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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended December 31, 2019
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period from _________________ to _______________________
Commission file number: 000-22427
HESKA CORPORATION
(Exact name of registrant as specified in its charter)
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Title of each class
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Trading Symbol
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Name of each exchange on which registered
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Common stock, $0.01 par value
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HSKA
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The Nasdaq Stock Market LLC
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Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
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Large accelerated filer o
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Accelerated filer x
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Non-accelerated filer o
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Smaller Reporting Company ¨
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Emerging Growth Company ¨
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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The aggregate market value of voting common stock held by non-affiliates of the Registrant was approximately $591,307,230 as of June 28, 2019 based upon the closing price on the Nasdaq Capital Market reported for such date. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose.
7,838,402 shares of the Registrant's Public Common Stock, $.01 par value, were outstanding at February 27, 2020.
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DOCUMENTS INCORPORATED BY REFERENCE
Items 10, 11, 12, 13 and 14 of Part III incorporate by reference information from the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the Registrant's 2020 Annual Meeting of Stockholders to be held on or about April 8, 2020.
TABLE OF CONTENTS
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Item 1.
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Item 1A.
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Item 1B.
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Item 2.
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Item 3.
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Item 4.
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Item 5.
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Item 6.
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Item 7.
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Item 7A.
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Item 8.
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Item 9.
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Item 9A.
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Item 9B.
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Item 10.
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Item 11.
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Item 12.
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Item 13.
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Item 14.
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Item 15.
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Item 16.
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HESKA, ALLERCEPT, HemaTrue, Solo Step, Element DC, Element HT5, Element POC, Element i, Element COAG, Element DC5X and Element RC are registered trademarks and SonoPod, DentiPod and Element i+ are trademarks of Heska Corporation. DRI-CHEM is a registered trademark of FUJIFILM Corporation. TRI-HEART is a registered trademark of Intervet Inc., d/b/a Merck Animal Health, formerly known as Schering-Plough Animal Health Corporation ("Merck Animal Health"), which is a unit of Merck & Co., Inc., in the United States and is a registered trademark of Heska Corporation in other countries. This annual report on Form 10-K also refers to trademarks and trade names of other organizations.
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Statement Regarding Forward Looking Statements
This Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). For this purpose, any statements contained herein that are not statements of current or historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results could differ materially from those expressed or forecasted in any such forward-looking statements as a result of certain factors. Such factors are set forth in "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this Form 10-K and include, among others, risks and uncertainties related to:
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the success of third parties in marketing our products;
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outside business interests of our Chief Executive Officer,
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our reliance on third party suppliers and collaborative partners;
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our dependence on key personnel;
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our dependence upon a number of significant customers;
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competitive conditions in our industry;
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our ability to market and sell our products successfully;
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expansion of our international operations;
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the impact of regulation on our business;
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the success of our acquisitions and other strategic development opportunities;
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our ability to develop, commercialize and gain market acceptance of our products;
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cybersecurity incidents and related disruptions and our ability to protect our stakeholders’ privacy;
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product returns or liabilities;
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volatility of our stock price;
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our ability to service our convertible notes and comply with their terms.
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Readers are cautioned not to place undue reliance on these forward-looking statements.
Although we believe that expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect the passage of time, any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based, except as otherwise required by applicable securities laws. These forward-looking statements apply only as of the date of this Form 10-K or for statements incorporated by reference from our 2020 proxy statement on Schedule 14A, as of the date of the Schedule 14A.
PART I
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Item 1.
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Business
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Unless we state otherwise or the context otherwise requires, the terms "Heska," "we," "our," "us" and the "Company" refer to Heska Corporation and its consolidated subsidiaries.
Our Certificate of Incorporation, as amended (the “Charter”), authorizes three classes of stock: Original Common Stock, Public Common Stock, and Preferred Stock. Pursuant to an NOL Protective Amendment to the Charter adopted in 2010, all shares of Original Common Stock then outstanding were automatically
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reclassified into shares of Public Common Stock. Our Public Common Stock trades on the Nasdaq Stock Market LLC. In this Annual Report on Form 10-K, references to “Public Common Stock” and “common stock” are references to our Public Common Stock, unless the context otherwise requires.
Overview
We sell veterinary and animal health diagnostic and specialty products. Our offerings include Point of Care diagnostic laboratory instruments and consumables; digital diagnostic imaging instruments, software and services; vaccines; local and cloud-based data services; allergy testing and immunotherapy; and single-use offerings such as in-clinic diagnostic tests and heartworm preventive products. Our core focus is on supporting veterinarians in the canine and feline healthcare space.
On February 24, 2013, the Company acquired a 54.6% interest in Cuattro Veterinary USA, LLC (the "Acquisition"), which was subsequently renamed Heska Imaging US, LLC ("U.S. Imaging") and marked our entry into the veterinary imaging market in the United States ("U.S."). The remaining minority position (45.4%) in U.S. Imaging was subject to purchase by Heska under performance-based puts and calls following the audit of our financial statements for 2016 and 2017. With the required performance criteria met in fiscal year 2016, we considered notice given on March 3, 2017 that the put option was being exercised and on May 31, 2017, we delivered $13.8 million in cash to obtain the remaining minority position in U.S. Imaging.
On May 31, 2016, the Company closed a transaction (the "Cuattro Merger") to acquire Cuattro Veterinary, LLC ("Cuattro International"), which was subsequently renamed Heska Imaging International, LLC ("International Imaging") and marked our entry into the international veterinary imaging market. Financial information broken out by geographic region is incorporated by reference to Note 17 to the financial statements included under Item 8 of this annual report on Form 10-K. As of the closing date of the Cuattro Merger, the Company's interest in both International Imaging and U.S. Imaging was transferred to the Company's wholly owned subsidiary, Heska Imaging Global, LLC ("Global Imaging").
On June 1, 2017, the Company consolidated its assets and liabilities in the U.S. Imaging and International Imaging companies into Global Imaging, which was re-named Heska Imaging, LLC ("Heska Imaging").
On June 13, 2017, the Company incorporated Heska Canada Limited in the province of British Columbia, in order to expand our footprint into more of the North American veterinary market.
On July 26, 2018, the Company incorporated Heska Australia Pty Ltd in the state of Victoria, in order to expand our footprint into the Australian veterinary market.
On February 22, 2019, the Company acquired Optomed. Optomed designs, develops, manufactures and distributes veterinary imaging solutions, with a primary focus and expertise in endoscopy technologies and has a direct sales presence in France.
On December 5, 2019, the Company acquired CVM Diagnostico Veterinario, S.L. and CVM Ecografia, jointly known as the CVM Companies ("CVM"). CVM is a Spanish company that primarily sells and performs marketing of medical equipment to veterinary clinics.
On January 14, 2020, the Company entered into an agreement among the Company, Heska GmbH, Covetrus Animal Health Holdings Limited and Covetrus, Inc. regarding the sale and purchase of the sole share in scil animal care company GmbH (“scil”) whereby Heska is acquiring 100% of the capital stock of scil from Covetrus Animal Health Holdings Limited, a subsidiary of Covetrus, Inc. Heska will purchase scil (the “Acquisition”) for $125 million in cash, subject to working capital and other adjustments. The Acquisition is expected to close no later than by the end of the second quarter of 2020.
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We were founded as Paravax, Inc. and incorporated in California in 1988. We changed our name to Heska Corporation in 1995, reincorporated in Delaware and completed our initial public offering in 1997.
Products and Services
Our business is composed of two reportable segments, Core Companion Animal ("CCA") and Other Vaccines and Pharmaceuticals ("OVP"). The CCA segment includes, primarily for canine and feline use, Point of Care laboratory instruments and consumables; digital imaging diagnostic instruments, software and services; local and cloud-based data services; allergy testing and immunotherapy; and single use offerings such as in-clinic diagnostic tests and heartworm preventive products. The CCA segment represents approximately 87% of our revenue. The OVP segment includes private label vaccine and pharmaceutical production, primarily for cattle but also for other species including equine, porcine, avian, feline and canine. OVP products are sold by third parties under third party labels. OVP represents approximately 13% of our revenue.
Core Companion Animal Segment
We presently sell a variety of companion animal health products and services, among the most significant of which are the following:
Point of Care Laboratory and Imaging Diagnostics
We offer a line of veterinary Point of Care (stationary and portable) laboratory diagnostic instruments for testing blood and other biological materials, for use in diagnostic imaging and for other uses, some of which are described below. We also market and sell consumable supplies and services for these instruments. Our line of veterinary instruments includes the following:
Blood Chemistry. Element DC® Veterinary Chemistry Analyzer (the "Element DC") is an easy-to-use, robust system that uses dry slide technology for blood chemistry and electrolyte analysis and has the ability to run 22 tests at a time with a single blood sample. Test slides are available as both pre-packaged panels as well as individual slides. The Element DC5x® Veterinary Chemistry Analyzer (the "Element DC5x"), launched during 2018, delivers faster run times, higher throughput, and allows simultaneous staging of five patient samples. The Element DC and Element DC5x utilize the same test slides. We are supplied with the Element DC and Element DC5x, as well as the affiliated test slides and supplies, under a contractual agreement with FUJIFILM.
We also market and distribute the Element RC®, an easy-to-use, compact chemistry system that utilizes load-and-go rotors for blood chemistry and electrolyte analysis. A small volume of whole blood can be loaded on the rotor, eliminating the need for external centrifugation. Rotors of various test menus are available, providing results for up to 20 measured tests plus additional calculated values. Typical rotor run times are 12 minutes.
Hematology. The Element HT5® Hematology Analyzer (the "HT5") is a true 5-part hematology analyzer which measures key parameters such as white blood cell count, red blood cell count, platelet count and hemoglobin levels in animals. The HT5 can generate results in less than a minute with 15 µL of sample. We are supplied with the HT5 and affiliated reagents and supplies under a contractual agreement with Shenzen Mindray Bio-Medical Electronics Co., Ltd. ("Mindray"). The HemaTrue® Veterinary Hematology Analyzer (the "HemaTrue") is an easy-to-use and reliable 3-part hematology blood analyzer that we continue to offer to our customers. We are supplied with the HemaTrue reagents and supplies under a contractual agreement with Boule Medical AB ("Boule").
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Blood Gases and Electrolytes. The Element POC® Blood Gas & Electrolyte Analyzer (the "EPOC") is a handheld, wireless analyzer which delivers rapid blood gas, electrolyte, metabolite and basic blood chemistry testing. The EPOC features test cards with room temperature storage which can offer results with less than 100 µL of sample as well as WiFi and Bluetooth connectivity. The EPOC and affiliated consumables and supplies are supplied to us under a contractual agreement with Siemens Healthcare Diagnostics, Inc., a unit of Siemens Healthineers AG.
Immunodiagnostics. The Element i® Immunodiagnostic Analyzer (the "Element i") utilizes fluorescence immunoassay technology to ensure sensitivity for accurate in-clinic detection of Total T4, TSH, Cortisol, Bile Acids, and Progesterone. The Element i is a benchtop technology with a test time of 10 minutes or less per analyte. Along with confidence in results, this measurement principle allows for simplified reagents and testing protocols. Element i units are supplied to us under a contractual agreement with FUJIFILM.
Coagulation. The Element COAG® Veterinary Analyzer (the "Element COAG") is a compact benchtop, cartridge-based system used for coagulation and specialty testing. There are five test cartridges offered: the PT/aPTT Coag Combo, Equine Fibrinogen, Canine Fibrinogen, Canine DEA 1 Blood Typing and Feline A and B Blood Typing. Each of these cartridges perform accurate, automated analysis using less than 100 µL of sample in just minutes. We are supplied with the Element COAG and affiliated cartridges and supplies under a contractual agreement with Zoetis US, LLC, a unit of Zoetis Inc.
IV Pumps. The VET/IV 2.2TM infusion pump is a compact, affordable IV pump that allows veterinarians to easily provide regulated infusion of fluids for their patients.
Digital Radiography. We sell hardware, including digital radiography detectors, acquisition workstation equipment, positioning aides, viewing computers, radiographic generators, anti-scatter grids and other accessories for use in digital radiography imaging diagnostics. With this hardware, we also provide licensed embedded software, support, data hosting, warranty and other services. CloudDRTM solutions combine flat panel digital radiography detectors, acquisition workstations and acquisition software to produce, review, archive and share radiographic image studies, primarily in fixed location companion animal veterinary settings.
We also sell mobile digital radiography products, primarily for equine use, such as the Uno 6TM, a full powered, portable digital radiography generator integrated with an embedded touchscreen acquisition and review function, based upon a patented design of Cuattro, LLC ("Cuattro"). In addition to Uno 6TM, we sell the Slate HUBTM, a mobile digital radiography acquisition console that is capable of operating as a general full field wireless x-ray imager and as the control and display for DentiPodTM, a large format equine intraoral dental sensor, and SonoPod TM, a wireless ultrasound.
Ultrasound Systems. We sell ultrasound products, including affiliated probes and peripherals, with varying features and corresponding price points.
Diagnostic Data and Support. CloudbankTM is an automatic, secure, web-based image storage solution designed to interface with the imaging products we sell. ViewCloudTM and HeskaView+TM are Picture Archival and Communications Systems (PACS) for CloudbankTM for web or local viewing, reporting, planning and email sharing of studies on Internet devices, including personal computers, tablet devices and smartphones. SupportCloudTM is a support package including call center voice and remote diagnostics, recovery and other services, such as the provision of warranty-related loaner units, to support customers. Access and operation between our imaging devices, CloudbankTM and SupportCloudTM is supported by the acquisition software used in the equipment we sell.
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With the acquisition of U.S. Imaging, we entered into supply and license agreements with Cuattro to secure exclusive rights to, among other things, proprietary acquisition software, CloudbankTM, ViewCloudTM, research and development and other benefits. Cuattro provided us with much of the hardware, software, data hosting and other services for our digital radiography solutions under these exclusive contractual arrangements. Cuattro is 100% owned by our President and Chief Executive Officer, Kevin S. Wilson, his spouse, Shawna M. Wilson ("Mrs. Wilson") and by trusts for the benefit of their children and family. On December 21, 2018, we closed on the purchase of the acquisition software previously provided by Cuattro in the amount of $8.2 million and terminated the supply and license agreement. Related party and acquisition disclosures are incorporated by reference to Note 3 to the financial statements included under Item 8 of this annual report on Form 10-K.
Point of Care Heartworm Diagnostic Tests
Heartworm infections of dogs and cats are caused by the parasite Dirofilaria immitis. This parasitic worm is transmitted in larval form to dogs and cats through the bite of an infected mosquito. Larvae develop into adult worms that live in the pulmonary arteries and heart of the host, where they can cause serious cardiovascular, pulmonary, liver and kidney disease. Our canine and feline heartworm diagnostic tests use monoclonal antibodies or a recombinant heartworm antigen, respectively, to detect heartworm antigens or antibodies circulating in the blood of an infected animal.
We market and sell heartworm diagnostic tests for both canine and feline species. Solo Step® CH for dogs and Solo Step® FH for cats are available in point-of-care, single use formats that can be used by veterinarians on site. We obtain Solo Step® CH and Solo Step® FH from Quidel Corporation ("Quidel").
Heartworm Preventive Products
We have an agreement with Merck Animal Health, a unit of Merck & Co., Inc., granting Merck Animal Health the exclusive distribution and marketing rights for our canine heartworm prevention product, Tri-Heart® Plus Chewable Tablets, ultimately sold to or through veterinarians in the U.S. Tri-Heart Plus Chewable Tablets (ivermectin/pyrantel) are indicated for use as a monthly preventive treatment of canine heartworm infection and for treatment and control of ascarid and hookworm infections. We manufacture Tri-Heart Plus Chewable Tablets at our Des Moines, Iowa production facility.
Allergy Products and Services
Allergy is common in companion animals. Clinical symptoms of allergy are variable, but are often manifested as persistent and serious skin disease in dogs and cats. Clinical management of allergic disease is problematic, as there are a large number of allergens that may give rise to these conditions. Although skin testing is often regarded as the most accurate diagnostic procedure, such tests can be painful, subjective and inconvenient. The effectiveness of the immunotherapy that is prescribed to treat symptoms of allergic disease is inherently limited by inaccuracies in the diagnostic process.
We believe that our ALLERCEPT® Definitive Allergen Panels provide the most accurate determination of which we are aware of the specific allergens to which an animal, such as a dog, cat or horse, is reacting. The panels use a highly specific recombinant version of the natural IgE receptor to test the serum of potentially allergic animals for IgE directed against a panel of known allergens. A typical test panel consists primarily of various pollen, grass, mold, insect and mite allergens. The test results serve as the basis for prescription ALLERCEPT® Therapy Shots and ALLERCEPT® Therapy Drops. We operate veterinary laboratories in Loveland, Colorado and Fribourg, Switzerland which both offer blood testing using our ALLERCEPT® Definitive Allergen Panels.
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We sell kits to conduct blood testing using our ALLERCEPT® Definitive Allergen Panels to third party veterinary diagnostic laboratories outside of the U.S. We also sell products to screen for the presence of allergen-specific IgE to these customers - we sell kits to conduct preliminary blood testing using products based on our ALLERCEPT® Definitive Allergen Panels. Animals testing positive for allergen-specific IgE using these screening tests are candidates for further evaluation using our ALLERCEPT® Definitive Allergen Panels.
Veterinarians who use our ALLERCEPT® Definitive Allergen Panels often purchase our ALLERCEPT® Therapy Shots or ALLERCEPT® Therapy Drops. These prescription immunotherapy treatment sets are formulated specifically for each allergic animal and contain only the allergens to which the animal has significant levels of IgE antibodies. The prescription formulations are administered in a series of subcutaneous injections (Shots) or by daily sublingual (under the tongue) administration (Drops), with doses increasing over several months, to ameliorate the allergic condition of the animal. Immunotherapy is generally continued for an extended time. We offer canine, feline and equine subcutaneous and sublingual immunotherapy treatment products. We believe our ALLERCEPT® Therapy Drops offer a convenient alternative to subcutaneous injection, thereby increasing the likelihood of pet owner compliance.
Other Vaccines and Pharmaceuticals Segment
We developed a line of bovine vaccines that are licensed by the U.S. Department of Agriculture ("USDA"). Historically, the largest distributor of these vaccines was Agri Laboratories, Ltd. ("AgriLabs"), who sold these vaccines primarily under the Titanium® and MasterGuard® brands. In November 2013, AgriLabs assigned the long-term agreement with us related to these vaccines, and the agreement was assumed by Eli Lilly and Company ("Eli Lilly") operating through Elanco. In January 2015, we signed a long-term Master Supply Agreement related to these vaccines with Eli Lilly operating through Elanco, thereby terminating the AgriLabs agreement previously assumed by Eli Lilly in November 2013.
We manufacture biological and pharmaceutical products for a number of other animal health companies. We manufacture products for animals other than cattle including horses, pigs, chickens, cats and dogs. Our offerings range from providing complete turnkey services which include research, licensing, production, labeling and packaging of products to providing any one of these services as needed by our customers as well as validation support and distribution services.
Marketing, Sales and Customer Support
We currently market our CCA products in the U.S. to veterinarians through an outside field organization, a telephone sales force and independent third-party distributors, as well as through trade shows, print advertising and through other distribution relationships, such as Merck Animal Health in the case of our heartworm preventive. As of December 31, 2019, our customer facing sales, installed base support and utilization organization consisted of 100 individuals in various parts of the U.S.
Veterinarians may obtain our products directly from us or indirectly through others. All of our CCA products ultimately are sold primarily to or through veterinarians. The acceptance of our products by veterinarians is critical to our success.
We have a staff dedicated to customer and product support in our CCA segment including veterinarians, technical support specialists and service technicians. Individuals from our product development group may also be used as a resource in responding to certain product inquiries.
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Internationally, we market our CCA products to veterinarians primarily through third-party veterinary diagnostic laboratories and independent third party distributors but through our recent acquisitions of Optomed and CVM and organic effort in Australia, we have begun to market directly.
All OVP products are marketed and sold by third-parties under third-party labels.
We grant third parties rights to our intellectual property as well as our products, with our compensation often taking the form of royalties and/or milestone payments.
Manufacturing
The majority of our revenue is from proprietary products manufactured by third parties. Third parties manufacture our veterinary instruments, including affiliated consumables and supplies, as well as other products including key components of our heartworm point-of-care diagnostic tests. We manufacture and supply Quidel with certain critical raw materials and perform the final packaging operations for these products.
Our facility in Des Moines, Iowa is a USDA, Food and Drug Administration ("FDA") and Drug Enforcement Agency ("DEA") licensed biological and pharmaceutical manufacturing facility. This facility currently has the capacity to manufacture more than 50 million doses of vaccine each year. We expect that we will, for the foreseeable future, manufacture most, or all of our pharmaceutical and biological products at this facility, as well as most, or all, of our recombinant proteins and other proprietary reagents for our diagnostic tests. We currently manufacture our canine heartworm prevention product, our allergy treatment products and all our OVP segment products at this facility. The OVP segment's customers purchase products in both finished and bulk format, and we perform all phases of manufacturing, including growth of the active bacterial and viral agents, sterile filling, lyophilization and packaging at this facility. We manufacture our various allergy products at our Des Moines facility, our Loveland facility and our Fribourg facility. We believe the raw materials for most of the products we manufacture are readily available from more than one source.
Product Development
We are committed to providing innovative products to address the health needs of companion animals. We may obtain such products from external sources, external collaboration or internal research and development.
We are committed to identifying external product opportunities and creating business and technical collaborations that lead to high value veterinary products. We believe that our active participation in scientific networks and our reputation for investing in research enhances our ability to acquire external product opportunities. We have collaborated, and intend to continue to do so, with a number of companies and universities. Examples of such collaborations include:
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Quidel for the development of SOLO STEP CH Cassettes and SOLO STEP FH Cassettes;
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Mindray for the development of veterinary applications for the HT5 Veterinary Hematology Analyzer and associated reagents;
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FUJIFILM for the development of veterinary applications for the Element DC and Element DC5x Veterinary Chemistry Analyzers and associated slides and supplies;
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•MBio Diagnostics for the development and manufacturing of the Immuno-assay Analyzer; and
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Collaborating with third-parties for the development and manufacturing of the Element UF urine and fecal analyzers.
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Internal research and development is managed on a case-by-case basis. We employ individuals with expertise in various applicable areas and will form multidisciplinary product-associated teams as appropriate.
Intellectual Property
We believe that patents, trademarks, copyrights and other proprietary rights represent opportunities to grow our business and maintain or enhance our competitive position. We also rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. The proprietary technologies of our OVP segment are primarily protected through trade secret protection of, for example, our manufacturing processes in this area.
We actively seek patent protection both in the U.S. and abroad. Our issued patent portfolios primarily relate to heartworm control, flea control, allergy, infectious disease vaccines, diagnostic and detection tests, immunomodulators, instrumentation, pain control and vaccine delivery technologies. As of December 31, 2019, we owned, co-owned or had rights to 18 issued U.S. patents expiring at various dates from January 2020 to April 2024 and had no pending U.S. patent applications. Our corresponding foreign patent portfolio as of December 31, 2019 included 16 issued patents in various foreign countries expiring at various dates from April 2020 to August 2024 and had no pending applications.
We also have obtained exclusive and non-exclusive licenses for numerous other patents held by academic institutions and for-profit companies.
Seasonality
While we do not experience significant seasonal fluctuations in our sales throughout the year, we generally experience higher sales in the fourth quarter due to industry trade shows and other similar activity.
Government Regulation
Although the majority of our revenue is from the sale of unregulated items, many of our products or products that we may develop are, or may be, subject to extensive regulation by governmental authorities in the U.S., including the USDA and the FDA and by similar agencies in other countries. These regulations govern, among other things, the development, testing, manufacturing, labeling, storage, pre-market approval, advertising, promotion, sale and distribution of our products. Satisfaction of these requirements can take several years to achieve and the time needed to satisfy them may vary substantially, based on the type, complexity and novelty of the product. Any product that we develop must receive all relevant regulatory approval or clearances, if required, before it may be marketed in a particular country. The following summarizes the major U.S. government agencies that regulate animal health products:
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USDA. Vaccines and certain single use, point-of-care diagnostics are considered veterinary biologics and are therefore regulated by the Center for Veterinary Biologics, or CVB, of the USDA. In contrast to vaccines, single use, point-of-care diagnostics can typically be licensed by the USDA in about two years, at considerably less cost. However, vaccines or diagnostics that use innovative materials, such as those resulting from recombinant DNA technology, usually require additional time to license. The USDA licensing process involves the submission of several data packages. These packages include information on how the product will be manufactured, information on the efficacy and safety of the product in laboratory and target animal studies and information on performance of the product in field conditions.
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FDA. Pharmaceutical products, which typically include synthetic compounds, are approved and monitored by the Center for Veterinary Medicine of the FDA. Under the Federal Food, Drug and Cosmetic Act, the same statutory standard for FDA approval applies to both human and animal drugs: demonstrated safety, efficacy and compliance with FDA manufacturing standards. However, unlike human drugs, neither preclinical studies nor a sequential phase system of studies are required. Rather, for animal drugs, studies for safety and efficacy may be conducted immediately in the species for which the drug is intended. Thus, there is no required phased evaluation of drug performance, and the Center for Veterinary Medicine will review data at appropriate times in the drug development process. The time and cost for developing companion animal drugs may be significantly less than for drugs for livestock animals, which generally have enhanced standards designed to ensure safety in the food chain.
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EPA. Products that are applied topically to animals or to premises to control external parasites are regulated by the Environmental Protection Agency, or EPA.
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After we have received regulatory licensing or approval for our products, numerous regulatory requirements typically apply. Among the conditions for certain regulatory approvals is the requirement that our manufacturing facilities or those of our third-party manufacturers conform to current Good Manufacturing Practices or other manufacturing regulations, which include requirements relating to quality control and quality assurance as well as maintenance of records and documentation. The USDA, FDA and foreign regulatory authorities strictly enforce manufacturing regulatory requirements through periodic inspections and/or reports.
A number of our animal health products are not regulated. For example, certain products such as our ALLERCEPT panels are not regulated by either the USDA or FDA. Similarly, none of our veterinary instruments requires regulatory approval to be marketed and sold in the U.S.
We have pursued CE Marking for imaging equipment and regulatory approval outside the U.S. based on market demographics of foreign countries. For marketing outside the U.S., we are subject to foreign regulatory requirements governing regulatory licensing and approval for many of our products. Licensing and approval by comparable regulatory authorities of foreign countries must be obtained before we can market products in those countries. Product licensing approval processes and requirements vary from country to country and the time required for such approvals may differ substantially from that required in the U.S. We cannot be certain that approval of any of our products in one country will result in approvals in any other country.
To date, we or our distributors have sought regulatory approval for certain of our products from the Canadian Center for Veterinary Biologics, or CCVB (Canada); the Japanese Ministry of Agriculture, Forestry and Fisheries, or MAFF (Japan); the Australian Department of Agriculture, Fisheries and Forestry, or ADAFF (Australia); the Republic of South Africa Department of Agriculture, or RSADA (South Africa); the Agriculture, Fisheries and Conservation Department, or ADCD (Hong Kong); the Macau Animal Health Division of Animal Control and Inspection, or IACM (Macau); and from the relevant regulatory authorities in certain other countries requiring such approval.
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CCA products previously discussed which have received regulatory approval in the U.S. and/or elsewhere are summarized below:
Customer Concentration
The information concerning our significant customers included in our Risk Factors section of this annual report under the caption “The loss of significant customers who, for example, are historically large purchasers or who are considered leaders in their field could damage our business and financial results” is incorporated herein by reference thereto.
Competition
Our market is intensely competitive. Our competitors include independent animal health companies and major pharmaceutical companies that have animal health divisions. We also compete with independent, third party distributors, including distributors who sell products under their own private labels. In the Point of Care diagnostic testing market, our major competitors include IDEXX Laboratories, Inc. ("IDEXX") and Zoetis Inc. ("Zoetis"). Idexx has a larger veterinary product and service offering than we do and a large sales infrastructure network and a well-established brand name. Zoetis also has a large sales infrastructure network.
The products manufactured by our OVP segment for sale by third parties compete with similar products offered by a number of other companies, some of which have substantially greater financial, technical, research and other resources than us and may have more established marketing, sales, distribution and service organizations than our OVP segment's customers. Companies with a significant presence in the animal health market such as Bayer AG, CEVA Santé Animale, Elanco, Merck, Sanofi, Vétoquinol S.A., Virbac S.A. and Zoetis may be marketing or developing products that compete with our products or would compete with them if successfully developed. These and other competitors and potential competitors may have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than we do. Our competitors may offer broader product lines and have greater name recognition than we do.
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Environmental Regulation
In connection with our product development activities and manufacturing of our biological, pharmaceutical, diagnostic and detection products, we are subject to federal, state and local laws, rules, regulations and policies governing the use, generation, manufacture, storage, handling and disposal of certain materials, biological specimens and wastes. Although we believe that we have complied with these laws, regulations and policies in all material respects and have not been required to take any significant action to correct any noncompliance, we may be required to incur significant costs to comply with environmental and health and safety regulations in the future. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be eliminated. In the event of such an accident, we could be held liable for any damages that result and any such liability could exceed our resources.
Employees
As of December 31, 2019, we and our subsidiaries employed 386 people.
Where You Can Find Additional Information
Our principal executive offices are located at 3760 Rocky Mountain Avenue, Loveland, Colorado 80538. Our telephone number is 970-493-7272 and our Internet address is www.heska.com. References to our website in this Annual Report on Form 10-K are inactive textual references only and the content of our website should not be deemed incorporated by reference for any purpose.
Because we believe it provides useful information in a cost-effective manner to interested investors, we make available free of charge, via a link on our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practical after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the "SEC").
In addition, you may also review and download a copy of this annual report on Form 10-K, including any exhibits and any schedules filed therewith, and our other periodic and current reports, proxy and information statements, and other information that we file with the SEC, without charge, by visiting the SEC's website (http://www.sec.gov).
Information About Our Executive Officers
Our executive officers and their ages as of February 28, 2020 are as follows:
Kevin S. Wilson was appointed President and Chief Executive Officer effective March 31, 2014. He previously served as our President and Chief Operating Officer from February 2013. Mr. Wilson became a member of our Board of Directors in May 2014. Mr. Wilson is a founder, member and officer of Cuattro,
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LLC, an imaging diagnostic company. Since 2008, he has been involved in developing technologies for radiographic imaging with Cuattro, LLC and as a founder of Cuattro Software, LLC, Cuattro Medical, LLC and Cuattro Veterinary, LLC. Mr. Wilson served on the board of various private, non-profit and educational organizations from 2005 to 2011. He was a founder of Sound Technologies, Inc., a diagnostic imaging company, in 1996. After Sound Technologies, Inc. was sold to VCA Antech, Inc. in 2004, Mr. Wilson served as Chief Strategy Officer for VCA Antech, Inc. until 2006. Mr. Wilson attended Saddleback College.
Catherine Grassman, CPA, was appointed Executive Vice President, Chief Financial Officer on May 6, 2019. She previously served as Vice President and Chief Accounting Officer from December 2017 to May 2019 and as Corporate Controller from January 2017 to December 2017. Ms. Grassman has been a central figure in the Company’s accounting and finance leadership. Prior to joining Heska, Ms. Grassman was Corporate Controller of KeyPoint Government Solutions, a mid-sized private-equity backed, background investigation services company. She also spent more than 15 years with PricewaterhouseCoopers, LLP as a senior manager in the audit practice. She is licensed in Colorado as a Certified Public Accountant and possesses a Master of Accountancy and a Bachelor of Business Administration from Stetson University.
Nancy Wisnewski, Ph.D. was appointed Executive Vice President, Chief Operating Officer in August 2019. She previously served as Executive Vice President, Diagnostic Operations and Product Development from September 2016 to August 2019, as Executive Vice President, Product Development and Customer Service from April 2011 to September 2016 and as Vice President, Product Development and Technical Customer Service from December 2006 to April 2011. From January 2006 to November 2006, Dr. Wisnewski was Vice President, Research and Development. Dr. Wisnewski held various positions in Heska's Research and Development organization between 1993 and 2005. She holds a Ph.D. in Parasitology/Biochemistry from the University of Notre Dame and a BS in Biology from Lafayette College.
Steven M. Eyl was appointed Executive Vice President, Global Sales and Marketing in September 2016. He previously served as our Executive Vice President, Commercial Operations from May 2013 to September 2016. Mr. Eyl was a principal of Eyl Business Services, a consulting firm, from January 2012 to May 2013. He was President of Sound Technologies, Inc. ("Sound") from 2000 to 2011, including after Sound's acquisition by VCA Antech, Inc. in 2004. Mr. Eyl has an extensive background in medical technology sales. He is a graduate of Indiana University.
Jason D. Aroesty was appointed Executive Vice President, International Diagnostics in April 2018. Mr. Aroesty worked more than 15 years in the In-Vitro Diagnostics industry, where he played key commercial leadership roles in the healthcare division at Siemens, a global imaging and laboratory diagnostics leader. Mr. Aroesty was based in Europe for more than 10 years, where he led multiple country organizations, eventually assuming European regional responsibilities. Prior to joining Heska, he was responsible for Global Sales, Marketing and Communications for Siemens Point of Care (2015-2018). Mr. Aroesty graduated with a BS degree from Syracuse University and an MBA degree from the University of Rochester's Simon School.
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Item 1A.
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Risk Factors
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Our future operating results may vary substantially from period to period due to a number of factors, many of which are beyond our control. The following discussion highlights some of these factors and the possible impact of these factors on future results of operations. The risks and uncertainties described below are not the only ones we face. Additional risks or uncertainties not presently known to us or that we deem to be currently immaterial also may impair our business operations. If any of the following factors actually occur, our business, financial condition or results of operations could be harmed. In that case, the price of our Public Common Stock could decline and investors in our Public Common Stock could experience losses on their investment.
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Risks related to our business and industry
If the third parties that have substantial marketing rights for certain of our historical products, existing products or future products under development are not successful in marketing those products, then our sales and financial position may suffer.
We are party to an agreement with Merck Animal Health, which grants Merck Animal Health exclusive distribution and marketing rights for our canine heartworm preventive product, TRI-HEART Plus Chewable Tablets, ultimately sold to or through veterinarians in the United States. In 2019, Merck failed to market, sell and support our heartworm preventive product, which resulted in depressed OVP segment annual revenue. Revenue from Merck & Co., Inc. ("Merck") entities, including Merck Animal Health, represented 1% of our 2019 revenue. Historically, a significant portion of our OVP segment’s revenue has been generated from the sale of certain bovine vaccines, which have been sold primarily under the Titanium and MasterGuard brands. We have a supply agreement with Elanco for the production of these vaccines, which represented 8% of our 2019 revenue. Either of these marketing partners may not devote sufficient resources to marketing our products and our sales and financial position could suffer significantly as a result. Furthermore, there may be nothing to prevent these partners from pursuing alternative technologies, products or supply arrangements, including as part of mergers, acquisitions or divestitures. Third party marketing assistance may not be available in the future on reasonable terms, if at all. If the third parties with marketing rights for our products were to merge or go out of business, the sale and promotion of our products could be diminished.
Our Chief Executive Officer has acknowledged outside business interests which may occupy a portion of his time.
On November 26, 2018, Heska Imaging, LLC entered into a Purchase Agreement for Certain Assets with Cuattro, LLC, pursuant to which Heska Imaging, LLC purchased certain software and related assets and terminated its existing Amended and Restated Master License Agreement and Supply Agreement with Cuattro, LLC. Heska Imaging, LLC is required to make a good faith effort to transition to a new cloud provider in a timely way; however, Cuattro, LLC is required to provide services until that transition happens. As discussed below, Mr. Wilson has an interest in these agreements and any time and resources devoted to monitoring and overseeing this relationship may prevent us from deploying such time and resources on more productive matters.
Mr. Wilson’s employment agreement with us acknowledges that Mr. Wilson has business interests in Cuattro, LLC, Cuattro Software, LLC and Cuattro Medical, LLC which may require a portion of his time, resources and attention during his working hours. If Mr. Wilson is distracted by these or other business interests, he may not contribute as much as he otherwise would have to enhancing our business, to the detriment of our shareholder value. Mr. Wilson is the spouse of Shawna M. Wilson (“Mrs. Wilson”). Mr. Wilson, Mrs. Wilson and trusts for their children and family own a majority interest in Cuattro Medical, LLC. In addition, including equity held by Mrs. Wilson and by trusts for the benefit of Mr. and Mrs. Wilson’s children and family, Mr. Wilson also owns a 100% interest in Cuattro, LLC, the largest supplier to Heska Imaging, LLC, our wholly-owned subsidiary. Cuattro, LLC owns a 100% interest in Cuattro Software, LLC.
Cuattro, LLC charged Heska Imaging $6.0 thousand, $4.6 million, and $17.7 million during 2019, 2018, and 2017, respectively, primarily related to digital imaging products, for which there was an underlying supply contract with minimum purchase obligations, software and services as well as other operating expenses. Heska Corporation charged Cuattro, LLC $0, $3.0 thousand, and $0.1 million in the years ended December 31, 2019, 2018, and 2017, respectively, primarily related to facility usage and other services.
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We rely substantially on third party suppliers. The loss of products or delays in product availability from one or more third party suppliers could substantially harm our business.
To be successful, we must contract for the supply of, or manufacture ourselves, current and future products of appropriate quantity, quality and cost. Such products must be available on a timely basis and be in compliance with any regulatory requirements. Similarly, we must provide ourselves, or contract for the supply of, certain services. Such services must be provided in a timely and appropriate manner. Failure to do any of the above could substantially harm our business.
We rely on third party suppliers to manufacture those products we do not manufacture ourselves and to provide services we do not provide ourselves. Proprietary products provided by these suppliers represent a majority of our revenue. We currently rely on these suppliers for our point of care laboratory instruments and consumable supplies for these instruments, for our imaging products and related software and services, for key components of our point-of-care diagnostic tests as well as for the manufacture of other products.
The loss of access to products from one or more suppliers could have a significant, negative impact on our business. Major suppliers that sell us proprietary products are FUJIFILM Corporation and Shenzen Mindray Bio-Medical Electronics Co., Ltd. We often purchase products from our suppliers under agreements that are of limited duration or potentially can be terminated on an annual basis. In the case of our point of care laboratory instruments and our digital radiography solutions, post-termination, we are typically entitled to non-exclusive access to consumable supplies, or ongoing non-exclusive access to products and services to meet the needs of an existing customer base, respectively, for a defined period upon expiration of exclusive rights, which could subject us to competitive pressures in the period of non-exclusive access. There can be no assurance that our suppliers will meet their obligations under any agreements we may have in place with them or that we will be able to compel them to do so. Risks of relying on suppliers include:
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Inability to meet minimum obligations. Current agreements, or agreements we may negotiate in the future, may commit us to certain minimum purchase or other spending obligations. It is possible we will not be able to create the market demand to meet such obligations, which could create a drain on our financial resources and liquidity. Some agreements may require minimum purchases and/or sales to maintain product rights and we may be significantly harmed if we are unable to meet such requirements and lose product rights.
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Loss of exclusivity. In the case of our point of care laboratory instruments, if we are entitled to non-exclusive access to consumable supplies for a defined period upon expiration of exclusive rights, we may face increased competition from a third party with similar non-exclusive access or our former supplier, which could cause us to lose customers and/or significantly decrease our margins and could significantly affect our financial results. In addition, current agreements, or agreements we may negotiate in the future, with suppliers may require us to meet minimum annual sales levels to maintain our position as the exclusive distributor of these products. We may not meet these minimum sales levels and maintain exclusivity over the distribution and sale of these products. If we are not the exclusive distributor of these products, competition may increase significantly, reducing our revenues and/or decreasing our margins.
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Changes in economics. An underlying change in the economics with a supplier, such as a large price increase or new requirement of large minimum purchase amounts, could have a significant, adverse effect on our business, particularly if we are unable to identify and implement an alternative source of supply in a timely manner.
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The loss of product rights upon expiration or termination of an existing agreement. Unless we are able to find an alternate supply of a similar product, we would not be able to continue to offer our customers the same breadth of products and our sales and operating results would likely suffer. In the case of an instrument supplier, we could also potentially suffer the loss of sales of consumable supplies, which would
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be significant in cases where we have built a significant installed base, further harming our sales prospects and opportunities. Even if we were able to find an alternate supply for a product to which we lost rights, we would likely face increased competition from the product whose rights we lost being marketed by a third party or the former supplier and it may take us additional time and expense to gain the necessary approvals and launch an alternative product.
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High switching costs. In our point of care laboratory instrument products, we could face significant competition and lose all or some of the consumable revenues from the installed base of those instruments if we were to switch to a competitive instrument. If we need to change to other commercial manufacturing contractors for certain of our regulated products, additional regulatory licenses or approvals generally must be obtained for these contractors prior to our use. This would require new testing and compliance inspections prior to sale, thus resulting in potential delays. Any new manufacturer would have to be educated in, or develop, substantially equivalent processes necessary for the production of our products. We likely would have to train our sales force, distribution network employees and customer support organization on the new product and spend significant funds marketing the new product to our customer base.
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The involuntary or voluntary discontinuation of a product line. Unless we are able to find an alternate supply of a similar product in this or similar circumstances with any product, we would not be able to continue to offer our customers the same breadth of products and our sales would likely suffer. Even if we are able to identify an alternate supply, it may take us additional time and expense to gain the necessary approvals and launch an alternative product, especially if the product is discontinued unexpectedly.
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Inconsistent or inadequate quality control. We may not be able to control or adequately monitor the quality of products we receive from our suppliers. Poor quality items could damage our reputation with our customers.
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Limited capacity or ability to scale capacity. If market demand for our products increases suddenly, our current suppliers might not be able to fulfill our commercial needs, which would require us to seek new manufacturing arrangements and may result in substantial delays in meeting market demand. If we consistently generate more demand for a product than a given supplier is capable of handling, it could lead to large backorders and potentially lost sales to competitive products that are readily available. This could require us to seek or fund new sources of supply, which may be difficult to find or may require terms that are less advantageous if available at all.
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Regulatory risk. Our manufacturing facility and those of some of our third party suppliers are subject to ongoing periodic unannounced inspection by regulatory authorities, including the FDA, USDA and other federal, state and foreign agencies for compliance with strictly enforced Good Manufacturing Practices, regulations and similar foreign standards. We do not have control over our suppliers’ compliance with these regulations and standards. Regulatory violations could potentially lead to interruptions in supply that could cause us to lose sales to readily available competitive products. If one of our suppliers is unable to provide a raw material or finished product due to regulatory issues, it could have a material adverse financial impact on our business and could expose us to legal action if we are unable to perform on contracts to our customers involving related products.
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Developmental delays. We may experience delays in the scale-up quantities needed for product development that could delay regulatory submissions and commercialization of our products in development, causing us to miss key opportunities.
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Limited geographic rights. We typically do not have global geographic rights to products supplied by third parties. If we were to determine a market opportunity in a geography where we did not have distribution rights and were unable to obtain such rights from the supplier, it might hamper our ability to succeed in such geography and our sales and profits would be lower than they otherwise would have been.
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Limited intellectual property rights. We typically do not have intellectual property rights, or may have to share intellectual property rights, to the products supplied by third parties and any improvements to the manufacturing processes or new manufacturing processes for these products.
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Changes to United States tariff and import/export regulations. Changes to United States trade policies, treaties and tariffs could have a material adverse effect on global trade. These changes could result in increased costs of goods imported into the United States for the Company and our third party suppliers. Our third party suppliers may limit their trade with companies in the United States, including us.
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Global human and animal health risk. Several of our suppliers have operations in areas that may be susceptible to public health emergencies that could restrict global trade generally, and our access to consumables and product, specifically. The risk of infectious disease in humans and animals may limit trade and product access with third party suppliers with companies inside and outside the United States, including us. In particular, the use of animal bi-product may affect our consumable supply as a result of global animal health risks.
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Potential problems with suppliers such as those discussed above could substantially decrease sales, lead to higher costs and/or damage our reputation with our customers due to factors such as poor quality goods or delays in order fulfillment, resulting in our being unable to sell our products effectively and substantially harming our business.
We depend on key personnel for our future success. If we lose our key personnel or are unable to attract and retain additional personnel, we may be unable to achieve our goals.
Our future success is substantially dependent on the efforts of our senior management and other key personnel, including our Chief Executive Officer (“CEO”) and President, Kevin Wilson. The loss of the services of members of our senior management or other key personnel may significantly delay or prevent the achievement of our business objectives. Although we have employment agreements with many of these individuals, all are at-will employees, which means that either the employee or Heska may terminate employment at any time without prior notice. If we lose the services of, or fail to recruit, key personnel, the growth of our business could be substantially impaired. We do not maintain key person life insurance for any of our senior management or key personnel.
The loss of significant customers who, for example, are historically large purchasers or who are considered leaders in their field could damage our business and financial results.
We are dependent upon a number of significant customers. In our CCA segment, revenue from Covetrus, Inc., formerly known as Henry Schein Animal Health ("Covetrus"), represented approximately 14%, 15% and 13% of our consolidated revenue for the years ended December 31, 2019, 2018 and 2017, respectively. Revenue from Merck entities, including Merck Animal Health, represented approximately 1%, 12% and 12% of our consolidated revenue for the years ended December 31, 2019, 2018 and 2017, respectively. In our OVP segment, revenue from Elanco represented approximately 8%, 9% and 11% of our consolidated revenue for the years ended December 31, 2019, 2018 and 2017, respectively. No other customer accounted for more than 10% of our consolidated revenue for the years ended December 31, 2019, 2018 or 2017.
Covetrus represented 19% and 12% of our consolidated accounts receivable at December 31, 2019 and 2018, respectively. Merck entities, including Merck Animal Health, represented approximately 1% and 10% of our consolidated accounts receivable at December 31, 2019 and 2018, respectively. Elanco represented approximately 4% and 32% of our consolidated accounts receivable at December 31, 2019 and 2018, respectively. No other customer accounted for more than 10% of our consolidated accounts receivable at December 31, 2019 or 2018. The loss of, or material reduction in business from, any of our significant customers could adversely affect our business and financial results.
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We operate in a highly competitive industry, which could render our products obsolete or substantially limit the volume of products that we sell. This would limit our ability to compete and maintain sustained profitability.
The market in which we compete is intensely competitive. Our competitors include independent animal health companies and major pharmaceutical companies that have animal health divisions. We also compete with independent, third party distributors, including distributors that sell products under their own private labels. In the point-of-care diagnostic testing market, our major competitors include IDEXX Laboratories, Inc. and Zoetis Inc.. The products manufactured by our OVP segment for sale by third parties compete with similar products offered by a number of other companies, some of which have substantially greater financial, technical, research and other resources than us and may have more established marketing, sales, distribution and service organizations than those of our OVP segment customers. Competitors may have facilities with similar capabilities to our OVP segment, which they may operate and sell at a lower unit price to customers than our OVP segment does, which could cause us to lose customers. Companies with a significant presence in the companion animal health market, such as Bayer AG, CEVA Sante´ Animale, Elanco, Merck, Sanofi, Vétoquinol S.A. and Virbac S.A. may be marketing or developing products that compete with our products or would compete with them if developed. These and other competitors and potential competitors may have substantially greater financial, technical, research and other resources and larger, more established marketing, sales and service organizations than we do. For example, if Zoetis devotes its significant commercial and financial resources to growing its market share in the veterinary allergy market, our allergy-related sales could suffer significantly. Our competitors may offer broader product lines and have greater name recognition than we do. Our competitors may also develop or market technologies or products that are more effective or commercially attractive than our current or future products or that would render our technologies and products obsolete. Further, additional competition could come from new entrants to the animal health care market. Moreover, we may not have the financial resources, technical expertise or marketing, sales or support capabilities to compete successfully. Zoetis has recently launched allergy products which may diminish the competitiveness and sales prospects for our own allergy immunotherapy products. IDEXX has recently launched an SDMA test in its point of care laboratory chemistry line, which may cause veterinary customers to prefer IDEXX products to ours.
If we fail to compete successfully, our ability to achieve sustained profitability will be limited and sustained profitability, or profitability at all, may not be possible.
We benefit from relationships or collaboration with third parties, including but not limited to, companies, buying groups, veterinary hospital groups and reference laboratory entities that operate in our markets. Beneficial third party, semi-competitive, directly competitive and cooperative relationships that affect how we go to market, develop products, generate leads and other commercial efforts of Heska may be negatively affected as a result of consolidation, acquisition, merger, exclusive arrangement or other agreements or activities between and amongst those third parties and others.
We often depend on third parties for products we intend to introduce in the future. If our current relationships and collaborations are not successful, we may not be able to introduce the products we intend to introduce in the future.
We are often dependent on third parties and collaborative partners to successfully and timely perform research and development activities to successfully develop new products. We routinely discuss Heska marketing in the veterinary market instruments being developed by third parties for use in the human health care market. In the future, one or more of these third parties or collaborative partners may not complete research and development activities in a timely fashion, or at all. Even if these third parties are successful in
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their research and development activities, we may not be able to come to an economic agreement with them. If these third parties or collaborative partners fail to complete research and development activities or fail to complete them in a timely fashion, or if we are unable to negotiate economic agreements with such third parties or collaborative partners, our ability to introduce new products will be impacted negatively and our revenues may decline.
We may be unable to market and sell our products successfully.
We may not develop and maintain marketing and/or sales capabilities successfully, and we may not be able to make arrangements with third parties to perform these activities on satisfactory terms, or at all. If our marketing and sales strategy is unsuccessful, our ability to sell our products will be negatively impacted and our revenues will decrease. This could result in the loss of distribution rights for products or failure to gain access to new products and could cause damage to our reputation and adversely affect our business and future prospects. The market for companion animal healthcare products is highly fragmented. Because our CCA proprietary products are generally available only to veterinarians or by prescription and our medical instruments require technical training to operate, we ultimately sell all our CCA products primarily to or through veterinarians. The acceptance of our products by veterinarians is critical to our success. Changes in our ability to obtain or maintain such acceptance or changes in veterinary medical practice could significantly decrease our anticipated sales. As the vast majority of cash flow to veterinarians ultimately is funded by pet owners without private insurance or government support, our business may be more susceptible to severe economic downturns than other health care businesses that rely less on individual consumers.
For our point of care laboratory blood diagnostics products, we primarily rely on contracts with our veterinary customers for their use of our owned equipment and our consumable supplies over a multiple year period. If veterinarians under these contracts experience a significant downturn in their business, they may not fulfill their use and financial obligations under these contracts. If veterinarians breach our contracts, and we are unable to collect on default payment provisions or otherwise enforce the terms of our contracts, our business will be adversely affected. If we have to litigate against customer(s) to enforce our contracts, our expenses may increase, our sales may decrease to those customers, and our reputation may suffer. If significant numbers of our customers under contracts for use of our equipment and consumable supplies do not renew their contracts, our business will be adversely affected.
We have entered into agreements with independent third party distributors, including Covetrus, who we anticipate will market and sell our products to a greater degree than in the recent past. Independent third party distributors may be effective in increasing sales of our products to veterinarians, although we would expect a corresponding lower gross margin as such distributors typically buy products from us at a discount to end user prices. It is possible new or existing independent third party distributors could cannibalize our direct sales efforts and lower our total gross margin. For us to be effective when working with an independent third party distributor, the distributor must agree to market and/or sell our products and we must provide proper economic incentives to the distributor as well as contend effectively for the time, energy and focus of the employees of such distributor given other products the distributor may be carrying, potentially including those of our competitors. If we fail to be effective with new or existing independent third party distributors, our financial performance may suffer.
A core component of our future growth strategy is international expansion. As we continue to expand our international footprint, we will be increasingly susceptible to the risks associated with international operations including, but not limited to, the following:
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uncertain political and economic climates, fluctuations in exchange rates that may increase the volatility of foreign-based revenue and expenses.
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burdens of complying with and unexpected changes in foreign laws, accounting and legal standards, regulatory requirements, taxes, tariffs and other barriers or trade restrictions.
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lack of experience in connection with the customs, cultures, languages and sales cycle.
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reduced or altered protection for intellectual property rights and data privacy laws in foreign countries, which require that data storage and processing be subject to laws different than the United States.
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As a result of these and other factors, international expansion may be more difficult and not generate the results we anticipate, which could negatively impact our business.
We may face costly legal disputes, including disputes related to our intellectual property or technology or that of our suppliers or collaborators.
We may face legal disputes related to our business. Even if meritless, these disputes may require significant expenditures on our part and could entail a significant distraction to members of our management team or other key employees. For example, it took us until October 10, 2018, to reach an agreement in principle to settle the complaint that was filed against the Company by Shaun Fauley on March 12, 2015 in the United States District Court for the Northern District of Illinois alleging our transmittal of unauthorized faxes in violation of the federal Telephone Consumer Protection Act of 1991, as amended by the Junk Fax Prevention Act of 2005, as a class action (the “Fauley class action”). The settlement, which was approved by the court on February 28, 2019, required us, among other things, to pay $6.75 million to class members, as well as to pay attorneys’ fees and expenses to legal counsel to the class, which we paid in full on April 3, 2019. Insurance coverage may not cover any costs required to litigate a legal dispute or an unfavorable ruling or settlement. We did not have insurance coverage for the settlement arrangement regarding the Fauley class action and had to borrow under our Credit Facility to fund the settlement. A legal dispute leading to an unfavorable ruling or settlement, whether or not insurance coverage may be available for any portion thereof, could have material adverse consequences on our business. Moreover, we may have to use legal means and incur affiliated costs to secure the benefits to which we are entitled under third party agreements, such as to collect payment for goods shipped to third parties, which would reduce our income as compared to what it otherwise would have been.
We may become subject to patent infringement claims and litigation in the United States or other countries or interference proceedings conducted in the United States Patent and Trademark Office, or USPTO, to determine the priority of inventions. The defense and prosecution of intellectual property suits, USPTO interference proceedings and related legal and administrative proceedings are likely to be costly, time-consuming and distracting. As is typical in our industry, from time to time we and our collaborators and suppliers have received, and may in the future receive, notices from third parties claiming infringement and invitations to take licenses under third-party patents. Any legal action against us or our collaborators or suppliers may require us or our collaborators or suppliers to obtain one or more licenses in order to market or manufacture affected products or services. We or our collaborators or suppliers may not, however, be able to obtain licenses for technology patented by others on commercially reasonable terms, or at all, or to develop alternative approaches to access or replace such technology if we or they are unable to obtain such licenses or if current and future licenses prove inadequate, any of which could substantially harm our business.
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 proceedings will likely result in substantial expense to us and significant diversion of the efforts of our technical and management personnel. Any adverse determination in litigation or interference proceedings could subject us to significant liabilities to third parties. Further, as a result of litigation or other proceedings,
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we may be required to seek licenses from third parties which may not be available on commercially reasonable terms, or at all.
Interpretation of existing legislation, regulations and rules, including financial accounting standards, or implementation of future legislation, regulations and rules could cause our costs to increase or could harm us in other ways.
We prepare our financial statements in conformance with GAAP. These accounting principles are established by and are subject to interpretation by the SEC, the FASB and others which interpret and create accounting policies. A change in those policies or how those policies are interpreted can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is made effective. Such changes may adversely affect our reported financial results and the way we conduct our business or have a negative impact on us if we fail to track such changes.
If our regulators and/or auditors adopt or interpret more stringent standards than we anticipate, we could experience unanticipated changes in our reported financial statements, including but not limited to restatements, which could adversely affect our business due to litigation and investor confidence in our financial statements. In addition, changes in the underlying circumstances to which we apply given accounting standards and principles may affect our results of operations and have a negative impact on us. For example, we review goodwill recognized on our consolidated balance sheets at least annually and if we were to conclude there was an impairment of goodwill, we would reduce the corresponding goodwill to its estimated fair value and recognize a corresponding expense in our statement of operations. This impairment and corresponding expense could be as large as the total amount of goodwill recognized on our consolidated balance sheets, which was $36.2 million at December 31, 2019 and $26.7 million at December 31, 2018. There can be no assurance that future goodwill impairments will not occur if projected financial results are not met, or otherwise.
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) has increased our required administrative actions and expenses as a public company since its enactment. The general and administrative costs of complying with Sarbanes-Oxley will depend on how it is interpreted over time. Of particular concern are the level of standards for internal control evaluation and reporting adopted under Section 404 of Sarbanes-Oxley. If our regulators and/or auditors adopt or interpret more stringent standards than we anticipate, we and/or our auditors may be unable to conclude that our internal controls over financial reporting are designed and operating effectively, which could adversely affect investor confidence in our financial statements and cause our stock price to decline. Even if we and our auditors are able to conclude that our internal control over financial reporting is designed and operating effectively in such a circumstance, our general and administrative costs are likely to increase.
Similarly, we are required to comply with the SEC’s mandate to provide interactive data using the eXtensible Business Reporting Language as an exhibit to certain SEC filings. Compliance with this mandate has required a significant time investment, which has and may in the future preclude some of our employees from spending time on more productive matters. In addition, future legislative, regulatory or rule-making action or more stringent interpretations of existing legislation, regulations and rules may increase our general and administrative costs or have other adverse effects on us.
We are currently evaluating, and we intend to pursue, acquisitions and other strategic development opportunities, which may not have desired results and could be detrimental to our financial position.
We are in the process of completing our acquisition of scil. While we expect this acquisition to close by the end of the second quarter of 2020, certain issues may arise that prevent its completion. The scil acquisition is
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subject to risks and uncertainties, including, but not limited to, uncertainties related to the closing of the acquisition, the ability to achieve the anticipated benefits of the acquisition, uncertainties related to supplier availability, competing suppliers, any product’s ability to perform and be recognized as anticipated, in particular when such product is under development, uncertainties related to our ability to sell and market its products in an economically sustainable fashion, including related to varying customs, cultures, languages and sales cycles and uncertainties with foreign political and economic climates, and our ability to integrate the acquired scil business within our existing operations, and new product development and release schedules. We continue to evaluate, and we intend to pursue, acquisitions and other strategic development opportunities, including minority investments where strategic. The ultimate business and financial performance of these opportunities may not create, and may end up adversely affecting materially, the value we hope to enhance by pursuing them. Any acquisition may significantly underperform relative to our financial expectations and may serve to diminish rather than enhance shareholder value. We may also diminish our cash resources or dilute stockholders in order to finance any such acquisition or other strategic transaction.
The success of any acquisition will depend on, among other things, our ability to integrate assets and personnel acquired in these transactions and to apply our internal controls process to these acquired businesses. The integration of acquisitions is likely to require significant attention from our management, and the diversion of management’s attention and resources could have a material adverse effect on our ability to manage our business. Furthermore, we may not realize the degree or timing of benefits we anticipated when we first entered into the acquisition transaction. If actual integration costs are higher than amounts originally anticipated, if we are unable to integrate the assets and personnel acquired in an acquisition as anticipated, or if we are unable to fully benefit from anticipated synergies, our business, financial condition, results of operations and cash flows could be materially adversely affected. Furthermore, it is possible we will use management time and resources to pursue opportunities we ultimately are unable or decide not to consummate, in which case, we may not be able to utilize such management time and resources on what may have proved to be more productive matters in other areas of our business.
Obtaining and maintaining regulatory approvals in order to market our products may be costly and could delay the marketing and sales of our products. Failure to meet all regulatory requirements could cause significant losses from affected inventory and the loss of market share.
Many of the products we develop, market or manufacture may subject us to extensive regulation by one or more of the USDA, the FDA, the EPA and foreign and other regulatory authorities. These regulations govern, among other things, the development, testing, manufacturing, labeling, storage, pre-market approval, advertising, promotion and sale of some of our products. Satisfaction of these requirements can take several years and time needed to satisfy them may vary substantially, based on the type, complexity and novelty of the product. The decision by a regulatory authority to regulate a currently non-regulated product or product area could significantly impact our revenue and have a corresponding adverse impact on our financial performance and position while we attempt to comply with the new regulation, if such compliance is possible at all.
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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 may not be able to estimate the time to obtain required regulatory approvals accurately and such approvals may require significantly more time than we anticipate. We have experienced in the past, and may experience in the future, difficulties that could delay or prevent us from obtaining the regulatory approval or license necessary to introduce or market our products. Such delays in approval may cause us to forego a significant portion of a new product’s sales in its first year due to seasonality and advanced booking periods associated with certain products. Regulatory approval of our products may also impose limitations on the indicated or intended uses for which our products may be marketed.
Difficulties in making established products to all regulatory specifications may lead to significant losses related to affected inventory as well as market share. Among the conditions for certain regulatory approvals is the requirement that our facilities and/or the facilities of our third party manufacturers conform to current Good Manufacturing Practices and other analogous or additional requirements. If any regulatory authority determines that our manufacturing facilities or those of our third party manufacturers do not conform to appropriate manufacturing requirements, we or the manufacturers of our products may be subject to sanctions, including, but not limited to, warning letters, manufacturing suspensions, product recalls or seizures, injunctions, refusal to permit products to be imported into or exported out of the United States, refusals of regulatory authorities to grant approval or to allow us to enter into government supply contracts, withdrawals of previously approved marketing applications, civil fines and criminal prosecutions. Furthermore, third parties may perceive procedures required to obtain regulatory approval objectionable and may attempt to disrupt or otherwise damage our business as a result. In addition, certain of our agreements may require us to pay penalties if we are unable to supply products, including for failure to maintain regulatory approvals.
Any of these events, alone or in combination with others, could significantly damage our business or results of operations.
Our future revenues depend on successful product development, commercialization and/or market acceptance, any of which can be slower than we expect or may not occur.
The product development and regulatory approval process for many of our potential products is extensive and may take substantially longer than we anticipate. Research projects may fail. New products that we may be developing for the veterinary marketplace may not perform consistently within our expectations. Because we have limited resources to devote to product development and commercialization, any delay in the development of one product or reallocation of resources to product development efforts that prove unsuccessful may delay or jeopardize the development of other product candidates. If we fail to successfully develop new products and bring them to market in a timely manner, our ability to generate additional revenue will decrease.
Even if we are successful in the development of a product or obtain rights to a product from a third party supplier, we may experience delays or shortfalls in commercialization and/or market acceptance of the product. For example, veterinarians may be slow to adopt a product, a product may not achieve the anticipated technical performance in field use or there may be delays in producing large volumes of a product. The former is particularly likely where there is no comparable product available or historical precedent for such a product. The ultimate adoption of a new product by veterinarians, the rate of such adoption and the extent veterinarians choose to integrate such a product into their practice are all important factors in the economic success of any new products and are factors that we do not control to a large extent. If our products do not achieve a significant level of market acceptance, demand for our products will not develop as expected and our revenues will be lower than we anticipate.
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Many of our expenses are fixed and if factors beyond our control cause our revenue to fluctuate, this fluctuation could cause greater than expected losses, cash flow and liquidity shortfalls.
We believe that our future operating results will fluctuate on a quarterly basis due to a variety of factors which are generally beyond our control, including:
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supply of products, including minimum purchase agreements, from third party suppliers or termination, cancellation or expiration of such relationships;
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competition and pricing pressures from competitive products;
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the introduction of new products or services by our competitors or by us;
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large customers failing to purchase at historical levels;
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fundamental shifts in market demand;
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manufacturing delays;
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shipment problems;
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information technology problems, which may prevent us from conducting our business effectively, or at all, and may also raise our costs;
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regulatory and other delays in product development;
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product recalls or other issues which may raise our costs;
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changes in our reputation and/or market acceptance of our current or new products; and
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changes in the mix of products sold.
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We have high operating expenses, including those related to personnel. Many of these expenses are fixed in the short term and may increase over time. If any of the factors listed above cause our revenues to decline, our operating results could be substantially harmed.
Cyberattack related breaches of our information technology systems could have an adverse effect on our business.
Cyberattacks are increasing in their frequency, sophistication and intensity, and have become increasingly difficult to detect and defend against, notwithstanding our ongoing evaluation of and improvements to the preventive measures we take on to reduce the risks associated with these threats based on our own experience and those observed in the broader market. Cyberattacks, ranging from the use of malware, computer viruses, dedicated denial of services attacks, credential harvesting, social engineering and other means for obtaining unauthorized access to our Company's confidential information or assets or disrupting our Company’s ability to operate normally, could have a material adverse effect on our business. Cyberattacks may cause equipment failures, loss of information or assets, including sensitive personal information of third-party vendors, customers or employees, or valuable technical and marketing information, as well as disruptions to our or our vendor or customers’ operations. These attacks may be committed by company employees or external actors operating in any geography, including jurisdictions where law enforcement measures to address such attacks are unavailable or ineffective. Cyberattacks may occur alone or in conjunction with physical attacks, especially where disruption of service is an objective of the attacker. The preventive actions we take on an ongoing basis to reduce the risks and mitigate the potential damages associated with cyberattacks, including protection of our systems, networks and assets and the retention of cybersecurity insurance policies, may be insufficient to repel or mitigate entirely the effects of a cyberattack.
We devote significant resources to network security, data encryption and other security measures to protect our systems and data, but these security measures cannot provide absolute security. To the extent we were to experience a breach of our systems and were unable to protect sensitive data in the wake of the breach, such a breach could materially damage business partner and customer relationships and reduce or otherwise
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negatively impact access to online services. Moreover, if a computer security breach affects our systems or results in the unauthorized release of Personally Identifiable Information (“PII”), our reputation and brand could be materially damaged; use of our products and services could decrease, we could suffer from reputational harm impacting sales revenue, and we could be faced with unforeseen regulatory investigation, remediation and litigation costs. Our cybersecurity insurance policies may not cover the full extent, or any, of the potential financial harm that could be caused by a breach of our systems, including in respect of theft or possible damages claims that may be brought against us by our business partners and customers in respect of any such breach.
The frequently changing attack techniques, along with the increased volume and sophistication of the attacks, create additional potential for us to be adversely impacted by this activity. This impact could result in reputational, competitive, operational or other business harm as well as management distraction, financial losses and costs, and regulatory action.
We may be unable to protect our stakeholders’ privacy or we may fail to comply with privacy laws.
The protection of customer, employee, supplier and company data is critical and the regulatory environment surrounding information security, storage, use, processing, disclosure and privacy is demanding, with the frequent imposition of new and changing requirements. In addition, our customers, employees and suppliers expect that we will protect their personal information. Any actual or perceived significant breakdown, intrusion, interruption, cyberattack or corruption of customer, employee or supplier data or our failure to comply with federal, state, local and foreign privacy laws, including the European Union’s General Data Protection Regulation (“GDPR”) and the Health Insurance Portability and Accountability Act, could result in lost sales, remediation costs, and legal liability including severe penalties, regulatory action and reputational harm. GDPR became effective in 2018, for example, and requires companies to meet new and enhanced requirements regarding the handling of personal data, including its use, protection and the rights of data subjects to request correction or deletion of their personal data. Failure to meet GDPR requirements could result in penalties of up to 4% of worldwide revenue. Despite our efforts and investments in technology to secure our computer network, security could be compromised, confidential information could be misappropriated or system disruptions could occur. Failure to comply with the security requirements or rectify a security issue may result in fines and the imposition of restrictions on our ability to accept payment by credit or debit cards. In addition, the payment card industry (“PCI”) is controlled by a limited number of vendors that have the ability to impose changes in PCI’s fee structure and operational requirements on us without negotiation. Such changes in fees and operational requirements may result in our failure to comply with PCI security standards, as well as significant unanticipated expenses. Such failures could materially adversely affect our operating results and financial condition. Furthermore, we maintain cybersecurity insurance coverage at levels that we believe are appropriate for our business. The costs related to significant security breaches or disruptions, however, could be material and exceed the limits of the cybersecurity insurance we maintain against such risks. If the amounts of our insurance coverage are inadequate to satisfy any damages and losses in the event of a cybersecurity incident, we may have to expend significant resources to mitigate the impact of such an incident, and to develop and implement protections to prevent future incidents of this nature from occurring. Such financial exposure could have a material adverse effect on our business.
We may not be able to continue to achieve sustained profitability or increase profitability on a quarterly or annual basis.
Prior to 2005, we incurred net losses on an annual basis since our inception in 1988 and, as of December 31, 2019, we had an accumulated deficit of $136.4 million. Relatively small differences in our performance metrics may cause us to generate an operating or net loss in future periods. Our ability to continue to be
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profitable in future periods will depend, in part, on our ability to increase sales in our CCA segment, including maintaining and growing our installed base of instruments and related consumables, to maintain or increase gross margins and to limit the increase in our operating expenses to a reasonable level as well as avoid or effectively manage any unanticipated issues. We may not be able to generate, sustain or increase profitability on a quarterly or annual basis. If we cannot achieve or sustain profitability for an extended period, we may not be able to fund our expected cash needs, including the repayment of debt as it comes due, or continue our operations.
We may face product returns and product liability litigation in excess of, or not covered by, our insurance coverage or indemnities and/or warranties from our suppliers. If we become subject to product liability claims resulting from defects in our products, we may fail to achieve market acceptance of our products and our sales could substantially decline.
The testing, manufacturing and marketing of our current products as well as those currently under development entail an inherent risk of product liability claims and associated adverse publicity. Following the introduction of a product, adverse side effects may be discovered. Adverse publicity regarding such effects could affect sales of our other products for an indeterminate time period. To date, we have not experienced any material product liability claims, but any claim arising in the future could substantially harm our business. Potential product liability claims may exceed the amount of our insurance coverage or may be excluded from coverage under the terms of the policy. We may not be able to continue to obtain adequate insurance at a reasonable cost, if at all. In the event that we are held liable for a claim against which we are not indemnified or for damages exceeding the $10 million limit of our insurance coverage or which results in significant adverse publicity against us, we may lose revenue, be required to make substantial payments which could exceed our financial capacity and/or lose or fail to achieve market acceptance.
We may be held liable for the release of hazardous materials, which could result in extensive remediation costs or otherwise harm our business.
Certain of our products and development programs produced at our Des Moines, Iowa facility involve the controlled use of hazardous and biohazardous materials, including chemicals and infectious disease agents. We cannot eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for any fines, penalties, remediation costs or other damages that result. Our liability for the release of hazardous materials could exceed our resources, which could lead to a shutdown of our operations, significant remediation costs and potential legal liability. In addition, we may incur substantial costs to comply with environmental regulations if we choose to expand our manufacturing capacity.
Risks related to our common stock
Our stock price has historically experienced high volatility, and could do so in the future, including experiencing a material price decline resulting from a large sale in a short period of time. This volatility could affect the value of our common stock.
Should a relatively large stockholder decide to sell a large number of shares in a short period of time, it could lead to an excess supply of our shares available for sale and correspondingly result in a significant decline in our stock price.
The securities markets have experienced significant price and volume fluctuations and the market prices of securities of many small cap companies have in the past been, and can in the future be expected to be, especially volatile. During the twelve months ended December 31, 2019, the closing stock price of our common stock has ranged from a low of $64.17 to a high of $99.34, and the closing sale price of our common
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stock on February 27, 2020 was $97.54 per share. 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:
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stock sales by large stockholders or by insiders;
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changes in the outlook for our business;
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our quarterly operating results, including as compared to expected revenue or earnings and in comparison to historical results;
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termination, cancellation or expiration of our third-party supplier relationships;
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announcements of technological innovations or new products by our competitors or by us;
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litigation;
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regulatory developments, including delays in product introductions;
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developments or disputes concerning patents or proprietary rights;
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availability of our revolving line of credit and compliance with debt covenants;
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releases of reports by securities analysts;
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economic and other external factors;
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issuances of equity or equity-linked securities by us; and
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general market conditions
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In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. If a securities class action suit is filed against us, it is likely we would incur substantial legal fees and our management’s attention and resources would be diverted from operating our business in order to respond to the litigation.
On May 4, 2010, our stockholders approved an amendment (the “NOL Protective Amendment”) to our Certificate of Incorporation. The NOL Protective Amendment places restrictions on the transfer of our common stock that could adversely affect our ability to use our domestic Federal Net Operating Loss carryforward (“NOL”). In particular, the NOL Protective Amendment prevents the transfer of shares without the approval of our board of directors if, as a consequence, an individual, entity or groups of individuals or entities would become a 5-percent holder under Section 382 of the Internal Revenue Code of 1986, as amended, and the related Treasury regulations, and also prevents any existing 5-percent holder from increasing his or her ownership position in the Company without the approval of our board of directors. Any transfer of shares in violation of the NOL Protective Amendment (a “Transfer Violation”) shall be void ab initio under the our Certificate of Incorporation and our board of directors has procedures under our Certificate of Incorporation to remedy a Transfer Violation including requiring the shares causing such Transfer Violation to be sold and any profit resulting from such sale to be transferred to a charitable entity chosen by the Company’s board of directors in specified circumstances. The NOL Protective Amendment could have an adverse impact on the value and trading liquidity of our stock if certain buyers who would otherwise have bid on or purchased our stock, including buyers who may not be comfortable owning stock with transfer restrictions, do not bid on or purchase our stock as a result of the NOL Protective Amendment. In addition, because some corporate takeovers occur through the acquirer’s purchase, in the public market or otherwise, of sufficient shares to give it control of a company, any provision that restricts the transfer of shares can have the effect of preventing a takeover. The NOL Protective Amendment could discourage or otherwise prevent accumulations of substantial blocks of shares in which our stockholders might receive a substantial premium above market value and might tend to insulate management and the board of directors against the possibility of removal to a greater degree than had the NOL Protective Amendment not passed.
In February 2018, our board of directors granted a waiver to a non-affiliated stockholder to allow the purchase, subject to certain limitations, of up to 730,000 shares of our common stock without causing a Transfer Violation. This waiver can be withdrawn by our board of directors at any time, in which case the
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non-affiliated stockholder is to only sell our stock until the non-affiliated stockholder ceases to be a Five Percent Shareholder (as defined in our Certificate of Incorporation). On August 7, 2019, our board of directors determined to waive the application of any NOL transfer restrictions contained in our Certificate of Incorporation with respect to the issuance and transfer of our 3.75% Convertible Senior Notes due 2026 (the "Notes"), any issuance of shares of the Company’s common stock upon conversion of any of the Notes, and any subsequent and further transfer of any such common stock, to the extent such restrictions would otherwise have been applicable thereto. These waivers, and any similar waivers that our board of directors may grant in the future, may make it more likely that we have a “change of ownership” as defined under the provisions of Section 382 of the Internal Revenue Code of 1986, as amended, which could place a significant restriction on our ability to utilize our domestic Federal NOL in the future and materially adversely affect our results of operations. State net operating loss carryforwards may be similarly or more stringently limited. Any limitations on our ability to use our pre-change of ownership net operating losses to offset taxable income could potentially result in increased future tax liability to us.
If securities analysts do not publish research or reports about our business, or if they downgrade our stock, the price of our stock could decline.
The trading market for our common stock will likely be influenced by research and reports that securities or industry analysts publish about us or our business. In the event securities or industry analysts cover our company and one or more of these analysts downgrades our stock, lowers their price target, or publishes unfavorable or inaccurate research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.
We have not declared or paid any dividends on our common stock since 2012 and we do not anticipate paying any cash dividends in the foreseeable future.
We have not declared or paid any dividends on our common stock since October 2012. We intend to retain any earnings to finance the operation and expansion of our business, and we do not anticipate paying any cash dividends in the future. As a result, investors in our common stock may only receive a return on their investment in our common stock if the market price of our common stock increases.
We have fewer than 300 holders of record, which could allow us to terminate voluntarily the registration of our common stock with the SEC and after which we would no longer be eligible to maintain the listing of our common stock on The Nasdaq Capital Market. We may also be unable to otherwise maintain our listing on The Nasdaq Capital Market.
We have fewer than 300 holders of record as of our latest information, a fact which could make us eligible to terminate voluntarily the registration of our common stock with the SEC and therefore suspend our reporting obligations with the SEC under the Exchange Act and become a non-reporting company. If we were to cease reporting with the SEC, we would no longer be eligible to maintain the listing of our common stock on The Nasdaq Capital Market, which we would expect to materially adversely affect the liquidity and market price for our common stock. The Nasdaq Capital Market has several additional quantitative and qualitative requirements companies must comply with to maintain this listing. While we believe we are currently in compliance with all Nasdaq requirements, there can be no assurance we will continue to meet Nasdaq listing requirements, that Nasdaq will interpret these requirements in the same manner we do if we believe we meet the requirements, or that Nasdaq will not change such requirements or add new requirements to include requirements we do not meet in the future.
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If we were delisted from The Nasdaq Capital Market, our common stock may be considered a penny stock under the regulations of the SEC and would therefore be subject to rules that impose additional sales practice requirements on broker-dealers who sell our securities. The additional burdens imposed upon broker-dealers may discourage broker-dealers from effecting transactions in our common stock, which could severely limit market liquidity of the common stock and any stockholder’s ability to sell our securities in the secondary market. This lack of liquidity would also likely make it more difficult for us to raise capital in the future.
Provisions in our Certificate of Incorporation and bylaws and under Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.
Our Certificate of Incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change of control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:
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place restrictions on the transfer of our common stock that could adversely affect our ability to use our domestic NOL, which can have an effect of preventing a takeover;
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establish a classified board of directors through our 2020 annual meeting of stockholders so that not all members of our board of directors are elected at one time;
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provide that our board of directors may, without stockholder approval, issue shares of preferred stock with special voting or economic rights;
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prohibit stockholders from calling a special meeting of our stockholders;
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set forth supermajority requirements for amending certain provisions of our Certificate of Incorporation or our bylaws;
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provide that the board of directors is expressly authorized to make, alter or repeal our bylaws; and
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establish advance notice requirements for nominations for elections to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
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Additionally, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested’ stockholder and which may discourage, delay, or prevent a change of control of our company.
Any provision of our Certificate of Incorporation, bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also negatively affect the price that some investors are willing to pay for our common stock.
Risks related to the outstanding Notes
Servicing our debt will require a significant amount of cash, and we may not have sufficient cash flow from our business to pay our substantial debt.
Our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness, including the amounts payable under the Notes, depends on our future performance, which is subject to economic, financial, competitive and other factors beyond our control. Our business may not continue to generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and
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our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.
We may not have the ability to raise the funds necessary to settle conversions of the Notes in cash or to repurchase the notes upon a fundamental change, and our future debt may contain, limitations on our ability to pay cash upon conversion or repurchase of the notes.
Holders of the Notes will have the right to require us to repurchase their notes upon the occurrence of a fundamental change at a fundamental change repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any. In addition, upon conversion of the Notes, unless we elect to deliver solely shares of our common stock to settle such conversion (other than paying cash in lieu of delivering any fractional share), we will be required to make cash payments in respect of the Notes being converted. However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of Notes surrendered therefor or Notes being converted. In addition, our ability to repurchase the Notes or to pay cash upon conversions of the Notes may be limited by law, by regulatory authority or by agreements governing our existing and future indebtedness. Our failure to repurchase Notes at a time when the repurchase is required by the indenture or to pay any cash payable on future conversions of the Notes as required by the indenture would constitute a default under the indenture. If a fundamental change occurs, or if the Notes are accelerated due to an event of default under the indenture, such events may lead to a default under agreements governing our future indebtedness. Any future indebtedness of ours may contain restrictions on our ability to pay cash upon conversion or repurchase of the Notes. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the Notes or make cash payments upon conversions thereof.
The conditional conversion feature of the Notes, if triggered, may adversely affect our financial condition and operating results.
In the event the conditional conversion feature of the Notes is triggered, holders of Notes will be entitled to convert the Notes at any time during specified periods at their option. If one or more holders elect to convert their Notes, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share) or by electing an exchange process for the Notes and a designated financial institution delivers the applicable conversion consideration, we would be required to settle a portion or all of our conversion obligation through the payment of cash, which could adversely affect our liquidity. In addition, even if holders of Notes do not elect to convert their Notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the Notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.
The accounting method for convertible debt securities that may be settled in cash, such as the Notes, could have a material effect on our reported financial results.
Under Accounting Standards Codification 470-20, Debt with Conversion and Other Options (“ASC 470-20”), an entity must separately account for the liability and equity components of the convertible debt instruments (such as the Notes) that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. The effect of ASC 470-20 on the accounting for the Notes is that the equity component is required to be included in the additional paid-in capital section of stockholders’ equity on our consolidated balance sheet at the issuance date and the value of the equity component would be treated as debt discount for purposes of accounting for the debt component of the Notes. As a result, we will be required to record a greater amount of non-cash interest expense as a result of the amortization of the discounted
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carrying value of the Notes to their face amount over the term of the Notes. We will report lower net income (or larger net losses) in our financial results because ASC 470-20 will require interest to include both the amortization of the debt discount and the instrument’s non-convertible coupon interest rate, which could adversely affect our reported or future financial results and the trading price of our common stock and the trading price of the Notes.
In addition, under certain circumstances, convertible debt instruments (such as the Notes) that may be settled entirely or partly in cash may be accounted for utilizing the treasury stock method, the effect of which is that the shares issuable upon conversion of such Notes are not included in the calculation of diluted earnings per share except to the extent that the conversion value of such Notes exceeds their principal amount. Under the treasury stock method, for diluted earnings per share purposes, the transaction is accounted for as if the number of shares of common stock that would be necessary to settle such excess, if we elected to settle such excess in shares, are issued. We cannot be sure that the accounting standards in the future will continue to permit the use of the treasury stock method. If we are unable or otherwise elect not to use the treasury stock method in accounting for the shares issuable upon conversion of the Notes, then our diluted earnings per share could be adversely affected.
|
Item 1B.
|
Unresolved Staff Comments
|
None.
|
Item 2.
|
Properties
|
Our principal administrative and research and development activities are located in Loveland, Colorado. We lease approximately 60,000 square feet at a facility in Loveland, Colorado under an agreement that expires in 2023. Our principal production facility located in Des Moines, Iowa, consists of approximately 160,000 square feet of buildings on 34 acres of land, which we own. We also own a 169-acre farm used principally for testing products, located in Carlisle, Iowa. Our European facility in Fribourg, Switzerland has approximately 6,000 square feet leased under an agreement which expires in 2022. We also lease approximately 2,000 square feet at a facility in Nunawading, a suburb of Melbourne, Australia, with a base term that expires in January 2022. In November 2019, we acquired a 7,500 square foot facility on 4 acres of land in Les Ulis, France as part of the purchase agreement with Optomed. In December 2019, we entered into lease agreements for two warehouses in Tudela, Spain for the development of the business activities of the CVM companies. The warehouses are approximately 6,500 square feet and 4,000 square feet and are leased under agreements that both expire in November 2026.
|
Item 3.
|
Legal Proceedings
|
From time to time, the Company may be involved in litigation relating to claims arising out of its operations. The Company records accruals for outstanding legal matters when it believes it is probable that a loss will be incurred, and the amount can be reasonably estimated.
As of December 31, 2019, we were not a party to any legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on our business, financial condition or operating results.
|
Item 4.
|
Mine Safety Disclosures
|
Not applicable.
-30-
PART II
|
Item 5.
|
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|
Our Public Common Stock is quoted on the Nasdaq Capital Market under the symbol "HSKA".
As of February 27, 2020, there were approximately 250 holders of record of our Public Common Stock, and approximately 4,000 beneficial stockholders. We do not anticipate any dividend payments in the foreseeable future.
Issuer Purchases of Equity Securities
There were no purchases of our outstanding Public Common Stock during the fourth quarter of our fiscal year ended December 31, 2019.
-31-
STOCK PRICE PERFORMANCE GRAPH
The following graph provides a comparison over the five-year period ended December 31, 2019 of the cumulative total shareholder return from a $100 investment in the Company's common stock with the NASDAQ Medical Supplies Index and the NASDAQ Composite Total Return:
|
|
Dec-14
|
|
Dec-15
|
|
Dec-16
|
|
Dec-17
|
|
Dec-18
|
|
Dec-19
|
||||||||||||
|
Heska Corporation
|
$
|
100
|
|
|
$
|
213
|
|
|
$
|
395
|
|
|
$
|
442
|
|
|
$
|
475
|
|
|
$
|
529
|
|
|
NASDAQ Medical Supplies Index
|
$
|
100
|
|
|
$
|
111
|
|
|
$
|
126
|
|
|
$
|
165
|
|
|
$
|
177
|
|
|
$
|
234
|
|
|
NASDAQ Composite Total Return Index
|
$
|
100
|
|
|
$
|
107
|
|
|
$
|
116
|
|
|
$
|
151
|
|
|
$
|
147
|
|
|
$
|
200
|
|
-32-
|
Item 6.
|
Selected Financial Data
|
The selected consolidated statements of income and consolidated balance sheets data have been derived from our consolidated financial statements. The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and related Notes included as Items 7 and 8, respectively, in this Form 10-K.
|
|
2019
|
|
2018
|
|
2017
|
|
2016
|
|
2015
|
||||||||||
|
|
(In thousands, except per share data)
|
||||||||||||||||||
|
Consolidated Statements of Income Data:
|
|
|
|
|
|
|
|
|
|
||||||||||
|
Revenue, net
|
$
|
122,661
|
|
|
$
|
127,446
|
|
|
$
|
129,341
|
|
|
$
|
130,083
|
|
|
$
|
104,597
|
|
|
Net (loss) income attributable to Heska Corporation
|
$
|
(1,465
|
)
|
|
$
|
5,850
|
|
|
$
|
9,953
|
|
|
$
|
10,508
|
|
|
$
|
5,239
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
(Loss) earnings per share attributable to Heska Corporation:
|
|
|
|
|
|
|
|
|
|
||||||||||
|
Basic (loss) earnings per share attributable to Heska Corporation
|
$
|
(0.20
|
)
|
|
$
|
0.81
|
|
|
$
|
1.42
|
|
|
$
|
1.55
|
|
|
$
|
0.80
|
|
|
Diluted (loss) earnings per share attributable to Heska Corporation
|
$
|
(0.20
|
)
|
|
$
|
0.74
|
|
|
$
|
1.30
|
|
|
$
|
1.43
|
|
|
$
|
0.74
|
|
|
Basic weighted-average common shares outstanding
|
7,446
|
|
|
7,220
|
|
|
7,026
|
|
|
6,783
|
|
|
6,509
|
|
|||||
|
Diluted weighted-average common shares outstanding
|
7,446
|
|
|
7,856
|
|
|
7,642
|
|
|
7,361
|
|
|
7,074
|
|
|||||
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
Consolidated Balance Sheets Data:
|
|
|
|
|
|
|
|
|
|
||||||||||
|
Total assets
|
$
|
244,424
|
|
|
$
|
156,452
|
|
|
$
|
135,444
|
|
|
$
|
130,844
|
|
|
$
|
109,719
|
|
|
Long-term obligations and redeemable preferred stock
|
$
|
50,882
|
|
|
$
|
6,031
|
|
|
$
|
6,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
Cash dividends declared per share:
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
-33-
|
Item 7.
|
Management's Discussion and Analysis of Financial Condition and Results of Operations
|
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Selected Financial Data" and the Consolidated Financial Statements and related Notes included in Items 6 and 8, respectively, of this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Such statements, which include statements concerning future revenue sources and concentration, gross profit margins, selling and marketing expenses, research and development expenses, general and administrative expenses, capital resources, additional financings or borrowings and additional losses, are subject to risks and uncertainties, including, but not limited to, those discussed below and elsewhere in this Form 10-K, particularly in Item 1A. "Risk Factors," that could cause actual results to differ materially from those projected. The forward-looking statements set forth in this Form 10-K are as of the close of business on February 27, 2020, and we undertake no duty and do not intend to update this information, except as required by applicable securities laws.
Overview
We sell advanced veterinary diagnostic and specialty products. Our offerings include Point of Care laboratory instruments and consumables; Point of Care digital imaging diagnostic instruments; vaccines; local and cloud-based data services; allergy testing and immunotherapy; and single-use offerings such as in-clinic diagnostic tests and heartworm preventive products. Our core focus is on supporting veterinarians in the canine and feline healthcare space.
Our business is composed of two reportable segments, CCA and OVP. The CCA segment includes, primarily for canine and feline use, Point of Care laboratory instruments and consumables; digital imaging diagnostic instruments, software and services; local and cloud-based data services; allergy testing and immunotherapy; and single use offerings such as in-clinic diagnostic tests and heartworm preventive products. The OVP segment includes private label vaccine and pharmaceutical production, primarily for cattle but also for other species including equine, porcine, avian, feline and canine. OVP products are sold by third parties under third party labels.
CCA represented approximately 87% of our 2019 revenue. OVP represented approximately 13% of our 2019 revenue.
CCA Segment
Revenue from Point of Care laboratory including instruments, consumables and other revenue such as service represented $67.1 million, $57.4 million and $54.9 million of our 2019, 2018 and 2017 revenue, respectively. Revenue in this area primarily involves placing an instrument under contract in the field and generating future revenue from testing consumables, such as cartridges and reagents, as that instrument is used. Approximately $53.6 million, $44.8 million and $39.2 million of our 2019, 2018 and 2017 revenue, respectively, resulted from the sale of such testing consumables to an installed base of instruments. Approximately $12.1 million, $10.8 million and $13.8 million of our 2019, 2018 and 2017 revenue, respectively, was from instrument sales, including revenue recognized from sales-type lease treatment. Included in instrument sales are sales of infusion pumps, which are sold outright through distribution. Sales of infusion pumps were $3.0 million, $2.7 million, and $4.0 million for 2019, 2018 and 2017, respectively. Approximately $1.4 million, $1.8 million and $1.9 million of our 2019, 2018 and 2017 revenue, respectively, was from other revenue sources, such as charges for repairs. Instruments placed under subscription agreements are considered operating or sales-type leases, depending on the duration and other factors of the underlying agreement. A loss of, or disruption in, the supply of consumables we are selling to an installed base of instruments could substantially harm our business. All of our Point of Care laboratory and other non-imaging instruments and consumables are supplied by third parties, who typically own the product rights and
-34-
supply the product to us under marketing and/or distribution agreements. In many cases, we have collaborated with a third party to adapt a human instrument for veterinary use. Major products in this area include our instruments for chemistry, hematology, blood gas and immunodiagnostic testing and their affiliated operating consumables.
Point of Care digital imaging hardware, software and services represented approximately $25.7 million, $22.8 million and $21.9 million of 2019, 2018 and 2017 revenue, respectively. Digital radiography is the largest product offering in this area, which also includes ultrasound instruments. Digital radiography solutions typically consist of a combination of hardware and software placed with a customer, often combined with an ongoing service and support contract. We sell our imaging solutions both in the U.S. and internationally. Our experience has been that most of the revenue is generated at the time of sale in this area, in contrast to the Point of Care diagnostics laboratory placements discussed above where ongoing consumable revenue is often a larger component of economic value as a given instrument is used.
Other CCA revenue, including single use diagnostic and other tests, pharmaceuticals and biologicals, as well as research and development, licensing and royalty revenue, represented $13.8 million, $28.7 million and $28.4 million of our 2019, 2018 and 2017 revenue, respectively. Since items in this area are often single use by their nature, our typical aim is to build customer satisfaction and loyalty for each product, generate repeat annual sales from existing customers and expand our customer base in the future. Products in this area are both supplied by third parties and provided by us. Major products and services in this area include heartworm diagnostic tests and preventives, and allergy test kits, allergy immunotherapy and testing. Of our annual revenue, heartworm produced primarily for private-label accounted for approximately $1.7 million in 2019 and $16.8 million in both 2018 and 2017, respectively. The decrease in Other CCA revenue in 2019 was driven primarily by a $14.9 million decrease from contract manufactured heartworm preventive, Tri-Heart, as a result of reduced customer demand.
We consider the CCA segment to be our core business and devote most of our management time and other resources to improving the prospects for this segment. Maintaining a continuing, reliable and economic supply of products we currently obtain from third parties is critical to our success in this area. Virtually all of our sales and marketing expenses occur in the CCA segment. The majority of our research and development spending is dedicated to this segment as well.
All of our CCA products are ultimately sold primarily to or through veterinarians. In many cases, veterinarians will mark up their costs to their customer. The acceptance of our products by veterinarians is critical to our success. CCA products are sold directly to end users by us as well as through distribution relationships, such as the sale of kits to conduct blood testing to third-party veterinary diagnostic laboratories and independent third-party distributors. Revenue from direct sales and distribution relationships represented approximately 74% and 26%, respectively, of CCA 2019 revenue, 57% and 43%, respectively, of CCA 2018 revenue and 58% and 42%, respectively, of CCA 2017 revenue.
OVP Segment
The OVP segment includes our approximately 160,000 square foot USDA and FDA licensed production facility in Des Moines, Iowa. We view this facility as an asset which could allow us to control our cost of goods on any pharmaceuticals and vaccines that we may commercialize in the future. We have increased integration of this facility with our operations elsewhere. For example, virtually all our U.S. inventory, excluding our imaging products, is now stored at this facility and related fulfillment logistics are managed there. CCA segment products manufactured at this facility are transferred at cost and are not recorded as revenue for our OVP segment.
-35-
Historically, a significant portion of our OVP segment's revenue has been generated from the sale of certain bovine vaccines, which have been sold primarily under the Titanium® and MasterGuard® brands. We have an agreement with Elanco for the production of these vaccines (the "Elanco Agreement"). Our OVP segment also produces vaccines and pharmaceuticals for other third parties.
Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. "Part II, Item 8. Note 1. Summary of Significant Accounting Policies" to the consolidated financial statements included in this Annual Report on Form 10-K describes the significant accounting policies used in preparation of these consolidated financial statements. We believe the following critical accounting estimates and assumptions may have a material impact on reported financial condition and operating performance and involve significant levels of judgment to account for highly uncertain matters or are susceptible to significant change.
Revenue Recognition
Effective January 1, 2018, we adopted FASB Accounting Standards Codification ("ASC") Topic 606, Revenue from Contracts with Customers (the "New Revenue Standard"), using the modified retrospective method for all contracts not completed as of the date of adoption. Under the New Revenue Standard, revenue is recognized when, or as, performance obligations under the terms of a contract are satisfied, which occurs when control of the promised products or services is transferred to a customer. We exclude sales, use, value-added, and other taxes we collect on behalf of third parties from revenue. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or services to a customer. To meet the requirements of the New Revenue Standard and accurately present the consideration received in exchange for promised products or services, we applied the prescribed five-step model outlined below:
1. Identification of a contract or agreement with a customer
2. Identification of our performance obligations in the contract or agreement
3. Determination of the transaction price
4. Allocation of the transaction price to the performance obligations
5. Recognition of revenue when, or as, we satisfy a performance obligation
See "Part II. Item 8. Financial Statements and Supplementary Data, Note 2. Revenue Recognition" to the consolidated financial statements for the year ended December 31, 2019, included in this Annual Report on Form 10-K for additional information about our revenue recognition policy and criteria for recognizing revenue.
Application of the various accounting principles in GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, our subscription arrangements related to our Point of Care laboratory products provide our customers the right to use our instruments upon entering into multi-year agreements to purchase a minimum amount of consumables. These types of agreements include an embedded lease, designated as either an operating-type lease ("OTL") or a sales-type lease ("STL"), dependent upon individual contract terms, most often relating to the term of the contract relative to the life of the underlying instruments being placed under that contract. The determination of the amounts
-36-
allocated to each component of the contract are based upon fair value. Changes in fair value in any period of the underlying components will impact that amount of revenue recognized.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts receivable based on client-specific allowances, as well as a general allowance. Specific allowances are maintained for clients which are determined to have a high degree of collectability risk based on such factors, among others, as: (i) the aging of the accounts receivable balance; (ii) the client's past payment history; and (iii) a deterioration in the client's financial condition, evidenced by weak financial condition and/or continued poor operating results, reduced credit ratings and/or a bankruptcy filing. In addition to the specific allowance, the Company maintains a general allowance for credit risk in its accounts receivable which is not covered by a specific allowance. The general allowance is established based on such factors, among others, as: (i) the total balance of the outstanding accounts receivable, including considerations of the aging categories of those accounts receivable; (ii) past history of uncollectable accounts receivable write-offs; and (iii) the overall creditworthiness of the client base. A considerable amount of judgment is required in assessing the realizability of accounts receivable. Should any of the factors considered in determining the adequacy of the overall allowance change, an adjustment to the provision for doubtful accounts receivable may be necessary.
Inventory Valuation
We write down the carrying value of inventory for estimated obsolescence by an amount equal to the difference between the cost of inventory and the estimated market value when warranted based on assumptions of future demand, market conditions, remaining shelf life or product functionality. If actual market conditions or results of estimated functionality are less favorable than those we estimated, additional inventory write-downs may be required, which would have a negative effect on results of operations. The inventory allowance was $1.3 million and $1.6 million as of December 31, 2019 and 2018, respectively.
Deferred Tax Assets – Valuation Allowance
We evaluate our ability to realize the tax benefits associated with a deferred tax asset (“DTA”) by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. As of December 31, 2019 and 2018, we had valuation allowances of approximately $5.7 million and $10.2 million, respectively. The change in the valuation allowance resulted from the expiration of deferred tax assets which were offset with a valuation allowance at December 31, 2018. See "Part II. Item 8. Financial Statements and Supplementary Data, Note 5. Income Taxes" to the consolidated financial statements for additional information regarding our income taxes.
Business Combinations
We account for transactions that represent business combinations under the acquisition method of accounting, which requires us to allocate the total consideration paid for each acquisition to the assets we acquire and liabilities we assume based on their fair values as of the date of acquisition, including identifiable intangible assets. The allocation of the purchase price utilizes significant estimates in determining the fair values of identifiable assets acquired and liabilities assumed, especially with respect to intangible assets. We may refine our estimates and make adjustments to the assets acquired and liabilities assumed over a measurement period, not to exceed one year.
-37-
Valuation of Goodwill and Intangibles
We assess goodwill for impairment annually, at the reporting unit level, in the fourth quarter and whenever events or circumstances indicate impairment may exist. In evaluating goodwill for impairment, we have the option to first assess the qualitative factors to determine whether it is more-likely-than-not that the estimated fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the comparison of the estimated fair value of the reporting unit to the carrying value. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If, after assessing the totality of events or circumstances, we determine that is it more-likely-than-not that the estimated fair value of a reporting is less than its carrying amount, we would then estimate the fair value of the reporting unit and compare it to the carrying value. If the carrying value exceeds the estimated fair value we would recognize an impairment for the difference; otherwise, no further impairment test would be required. In contrast, we can opt to bypass the qualitative assessment for any reporting unit in any period and proceed directly to quantitative analysis. Doing so does not preclude us from performing the qualitative assessment in any subsequent period.
We performed qualitative assessments in the fourth quarters of 2019, 2018 and 2017 and determined that no indications of impairment existed.
We assess the realizability of intangible assets other than goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If an impairment review is triggered, we evaluate the carrying value of intangible assets based on estimated undiscounted future cash flows over the remaining useful life of the primary asset of the asset group and compare that value to the carrying value of the asset group. The cash flows that are used contain our best estimates, using appropriate and customary assumptions and projections at the time. If the net carrying value of an intangible asset exceeds the related estimated undiscounted future cash flows, an impairment to adjust the intangible asset to its fair value would be reported as a non-cash charge to earnings. If necessary, we would calculate the fair value of an intangible asset using the present value of the estimated future cash flows to be generated by the intangible asset, and applying a risk-adjusted discount rate. We had no impairments of our intangible assets during the years ended December 31, 2019, 2018 and 2017.
These valuations require the use of management’s assumptions, which would not reflect unanticipated events and circumstances that may occur.
Share-Based Compensation Expense
We utilize share-based compensation arrangements as part of our long-term incentive plan. Under these incentive arrangements, we currently issue restricted stock awards, both tied to time vesting or performance and time vesting to employees and directors. We also issue stock options awards to employees. All significant inputs into the determination of expense as well as the related expense are discussed further in "Part II. Item 8. Financial Statements and Supplementary Data, Note 12. Capital Stock".
Restricted Stock Awards (Time Vesting)
The fair value of restricted stock awards with only time-based vesting terms used in our expense recognition method is measured based on the number of shares granted and the closing market price of our common stock on the date of grant. Such value is recognized as an expense over the corresponding requisite service period. Forfeitures are accounted for as they occur.
-38-
Restricted Stock Awards (Performance Vesting)
We also grant restricted stock awards subject to performance vesting criteria, in addition to service to our executive officers and other key employees. This type of grant consists of the right to receive shares of common stock, subject to achievement of time-based criteria and certain company and market performance-related goals over a specified period, as established by the Compensation Committee of our Board of Directors. We recognize any related share-based compensation expense ratably over the service period based on the probability assessment on the outcome of the performance condition related to company performance metrics. The fair value used in our expense recognition method is measured based on the number of shares granted and the closing market price of our common stock on the date of grant. The amount of share-based compensation expense recognized in any one period can vary based on the attainment or expected attainment of the performance goals. If such performance goals are not ultimately met, no compensation expense is recognized and any previously recognized compensation expense is reversed. We recognize any related share-based compensation expense ratably over the service period based on the most probable outcome of the performance condition related to market performance metrics. The fair value used in our expense recognition method is measured based on the number of shares granted, and a Monte Carlo simulation model, which incorporates the probability of the achievement of the market-related performance goals as part of the grant date fair value. If such performance goals are not ultimately met, the expense is not reversed.
As of December 31, 2019, we reviewed each of the underlying corporate performance targets and determined that approximately 219,000 shares of common stock were related to corporate performance targets in which we did not deem achievement probable. No compensation expense had been recorded at any period prior to December 31, 2019. The unrecognized compensation cost associated with the restricted stock awards not deemed probable, based on grant date fair value, is approximately $17.8 million. Any change in the probability determination could accelerate the recognition of this expense.
Recent Accounting Pronouncements
In addition to the impacts from new accounting pronouncements included above, see "Part II. Item 8. Financial Statements and Supplementary Data, Note 1. Summary of Significant Accounting Policies" to the consolidated financial statements for the year ended December 31, 2019, included in this Annual Report on Form 10-K for a complete discussion of recent accounting pronouncements adopted and not adopted.
-39-
Results of Operations
Our analysis presented below is organized to provide the information we believe will facilitate an understanding of our historical performance and relevant trends going forward. This discussion should be read in conjunction with our consolidated financial statements, including the notes thereto, in Item 8 of this annual report on Form 10-K.
The following table sets forth, for the periods indicated, certain data derived from our Consolidated Statements of Income (in thousands):
|
|
Year Ended December 31,
|
||||||||||
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
Revenue
|
$
|
122,661
|
|
|
$
|
127,446
|
|
|
$
|
129,341
|
|
|
Gross profit
|
54,449
|
|
|
56,638
|
|
|
58,261
|
|
|||
|
Operating expenses
|
54,122
|
|
|
52,844
|
|
|
40,042
|
|
|||
|
Operating income
|
327
|
|
|
3,794
|
|
|
18,219
|
|
|||
|
Interest and other expense (income), net
|
2,910
|
|
|
(13
|
)
|
|
(150
|
)
|
|||
|
(Loss) income before income taxes and equity in losses of unconsolidated affiliates
|
(2,583
|
)
|
|
3,807
|
|
|
18,369
|
|
|||
|
Income tax (benefit) expense
|
(1,446
|
)
|
|
(2,115
|
)
|
|
8,913
|
|
|||
|
Net (loss) income before equity in losses of unconsolidated affiliates
|
(1,137
|
)
|
|
5,922
|
|
|
9,456
|
|
|||
|
Equity in losses of unconsolidated affiliates
|
(594
|
)
|
|
(72
|
)
|
|
—
|
|
|||
|
Net (loss) income, after equity in losses of unconsolidated affiliates
|
(1,731
|
)
|
|
5,850
|
|
|
9,456
|
|
|||
|
Net (loss) income attributable to non-controlling interest
|
(266
|
)
|
|
—
|
|
|
(497
|
)
|
|||
|
Net (loss) income attributable to Heska Corporation
|
$
|
(1,465
|
)
|
|
$
|
5,850
|
|
|
$
|
9,953
|
|
The following tables set forth, for the periods indicated, segment data derived from our Consolidated Statements of Income (in thousands):
CCA Segment
|
|
Year Ended December 31,
|
|
Change
|
|||||||||||||||||
|
|
2019
|
|
2018
|
|
2017
|
|
Dollar Change
|
% Change
|
Dollar Change
|
% Change
|
||||||||||
|
Point of Care Laboratory:
|
$
|
67,132
|
|
|
$
|
57,375
|
|
|
$
|
54,855
|
|
|
$
|
9,757
|
|
17%
|
$
|
2,520
|
|
5%
|
|
Consumables
|
53,590
|
|
|
44,771
|
|
|
39,161
|
|
|
8,819
|
|
20%
|
5,610
|
|
14%
|
|||||
|
Instruments
|
12,137
|
|
|
10,810
|
|
|
13,773
|
|
|
1,327
|
|
12%
|
(2,963
|
)
|
(22)%
|
|||||
|
Other
|
1,405
|
|
|
1,794
|
|
|
1,921
|
|
|
(389
|
)
|
(22)%
|
(127
|
)
|
(7)%
|
|||||
|
Point of Care Imaging
|
25,652
|
|
|
22,832
|
|
|
21,907
|
|
|
2,820
|
|
12%
|
925
|
|
4%
|
|||||
|
Other CCA Revenue
|
13,786
|
|
|
28,717
|
|
|
28,429
|
|
|
(14,931
|
)
|
(52)%
|
288
|
|
1%
|
|||||
|
Total CCA Revenue
|
$
|
106,570
|
|
|
$
|
108,924
|
|
|
$
|
105,191
|
|
|
$
|
(2,354
|
)
|
(2)%
|
$
|
3,733
|
|
4%
|
|
Percent of Total Revenue
|
86.9
|
%
|
|
85.5
|
%
|
|
81.3
|
%
|
|
|
|
|
|
|||||||
|
Cost of Revenue
|
52,923
|
|
|
56,326
|
|
|
54,509
|
|
|
(3,403
|
)
|
(6)%
|
1,817
|
|
3%
|
|||||
|
Gross Profit
|
53,647
|
|
|
52,598
|
|
|
50,682
|
|
|
1,049
|
|
2%
|
1,916
|
|
4%
|
|||||
|
Operating Income
|
$
|
1,358
|
|
|
$
|
2,040
|
|
|
$
|
12,656
|
|
|
$
|
(682
|
)
|
(33)%
|
$
|
(10,616
|
)
|
(84)%
|
-40-
OVP Segment
|
|
Year Ended December 31,
|
|
Change
|
|||||||||||||||||
|
|
2019
|
|
2018
|
|
2017
|
|
Dollar Change
|
% Change
|
Dollar Change
|
% Change
|
||||||||||
|
Revenue
|
$
|
16,091
|
|
|
$
|
18,522
|
|
|
$
|
24,150
|
|
|
$
|
(2,431
|
)
|
(13)%
|
$
|
(5,628
|
)
|
(23)%
|
|
Percent of Total Revenue
|
13.1
|
%
|
|
14.5
|
%
|
|
18.7
|
%
|
|
|
|
|
|
|||||||
|
Cost of Revenue
|
15,289
|
|
|
14,482
|
|
|
16,570
|
|
|
807
|
|
6%
|
(2,088
|
)
|
(13)%
|
|||||
|
Gross Profit
|
802
|
|
|
4,040
|
|
|
7,580
|
|
|
(3,238
|
)
|
(80)%
|
(3,540
|
)
|
(47)%
|
|||||
|
Operating (Loss) Income
|
$
|
(1,031
|
)
|
|
$
|
1,754
|
|
|
$
|
5,563
|
|
|
$
|
(2,785
|
)
|
(159)%
|
$
|
(3,809
|
)
|
(68)%
|
Revenue
Total revenue decreased 4% to $122.7 million in 2019 compared to $127.4 million in 2018. Total revenue decreased 1% to $127.4 million in 2018 compared to $129.3 million in 2017.
CCA segment revenue decreased 2% to $106.6 million in 2019 compared to $108.9 million in 2018. The decrease was driven by an anticipated reduction in sales to Merck for a heartworm preventive as previously disclosed on our 2018 fourth quarter earnings release. The decline was offset by a 20% increase in Point of Care laboratory consumables, as well as a 12% increase from Point of Care imaging revenue primarily due to the Optomed acquisition. CCA segment revenue increased 4% to $108.9 million in 2018 compared to $105.2 million in 2017. The increase was driven primarily by a 14% increase in revenue from Point of Care laboratory consumables, as well as a 4% increase in revenue from Point of Care imaging products due to increased sales of digital radiography systems. This was partially offset by a 22% decrease in revenue from Point of Care laboratory instruments due to lower sales-type lease instrument revenue recognition of $1.5 million and lower infusion pump sales of $1.3 million.
OVP segment revenue decreased 13% to $16.1 million in 2019 compared to $18.5 million in 2018. The decrease was driven primarily by reduced customer requirements and supply issues with materials. OVP segment revenue decreased 23% to $18.5 million in 2018 compared to $24.2 million in 2017. The decrease was driven by decreased volume of sales under contract manufacturing arrangements.
Gross Profit
Gross profit decreased 4% to $54.4 million in 2019 compared to $56.6 million in 2018. Gross margin percent remained consistent at 44.4% in 2019 compared to 44.4% in 2018. Gross profit decreased 3% to $56.6 million in 2018 compared to $58.3 million in 2017. Gross margin percent decreased to 44.4% in 2018 compared to 45.0% in 2017. The decrease in both gross profit and gross margin percentage was driven primarily by unfavorable product mix and plant utilization charges in our OVP segment.
Operating Expenses
Selling and marketing expenses increased 12% to $27.7 million in 2019 compared to $24.7 million in 2018. Selling and marketing expenses increased 6% to $24.7 million in 2018 compared to $23.2 million in 2017. The increase in both periods was primarily driven by an increase in compensation, including stock-based compensation, benefits and commissions expense, which is mostly related to our commercial team expansion both domestically and internationally. The increase is in line with management expectations as we continue to invest in future growth and expanding the footprint of the Company.
Research and development expenses increased 147% to $8.2 million in 2019, compared to $3.3 million in 2018. Research and development increased 66% to $3.3 million in 2018, as compared to $2.0 million in 2017. The increase in both periods was primarily driven by spending on product development for urine and
-41-
fecal diagnostic analyzer and enhanced immunodiagnostic offerings. As we invest in future growth of the Company, the increased research and development expenses is consistent with the spending initiatives of management.
General and administrative expenses decreased 27% to $18.2 million in 2019, compared to $24.8 million in 2018. The decrease was primarily driven by a $7.0 million settlement accrual and related legal expenses in the prior year; partially offset by increased expenses associated with international expansion. General and administrative expenses increased 68% to $24.8 million in 2018, as compared to $14.8 million in 2017. The increase was driven by a $7.0 million settlement accrual and related legal expenses, a $1.4 million increase in stock-based compensation, a $0.6 million increase in compensation and benefits, a $0.5 million increase in legal fees and a $0.5 million increase in consulting fees.
Interest and Other Expense (Income), Net
Interest and other expense (income), net, was expense of $2.9 million in 2019, compared to income of $13 thousand in 2018 and income of $150 thousand in 2017. The increase in other expense in 2019 was primarily driven by interest expense as a result of the Notes. The decrease in other income in 2018, compared to 2017, was primarily driven by an increase in net foreign currency losses, and an increase in interest expense, partially offset by an increase in interest income and other gains.
Income Tax (Benefit) Expense
In 2019, we had total income tax benefit of $1.4 million compared to a total income tax benefit in 2018 of $2.1 million and total income tax expense of $8.9 million in 2017. See "Part II, Item 8. Financial Statements and Supplementary Data, Note 5. Income Taxes" in the accompanying notes to the consolidated financial statements for additional information regarding our income taxes.
Net (Loss) Income Attributable to Heska Corporation
Net loss attributable to Heska Corporation was $1.5 million in 2019, compared to net income attributable to Heska Corporation of $5.9 million in 2018 and net income attributable to Heska Corporation of $10.0 million in 2017. The difference between this line item and "Net (loss) income after equity in losses of unconsolidated affiliates" is the net income or loss attributable to our minority interest in our French subsidiary, which we purchased in February 2019. The difference between these line items was a gain of $0.3 million for 2019. There was no difference between these line items in 2018, and a gain of $0.5 million in 2017.
Non-GAAP Financial Measures
In addition to financial measures presented on the basis of accounting principles generally accepted in the U.S. (“U.S. GAAP”), we also present fourth quarter and full year 2019 operating income, operating margin, net income attributable to Heska, earnings per diluted share, Adjusted EBITDA, Adjusted EBITDA margin, and the effective tax rate, excluding acquisition and other one-time charges, which are non-GAAP measures. We also present fourth quarter and full year 2018 operating income, operating margin, net income attributable to Heska, earnings per diluted share, Adjusted EBITDA, Adjusted EBITDA margin, and the effective tax rate, excluding TCPA Settlement, which are non-GAAP measures.
These measures should be viewed as a supplement to (not substitute for) our results of operations presented under U.S. GAAP. The non-GAAP financial measures presented may not be comparable to similarly titled measures of other companies because they may not calculate their measures in the same manner. Our management has included these measures to assist in comparing performance from period to period on a consistent basis.
-42-
The following tables reconcile our adjusted non-GAAP financial measures to our most directly comparable as-reported financial measures calculated in accordance with GAAP (in thousands, except per share amounts):
|
|
|
Three Months Ended
December 31,
|
|
Year Ended
December 31,
|
||||||||||||
|
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
||||||||
|
Operating income
|
|
$
|
775
|
|
|
$
|
3,314
|
|
|
$
|
327
|
|
|
$
|
3,794
|
|
|
Acquisition-related costs(1)
|
|
674
|
|
|
—
|
|
|
674
|
|
|
—
|
|
||||
|
Litigation and other one-time costs(2)
|
|
—
|
|
|
232
|
|
|
—
|
|
|
7,407
|
|
||||
|
Non-GAAP operating income
|
|
$
|
1,449
|
|
|
$
|
3,546
|
|
|
$
|
1,001
|
|
|
$
|
11,201
|
|
|
Non-GAAP operating margin
|
|
4.3
|
%
|
|
10.4
|
%
|
|
0.8
|
%
|
|
8.8
|
%
|
||||
|
|
|
|
|
|
|
|
|
|
||||||||
|
Net (loss) income attributable to Heska Corporation
|
|
$
|
(1,728
|
)
|
|
$
|
3,468
|
|
|
$
|
(1,465
|
)
|
|
$
|
5,850
|
|
|
Income tax expense (benefit)
|
|
520
|
|
|
(175
|
)
|
|
(1,446
|
)
|
|
(2,115
|
)
|
||||
|
Interest expense (income)
|
|
2,075
|
|
|
4
|
|
|
2,428
|
|
|
49
|
|
||||
|
Depreciation and amortization
|
|
1,157
|
|
|
1,122
|
|
|
4,916
|
|
|
4,595
|
|
||||
|
EBITDA
|
|
$
|
2,024
|
|
|
$
|
4,419
|
|
|
$
|
4,433
|
|
|
$
|
8,379
|
|
|
Acquisition-related costs(1)
|
|
674
|
|
|
—
|
|
|
674
|
|
|
—
|
|
||||
|
Litigation and other one-time costs(3)
|
|
(250
|
)
|
|
232
|
|
|
307
|
|
|
7,407
|
|
||||
|
Stock-based compensation
|
|
1,343
|
|
|
1,453
|
|
|
4,968
|
|
|
5,227
|
|
||||
|
Adjusted EBITDA
|
|
$
|
3,791
|
|
|
$
|
6,104
|
|
|
$
|
10,382
|
|
|
$
|
21,013
|
|
|
Adjusted EBITDA margin(4)
|
|
11.2
|
%
|
|
17.9
|
%
|
|
8.5
|
%
|
|
16.5
|
%
|
||||
(1) To exclude the effect of one-time charges of $0.7 million in the fourth quarter and for the full year 2019 incurred as part of the expected acquisition of scil animal care company GmbH.
(2) To exclude $0.2 million and $7.4 million in the fourth quarter of 2018 and for the full year 2018, respectively, due to the agreement in principle to settle the complaint filed against the Company for $6.75 million, approximately $0.6 million of legal costs incurred in relation to the settlement negotiation, and other one-time costs.
(3)To exclude the effect of one-time benefit of $0.3 million for the fourth quarter of 2019 related to the insurance recovery of cyber incident and a net charge of $0.3 million for the full year of 2019 related to the costs associated with the cyber incident. In addition, this excludes $0.2 million and $7.4 million in the fourth quarter of 2018 and for the full year 2018, respectively, as noted above.
(4) Adjusted EBITDA margin is calculated as the ratio of adjusted EBITDA to revenue.
-43-
|
|
|
Three Months Ended
December 31,
|
|
Year Ended
December 31,
|
||||||||||||
|
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
||||||||
|
GAAP net income attributable to Heska per diluted share
|
|
$
|
(0.23
|
)
|
|
$
|
0.44
|
|
|
$
|
(0.20
|
)
|
|
$
|
0.74
|
|
|
Acquisition-related costs(1)
|
|
0.08
|
|
|
—
|
|
|
0.08
|
|
|
—
|
|
||||
|
Litigation and other one-time costs(2)
|
|
(0.03
|
)
|
|
0.03
|
|
|
0.04
|
|
|
0.94
|
|
||||
|
Amortization of debt discount and issuance costs
|
|
0.19
|
|
|
—
|
|
|
0.23
|
|
|
0.01
|
|
||||
|
Stock-based compensation
|
|
0.17
|
|
|
0.18
|
|
|
0.62
|
|
|
0.67
|
|
||||
|
Gain (loss) on equity investee transactions
|
|
0.02
|
|
|
0.01
|
|
|
0.07
|
|
|
0.01
|
|
||||
|
Estimated income tax effect of above non-GAAP adjustments(3)
|
|
(0.11
|
)
|
|
(0.06
|
)
|
|
(0.26
|
)
|
|
(0.40
|
)
|
||||
|
Discrete tax benefits associated with stock-based compensation activity
|
|
(0.02
|
)
|
|
(0.06
|
)
|
|
(0.21
|
)
|
|
(0.33
|
)
|
||||
|
Non-GAAP net income per diluted share
|
|
$
|
0.07
|
|
|
$
|
0.54
|
|
|
$
|
0.37
|
|
|
$
|
1.64
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
Shares used in diluted per share calculations
|
|
8,036
|
|
|
7,947
|
|
|
7,977
|
|
|
7,856
|
|
||||
(1) To exclude the effect of one-time charges of $0.7 million in the fourth quarter and for the full year 2019 incurred as part of the expected acquisition of scil animal care company GmbH.
(2) To exclude the effect of a one-time benefit of $0.3 million for the fourth quarter of 2019 of insurance recovery relating to the cyber incident disclosed in the third quarter 2019, and a net charge of $0.3 million for the full year of 2019 related to the net loss after insurance recovery associated with the cyber incident. In addition, this also excludes $0.2 million and $7.4 million in the fourth quarter of 2018 and for the full year 2018, respectively, due to the agreement in principle to settle the complaint filed against the Company for $6.75 million, approximately $0.6 million of legal costs incurred in relation to the settlement negotiation, and other one-time costs.
(3) Represents income tax expense utilizing an estimated effective tax rate that adjusts for non-GAAP measures including: acquisition-related costs, litigation and other one-time costs, amortization of debt discount and issuance costs, and stock-based compensation. Adjusted effective tax rates are 25% for the fourth quarter and full year 2019 and 24% for the fourth quarter and full year 2018.
Impact of Inflation
In recent years, inflation has not had a significant impact on our operations.
Liquidity, Capital Resources and Financial Condition
We believe that adequate liquidity and cash generation is important to the execution of our strategic initiatives. Our ability to fund our operations, acquisitions, capital expenditures, and product development efforts may depend on our ability to generate cash from operating activities, which is subject to future operating performance, as well as general economic, financial, competitive, legislative, regulatory, and other conditions, some of which may be beyond our control. Our primary sources of liquidity are our available cash, including $70.9 million from the issuance and sale of the Notes, after deducting the initial purchasers’ discounts, debt issuance costs paid or payable by us, and the repayment in full of our Credit Facility, as described in Note 16 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, and cash generated from current operations. Subsequent to December 31, 2019, the Company transferred $14.6 million of consideration for the purchase of the CVM companies. Refer to Part II. Item 8. Financial Statements and Supplementary Data, Note 3. Acquisition and Related Party Items. Additionally, we announced our intention to acquire scil and finance the transaction through a private placement of convertible preferred equity. Refer to Part II. Item 8. Financial Statements and Supplementary Data, Note 19. Subsequent Events.
-44-
For the year ended December 31, 2019, we had a net loss after equity in losses of unconsolidated affiliates of $1.7 million and net cash provided by operations of $3.3 million. At December 31, 2019, we had $89.0 million of cash and cash equivalents and working capital of $107.7 million.
A summary of our cash provided by and used in operating, investing and financing activities is as follows (in thousands):
|
|
Year Ended December 31,
|
||||||||||
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
Net cash provided by operating activities
|
$
|
3,296
|
|
|
$
|
13,287
|
|
|
$
|
10,409
|
|
|
Net cash used in investing activities
|
(1,923
|
)
|
|
(12,174
|
)
|
|
(17,169
|
)
|
|||
|
Net cash provided by financing activities
|
74,264
|
|
|
2,627
|
|
|
5,551
|
|
|||
|
Effect of currency translation on cash
|
4
|
|
|
(10
|
)
|
|
74
|
|
|||
|
Increase (decrease) in cash and cash equivalents
|
75,641
|
|
|
3,730
|
|
|
(1,135
|
)
|
|||
|
Cash and cash equivalents, beginning of the period
|
13,389
|
|
|
9,659
|
|
|
10,794
|
|
|||
|
Cash and cash equivalents, end of the period
|
$
|
89,030
|
|
|
$
|
13,389
|
|
|
$
|
9,659
|
|
Net cash provided by operating activities was $3.3 million in 2019, compared to net cash provided by operating activities of $13.3 million in 2018, a decrease of approximately $10.0 million. Net cash provided by operating activities decreased due to significant working capital fluctuations such as a $12.0 million decrease in cash provided by accrued liabilities, primarily driven by a $6.8 million settlement payment and $0.3 million in related legal fees in 2019 (see Note 14. Commitments and Contingencies in our Consolidated Financial Statements included in Item 8 of this Form 10-K) and a $5.1 million decrease in cash provided by inventories, due to the timing of purchases and lower sales in the current year. Additionally, net cash from operating activities was $7.6 million less in 2019 due to the decrease in net income compared to 2018. These factors were partially offset by a $9.7 million decrease in cash used by the aggregate of accounts receivable, accounts payable, related party balances, deferred revenue and other current and non-current assets, due to the timing of collections and payments in the ordinary course of business. Non-cash transactions impacting cash provided by operating activities included a $1.8 million increase related to the amortization of debt discount and issuance costs and $1.6 million increase from our leases and rights of use asset amortization.
Net cash provided by operating activities was $13.3 million in 2018, compared to net cash provided by operating activities of $10.4 million in 2017, an increase of approximately $2.9 million. Net cash provided by operating activities increased due to significant working capital fluctuations such as a $19.9 million increase in cash provided by inventories, due to the timing of inventory purchases in 2017; a $7.5 million increase in cash provided by accrued liabilities, largely due to a preliminary settlement agreement relating to outstanding litigation in the amount of $6.8 million which we paid in the first half of 2019 (see Note 14. Commitments and Contingencies in our Consolidated Financial Statements included in Item 8 of this Form 10-K); and a $2.8 million increase in cash provided by current and non-current lease receivables due to a lower level of sales-type lease placements and timing of collections on existing leases. These factors were partially offset by a $3.6 million decrease in net income, as well as a $15.2 million increase in cash used by the aggregate of accounts receivable, accounts payable, related party balances, deferred revenue and other current assets, due to the timing of collections and payments in the ordinary course of business. Non-cash transactions impacting cash provided by operating activities included a $11.1 million increase in our deferred tax benefit, net, offset by a $2.5 million increase in stock-based compensation.
Net cash used in investing activities was $1.9 million in 2019, compared to net cash used in investing activities of $12.2 million in 2018, a decrease of approximately $10.3 million. The decrease in cash used for
-45-
investing activities was mainly driven by the 2018 investments made in unconsolidated affiliates for $8.1 million and 2018 intangible asset acquisition for $2.8 million (cash portion). This was partially offset by $1.2 million increase in cash used for the Optomed real estate asset acquisition; and $0.9 million increase in acquired cash from the acquisition of CVM. Net cash used in investing activities was $12.2 million in 2018, compared to net cash used in investing activities of $17.2 million in 2017, a decrease of approximately $5.0 million. The decrease in cash used for investing activities was mainly driven by the 2017 purchase of the Heska Imaging minority for $13.8 million, compared to the 2018 investments made in unconsolidated affiliates for $8.1 million and 2018 intangible asset acquisition for $2.8 million (cash portion). Additionally, we had a $2.1 million decrease in cash used for purchases of property and equipment.
Net cash provided by financing activities was $74.3 million in 2019, compared to net cash provided by financing activities of $2.6 million in 2018, an increase of approximately $71.6 million. The change was driven primarily by an $86.3 million increase in proceeds from the convertible notes offering (see Note 16. Convertible Notes and Credit Facility in our Consolidated Financial Statements included in Item 8 of this Form 10-K). The increase in proceeds from the notes was partially offset by a $6.0 million decrease in net borrowings as a result of the repayment in full of our Credit Facility; $3.2 million of cash used to pay debt issuance costs; and $2.2 million decrease in proceeds from issuance of common stock, net of distributions. Net cash provided by financing activities was $2.6 million in 2018, compared to net cash provided by financing activities of $5.6 million in 2017, a decrease of approximately $2.9 million. The change was driven primarily by a $5.3 million decrease in borrowings, net of repayments. This was partially offset by a $1.6 million increase in proceeds from issuance of common stock, net of distributions, and a $0.8 million decrease in distributions to non-controlling interest members.
We believe that our cash, cash equivalents and marketable securities balances, as well as the cash flows generated by our operations, will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures, including selling and marketing team expansion and product development initiatives, for at least the next 12 months. Our belief may prove to be incorrect, however, and we could utilize our available financial resources sooner the we currently expect. For example, we are actively seeking acquisitions that are consistent with our strategic direction, which may require additional capital. Our future capital requirements and the adequacy of available funds will depend on many factors, including those set forth in Part I, Item 1A, "Risk Factors", of this Form 10-K. We may be required to seek additional equity or debt financing in order to meet these future capital requirements, even in the absence of any acquisitions. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us, or at all. If we are unable to raise additional capital when desired, our business, results of operations and financial condition would be adversely affected.
Effect of currency translation on cash
Net effect of foreign currency translations on cash changed $14 thousand to a $4 thousand positive impact in 2019, compared to a $10 thousand negative impact in 2018. The net effect of foreign currency translation on cash changed $84 thousand to a $10 thousand negative impact in 2018 from a $74 thousand positive impact in 2017. These effects are related to changes in exchange rates between the U.S. Dollar and the Swiss Franc, Euro, and Australian Dollar which are the functional currencies of our subsidiaries.
Off Balance Sheet Arrangements
We have no off balance sheet arrangements or variable interest entities.
-46-
Contractual Obligations
The Company has not entered into any transactions with unconsolidated entities whereby the Company has financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose the Company to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provided financing, liquidity, market risk or credit risk support to the Company, or engages in leasing, hedging or research and development services with the Company.
Purchase obligations represent contractual agreements to purchase goods or services that are legally binding; specify a fixed, minimum or range of quantities; specify a fixed, minimum, variable, or indexed price provision; and specify approximate timing of the transaction.
See "Part II, Item 8. Financial Statements and Supplementary Data, Note 6. Leases", included in this Form 10-K for a description of our operating lease obligations, and "Part II, Item 8. Financial Statements and Supplementary Data, Note 1. Operations and Summary of Significant Accounting Policies", for a discussion of the impact of the adoption of FASB Accounting Standards Codification ("ASC") Topic 842, Leases.
The following table presents certain future payments due by the Company as of December 31, 2019 (in thousands):
|
|
Total
|
|
Less Than 1 Year
|
|
1 - 3 Years
|
|
3 - 5 Years
|
|
After 5 Years
|
||||||||||
|
Purchase obligations
|
$
|
13,539
|
|
|
$
|
9,122
|
|
|
$
|
3,329
|
|
|
$
|
1,088
|
|
|
$
|
—
|
|
|
Consideration payable for acquisition(1)
|
14,579
|
|
|
14,579
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|||||
|
Operating lease obligations
|
6,727
|
|
|
1,792
|
|
|
3,052
|
|
|
1,826
|
|
|
57
|
|
|||||
|
Finance lease obligations
|
82
|
|
|
46
|
|
|
34
|
|
|
2
|
|
|
—
|
|
|||||
|
Other long term borrowings
|
1,121
|
|
|
—
|
|
|
—
|
|
|
673
|
|
|
448
|
|
|||||
|
Convertible senior notes (2)
|
86,250
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
86,250
|
|
|||||
|
Future interest obligations (3)
|
22,650
|
|
|
3,237
|
|
|
6,475
|
|
|
6,473
|
|
|
6,465
|
|
|||||
|
Total
|
$
|
144,948
|
|
|
$
|
28,776
|
|
|
$
|
12,890
|
|
|
$
|
10,062
|
|
|
$
|
93,220
|
|
(1) Relates to acquisition of CVM companies. For additional information, refer to Part II, Item 8. Financial Statements and Supplementary Data, Note 3. Acquisition and Related Party Items.
(2) Includes the principal amount of the convertible senior notes. Although the notes mature in 2026, they can be converted into cash and shares of our common stock prior to maturity if certain conditions are met. Any conversion prior to maturity can result in repayments of the principal amounts sooner than the scheduled repayments as indicated in the table. For additional information, refer to Part II, Item 8. Financial Statements and Supplementary Data, Note 16. Convertible Notes and Credit Facility.
(3) Includes interest payments for both the convertible senior notes and other long term borrowings.
Net Operating Loss Carryforwards
As of December 31, 2019, we had a net operating loss carryforward (“NOL”) and domestic research and development tax credit carryforward. See "Part II, Item 8. Financial Statements and Supplementary Data, Note 5. Income Taxes" in our Consolidated Financial Statements for additional information regarding our carryforwards.
Recent Accounting Pronouncements
From time to time, the FASB or other standard setting bodies issue new accounting pronouncements. Updates
-47-
to the FASB ASC are communicated through issuance of an ASU. Unless otherwise discussed, we believe that the impact of recently issued guidance, whether adopted or to be adopted in the future, is not expected to have a material impact on our Consolidated Financial Statements upon adoption.
To understand the impact of recently issued guidance, whether adopted or to be adopted, please review the information provided in Note 1. Operations and Summary of Significant Accounting Policies to our Consolidated Financial Statements included in Item 8 of this Form 10-K.
-48-
|
Item 7A.
|
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 U.S. and foreign interest rates and changes in foreign currency exchange rates as measured against the U.S. Dollar. These exposures are directly related to our normal operating and funding activities.
Interest Rate Risk
In September 2019, we issued $86.25 million aggregate principal amount of Notes. The fair market value of the Notes is affected by our common stock price. The fair value of the Notes will generally increase as our common stock price increases and will generally decrease as our common stock price declines in value. In addition, the fair market value of the Notes is exposed to interest rate risk. Generally, the fair market value of our fixed interest rate Notes will increase as interest rates fall and decrease as interest rates rise. Additionally, on our balance sheet we carry the Notes at face value less unamortized discount and debt issuance cost and we present the fair value for required disclosure purposes only. For additional information, refer to Part II, Item 8. Financial Statements and Supplementary Data, Note 16. Credit Facility and Long-Term Debt to our consolidated financial statements included in this Form 10-K.
At December 31, 2019, we terminated our revolving credit facility with Chase. We had no interest rate hedge transactions in place on December 31, 2019.
Foreign Currency Risk
Foreign currency risk may impact our results of operations. In cases where we purchase inventory in one currency and sell corresponding products in another, our gross margin percentage is typically at risk based on foreign currency exchange rates. In addition, in cases where we may be generating operating income in foreign currencies, the magnitude of such operating income when translated into U.S. dollars will be at risk based on foreign currency exchange rates. We had no foreign currency hedge transactions in place on December 31, 2019. We do not currently consider foreign currency risk to be material to our business.
-49-
|
Item 8.
|
Financial Statements and Supplementary Data
|
HESKA CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
|
|
Page
|
-50-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of Heska Corporation
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Heska Corporation and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the years in the two-year period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO framework”).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in the COSO framework.
Change in Accounting Principle
As discussed in Note 1 to the financial statements, the Company adopted the Accounting Standards Codification (ASC) Topic 842, “Leases,” using the modified retrospective adoption method on January 1, 2019.
Basis for Opinion
The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Controls over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other
-51-
procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Plante & Moran, PLLC
We have served as the Company’s auditor since 2006.
Denver, Colorado
February 28, 2020
-52-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of
Heska Corporation
Loveland, Colorado
OPINION ON THE CONSOLIDATED FINANCIAL STATEMENTS
We have audited the accompanying consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows of Heska Corporation and subsidiaries (the “Company”) for the year ended December 31, 2017, and the related notes (collectively referred to as the “financial statements”).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017, and the results of its operations and its cash flows for the year ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
BASIS FOR OPINION
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (the “PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ EKS&H LLLP
March 19, 2018
Denver, Colorado
We began serving as the Company’s auditor in 2006. In 2018, we became the predecessor auditor.
-53-
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
|
|
|
December 31,
|
||||||
|
|
|
2019
|
|
2018
|
||||
|
ASSETS
|
||||||||
|
Current assets:
|
|
|
|
|
|
|
||
|
Cash and cash equivalents
|
|
$
|
89,030
|
|
|
$
|
13,389
|
|
|
Accounts receivable, net of allowance for doubtful accounts of $186 and $245, respectively
|
|
15,161
|
|
|
16,454
|
|
||
|
Inventories, net
|
|
26,601
|
|
|
25,104
|
|
||
|
Net investment in leases, current, net of allowance for doubtful accounts of $105 and $40, respectively
|
|
3,856
|
|
|
2,989
|
|
||
|
Prepaid expenses
|
|
2,219
|
|
|
1,533
|
|
||
|
Other current assets
|
|
3,000
|
|
|
2,938
|
|
||
|
Total current assets
|
|
139,867
|
|
|
62,407
|
|
||
|
Property and equipment, net
|
|
15,469
|
|
|
15,981
|
|
||
|
Operating lease right-of-use assets
|
|
5,726
|
|
|
—
|
|
||
|
Goodwill
|
|
36,204
|
|
|
26,679
|
|
||
|
Other intangible assets, net
|
|
11,472
|
|
|
9,764
|
|
||
|
Deferred tax asset, net
|
|
6,429
|
|
|
14,121
|
|
||
|
Net investment in leases, non-current
|
|
14,307
|
|
|
11,908
|
|
||
|
Investments in unconsolidated affiliates
|
|
7,424
|
|
|
8,018
|
|
||
|
Other non-current assets
|
|
7,526
|
|
|
7,574
|
|
||
|
Total assets
|
|
$
|
244,424
|
|
|
$
|
156,452
|
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
||||||||
|
Current liabilities:
|
|
|
|
|
|
|
||
|
Accounts payable
|
|
$
|
6,600
|
|
|
$
|
7,469
|
|
|
Due to related parties
|
|
—
|
|
|
226
|
|
||
|
Accrued liabilities
|
|
6,345
|
|
|
10,142
|
|
||
|
Accrued purchase consideration payable
|
|
14,579
|
|
|
—
|
|
||
|
Current operating lease liabilities
|
|
1,745
|
|
|
—
|
|
||
|
Current portion of deferred revenue, and other
|
|
2,930
|
|
|
2,526
|
|
||
|
Total current liabilities
|
|
32,199
|
|
|
20,363
|
|
||
|
Convertible note, long-term, net
|
|
45,348
|
|
|
—
|
|
||
|
Deferred revenue, net of current portion
|
|
5,966
|
|
|
7,082
|
|
||
|
Line of credit and other long-term borrowings
|
|
1,121
|
|
|
6,000
|
|
||
|
Non-current operating lease liabilities
|
|
4,413
|
|
|
—
|
|
||
|
Deferred tax liability
|
|
691
|
|
|
—
|
|
||
|
Other liabilities
|
|
152
|
|
|
598
|
|
||
|
Total liabilities
|
|
89,890
|
|
|
34,043
|
|
||
|
|
|
|
|
|
||||
|
Redeemable non-controlling interest and mezzanine equity
|
|
170
|
|
|
—
|
|
||
|
|
|
|
|
|
||||
|
Stockholders' equity:
|
|
|
|
|
|
|
||
|
Preferred stock, $.01 par value, 2,500,000 and 2,500,000 shares authorized, respectively, none issued or outstanding
|
|
—
|
|
|
—
|
|
||
|
Original common stock, $.01 par value, 10,250,000 and 10,250,000 shares authorized,
respectively, none issued or outstanding |
|
—
|
|
|
—
|
|
||
|
Public common stock, $.01 par value, 10,250,000 and 10,250,000 shares authorized, 7,881,928 and 7,675,692 shares issued and outstanding, respectively
|
|
79
|
|
|
77
|
|
||
|
Additional paid-in capital
|
|
290,216
|
|
|
257,034
|
|
||
|
Accumulated other comprehensive income
|
|
513
|
|
|
277
|
|
||
|
Accumulated deficit
|
|
(136,444
|
)
|
|
(134,979
|
)
|
||
|
Total stockholders' equity
|
|
154,364
|
|
|
122,409
|
|
||
|
Total liabilities and stockholders' equity
|
|
$
|
244,424
|
|
|
$
|
156,452
|
|
See accompanying notes to consolidated financial statements.
-54-
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
|
|
|
Year Ended December 31,
|
||||||||||
|
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|||
|
Core companion animal
|
|
$
|
106,570
|
|
|
$
|
108,924
|
|
|
$
|
105,191
|
|
|
Other vaccines and pharmaceuticals
|
|
16,091
|
|
|
18,522
|
|
|
24,150
|
|
|||
|
Total revenue, net
|
|
122,661
|
|
|
127,446
|
|
|
129,341
|
|
|||
|
|
|
|
|
|
|
|
||||||
|
Cost of revenue
|
|
68,212
|
|
|
70,808
|
|
|
71,080
|
|
|||
|
|
|
|
|
|
|
|
||||||
|
Gross profit
|
|
54,449
|
|
|
56,638
|
|
|
58,261
|
|
|||
|
|
|
|
|
|
|
|
||||||
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|||
|
Selling and marketing
|
|
27,678
|
|
|
24,663
|
|
|
23,225
|
|
|||
|
Research and development
|
|
8,240
|
|
|
3,334
|
|
|
2,004
|
|
|||
|
General and administrative
|
|
18,204
|
|
|
24,847
|
|
|
14,813
|
|
|||
|
Total operating expenses
|
|
54,122
|
|
|
52,844
|
|
|
40,042
|
|
|||
|
Operating income
|
|
327
|
|
|
3,794
|
|
|
18,219
|
|
|||
|
Interest and other expense (income), net
|
|
2,910
|
|
|
(13
|
)
|
|
(150
|
)
|
|||
|
(Loss) income before income taxes and equity in losses of unconsolidated affiliates
|
|
(2,583
|
)
|
|
3,807
|
|
|
18,369
|
|
|||
|
Income tax (benefit) expense:
|
|
|
|
|
|
|
|
|
|
|||
|
Current income tax expense
|
|
359
|
|
|
140
|
|
|
49
|
|
|||
|
Deferred income tax (benefit) expense
|
|
(1,805
|
)
|
|
(2,255
|
)
|
|
8,864
|
|
|||
|
Total income tax (benefit) expense
|
|
(1,446
|
)
|
|
(2,115
|
)
|
|
8,913
|
|
|||
|
|
|
|
|
|
|
|
||||||
|
Net (loss) income before equity in losses of unconsolidated affiliates
|
|
(1,137
|
)
|
|
5,922
|
|
|
9,456
|
|
|||
|
Equity in losses of unconsolidated affiliates
|
|
(594
|
)
|
|
(72
|
)
|
|
—
|
|
|||
|
Net (loss) income, after equity in losses of unconsolidated affiliates
|
|
(1,731
|
)
|
|
5,850
|
|
|
9,456
|
|
|||
|
Net loss attributable to non-controlling interest
|
|
(266
|
)
|
|
—
|
|
|
(497
|
)
|
|||
|
Net (loss) income attributable to Heska Corporation
|
|
$
|
(1,465
|
)
|
|
$
|
5,850
|
|
|
$
|
9,953
|
|
|
|
|
|
|
|
|
|
||||||
|
Basic (loss) earnings per share attributable to Heska Corporation
|
|
$
|
(0.20
|
)
|
|
$
|
0.81
|
|
|
$
|
1.42
|
|
|
Diluted (loss) earnings per share attributable to Heska Corporation
|
|
$
|
(0.20
|
)
|
|
$
|
0.74
|
|
|
$
|
1.30
|
|
|
|
|
|
|
|
|
|
||||||
|
Weighted average outstanding shares used to compute basic (loss) earnings per share attributable to Heska Corporation
|
|
7,446
|
|
|
7,220
|
|
|
7,026
|
|
|||
|
Weighted average outstanding shares used to compute diluted (loss) earnings per share attributable to Heska Corporation
|
|
7,446
|
|
|
7,856
|
|
|
7,642
|
|
|||
See accompanying notes to consolidated financial statements.
-55-
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
|
|
|
Year Ended December 31,
|
||||||||||
|
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
|
|
|
|
|
|
|
||||||
|
Net (loss) income, after equity in losses of unconsolidated affiliates
|
|
$
|
(1,731
|
)
|
|
$
|
5,850
|
|
|
$
|
9,456
|
|
|
Other comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|||
|
Minimum pension liability
|
|
73
|
|
|
70
|
|
|
12
|
|
|||
|
Foreign currency translation
|
|
163
|
|
|
(25
|
)
|
|
123
|
|
|||
|
Comprehensive (loss) income
|
|
(1,495
|
)
|
|
5,895
|
|
|
9,591
|
|
|||
|
|
|
|
|
|
|
|
||||||
|
Comprehensive loss attributable to non-controlling interest
|
|
(266
|
)
|
|
—
|
|
|
(497
|
)
|
|||
|
Comprehensive (loss) income attributable to Heska Corporation
|
|
$
|
(1,229
|
)
|
|
$
|
5,895
|
|
|
$
|
10,088
|
|
See accompanying notes to consolidated financial statements.
-56-
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
|
|
|
Common Stock
|
|
Additional
Paid-in
Capital
|
|
Accumulated
Other
Comprehensive
Income
|
|
Accumulated
Deficit
|
|
Total Stockholders' Equity |
|||||||||||||
|
|
|
Shares
|
|
Amount
|
|
||||||||||||||||||
|
Balances, January 1, 2017
|
|
7,026
|
|
|
$
|
70
|
|
|
$
|
238,635
|
|
|
$
|
97
|
|
|
$
|
(151,827
|
)
|
|
$
|
86,975
|
|
|
Net income attributable to Heska Corporation
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
9,456
|
|
|
9,456
|
|
|||||
|
Issuance of common stock, net of shares withheld for employee taxes
|
|
277
|
|
|
3
|
|
|
1,373
|
|
|
—
|
|
|
—
|
|
|
1,376
|
|
|||||
|
Stock-based compensation
|
|
—
|
|
|
—
|
|
|
2,745
|
|
|
—
|
|
|
—
|
|
|
2,745
|
|
|||||
|
Accretion of non-controlling interest
|
|
—
|
|
|
—
|
|
|
845
|
|
|
—
|
|
|
—
|
|
|
845
|
|
|||||
|
Distribution for Heska Imaging minority
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(1,092
|
)
|
|
(1,092
|
)
|
|||||
|
Other comprehensive income
|
|
—
|
|
|
—
|
|
|
—
|
|
|
135
|
|
|
—
|
|
|
135
|
|
|||||
|
Balances, December 31, 2017
|
|
7,303
|
|
|
$
|
73
|
|
|
$
|
243,598
|
|
|
$
|
232
|
|
|
$
|
(143,463
|
)
|
|
$
|
100,440
|
|
|
Adoption of accounting standards
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
2,634
|
|
|
2,634
|
|
|||||
|
Balances, January 1, 2018, as adjusted
|
|
7,303
|
|
|
73
|
|
|
243,598
|
|
|
232
|
|
|
(140,829
|
)
|
|
103,074
|
|
|||||
|
Net income attributable to Heska Corporation
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
5,850
|
|
|
5,850
|
|
|||||
|
Issuance of common stock, net of shares withheld for employee taxes
|
|
318
|
|
|
3
|
|
|
2,759
|
|
|
—
|
|
|
—
|
|
|
2,762
|
|
|||||
|
Issuance of common stock related to acquisition of assets from Cuattro, LLC
|
|
55
|
|
|
1
|
|
|
5,450
|
|
|
—
|
|
|
—
|
|
|
5,451
|
|
|||||
|
Stock-based compensation
|
|
—
|
|
|
—
|
|
|
5,227
|
|
|
—
|
|
|
—
|
|
|
5,227
|
|
|||||
|
Other comprehensive income
|
|
—
|
|
|
—
|
|
|
—
|
|
|
45
|
|
|
—
|
|
|
45
|
|
|||||
|
Balances, December 31, 2018
|
|
7,676
|
|
|
77
|
|
|
257,034
|
|
|
277
|
|
|
(134,979
|
)
|
|
122,409
|
|
|||||
|
Net loss attributable to Heska Corporation
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(1,465
|
)
|
|
(1,465
|
)
|
|||||
|
Issuance of common stock, net of shares withheld for employee taxes
|
|
206
|
|
|
2
|
|
|
(1,620
|
)
|
|
—
|
|
|
—
|
|
|
(1,618
|
)
|
|||||
|
Stock-based compensation
|
|
—
|
|
|
—
|
|
|
4,968
|
|
|
—
|
|
|
—
|
|
|
4,968
|
|
|||||
|
Convertible notes, equity
|
|
—
|
|
|
—
|
|
|
29,834
|
|
|
—
|
|
|
—
|
|
|
29,834
|
|
|||||
|
Other comprehensive income
|
|
—
|
|
|
—
|
|
|
—
|
|
|
236
|
|
|
—
|
|
|
236
|
|
|||||
|
Balances, December 31, 2019
|
|
7,882
|
|
|
$
|
79
|
|
|
$
|
290,216
|
|
|
$
|
513
|
|
|
$
|
(136,444
|
)
|
|
$
|
154,364
|
|
See accompanying notes to consolidated financial statements.
-57-
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
|
|
|
Year Ended December 31,
|
||||||||||
|
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
||||||
|
Net (loss) income, after equity in losses from unconsolidated affiliates
|
|
$
|
(1,731
|
)
|
|
$
|
5,850
|
|
|
$
|
9,456
|
|
|
Adjustments to reconcile net income to cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|||
|
Depreciation and amortization
|
|
4,916
|
|
|
4,595
|
|
|
4,754
|
|
|||
|
Non-cash impact of operating leases
|
|
1,565
|
|
|
—
|
|
|
—
|
|
|||
|
Deferred income tax (benefit) expense
|
|
(1,805
|
)
|
|
(2,255
|
)
|
|
8,864
|
|
|||
|
Stock-based compensation
|
|
4,968
|
|
|
5,227
|
|
|
2,745
|
|
|||
|
Equity in losses of unconsolidated affiliates
|
|
594
|
|
|
72
|
|
|
—
|
|
|||
|
Amortization of debt discount and issuance costs
|
|
1,842
|
|
|
—
|
|
|
—
|
|
|||
|
Accretion of non-controlling interest
|
|
14
|
|
|
—
|
|
|
—
|
|
|||
|
Unrealized foreign currency transaction loss on purchase consideration payable
|
|
159
|
|
|
—
|
|
|
—
|
|
|||
|
Other losses (gains)
|
|
387
|
|
|
8
|
|
|
(46
|
)
|
|||
|
Changes in operating assets and liabilities (net of effect of acquisitions):
|
|
|
|
|
|
|
|
|
|
|||
|
Accounts receivable
|
|
3,796
|
|
|
(1,076
|
)
|
|
5,243
|
|
|||
|
Inventories
|
|
918
|
|
|
6,046
|
|
|
(13,834
|
)
|
|||
|
Due from related parties
|
|
—
|
|
|
1
|
|
|
99
|
|
|||
|
Lease receivable, current
|
|
(846
|
)
|
|
(920
|
)
|
|
(1,244
|
)
|
|||
|
Other current assets
|
|
(394
|
)
|
|
(505
|
)
|
|
(474
|
)
|
|||
|
Accounts payable
|
|
(1,686
|
)
|
|
(2,020
|
)
|
|
3,143
|
|
|||
|
Due to related parties
|
|
(226
|
)
|
|
(1,477
|
)
|
|
250
|
|
|||
|
Accrued liabilities and other
|
|
(5,883
|
)
|
|
6,146
|
|
|
(1,380
|
)
|
|||
|
Lease receivable, non-current
|
|
(2,283
|
)
|
|
(2,294
|
)
|
|
(4,782
|
)
|
|||
|
Other non-current assets
|
|
(57
|
)
|
|
(871
|
)
|
|
(984
|
)
|
|||
|
Deferred revenue and other
|
|
(952
|
)
|
|
(3,240
|
)
|
|
(1,401
|
)
|
|||
|
Net cash provided by operating activities
|
|
3,296
|
|
|
13,287
|
|
|
10,409
|
|
|||
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
||||||
|
Investment in subsidiary, net of cash acquired
|
|
(622
|
)
|
|
—
|
|
|
—
|
|
|||
|
Cash acquired from acquisition of CVM
|
|
927
|
|
|
—
|
|
|
—
|
|
|||
|
Acquisition of intangible asset
|
|
—
|
|
|
(2,750
|
)
|
|
—
|
|
|||
|
Investments in unconsolidated affiliates
|
|
—
|
|
|
(8,091
|
)
|
|
—
|
|
|||
|
Purchase of minority interest
|
|
—
|
|
|
—
|
|
|
(13,757
|
)
|
|||
|
Real estate asset acquisition
|
|
(1,184
|
)
|
|
—
|
|
|
—
|
|
|||
|
Purchases of property and equipment
|
|
(1,044
|
)
|
|
(1,358
|
)
|
|
(3,469
|
)
|
|||
|
Proceeds from disposition of property and equipment
|
|
—
|
|
|
25
|
|
|
57
|
|
|||
|
Net cash used in investing activities
|
|
(1,923
|
)
|
|
(12,174
|
)
|
|
(17,169
|
)
|
|||
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
||||||
|
Proceeds from issuance of common stock
|
|
1,829
|
|
|
4,034
|
|
|
2,452
|
|
|||
|
Repurchase of common stock
|
|
(3,447
|
)
|
|
(1,271
|
)
|
|
(1,076
|
)
|
|||
|
Distributions to non-controlling interest members
|
|
—
|
|
|
(126
|
)
|
|
(965
|
)
|
|||
|
Convertible debt proceeds
|
|
86,250
|
|
|
—
|
|
|
—
|
|
|||
|
Proceeds from line of credit borrowings
|
|
6,750
|
|
|
3,000
|
|
|
40,307
|
|
|||
|
Repayments of line of credit borrowings
|
|
(12,750
|
)
|
|
(3,000
|
)
|
|
(34,979
|
)
|
|||
|
Repayments of other debt
|
|
(1,191
|
)
|
|
(10
|
)
|
|
(68
|
)
|
|||
|
Payment of debt issuance costs
|
|
(3,177
|
)
|
|
—
|
|
|
(120
|
)
|
|||
|
Net cash provided by financing activities
|
|
74,264
|
|
|
2,627
|
|
|
5,551
|
|
|||
|
NET EFFECT OF EXCHANGE RATE CHANGES ON CASH
|
|
4
|
|
|
(10
|
)
|
|
74
|
|
|||
|
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
75,641
|
|
|
3,730
|
|
|
(1,135
|
)
|
|||
|
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
|
|
13,389
|
|
|
9,659
|
|
|
10,794
|
|
|||
|
CASH AND CASH EQUIVALENTS, END OF YEAR
|
|
$
|
89,030
|
|
|
$
|
13,389
|
|
|
$
|
9,659
|
|
-58-
|
NON-CASH TRANSACTIONS:
|
|
|
|
|
|
|
||||||
|
Transfers of equipment between inventory and property and equipment, net
|
|
$
|
827
|
|
|
$
|
1,449
|
|
|
$
|
1,637
|
|
|
Consideration payable for CVM Acquisition (See Note 3)
|
|
$
|
14,420
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Common stock issued as partial consideration of Cuattro acquisition transactions (See Note 3)
|
|
$
|
—
|
|
|
$
|
5,450
|
|
|
$
|
—
|
|
-59-
1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Heska Corporation and its wholly-owned subsidiaries ("Heska", the "Company", "we" or "our") sell veterinary and animal health diagnostic and specialty products. Our offerings include Point of Care diagnostic laboratory instruments and supplies; digital imaging diagnostic products, software and services; vaccines; local and cloud-based data services; allergy testing and immunotherapy; and single-use offerings such as in-clinic diagnostic tests and heartworm preventive products. Our core focus is on supporting veterinarians in the canine and feline healthcare space.
Basis of Presentation and Consolidation
In the opinion of management, the accompanying Consolidated Financial Statements contain all adjustments, consisting of normal, recurring adjustments, necessary to present fairly the financial position of the Company as of December 31, 2019 and 2018, as well as the results of our operations, statements of stockholders' equity and cash flows for the twelve months ended December 31, 2019, 2018 and 2017.
The audited Consolidated Financial Statements included herein have been prepared pursuant to the rules and regulations of the SEC. Our audited 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. Where our ownership of a subsidiary was less than 100%, the non-controlling interest is reported on our consolidated balance sheets. The non-controlling interest in our consolidated net income is reported as "Net loss attributable to non-controlling interest" on our Consolidated Statements of Income. Our audited Consolidated Financial Statements are stated in U.S. Dollars and have been prepared in accordance with accounting principles generally accepted in the U.S. ("GAAP").
Reclassification
To maintain consistency and comparability, certain amounts in the financial statements have been reclassified to conform to current year presentation.
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 doubtful accounts 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 of instruments under leasing arrangements; determining the allocation of purchase price under purchase accounting; estimating the expense associated with the granting of stock options; determining the need for, and the amount of a valuation allowance on deferred tax assets; determining the non-controlling interest in a business combination; and determining the fair value of the liability component associated with the issuance of convertible debt.
Concentration of Credit Risk
Financial instruments that potentially subject us to a concentration of credit risk consist of cash and cash equivalents and accounts receivable. We maintain the majority of our cash and cash equivalents with financial
-60-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
institutions that management believes are creditworthy in the form of demand deposits. We have no off-balance-sheet concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign currency hedging arrangements. Our accounts receivable balances are due largely from distribution partners, domestic veterinary clinics and individual veterinarians and other animal health companies.
Covetrus represented 19% and 12% of our consolidated accounts receivable at December 31, 2019 and 2018, respectively. Merck entities represented approximately 1% and 10% of our consolidated accounts receivable at December 31, 2019 and 2018, respectively. Elanco represented approximately 4% and 32% of our consolidated accounts receivable at December 31, 2019 and 2018, respectively. No other customer accounted for more than 10% of our consolidated accounts receivable at December 31, 2019 or 2018.
We have established an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are recorded at net realizable value. From time to time, our customers are unable to meet their payment obligations. We continuously monitor our customers' credit worthiness and use our judgment in establishing a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, there is no assurance that we will continue to experience the same credit loss rates that we have in the past. A significant change in the liquidity or financial position of our customers could have a material adverse impact on the collectability of accounts receivable and our future operating results.
Changes in allowance for doubtful accounts are summarized as follows (in thousands):
|
|
Years Ended December 31,
|
||||||||||
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
Balances at beginning of period
|
$
|
245
|
|
|
$
|
215
|
|
|
$
|
237
|
|
|
Additions - charged to expense
|
113
|
|
|
104
|
|
|
168
|
|
|||
|
Deductions - write offs, net of recoveries
|
(172
|
)
|
|
(74
|
)
|
|
(190
|
)
|
|||
|
Balances at end of period
|
$
|
186
|
|
|
$
|
245
|
|
|
$
|
215
|
|
Cash and Cash Equivalents
Cash and cash equivalents are stated at cost, which approximates market value, and include short-term, highly liquid investments with original maturities of less than three months. We valued our foreign cash accounts at the spot market foreign exchange rate as of each balance sheet date, with changes due to foreign exchange fluctuations recorded in current earnings. The majority of our cash and cash equivalents are held in accounts not insured by governmental entities. The foreign cash balances are summarized as follows (in thousands):
|
|
As of December 31,
|
||||
|
|
2019
|
|
2018
|
||
|
European Union Euros
|
1,773
|
|
|
1,615
|
|
|
Swiss Francs
|
124
|
|
|
156
|
|
|
Canadian Dollars
|
88
|
|
|
—
|
|
|
Australian Dollars
|
54
|
|
|
—
|
|
-61-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Fair Value of Financial Instruments
Our financial instruments consist of cash and cash equivalents, short-term trade receivables and payables, and 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 value of our line of credit balance was estimated based on current rates available for similar debt with similar maturities and collateral, and at December 31, 2018, approximated the carrying value due primarily to the floating rate of interest on such debt instruments. The Company repaid all outstanding indebtedness and terminated Revolving Commitments under the Credit Agreement with JPMorgan Chase Bank, N.A., effective as of December 31, 2019.
The estimated fair value of the convertible senior notes disclosed at each reporting period is evaluated through consideration of quoted market prices in less active markets. The fair value measurement is classified as Level 2 in the fair value hierarchy, which is defined in ASC 820 as inputs other than quoted prices in active markets that are either directly or indirectly observable. For additional information regarding the Company's accounting treatment for the issuance of the convertible senior notes, including the fair value measurement of the liability component, refer to Note 16. Convertible Notes and Credit Facility.
Property and Equipment
Property and equipment is stated at cost, net of accumulated depreciation. The costs of additions and improvements are capitalized, while maintenance and repairs are charged to expense as incurred. When an item is sold or retired, the cost and related accumulated depreciation is relieved and the resulting gain or loss, if any, is recognized in the Consolidated Statements of Income. We provide for depreciation primarily using the straight-line method by charges to income in amounts that allocate the cost of property and equipment over their estimated useful lives as follows:
We capitalize certain costs incurred in connection with developing or obtaining software designated for internal use based on three distinct stages of development. Qualifying costs incurred during the application development stage, which consist primarily of internal payroll and direct fringe benefits and external direct project costs, including labor and travel, are capitalized and amortized on a straight-line basis over the estimated useful life of the asset, which range from three to five years. Costs incurred during the preliminary project and post-implementation and operation phases are expensed as incurred. These costs are general and administrative in nature and related primarily to the determination of performance requirements, data conversion and training.
Inventories
Inventories are stated at the lower of cost or net realizable value using the first-in, first-out method. Inventory we manufacture includes the cost of material, labor and overhead. If the cost of inventories exceeds estimated net realizable value, provisions are made to reduce the carrying value to estimated net realizable value. This
-62-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
estimate is calculated utilizing various information, including assumptions of future market demand, market conditions and remaining shelf life.
Investments in Unconsolidated Affiliates
Investments in unconsolidated affiliates are measured and recorded as either non-marketable equity securities or equity method investments. Non-marketable equity securities are equity securities without readily determinable fair value that are measured and recorded using a measurement alternative which measures the securities at cost minus impairment, if any, plus or minus changes from qualifying observable price changes. Equity method investments are equity securities in investees we do not control but over which we have the ability to exercise significant influence. When the equity method of accounting is determined to be appropriate, the initial measurement of the investment includes the cost of the investment and all direct transaction costs incurred to acquire the investment. Equity method investments are measured at cost minus impairment, if any, plus or minus our share of equity method investee income or loss, which is recorded as a separate line on the income statement. Both types of investments are evaluated for impairment if a triggering event occurs.
Goodwill, Intangible and Other Long-Lived Assets
Goodwill is initially valued based on the excess of the purchase price of a business combination over the fair value of acquired net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Intangible assets other than goodwill are initially valued at fair value. If a quoted price in an active market for the identical asset is not readily available at the measurement date, the fair value of the intangible asset is estimated based on discounted cash flows using market participant assumptions, which are assumptions that are not specific to the Company. The selection of appropriate valuation methodologies and the estimation of discounted cash flows require significant assumptions about the timing and amounts of future cash flows, risks, appropriate discount rates, and the useful lives of intangible assets. When material, we utilize independent valuation experts to advise and assist us in determining the fair values of the identified intangible assets acquired in connection with a business acquisition and in determining appropriate amortization methods and periods for those intangible assets.
We assess goodwill for impairment annually, at the reporting unit level, in the fourth quarter and whenever events or circumstances indicate impairment may exist. In evaluating goodwill for impairment, we have the option to first assess the qualitative factors to determine whether it is more-likely-than-not that the estimated fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the comparison of the estimated fair value of the reporting unit to the carrying value. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If, after assessing the totality of events or circumstances, we determine that it is more-likely-than-not that the estimated fair value of a reporting is less than its carrying amount, we would then estimate the fair value of the reporting unit and compare it to the carrying value. If the carrying value exceeds the estimated fair value we would recognize an impairment for the difference; otherwise, no further impairment test would be required. In contrast, we can opt to bypass the qualitative assessment for any reporting unit in any period and proceed directly to quantitative analysis. Doing so does not preclude us from performing the qualitative assessment in any subsequent period.
We performed qualitative assessments in the fourth quarters of 2019, 2018, and 2017 and determined that no indications of impairment existed.
We assess the realizability of intangible assets other than goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If an impairment review is triggered,
-63-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
we evaluate the carrying value of intangible assets based on estimated undiscounted future cash flows over the remaining useful life of the primary asset of the asset group and compare that value to the carrying value of the asset group. The cash flows that are used contain our best estimates, using appropriate and customary assumptions and projections at the time. If the net carrying value of an intangible asset exceeds the related estimated undiscounted future cash flows, an impairment to adjust the intangible asset to its fair value would be reported as a non-cash charge to earnings. If necessary, we would calculate the fair value of an intangible asset using the present value of the estimated future cash flows to be generated by the intangible asset, and applying a risk-adjusted discount rate. We had no impairments of our intangible assets during the years ended December 31, 2019, 2018, and 2017.
Revenue Recognition
We account for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers, which we adopted on January 1, 2018, using the modified retrospective transition approach. See "Adoption of New Accounting Pronouncements" below for impacts of adoption.
We generate our CCA segment revenue through the sale of products, either by outright purchase by our customers or through a subscription agreement whereby our customers receive instruments and pay us a monthly fee for the consumables needed to conduct testing. Subscription placement is the majority of our Point of Care laboratory transactions while outright sales to customers are the majority of both Point of Care imaging diagnostic transactions and the sale of pharmaceuticals and vaccines.
For outright sales of products, revenue is recognized when control of the promised product or service is transferred to our customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those products or services (the transaction price). Taxes assessed by governmental authorities and collected from the customer are excluded from our revenue recognition. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer and is the unit of account under ASC 606. For instruments, consumables and most software licenses sold by the Company, control transfers to the customer at a point in time. To indicate the transfer of control, the Company must have a present right to payment, legal title must have passed to the customer, the customer must have the significant risks and rewards of ownership and where acceptance is not a formality, the customer must have accepted the product or service. Heska’s principal terms of sale are FOB Shipping Point, or equivalent, and, as such, we primarily transfer control and record revenue for product sales upon shipment. If a performance obligation to the customer with respect to a sales transaction remains unfulfilled following shipment (typically owed installation or acceptance by the customer), revenue recognition for that performance obligation is deferred until such commitments have been fulfilled. For extended warranty and service plans, control transfers to the customer over the term of the arrangement. Revenue for extended warranties and service is recognized based upon the period of time elapsed under the arrangement.
Our revenue under subscription agreements relates to OTL arrangements or STL arrangements. Determination of an OTL or STL is primarily determined as a result of the length of the contract as compared to the estimated useful life of the instrument, among other factors. Leases are outside of the scope of ASC 606 and are therefore accounted for in accordance with ASC 842, Leases. A STL would result in earlier recognition of instrument revenue as compared to an OTL, which is generally upon installation of the instruments. The cash collected under both arrangements is over the term of the contract. The cost of the customer-leased instruments is removed from inventory and recognized in the Consolidated Statements of Income. Instrument lease revenue for OTL agreements is recognized on a straight-line basis over the life of the lease, and the costs of customer-leased instruments are recorded within property and equipment in the accompanying Consolidated Balance Sheets and depreciated over the instrument’s estimated useful life. The depreciation expense is reflected in cost of revenue in the accompanying Consolidated Statements of Income. The OTLs
-64-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
and STLs are not cancellable until after an initial term. OTLs may include a minimum utilization rather than a minimum supply credit.
For contracts with multiple performance obligations, the Company allocates the contracts' transaction price for each performance obligation on a relative standalone selling price basis using our best estimate of the standalone selling price of each distinct product or service in the contract. The primary method used to estimate the standalone selling price is the price observed in standalone sales to customers of a prior period. Changes in these values can impact the amount of consideration allocated to each component of the contract. When prices in standalone sales are not available, we may use a cost-plus margin approach. Allocation of the transaction price is determined at the contracts' inception. The Company does not adjust the transaction price for the effects of a significant financing component when the period between the transfer of the promised good or service to the customer and payment for that good or service by the customer is expected to be one year or less. This allocation approach also applies to contracts for which a portion of the contract relates to a lease component.
To the extent the transaction price includes variable consideration, such as future payments based on consumable usage over time, we apply judgment to determine if the variable consideration should be constrained. As the variable consideration is highly susceptible to factors outside of the Company’s influence, and the potential values contain a broad range of possible outcomes given all potential amounts of consumption that could occur, it is likely that a significant revenue reversal would occur should the variable consideration be estimated at an amount greater than the minimum stated amount until such a time as the uncertainty is resolved.
We generate revenue within our OVP segment through contract manufacturing agreements with customers. The timing of revenue recognition of our customer contracts are generally recognized upon shipment or acceptance by our customer, under the same guidelines noted above for other outright product sales. Heska assessed the over-time criteria within ASC 606 and concluded that while products within this segment have no alternative use to Heska, as Heska is contractually prohibited to redirect the product to other customers, Heska does not have right to payment for performance to date. Therefore, point in time revenue recognition has been determined to be appropriate.
Revenue generated from licensing arrangements is recognized based on the underlying terms of the contract.
Recording revenue from the sale of products involves the use of estimates and management's judgment. We must make a determination at the time of sale whether the customer has the ability and intent to make payments in accordance with arrangements. While we do utilize past payment history and, to the extent available for new customers, public credit information in making our assessment, the determination of whether collectability is reasonably assured is ultimately a judgment that must be made by management. For contracts with multiple performance obligations, we exercise judgment in allocating the transaction price for each performance obligation based on an estimated standalone selling price for each distinct product or service. We must also make estimates regarding our future obligations relating to returns, rebates, allowances and similar other programs. We do not generally allow return of products or instruments. Distributor rebates are recorded as a reduction to revenue.
Refer to Note 2 for additional disclosures required by ASC 606.
Prior to the adoption of ASC 606 on January 1, 2018, the Company recognized revenue in accordance with Topic 605, Revenue Recognition. Our policy was to recognize revenue when the applicable revenue recognition criteria were met, which generally included the following: persuasive evidence of an arrangement exists; delivery has occurred or services rendered; price is fixed or determinable; and collectability is
-65-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
reasonably assured. The adoption of the new revenue standard did not materially change our recognition from ASC 605 (as disclosed under Adoption of New Accounting Pronouncements).
Stock-based Compensation
Stock-based compensation expense is measured at the grant date based upon the estimated fair value of the portion of the award that is ultimately expected to vest and is recognized as expense over the applicable vesting period of the award generally using the straight-line method.
Advertising Costs
Advertising costs are expensed as incurred and are included in sales and marketing expenses. Advertising expenses were $0.3 million for the year ended December 31, 2019 and $0.2 million for each of the years ended December 31, 2018 and 2017.
Income Taxes
The Company records a current provision for income taxes based on estimated amounts payable or refundable on tax returns filed or to be filed each year. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates, in each tax jurisdiction, expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date. The overall change in deferred tax assets and liabilities for the period measures the deferred tax expense or benefit for the period. Deferred tax assets are reduced by a valuation allowance based on a judgmental assessment of available evidence if the Company is unable to conclude that it is more likely than not that some or all of the deferred tax assets will be realized.
Earnings Per Share
Basic earnings per share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued.
Foreign Currency Translation
The functional currency of certain foreign subsidiaries is the local currency. Accordingly, assets and liabilities of these subsidiaries are translated using the exchange rate in effect at the balance sheet date. Revenue and expense accounts and cash flows are translated using an average of exchange rates in effect during the period. Cumulative translation gains and losses are shown in the Consolidated Balance Sheets as a separate component of stockholders' equity. Exchange gains and losses arising from transactions denominated in foreign currencies (i.e., transaction gains and losses) are recognized as a component of other income (expense) in current operations, as are exchange gains and losses on intercompany transactions expected to be settled in the near term.
-66-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Warranty Costs
The Company generally provides for the estimated cost of hardware and software warranties in the period the related revenue is recognized. The Company assesses the adequacy of its accrued warranty liabilities and adjusts the amounts as necessary based on actual experience and changes in future estimates. Should product failure rates differ from our estimates, actual costs could vary significantly from our expectations. Extended warranties are sold to our customers and revenue is recognized over the term of the warranty agreement, as expected costs are incurred.
Adoption of New Accounting Pronouncements
Effective January 1, 2019, we adopted Accounting Standard Update ("ASU") 2018-07, Compensation – Stock Compensation (Topic 718), Improvements to Non-employee Share-Based Payment Accounting. This ASU is intended to simplify aspects of share-based compensation issued to non-employees by making the guidance consistent with accounting for employee share-based compensation. Guidance related to the stock compensation granted to employees is followed for non-employees, including the measurement date, valuation approach and performance conditions. The expense is recognized in the same period as though cash were paid for the good or service, ratably over the service period. The adoption of this ASU did not have an impact on our consolidated financial statements but did have a minimal impact on our related disclosures.
Effective January 1, 2019, we adopted ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The ASU permits companies to elect a reclassification of the disproportionate tax effects in accumulated other comprehensive income ("AOCI") caused by the 2017 Tax Act to retained earnings. As of December 31, 2019, the Company does not have any disproportionate income tax effects in AOCI to reclassify. However, if the Company did have disproportionate income tax effects in AOCI in the future, it would reclassify them to retained earnings.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which supersedes ASC 840, Leases. This update requires lessees to recognize a right-of-use (“ROU”) asset and a lease liability for all leases, including operating leases, with terms greater than 12 months on its balance sheet. The update also expands the required quantitative and qualitative disclosures by lessees and lessors about the amount, timing and uncertainty of cash flows arising from leases. The accounting for lessors does not fundamentally change except for changes to conform and align guidance to the lessee guidance as well as to the new revenue recognition guidance in ASU 2014-09, Revenue from Contracts with Customers (Topic 606). Subsequent to the issuance of Topic 842, the FASB clarified the guidance through several ASUs; hereinafter the collection of lease guidance is referred to as “ASC 842”.
The Company adopted ASC 842 on January 1, 2019, using the modified retrospective approach for all lease arrangements at the beginning of the period of adoption. Results for reporting periods beginning January 1, 2019 are presented under ASC 842, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historic accounting under ASC 840, Leases. For leases that commenced before the effective date of ASC 842, the Company elected the permitted practical expedients to not reassess the following: (i) whether any expired or existing contracts contain leases; (ii) the lease classification for any expired or existing leases; and (iii) initial direct costs for any existing leases. The Company also elected to exclude leases with a term of 12 months or less from the recognized ROU assets and lease liabilities.
Adoption of the standard did not have a material net impact in our Consolidated Balance Sheets, Consolidated Statements of Income or Consolidated Statements of Cash Flows. The most significant impact was the recognition of ROU assets and lease liabilities for the operating leases, of which we are the lessee. As a result of the cumulative impact of adopting ASC 842, the Company recorded operating lease ROU assets of $6.5
-67-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
million and operating lease liabilities of $6.9 million as of January 1, 2019, primarily related to building, vehicle, and office equipment leases, based on the present value of the future lease payments on the date of adoption. As a lessor, accounting for our subscription agreements remains substantially unchanged. Refer to Note 6 for additional disclosures required by ASC 842.
The Company determines if an arrangement is a lease at inception based on whether control of an identified asset is transferred. For leases where the Company is the lessee, ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent an obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. As most of the Company’s leases do not provide an implicit interest rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The lease terms used to calculate the ROU asset and related lease liability include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for operating leases is recognized on a straight-line basis over the lease term as an operating expense while the expense for finance leases is recognized as amortization expense and interest expense. The Company has lease agreements which require payments for lease and non-lease components and has elected to account for these as a single lease component for our building and office equipment leases, but as separate components for our vehicle leases.
Our revenue under subscription agreements relates to both operating-type lease (“OTL”) arrangements and sales-type lease (“STL”) arrangements. Determination of an OTL or STL is primarily a result of the length of the contract as compared to the estimated useful life of the instrument, among other factors. A STL results in earlier recognition of instrument revenue. The cost of the customer-leased instruments is removed from inventory and recognized in the Consolidated Statements of Income. There is no residual value taken into consideration as it does not meet our capitalization requirements. Instrument lease revenue for OTL agreements is recognized on a straight-line basis over the life of the lease and included with the predominant non-lease components in consumable revenue. The costs of customer-leased instruments are recorded within property and equipment in the accompanying Consolidated Balance Sheets and depreciated over the instrument’s estimated useful life. The depreciation expense is reflected in cost of revenue in the accompanying Consolidated Statements of Income. The OTLs and STLs are not cancellable until after an initial term and include an option to renew.
For lease arrangements with lease and non-lease components where the Company is the lessor, the Company allocates the total contract consideration to the lease and non-lease components on a relative standalone selling price basis using the Company’s best estimate of the standalone selling price of each distinct product or service in the contract. The primary method used to estimate standalone selling price is the price observed in standalone sales to customers of a prior period. Changes in these values can impact the amount of consideration allocated to each component of the contract. When prices in standalone sales are not available, we may use a cost-plus margin approach. Allocation of the transaction price is determined at the inception of the lease arrangement. The Company’s leases consist of leases with fixed and variable lease payments. For those leases with variable lease payments, the variable lease payment is typically based upon purchase of consumables used with the leased instruments and included in consumable revenue.
Effective January 1, 2018, we adopted FASB ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, which provides clarification on accounting for modifications in share-based payment awards. The adoption of this guidance did not have an impact on our consolidated financial statements or related disclosures as there were no modifications to our share-based payment awards during 2018.
In March 2018, we adopted FASB ASU 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118, which updates the income tax accounting to reflect the
-68-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEC's interpretive guidance released on December 22, 2017, when the 2017 Tax Act was signed into law. See Item 8, Note 5. Income Taxes, for the impact of adoption to our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers and has subsequently issued several supplemental and/or clarifying ASUs (collectively "ASC 606"). ASC 606 prescribes a single common revenue standard that replaces most existing GAAP revenue recognition guidance. ASC 606 outlines a five-step model, under which Heska recognized revenue as performance obligations within customer contracts are satisfied. ASC 606 is intended to provide more consistent interpretation and application of the principles outlined in the standard across filers in multiple industries and within the same industries compared to current practices, which should improve comparability. Along with the issuance of ASC 606, additional cost guidance was issued and codified under ASC 340-40 that outlines the requirements for capitalizing incremental costs of obtaining a contract and costs to fulfill a contract that meet certain capitalization criteria.
On January 1, 2018, we adopted ASC 606 using the modified retrospective method for all customer contracts not yet completed as of the adoption date. Results for reporting periods beginning January 1, 2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with the Company's historic accounting under Topic 605, Revenue Recognition.
We recorded an increase to beginning retained earnings of $2.6 million as of January 1, 2018 due to the cumulative impact of adopting ASC 606. The impact to beginning retained earnings was primarily driven by the capitalization of certain costs to obtain our customer contracts, which were primarily sales-related commissions. The adoption of ASC 606 did not have a significant impact on our Consolidated Financial Statements as of and for the twelve months ended December 31, 2019 and 2018. As a result, comparisons of revenues and operating profit performance between periods are not affected by the adoption of this ASU.
Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), which requires that financial assets measured at amortized cost be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset to present the net carrying value at the amount expected to be collected. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is based upon historical experience, current conditions and reasonable and supportable forecasts that affect the collectability of the reported amount. Subsequent to the issuance of ASU 2016-13, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, in November 2018. This ASU clarifies that receivables from operating leases are accounted for using the lease guidance and not as financial instruments. In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which further clarifies and improves guidance related to accounting for credit losses. In May 2019, the FASB issued ASU 2019-05, Financial Instruments - Credit Losses (Topic 326). This ASU provides relief to certain entities adopting ASU 2016-13. The amendment provides entities with an option to irrevocably elect the fair value option for certain financial assets. These amendments are effective for fiscal years beginning after December 15, 2019 and interim periods within those annual periods. We evaluated the impact of the standard on our consolidated financial statements and do not expect the standard to have a material impact on our consolidated financial statements and disclosures, accounting processes, and internal controls. We expect to implement the standard with a cumulative-effect adjustment in retained earnings effective as of the beginning of the period of adoption.
-69-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which is intended to simplify various aspects related to the accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740, and also clarifies and amends existing guidance to improve consistent application. This guidance will be effective for interim and annual periods beginning after December 15, 2020, and early adoption is permitted. We are currently evaluating the impact of this update on our consolidated financial statements.
2. REVENUE
We separate our goods and services among two reportable segments, Core companion animal ("CCA") and Other vaccines and pharmaceuticals ("OVP"). The CCA segment consists of revenue generated from the following:
|
•
|
Point of Care laboratory products including instruments, consumables and services;
|
|
•
|
Point of Care imaging products including instruments, software and services;
|
|
•
|
Single use pharmaceuticals, vaccines and diagnostic tests primarily related to companion animals; and
|
|
•
|
Other vaccines and pharmaceuticals.
|
The OVP segment consists of revenue generated from the following:
|
•
|
Contract manufacturing agreements; and
|
|
•
|
Other license, research and development revenue.
|
The following table summarizes our CCA revenue (in thousands):
|
|
Year Ended December 31,
|
||||||||||
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
Point of Care laboratory revenue:
|
$
|
67,132
|
|
|
$
|
57,375
|
|
|
$
|
54,855
|
|
|
Consumables
|
53,590
|
|
|
44,771
|
|
|
39,161
|
|
|||
|
Sales-type leases
|
6,890
|
|
|
5,888
|
|
|
7,382
|
|
|||
|
Outright instrument sales
|
5,247
|
|
|
4,922
|
|
|
6,391
|
|
|||
|
Other
|
1,405
|
|
|
1,794
|
|
|
1,921
|
|
|||
|
|
|
|
|
|
|
||||||
|
Point of Care imaging revenue:
|
25,652
|
|
|
22,832
|
|
|
21,907
|
|
|||
|
Outright instrument sales
|
22,594
|
|
|
19,746
|
|
|
19,187
|
|
|||
|
Other
|
3,058
|
|
|
3,086
|
|
|
2,720
|
|
|||
|
|
|
|
|
|
|
||||||
|
Other CCA revenue:
|
13,786
|
|
|
28,717
|
|
|
28,429
|
|
|||
|
Other pharmaceuticals, vaccines and diagnostic tests
|
13,495
|
|
|
28,265
|
|
|
28,008
|
|
|||
|
Research and development, license and royalty revenue
|
291
|
|
|
452
|
|
|
421
|
|
|||
|
|
|
|
|
|
|
||||||
|
Total CCA revenue
|
$
|
106,570
|
|
|
$
|
108,924
|
|
|
$
|
105,191
|
|
-70-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes our OVP revenue (in thousands):
|
|
Year Ended December 31,
|
||||||||||
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
Contract manufacturing
|
$
|
15,374
|
|
|
$
|
17,508
|
|
|
$
|
23,490
|
|
|
License, research and development
|
717
|
|
|
1,014
|
|
|
660
|
|
|||
|
Total OVP revenue
|
$
|
16,091
|
|
|
$
|
18,522
|
|
|
$
|
24,150
|
|
Remaining Performance Obligations
Remaining performance obligations related to ASC 606 represent the aggregate transaction price allocated to performance obligations with an original contract term greater than one year which are fully or partially unsatisfied at the end of the period. Remaining performance obligations include noncancelable purchase orders, the non-lease portion of minimum purchase commitments under long-term supply arrangements, extended warranty, service and other long-term contracts. Remaining performance obligations do not include revenue from contracts with customers with an original term of one year or less, revenue from long-term supply arrangements with no minimum purchase requirements, revenue expected from purchases made in excess of the minimum purchase requirements, or revenue from instruments leased to customers. While the remaining performance obligation disclosure is similar in concept to backlog, the definition of remaining performance obligations excludes leases and contracts that provide the customer with the right to cancel or terminate for convenience with no substantial penalty, even if historical experience indicates the likelihood of cancellation or termination is remote. Additionally, the Company has elected to exclude contracts with customers with an original term of one year or less from remaining performance obligations.
As of December 31, 2019, the aggregate amount of the transaction price allocated to remaining minimum performance obligations was approximately $117.8 million. As of December 31, 2019, the Company expects to recognize revenue as follows (in thousands):
|
Year Ending December 31,
|
Revenue
|
|
|
|
2020
|
$
|
26,939
|
|
|
2021
|
23,808
|
|
|
|
2022
|
20,724
|
|
|
|
2023
|
17,815
|
|
|
|
2024
|
13,626
|
|
|
|
Thereafter
|
14,897
|
|
|
|
|
$
|
117,809
|
|
Contract Balances
The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets) and deferred revenue, and customer deposits and billings in excess of revenue recognized (contract liabilities) on the Consolidated Balance Sheets. In addition, the Company defers certain costs incurred to obtain contracts (contract costs).
-71-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Contract Receivables
Certain unbilled receivable balances related to long-term contracts for which we provide a free term to the customer are recorded in "Other current assets" and "Other non-current assets" on the accompanying Consolidated Balance Sheets. We have no further performance obligations related to these receivable balances and the collection of these balances occurs over the term of the underlying contract. The balances as of December 31, 2019 were $1.1 million and $3.7 million for current and non-current assets, respectively, shown net of related unearned interest. The balances as of December 31, 2018 were $0.9 million and $3.3 million for current and non-current assets, respectively, shown net of related unearned interest.
Contract Liabilities
The Company receives cash payments from customers for licensing fees or other arrangements that extend for a specified term. These contract liabilities are classified as either current or long-term in the Consolidated Balance Sheets based on the timing of when the Company expects to recognize revenue. As of December 31, 2019 and 2018, contract liabilities were $8.7 million and $9.6 million, respectively, and are included within "Current portion of deferred revenue, and other" and "Deferred revenue, net of current portion" in the accompanying Consolidated Balance Sheets. The decrease in the contract liability balance during the year ended December 31, 2019 is $3.1 million of revenue recognized during the period, offset by $2.2 million of additional deferred sales. The decrease in the contract liability balance during the year ended December 31, 2018 is $4.1 million of revenue recognized during the period, offset by $1.4 million of additional deferred sales.
Contract Costs
The Company capitalizes certain direct incremental costs incurred to obtain customer contracts, typically sales-related commissions, where the recognition period for the related revenue is greater than one year. Contract costs are classified as current or non-current, and are included in "Other current assets" and "Other non-current assets" in the Consolidated Balance Sheets based on the timing of when the Company expects to recognize the expense. Contract costs are generally amortized into selling and marketing expense with a certain percentage recognized immediately based upon placement of the instrument with the remainder recognized on a straight-line basis (which is consistent with the transfer of control for the related goods or services) over the average term of the underlying contracts, approximately 6 years. Management assesses these costs for impairment at least quarterly on a portfolio basis and as “triggering” events occur that indicate it is more-likely-than-not that an impairment exists. The balance of contract costs as of December 31, 2019 and December 31, 2018 was $2.7 million and $2.5 million, respectively. Amortization expense for the year ended December 31, 2019 was approximately $0.9 million, offset by approximately $1.1 million of additional contract costs capitalized. Amortization expense for the year ended December 31, 2018 was approximately $1.0 million, offset by approximately $1.0 million of additional contract costs capitalized.
Contract liabilities are reported on the accompanying Consolidated Balance Sheets on a contract-by-contract basis whereas contract costs are calculated and reported on a portfolio basis.
3. ACQUISITION AND RELATED PARTY ITEMS
CVM
On December 5, 2019, Heska entered into a definitive agreement to purchase 100% of the outstanding shares of CVM Diagnostico Veternario S.L. and CVM Ecografia S.L. (“CVM”, collectively), primarily to expand international operations in Europe. CVM is headquartered in Tudela, outside of Madrid, Spain. CVM mainly operates in Spain. The terms of the agreement transferred administrative control of CVM upon signing, and
-72-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
the transfer of the purchase price of approximately $14.4 million and shares occurred subsequently in January 2020. The purchase price exceeded the fair value of the identifiable net assets and, accordingly, $8.8 million was allocated to goodwill based on the preliminary purchase price allocation, all of which is tax deductible for U.S. federal income tax purposes.
The preliminary fair values allocated to CVM's assets and liabilities as of the acquisition date, as well as the purchase price, are reflected in the table below (in thousands):
|
Purchase Price
|
December 5, 2019
|
||
|
Consideration payable to former owners
|
$
|
14,420
|
|
|
Total
|
$
|
14,420
|
|
|
|
|
||
|
Net Assets Acquired
|
|
||
|
Cash and cash equivalents
|
$
|
927
|
|
|
Accounts receivable
|
2,392
|
|
|
|
Inventories
|
1,494
|
|
|
|
Other current assets
|
10
|
|
|
|
Property and equipment
|
382
|
|
|
|
Other intangible assets
|
2,551
|
|
|
|
Other non-current assets
|
178
|
|
|
|
Accounts payable
|
(250
|
)
|
|
|
Current portion of deferred revenue, and other
|
(164
|
)
|
|
|
Deferred tax liability
|
(683
|
)
|
|
|
Other long-term borrowings
|
(1,109
|
)
|
|
|
Other liabilities
|
(157
|
)
|
|
|
Total fair value of net assets acquired
|
5,571
|
|
|
|
Goodwill
|
8,849
|
|
|
|
Total fair value of consideration transferred
|
$
|
14,420
|
|
The Company's preliminary estimates of fair values of the assets acquired and the liabilities assumed are based on the information that was available at the date of the acquisition, and the Company is continuing to evaluate the underlying inputs and assumptions used in its valuations. Accordingly, these preliminary estimates are subject to change during the measurement period, which is up to one year from the date of the acquisition.
Intangible assets acquired, amortization method and estimated useful life as of December 5, 2019, was as follows (dollars in thousands):
|
|
Useful Life
|
|
Amortization Method
|
|
Fair Value
|
|
Customer relationships
|
6 years
|
|
Straight-line
|
|
$2,440
|
|
Trade name
|
4 years
|
|
Straight-line
|
|
$111
|
The Company incurred acquisition related costs of approximately $0.1 million for the year ended December 31, 2019, which are included within general and administrative expenses on our Consolidated Statements of Income.
-73-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CVM generated net revenue of $0.8 million and net income of $0.1 million, for the period from December 6, 2019 to December 31, 2019.
Unaudited Pro Forma Financial Information
The following table presents unaudited supplemental pro forma financial information as if the CVM acquisition had occurred on January 1, 2018 (in thousands):
|
|
Year Ended December 31,
|
||||||
|
|
2019
|
|
2018
|
||||
|
Total revenue, net
|
$
|
130,434
|
|
|
$
|
135,344
|
|
|
Net (loss) income attributable to Heska Corporation
|
(788
|
)
|
|
5,970
|
|
||
The pro forma financial information presented above has been prepared by combining our historical results and the historical results of CVM and further reflects the effect of purchase accounting adjustments. The unaudited pro forma results are presented for informational purposes only and are not necessarily indicative of what actual results of operations would have been if the acquisition had occurred as the beginning of the period presented, nor are they indicative of future results of operations.
Optomed
On February 22, 2019, Heska acquired 70% of the equity of Optomed, a French-based endoscopy company, in exchange for approximately $0.2 million in cash and the assumption of approximately $0.4 million in debt. As part of the purchase, Heska entered into put and call options on the remaining 30% minority interest. The written put options can be exercised based on the achievement of certain financial conditions over a specified period of time for a fixed amount. The options are not currently exercisable at the acquisition date or the reporting date. The estimated value of the non-controlling interest is inclusive of the probability weighted outcome of the options described herein. As of December 31, 2019, the purchase price allocation is final. As part of the purchase agreement, Heska also committed to purchase from the minority interest holder real estate in the amount of $1.2 million, which was paid in full as of December 31, 2019.
Cuattro Veterinary Acquisitions
In February 2013, the Company acquired a majority interest in Cuattro Veterinary USA, LLC, which was owned by Kevin S. Wilson, the CEO and President of the Company, among other members. The subsidiary was subsequently renamed Heska Imaging US, LLC ("US Imaging"). The remaining minority position in US Imaging was subject to purchase by Heska under a performance-based put option which was exercised in March 2017. In May 2017, we purchased the remaining minority interest position in US Imaging.
In May 2016, the Company closed a transaction to acquire Cuattro Veterinary, LLC ("International Imaging"), which was owned by Kevin S. Wilson, among other members. International Imaging is a provider to international markets of digital radiography technologies for veterinarians. As a leading provider of advanced veterinary diagnostic and specialty products, we made the acquisition in an effort to combine International Imaging's global reach with our domestic success in the imaging and laboratory markets in the United States.
In June 2017, the Company consolidated its assets and liabilities in the US Imaging and International Imaging companies into Heska Imaging, LLC ("Heska Imaging"). Cuattro, LLC ("Cuattro") is owned by Kevin S. Wilson, in addition to Mrs. Wilson and trusts for the benefit of Mr. and Mrs. Wilson's children and family. Steven M. Asakowicz and Rodney A. Lippincott, members of Cuattro Veterinary USA, LLC and Cuattro
-74-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
International prior to the acquisitions, and as of December 31, 2019, serve as Executive Vice President, Companion Animal Health Sales for the Company.
Purchase Agreement for Certain Assets
On December 21, 2018, the Company closed a transaction (the "Asset Acquisition") to acquire certain assets from Cuattro, LLC ("Cuattro"), all related to the CCA segment. Cuattro is owned by Kevin S. Wilson, the CEO and President of Heska Corporation. Pursuant to the Asset Acquisition, dated November 26, 2018, the Company issued 54,763 shares of the Company's common stock, $0.01 par value per share (the "Common Stock"), to Cuattro on the Closing Date, at an aggregate value equal to approximately $5.4 million based on the adjusted closing price per share of the Common Stock as reported on the Nasdaq Stock Market on the Asset Acquisition agreement date. These shares were issued to Cuattro in a private placement in reliance upon an exemption from the registration requirements of the Securities Act pursuant to Section 4(a)(2) thereof and the safe harbor provided by Rule 506 of Regulation D promulgated thereunder. In addition to the Common Stock, the Company paid cash in the amount of $2.8 million to Cuattro as part of the transaction. The total purchase price was determined based on a valuation report from an independent third party. Part of the Asset Acquisition was an agreement to terminate the supply and license agreement that Heska had been operating under since the acquisition of Cuattro Veterinary USA, LLC.
The Company evaluated the acquisition of the purchased assets under ASC 805, Business Combinations and ASU 2017-01, Business Combinations (Topic 805) and concluded that as substantially all of the fair value of the gross assets acquired is concentrated in an identifiable group of similar assets, the transaction did not meet the requirements to be accounted for as a business combination and therefore was accounted for as an asset acquisition. Accordingly, the $8.2 million purchase price of the purchased assets was allocated entirely to an identifiable intangible asset amortizing on a straight-line basis over a 10-year useful life. In addition to the software assets acquired, Cuattro is obligated, without further compensation, to assist the Company with the implementation of third-party image hosting platform and necessary data migration.
Related Party Activities
Cuattro, LLC charged Heska Imaging $6.0 thousand, $4.6 million and $17.7 million during 2019, 2018 and 2017, respectively, primarily related to digital imaging products, pursuant to an underlying supply contract that contains minimum purchase obligations, software and services as well as other operating expenses. The Company charged Cuattro, LLC $0, $3.0 thousand and $0.1 million in the years ended December 31, 2019, 2018 and 2017, respectively, for facility usage and other services.
The Company had no receivables from Cuattro, LLC as of December 31, 2019 and 2018. Heska Imaging owed Cuattro $0 and $0.2 million as of December 31, 2019 and 2018, respectively, which is included in "Due to - related parties" on the Company's Consolidated Balance Sheets.
Heska Corporation charged U.S. Imaging $2.9 million from January 1, 2017 to May 31, 2017, prior to the acquisition of the minority interest.
-75-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. INVESTMENTS IN UNCONSOLIDATED AFFILIATES
The carrying values of investments in unconsolidated affiliates, categorized by type of investment, is as follows (in thousands):
|
|
December 31, 2019
|
|
December 31, 2018
|
||||
|
Equity method investment
|
$
|
4,406
|
|
|
$
|
5,000
|
|
|
Non-marketable equity security investment
|
3,018
|
|
|
3,018
|
|
||
|
|
$
|
7,424
|
|
|
$
|
8,018
|
|
Equity Method Investment
On September 24, 2018, the Company invested $5.1 million, including costs, in exchange for a 28.7% interest of a business as part of our product development strategy. In connection with the investment, the Company entered into a 15-year Manufacturing Supply Agreement, which grants the Company global exclusivity to specified products to be delivered under the agreement for a 15-year period that begins upon the Company's receipt and acceptance of an initial order under the agreement. The Company accounts for this investment using the equity method of accounting. Under the equity method, the carrying value of the investment is adjusted for the Company's proportionate share of the investee's reported earnings or losses with the corresponding share of earnings or losses reported as Equity in losses of unconsolidated affiliates, listed below Net income before equity in losses of unconsolidated affiliates within the Consolidated Statements of Income.
Non-Marketable Equity Security Investment
On August 8, 2018, the Company invested $3.0 million, including costs, in MBio Diagnostics, Inc. ("MBio"), in exchange for 1,714,285 shares of Series B-3 preferred stock, representing a 6.9% interest in MBio. The Company's investment in MBio is a non-marketable equity security, recorded using the measurement alternative of cost minus impairment, if any, plus or minus changes resulting from qualifying observable price changes.
As part of the agreement, the Company entered into a Supply and License Agreement with MBio, which provides that MBio produce and commercialize products that will enhance the Company's diagnostic portfolio. As part of this agreement, the Company made upfront payment to MBio of $1.0 million related to a worldwide exclusive license agreement over a 20-year period, recorded in both short and long-term other assets. In addition, the agreement provides for an additional contingent payment from Heska to MBio of $10.0 million, relating to the successful achievement of sales milestones. This potential future milestone payment has not yet been accrued as it is not deemed by the Company to be probable at this time.
Both parties in this arrangement are active participants and are exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. The parties are actively working on developing and testing the product as well as funding the research and development. Heska classifies the amounts paid for MBio's research and development work within the CCA segment research and development operating segments. Expense is recognized ratably when incurred and in accordance with the development plan.
The Company evaluated both its equity method investment and non-marketable equity security investment for impairment as of December 31, 2019, and determined that no indications of impairment existed.
-76-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
5. INCOME TAXES
Income Taxes
As of December 31, 2019, the Company had net operating loss carryforwards ("NOL"), of approximately $47.0 million, a foreign tax credit of $64 thousand and a domestic research and development tax credit carryforward of approximately $1.0 million. Our federal NOL is expected to expire as follows if unused: $41.0 million in 2020 through 2022, $5.5 million in 2024 through 2025 and $0.5 million in 2027 and later.
The Company is subject to income taxes in the U.S. federal jurisdiction, and various foreign, state and local jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. Although the U.S. and many states generally have statutes of limitations ranging from 3 to 5 years, those statutes could be extended due to the Company’s net operating loss and tax credit carryforward positions in several of the Company's tax jurisdictions. In the U.S., the tax years 2016 - 2018 remain open to examination by the Internal Revenue Service.
Cash paid for income taxes for the years ended December 31, 2019, 2018 and 2017 was $128 thousand, $36 thousand and $213 thousand, respectively.
The components of income before income taxes were as follows (in thousands):
-77-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Temporary differences that give rise to the components of net deferred tax assets are as follows (in thousands):
|
|
|
December 31,
|
||||||
|
|
|
2019
|
|
2018
|
||||
|
Inventory
|
|
$
|
2,005
|
|
|
$
|
1,249
|
|
|
Accrued compensation
|
|
122
|
|
|
110
|
|
||
|
Stock options
|
|
1,858
|
|
|
1,281
|
|
||
|
Research and development
|
|
990
|
|
|
476
|
|
||
|
Legal settlement
|
|
—
|
|
|
1,678
|
|
||
|
Research and development expense
|
|
1,417
|
|
|
—
|
|
||
|
Deferred revenue
|
|
2,052
|
|
|
3,305
|
|
||
|
Property and equipment
|
|
3,469
|
|
|
3,065
|
|
||
|
Net operating loss carryforwards
|
|
11,676
|
|
|
17,088
|
|
||
|
Foreign tax credit carryforward
|
|
64
|
|
|
38
|
|
||
|
Sales-type leases
|
|
(1,968
|
)
|
|
(3,936
|
)
|
||
|
Convertible debt equity component
|
|
(9,421
|
)
|
|
—
|
|
||
|
Foreign intangible
|
|
(691
|
)
|
|
—
|
|
||
|
Other
|
|
(179
|
)
|
|
—
|
|
||
|
|
|
11,394
|
|
|
24,354
|
|
||
|
Valuation allowance
|
|
(5,656
|
)
|
|
(10,233
|
)
|
||
|
Total net deferred tax assets
|
|
$
|
5,738
|
|
|
$
|
14,121
|
|
The components of the income tax (benefit) expense are as follows (in thousands):
|
|
|
Year Ended December 31,
|
||||||||||
|
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
Current income tax expense:
|
|
|
|
|
|
|
|
|
|
|||
|
Federal
|
|
$
|
—
|
|
|
$
|
(115
|
)
|
|
$
|
—
|
|
|
State
|
|
189
|
|
|
192
|
|
|
6
|
|
|||
|
Foreign
|
|
170
|
|
|
63
|
|
|
43
|
|
|||
|
Total current expense
|
|
$
|
359
|
|
|
$
|
140
|
|
|
$
|
49
|
|
|
Deferred income tax (benefit) expense:
|
|
|
|
|
|
|
|
|
|
|||
|
Federal
|
|
$
|
(1,610
|
)
|
|
$
|
(1,877
|
)
|
|
$
|
9,736
|
|
|
State
|
|
(307
|
)
|
|
(378
|
)
|
|
(872
|
)
|
|||
|
Foreign
|
|
112
|
|
|
—
|
|
|
—
|
|
|||
|
Total deferred (benefit) expense
|
|
(1,805
|
)
|
|
(2,255
|
)
|
|
8,864
|
|
|||
|
Total income tax (benefit) expense
|
|
$
|
(1,446
|
)
|
|
$
|
(2,115
|
)
|
|
$
|
8,913
|
|
-78-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company's income tax (benefit) expense relating to income (loss) for the periods presented differs from the amounts that would result from applying the federal statutory rate to that income (loss) as follows:
|
|
Year Ended December 31,
|
|||||||
|
|
2019
|
|
2018
|
|
2017
|
|||
|
Statutory federal tax rate
|
21
|
%
|
|
21
|
%
|
|
34
|
%
|
|
State income taxes, net of federal benefit
|
9
|
%
|
|
(8
|
)%
|
|
(5
|
)%
|
|
Non-controlling interest in Heska Imaging US, LLC
|
—
|
%
|
|
—
|
%
|
|
1
|
%
|
|
Non-controlling interest in Optomed
|
(2
|
)%
|
|
—
|
%
|
|
—
|
%
|
|
Non-temporary stock option benefit
|
48
|
%
|
|
(50
|
)%
|
|
(30
|
)%
|
|
Meals and entertainment permanent difference
|
(2
|
)%
|
|
1
|
%
|
|
—
|
%
|
|
GILTI permanent difference
|
2
|
%
|
|
1
|
%
|
|
—
|
%
|
|
Other permanent differences
|
(1
|
)%
|
|
1
|
%
|
|
1
|
%
|
|
Foreign tax rate differences
|
6
|
%
|
|
—
|
%
|
|
—
|
%
|
|
Change in tax rate
|
(6
|
)%
|
|
—
|
%
|
|
32
|
%
|
|
Change in valuation allowance
|
(17
|
)%
|
|
—
|
%
|
|
16
|
%
|
|
Other deferred differences
|
(9
|
)%
|
|
(21
|
)%
|
|
—
|
%
|
|
Transaction costs
|
(6
|
)%
|
|
—
|
%
|
|
—
|
%
|
|
Executive compensation limit
|
(7
|
)%
|
|
—
|
%
|
|
—
|
%
|
|
Research & development credit
|
20
|
%
|
|
—
|
%
|
|
—
|
%
|
|
Other
|
—
|
%
|
|
(1
|
)%
|
|
—
|
%
|
|
Effective income tax rate
|
56
|
%
|
|
(56
|
)%
|
|
49
|
%
|
In 2019, we had total income tax benefit of $1.4 million, including $1.9 million in domestic deferred income tax benefit and $0.1 million in foreign deferred tax expense, and $0.4 million in current income tax expense. In 2018, we had total income tax benefit of $2.1 million, including approximately $2.3 million in domestic deferred income tax benefit, a non-cash benefit, and approximately $0.1 million in current income tax expense. In 2017, we had total income tax expense of $8.9 million, including $8.9 million in domestic deferred income tax expense, a non-cash expense, and $0.05 million in current income tax expense. Income tax benefit decreased in 2019 from 2018 due to executive compensation limitations and lower excess tax benefits related to stock-based compensation deductions. Income tax expense decreased in 2018 from 2017 from the recognition of $1.9 million in tax benefits related to stock-based compensation deductions.
ASC 740 provides detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in the financial statements. Tax positions must meet a "more-likely-than-not" recognition threshold before a benefit is recognized in the financial statements. As of December 31, 2019, the Company has not recorded a liability for uncertain tax positions. The Company would recognize interest and penalties related to uncertain tax positions in income tax (benefit) expense. No interest and penalties related to uncertain tax positions were accrued at December 31, 2019.
6. LEASES
Lessee Accounting
The Company leases buildings, office equipment, and vehicles. The Company’s finance leases were not material as of December 31, 2019 and for the twelve-month period then ended. ROU assets arising from finance leases are included in Property and equipment, net in the accompanying Consolidated Balance Sheets.
-79-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The current portion of the finance lease liabilities are included in Current portion of deferred revenue, and other and the non-current portion of the finance lease liabilities are included in Other liabilities in the accompanying Consolidated Balance Sheets.
For the twelve months ended December 31, 2019, operating lease expense was approximately $2.4 million, including immaterial variable lease costs. The Company had building and other rent expense of $1.9 million and $2.0 million for the years ended December 31, 2018 and 2017, respectively, under ASC 840, Leases.
Supplemental cash flow information related to the Company's operating leases for the twelve months ended December 31, 2019 was as follows (in thousands):
|
Cash paid for amounts included in the measurement of operating lease liabilities
|
$
|
1,800
|
|
|
ROU assets obtained in exchange for operating lease obligations
|
604
|
|
|
The following table presents the weighted average remaining lease term and weighted average discount rate related to the Company's operating leases as of December 31, 2019:
|
Weighted average remaining lease term
|
3.8 years
|
|
|
Weighted average discount rate
|
4.44
|
%
|
The following table presents the maturity of the Company's operating lease liabilities as of December 31, 2019 (in thousands):
|
Year Ending December 31,
|
|
||
|
2020
|
$
|
1,792
|
|
|
2021
|
1,639
|
|
|
|
2022
|
1,413
|
|
|
|
2023
|
1,796
|
|
|
|
2024
|
30
|
|
|
|
Thereafter
|
57
|
|
|
|
Total operating lease payments
|
6,727
|
|
|
|
Less: imputed interest
|
569
|
|
|
|
Total operating lease liabilities
|
$
|
6,158
|
|
-80-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Lessor Accounting
In our CCA segment, primarily related to our Point of Care laboratory products, the Company enters into sales-type leases as part of our subscription agreements. The following table presents the maturity of the Company's undiscounted lease receivables as of December 31, 2019 (in thousands):
|
Year Ending December 31,
|
|
||
|
2020
|
$
|
3,856
|
|
|
2021
|
4,087
|
|
|
|
2022
|
3,758
|
|
|
|
2023
|
3,047
|
|
|
|
2024
|
2,118
|
|
|
|
Thereafter
|
1,297
|
|
|
|
|
$
|
18,163
|
|
-81-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing net income attributable to the Company by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that the numerator is increased to exclude charges that would not have been incurred, and the denominator is increased to include the number of additional common shares that would have been outstanding (using the if-converted and treasury stock methods), if securities containing potentially dilutive common shares (stock options and restricted stock awards but excluding options to purchase fractional shares resulting from the Company's December 2010 1-for-10 reverse stock split) had been converted to common shares, and if such assumed conversion is dilutive.
The following is a reconciliation of the weighted-average shares outstanding used in the calculation of basic and diluted earnings per share for the years ended December 31, 2019, 2018 and 2017 (in thousands, except per share data):
|
|
Years ended December 31,
|
||||||||||
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
Net (loss) income attributable to Heska Corporation
|
$
|
(1,465
|
)
|
|
$
|
5,850
|
|
|
$
|
9,953
|
|
|
|
|
|
|
|
|
||||||
|
Basic weighted-average common shares outstanding
|
7,446
|
|
|
7,220
|
|
|
7,026
|
|
|||
|
Assumed exercise of dilutive stock options and restricted shares
|
—
|
|
|
636
|
|
|
616
|
|
|||
|
Diluted weighted-average common shares outstanding
|
7,446
|
|
|
7,856
|
|
|
7,642
|
|
|||
|
|
|
|
|
|
|
||||||
|
Basic (loss) earnings per share attributable to Heska Corporation
|
$
|
(0.20
|
)
|
|
$
|
0.81
|
|
|
$
|
1.42
|
|
|
Diluted (loss) earnings per share attributable to Heska Corporation
|
$
|
(0.20
|
)
|
|
$
|
0.74
|
|
|
$
|
1.30
|
|
The following stock options and restricted awards were excluded from the computation of diluted earnings per share because they would have been anti-dilutive (in thousands):
|
|
Years ended December 31,
|
|||||||
|
|
2019
|
|
2018
|
|
2017
|
|||
|
Stock options and restricted shares
|
300
|
|
|
111
|
|
|
123
|
|
As more fully described in Note 16, our Notes are convertible under certain circumstances, as defined in the indenture, into a combination of cash and shares of our common stock. The Company intends to settle the principal value of the Notes in cash and issue shares of our common stock to settle the intrinsic value of the conversion feature. The Company will use the treasury stock method when calculating the potential dilutive effect of the conversion feature on earnings per share, if any. Potential dilution upon conversion of the Notes occurs when the market price per share of our common stock is greater than the conversion price of the Notes of $86.63. The average price of our common stock exceeded the conversion price of the Notes during the fourth quarter of 2019; therefore, under the net share settlement method, less than one thousand potential shares issuable under the Notes would be included in the calculation of diluted EPS for the year ended December 31, 2019. However, these shares were excluded from the computation of diluted EPS because the effect would have been anti-dilutive.
-82-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8. GOODWILL AND OTHER INTANGIBLES
The following summarizes the changes in goodwill during the years ended December 31, 2019 and 2018 (in thousands):
|
Carrying amount, December 31, 2017
|
$
|
26,687
|
|
|
Foreign currency adjustments
|
(8
|
)
|
|
|
Carrying amount, December 31, 2018
|
$
|
26,679
|
|
|
Goodwill attributable to acquisitions (subject to change)
|
9,396
|
|
|
|
Foreign currency adjustments
|
129
|
|
|
|
Carrying amount, December 31, 2019
|
$
|
36,204
|
|
Other intangibles assets, net consisted of the following as of December 31, 2019 and 2018 (in thousands):
|
|
2019
|
|
2018
|
||||||||||||||||||||
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Net Carrying Amount
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Net Carrying Amount
|
||||||||||||
|
Developed technology
|
$
|
8,200
|
|
|
$
|
(819
|
)
|
|
$
|
7,381
|
|
|
$
|
8,200
|
|
|
$
|
—
|
|
|
$
|
8,200
|
|
|
Customer relationships and other
|
6,317
|
|
|
(2,226
|
)
|
|
4,091
|
|
|
3,303
|
|
|
(1,739
|
)
|
|
1,564
|
|
||||||
|
Total intangible assets
|
$
|
14,517
|
|
|
$
|
(3,045
|
)
|
|
$
|
11,472
|
|
|
$
|
11,503
|
|
|
$
|
(1,739
|
)
|
|
$
|
9,764
|
|
Amortization expense relating to other intangibles is as follows (in thousands):
|
|
Years Ended December 31,
|
||||||||||
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
Amortization expense
|
$
|
1,278
|
|
|
$
|
388
|
|
|
$
|
388
|
|
Estimated amortization expense related to intangibles for each of the five years from 2020 through 2024 and thereafter is as follows (in thousands):
-83-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. PROPERTY AND EQUIPMENT
Property and equipment, net, consisted of the following (in thousands):
|
|
December 31,
|
||||||
|
|
2019
|
|
2018
|
||||
|
Land
|
$
|
694
|
|
|
$
|
377
|
|
|
Building
|
3,845
|
|
|
2,978
|
|
||
|
Machinery and equipment
|
28,777
|
|
|
33,087
|
|
||
|
Office furniture and equipment
|
1,345
|
|
|
1,687
|
|
||
|
Computer hardware and software
|
3,408
|
|
|
4,704
|
|
||
|
Leasehold and building improvements
|
10,558
|
|
|
9,953
|
|
||
|
Construction in progress
|
671
|
|
|
1,274
|
|
||
|
Property and equipment, gross
|
49,298
|
|
|
54,060
|
|
||
|
Less accumulated depreciation
|
(33,829
|
)
|
|
(38,079
|
)
|
||
|
Total property and equipment, net
|
$
|
15,469
|
|
|
$
|
15,981
|
|
The Company has subscription agreements whereby its instruments in inventory may be placed in a customer's location on a rental basis. The cost of these instruments is transferred to machinery and equipment and depreciated, typically over a five to seven-year period depending on the circumstance under which the instrument is placed with the customer. Our cost of equipment under operating leases at December 31, 2019 and 2018, respectively, was $8.1 million and $10.8 million, before accumulated depreciation of $4.6 million and $6.1 million.
Depreciation expense for property and equipment was $3.6 million, $4.2 million and $4.3 million for the years ended December 31, 2019, 2018 and 2017, respectively.
10. INVENTORIES, NET
Inventories, net, consisted of the following (in thousands):
|
|
December 31,
|
||||||
|
|
2019
|
|
2018
|
||||
|
Raw materials
|
$
|
15,320
|
|
|
$
|
15,000
|
|
|
Work in process
|
2,802
|
|
|
3,592
|
|
||
|
Finished goods
|
9,786
|
|
|
8,085
|
|
||
|
Allowance for excess or obsolete inventory
|
(1,307
|
)
|
|
(1,573
|
)
|
||
|
Total inventory, net
|
$
|
26,601
|
|
|
$
|
25,104
|
|
Inventories are measured on a first-in, first-out basis and stated at lower of cost or net realizable value.
-84-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
|
|
December 31,
|
||||||
|
|
2019
|
|
2018
|
||||
|
Accrued payroll and employee benefits
|
$
|
1,175
|
|
|
$
|
759
|
|
|
Accrued property taxes
|
681
|
|
|
632
|
|
||
|
Accrued settlement (see Note 14)
|
—
|
|
|
6,750
|
|
||
|
Accrued purchase orders
|
739
|
|
|
699
|
|
||
|
Other
|
3,750
|
|
|
1,302
|
|
||
|
Total accrued liabilities
|
$
|
6,345
|
|
|
$
|
10,142
|
|
Other accrued liabilities consist of items that are individually less than 5% of total current liabilities.
12. CAPITAL STOCK
Stock Plans
We have two stock option plans which authorize granting of stock options, restricted and stock purchase rights to our employees, officers, directors and consultants. In 1997, the board of directors adopted the 1997 Stock Incentive Plan (the "1997 Plan") and terminated two prior stock plans. All shares that remained available for grant under the terminated plans were incorporated into the 1997 Plan, including shares subsequently canceled under prior plans. In May 2012, the stockholders approved an amendment to the 1997 Plan allowing for an increase of 250,000 shares and an annual increase through 2016 based on the number of non-employee directors serving as of our Annual Meeting of Stockholders, subject to a maximum of 45,000 shares per year. In May 2016, the stockholders approved a further amendment to the 1997 Plan to authorize an additional 500,000 shares to be available for issuance thereunder. In May 2018, the stockholders approved a further amendment to the 1997 Plan to authorize an additional 250,000 shares to be available for issuance thereunder. In December 2018, the Company's Board of Directors amended the 1997 Plan and renamed it the "Stock Incentive Plan". In May 2003, the stockholders approved a new plan, the 2003 Equity Incentive Plan (the "2003 Plan"), which allows for the granting of stock options/restricted stock for up to 239,050 shares of the Company's common stock. The number of shares reserved for issuance under both plans as of December 31, 2019 was 85,850.
Stock Options
The stock options granted by the Board of Directors may be either incentive stock options ("ISOs") or non-qualified stock options ("NQs"). The exercise price for options under all of the plans may be no less than 100% of the fair value of the underlying common stock. Options granted will expire no later than the tenth anniversary subsequent to the date of grant or three months following termination of employment, except in cases of death or disability, in which case the options will remain exercisable for up to twelve months. Under the terms of the Stock Incentive Plan, in the event we are sold or merged, outstanding options will either be assumed by the surviving corporation or vest immediately.
There are four key inputs to the Black-Scholes model which we use to estimate the fair value for options which we issue: expected term, expected volatility, risk-free interest rate and expected dividends, all of which require us to make estimates. Our estimates for these inputs may not be indicative of actual future performance and changes to any of these inputs can have a material impact on the resulting estimated fair value calculated for the option. Our expected term input was estimated based on our historical experience for
-85-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
time from option grant to option exercise for all employees in 2019, 2018 and 2017. We treated all employees in one grouping in all three years. Our expected volatility input was estimated based on our historical stock price volatility in 2019, 2018 and 2017. Our risk-free interest rate input was determined based on the U.S. Treasury yield curve at the time of option issuance in 2019, 2018 and 2017. Our expected dividends inputs were zero in all periods as we did not anticipate paying dividends in the foreseeable future. We recognize forfeitures as they occur.
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for options granted in 2019, 2018 and 2017 for the year ended December 31, 2019.
|
|
2019
|
|
2018
|
|
2017
|
|
Risk-free interest rate
|
1.62%
|
|
2.66%
|
|
1.76%
|
|
Expected lives
|
4.7 years
|
|
4.9 years
|
|
4.8 years
|
|
Expected volatility
|
40%
|
|
40%
|
|
41%
|
|
Expected dividend yield
|
0%
|
|
0%
|
|
0%
|
A summary of our stock option plans is as follows:
|
|
Year Ended December 31,
|
|||||
|
|
2019
|
|||||
|
|
Options
|
|
Weighted Average Exercise Price
|
|||
|
Outstanding at beginning of period
|
620,553
|
|
|
$
|
40.741
|
|
|
Granted at market
|
88,200
|
|
|
$
|
84.234
|
|
|
Forfeited
|
(1,353
|
)
|
|
$
|
98.660
|
|
|
Expired
|
(716
|
)
|
|
$
|
98.660
|
|
|
Exercised
|
(170,369
|
)
|
|
$
|
18.125
|
|
|
Outstanding at end of period
|
536,315
|
|
|
$
|
54.855
|
|
|
Exercisable at end of period
|
315,964
|
|
|
$
|
37.644
|
|
The total estimated fair value of stock options granted was computed to be approximately $2.6 million, $4.4 million and $1.0 million during the years ended December 31, 2019, 2018 and 2017, respectively. The amounts are amortized ratably over the vesting periods of the options. The weighted average estimated fair value of options granted was computed to be approximately $29.89, $28.81 and $37.35 during the years ended December 31, 2019, 2018 and 2017, respectively. The total intrinsic value of options exercised was $12.8 million, $10.5 million and $17.7 million during the years ended December 31, 2019, 2018 and 2017, respectively. The cash proceeds from options exercised were $1.0 million, $3.2 million and $1.8 million during the years ended December 31, 2019, 2018 and 2017, respectively.
-86-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes information about stock options outstanding and exercisable at December 31, 2019.
|
|
|
Options Outstanding
|
|
Options Exercisable
|
||||||||||||||
|
Exercise Prices
|
|
Number of
Options Outstanding at December 31, 2019 |
|
Weighted
Average Remaining Contractual Life in Years |
|
Weighted
Average Outstanding Price |
|
Number of
Options Exercisable at December 31, 2019 |
|
Weighted
Average Remaining Contractual Life in Years |
|
Weighted
Average Exercise Price |
||||||
|
$4.96 - $7.36
|
|
85,552
|
|
|
3.18
|
|
$
|
7.043
|
|
|
85,552
|
|
|
3.18
|
|
$
|
7.043
|
|
|
$7.37 - $32.21
|
|
74,668
|
|
|
4.25
|
|
$
|
15.697
|
|
|
74,668
|
|
|
4.25
|
|
$
|
15.697
|
|
|
$32.22 - $62.50
|
|
52,939
|
|
|
6.07
|
|
$
|
39.800
|
|
|
52,771
|
|
|
6.07
|
|
$
|
39.752
|
|
|
$62.51 - $69.77
|
|
128,333
|
|
|
8.18
|
|
$
|
69.770
|
|
|
41,670
|
|
|
8.18
|
|
$
|
69.770
|
|
|
$69.78 - $108.25
|
|
194,823
|
|
|
8.46
|
|
$
|
85.125
|
|
|
61,303
|
|
|
7.18
|
|
$
|
83.428
|
|
|
$4.96 - $108.25
|
|
536,315
|
|
|
6.73
|
|
$
|
54.855
|
|
|
315,964
|
|
|
5.35
|
|
$
|
37.644
|
|
As of December 31, 2019, there was approximately $5.1 million of total unrecognized compensation cost related to outstanding stock options. That cost is expected to be recognized over a weighted-average period of 1.54 years with all cost to be recognized by the end of November 2022, assuming all options vest according to the vesting schedules in place at December 31, 2019. As of December 31, 2019, the aggregate intrinsic value of outstanding options was approximately $22.3 million and the aggregate intrinsic value of exercisable options was approximately $18.5 million.
Employee Stock Purchase Plan
Under the 1997 Employee Stock Purchase Plan (the "ESPP"), we are authorized to issue up to 450,000 shares of common stock to our employees, of which 440,427 had been issued as of December 31, 2019. On May 5, 2015, our shareholders approved the amendment and restatement of the ESPP, including a 75,000 share increase to 450,000 total shares authorized under the ESPP as well as changes discussed below as compared to the ESPP prior to the amendment and restatement. Employees who are expected to work at least 20 hours per week and 5 months per year are eligible to participate and can choose to have up to 10% of their compensation withheld to purchase our stock under the ESPP when they choose to withhold a whole percentage of their compensation.
Beginning on July 1, 2013, our ESPP had a 27-month offering period and three-month accumulation periods ending on each March 31, June 30, September 30 and December 31. The purchase price of stock on March 31, June 30, September 30 and December 31 was the lesser of (1) 85% of the fair market value at the time of purchase and (2) the greater of (i) 95% of the fair market value at the beginning of the applicable offering period or (ii) 65% of the fair market value at the time of purchase. In addition, participating employees may purchase shares under the ESPP at the beginning of an applicable offering period for a purchase price of stock equal to 95% of the fair market value at such time or at 5 pm on a day other than March 31, June 30, September 30 and December 31 during the applicable offering period for a purchase price of stock equal to 95% of the fair market value at purchase.
Beginning April 1, 2015, employees may elect to withhold a positive fixed amount from each compensation payment in addition to the previous approach of withholding a whole percentage of such compensation payment, with all withholding for a given employee subject to a maximum monthly amount of $2,500 following the amendment and restatement as opposed to a $25,000 maximum annual amount prior to the amendment and restatement. For offering periods beginning on or after April 1, 2015, the purchase price of stock on March 31, June 30, September 30 and December 31 is to be the lesser of (1) 85% of the fair market
-87-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
value at the time of purchase and (2) the greater of (i) 85% of the fair market value at the beginning of the applicable offering period, (ii) the fair market value at the beginning of the applicable offering period less 1 cent and (iii) 65% of the fair market value at the time of purchase. In addition, participating employees may elect to purchase shares under the ESPP at the beginning of an applicable offering period for a purchase price of stock equal to the greater of (1) 85% of the fair market value at the beginning of the applicable offering period and (2) the fair market value at the beginning of the applicable offering period less 1 cent or at 5 pm on a day other than March 31, June 30, September 30 and December 31 during the applicable offering period for a purchase price of stock equal to the greater of (1) 85% of the fair market value at the time of purchase and (2) the fair market value at the time of purchase less 1 cent.
We issued 10,698, 10,078 and 10,983 shares under the ESPP for the years ended December 31, 2019, 2018 and 2017, respectively.
For the years ended December 31, 2019, 2018 and 2017, we estimated the fair values of stock purchase rights granted under the ESPP using the Black-Scholes pricing model and the following weighted average assumptions:
|
|
2019
|
|
2018
|
|
2017
|
|
Risk-free interest rate
|
2.09%
|
|
1.67%
|
|
0.74%
|
|
Expected lives
|
1.1 years
|
|
1.2 years
|
|
1.2 years
|
|
Expected volatility
|
40%
|
|
42%
|
|
45%
|
|
Expected dividend yield
|
0%
|
|
0%
|
|
0%
|
The weighted-average fair value of the purchase rights granted was $18.10, $18.14 and $15.72 per share for the years ended December 31, 2019, 2018 and 2017, respectively.
Restricted Stock
We have granted non-vested restricted stock awards (“restricted stock”) to management and directors pursuant to the 1997 Plan. The restricted stock awards have varying vesting periods, but generally become fully vested between one and four years after the grant date, depending on the specific award, performance targets met for performance based awards granted to management, and vesting period for time based awards. Management performance based awards are granted at the target amount of shares that may be earned. We valued the restricted stock awards related to service and/or company performance targets based on grant date fair value and expense over the period when achievement of those conditions is deemed probable. For restricted stock awards related to market conditions, we utilize a Monte Carlo simulation model to estimate grant date fair value and expense over the requisite period. We recognize forfeitures as they occur.
The following table summarizes restricted stock transactions for the year ended December 31, 2019:
|
|
|
Restricted Stock
|
|
Weighted-Average Grant Date Fair Value Per Award
|
|||
|
Non-vested as of December 31, 2018
|
|
259,430
|
|
|
$
|
74.26
|
|
|
Granted
|
|
83,567
|
|
|
$
|
74.93
|
|
|
Vested
|
|
(4,230
|
)
|
|
$
|
85.09
|
|
|
Forfeited
|
|
(3,100
|
)
|
|
$
|
80.90
|
|
|
Non-vested as of December 31, 2019
|
|
335,667
|
|
|
$
|
74.29
|
|
-88-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The weighted average grant date fair value of awards granted during the year was $74.93, $71.77 and $82.36 for the years ended December 31, 2019, 2018 and 2017, respectively. Fair value of restricted stock vested was $0.3 million, $4.4 million and $3.9 million for the years ended December 31, 2019, 2018 and 2017, respectively.
As of December 31, 2019, there was approximately $2.7 million of total unrecognized compensation cost related to restricted stock with market and time vesting conditions. The Company expects to recognize this expense over a weighted average period of 1.1 years. As of December 31, 2019, we reviewed each of the underlying corporate performance targets and determined that approximately 219,000 shares of common stock were related to corporate performance targets in which we did not deem achievement probable. No compensation expense had been recorded at any period prior to December 31, 2019. The unrecognized compensation cost associated with the restricted stock awards not deemed probable, based on grant date fair value, is approximately $17.8 million. Any change in the probability determination could accelerate the recognition of this expense.
13. ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income consisted of the following (in thousands):
|
|
Minimum pension liability
|
|
Foreign currency translation
|
|
Total accumulated other comprehensive income
|
||||||
|
Balances at December 31, 2017
|
$
|
(489
|
)
|
|
$
|
721
|
|
|
$
|
232
|
|
|
Other comprehensive income
|
70
|
|
|
(25
|
)
|
|
45
|
|
|||
|
Balances at December 31, 2018
|
(419
|
)
|
|
696
|
|
|
277
|
|
|||
|
Other comprehensive income
|
73
|
|
|
163
|
|
|
236
|
|
|||
|
Balances at December 31, 2019
|
$
|
(346
|
)
|
|
$
|
859
|
|
|
$
|
513
|
|
14. COMMITMENTS AND CONTINGENCIES
Royalty Agreements
The Company holds certain rights to market and manufacture all products developed or created under certain research, development and licensing agreements with various entities. In connection with such agreements, the Company has agreed to pay the entities royalties on net product sales. Royalties of $0.3 million became payable under these agreements for each of the years ended December 31, 2019, 2018 and 2017, respectively.
Warranties
The Company's current terms and conditions of sale include a limited warranty that its products and services will conform to published specifications at the time of shipment and a more extensive warranty related to certain of its products. The Company also sells a renewal warranty for certain of its products. The typical remedy for breach of warranty is to correct or replace any defective product, and if not possible or practical, the Company will accept the return of the defective product and refund the amount paid. Historically, the Company has incurred minimal warranty costs. The Company's warranty reserve was $0.3 million and $0.2 million as of December 31, 2019 and 2018.
-89-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Litigation
From time to time, the Company may be involved in litigation relating to claims arising out of its operations. The Company records accruals for outstanding legal matters when it believes it is probable that a loss will be incurred, and the amount can be reasonably estimated.
On October 10, 2018, we reached an agreement in principle to settle the complaint that was filed against the Company by Shaun Fauley on March 12, 2015 in the U.S. District Court Northern District of Illinois (the "Court") alleging our transmittal of unauthorized faxes in violation of the federal Telephone Consumer Protection Act of 1991, as amended by the Junk Fax Prevention Act of 2005, as a class action (the "Fauley Complaint"). The settlement, which received the Court's approval on February 28, 2019 and was not subsequently appealed by a class member, required us to make available a total of $6.8 million to pay class members, as well as to pay attorneys' fees and expenses to legal counsel to the class. The Company recorded the loss provision in the third quarter of 2018 in connection with the settlement agreement and does not have insurance coverage for the Fauley Complaint. The payment in respect of the settlement was made in full on April 3, 2019, and all activity related to the Fauley Complaint has ceased.
At December 31, 2019, the Company was not a party to any other legal proceedings that were expected, individually or in the aggregate, to have a material adverse effect on our business, financial condition or operating results.
15. INTEREST AND OTHER EXPENSE (INCOME)
Interest and other expense (income), net, consisted of the following (in thousands):
|
|
Year Ended December 31,
|
||||||||||
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
Interest income
|
$
|
(661
|
)
|
|
$
|
(261
|
)
|
|
$
|
(167
|
)
|
|
Interest expense
|
3,089
|
|
|
310
|
|
|
245
|
|
|||
|
Other expense (income), net
|
482
|
|
|
(62
|
)
|
|
(228
|
)
|
|||
|
Interest and other expense (income), net
|
$
|
2,910
|
|
|
$
|
(13
|
)
|
|
$
|
(150
|
)
|
Cash paid for interest was $351 thousand, $224 thousand and $206 thousand for the years ended December 31, 2019, 2018 and 2017, respectively.
16. CONVERTIBLE NOTES AND CREDIT FACILITY
Convertible Notes
On September 17, 2019, the Company issued $86.25 million aggregate principal amount of 3.750% Convertible Senior Notes due 2026, which included the exercise in full of an $11.25 million purchase option, to certain financial institutions as the initial purchasers of the Notes (the "Initial Purchasers"). The Notes are senior unsecured obligations of the Company. The Notes were issued pursuant to an Indenture, dated September 17, 2019 (the “Indenture”), between the Company and U.S. Bank National Association, as trustee.
The net proceeds from the sale of the Notes were approximately $83.7 million after deducting the initial purchasers’ discounts and the offering expenses payable by the Company. The Company used approximately $12.8 million of the net proceeds from the Notes to repay all outstanding indebtedness on its existing Credit Facility (defined below), and an additional $2.0 million to fully fund a cash collateralized, letter of credit facility under the new Credit Facility as amended by the Amendment (as defined below). The Company expects to use the remainder of the net proceeds from the sale of the Notes to fund our intended
-90-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
expansion efforts, including through acquisitions of complementary businesses or technologies or other strategic transactions, and for working capital and other general corporate purposes.
The Notes are senior unsecured obligations of the Company and will rank senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the Notes; equal in right of payment to any of our unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including any letters of credit issued under our Credit Facility) to the extent of the value of assets securing such indebtedness; and structurally junior to all indebtedness and other liabilities (including trade payables) of our subsidiaries.
The Company pays interest on the Notes semiannually in arrears at a rate of 3.750% per annum on March 15 and September 15 of each year. The Notes are convertible based upon an initial conversion rate of 11.5434 shares of the Company’s common stock per $1,000 principal amount of Notes (equivalent to a conversion price of approximately $86.63 per share of common stock). The Notes would convert in full into 995,618 shares of common stock based on the initial conversion rate. The conversion rate will be subject to standard anti-dilution adjustments upon the occurrence of certain events but will not be adjusted for accrued and unpaid interest. The interest rate on the Notes may be increased by up to 0.50% upon the occurrence of certain events of default or non-timely filings until such matter has been cured.
The Indenture includes customary covenants, but no financial or operating covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities, and sets forth certain events of default and certain types of bankruptcy or insolvency events of default involving the Company after which the Notes become automatically due and payable. The Company can settle any conversions of the Notes in cash, shares of the Company’s common stock or a combination thereof, with the form of consideration determined at the Company’s election. The Company intends to settle the principal value of the Notes in cash and issue shares of the Company’s common stock to settle the intrinsic value of the conversion feature. There can be no guarantee, however, that any settlement will be affected by the Company as currently intended, and the timing and other factors of any settlement, many of which may be outside the Company's control, could impact the actual amounts to be settled in either cash or common stock.
The Notes will mature on September 15, 2026, unless earlier repurchased, redeemed or converted. Prior to March 15, 2026, holders may convert all or a portion of their Notes only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on December 31, 2019 (and only during such calendar quarter), if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the 5 business day period after any 5 consecutive trading day period (the "Notes measurement period") in which the trading price per $1,000 principal amount of Notes for each trading day of the Notes measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day; (3) with respect to any Notes called for redemption by the Company, at any time prior to the close of business on the scheduled trading day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events. On and after March 15, 2026 until the close of business on the scheduled trading day immediately preceding the maturity date, holders may convert their Notes at any time, regardless of the foregoing circumstances. Holders of Notes who convert their Notes in connection with a notice of a redemption or a make-whole fundamental change (each as defined in the Indenture) may be entitled to a premium in the form of an increase in the conversion rate of the Notes.
The Company may not redeem the Notes prior to September 20, 2023. On or after September 20, 2023, the Company may redeem for cash all or part of the Notes if the last reported sale price of the Company’s
-91-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
common stock equals or exceeds 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which the Company provides notice of the redemption. The redemption price will be 100% of the principal amount of the Notes to be redeemed, plus accrued and unpaid interest, if any. No sinking fund is provided for the Notes.
Upon the occurrence of a fundamental change (as defined in the Indenture), holders may require the Company to repurchase all or a portion of their Notes for cash at a price equal to 100% of the principal amount of the Notes to be repurchased plus any accrued but unpaid interest to, but excluding, the fundamental change repurchase date.
In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, representing the conversion option, which does not meet the criteria for separate accounting as a derivative as it is indexed to the Company's own stock, was determined by deducting the fair value of the liability component from the par value of the Notes. The difference between the principal amount of the Notes and the liability component represents the debt discount, which is recorded as a direct deduction from the related debt liability in the Consolidated Balance Sheet and amortized to interest expense using the effective interest method over the term of the Notes. The effective interest rate of the Notes is 10.8% per annum. The equity component of the Notes of approximately $39.5 million, net of allocated issuance costs and deferred tax impacts, is included in additional paid-in capital in the Consolidated Balance Sheet and is not remeasured as long as it continues to meet the conditions for equity classification. The Company allocated transaction costs related to the Notes using the same proportions as the proceeds from the Notes. Transaction costs attributable to the liability component were recorded as a direct deduction from the related debt liability in the Consolidated Balance Sheet and amortized to interest expense over the term of the Notes, and transaction costs attributable to the equity component were netted with the equity component in shareholders’ equity.
In addition, the Company determined that the additional interest that could be due to the holders of the Notes upon an event of default or non-timely filing represented an embedded derivative feature that should be bifurcated from the Notes. The Company concluded that the fair value of this embedded derivative feature was de minimis upon the issuance of the Notes and at December 31, 2019.
The following table summarizes the net carrying amount of the Notes as of December 31, 2019 (in thousands):
|
|
December 31, 2019
|
||
|
Carrying amount of equity component
|
$
|
39,508
|
|
|
|
|
||
|
Principal amount of the Notes
|
86,250
|
|
|
|
Unamortized debt discount
|
(40,902
|
)
|
|
|
Net carrying amount
|
$
|
45,348
|
|
-92-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Interest expense related to the Notes for the year ended December 31, 2019 was $2.7 million, which is comprised of the amortization of debt discount and debt issuance costs and the contractual coupon interest as follows (in thousands):
|
|
Twelve Months Ended December 31, 2019
|
||
|
Interest expense related to contractual coupon interest
|
$
|
925
|
|
|
Interest expense related to amortization of the debt discount
|
1,744
|
|
|
|
|
$
|
2,669
|
|
As of December 31, 2019, the remaining period over which the unamortized discount will be amortized is 80.5 months.
The estimated fair value of the Notes was $116.0 million as of December 31, 2019, determined through consideration of quoted market prices in less active markets. The fair value measurement is classified as Level 2 in the fair value hierarchy, which is defined in ASC 820 as inputs other than quoted prices in active markets that are either directly or indirectly observable. Based on our closing stock price of $95.94 on December 31, 2019, the if-converted value exceeded the aggregate principal amount of the Notes by $9.3 million.
Credit Facility
We entered into a Credit Agreement, dated July 27, 2017, as amended in May 2018, December 2018, and July 2019 (the "Credit Agreement") with JPMorgan Chase Bank, N.A. ("Chase") which provided for a revolving credit facility up to $30.0 million (the "Credit Facility"). The Credit Facility provided us with the ability to borrow up to $30.0 million, although the amount of the Credit Facility may have been increased by an additional $20.0 million up to a total of $50.0 million subject to receipt of additional lender commitments and other conditions. Any interest on borrowings due was to be charged at either the (i) rate of interest per annum publicly announced from time to time by Chase at its prime rate in effect at its principal offices in New York City, subject to a floor, minus 1.65%, or (ii) the interest rate per annum equal to (a) LIBOR for the interest period in effect multiplied by (b) Chase's Statutory Reserve Rate (as defined in the Credit Agreement), plus 1.10% and payable monthly. There was an annual minimum interest charge of $60 thousand under the Credit Agreement. Chase held first right of priority over all other liens, if any were to exist.
In September 2019, we entered into an amendment to the Credit Agreement (the “Amendment”), which among other things, reduced and limited the Credit Facility to a $2.0 million, cash collateralized, letter of credit facility and eliminated a majority of the negative covenants previously contained in the Credit Facility, including any covenants that could have prohibited the issuance of any Notes and the Company's ability to pay cash upon conversion, repurchase or redemption of any Notes issued. The Company was required to repay in full the approximately $12.8 million of indebtedness outstanding under the Credit Facility and fully fund the $2.0 million collateral account to be held by Chase to secure the Company's obligations under the Amendment to the Credit Facility in connection with the issuance of the Notes. The maturity date of the Credit Facility, as amended by the Amendment, was September 9, 2021. This Amendment became effective on September 17, 2019, the first date any Notes were issued. The Company accounted for the modification of the Credit Facility by writing off approximately $33 thousand of remaining unamortized debt issuance costs related to the Credit Agreement. On December 31, 2019, we terminated our $2.0 million letter of credit facility with Chase and expensed the remaining debt issuance costs.
As of December 31, 2018, we had $6.0 million of borrowings outstanding under the Credit Agreement. In connection with the Credit Agreement, the Company incurred debt issuance costs of $120 thousand. These
-93-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
costs are included in other non-current assets on the Company's Consolidated Balance Sheet as of December 31, 2018.
17. SEGMENT REPORTING
The Company's two reportable segments are CCA and OVP. The CCA segment includes Point of Care diagnostic laboratory instruments and consumables, and Point of Care digital imaging diagnostic instruments and software services as well as single use diagnostic and other tests, pharmaceuticals and vaccines, primarily for canine and feline use. These products are sold directly by the Company as well as through independent third party distributors and through other distribution relationships. CCA segment products manufactured at the Des Moines, Iowa production facility included in the OVP segment's assets are transferred at cost and are not recorded as revenue for the OVP segment. The OVP segment includes private label vaccine and pharmaceutical production, primarily for cattle, in addition to other small mammals. All OVP products are sold by third parties under third party labels.
-94-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Summarized financial information concerning the Company's reportable segments is shown in the following tables (in thousands):
|
Year Ended December 31, 2019
|
|
Core
Companion Animal |
|
Other Vaccines and
Pharmaceuticals |
|
Total |
||||||
|
Total revenue
|
|
$
|
106,570
|
|
|
$
|
16,091
|
|
|
$
|
122,661
|
|
|
Operating income (loss)
|
|
1,358
|
|
|
(1,031
|
)
|
|
327
|
|
|||
|
(Loss) income before income taxes
|
|
(1,552
|
)
|
|
(1,031
|
)
|
|
(2,583
|
)
|
|||
|
Investments in unconsolidated affiliates
|
|
7,424
|
|
|
—
|
|
|
7,424
|
|
|||
|
Total assets
|
|
223,980
|
|
|
20,444
|
|
|
244,424
|
|
|||
|
Net assets
|
|
137,072
|
|
|
17,292
|
|
|
154,364
|
|
|||
|
Capital expenditures
|
|
259
|
|
|
785
|
|
|
1,044
|
|
|||
|
Depreciation and amortization
|
|
3,611
|
|
|
1,305
|
|
|
4,916
|
|
|||
|
Year Ended December 31, 2018
|
|
Core
Companion Animal |
|
Other Vaccines and
Pharmaceuticals |
|
Total |
||||||
|
Total revenue
|
|
$
|
108,924
|
|
|
$
|
18,522
|
|
|
$
|
127,446
|
|
|
Operating income
|
|
2,040
|
|
|
1,754
|
|
|
3,794
|
|
|||
|
Income before income taxes
|
|
2,053
|
|
|
1,754
|
|
|
3,807
|
|
|||
|
Investments in unconsolidated affiliates
|
|
8,018
|
|
|
—
|
|
|
8,018
|
|
|||
|
Total assets
|
|
133,586
|
|
|
22,866
|
|
|
156,452
|
|
|||
|
Net assets
|
|
96,129
|
|
|
26,280
|
|
|
122,409
|
|
|||
|
Capital expenditures
|
|
180
|
|
|
1,178
|
|
|
1,358
|
|
|||
|
Depreciation and amortization
|
|
3,369
|
|
|
1,226
|
|
|
4,595
|
|
|||
|
Year Ended December 31, 2017
|
|
Core
Companion Animal |
|
Other Vaccines and
Pharmaceuticals |
|
Total |
||||||
|
Total revenue
|
|
$
|
105,191
|
|
|
$
|
24,150
|
|
|
$
|
129,341
|
|
|
Operating income
|
|
12,656
|
|
|
5,563
|
|
|
18,219
|
|
|||
|
Income before income taxes
|
|
12,828
|
|
|
5,541
|
|
|
18,369
|
|
|||
|
Investments in unconsolidated affiliates
|
|
—
|
|
|
—
|
|
|
—
|
|
|||
|
Total assets
|
|
111,625
|
|
|
23,819
|
|
|
135,444
|
|
|||
|
Net assets
|
|
75,984
|
|
|
24,456
|
|
|
100,440
|
|
|||
|
Capital expenditures
|
|
209
|
|
|
3,260
|
|
|
3,469
|
|
|||
|
Depreciation and amortization
|
|
3,736
|
|
|
1,018
|
|
|
4,754
|
|
|||
-95-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Revenue is attributed to individual countries based on customer location. Total revenue by principal geographic area was as follows (in thousands):
|
|
For the Years Ended December 31,
|
||||||||||
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
U.S.
|
$
|
108,469
|
|
|
$
|
115,543
|
|
|
$
|
116,823
|
|
|
Canada
|
3,042
|
|
|
2,992
|
|
|
2,924
|
|
|||
|
Europe
|
8,289
|
|
|
5,995
|
|
|
4,780
|
|
|||
|
Other International
|
2,861
|
|
|
2,916
|
|
|
4,814
|
|
|||
|
Total
|
$
|
122,661
|
|
|
$
|
127,446
|
|
|
$
|
129,341
|
|
Total long-lived assets by principal geographic areas were as follows (in thousands):
|
|
As of December 31,
|
||||||||||
|
|
2019
|
|
2018
|
|
2017
|
||||||
|
U.S.
|
$
|
14,712
|
|
|
$
|
15,933
|
|
|
$
|
17,288
|
|
|
Europe
|
576
|
|
|
37
|
|
|
18
|
|
|||
|
Other International
|
181
|
|
|
11
|
|
|
25
|
|
|||
|
Total
|
$
|
15,469
|
|
|
$
|
15,981
|
|
|
$
|
17,331
|
|
In our CCA segment, revenue from Covetrus represented approximately 14%, 15% and 13% of our consolidated revenue for the years ended December 31, 2019, 2018 and 2017, respectively. Revenue from Merck entities, including Merck Animal Health, represented approximately 1%, 12% and 12% for the years ended December 31, 2019, 2018 and 2017, respectively. In our OVP segment, revenue from Elanco represented approximately 8%, 9% and 11% for the years ended December 31, 2019, 2018 and 2017, respectively. No other customer accounted for more than 10% of our consolidated revenue for the years ended December 31, 2019, 2018 or 2017.
-96-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
18. SUPPLEMENTAL QUARTERLY FINANCIAL DATA (Unaudited)
The following tables present quarterly unaudited results for the two years ended December 31, 2019 and 2018 (amounts in thousands, except per share data).
|
|
Q1
|
|
Q2
|
|
Q3
|
|
Q4
|
|
Total
|
||||||||||
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Total revenue
|
$
|
29,511
|
|
|
$
|
28,146
|
|
|
$
|
31,237
|
|
|
$
|
33,767
|
|
|
$
|
122,661
|
|
|
Gross profit
|
12,543
|
|
|
12,412
|
|
|
13,664
|
|
|
15,830
|
|
|
54,449
|
|
|||||
|
Operating income (loss)
|
(75
|
)
|
|
(566
|
)
|
|
193
|
|
|
775
|
|
|
327
|
|
|||||
|
Net income (loss) before equity in losses of unconsolidated affiliates
|
951
|
|
|
(161
|
)
|
|
(204
|
)
|
|
(1,723
|
)
|
|
(1,137
|
)
|
|||||
|
Net income (loss), after equity in losses of unconsolidated affiliates
|
770
|
|
|
(288
|
)
|
|
(351
|
)
|
|
(1,862
|
)
|
|
(1,731
|
)
|
|||||
|
Net income (loss) attributable to Heska Corporation
|
814
|
|
|
(241
|
)
|
|
(310
|
)
|
|
(1,728
|
)
|
|
(1,465
|
)
|
|||||
|
Basic earnings (loss) per share attributable to Heska Corporation
|
0.11
|
|
|
(0.03
|
)
|
|
(0.04
|
)
|
|
(0.23
|
)
|
|
(0.20
|
)
|
|||||
|
Diluted earnings (loss) per share attributable to Heska Corporation
|
0.10
|
|
|
(0.03
|
)
|
|
(0.04
|
)
|
|
(0.23
|
)
|
|
(0.20
|
)
|
|||||
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Total revenue
|
$
|
32,765
|
|
|
$
|
29,662
|
|
|
$
|
30,955
|
|
|
$
|
34,064
|
|
|
$
|
127,446
|
|
|
Gross profit
|
13,307
|
|
|
13,065
|
|
|
14,794
|
|
|
15,472
|
|
|
56,638
|
|
|||||
|
Operating income (loss)
|
1,871
|
|
|
2,204
|
|
|
(3,595
|
)
|
|
3,314
|
|
|
3,794
|
|
|||||
|
Net income (loss) before equity in losses of unconsolidated affiliates
|
2,155
|
|
|
1,897
|
|
|
(1,670
|
)
|
|
3,540
|
|
|
5,922
|
|
|||||
|
Net income (loss), after equity in losses of unconsolidated affiliates
|
2,155
|
|
|
1,897
|
|
|
(1,670
|
)
|
|
3,468
|
|
|
5,850
|
|
|||||
|
Net income (loss) attributable to Heska Corporation
|
2,155
|
|
|
1,897
|
|
|
(1,670
|
)
|
|
3,468
|
|
|
5,850
|
|
|||||
|
Basic earnings (loss) per share attributable to Heska Corporation
|
0.30
|
|
|
0.26
|
|
|
(0.23
|
)
|
|
0.47
|
|
|
0.81
|
|
|||||
|
Diluted earnings (loss) per share attributable to Heska Corporation
|
0.28
|
|
|
0.24
|
|
|
(0.23
|
)
|
|
0.44
|
|
|
0.74
|
|
|||||
Note that the sum of each value line for the four quarters does not necessarily equal the amount reported for the full year due to rounding.
19. SUBSEQUENT EVENTS
On January 14, 2020, the Company entered into an agreement (the “Agreement”) among the Company, Heska GmbH, Covetrus Animal Health Holdings Limited and Covetrus, Inc. regarding the sale and purchase of the sole share in scil animal care company GmbH (“scil”) whereby Heska is acquiring 100% of the capital stock of scil from Covetrus Animal Health Holdings Limited, a subsidiary of Covetrus, Inc. (“Covetrus”). Heska will purchase scil (the “Acquisition”) for $125 million in cash, subject to working capital and other adjustments. The Acquisition is expected to close no later than by the end of the second quarter of 2020.
The obligation of Heska and Covetrus to consummate the Acquisition is subject to the satisfaction or waiver of closing conditions set forth in the Agreement, including, among others (i) the receipt by Heska of audited financial statements of scil for the years ended December 31, 2018 and 2019 and (ii) the absence of a "Material Adverse Change" (as defined in the Agreement) with respect to scil and its subsidiaries or the ability of Covetrus to consummate the Acquisition. The Acquisition is not subject to any financing condition.
-97-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Under the terms of the Agreement, each of Heska and Covetrus has agreed to certain indemnification obligations with respect to the guarantees made by each party and/or each party’s respective subsidiaries under the Agreement.
If the Acquisition has not been consummated by May 31, 2020, each of Heska and Covetrus may terminate the Agreement.
Heska expects to finance the Acquisition through a private offering of $125 million of Series X Convertible Preferred Stock, par value $0.01 per share (the “Preferred”) pursuant to a Securities Purchase Agreement, dated as of January 12, 2020, among the Company and certain investors. The Preferred offering is being undertaken in reliance upon the exemption from securities registration afforded by Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”), and Rule 506 of Regulation D as promulgated by the SEC under the Securities Act, as a transaction not involving a public offering. 125,000 shares of Preferred will be issued at the Closing of the Preferred offering, and the Preferred is convertible into shares of the Company’s Public Common Stock at an initial ratio of approximately 12 shares of Public Common Stock for each Preferred share at the option of the Preferred holders or the Company. The Preferred offering is expected to close at the time the Company closes the Acquisition, subject to customary closing conditions. The Company expects to exercise its right to convert the Preferred shares into 1,508,751 shares of Public Common Stock after the Company’s annual shareholder meeting, subject to the receipt of an affirmative shareholder vote to amend the Company’s Restated Certificate of Incorporation, as amended (the “Certificate”), to increase the number of authorized shares of Public Common Stock. The conversion of the Preferred shares will result in dilution of less than 20% of total shares of the Company’s Public Common Stock currently issued and outstanding. If such shareholder vote is not obtained and the conversion of the Preferred shares does not occur, the Company will be required to pay a cash dividend to the Investors at a per annum rate of 5.75%; provided, that such amount shall increase in subsequent periods up to a maximum per annum rate of 7.25%. In connection with the Preferred offering, the Company has agreed to enter into a Registration Rights Agreement with the Investors pursuant to which the Company is obligated to file a registration statement with the Commission relating to the shares of Public Common Stock issuable to the Investors upon conversion of the Preferred shares.
|
Item 9.
|
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
|
None.
|
Item 9A.
|
Controls and Procedures
|
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our principal executive officer and our principal financial officer, evaluated the effectiveness of our disclosure controls and procedures, as defined by Rule 13a-15 of the Exchange Act, as of December 31, 2019. Based on this evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the SEC's rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding disclosure.
-98-
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, the Company's management has concluded that the Company's internal control over financial reporting was effective as of December 31, 2019.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Accordingly, even an effective system of internal control will provide only reasonable assurance that the objectives of the internal control system are met.
Plante & Moran, PLLC, an independent registered public accounting firm, has audited our Consolidated Financial Statements included in this Form 10-K, and as part of the audit, has issued a report, included herein, on the effectiveness of our internal control over financial reporting as of December 31, 2019.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting that occurred during the fourth quarter of 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
|
Item 9B.
|
Other Information
|
None.
-99-
PART III
Certain information required by Part III is incorporated by reference to our definitive Proxy Statement to be filed with the SEC in connection with the solicitation of proxies for our 2020 Annual Meeting of Stockholders.
|
Item 10.
|
Directors, Executive Officers and Corporate Governance
|
Executive Officers
The information required by this item with respect to executive officers is incorporated by reference to Item 1 of this report and can be found under the caption "Information About Our Executive Officers."
Directors
The information required by this section with respect to our directors will be incorporated by reference to the information in the sections entitled Proposal No. 1 "Election of Directors" in the Proxy Statement.
Code of Ethics
Our Board of Directors has adopted a code of ethics for our senior executive and financial officers (including our principal executive officer, principal financial officer and principal accounting officer). The code of ethics is available on our website at www.heska.com under the Corporate Governance section under the Investor Relations section under the "Company" tab. We intend to disclose any amendments to or waivers from the code of ethics at that location.
Audit Committee
The information required by this section with respect to our Audit Committee will be incorporated by reference to the information in the section entitled "Board Structure and Committees" in the Proxy Statement.
|
Item 11.
|
Executive Compensation
|
The information required by this section will be incorporated by reference to the information in the sections entitled "Director Compensation," "Executive Compensation," "Compensation Committee Report" in the Proxy Statement.
|
Item 12.
|
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|
The other information required by this section will be incorporated by reference to the information in the section entitled "Ownership of Securities - Common Stock Ownership of Certain Beneficial Owners and Management" in the Proxy Statement.
-100-
Equity Compensation Plan Information
The following table sets forth information about our common stock that may be issued upon exercise of options and rights under all of our equity compensation plans as of December 31, 2019, including the Stock Incentive Plan, as amended and restated, the 2003 Stock Incentive Plan, as amended and restated and the 1997 Employee Stock Purchase Plan, as amended and restated (the "1997 ESPP"). Our stockholders have approved all of these plans.
|
Plan Category
|
(a) Number of Securities to be Issued Upon Exercise of Outstanding Options and Rights
|
|
(b) Weighted-Average Exercise Price of Outstanding Options and Rights
|
|
(c) Number of Securities
Remaining Available for Future Issuance Under Equity Compensation Plans |
|
Equity Compensation Plans Approved by Stockholders
|
536,315
|
|
$54.86
|
|
95,423
|
|
Equity Compensation Plans Not Approved
by Stockholders |
None |
|
None |
|
None |
|
Total
|
536,315
|
|
$54.86
|
|
95,423
|
|
Item 13.
|
Certain Relationships and Related Transactions and Director Independence
|
The information required by this section will be incorporated by reference to the information in the sections entitled "Board Structure and Committees" and "Significant Relationships and Transactions with Directors, Officers or Principal Stockholders" in the Proxy Statement.
|
Item 14.
|
Principal Accountant Fees and Services
|
The information required by this section will be incorporated by reference to the information in the section entitled "Auditor Fees and Services" in the Proxy Statement.
The information required by Part III to the extent not set forth herein, will be incorporated herein by reference to our definitive Proxy Statement for the 2020 Annual Meeting of Stockholders.
-101-
PART IV
|
Item 15.
|
Exhibits and Financial Statement Schedules
|
(a) The following documents are filed as a part of this Form 10-K.
(1) Financial Statements:
Reference is made to the Index to Consolidated Financial Statements under Item 8 in Part II of this Form 10-K.
(2) Financial Statement Schedules:
NOTE: All schedules have been omitted because they are either not required or the information is included in the financial statements and notes thereto.
(3) Exhibits:
The exhibits listed below are required by Item 601 of Regulation S-K. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K has been identified.
|
|
Exhibit Number
|
|
Notes
|
|
Description of Document
|
|
|
2.1#++
|
|
|
|
|
|
|
3(i)
|
|
(8)
|
|
|
|
|
3(ii)
|
|
(8)
|
|
|
|
|
3(iii)
|
|
(8)
|
|
|
|
|
3(iv)
|
|
(19)
|
|
|
|
|
3(v)
|
|
(20)
|
|
|
|
|
3(vi)
|
|
(25)
|
|
|
|
|
3(vii)
|
|
(29)
|
|
|
|
|
3(viii)
|
|
(29)
|
|
|
|
|
4.1
|
|
(32)
|
|
|
|
|
4.2
|
|
|
|
|
|
|
10.1*
|
|
(29)
|
|
|
|
|
10.2*
|
|
(31)
|
|
|
|
|
10.3*
|
|
(31)
|
|
|
|
|
10.4*
|
|
(31)
|
|
|
|
|
10.5*
|
|
(31)
|
|
|
-102-
|
|
10.6*
|
|
(31)
|
|
|
|
|
10.7*
|
|
(31)
|
|
|
|
|
10.8*
|
|
(6)
|
|
|
|
|
10.09*
|
|
(19)
|
|
|
|
|
10.10*
|
|
(19)
|
|
|
|
|
10.11*
|
|
(19)
|
|
|
|
|
10.12*
|
|
(19)
|
|
|
|
|
10.13*
|
|
(19)
|
|
|
|
|
10.14*
|
|
(14)
|
|
|
|
|
10.15*
|
|
(13)
|
|
|
|
|
10.16*
|
|
|
|
|
|
|
10.17*
|
|
(5)
|
|
|
|
|
10.18*
|
|
(24)
|
|
|
|
|
10.19*
|
|
(11)
|
|
|
|
|
10.20*
|
|
(13)
|
|
|
|
|
10.21*
|
|
(23)
|
|
|
|
|
10.22*
|
|
(24)
|
|
|
|
|
10.23*
|
|
(26)
|
|
|
|
|
10.24*
|
|
(1)
|
|
|
|
|
10.25*
|
|
(5)
|
|
|
|
|
10.26*
|
|
|
|
|
|
|
10.27*
|
|
(30)
|
|
|
|
|
10.28*
|
|
(4)
|
|
|
|
|
10.29*
|
|
(5)
|
|
|
|
|
10.30*
|
|
(11)
|
|
|
|
|
10.31*
|
|
(24)
|
|
|
|
|
10.32*
|
|
(8)
|
|
|
-103-
|
|
10.33*
|
|
(13)
|
|
|
|
|
10.34*
|
|
(24)
|
|
|
|
|
10.35*
|
|
|
|
|
|
|
10.36*
|
|
(8)
|
|
|
|
|
10.37*
|
|
(13)
|
|
|
|
|
10.38*
|
|
(24)
|
|
|
|
|
10.39*
|
|
|
|
|
|
|
10.40*
|
|
(26)
|
|
|
|
|
10.41*
|
|
(27)
|
|
|
|
|
10.42*
|
|
(24)
|
|
|
|
|
10.43*
|
|
(24)
|
|
|
|
|
10.44
|
|
(2)
|
|
|
|
|
10.45
|
|
(3)
|
|
|
|
|
10.46
|
|
(3)
|
|
|
|
|
10.47
|
|
(7)
|
|
|
|
|
10.48+
|
|
(4)
|
|
|
|
|
10.49+
|
|
(6)
|
|
|
|
|
10.50+
|
|
(8)
|
|
|
|
|
10.51+
|
|
(10)
|
|
|
|
|
10.52+
|
|
(11)
|
|
|
|
|
10.53+
|
|
(17)
|
|
|
|
|
10.54+
|
|
(23)
|
|
|
|
|
10.55+
|
|
(12)
|
|
|
|
|
10.56
|
|
(14)
|
|
|
-104-
|
|
10.57++
|
|
|
|
|
|
|
10.58
|
|
(28)
|
|
|
|
|
10.59+
|
|
(9)
|
|
|
|
|
10.60++
|
|
(29)
|
|
|
|
|
10.61++
|
|
(29)
|
|
|
|
|
10.62+
|
|
(15)
|
|
|
|
|
10.63+
|
|
(15)
|
|
|
|
|
10.64++
|
|
(29)
|
|
|
|
|
10.65+
|
|
(23)
|
|
|
|
|
10.66+
|
|
(23)
|
|
|
|
|
10.67+
|
|
(23)
|
|
|
|
|
10.68#
|
|
|
|
|
|
|
21.1
|
|
|
|
|
|
|
23.1
|
|
|
|
|
|
|
23.2
|
|
|
|
|
|
|
24.1
|
|
|
|
|
|
|
31.1
|
|
|
|
|
|
|
31.2
|
|
|
|
|
|
|
32.1**
|
|
|
|
|
|
|
101.INS
|
|
|
|
XBRL Instance Document.
|
|
|
101.SCH
|
|
|
|
XBRL Taxonomy Extension Schema Document.
|
|
|
101.CAL
|
|
|
|
XBRL Taxonomy Extension Calculation Linkbase Document.
|
|
|
101.DEF
|
|
|
|
XBRL Taxonomy Extension Definition Linkbase Document.
|
-105-
|
|
101.PRE
|
|
|
|
XBRL Taxonomy Extension Presentation Linkbase Document.
|
|
|
101.LAB
|
|
|
|
XBRL Taxonomy Extension Label Linkbase Document.
|
|
Notes
|
|
|
*
|
Indicates management contract or compensatory plan or arrangement.
|
|
+
|
Portions of the exhibit have been omitted pursuant to a request for confidential treatment.
|
|
++
|
Certain confidential information contained in this exhibit has been omitted because it is both (i) not material and (ii) would be competitively harmful if publicly disclosed.
|
|
#
|
Certain personally identifiable information has been omitted from this exhibit pursuant to Item 601(a)(6) under Regulation S-K.
|
|
**
|
Furnished herewith but not filed.
|
|
(1)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2002.
|
|
(2)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2004.
|
|
(3)
|
Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2005.
|
|
(4)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2006.
|
|
(5)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2007.
|
|
(6)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2008.
|
|
(7)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2011.
|
|
(8)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2012.
|
|
(9)
|
Filed with the Registrant's Form 8-K/A on August 29, 2013.
|
|
(10)
|
Filed with the Registrant's Form 10-Q for the quarter ended September 30, 2013.
|
|
(11)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2013.
|
|
(12)
|
Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2014.
|
|
(13)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2014.
|
|
(14)
|
Filed with the Registrant's Form 10-Q for the quarter ended March 31, 2015.
|
|
(15)
|
Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2015.
|
|
(16)
|
Filed with the Registrant's Form 10-Q for the quarter ended September 30, 2015.
|
|
(17)
|
Filed with the Registrant's Form 10-Q for the quarter ended March 31, 2016.
|
|
(18)
|
Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2016.
|
|
(19)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2016.
|
|
(20)
|
Filed with the Registrant's Form 10-Q for the quarter ended March 31, 2017.
|
|
(21)
|
Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2017.
|
|
(22)
|
Filed with the Registrant's Form 8-K on August 2, 2017.
|
|
(23)
|
Filed with the Registrant's Form 10-K for the year ended December 31, 2017.
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(24)
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Filed with the Registrant's Form 10-Q for the quarter ended March 31, 2018.
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(25)
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Filed with the Registrant's Form 8-K on May 9, 2018.
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(26)
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Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2018.
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(27)
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Filed with the Registrant's Form 10-Q for the quarter ended September 30, 2018.
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(28)
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Filed with the Registrant's Form 8-K on November 30, 2018.
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(29)
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Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2019.
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(30)
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Filed with the Registrant's Form 8-K on June 1, 2019.
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(31)
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Filed with the Registrant's Form 10-K for the year ended December 31, 2018.
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(32)
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Filed with the Registrant's Form 8-K on September 17, 2019.
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Item 16.
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Form 10-K Summary
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Registrants may voluntarily include a summary of information required by Form 10-K under this item 16. The Registrant has elected not to include such summary information.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 28, 2020.
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HESKA CORPORATION
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By: /s/ KEVIN S. WILSON
Kevin S. Wilson
Chief Executive Officer and President
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POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Catherine Grassman his or her true and lawful attorneys-in-fact, with full power of substitution, for him or her in any and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all of said attorney-in-fact or their substitute may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
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Signature
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Title
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Date
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/s/ KEVIN S. WILSON
Kevin S. Wilson
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Chief Executive Officer, President and Director (Principal Executive Officer)
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February 28, 2020
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/s/ CATHERINE GRASSMAN
Catherine Grassman
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Executive Vice President, Chief Financial Officer (Principal Financial and Accounting Officer)
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February 28, 2020
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/s/ SCOTT HUMPHREY
Scott Humphrey
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Chair
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February 28, 2020
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/s/ MARK F. FURLONG
Mark F. Furlong
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Director
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February 28, 2020
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/s/ SHARON J. LARSON
Sharon J. Larson
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Director
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February 28, 2020
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/s/ DAVID E. SVEEN
David E. Sveen, Ph.D.
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Director
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February 28, 2020
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/s/ BONNIE J. TROWBRIDGE
Bonnie J. Trowbridge
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Director
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February 28, 2020
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