Heska shall maintain as of the last day of each month, on a consolidated basis, its Liquidity at not less than $3,000,000." 9. New Covenants: Section 6.16 of the Credit Agreement is hereby amended by deleting such Section in its entirety and replacing it with the following: "Section 6.16 New Covenants. On or before December 31, 2001, the Borrowers and the Lender shall agree on new covenant levels for Sections 6.12, 6.13, 6.14, 6.15, 7.4(a)(v), and 7.10 for periods after such date. The new covenant levels will be based on (i) the Borrower's projections for such periods and (ii) the year to date financial results of Heska, on a consolidated basis, and such new covenant levels shall be no less stringent than the present levels. An Event of Default shall occur if the new covenants are not agreed to by the above date." 10. Investments and Subsidiaries: Section 7.4(a)(v) of the Credit Agreement is hereby amended by deleting the phrase "during the 2000 fiscal year" and replacing such phrase with "during the 2001 fiscal year". 11. Capital Expenditures. Section 7.10 of the Credit Agreement is hereby amended by deleting such Section in its entirety and replacing it with the following: "Section 7.10 Capital Expenditures. The Borrowers, together with any Affiliates, will not incur or contract to incur, in the aggregate, Capital Expenditures of more than $1,800,000 in the aggregate during the period from January 1, 2001 through December 31, 2001." 12. No Other Changes. Except as explicitly amended by this Amendment, all of the terms and conditions of the Credit Agreement shall remain in full force and effect and shall apply to any advance or letter of credit thereunder. 13. Conditions Precedent. This Amendment shall be effective when the Lender shall have received an executed original hereof, together with each of the following, each in substance and form acceptable to the Lender in its sole discretion: (a) The Acknowledgment and Agreement of Guarantor set forth at the end of this Amendment, duly executed by the Guarantor. (b) Such other matters as the Lender may require. 14. Representations and Warranties. Each Borrower hereby represents and warrants to the Lender as follows: (a) Each Borrower has all requisite power and authority to execute this Amendment and to perform all of its obligations hereunder, and this Amendment has been duly executed and delivered by each Borrower and constitutes the legal, valid and binding obligation of each Borrower, enforceable in accordance with its terms. (b) The execution, delivery and performance by each Borrower of this Amendment has been duly authorized by all necessary corporate action and do not (i) require any authorization, consent or approval by any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, (ii) violate any provision of any law, rule or regulation or of any order, writ, injunction or decree presently in effect, having applicability to any Borrower, or the articles of incorporation or by-laws of any Borrower, or (iii) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other agreement, lease or instrument to which any Borrower is a party or by which it or its properties may be bound or affected. (c) All of the representations and warranties contained in Article V of the Credit Agreement are correct as of the date such representations and warranties were given with no changes adverse to the Lender. 15. References. All references in the Credit Agreement to "this Agreement" shall be deemed to refer to the Credit Agreement as amended hereby; and any and all references in the Security Documents to the Credit Agreement shall be deemed to refer to the Credit Agreement as amended hereby. 16. No Waiver. The execution of this Amendment and acceptance of any documents related hereto shall not be deemed to be a waiver of any Default or Event of Default under the Credit Agreement or breach, default or event of default under any Security Document or other document held by the Lender, whether or not known to the Lender and whether or not existing on the date of this Amendment. 17. Release. The Borrowers, and the Guarantor by signing the Acknowledgment and Agreement of Guarantor set forth below, each hereby absolutely and unconditionally releases and forever discharges the Lender, and any and all participants, parent corporations, subsidiary corporations, affiliated corporations, insurers, indemnitors, successors and assigns thereof, together with all of the present and former directors, officers, agents and employees of any of the foregoing, from any and all claims, demands or causes of action of any kind, nature or description, whether arising in law or equity or upon contract or tort or under any state or federal law or otherwise, which any Borrower or such Guarantor has had, now has or has made claim to have against any such person for or by reason of any act, omission, matter, cause or thing whatsoever arising from the beginning of time to and including the date of this Amendment, whether such claims, demands and causes of action are matured or unmatured or known or unknown. 18. Costs and Expenses. The Borrowers hereby reaffirm their agreement under the Credit Agreement to pay or reimburse the Lender on demand for all costs and expenses incurred by the Lender in connection with the Credit Agreement, the Security Documents and all other documents contemplated thereby, including without limitation all reasonable fees and disbursements of legal counsel. Without limiting the generality of the foregoing, the Borrowers specifically agree to pay all fees and disbursements of counsel to the Lender for the services performed by such counsel in connection with the preparation of this Amendment and the documents and instruments incidental hereto. The Borrowers hereby agree that the Lender may, at any time or from time to time in its sole discretion and without further authorization by the Borrowers, make a loan to any Borrower under the Credit Agreement, or apply the proceeds of any loan, for the purpose of paying any such fees, disbursements, costs and expenses. 19. Miscellaneous. This Amendment and the Acknowledgment and Agreement of Guarantor may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and all of which counterparts, taken together, shall constitute one and the same instrument. [SIGNATURE PAGE FOLLOWS] IN WITNESS WHEREOF, the parties hereto have caused this First Amendment to be duly executed as of the date first written above. HESKA CORPORATION DIAMOND ANIMAL HEALTH, INC. By: /s/ Ronald L. Hendrick By: /s/ Ronald L. Hendrick ---------------------- ---------------------- Name: RONALD L. HENDRICK Name: RONALD L. HENDRICK Title: EVP and CFO Title: Secretary and Treasurer WELLS FARGO BUSINESS CREDIT, INC. f/k/a Norwest Business Credit, Inc. By: /s/Colette Taylor ---------------------- Name: COLETTE TAYLOR Title: Assistant Vice President ACKNOWLEDGMENT AND AGREEMENT OF GUARANTOR The undersigned, a guarantor of the indebtedness of Heska Corporation and Diamond Animal Health, Inc. (collectively, the "Borrowers") to Wells Fargo Business Credit, Inc., f/k/a Norwest Business Credit, Inc. (the "Lender") pursuant to a Guaranty dated as of June 14, 2000 (the "Guaranty"), hereby (i) acknowledges receipt of the foregoing First Amendment; (ii) consents to the terms and execution thereof; (iii) reaffirms its obligations to the Lender pursuant to the terms of its Guaranty; and (iv) acknowledges that the Lender may amend, restate, extend, renew or otherwise modify the Credit Agreement and any indebtedness or agreement of the Borrowers, or enter into any agreement or extend additional or other credit accommodations, without notifying or obtaining the consent of the undersigned and without impairing the liability of the undersigned under its Guaranty for all of the Borrowers' present and future indebtedness to the Lender. DIAMOND ANIMAL HEALTH, INC. By: /s/ Ronald L. Hendrick ---------------------- Name: RONALD L. HENDRICK Title: Secretary and Treasurer -----END PRIVACY-ENHANCED MESSAGE-----