BUSINESS OVERVIEW AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

3 Months Ended

Mar. 31, 2023

BUSINESS OVERVIEW AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Heska Corporation and its wholly-owned subsidiaries ("Heska", the "Company", "we" or "our") sell, manufacture, market and support diagnostic and specialty products and solutions for veterinary practitioners. Our portfolio includes Point of Care ("POC") diagnostic laboratory instruments and consumables including rapid assay diagnostic products and digital cytology services; POC digital imaging diagnostic products; local and cloud-based data services; veterinary practice information management software solutions ("PIMS") and related software and support; reference laboratory testing; allergy testing and immunotherapy; heartworm preventive products; and vaccines. Our primary focus is on supporting companion animal veterinarians in providing care to their patients.

Proposed Merger

On March 31, 2023, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Antech Diagnostics, Inc., a California corporation (“Acquiror”), Helsinki Merger Sub LLC, a Delaware limited liability company and a wholly owned subsidiary of Acquiror (“Merger Sub”), and, solely for purposes of Section 9.15 of the Merger Agreement, Mars, Incorporated, a Delaware corporation ("Mars").

The Merger Agreement provides that, subject to the terms and conditions set forth therein, at the effective time of the Merger, Merger Sub will be merged with and into the Company (the “Merger”), with the Company continuing as the surviving corporation and wholly owned subsidiary of Acquiror, and each share of public common stock, par value $0.01 per share, of the Company (other than shares held in the treasury of the Company, shares held, directly or indirectly, by Mars, Acquiror or Merger Sub (or any of their subsidiaries) or any wholly-owned subsidiary of the Company immediately prior to the Effective Time, restricted stock of Heska (the treatment of which is described elsewhere in the Merger Agreement) or shares held by a holder who properly demands appraisal of such shares pursuant to, and who complies in all respects with, Section 262 of the Delaware General Corporation Law) will be automatically cancelled and converted into the right to receive $120.00 per share in cash, without interest.

Completion of the Merger is subject to customary closing conditions, including approval of the Company's shareholders and the receipt of required regulatory approvals. The parties expect the transaction to close in the second half of 2023. The Merger Agreement and the Merger are described in greater detail in the Preliminary Proxy Statement and other materials and documents filed with the SEC, all of which are available on the SEC's website at www.sec.gov.

During the quarter ended March 31, 2023, the Company incurred $5.1 million of costs related to the Merger Agreement, which are included within General and administrative on the Condensed Consolidated Statements of Loss.

Basis of Presentation and Consolidation

The accompanying interim Condensed Consolidated Financial Statements are unaudited. The interim unaudited Condensed Consolidated Financial Statements have been prepared on a basis consistent with the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include normal, recurring adjustments, necessary to present fairly the financial position of the Company as of March 31, 2023, and the results of our operations and statements of stockholders' equity for the three months ended March 31, 2023 and 2022, and cash flows for the three months ended March 31, 2023 and 2022.

The unaudited Condensed Consolidated Financial Statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted pursuant to such rules and regulations. Our unaudited Condensed Consolidated Financial Statements include our accounts and the accounts of our wholly-owned subsidiaries since their respective dates of acquisitions. All intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three months ended March 31, 2023 are not necessarily indicative of the results to be expected for the full year or any future period. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2022 and other financial information filed with the SEC.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates are required when establishing the allowance for credit losses and the net realizable value of inventory; determining future costs associated with warranties provided; determining the period over which our obligations are fulfilled under agreements to license product rights and/or technology rights; evaluating long-lived and intangible assets and investments for estimated useful lives and impairment; estimating the useful lives and standalone selling prices of instruments under leasing arrangements; determining the allocation of purchase price under purchase accounting; estimating the timing and probability of expense associated with the granting of performance-based stock awards; determining the need for, and the amount of a valuation allowance on deferred tax assets; determining the fair value of our embedded derivatives; determining the value of the contingent consideration in a business combination and determining the value of the non-controlling interest in a business combination. Our actual results may differ from these estimates and there may be changes to those estimates in future periods.

Fair Value of Financial Instruments

In accordance with ASC 820, Fair Value Measurements (“ASC 820”), the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Quoted prices in active markets for similar assets and liabilities, quoted prices for identically similar assets or liabilities in markets that are not active and models for which all significant inputs are observable either directly or indirectly.

Level 3: Unobservable inputs reflecting the reporting entity’s own assumptions or external inputs for inactive markets.

The Company's financial instruments consist of cash and cash equivalents, short-term trade receivables and payables, a short-term note receivable with an embedded derivative asset, and its 3.75% Convertible Senior Notes due 2026 (the "Notes"). The carrying values of cash and cash equivalents and short-term trade receivables and payables approximate fair value because of the short-term nature of the instruments.

The fair values of our financial instruments at March 31, 2023 and December 31, 2022 were (in thousands):


	Total		Level 1		Level 2		Level 3
2023
Financial Assets
Money market fund	$	93,000	$	93,000	$	—	$	—
Convertible note receivable embedded derivative	177		—		—		177

Financial Liabilities
BiEsseA contingent consideration	453		—		—		453
Balances, March 31, 2023	$	93,630	$	93,000	$	—	$	630

2022	Total		Level 1		Level 2		Level 3

Financial Assets
Money market fund	$	95,000	$	95,000	$	—	$	—
Convertible note receivable embedded derivative	177		—		—		177
Financial Liabilities
BiEsseA contingent consideration	438		—		—		438
Balances, December 31, 2022	$	95,615	$	95,000	$	—	$	615

The Company's financial assets based upon Level 3 inputs include embedded derivatives relating to its notes receivable. The Company determined the redemption features of its convertible note receivable represent an embedded derivative. The estimated fair value of the embedded derivative asset is evaluated through Level 3 inputs using a probability-weighted scenario analysis. The Company determined the warrant associated with its promissory note receivable represents a derivative. The estimated fair value of the derivative asset is evaluated through Level 3 inputs, using an enterprise valuation model. The fair value of the warrant was $0 as of December 31, 2022. The warrant was cancelled as of January 3, 2023, due to the LightDeck acquisition further discussed in Note 3. For additional information regarding the Company's notes receivable and derivatives, refer to Note 17, Notes Receivable.

The estimated fair value of the Notes is disclosed at each reporting period and is evaluated through Level 2 inputs with consideration of quoted market prices in less active markets. For additional information regarding the Company's accounting treatment for the issuance of the Notes, refer to Note 16, Convertible Notes.

The Company's financial liabilities based upon Level 3 inputs include contingent consideration arrangements and notes payable relating to its acquisitions of Lacuna Diagnostics, Inc. ("Lacuna"), BiEsse A-Laboratorio die Analisi Veterinarie S.r.l. (“BSA”), and Biotech Laboratories U.S.A. LLC ("Biotech"). The Company is obligated to pay contingent consideration payments of $2.0 million in connection with the Lacuna acquisition based on the achievement of certain performance metrics within a twelve month period ("Initial Earn Out Period"), reducing to $1.0 million if such metrics were met in a twelve month period subsequent to the Initial Earn Out Period. The twelve month period subsequent to the Initial Earn Out Period ended on March 31, 2023. The required performance metrics were not achieved, and no contingent consideration was paid. The Company is obligated to pay contingent consideration payments of $2.7 million in connection with the BSA acquisition based on the achievement of certain revenue metrics within three annual periods after 2021. Refer to Note 3, Acquisitions and Related Party Items for further discussion.

The fair value of our contingent consideration and notes payable arrangements was determined at inception based on a probability-weighted outcome analysis. The fair value of the contingent consideration and notes payable liabilities associated with future payments were based on several factors, the most significant of which are the financial and product development performance of the acquired businesses. For the contingent consideration liabilities, the Company will update its assumptions each reporting period based on new developments and record such amounts at fair value based on the revised assumptions until the agreements expire. Changes in fair value are recorded in the Condensed Consolidated Statements of Loss within General and administrative expenses. The note payable associated with the Biotech acquisition is not adjusted to fair value each period.

The following table presents the changes of our Level 3 assets and liabilities as of March 31, 2023 (in thousands):


	Derivative Assets		Contingent Consideration Liabilities
	Convertible note receivable		Lacuna		BiEsseA
Balances, December 31, 2022	$	177	$	—	$	438


Changes in fair value	—		—		8
Foreign currency impact	—		—		7
Balances, March 31, 2023	$	177	$	—	$	453

Significant Accounting Policies

Our accounting policies are described in our audited Consolidated Financial Statements and Notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2022, and have not changed materially since such filing.

Accounting Pronouncements Not Yet Adopted

There have been no recent accounting pronouncements issued and not yet adopted that would have a material impact on our financial position or disclosures.