-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KRhwNL4oSLqmAJ6ND25TLVaI0AEyztgF+AhpgqRAOdO2ugK5diOoVPedy1cCnqNK feRX/ysWKh7IGWdFpRcRkQ== 0000950134-00-002290.txt : 20000327 0000950134-00-002290.hdr.sgml : 20000327 ACCESSION NUMBER: 0000950134-00-002290 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000324 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HESKA CORP CENTRAL INDEX KEY: 0001038133 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 770192527 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 333-72155 FILM NUMBER: 577104 BUSINESS ADDRESS: STREET 1: 1825 SHARP POINT DR CITY: FORT COLLINS STATE: CO ZIP: 80525 BUSINESS PHONE: 9704937272 MAIL ADDRESS: STREET 1: 1825 SHARP POINT DR CITY: FORT COLLINS STATE: CO ZIP: 80525 10-K 1 FORM 10-K FOR FISCAL YEAR END DECEMBER 31, 1999 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE --- ACT OF 1934 For the fiscal year ended December 31, 1999 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES --- EXCHANGE ACT OF 1934 For the transition period from to ---------- ---------- Commission file number 0-22427 HESKA CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) Delaware 77-0192527 - --------------------------------- ------------------------------------ [State or other jurisdiction [I.R.S. Employer Identification No.] of incorporation or organization] 1613 Prospect Parkway Fort Collins, Colorado 80525 - ---------------------------------------- ---------- [Address of principal executive offices] [Zip Code] Registrant's telephone number, including area code: (970) 493-7272 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference to Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock held by non-affiliates of the Registrant was approximately $97,400,000 as of March 20, 2000 based upon the closing price on the Nasdaq National Market reported for such date. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose. 33,660,166 shares of the Registrant's Common Stock, $.001 par value, were outstanding at March 20, 2000. DOCUMENTS INCORPORATED BY REFERENCE Items 10 (as to directors), 11, 12 and 13 of Part III incorporate by reference information from the Registrant's Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the Registrant's 2000 Annual Meeting of Stockholders. ================================================================================ 2 PART I ITEM 1. BUSINESS. We are primarily focused on the discovery, development and marketing of companion animal health products. In addition to manufacturing certain of our companion animal products, our primary manufacturing subsidiary, Diamond Animal Health, Inc. ("Diamond"), also manufactures animal health vaccine products which are marketed and distributed by third parties. In addition to manufacturing veterinary allergy products for marketing and sale by us, our subsidiaries, Center Laboratories, Inc. ("Center") and CMG-Heska Allergy Products S.A. ("CMG"), a Swiss corporation, also manufacture and sell human allergy products. ANIMAL HEALTH PRODUCTS We presently sell a variety of companion animal health products, among the most significant of which are the following. DIAGNOSTICS Heartworm Diagnostics 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 which live in the pulmonary arteries and heart of the host, where they can cause serious cardiovascular, pulmonary, liver and kidney disease. In 1997, we developed a diagnostic test for heartworm infection in dogs. This test uses monoclonal antibodies reactive with heartworm antigens to detect the presence of these antigens in the blood of the infected dog. This test was first offered through our own veterinary diagnostic laboratory. A simple, rapid, and easy to use point-of-care version of this test, Solo Step(TM) CH, was introduced in Italy in 1998. We received regulatory clearance to sell Solo Step(TM) CH in the United States in January 1999, and the product has been successfully introduced in the United States. In March 2000 we received regulatory clearance to sell a batch test version of this product, Solo Step(TM) CH Batch Test Strips, and we expect to make this product available to veterinarians shortly. Also in 1997, we introduced a new test in our veterinary diagnostic laboratory for feline heartworm infections of cats which allowed veterinarians for the first time to accurately establish the prevalence of heartworm exposure in cats in their practices. This test is highly accurate and identifies antibodies in cat serum that react with a recombinant heartworm antigen. In 1997, we introduced a rapid, point-of-care version of this test in Italy. After receiving regulatory clearance, we introduced this point-of-care feline heartworm test, Solo Step(TM) FH, in the United States in 1998. Allergy Allergy is common in companion animals, and it is estimated to affect approximately 10% to 15% of dogs. Clinical symptoms of allergy are variable, but are often manifested as persistent and serious skin disease in dogs and cats. Clinical management of allergic disease is problematic, as there are a large number of allergens that may give rise to these conditions. Although skin testing is often regarded as the most accurate diagnostic procedure, such tests are painful, subjective and inconvenient. 2 3 The effectiveness of the immunotherapy that is prescribed to treat allergic disease is inherently limited by inaccuracies in the diagnostic process. We have developed the HESKA(R) ALLERCEPT(TM) Detection System, a more accurate in vitro technology, to detect IgE, the antibody involved in most allergic reactions. This technology permits the design of tests that, in contrast to other in vitro tests, more specifically identify the animal's allergic responses to particular allergens. During 1997, we adapted this technology to a broad range of our canine and feline allergy tests. ALLERCEPT uses a recombinant version of the natural IgE receptor to screen 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 and insect allergens. BIOLOGICS AND VACCINES Equine Influenza Vaccine Equine influenza is a common viral disease of horses and is similar to human influenza. This disease poses a significant risk to the estimated six million horses in the United States. Infected horses have severe respiratory disease and diminished performance for an extended period following infection. We currently believe that approximately half of the six million horses in the United States receive vaccination. Most competitive equine influenza vaccines are administered as a component of a multi-purpose vaccine, intended to provide protection against multiple infectious diseases. Industry sources have estimated the total equine vaccine market at $50 million in the United States. Currently available vaccines for equine influenza are of limited efficacy. We have developed a unique vaccine for equine influenza, Flu Avert(TM) I.N. vaccine, which we believe has improved efficacy and duration of immunity compared to existing products. This product was approved by the USDA on November 17, 1999 and was first sold to veterinarians in December 1999. Allergy Immunotherapy Veterinarians who use our in vitro allergy testing services often purchase immunotherapy treatment sets for those animals with positive test results. These prescription treatment sets are formulated specifically for each allergic animal and contain only the allergens to which the animal has demonstrated significant levels of IgE antibodies. The prescription formulations are administered in a series of injections, with doses increasing over several months, to ameliorate the allergic condition of the animal. Immunotherapy is generally continued for an extended time. We offer both canine and feline immunotherapy treatment sets. Feline Respiratory Disease In 1997, we introduced in the United States a three-way modified live vaccine (HESKA(TM) Trivalent Intranasal/Intraocular Vaccine) for the three most common viral diseases of cats: calicivirus, rhinotracheitis virus and panleukopenia virus. This vaccine is administered without needle injection by dropping the liquid preparation into the eyes and nostrils of cats. While there is one competitive non-injectable two-way vaccine, all other competitive products are injectable formulations. The use of injectable vaccines in cats has become controversial due to the frequency of injection site-associated side effects. The most serious of these side effects are injection site sarcomas, tumors which, if untreated, are nearly always fatal. Our vaccines avoid injection site side effects and we believe them to be very efficacious. 3 4 PHARMACEUTICALS Dentistry It is estimated that more than 80% of all dogs over three years old exhibit symptoms of periodontal disease, which often manifests as bad breath. Left untreated, periodontal disease can cause loss of teeth and systemic bacterial infection. The most prevalent treatment is the cleaning and scaling of the dog's teeth. Although periodic cleaning and scaling is recommended for all dogs, this procedure alone does not adequately address the underlying infection in dogs with periodontal disease. Systemic antibiotics to be administered by the pet owner at home are widely prescribed but present convenience and compliance issues. Our periodontal disease therapeutic, PERIOceutic(TM) Gel, is an innovative product for the treatment of periodontal disease in dogs which is currently marketed in the United States. This product received approval by the European Commission in September 1999 for marketing and distribution in Europe, and we are currently considering distribution alternatives in Europe. Canine Thyroid Supplement Canine hypothyroidism is a serious disease that is usually caused by abnormalities of the thyroid gland. It is estimated that 3% to 4% of all dogs require thyroid hormone replacement therapy. Common clinical signs include dry, coarse, thin hair, possibly with patches of hair loss and pigment changes. The disease can affect multiple organ systems and cause recurrent infections. In 1997, we introduced a thyroid supplement for dogs in the United States, which we believe is the first and only vitamin-enriched, chewable tablet for the treatment of hypothyroidism in dogs. These chewable tablets, which are administered daily for the life of the dog, provide levothyroxine sodium, a replacement therapy for the hormone normally produced by the dog. Nutritional Supplements Arising partly from our allergy expertise, in 1998, we developed and introduced in the United States a novel fatty acid supplement, HESKA(TM) F.A. Granules. The unique source of the fatty acids in this product, flaxseed oil, leads to high omega-3:omega-6 ratios of fatty acids. Diets high in omega-3 fatty acids are believed to lead to lower levels of inflammatory response. The HESKA(TM) F.A. Granules include vitamins and are formulated in a palatable flavor base that makes the product convenient and easy to administer. MEDICAL INSTRUMENTS We currently offer a broad line of monitoring, diagnostic and other instruments which are described below. We entered this line of business in March 1998, when we acquired a manufacturer and marketer of patient monitoring and diagnostic instruments, which was located in Waukesha, Wisconsin. Following that acquisition, we completed the development of certain other instruments and entered into agreements for the distribution of additional instruments to veterinarians. In 1999, we consolidated all of these operations into our existing operations in Fort Collins, Colorado and Des Moines, Iowa. 4 5 Diagnostic Instruments Our line of diagnostic instruments includes the i-STAT(R) Portable Clinical Analyzer(1), a hand-held, portable clinical analyzer that provides quick, easy analysis of blood gases and other key analytes, such as sodium, potassium and glucose, with whole blood. In the United States we also market the Heska(TM) Vet Diff ABC Hematology Analyzer, an easy to use blood analyzer that measures such key parameters as white blood cell count, red blood cell count, platelet count and hemoglobin levels in animals. We also offer the Reflovet(R) Clinical Analyzer(2), an easy to operate, cost effective blood chemistry analyzer that measures a broad range of animal blood analytes, such as amylase, creatinine, uric acid, bilirubin and glucose. Consumable supplies for the i-STAT, Vet ABC Hematology Analyzer and Reflovet are also provided to veterinarians through Heska sales and distribution channels. Monitoring and Other Instruments The use by veterinarians of the types of patient monitoring products that are taken for granted in human medicine is becoming the state of the art in companion animal health. The centerpiece of our monitoring instrument product line are oxygen saturation monitors designed for monitoring animals under anesthesia: the VET/OX(R) 4404 and VET/OX(R) 4800, each of which includes a variety of additional monitoring parameters, such as pulse rate and strength, body temperature, respiration and ECG. We also offer a proprietary esophageal ECG sensor, VET E/Sig(TM) probe for monitoring ECG, temperature and heart and breath sounds of anesthetized dogs. Our monitoring line also includes the VET/ECG(TM) 2000 hand-held ECG monitor. The VET/IV(TM) 2.2 infusion pump is a compact, affordable IV pump that allows veterinarians to easily provide regulated infusion of blood or nutritional products for their patients. VETERINARY DIAGNOSTIC LABORATORY We have a veterinary diagnostic laboratory at our Fort Collins facility. This diagnostic laboratory currently offers our allergy diagnostics, canine and feline heartworm diagnostics and flea bite allergy assays, in addition to other diagnostic and pathology services. Our Fort Collins veterinary diagnostic laboratory is currently staffed by four diplomates of the American College of Veterinary Pathologists, medical technologists experienced in animal disease and several additional technical staff. We intend to continue to use our Fort Collins diagnostic laboratory both as a stand-alone service center for our customers and as an adjunct to our product development efforts. Many of the assays which we intend to develop in a point-of-care format are initially validated and made available in the veterinary diagnostic laboratory and will also remain available there after the introduction of the analogous point-of-care test. In 1999, we also offered veterinary diagnostic laboratory services in the United Kingdom through our U.K. subsidiary, Heska UK, formerly known as Bloxham Laboratories. We sold this business in March 2000, as we did not believe operation of a veterinary diagnostic laboratory in the U.K. was strategic to our business. - -------- (1) i-STAT(R)is a registered trademark of i-STAT Corporation. (2) Reflovet(R)is a registered trademark of Boehringer Manheim GmBH. 5 6 FOOD ANIMAL PRODUCTS In addition to manufacturing companion animal health products for marketing and sale by Heska, Diamond has completed the development of new bovine vaccines that were licensed by the USDA in the United States in 1998 and 1999. Diamond has entered into an agreement with a food animal products distributor, Agri Laboratories, Ltd., for the exclusive marketing and sale of these vaccines worldwide. AgriLabs currently has agreements with Bayer for the distribution of these vaccines in the United States and Canada and with Intervet, Inc., a division of Akzo Nobel, for the distribution of these vaccines worldwide except in the United States. Diamond is the sole manufacturer of these products. In 1999, Diamond also manufactured bovine vaccines which were marketed and sold by Bayer, primarily in the United States, pursuant to a take-or-pay contract which expired in February 2000. It is expected that a portion of these sales will be replaced by sales of the new vaccines to AgriLabs for distribution by Bayer and others. Diamond also manufactures vaccine products for a number of other animal health companies. This activity ranges from providing bulk vaccine antigens which are included in the vaccines which are manufactured by other companies to filling and finishing final products using bulk antigens provided by other animal health companies. HUMAN ALLERGY PRODUCTS In addition to manufacturing veterinary products for marketing and sale by Heska, Center manufactures a broad line of allergenic extracts, such as those from pollens, grasses and trees, for use in human allergy immunotherapy and diagnosis in the United States. Center provides these allergenic extracts to human allergists both in bulk form to those allergists who wish to mix their own allergenic immunotherapy treatment sets and in the form of custom-made patient immunotherapy treatment sets of multiple allergens. In December 1999, we announced that our operations at Center were under strategic review. We continue to evaluate Center's business from both a strategic and operational perspective and are looking for opportunities to optimize this business. In addition to manufacturing and marketing veterinary allergy products, CMG manufactures and markets a broad range of human allergy diagnostic products for sale primarily in Europe. These products are sold primarily through distributors. PRODUCT CREATION We are committed to creating innovative products to address significant unmet health needs of companion animals. We create products both through internal research and development and through external collaborations. Internal research is managed by multidisciplinary product-associated project teams consisting of veterinarians, biologists, molecular and cellular biologists, biochemists and immunologists. We believe that we have one of the most sophisticated scientific efforts in the world devoted to applying biotechnology to the creation of companion animal products. We are also committed to identifying external product opportunities and creating business and technical collaborations that lead to the creation of other 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. 6 7 Our product pipeline currently includes numerous products in various stages of development. Products under development include several point-of-care diagnostic products, vaccines for infectious diseases in cats, dogs and horses and therapeutic products for allergy, cancer, osteoarthritis and flea control. The vast majority of all our research and development resources are directed towards the development of new companion animal health products. We incurred expenses of $20.3 million, $25.1 million and $17.0 million in the years ended December 31, 1997, 1998 and 1999, respectively in support of our research and development activities. SALES AND MARKETING We presently market our products in the United States directly to veterinarians through the use of our field sales force, inside customer service/tele-sales force and veterinary distributors acting as contract sales agents. As of December 1999, we had approximately 36 field sales representatives and field sales supervisors and 15 customer service/tele-sales representatives and supervisors. The 17 veterinary distributors with whom we have entered into sales agency relationships, and three direct sales distributors employ approximately 700 field and customer service/tele-sales representatives, although some of these distributors do not sell all of our products. In October 1999, we entered into an agreement with a third party to provide a contract sales force for the sale of our products to equine veterinarians. Internationally, we market our products to veterinarians primarily through distributors. We estimate that there are approximately 30,000 veterinarians in the United States whose practices are devoted principally to small animal medicine. Those veterinarians practice in approximately 20,000 clinics in the United States. We plan to market our products to these clinics primarily through the use of our field and telephone sales force, sales agents, direct sales distributors, trade shows and print advertising. During the past year, we sold our products to more than 14,000 such clinics in the United States. Certain of the products which we have under research and development, if completed, may be marketed partially or wholly by third parties with whom we have collaborative agreements. Center's human allergy immunotherapy products are marketed and sold in the United States by Center Pharmaceuticals, Inc., an unaffiliated sales and marketing company that markets allergy related products primarily to human allergists in the United States. Center Pharmaceuticals markets and sells Center's human allergy products as a contract sales agent of Center. MANUFACTURING Our products are manufactured by our Diamond, Center and CMG subsidiaries and/or by third-party manufacturers. Diamond's facility is a USDA and FDA licensed biological and pharmaceutical manufacturing facility in Des Moines, Iowa. We expect that we will manufacture most or all of our biological products at this facility, as well as most or all of our recombinant proteins and other proprietary reagents for our diagnostic products. We manufacture all of our allergy immunotherapy products at Center's USDA and FDA licensed manufacturing facility in Port Washington, New York. CMG manufactures its veterinary and human allergy diagnostic products at its facility in Fribourg, Switzerland. Diamond and Center's facilities are subject to regulation and inspection by the USDA and the FDA. Our heartworm point-of-care diagnostic products are manufactured by Quidel Corporation and Diamond. Our periodontal disease therapeutic is manufactured by Atrix Laboratories, Inc., the company that developed this product for human use. Our patient monitoring and diagnostic instruments, including 7 8 our clinical and hematology analyzers and veterinary sensors, are manufactured by third-party manufacturers. In addition to manufacturing our proprietary products, Diamond manufactures animal health vaccine products for marketing and sale by other companies. Diamond currently has the capacity to manufacture more than 50 million doses of vaccines each year. Diamond's customers purchase products in both bulk and finished format, and Diamond performs all phases of manufacturing, including growth of the active bacterial and viral agents, sterile filling, lyophilization and packaging. In addition, Diamond offers to support its customers through research services, regulatory compliance services, validation support and distribution services. In addition to manufacturing our proprietary products, Center manufactures allergy immunotherapy products which are distributed in the human market using an independent and unaffiliated distribution company, Center Pharmaceuticals, Inc. COLLABORATIVE AGREEMENTS Novartis We have entered into several agreements with Novartis. Novartis has certain rights to manufacture and market any flea control vaccine or feline heartworm control vaccine developed by us as to which USDA prelicensing serials are completed on or before December 31, 2005. We and Novartis have co-exclusive rights to market these products under our own trade names throughout the world (other than in countries in which Eisai Co., Ltd. has such rights) and, if we both elect to market, we will share revenues on each other's sales. The marketing agreements remain in force through 2010 or longer, if Novartis is still actively marketing such products. In addition, we entered into a screening and development agreement under which we may undertake joint research and development activities in certain fields. If we fail to agree to perform joint research activities, then Novartis has the right to use certain of our materials on an exclusive basis to develop food animal pharmaceutical products or on a co-exclusive basis with us to develop pharmaceutical products for parasite control in companion animals or food animal vaccines. Novartis would pay royalties on any such products developed by it. Currently, there are no joint research projects being undertaken under this agreement. We also entered into a right of first refusal agreement under which, prior to granting licenses to any third-party to any products or technology developed or acquired by us for either companion animal or food animal applications, we must first notify and offer Novartis such rights. If we are unable to come to an agreement within 150 days of the first notice, we may thereafter license such rights to third parties on terms not materially more favorable than the terms last offered by us to Novartis. The screening and development agreement and right of first refusal agreement each terminate in 2005. Heska and Novartis have subsequently entered into additional research and development agreements. We also have an exclusive distribution agreement pursuant to which Novartis has the exclusive right to distribute selected Heska products in Japan, including our in-clinic feline and canine heartworm diagnostic products and feline viral vaccines, upon obtaining regulatory approval in Japan for such products. Novartis also granted us a right of first refusal to evaluate for possible development and marketing worldwide certain new product technologies for the veterinary market as they may become available from Novartis. 8 9 Bayer We currently have a research agreement with Bayer providing for funding of research by Bayer on a canine heartworm vaccine. Bayer has the option to obtain an exclusive, royalty-bearing license to sell this vaccine in all countries except in those in which Eisai has rights. If Bayer exercises this option, we will negotiate license and distribution agreements. We have the first option to manufacture any products sold pursuant to any such distribution agreement. The research agreement will terminate upon completion of the research program. Bayer may terminate the research agreement prior to completion, but would not have any rights to market the vaccine (unless it terminated due to our breach), although it would have non-exclusive access to technology developed in the research program for use other than in similar vaccines. In the event Bayer elects to terminate the research agreement (other than due to our breach), we would recover the right to market the vaccine, subject to certain royalties to Bayer intended to repay certain amounts Bayer paid under the research agreement. We also had a research agreement with Bayer with respect to a recombinant feline toxoplasmosis vaccine which has been terminated. Eisai We have an agreement with Eisai, a leading Japanese pharmaceutical company, pursuant to which Eisai has the exclusive right to market our feline and canine heartworm vaccines and flea control vaccine in Japan and most other countries in East Asia. We received an up-front license fee and research funding for the development of these products. We have the right to manufacture any such products pursuant to a supply agreement to be negotiated. The agreement will terminate in January 2008, unless extended or earlier terminated by either party for material breach of the agreement or by Eisai pursuant to certain early termination rights. Ralston Purina Company We have a strategic alliance with Ralston Purina Company, the world's largest manufacturer of dry dog foods and dry and soft-moist cat foods. Ralston Purina holds exclusive rights to license our discoveries, know-how and technologies for innovative diets for dogs and cats. We are jointly developing therapeutic diets. We believe that the combination of our expertise in companion animal disease physiology with Ralston Purina's expertise in formulation and diet testing will lead to the development of novel nutritional products. Testing of experimental formulations is ongoing. In the event any products that are the subject of the collaboration are commercialized by Ralston Purina, Ralston Purina will pay us a royalty on products incorporating our technology. Quidel We have a development agreement with Quidel under which we jointly developed our Solo Step(TM) CH, Solo Step(TM) CH Batch Test Strips and Solo Step(TM) FH point-of-care diagnostic products using Quidel's rapid in-clinic test technology. We also have a supply agreement under which Quidel manufactures these products. INTELLECTUAL PROPERTY We believe that patents, trademarks, copyrights and other proprietary rights are important to our business. We also rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. 9 10 We actively seek patent protection both in the United States and abroad. As of December 31, 1999, we owned or co-owned 57 issued U.S. patents and 131 pending U.S. patent applications. Our issued U.S. patents primarily relate to proprietary allergy, flea control, heartworm, trichinosis and diagnostic and vaccine delivery technology. Our pending patent applications primarily relate to proprietary allergy, flea control, heartworm, equine influenza, diagnostic, vaccine delivery and patient monitoring instrument technologies. Applications corresponding to pending U.S. applications have been or will be filed in other countries. We also have obtained exclusive and non-exclusive licenses for numerous other patents held by academic institutions and biotechnology and pharmaceutical companies. The proprietary technologies of Diamond, Center and CMG are primarily protected through trade secret protection of, for example, their manufacturing processes. In general, the intellectual property of Diamond's customers belongs to such customers. As patent applications in the United States are maintained in secrecy until patents issue and as publication of discoveries in the scientific or patent literature often lags behind the actual discoveries, we cannot be certain that we were the first to make the inventions covered by each of our pending patent applications or that we were the first to file patent applications for such inventions. Furthermore, the patent positions of biotechnology and pharmaceutical companies are highly uncertain and involve complex legal and factual questions, and, therefore, the breadth of claims allowed in biotechnology and pharmaceutical patents or their enforceability cannot be predicted. There can be no assurance that patents will issue from any of our patent applications or, should patents issue, that we will be provided with adequate protection against potentially competitive products. Furthermore, there can be no assurance that should patents issue, they will be of commercial value to us, or that the United States Patent and Trademark Office or private parties, including competitors, will not successfully challenge our patents or circumvent our patent position. For example, we are currently in litigation with Synbiotics Corporation over a patent relating to heartworm diagnostic technology. Pursuant to the terms of the Uruguay Round Agreements Act, patents issuing from applications filed on or after June 8, 1995 have a term of 20 years from the date of such filing, irrespective of the period of time it may take for such patent to ultimately issue. This method of patent term calculation can result in a shorter period of patent protection afforded to our products compared to the prior method of term calculation (17 years from the date of issue) as patent applications in the biopharmaceutical sector often take considerable time to issue. Under the Drug Price Competition and Patent Term Restoration Act of 1984 and the Generic Animal Drug and Patent Term Restoration Act, a patent which claims a product, use or method of manufacture covering drugs and certain other products may be extended for up to five years to compensate the patent holder for a portion of the time required for FDA review of the product. There can be no assurance that we will be able to take advantage of the patent term extension provisions of this law. GOVERNMENT REGULATION Most of our products being developed will require licensing by a governmental agency before marketing. In the United States, governmental oversight of animal health products is primarily provided by two agencies: the USDA and the FDA. Vaccines and point-of-care diagnostics for animals are considered veterinary biologics and are regulated by the Center for Veterinary Biologics of the USDA under the auspices of the Virus-Serum-Toxin Act. Alternatively, animal drugs, which generally include all synthetic compounds, are approved and monitored by the Center for Veterinary Medicine of the FDA under the auspices of the Federal Food, Drug and Cosmetic Act. A third agency, the Environmental 10 11 Protection Agency, has jurisdiction over certain products applied topically to animals or to premises to control external parasites. In the United States, governmental oversight of human health products is provided exclusively by the FDA. Many of our regulated products presently under development will be regulated by the USDA. The purpose of the Virus-Serum-Toxin Act is to ensure that veterinary biologics sold in the United States are safe and efficacious. Pre-market testing is performed by the manufacturer and the CVB prior to approval of the product for sale, as well as on each new lot. Although the procedures for licensing products by the USDA are formalized, the acceptable standards of performance for any product are agreed upon between the manufacturer and the CVB. For novel products that are unlike others already licensed, the agreement on expected performance standards is typically reached through a dialogue between the CVB and the manufacturer. The formal demonstration of acceptable efficacy of the product is typically done in carefully controlled laboratory trials. This is normally a much more efficient and reliable process than demonstration of efficacy in clinical trials using client-owned animals. Industry data indicates that it takes approximately four years and $1.0 million to license a conventional vaccine for animals from basic research through licensing. In contrast to vaccines, point-of-care diagnostics can typically be licensed by the USDA in about a year, with 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 prepared, information on the performance and safety of the product in laboratory studies and information on performance of the product in field conditions. However, the submission and review of these data packages is not staged, so that one must be completed before beginning the next. Industry data indicates that it takes about 11 years and $5.5 million to develop a new drug for animals, from commencement of research to market introduction. Of this time, approximately three years is spent in the clinical trial and review process. However, unlike human drugs, neither preclinical studies in model systems nor a sequential phase system of clinical trials are required. Rather, for animal drugs, clinical trials 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 and productive times in the drug development process. In addition, the time and cost for developing companion animal drugs may be significantly less than for drugs for food producing animals, as food safety issues relating to tissue residue levels are not present. A number of animal health products are not regulated. For example, assays for use in a veterinary diagnostic laboratory and certain medical instruments do not have to be licensed by either the USDA or FDA. Additionally, certain botanically derived products, certain nutritional products and grooming and supportive care products are exempt from significant regulation as long as they do not bear a therapeutic claim that represents the product as a drug. The European Union has centralized the regulatory process for companion animal drugs and biologics for member states. In addition, both the USDA and the FDA are working with the European Union and Japan via the Veterinary International Cooperation on Harmonization initiative to harmonize the regulatory requirements for companion animal health products. Thus, in the future, it is hoped that a single set of requirements will be in place to streamline the licensing of veterinary products in the major companion animal markets. 11 12 Delays in obtaining or failure to obtain any necessary regulatory approvals for our products could harm our future product sales and operations. Heska has experienced delays in the past and could incur additional delays in the future. Any acquisitions of new products and technologies may subject us to additional government regulation. COMPETITION 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. Companies with a significant presence in the companion animal health market, such as American Home Products, Bayer, Merial Ltd., Novartis, Pfizer Inc., Schering-Plough Corp., Pharmacia & Upjohn, Inc. and IDEXX Laboratories, Inc., have developed or are developing products that do or would compete with our products. These competitors may have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than us. Moreover, such competitors may offer broader product lines and have greater name recognition than us. Novartis and Bayer are our marketing partners and their agreements with us do not restrict their ability to develop and market competing products. The market for companion animal health care products is highly fragmented, with discount stores and specialty pet stores accounting for a substantial percentage of such sales. As we intend to distribute our products primarily through veterinarians, a substantial segment of the potential market may not be reached and we may not be able to offer our products at prices which are competitive with those of companies that distribute their products through retail channels. Center's human allergy immunotherapy products compete with similar products offered by a number of other companies, some of which have substantially greater financial, technical, research and other resources than Center and more established marketing, sales, distribution and service organizations than Center Pharmaceuticals, Inc. The bovine vaccines sold by Diamond to AgriLabs compete with similar products offered by a number of other companies, some of which have substantially greater financial, technical, research and other resources than Diamond and more established marketing, sales, distribution and service organizations than AgriLabs. EMPLOYEES As of December 31, 1999, we and our subsidiaries employed 463 full-time persons, of whom 165 were in manufacturing, quality control, shipping and receiving, and materials management, 92 were in research, development and regulatory affairs, 73 were in management, finance, administration, legal, information systems, human resources and facilities management, 89 were in sales, marketing and customer service and 44 were in the diagnostic laboratories. None of our employees is covered by a collective bargaining agreement, and we believe employee relations are good. 12 13 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company and their ages as of March 20, 2000 are as follows:
NAME AGE POSITION - ---- --- -------- Robert B. Grieve, Ph.D. 48 Vice Chairman and Chief Executive Officer James H. Fuller 55 President and Chief Operating Officer Ronald L. Hendrick 54 Executive Vice President, Chief Financial Officer and Secretary Paul S. Hudnut 41 Executive Vice President Guiseppe Miozzari, Ph.D. 53 Managing Director, Heska Europe Dan T. Stinchcomb, Ph.D. 46 Executive Vice President, Research and Development
Robert B. Grieve, Ph.D., a founder of the Company, currently serves as Chief Executive Officer and Vice Chairman of the Board of Directors. Dr. Grieve was named Chief Executive Officer effective January 1, 1999 and Vice Chairman effective March 1992. Dr. Grieve also served as Chief Scientific Officer from December 1994 to January 1999 and Vice President, Research and Development, from March 1992 to December 1994. He has been a member of the Company's Board of Directors since 1990. He holds a Ph.D. degree from the University of Florida and M.S. and B.S. degrees from the University of Wyoming. James H. Fuller is President and Chief Operating Officer of the Company. He joined the Company in January 1999. Prior to joining the Company, Mr. Fuller served as Corporate Vice President of Allergan, Inc., a leading specialty pharmaceutical company, from 1994 through 1998. Prior to that, Mr. Fuller served in a number of sales and marketing positions at Allergan since 1974. He holds M.S. and B.S. degrees from the University of Southern California. Ronald L. Hendrick is Executive Vice President, Chief Financial Officer and Secretary of the Company. He joined the Company in December 1998. Prior to joining the Company, Mr. Hendrick was Executive Vice President and Chief Financial Officer of Xenometrix, Inc., a human biotechnology concern, from 1995 until December 1998. Prior to that, Mr. Hendrick served as Vice President and Corporate Controller at Alexander & Alexander Services, Inc., a NYSE financial services firm, from 1993 until 1995, and before that he was Vice President and Corporate Controller, Adolph Coors Company. Mr. Hendrick is a Certified Public Accountant. He holds a M.B.A. from the University of Colorado and a B.A. degree from Michigan State University. Paul S. Hudnut is Executive Vice President of the Company. He was elected Executive Vice President in September 1998, and prior to that was Vice President of Business Development of the Company since June 1996. Prior to joining the Company in June 1996, Mr. Hudnut was a General Manager at US WEST Media Group and held various positions in management and business development at subsidiaries of US WEST, Inc. from February 1988. Prior to joining US WEST, Mr. Hudnut was an associate with the Denver, Colorado law firm of Davis, Graham and Stubbs. He holds a J.D. degree from the University of Virginia and a B.A. degree from The Colorado College. Giuseppe Miozzari, Ph.D., joined the Company as Managing Director, Heska Europe in March 1997. From 1980 to March 1997, Dr. Miozzari served in senior research positions with Novartis, most recently as the Head of Research of the Animal Health Sector and prior to that, from 1980 to 1983, as Head of the Molecular Biology Research Unit in the Pharmaceuticals Division. Dr. Miozzari also served as Novartis' designate on the Board of Directors of the Company from April 1996 to March 1997. 13 14 Dr. Miozzari holds Ph.D. and Dipl. Sc. Nat. degrees from the Federal Institute of Technology (ETH) in Zurich, Switzerland. Dan T. Stinchcomb, Ph.D., was appointed Executive Vice President, Research and Development in December 1999. He previously was appointed Vice President, Research, in December 1998. He joined Heska in May 1996 as Vice President, Biochemistry and Molecular Biology. Prior to joining the Company, from July 1993 until May 1996, Dr. Stinchcomb was employed by Ribozyme Pharmaceuticals, Inc., most recently as Director of Biology Research. From 1988 until 1993, Dr. Stinchcomb held various positions with Synergen, Inc. Prior to joining Synergen, Dr. Stinchcomb was an Associate Professor in Cellular and Developmental Biology at Harvard University. He holds a Ph.D. degree from Stanford University and a B.A. degree from Harvard University. ITEM 2. PROPERTIES. We currently lease an aggregate of approximately 64,000 square feet of administrative and laboratory space in four buildings located in Fort Collins, Colorado under leases expiring through 2005, with options to extend through 2010 for the larger facilities. We believe that our present Fort Collins facilities are adequate for our current and planned activities and that suitable additional or replacement facilities in the Fort Collins area are readily available on commercially reasonable terms should such facilities be needed in the future. Diamond's principal manufacturing facility in Des Moines, Iowa, consisting of 166,000 square feet of buildings on 34 acres of land, is owned by Diamond. Diamond also owns a 160-acre farm used principally for research purposes located in Carlisle, Iowa. Center owns its approximately 27,000 square foot facility in Port Washington, New York. The Company's European subsidiaries lease their facilities. We also currently lease approximately 19,500 square feet of office and manufacturing space in Waukesha, Wisconsin which we have vacated and are currently seeking to sublease. ITEM 3. LEGAL PROCEEDINGS. In November 1998, Synbiotics Corporation filed a lawsuit against us in the United States District Court for the Southern District of California in which it alleges that we infringe a patent owned by Synbiotics relating to heartworm diagnostic technology. Discovery continues, and no trial date has been set. We have obtained legal opinions from our outside patent counsel that our heartworm diagnostic products do not infringe the Synbiotics patent and that the patent is invalid. The opinions of non-infringement are consistent with the results of our internal evaluations. While we believe that we have valid defenses to Synbiotics' allegations and intend to defend the action vigorously, there can be no assurance that an adverse result or settlement would not have a material adverse effect on our financial position, results of operations or cash flow. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. 14 15 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Our common stock is quoted on the Nasdaq National Market under the symbol "HSKA." The following table sets forth the intraday high and low prices for our common stock as reported by the Nasdaq National Market, for the periods indicated below.
HIGH LOW --------- --------- 1998 First Quarter...................... $ 14.875 $ 9.25 Second Quarter..................... 16.75 8.75 Third Quarter...................... 11.938 5.125 Fourth Quarter..................... 7.625 3.00 1999 First Quarter...................... 6.00 3.00 Second Quarter..................... 5.125 2.25 Third Quarter...................... 3.938 2.00 Fourth Quarter..................... 2.938 1.375 2000 First Quarter (through March 20)... 6.00 2.063
On March 20, 2000, the last reported sale price of our common stock was $4.75 per share. As of February 29, 2000, there were approximately 285 holders of record of our common stock and approximately 4,062 beneficial stockholders. We have never declared or paid cash dividends on our capital stock and do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings for the development of our business. 15 16 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA. The data set forth below 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 in this Form 10-K.
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------- 1995 1996 1997 1998 1999 -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues: Products, net ..................................... $ 4,719 $ 15,570 $ 26,725 $ 38,451 $ 50,291 Research and development .......................... 2,230 1,946 2,578 1,321 885 -------- -------- -------- -------- -------- Total revenues ................................ 6,949 17,516 29,303 39,772 51,176 Costs and operating expenses: Cost of goods sold ................................ 2,842 12,002 20,077 29,087 36,386 Research and development .......................... 6,412 14,513 20,343 25,126 17,042 Selling and marketing ............................. 902 4,168 9,954 13,188 15,073 General and administrative ........................ 1,442 5,514 13,192 11,939 11,231 Amortization of intangible assets and deferred compensation .................................. 278 1,289 2,500 2,745 2,228 Purchased research and development ................ -- -- 2,399 -- -- Loss on assets held for disposition ............... -- -- -- 1,287 2,593 Restructuring expense ............................. -- -- -- 2,356 1,210 -------- -------- -------- -------- -------- Total costs and operating expenses ............ 11,876 37,486 68,465 85,728 85,763 -------- -------- -------- -------- -------- Loss from operations ..................................... (4,927) (19,970) (39,162) (45,956) (34,587) Other income (expense) ................................... 19 721 298 1,682 (1,249) -------- -------- -------- -------- -------- Net loss ................................................. $ (4,908) $(19,249) $(38,864) $(44,274) $(35,836) ======== ======== ======== ======== ======== Basic net loss per share ................................. $ (1.79) $ (1.31) ======== ======== Unaudited pro forma basic net loss per share(1) .......... $ (1.53) $ (2.42) ======== ======== Shares used to compute basic net loss per share and unaudited pro forma basic net loss per share ...... 12,609 16,042 24,693 27,290
DECEMBER 31, --------------------------------------------------------------------- 1995 1996 1997 1998 1999 --------- --------- --------- --------- --------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash, cash equivalents and marketable securities .... $ 6,849 $ 23,721 $ 28,752 $ 51,930 $ 23,981 Working capital ..................................... 6,843 24,224 31,461 51,947 28,234 Total assets ........................................ 11,291 45,651 69,020 98,054 71,168 Long-term obligations ............................... 903 5,077 10,754 11,367 5,346 Accumulated deficit ................................. (14,379) (33,628) (72,492) (116,766) (152,602) Total stockholders' equity .......................... 7,414 32,671 43,850 67,114 45,439
- ----------- (1) See Note 2 of Notes to Consolidated Financial Statements for information concerning the computation of pro forma basic net loss per share. 16 17 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 Consolidated Financial Data" and the Consolidated Financial Statements and related Notes included in Items 6 and 8 of this Form 10-K. This discussion contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Our actual results and the timing of certain events could differ materially from the results discussed in the forward-looking statements. When used in this discussion, the words "expects," "anticipates," "estimates" and similar expressions are intended to identify forward-looking statements. Such statements, which include statements concerning future revenue sources and concentration, gross margins, research and development expenses, selling and marketing expenses, general and administrative expenses, capital resources, additional financings or borrowings and additional losses, are subject to risks and uncertainties, including those set forth below under "--Factors that May Affect Results" that could cause actual results to differ materially from those projected. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions, or circumstances on which any such statement is based. OVERVIEW We are primarily focused on the discovery, development and marketing of companion animal health products. In addition to manufacturing certain of our companion animal products, our primary manufacturing subsidiary, Diamond also manufactures bovine vaccine products and pharmaceutical products that are marketed and distributed by third parties. In addition to manufacturing veterinary allergy products for marketing and sale by us, our subsidiaries, Center and CMG, also manufacture and sell human allergy products. We also offer diagnostic services to veterinarians at our Fort Collins, Colorado location. From our inception in 1988 until early 1996, our operating activities related primarily to research and development activities, entering into collaborative agreements, raising capital and recruiting personnel. Prior to 1996, we had not received any revenues from the sale of products. During 1996, we grew from being primarily a research and development concern to a fully-integrated research, development, manufacturing and marketing company. We accomplished this by acquiring Diamond, a licensed pharmaceutical and biological manufacturing facility in Des Moines, Iowa, hiring key employees and support staff, establishing marketing and sales operations to support our products introduced in 1996, and designing and implementing more sophisticated operating and information systems. We also expanded the scope and level of our scientific and business development activities, increasing the opportunities for new products. In 1997, we introduced 13 additional products and expanded in the United States through the acquisition of Center, an FDA and USDA licensed manufacturer of allergy immunotherapy products located in New York, and internationally through the acquisitions of Heska UK, a veterinary diagnostic laboratory in England and CMG in Switzerland, which manufactures and markets allergy diagnostic products for use in veterinary and human medicine, primarily in Europe. Each of our acquisitions during this period was accounted for under the purchase method of accounting and accordingly, our financial statements reflect the operations of these businesses only for the periods subsequent to the acquisitions. In July 1997, we established a new subsidiary, Heska AG, located near Basel, Switzerland, for the purpose of managing our European operations. 17 18 During the first quarter of 1998 we acquired a manufacturer and marketer of patient monitoring devices. The financial results of this entity have been consolidated with ours under the pooling-of-interests accounting method for all periods presented. These operations were consolidated with our existing operations in Fort Collins, Colorado and Des Moines, Iowa as of December 31, 1999, and our facility in Waukesha, Wisconsin was closed. In December 1999, we announced our intent to sell our subsidiary in the United Kingdom, Heska UK. The sale was completed in March 2000. In 1999, we recorded a loss on disposition of approximately $1.0 million related to the sale of Heska UK. We have incurred net losses since our inception and anticipate that we will continue to incur additional net losses in the near term as we introduce new products, expand our sales and marketing capabilities and continue our research and development activities. Cumulative net losses from inception in 1988 through December 31, 1999 have totaled $152.6 million. Our ability to achieve profitable operations will depend primarily upon our ability to successfully market our products, commercialize products that are currently under development and develop new products. Most of our products are subject to long development and regulatory approval cycles, and there can be no assurance that we will successfully develop, manufacture or market these products. There can also be no assurance that we will attain profitability or, if achieved, will remain profitable on a quarterly or annual basis in the future. Until we attain positive cash flow, we may continue to finance operations with additional equity and debt financing. There can be no assurance that such financing will be available when required or will be obtained under favorable terms. See the discussion later in this section titled "Factors That May Affect Results" for a more in-depth explanation of risks faced by us. RESULTS OF OPERATIONS Year Ended December 31, 1999 Total revenues, which include product and research and development revenues, increased 29% to $51.2 million in 1999 compared to $39.8 million in 1998. Product revenues increased 31% to $50.3 million in 1999 compared to $38.5 million in 1998. The growth in revenues during 1999 was primarily due to sales of new products introduced during 1999 and increased sales of our existing products. Sales to one customer, Bayer, represented 12% of total revenues in 1999 and are expected to decline in future years due to the expiration in February 2000 of a take-or-pay contract with Bayer. It is expected that a portion of these sales will be replaced under an agreement for the sale of certain new vaccines to AgriLabs for distribution by Bayer and others. Revenues from sponsored research and development decreased to $900,000 in 1999 from $1.3 million in 1998. Fluctuations in revenues from sponsored research and development are generally the result of changes in the number of funded research projects as well as the timing and performance of contract milestones. We may engage in additional sponsored research if such projects become available and are consistent with our research priorities. Cost of goods sold totaled $36.4 million in 1999 compared to $29.1 million in 1998, and the resulting gross profit from product sales for 1999 increased to $13.9 million from $9.4 million in 1998. Our gross margin percentage was 28% in 1999, compared to 24% in 1998. During 1999, the gross profit margin improved as our product mix included a higher percentage of proprietary products with higher 18 19 gross profit margins. Also during fiscal 1999, we eliminated certain product lines that did not meet gross profit expectations. We believe that gross profit margins as a percentage of revenues will improve in future years, as more of our proprietary diagnostic, vaccine and pharmaceutical products are approved by the applicable regulatory bodies and achieve market acceptance. Research and development expenses decreased to $17.0 million in 1999 from $25.1 million in 1998. The decrease in 1999 was primarily due to reductions in our internal research and development activities, resulting from our restructuring in December 1998, and our decision to eliminate or defer research projects which appeared to have greater long-term risk or lower market potential. Research and development expenses are expected to decrease as a percentage of total revenues in future years. Selling and marketing expenses increased to $15.1 million in 1999 from $13.2 million in 1998. This increase reflects primarily the expansion of our sales and marketing organization and costs associated with the introduction and marketing of new products. Selling and marketing expenses consist primarily of salaries, commissions and benefits for sales and marketing personnel, commissions paid to contract sales personnel and expenses of product advertising and promotion. We expect selling and marketing expenses to increase as sales volumes increase and new products are introduced to the marketplace, but to decrease as a percentage of total revenues in future years. General and administrative expenses decreased to $11.2 million in 1999 from $11.9 million in 1998. The decrease in 1999 was primarily due to reductions in staffing and expenditures, resulting from our restructuring in December 1998. General and administrative expenses are expected to decrease as a percentage of total revenues in future years. Amortization of intangible assets and deferred compensation decreased to $2.2 million in 1999 from $2.7 million in 1998. Intangible assets resulted primarily from our 1997 and 1996 business acquisitions and are being amortized over lives of 2 to 10 years. The amortization of deferred compensation resulted in a non-cash charge to operations in 1999 of approximately $629,000 compared to $736,000 in 1998. In connection with the grant of certain stock options in 1997 and 1996, we recorded deferred compensation representing the difference between the deemed value of the common stock for accounting purposes and the exercise price of such options at the date of grant. Compensation costs, equal to the fair value of the options on the date of grant, will be recognized over the service period. We expect to incur a non-cash charge to operations as a result of option grants outstanding at December 31, 1999 of approximately $574,000 and $74,000 per year for 2000 and 2001, respectively, for amortization of deferred compensation. The loss on assets held for disposition of $2.6 million recorded in 1999 reflects the write-down of certain tangible and intangible assets to their expected net realizable values. Included in the loss was $1.0 million related to the sale of Heska UK, a write-off of $580,000 in book value of assets held for sale resulting from our decision to discontinue contract manufacturing of certain low margin human healthcare products for third parties at Diamond and a write-off of $1.0 million in book value of certain intangible and tangible assets no longer considered strategic and held for sale or other disposition. During the third quarter of 1999, we recognized a charge to operations of approximately $1.2 million related to our decision to consolidate the operations of our Waukesha, Wisconsin facility into our existing operations in Fort Collins, Colorado and Des Moines, Iowa. The charge was primarily for personnel severance costs and the cost of closing the facility in Waukesha, Wisconsin. 19 20 Interest income decreased to $1.6 million in 1999 from $3.2 million in 1998 as a result of reduced cash available for investment as we funded our business operations. Interest income is expected to decline in the future as we continue to use cash to fund our business operations. Interest expense decreased slightly to $1.9 million in 1999 from $2.0 million in 1998. Other expense of nearly $1.0 million in 1999 is due primarily to the loss realized on the sale of certain long-term, interest-bearing government securities. Year Ended December 31, 1998 Total revenues, which include product and research and development revenues, increased 36% to $39.8 million in 1998 compared to $29.3 million in 1997. Product revenues increased 44% to $38.5 million in 1998 compared to $26.7 million in 1997. The growth in revenues during 1998 was primarily due to sales of new products introduced during 1998, increased sales of our existing products and from consolidating revenues of Center and CMG subsequent to their acquisitions in July 1997 and September 1997, respectively. Sales to one customer, Bayer, represented 15% of total revenues in 1998. Revenues from sponsored research and development decreased to $1.3 million in 1998 from $2.6 million in 1997. Fluctuations in revenues from sponsored research and development are generally the result of changes in the number of funded research projects as well as the timing and performance of contract milestones. Cost of goods sold totaled $29.1 million in 1998 compared to $20.1 million in 1997, and the resulting gross profit from product sales for 1998 increased to $9.4 million from $6.6 million in 1997. Our gross margin percentage was 24% in 1998, compared to 25% in 1997. Gross profit margins in 1998 were adversely affected by inventory write-downs of approximately $1.5 million during the year. Without these inventory write-downs, gross profit margins would have been 28%. Research and development expenses increased to $25.1 million in 1998 from $20.3 million in 1997. The increase in 1998 was primarily due to increases in the level and scope of our internal research and development activities, expenses related to new collaborative agreements and licenses to support research efforts for potential products to be developed by us. Selling and marketing expenses increased to $13.2 million in 1998 from $10.0 million in 1997. This increase reflects primarily the expansion of our sales and marketing organization and costs associated with the introduction and marketing of new products. General and administrative expenses decreased to $11.9 million in 1998 from $13.2 million in 1997. The decrease in 1998 was primarily due to a one-time charge in 1997 relating to a supply agreement termination fee. Amortization of intangible assets and deferred compensation increased to $2.7 million in 1998 from $2.5 million in 1997. Intangible assets resulted primarily from our 1997 and 1996 business acquisitions and are being amortized over lives of 2 to 10 years. The amortization of deferred compensation resulted in a non-cash charge to operations in 1998 of approximately $736,000 compared to $645,000 in 1997. In connection with the grant of certain stock options in 1997 and 1996, we deferred compensation representing the difference between the deemed value of the common stock for accounting purposes and the exercise price of such options at the date of grant. In 1998, we also granted stock options to non-employees in exchange for consulting services. Compensation costs, equal to the fair value of the options on the date of grant, will be recognized over the service period. 20 21 The loss on assets held for sale recorded in 1998 reflects the write-down of certain tangible and intangible assets to their expected net realizable values. In December 1998, we completed a cost reduction and restructuring plan. The restructuring was based on our determination that, while revenues had been increasing steadily, we believed that reducing expenses was necessary in order to accelerate our efforts to reach profitability. In connection with the restructuring, we recognized a charge to operations in 1998 of approximately $2.4 million. These expenses primarily related to personnel severance costs and costs associated with excess facilities and equipment. Interest income increased to $3.2 million in 1998 from $1.6 million in 1997 as a result of increased cash available for investment arising from the proceeds from our IPO in July 1997, the follow-on offering completed in March 1998 and the private placement of common stock in July 1998. Interest expense increased to $2.0 million in 1998 from $1.4 million in 1997 due to increases in debt financing for laboratory and manufacturing equipment and debt related to our 1997 business acquisitions. Year Ended December 31, 1997 Total revenues, which include product and research and development revenues, increased 67% to $29.3 million in 1997 compared to $17.5 million in 1996. Product revenues increased 71% to $26.7 million in 1997 compared to $15.6 million in 1996. The growth in revenues during 1997 was primarily due to new product introductions, increased sales of our existing products and from consolidating revenues of Diamond, Center and CMG subsequent to their acquisitions in April 1996, July 1997 and September 1997, respectively. Sales to one customer, Bayer, represented 21% of total revenues in 1997. Revenues from sponsored research and development increased to $2.6 million in 1997 from $1.9 million in 1996. Fluctuations in revenues from sponsored research and development are generally the result of changes in the number of funded research projects as well as the timing and performance of contract milestones. Cost of goods sold totaled $20.1 million in 1997 compared to $12.0 million in 1996, and the resulting gross profit for 1997 increased to $6.6 million from $3.6 million in 1996. Our gross profit margin from product sales was 25% in 1997, compared to 23% in 1996. Research and development expenses increased to $20.3 million in 1997 from $14.5 million in 1996. The increase in 1997 was primarily due to increases in the level and scope of our internal research and development activities, expenses related to new collaborative agreements and licenses to support research efforts for potential products to be developed by us. Selling and marketing expenses increased to $10.0 million in 1997 from $4.2 million in 1996. This increase reflects primarily the expansion of our sales and marketing organization and costs associated with the introduction and marketing of new products. General and administrative expenses increased to $13.2 million in 1997 from $5.5 million in 1996. The increase in 1997 primarily resulted from the growth of accounting and finance, human resources, legal, administrative, information systems and facilities operations to support our increased 21 22 business, financing and financial reporting requirements. General and administrative expenses for 1997 include a one-time charge of $750,000 for the termination of a supply agreement. Amortization of intangible assets and deferred compensation increased to $2.5 million in 1997 from $1.3 million in 1996. Intangible assets resulted primarily from our 1997 and 1996 business acquisitions and are being amortized over lives of 2 to 10 years. The amortization of deferred compensation resulted in a non-cash charge to operations in 1997 of approximately $645,000 compared to $188,000 in 1996. In connection with the grant of certain stock options in 1997 and 1996, we recorded deferred compensation representing the difference between the deemed value of the common stock for accounting purposes and the exercise price of such options at the date of grant. Purchased research and development expenses of $2.4 million for 1997 reflect a one-time non-cash charge related to the acquisition in May 1997 of a development stage company. Interest income increased to $1.6 million in 1997 from $1.4 million in 1996 as a result of increased cash available for investment resulting from the proceeds from our IPO. Interest expense increased to $1.4 million in 1997 from $500,000 in 1996 due to increases in debt financing for laboratory and manufacturing equipment and debt related to our 1996 and 1997 business acquisitions. LIQUIDITY AND CAPITAL RESOURCES Our primary source of liquidity at December 31, 1999 was $24.0 million in cash, cash equivalents and marketable securities. The source of these funds was primarily attributable to our public offering of common stock in December 1999, which provided us with net proceeds of approximately $13.3 million, our follow-on public offering of common stock in March 1998 and the July 1998 private placement of common stock, which provided us with net proceeds of approximately $48.6 million and $15.0 million, respectively. As additional sources of liquidity, we and our subsidiaries have secured lines of credit totaling approximately $2.9 million, against which borrowings of approximately $1.2 million were outstanding at December 31, 1999. These financing facilities are secured by our assets and those of our respective subsidiaries, and by corporate guarantees of Heska. We expect to seek additional asset-based borrowing facilities. Net cash used in operating activities was $33.2 million in 1999, compared to $38.1 million in 1998. Accounts receivable increased by $3.0 million in 1999 as a result of the increase in product sales. Inventory levels increased by $1.8 million in 1999, primarily to support increased sales of existing products and inventory build-up in anticipation of new product introductions. Net cash flows from investing activities provided us with $20.3 million during 1999, compared to a use of $34.6 million in 1998. The cash provided in 1999 resulted from the sale of marketable securities and was used to fund our current year operations. Expenditures for property and equipment totaled $3.3 million for 1999 compared to $6.5 million in 1998. We have historically used, and anticipate that we will continue, to use capital equipment lease and debt facilities to finance equipment purchases and, if possible, leasehold improvements. We currently expect to spend approximately $2.0 million in 2000 for capital equipment, including expenditures to upgrade certain manufacturing operations to improve efficiencies and to assure ongoing compliance with regulatory requirements. We expect to finance these expenditures through equipment leases and secured debt facilities, where possible. 22 23 Net cash flows from financing activities generated $8.4 million in cash in 1999, compared to $67.9 million in 1998. The primary source of cash in 1999 was the public offering of common stock in December which provided us with net proceeds of approximately $13.3 million. We also borrowed an additional $971,000 under our available credit facilities. We used cash to repay $6.5 million of debt and capital lease obligations. Our primary short-term needs for capital, which are subject to change, are for our continuing research and development efforts, our sales, marketing and administrative activities, working capital associated with increased product sales and capital expenditures relating to developing and expanding our manufacturing operations. Our future liquidity and capital requirements will depend on numerous factors, including the extent to which our present and future products gain market acceptance, the extent to which products or technologies under research or development are successfully developed, the timing of regulatory actions regarding our products, the costs and timing of expansion of sales, marketing and manufacturing activities, the cost, timing and business management of current and potential acquisitions and contingent liabilities associated with such acquisitions, the procurement and enforcement of patents important to our business and the results of competition. We believe that our available cash, cash from operations and available borrowings will be sufficient to satisfy our projected cash requirements for at least the next 12 months, assuming no significant uses of cash in acquisition activities. Thereafter, if cash generated from operations is insufficient to satisfy our cash requirements, we will need to raise additional capital to continue our business operations. There can be no assurance that such additional capital will be available on terms acceptable to us, if at all. Furthermore, any additional equity financing would likely be dilutive to stockholders and debt financing, if available, may include restrictive covenants which may limit our operations and strategies. As of December 31, 1999, one of the Company's wholly-owned subsidiaries, Diamond, did not meet certain financial covenants contained in its existing $2,500,000 line of credit agreement. The commercial bank who provides the line of credit waived the covenant non-compliance as of December 31, 1999. The Company has reflected the $917,000 outstanding under the existing agreement as current in its financial statements. The Company has received a proposal for a new, larger corporate line of credit with the same commercial bank. The commitment is subject to a number of closing conditions. Management believes that such conditions will be satisfactorily met, however there can be no assurance the new line of credit facility will close. Under the terms and covenants of the proposed facility, the Company would have been in compliance as of December 31, 1999. NET OPERATING LOSS CARRYFORWARDS As of December 31, 1999, we had a net operating loss carryforward of approximately $127.5 million and approximately $2.7 million of research and development tax credits available to offset future federal income taxes. The NOL and tax credit carryforwards, which are subject to alternative minimum tax limitations and to examination by the tax authorities, expire from 2003 to 2019. Our acquisition of Diamond resulted in a "change of ownership" under the provisions of Section 382 of the Internal Revenue Code of 1986, as amended. As such, we will be limited in the amount of NOL's incurred prior to the merger that we may utilize to offset future taxable income. This limitation will total approximately $4.7 million per year for periods subsequent to the Diamond acquisition. Similar limitations also apply to utilization of R&D tax credits to offset taxes payable. We believe that this limitation may affect the eventual utilization of our total NOL carryforwards. 23 24 RECENT ACCOUNTING PRONOUNCEMENTS In December 1999, the SEC issued SAB No. 101, Revenue Recognition. SAB 101 clarifies the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. The guidance in SAB 101 must be implemented by our first fiscal quarter of fiscal 2000. We are currently reviewing the guidelines provided in SAB 101, and believe that SAB 101 will not significantly affect our results of operations. We do not expect the adoption of any standards recently issued by the Financial Accounting Standards Board or the Securities and Exchange Commission to have a material impact on our financial position or results of operations. FACTORS THAT MAY AFFECT RESULTS We have a history of losses and may never achieve profitability. We have incurred net losses since our inception. At December 31, 1999, our accumulated deficit was $152.6 million. We anticipate that we will continue to incur additional operating losses in the near term. These losses have resulted principally from expenses incurred in our research and development programs and from general and administrative and sales and marketing expenses. We cannot assure you that we will attain profitability or, if we do, that we will remain profitable on a quarterly or annual basis in the future. We have limited resources to devote to product development and commercialization. Our strategy is to develop a broad range of products addressing companion animal healthcare. We believe that our revenue growth and profitability, if any, will substantially depend upon our ability to: o improve market acceptance of our current products; o complete development of new products; and o successfully introduce and commercialize new products. We have introduced some of our products only recently and many of our products are still under development. Because we have limited resources to devote to product development and commercialization, any delay in the development of one product or reallocation of resources to product development efforts that prove unsuccessful may delay or jeopardize the development of our other product candidates. If we fail to develop new products and bring them to market, our business could be substantially harmed. We may experience difficulty in commercializing our products. Because several of our current products, as well as a number of products under development, are novel, we may need to expend substantial efforts in order to educate our customers about the uses of our products and to convince them of the need for our products. We cannot assure you that any of our products will achieve satisfactory market acceptance or that we will successfully commercialize them on a timely basis, or at all. If any of our products do not achieve a significant level of market acceptance, our business could be substantially harmed. 24 25 We must obtain costly regulatory approvals in order to bring our products to market. Many of the products we develop and market are subject to regulation by one or more of the USDA, FDA, EPA and foreign regulatory authorities. The development and regulatory approval activities necessary to bring new products to market are time-consuming and costly. We have experienced in the past, and may experience in the future, difficulties that could delay or prevent us from obtaining the regulatory approvals necessary to introduce new products or to market them. We cannot assure you that the USDA, FDA, EPA or foreign regulatory authorities will issue regulatory clearance or new product approvals on a timely basis, or at all. Any acquisitions of new products and technologies may subject us to additional government regulation. If we do not secure the necessary regulatory approvals for our products, our business could be substantially harmed. Factors beyond our control may cause our operating results to fluctuate and many of our expenses are fixed. We believe that our future operating results will fluctuate on a quarterly basis due to a variety of factors, including: o the introduction of new products by us or by our competitors; o market acceptance of our current or new products; o regulatory and other delays in product development; o product recalls; o competition and pricing pressures from competitive products; o manufacturing delays; o shipment problems; o product seasonality; and o changes in the mix of products sold. We have high operating expenses for personnel, new product development and marketing. Many of these expenses are fixed in the short term. If any of the factors listed above cause our revenues to decline, our operating results could be substantially harmed. We may need to seek additional financing in the future. We have incurred negative cash flow from operations since inception. We do not expect to generate positive cash flow sufficient to fund our operations in the near term. We believe that our available cash, cash from operations and available borrowings will be sufficient to satisfy our projected cash requirements for at least the next 12 months, assuming no significant uses of cash in acquisition activities. Thus, we may need to raise additional capital to fund our research and development, manufacturing, sales and marketing activities. Our future liquidity and capital requirements will depend on numerous factors, including: o the extent to which our present and future products gain market acceptance; o the extent to which we successfully develop products from technologies under research or development; o the timing of regulatory actions concerning our products; o the costs and timing of expansions of our sales, marketing and manufacturing activities; o the cost, timing and business management of recent and potential acquisitions and contingent liabilities associated with acquisitions; 25 26 o the procurement and enforcement of important patents, and o the results of competition. We cannot assure you that additional capital will be available on acceptable terms, if at all. Furthermore, any additional equity financing would likely be dilutive to stockholders, and debt financing, if available, may include restrictive covenants which may limit our currently planned operations and strategies. If adequate funds are not available, we may be required to curtail our operations significantly or to obtain funds by entering into collaborative agreements or other arrangements on unfavorable terms. If we fail to raise capital on acceptable terms when we need to, our business could be substantially harmed. A small number of large customers account for a large percentage of our revenues. We currently derive a substantial portion of our revenues from Diamond, which manufactures certain of our products and products for other companies in the animal health industry. Revenues from one Diamond customer comprised approximately 12% of total revenues in 1999 under the terms of a take-or-pay contract that expired in February 2000. If this customer does not continue to purchase from Diamond and if we fail to replace the lost revenues with revenues from other customers, our business could be substantially harmed. We have limited experience in marketing our products. The market for companion animal healthcare products is highly fragmented, with discount stores and specialty pet stores accounting for a substantial percentage of sales. Because we sell our companion animal health products only to veterinarians, we may fail to reach a substantial segment of the potential market, and we may not be able to offer our products at prices which are competitive with those of companies that distribute their products through retail channels. We currently market our products to veterinarians through a direct sales force and through third parties. To be successful, we will have to continue to develop and train our direct sales force or rely on marketing partnerships or other arrangements with third parties to market, distribute and sell our products. We cannot assure you that we will successfully develop and maintain marketing, distribution or sales capabilities, or that we will be able to make arrangements with third parties to perform these activities on satisfactory terms. If we fail to develop a successful marketing strategy, our business could be substantially harmed. We operate in a highly competitive industry. The market in which we operate is intensely competitive. Our competitors include independent animal health companies and major pharmaceutical companies that have animal health divisions. Companies with a significant presence in the animal health market, such as American Home Products, Bayer, Merial Ltd., Novartis, Pfizer Inc., Schering Plough Corporation, Pharmacia & Upjohn, Inc. and IDEXX Laboratories, Inc., have developed or are developing products that compete with our products or would compete with them if developed. These competitors may have substantially greater financial, technical, research and other resources and larger, better-established marketing, sales, distribution and service organizations than us. Our competitors offer broader product lines and have greater name recognition than we do. We cannot assure you that our competitors will not 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. Moreover, we cannot assure you that we will have the financial resources, technical expertise or marketing, distribution or support 26 27 capabilities to compete successfully. If we fail to compete successfully, our business could be substantially harmed. We have granted third parties substantial marketing rights to our products under development. We have granted marketing rights to certain products under development to third parties, including Novartis, Bayer, Eisai and Ralston Purina. Novartis has the right to manufacture and market throughout the world (except in countries where Eisai has such rights) under the Novartis trade name any flea control vaccine or feline heartworm vaccine we develop on or before December 31, 2005. We have retained the right to co-exclusively manufacture and market these products throughout the world under our own trade names. Accordingly, we and Novartis may become direct competitors, with each party sharing revenues on the other's sales. We have also granted Novartis a right of first refusal pursuant to which, prior to granting rights to any third party for any products or technology we develop or acquire for either companion animal or food animal applications, we must first offer Novartis such rights. In Japan, Novartis also has the exclusive right, upon regulatory approval, to distribute our (a) heartworm diagnostics, (b) trivalent and bivalent feline vaccines and (c) certain other Heska products. Bayer has exclusive marketing rights to our canine heartworm vaccine, except in countries where Eisai has such rights. Eisai has exclusive rights in Japan and most countries in East Asia to market our feline and canine heartworm vaccines, our feline and canine flea control vaccine and our feline toxoplasmosis vaccine. In addition, we granted Ralston Purina the exclusive rights to develop and commercialize our discoveries, know-how and technologies in various pet food products. Our agreements with our corporate marketing partners generally contain no minimum purchase requirements in order for them to maintain their exclusive or co-exclusive marketing rights. We cannot assure you that Novartis, Bayer, Eisai or Ralston Purina or any other collaborative party will devote sufficient resources to marketing our products. Furthermore, there is nothing to prevent Novartis, Bayer, Eisai or Ralston Purina or any other collaborative party from pursuing alternative technologies or products that may compete with our products. If we fail to develop and maintain our own marketing capabilities, we may find it necessary to continue to rely on potential or actual competitors for third-party marketing assistance. Third party marketing assistance may not be available in the future on reasonable terms, if at all. We may face costly intellectual property disputes. Our ability to compete effectively will depend in part on our ability to develop and maintain proprietary aspects of our technology and either to operate without infringing the proprietary rights of others or to obtain rights to technology owned by third parties. We have United States and foreign-issued patents and are currently prosecuting patent applications in the United States and with various foreign patent offices. We cannot assure you that any of our pending patent applications will result in the issuance of any patents or that any issued patents will offer protection against competitors with similar technology. We cannot assure you that any patents we receive will not be challenged, invalidated or circumvented in the future or that the rights created by those patents will provide a competitive advantage. We also rely on trade secrets, technical know-how and continuing invention to develop and maintain our competitive position. We cannot assure you that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets. The biotechnology and pharmaceutical industries have been characterized by extensive litigation relating to patents and other intellectual property rights. In 1998, Synbiotics Corporation filed a lawsuit 27 28 against us alleging infringement of a Synbiotics patent relating to heartworm diagnostic technology and this litigation remains ongoing. We cannot assure you that we will not become subject to additional patent infringement claims and litigation in the United States or other countries or interference proceedings conducted in the United States Patent and Trademark Office to determine the priority of inventions. The defense and prosecution of intellectual property suits, USPTO interference proceedings, and related legal and administrative proceedings are costly, time-consuming and distracting. We may also need to pursue litigation to enforce any patents issued to us or our collaborative partners, to protect trade secrets or know-how owned by us or our collaborative partners, or to determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or interference proceeding will result in substantial expense to us and significant diversion of the efforts of our technical and management personnel. Any adverse determination in litigation or interference proceedings could subject us to significant liabilities to third parties. Further, as a result of litigation or other proceedings, we may be required to seek licenses from third parties which may not be available on commercially reasonable terms, if at all. We license technology from a number of third parties. The majority of these license agreements impose due diligence or milestone obligations on us, and in some cases impose minimum royalty and/or sales obligations on us, in order for us to maintain our rights under these agreements. Our products may incorporate technologies that are the subject of patents issued to, and patent applications filed by, others. As is typical in our industry, from time to time we and our collaborators have received, and may in the future receive, notices from third parties claiming infringement and invitations to take licenses under third-party patents. It is our policy that when we receive such notices, we conduct investigations of the claims they assert. With respect to the notices we have received to date, we believe, after due investigation, that we have meritorious defenses to the infringement claims asserted. Any legal action against us or our collaborators may require us or our collaborators to obtain one or more licenses in order to market or manufacture affected products or services. However, we cannot assure you that we or our collaborators will be able to obtain licenses for technology patented by others on commercially reasonable terms, that we will be able to develop alternative approaches if unable to obtain licenses, or that the current and future licenses will be adequate for the operation of our businesses. Failure to obtain necessary licenses or to identify and implement alternative approaches could prevent us and our collaborators from commercializing certain of our products under development and could substantially harm our business. We have limited manufacturing experience and capacity and rely substantially on third-party manufacturers. To be successful, we must manufacture, or contract for the manufacture of, our current and future products in compliance with regulatory requirements, in sufficient quantities and on a timely basis, while maintaining product quality and acceptable manufacturing costs. In order to increase our manufacturing capacity, we acquired Diamond in April 1996 and certain assets of Center in July 1997. We must complete significant improvements in our manufacturing infrastructure in order to scale up for the manufacturing of our new products. We cannot assure you that we can complete such work successfully or on a timely basis. We currently rely on third parties to manufacture those products we do not manufacture at our Diamond or Center facilities. We currently have supply agreements with Atrix Laboratories, Inc. for our canine periodontal disease therapeutic and with Quidel Corporation for certain manufacturing services relating to our point-of-care diagnostic tests. Third parties also manufacture our patient monitoring instruments and associated consumable products. We cannot assure you that these partners will 28 29 manufacture products to regulatory standards and our specifications in a cost-effective and timely manner. If one or more of our suppliers experiences delays in scaling up commercial manufacturing, fails to produce a sufficient quantity of products to meet market demand, or requests renegotiation of contract prices, our business could be substantially harmed. While we typically retain the right to manufacture products ourselves or contract with an alternative supplier in the event of a manufacturer's breach, any transfer of production would cause significant production delays and additional expense to us to scale up production at a new facility and to apply for regulatory licensure at that new facility. In addition, we cannot assure you that suitable manufacturing partners or alternative suppliers will be available for our products under development if present arrangements are not satisfactory. Our manufacturing facilities are subject to governmental regulation. Our manufacturing facilities and those of any third-party manufacturers we may use are subject to the requirements of and periodic regulatory inspections by one or more of the FDA, USDA and other federal, state and foreign regulatory agencies. We cannot assure you that we or our contractors will continue to satisfy these regulatory requirements. Any failure to do so could substantially harm our business, financial condition or results of operations. We cannot assure you that we will not incur significant costs to comply with laws and regulations in the future or that new laws and regulations will not substantially harm our business. We depend on partners in our research and development activities. For certain of our proposed products, we are dependent on collaborative partners to successfully and timely perform research and development activities on our behalf. We cannot assure you that these collaborative partners will complete research and development activities on our behalf in a timely fashion, or at all. If our collaborative partners fail to complete research and development activities, or fail to complete them in a timely fashion, our business could be substantially harmed. We depend on key personnel for our future success. Our future success is substantially dependent on the efforts of our senior management and scientific team. The loss of the services of members of our senior management or scientific staff may significantly delay or prevent the achievement of product development and other business objectives. Because of the specialized scientific nature of our business, we depend substantially on our ability to attract and retain qualified scientific and technical personnel. There is intense competition among major pharmaceutical and chemical companies, specialized biotechnology firms and universities and other research institutions for qualified personnel in the areas of our activities. If we lose the services of, or fail to recruit, key scientific and technical personnel, our business could be substantially harmed. We must manage our growth effectively. We anticipate that our business will grow as we develop and commercialize new products, and that this growth will result in an increase in responsibilities for both existing and new management personnel. In order to manage growth effectively, we will need to continue to implement and improve our operational, financial and management information systems, to train, motivate and manage our current employees and to hire new employees. We cannot assure you that we will be able to manage our expansion effectively. Failure to do so could substantially harm our business. 29 30 We may face product liability litigation and the extent of our insurance coverage is limited. 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. 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 cannot assure you that we will 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 limits of our insurance coverage or which results in significant adverse publicity against us, our business could be substantially harmed. Side effects of our products may generate adverse publicity. Following the introduction of a product, adverse side effects may be discovered that make a product no longer commercially viable. Publicity regarding such adverse effects could affect sales of our other products for an indeterminate time period. We are dependent on the acceptance of our products by both veterinarians and pet owners. If we fail to engender confidence in our products and services, our ability to attain and sustain market acceptance of our products could be substantially harmed. We may be held liable for the release of hazardous materials. Our products and development programs involve the controlled use of hazardous and biohazardous materials, including chemicals, infectious disease agents and various radioactive compounds. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by applicable local, state and federal regulations, we cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for any damages or fines that result. Our liability for the release of hazardous materials could exceed our resources. We may incur substantial costs to comply with environmental regulations as we expand our manufacturing capacity. We expect to experience volatility in our stock price. The securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. The market prices of securities of many publicly-held biotechnology companies have in the past been, and can in the future be expected to be, especially volatile. The market price of our common stock may fluctuate substantially due to factors such as: o announcements of technological innovations or new products by us or by our competitors; o releases of reports by securities analysts; o developments or disputes concerning patents or proprietary rights; o regulatory developments; o changes in regulatory policies; o economic and other external factors; and o quarterly fluctuations in our financial results. 30 31 Our directors, executive officers and entities affiliated with them have substantial control over our affairs. Our directors, executive officers and entities affiliated with them own approximately 39% of our outstanding common stock. Three of our major stockholders, Charter Ventures, Novartis and Volendam, who together own approximately 33% of our outstanding common stock, have entered into a voting agreement dated as of April 12, 1996 whereby each agreed to collectively vote its shares in such a manner so as to ensure that each major stockholder was represented by one member on our Board of Directors. The voting agreement terminates on December 31, 2005 unless prior to that date any of the investors ceases to beneficially hold 2,000,000 shares of our voting stock, at which time the voting agreement will terminate. Our major stockholders, acting together, could substantially influence matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. These stockholders may have interests different from, or in addition to, those of non-affiliated stockholders. 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 United States and foreign interest rates and changes in foreign currency exchange rates as measured against the United States dollar. These exposures are directly related to our normal operating and funding activities. Historically and as of December 31, 1999, we have not used derivative instruments or engaged in hedging activities. Interest Rate Risk The interest payable on certain of our lines of credit and other borrowings is variable based on the United States prime rate, or LIBOR, and, therefore, affected by changes in market interest rates. At December 31, 1999, approximately $5.6 million was outstanding on these lines of credit and other borrowings with a weighted average interest rate of 9.6%. The lines of credit mature from January 2000 through September 2001 and are subject to annual renewal. We may pay the balance in full at any time without penalty. We manage interest rate risk by investing excess funds principally in cash equivalents or marketable securities which bear interest rates that reflect current market yields. Additionally, we monitor interest rates and at December 31, 1999 had sufficient cash balances to pay off the lines-of-credit should interest rates increase significantly. As a result, we do not believe that reasonably possible near-term changes in interest rates will result in a material effect on our future earnings, financial position or cash flows. Foreign Currency Risk At December 31, 1999, we had wholly-owned subsidiaries located in England, Switzerland and France. Sales from these operations are denominated in British Pounds, Swiss Francs, French Francs or Euros, thereby creating exposures to changes in exchange rates. The changes in the British/U.S. exchange rate, Swiss/U.S. exchange rate, French/U.S. exchange rate or Euro/U.S. exchange rate may positively or negatively affect our sales, gross margins and retained earnings. We do not believe that reasonably possible near-term changes in exchange rates will result in a material effect on future earnings, fair values or cash flows, and therefore, have chosen not to enter into foreign currency hedging instruments. There can be no assurance that such an approach will be successful, especially in the event of a significant and sudden decline in the value of the British Pound, Swiss Franc, French Franc or Euro. In March 2000, we sold our wholly-owned subsidiary in England. 31 32 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of Independent Public Accountants.......................................................................... 33 Consolidated Balance Sheets as of December 31, 1998 and 1999...................................................... 34 Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 1997, 1998 and 1999................................................................................................. 35 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1998 and 1999.............. 36 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999........................ 37 Notes to Consolidated Financial Statements........................................................................ 38
32 33 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Heska Corporation: We have audited the accompanying consolidated balance sheets of Heska Corporation (a Delaware corporation) and subsidiaries as of December 31, 1998 and 1999, and the related consolidated statements of operations and comprehensive loss, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Heska Corporation and subsidiaries as of December 31, 1998 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Denver, Colorado January 28, 2000. 33 34 HESKA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (dollars in thousands)
ASSETS DECEMBER 31, ------------------------ 1998 1999 --------- --------- Current assets: Cash and cash equivalents ............................................................. $ 5,921 $ 1,499 Marketable securities ................................................................. 46,009 22,482 Accounts receivable, net of allowance for doubtful accounts of $93 and $188, respectively .................................................................. 6,659 9,652 Inventories, net ...................................................................... 12,197 13,957 Other current assets .................................................................. 734 1,027 --------- --------- Total current assets ............................................................. 71,520 48,617 Property and equipment, net ................................................................... 21,226 19,574 Intangible assets, net ........................................................................ 4,311 1,629 Restricted marketable securities and other assets ............................................. 997 1,348 --------- --------- Total assets ..................................................................... $ 98,054 $ 71,168 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ...................................................................... $ 7,542 $ 6,928 Accrued liabilities ................................................................... 3,871 4,369 Deferred revenue ...................................................................... 656 930 Current portion of capital lease obligations .......................................... 562 604 Current portion of long-term debt ..................................................... 6,942 7,552 --------- --------- Total current liabilities ........................................................ 19,573 20,383 Capital lease obligations, less current portion ............................................... 1,129 718 Long-term debt, less current portion .......................................................... 10,162 4,428 Other long-term liabilities ................................................................... 76 200 --------- --------- Total liabilities ................................................................ 30,940 25,729 --------- --------- Commitments and contingencies Stockholders' equity: Preferred stock, $.001 par value, 25,000,000 shares authorized; none outstanding ...... -- -- Common stock, $.001 par value, 40,000,000 shares authorized; 26,458,424 and 33,436,669 shares issued and outstanding, respectively ........................... 26 33 Additional paid-in capital ............................................................ 185,163 199,156 Deferred compensation ................................................................. (1,277) (648) Stock subscription receivable from officers ........................................... (120) (124) Accumulated other comprehensive income ................................................ 88 (376) Accumulated deficit ................................................................... (116,766) (152,602) --------- --------- Total stockholders' equity ....................................................... 67,114 45,439 --------- --------- Total liabilities and stockholders' equity ....................................... $ 98,054 $ 71,168 ========= =========
See accompanying notes to consolidated financial statements 34 35 HESKA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (in thousands, except per share amounts)
YEAR ENDED DECEMBER 31, ----------------------------------- 1997 1998 1999 -------- -------- -------- Revenues: Products, net .............................................................. $ 26,725 $ 38,451 $ 50,291 Research and development ................................................... 2,578 1,321 885 -------- -------- -------- 29,303 39,772 51,176 Costs and operating expenses: Cost of goods sold ......................................................... 20,077 29,087 36,386 Research and development ................................................... 20,343 25,126 17,042 Selling and marketing ...................................................... 9,954 13,188 15,073 General and administrative ................................................. 13,192 11,939 11,231 Amortization of intangible assets and deferred compensation ................ 2,500 2,745 2,228 Purchased research and development ......................................... 2,399 -- -- Loss on assets held for disposition ........................................ -- 1,287 2,593 Restructuring expense ...................................................... -- 2,356 1,210 -------- -------- -------- 68,465 85,728 85,763 -------- -------- -------- Loss from operations ............................................................. (39,162) (45,956) (34,587) Other income (expense): Interest income ............................................................ 1,571 3,183 1,611 Interest expense ........................................................... (1,364) (2,009) (1,857) Other, net ................................................................. 91 508 (1,003) -------- -------- -------- Net loss ......................................................................... (38,864) (44,274) (35,836) -------- -------- -------- Other comprehensive income (loss): Foreign currency translation adjustments ................................... 1 2 (88) Unrealized gain (loss) on marketable securities ............................ -- 85 (376) -------- -------- -------- Other comprehensive income (loss) ................................................ 1 87 (464) -------- -------- -------- Comprehensive loss ............................................................... $(38,863) $(44,187) $(36,300) ======== ======== ======== Basic and diluted net loss per share ............................................. $ (1.79) $ (1.31) ======== ======== Unaudited pro forma basic and diluted net loss per share ......................... $ (2.42) ======== Shares used to compute basic and diluted net loss per share and unaudited pro forma basic and diluted net loss per share .................................... 16,042 24,693 27,290
See accompanying notes to consolidated financial statements 35 36 HESKA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except per share data)
PREFERRED STOCK COMMON STOCK ADDITIONAL ------------------- ----------------- PAID-IN DEFERRED SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION ------ --------- ------ --------- --------- ------------ Balances, December 31, 1996 .............................. 10,460 $ 62,588 1,570 $ 1 $ 4,903 $ (1,075) Issuance of common stock for cash ...................... -- -- 89 -- 1,342 -- Issuance of common stock for stock subscription receivable ........................................... -- -- 25 -- 30 -- Issuance of preferred stock related to business acquisitions ......................................... 124 1,236 -- -- -- -- Issuance of common stock related to business acquisitions ......................................... -- -- 454 -- 2,656 -- Issuance of common stock upon the Company's initial public offering ("IPO"), net ......................... -- -- 5,638 6 43,867 -- Conversion of preferred stock into common stock upon the IPO ......................................... (10,584) (63,824) 11,289 11 63,813 -- Issuance of common stock for services .................. -- -- 1 -- -- -- Cashless exercise of warrants to purchase common stock ................................................ -- -- 5 -- -- -- Issuance of common stock related to options and the Employee Stock Purchase Plan (the "ESPP") ....... -- -- 420 1 299 -- Interest on stock subscription receivable .............. -- -- -- -- -- -- Foreign currency translation adjustments ............... -- -- -- -- -- -- Deferred compensation related to stock options ......... -- -- -- -- 1,537 (1,537) Amortization of deferred compensation .................. -- -- -- -- -- 645 Net loss ............................................... -- -- -- -- -- -- ------- --------- ------ --------- --------- --------- Balances, December 31, 1997 ............................... -- -- 19,491 19 118,447 (1,967) Issuance of common stock for cash ...................... -- -- 3 -- 6 -- Issuance of common stock upon the Company's follow-on public offering, net ....................... -- -- 5,250 5 48,595 -- Issuance of common stock and warrants for cash ......... -- -- 1,165 1 14,999 -- Issuance of common stock in exchange for assets and in repayment of debt ................................. -- -- 206 -- 2,262 -- Issuance of common stock for services .................. -- -- 32 -- 461 -- Cashless exercise of warrants to purchase common stock ................................................ -- -- 5 -- -- -- Issuance of common stock related to options, the ESPP and other ....................................... -- -- 306 1 347 -- Deferred compensation related to stock options ......... -- -- -- -- 46 (46) Amortization of deferred compensation .................. -- -- -- -- -- 736 Interest on stock subscription receivable .............. -- -- -- -- -- -- Payments received on stock subscription receivable ..... -- -- -- -- -- -- Foreign currency translation adjustments ............... -- -- -- -- -- -- Unrealized gain on marketable securities ............... -- -- -- -- -- -- Net loss ............................................... -- -- -- -- -- -- ------- --------- ------ --------- --------- --------- Balances, December 31, 1998 .............................. -- -- 26,458 26 185,163 (1,277) Issuance of common stock for services .................. -- -- 17 -- 116 -- Cashless exercise of warrants to purchase common stock ................................................ -- -- 5 -- -- -- Issuance of common stock upon the Company's follow-on public offering, net ....................... -- -- 6,500 7 13,282 -- Issuance of common stock related to options, the ESPP and other ....................................... -- -- 457 -- 595 -- Amortization of deferred compensation .................. -- -- -- -- -- 629 Interest on stock subscription receivable .............. -- -- -- -- -- -- Payments received on stock subscription receivable ..... -- -- -- -- -- -- Foreign currency translation adjustments ............... -- -- -- -- -- -- Unrealized loss on marketable securities ............... -- -- -- -- -- -- Net loss ............................................... -- -- -- -- -- -- ------- --------- ------ --------- --------- --------- Balances, December 31, 1999 .............................. -- $ -- 33,437 $ 33 $ 199,156 $ (648) ======= ========= ====== ========= ========= ========= ACCUMULATED STOCK OTHER TOTAL SUBSCRIPTION COMPREHENSIVE ACCUMULATED STOCKHOLDERS' RECEIVABLE INCOME DEFICIT EQUITY ---------- ------ --------- --------- Balances, December 31, 1996 .............................. $ (118) $ -- $ (33,628) $ 32,671 Issuance of common stock for cash ...................... -- -- -- 1,342 Issuance of common stock for stock subscription receivable ........................................... (30) -- -- -- Issuance of preferred stock related to business acquisitions ......................................... -- -- -- 1,236 Issuance of common stock related to business acquisitions ......................................... -- -- -- 2,656 Issuance of common stock upon the Company's initial public offering ("IPO"), net ......................... -- -- -- 43,873 Conversion of preferred stock into common stock upon the IPO ......................................... -- -- -- -- Issuance of common stock for services .................. -- -- -- -- Cashless exercise of warrants to purchase common stock ................................................ -- -- -- -- Issuance of common stock related to options and the Employee Stock Purchase Plan (the "ESPP") ........ -- -- -- 300 Interest on stock subscription receivable .............. (10) -- -- (10) Foreign currency translation adjustments ............... -- 1 -- 1 Deferred compensation related to stock options ......... -- -- -- -- Amortization of deferred compensation .................. -- -- -- 645 Net loss ............................................... -- -- (38,864) (38,864) --------- --------- --------- --------- Balances, December 31, 1997 ............................... (158) 1 (72,492) 43,850 Issuance of common stock for cash ...................... -- -- -- 6 Issuance of common stock upon the Company's follow-on public offering, net ....................... -- -- -- 48,600 Issuance of common stock and warrants for cash ......... -- -- -- 15,000 Issuance of common stock in exchange for assets and in repayment of debt ................................. -- -- -- 2,262 Issuance of common stock for services .................. -- -- -- 461 Cashless exercise of warrants to purchase common stock ................................................ -- -- -- -- Issuance of common stock related to options, the ESPP and other ....................................... -- -- -- 348 Deferred compensation related to stock options ......... -- -- -- -- Amortization of deferred compensation .................. -- -- -- 736 Interest on stock subscription receivable .............. (13) -- -- (13) Payments received on stock subscription receivable ..... 51 -- -- 51 Foreign currency translation adjustments ............... -- 2 -- 2 Unrealized gain on marketable securities ............... -- 85 -- 85 Net loss ............................................... -- -- (44,274) (44,274) --------- --------- --------- --------- Balances, December 31, 1998 .............................. (120) 88 (116,766) 67,114 Issuance of common stock for services .................. -- -- -- 116 Cashless exercise of warrants to purchase common stock ................................................ -- -- -- -- Issuance of common stock upon the Company's follow-on public offering, net ....................... -- -- -- 13,289 Issuance of common stock related to options, the ESPP and other ....................................... -- -- -- 595 Amortization of deferred compensation .................. -- -- -- 629 Interest on stock subscription receivable .............. (7) -- -- (4) Payments received on stock subscription receivable ..... 3 -- -- -- Foreign currency translation adjustments ............... -- (88) -- (88) Unrealized loss on marketable securities ............... -- (376) -- (376) Net loss ............................................... -- -- (35,836) (35,836) --------- --------- --------- --------- Balances, December 31, 1999 .............................. $ (124) $ (376) $(152,602) $ 45,439 ========= ========= ========= =========
See accompanying notes to consolidated financial statements 36 37 HESKA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
YEAR ENDED DECEMBER 31, --------------------------------------- 1997 1998 1999 --------- --------- --------- CASH FLOWS USED IN OPERATING ACTIVITIES: Net loss ................................................................... $ (38,864) $ (44,274) $ (35,836) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization ............................................ 2,391 3,600 3,864 Amortization of intangible assets and deferred compensation .............. 2,500 2,745 2,228 Purchased research and development ....................................... 2,399 -- -- Loss (gain) on disposition of assets ..................................... (132) 2 2,215 Interest receivable on stock subscription ................................ (10) (13) (7) (Increase) decrease in other long-term assets ............................ -- -- (1,092) Increase (decrease) in other long-term liabilities ....................... (14) (37) 124 Changes in operating assets and liabilities: Accounts receivable, net ............................................ (3,142) (1,177) (2,993) Inventories, net .................................................... (2,951) (1,608) (1,760) Other assets ........................................................ (950) 406 (293) Accounts payable .................................................... 3,111 1,189 (614) Accrued liabilities ................................................. 1,707 896 498 Deferred revenue .................................................... (1,129) 502 274 Other ............................................................... 23 (352) 201 --------- --------- --------- Net cash (used in) operating activities ........................ (35,061) (38,121) (33,191) --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisitions of businesses, net of cash acquired ........................... (2,714) -- -- Cash (deposited in) withdrawn from restricted cash account ................. (238) -- 238 Additions to intangible assets ............................................. (157) (549) -- Purchase of marketable securities .......................................... (18,718) (123,842) (21,229) Proceeds from sale of marketable securities ................................ 18,342 96,248 44,300 Proceeds from disposition of property and equipment ........................ 343 -- 262 Purchases of property and equipment ........................................ (6,248) (6,470) (3,296) --------- --------- --------- Net cash provided by (used in) investing activities ............ (9,390) (34,613) 20,275 --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock ..................................... 45,515 64,505 13,884 Proceeds from stock subscription receivable ................................ -- 51 3 Proceeds from borrowings ................................................... 5,528 10,171 971 Repayments of debt and capital lease obligations ........................... (2,537) (6,804) (6,464) --------- --------- --------- Net cash provided by financing activities ...................... 48,506 67,923 8,394 --------- --------- --------- EFFECT OF EXCHANGE RATE CHANGES ON CASH .......................................... (6) 53 100 --------- --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ................................. 4,049 (4,758) (4,422) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ..................................... 6,630 10,679 5,921 --------- --------- --------- CASH AND CASH EQUIVALENTS, END OF YEAR ........................................... $ 10,679 $ 5,921 $ 1,499 ========= ========= =========
See accompanying notes to consolidated financial statements 37 38 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND BUSINESS Heska Corporation ("Heska" or the "Company") is primarily focused on the discovery, development and marketing of companion animal health products. In addition to manufacturing certain of Heska's companion animal health products, the Company's primary manufacturing subsidiary, Diamond Animal Health, Inc. ("Diamond"), also manufactures bovine vaccine products and pharmaceutical products that are marketed and distributed by third parties. In addition to manufacturing veterinary allergy products for marketing and sale by Heska, Heska's subsidiaries, Center Laboratories, Inc. ("Center") and CMG-Heska Allergy Products S.A. ("CMG"), a Swiss corporation, also manufacture and sell human allergy products. The Company also offers diagnostic services to veterinarians at its Fort Collins, Colorado location. From the Company's inception in 1988 until early 1996, the Company's operating activities related primarily to research and development activities, entering into collaborative agreements, raising capital and recruiting personnel. Prior to 1996, the Company had not received any revenues from the sale of products. During 1996, Heska grew from being primarily a research and development concern to a fully-integrated research, development, manufacturing and marketing company. The Company accomplished this by acquiring Diamond, a licensed pharmaceutical and biological manufacturing facility in Des Moines, Iowa, hiring key employees and support staff, establishing marketing and sales operations to support Heska products introduced in 1996, and designing and implementing more sophisticated operating and information systems. The Company also expanded the scope and level of its scientific and business development activities, increasing the opportunities for new products. In 1997, the Company introduced additional products and expanded in the United States through the acquisition of Center, a Food and Drug Administration ("FDA") and United States Department of Agriculture ("USDA") licensed manufacturer of allergy immunotherapy products located in Port Washington, New York, and internationally through the acquisitions of Heska UK Limited ("Heska UK", formerly Bloxham Laboratories Limited), a veterinary diagnostic laboratory in Teignmouth, England and CMG (formerly Centre Medical des Grand'Places S.A.) in Fribourg, Switzerland, which manufactures and markets allergy diagnostic products for use in veterinary and human medicine, primarily in Europe. Each of the Company's acquisitions during this period was accounted for under the purchase method of accounting and accordingly, the Company's financial statements reflect the operations of these businesses only for the periods subsequent to the acquisitions. In July 1997, the Company established a new subsidiary, Heska AG, located near Basel, Switzerland, for the purpose of managing its European operations. During the first quarter of 1998 the Company acquired Heska Waukesha (formerly Sensor Devices, Inc.), a manufacturer and marketer of patient monitoring devices used in both animal health and human applications. The financial results of Heska Waukesha have been consolidated with those of the Company under the pooling-of-interests accounting method for all periods presented. The operations of Heska Waukesha were combined with existing operations in Fort Collins, Colorado and Des Moines, Iowa during the fourth quarter of 1999. The Heska Waukesha facility was closed in December 1999. In late 1999, the Company announced its intent to sell Heska UK. The transaction was completed in March 2000. The Company recorded a loss on disposition of approximately $1.0 million during 1999 for this sale. The Company has incurred net losses since its inception and anticipates that it will continue to incur additional net losses in the near term as it introduces new products, expands its sales and marketing 38 39 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS capabilities and continues its research and development activities. Cumulative net losses from inception of the Company in 1988 through December 31, 1999 have totaled $152.6 million. The Company's ability to achieve profitable operations will depend primarily upon its ability to successfully market its products, commercialize products that are currently under development, develop new products and efficiently integrate acquired businesses. Most of the Company's products are subject to long development and regulatory approval cycles and there can be no guarantee that the Company will successfully develop, manufacture or market these products. There can also be no guarantee that the Company will attain profitability or, if achieved, will remain profitable on a quarterly or annual basis in the future. Until the Company attains positive cash flow, the Company may continue to finance operations with additional equity and debt financing. There can be no guarantee that such financing will be available when required or will be obtained under favorable terms. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and of its wholly-owned subsidiaries since their respective dates of acquisitions when accounted for under the purchase method of accounting, and for all periods presented when accounted for under the pooling-of-interests method of accounting. All material intercompany transactions and balances have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles 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. Cash and Cash Equivalents Cash and cash equivalents are stated at cost, which approximates market, and include short-term highly liquid investments with original maturities of less than three months. Marketable Securities and Restricted Investments The Company classifies its marketable securities as "available-for-sale" and, accordingly, carries such securities at aggregate fair value. During 1999, the Company recognized a loss in its financial statements of $943,000 on the sale of certain long-term U.S. government agency obligations. Unrealized gains or losses, if material, are included as a component of accumulated other comprehensive income. At December 31, 1998 these securities had an aggregate amortized cost, using specific identification, of $46.2 million, a maximum maturity of approximately ten years and consisted entirely of U.S. government agency obligations. At December 31, 1999 these securities had an aggregate amortized cost, using specific identification, of $23.1 million, a maximum maturity of approximately 4 years and consisted of $7.8 million of U.S. government agency obligations and $15.3 million of U.S. corporate commercial paper. The fair market value of marketable securities at December 31, 1998 and 1999 was approximately $46.3 million and $22.8 million, respectively. An unrealized gain of approximately 39 40 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS $85,000 has been recorded as a component of accumulated comprehensive income within stockholders' equity as of December 31, 1998. An unrealized loss on its marketable securities invested in U.S. government agency obligations of approximately $291,000 has been recorded as a component of accumulated comprehensive income within stockholders' equity as of December 31, 1999. Marketable securities at both December 31, 1998 and 1999 included approximately $281,000 of restricted investments held as collateral for capital leases (See Note 4) and $46.0 million and $22.5 million of short-term marketable securities, respectively. Concentration of Credit Risk Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents, marketable securities and accounts receivable. The Company maintains the majority of its cash, cash equivalents and marketable securities with financial institutions that management believes are creditworthy in the form of demand deposits, U.S. government agency obligations and U.S. corporate commercial paper. The Company has no significant off-balance sheet concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements. The Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. Its accounts receivable balances are due primarily from domestic veterinary clinics and individual veterinarians, and both domestic and international corporations. Fair Value of Financial Instruments The Company's financial instruments consist of cash and cash equivalents, short-term trade receivables and payables and notes payable. The carrying values of cash and cash equivalents and short-term trade receivables and payables approximate fair value. The fair value of notes payable is estimated based on current rates available for similar debt with similar maturities and collateral, and at December 31, 1999, approximates the carrying value. Inventories, net Inventories are stated at the lower of cost or market using the first-in, first-out method. If the cost of inventories exceeds fair market value, provisions are made for the difference between cost and fair market value. Inventories, net of provisions, consist of the following (in thousands):
DECEMBER 31, ------------------- 1998 1999 ------- ------- Raw materials ............................................. $ 3,271 $ 3,436 Work in process ........................................... 5,338 6,445 Finished goods ............................................ 3,588 4,076 ------- ------- $12,197 $13,957 ======= =======
Derivative Instruments and Hedging Activities During 2001, the Company will adopt the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The Statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at fair value. The 40 41 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedging criteria are met. The Company does not expect that the adoption of this Statement will have a material impact on its reported earnings or comprehensive income. Property, Equipment and Intangible Assets Property and equipment are recorded at cost and depreciated on a straight-line or declining balance basis over the estimated useful lives of the related assets. Amortization of assets acquired under capital leases is included with depreciation expense on owned assets. Leasehold improvements are amortized over the applicable lease period or their estimated useful lives, whichever is shorter. Maintenance and repairs are charged to expense when incurred, and major renewals and improvements are capitalized. Intangible assets primarily consist of various assets arising from business combinations and are amortized using the straight-line method over the period of expected benefit. The Company periodically reviews the appropriateness of the remaining life of its property, equipment and intangible assets considering whether any events have occurred or conditions have developed which may indicate that the remaining life requires adjustment. After reviewing the appropriateness of the remaining life and the pattern of usage of these assets, the Company then assesses their overall recoverability by determining if the net book value can be recovered through undiscounted future operating cash flows. Absent any unfavorable findings, the Company continues to amortize and depreciate its property, equipment and intangible assets based on the existing estimated life. During 1999, the Company's review of property, equipment and intangible assets determined that a write-down to fair market value of $1.0 million for equipment and $372,000 for intangible assets was needed. These amounts were recorded as part of the loss on assets held for disposition in the accompanying statement of operations. Property and equipment consist of the following (in thousands):
DECEMBER 31, ESTIMATED ---------------------- USEFUL LIFE 1998 1999 -------------- -------- -------- Land .............................................. N/A $ 435 $ 435 Buildings ......................................... 10 to 20 years 4,091 4,154 Machinery and equipment ........................... 3 to 15 years 20,431 22,503 Leasehold improvements ............................ 7 to 15 years 3,404 3,482 -------- -------- 28,361 30,574 Less accumulated depreciation and amortization .... (7,135) (11,000) -------- -------- $ 21,226 $ 19,574 ======== ========
Depreciation and amortization expense for property and equipment was $2.4 million, $3.6 million and $3.9 million for the years ended December 31, 1997, 1998 and 1999, respectively. 41 42 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Intangible assets consist of the following (in thousands):
DECEMBER 31, ESTIMATED -------------------- USEFUL LIFE 1998 1999 ------------- ------- ------- Take-or-pay contract .................. 37 months $ 3,873 $ -- Customer lists and market presence .... 7 years 2,848 2,848 Other intangible assets ............... 2 to 10 years 2,594 394 ------- ------- 9,315 3,242 Less accumulated amortization ......... (5,004) (1,613) ------- ------- $ 4,311 $ 1,629 ======= =======
The customer lists and market presence resulted from the Company's 1997 acquisitions. The remaining intangible assets resulted primarily from the acquisitions of certain lines of business and assets in 1996, 1997 and 1998. Amortization expense for intangible assets was $1.9 million, $2.0 million and $1.6 million for the years ended December 31, 1997, 1998 and 1999, respectively. Revenue Recognition Product revenues are recognized at the time goods are shipped to the customer, or at the time services are performed, with an appropriate provision for returns and allowances. The Company recognizes revenue from sponsored research and development as research activities are performed or as development milestones are completed under the terms of the research and development agreements. Costs incurred in connection with the performance of sponsored research and development are expensed as incurred. The Company defers revenue recognition of advance payments received during the current year until research activities are performed or development milestones are completed. In connection with these sponsored research and development agreements, the Company has recognized $2.6 million, $1.3 million and $900,000 of research and development revenue for the years ended December 31, 1997, 1998 and 1999, respectively. In addition to its direct sales force and a contract sales force specializing in equine products, the Company utilizes both distributors and sales agency organizations to sell its products. Distributors purchase goods from the Company, take title to those goods and resell them to their customers in the distributors' territory. Sales agents maintain inventories of goods on consignment from the Company and sell these goods on behalf of the Company to customers in the sales agents' territory. The Company recognizes revenue at the time goods are sold to the customers by the sales agents. Sales agents are paid a fee for their services, which include maintaining product inventories, sales activities, billing and collections. Fees earned by sales agents are netted against revenues generated by these entities. In December 1999, the SEC issued SAB No. 101, Revenue Recognition ("SAB 101"). SAB 101 clarifies the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues. The guidance in SAB 101 must be implemented by the Company's first quarter of fiscal 2000. The Company is currently reviewing the guidelines provided in SAB 101, and believes that SAB 101 will not significantly affect its results of operations. 42 43 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Cost of Sales Royalties payable in connection with certain research, development and licensing agreements (See Note 9) are reflected in cost of sales as incurred. Basic and Diluted Net Loss Per Share The Company presents basic and diluted net loss per share in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings per Share, which establishes standards for computing and presenting basic and diluted earnings per share. Also, the Company has adopted the guidance of Securities and Exchange Commission ("SEC") Staff Accounting Bulletin ("SAB") No. 98 and related interpretations. Basic net loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed using the sum of the weighted average number of shares of common stock outstanding and, if not anti-dilutive, the effect of outstanding stock options and warrants determined using the treasury stock method. At December 31, 1999, securities that have been excluded from diluted net loss per share because they would be anti-dilutive are outstanding options to purchase 4,246,183 shares of the Company's common stock and warrants to purchase 1,165,000 shares of the Company's common stock. Due to the automatic conversion of all shares of convertible preferred stock into common stock upon the closing of the Company's initial public offering in July 1997 (the "IPO"), historical basic and diluted net loss per common share for fiscal 1997 is not considered meaningful as it would differ materially from the pro forma basic and diluted net loss per common share and common stock equivalent shares given the changes in the capital structure of the Company. The Company has assumed the conversion of convertible preferred stock issued into 11,289 shares of common stock in 1997. Foreign Currency Translation The functional currencies of the Company's international subsidiaries are the Pound Sterling ("pound"), the French Franc ("FRF") and the Swiss Franc ("CHF"). Assets and liabilities of the Company's international subsidiaries are translated using the exchange rate in effect at the balance sheet date. Revenue and expense accounts are translated using an average of exchange rates in effect during the period. Cumulative translation gains and losses, if material, 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 in current operations. To date, the Company has not entered into any forward contracts or hedging transactions. 3. BUSINESS ACQUISITION Acquisition of Heska Waukesha. In March 1998 the Company completed its acquisition of all of the outstanding shares of Heska Waukesha, a manufacturer and marketer of medical sensor products, in a transaction valued at approximately $8.9 million using the pooling-of-interests accounting method. The Company issued 639,622 shares of its common stock and also reserved an additional 147,898 shares of its common stock for issuance in connection with outstanding Heska Waukesha options that were assumed by the Company in the merger. Accordingly, in 1998, the consolidated financial statements of the Company were restated to include the accounts of Heska Waukesha for all prior periods presented. There were no adjustments required to the net assets or previously reported results of operations of the 43 44 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Company or Heska Waukesha as a result of the adoption of the same accounting practices by the respective entities. 4. CAPITAL LEASE OBLIGATIONS The Company has entered into certain capital lease agreements for laboratory equipment, office equipment, machinery and equipment, and computer equipment and software. For the years ended December 31, 1998 and 1999, the Company had capitalized machinery and equipment under capital leases with a gross value of approximately $2.3 million and $2.5 million and net book value of approximately $1.4 million and $1.2 million, respectively. The capitalized cost of the equipment under capital leases is included in the accompanying balance sheets under the respective asset classes. Under the terms of the Company's lease agreements, the Company is required to make monthly payments of principal and interest through the year 2004, at interest rates ranging from 4.05% to 20.00% per annum. The equipment under the capital leases serves as security for the leases. The Company has a capital lease with a commercial bank which requires the Company to pledge cash or investments as additional collateral for the lease. The lease agreement, which has a borrowing limit of $2.0 million calls for a collateral balance equal to 25% of the borrowed amount when the Company's annual revenues reach $28.0 million. The lease also requires the Company to maintain minimum levels of cash and cash equivalent balances throughout the term of the lease. At both December 31, 1998 and 1999, the Company was in compliance with all covenants of the master lease and held restricted U.S. Treasury Bonds of approximately $281,000 as additional collateral under the lease. The future annual minimum required payments under capital lease obligations as of December 31, 1999 were as follows (in thousands):
YEAR ENDING DECEMBER 31, - ------------ 2000 .................................................................... $ 687 2001 .................................................................... 596 2002 .................................................................... 106 2003 .................................................................... 67 2004 .................................................................... 6 ------- Total minimum lease payments ........................................ 1,462 Less amount representing interest ................................... (140) ------- Present value of net minimum lease payments ......................... 1,322 Less current portion ................................................ (604) ------- Total long-term capital lease obligations ..................... $ 718 =======
5. RESTRUCTURING EXPENSES In August 1999, the Company announced plans to consolidate its Heska Waukesha operations with existing operations in Fort Collins, Colorado and Des Moines, Iowa. This consolidation was based on the Company's determination that significant operating efficiencies could be achieved through the combined operations. The Company recognized a charge to operations of approximately $1.2 million for 44 45 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS this consolidation. These expenses related primarily to personnel severance costs for 40 individuals and the costs associated with facilities being closed and excess equipment, primarily at the Company's Waukesha, Wisconsin location. This facility was closed in December 1999. In December 1998 the Company completed a cost reduction and restructuring plan. The restructuring was based on the Company's determination that, while revenues had been increasing steadily, management believed that reducing expenses was necessary in order to accelerate the Company's efforts to reach profitability. In connection with the restructuring, the Company recognized a charge to operations in 1998 of approximately $2.4 million. These expenses related to personnel severance costs for 69 individuals and costs associated with excess facilities and equipment, primarily at the Company's Fort Collins, Colorado location. Shown below is a reconciliation of restructuring costs for the year ended December 31, 1999 (in thousands):
Additions for the Payments/Charges Balance at Fiscal Year Ended through Balance at December 31, December 31, December 31, December 31, 1998 1999 1999 1999 ------------ ----------------- --------------- ------------ Severance pay, benefits and relocation expenses .... $1,093 $ 625 $(1,289) $ 429 Noncancellable leased facility closure costs ....... 430 350 (86) 694 Other .............................................. 108 235 (343) -- ------ ------ ------- ------ Total ......................................... $1,631 $1,210 $(1,718) $1,123 ====== ====== ======= ======
The balance of $1.6 million and $1.1 million is included in accrued liabilities in the accompanying consolidated balance sheets as of December 31, 1998 and 1999, respectively. 45 46 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. LONG-TERM DEBT Long-term debt consists of the following (in thousands):
DECEMBER 31, ------------------ 1998 1999 -------- -------- Heska, Diamond, Center and Heska Waukesha obligations: Equipment financing due in monthly installments through November 2001, and final payments due March 2000 through January 2002, with stated interest rates between 14.0% and 18.1%, secured by certain equipment and fixtures ............................ $ 6,957 $ 5,817 Center obligations: Promissory note to former owner of Center due in July 2000, with quarterly interest payments at a stated interest rate of prime (7.75% and 8.5% at December 1998 and 1999, respectively) plus 0.75% ... 3,464 3,464 Diamond obligations: Promissory note to the Iowa Department of Economic Development ("IDED"), due in annual installments through June 2004, with a stated interest rate of 3.0% and a 9.5% imputed interest rate, net .................................................................................. 175 67 Promissory note to the City of Des Moines, due in monthly installments through May 2004, with a stated interest rate of 3% and a 9.5% imputed interest rate, net ............................. 97 97 $2,000 and $2,500 commercial bank line of credit, due September 2001, with monthly interest payments at prime (7.75% and 8.5% at December 1998 and 1999, respectively) plus 1.75% ........................ 1,749 917 Real estate mortgage to a commercial bank, due in monthly installments through September 2003, with a stated interest rate of prime (7.75% and 8.5% at December 1998 and 1999, respectively) plus 1.75% .......................................................................................... 1,520 1,200 Heska Waukesha obligations: $800 commercial bank line of credit, with monthly interest payments at prime (7.75% at December 1998) plus 1.75%, paid in full in October 1999 ............................................................ 800 -- Note payable to bank, guaranteed by the Small Business Administration ("SBA"), with a stated interest rate of prime (7.75% at December 1998) plus 1.75%, paid in full in December 1999 .......... 350 -- Note payable to the State of Wisconsin, with a stated interest rate of 5%, paid in full in April 1999 .......................................................................................... 50 -- Unsecured note payable, with no stated interest rate, paid in full in May 1999 ........................ 44 -- Heska obligations: Promissory notes to former Heska UK stockholders, with a stated interest rate of 4.5%, denominated in pounds sterling, paid in full in April 1999 .......................................... 262 -- Heska UK obligations: Real estate mortgage due in monthly principal payments and quarterly interest payments through December 2006, with a stated interest rate of a bank's base rate (7.75% and 8.5% at December 1998 and 1999, respectively) plus 2.75%, denominated in pounds sterling ............................. 142 142 (pound)725 commercial bank line of credit, with a stated interest rate of LIBOR (5.1% at December 1998) plus 4.0%, paid in full in February 1999 ...................................................... 1,153 -- CMG obligations: CHF150 commercial bank line of credit, due upon demand, with quarterly interest payments, with a stated interest rate of 5.5%, plus 0.25% per quarter ...................... -- 145 CHF400 commercial bank line of credit, due upon demand, with quarterly interest payments, with a stated interest rate of 5.75%, plus 0.25% per quarter ............................................. 341 131 -------- -------- 17,104 11,980 Less installments due within one year ..................................................................... (6,942) (7,552) -------- -------- $ 10,162 $ 4,428 ======== ========
46 47 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The IDED and City of Des Moines promissory notes are secured by a first security interest in essentially all assets of Diamond except assets acquired through capital leases and are included as cross- collateralized obligations by the respective lenders. These notes were assumed as a result of the 1996 Diamond acquisition. The Heska Waukesha line of credit and SBA and State of Wisconsin loans were secured by a first security interest in essentially all assets of Heska Waukesha except assets acquired through capital leases and were included as cross-collateralized obligations by the respective lenders. These obligations, along with the unsecured note payable, were assumed as a result of the acquisition of Heska Waukesha in March 1998. The Company's other debt instruments are secured by the assets of the respective subsidiaries and general corporate guarantees by Heska Corporation. As of December 31, 1999, one of the Company's wholly-owned subsidiaries, Diamond, did not meet certain financial covenants contained in its existing $2,500,000 line of credit agreement. The commercial bank who provides the line of credit waived the covenant non-compliance as of December 31, 1999. The Company has reflected the $917,000 outstanding under the existing agreement as current in its financial statements. The Company has received a proposal for a new, larger corporate line of credit with the same commercial bank. The proposal is subject to a number of closing conditions. Management believes that such conditions will be satisfactorily met, however there can be no assurance the new line of credit facility will close. Under the terms and covenants of the proposed facility, the Company would have been in compliance as of December 31, 1999. Maturities of long-term debt as of December 31, 1999 were as follows (in thousands):
YEAR ENDING DECEMBER 31, - ------------ 2000 ................................................................. $ 6,635 2001 ................................................................. 2,737 2002 ................................................................. 845 2003 ................................................................. 501 2004 ................................................................. 249 Thereafter ........................................................... 1,013 ------- $11,980 =======
7. ACCRUED PENSION LIABILITY Diamond has a noncontributory defined benefit pension plan covering all employees who have met the eligibility requirements. The plan provides monthly benefits based on years of service which are subject to certain reductions if the employee retires before reaching age 65. Diamond's funding policy is to make the minimum annual contribution that is required by applicable regulations. Effective October 1992, Diamond froze the plan, restricting new participants and benefits for future service. 47 48 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table sets forth the plan's funded status and amounts recognized in the accompanying balance sheets (in thousands):
DECEMBER 31, ------------------------- 1998 1999 ------- ------- Change in benefit obligation: Benefit obligation, beginning ........... $ 1,117 $ 1,126 Service cost ............................ -- -- Interest cost ........................... 76 76 Actuarial loss .......................... 2 31 Benefits paid ........................... (69) (62) ------- ------- Benefit obligation, ending .............. 1,126 1,171 ------- ------- Change in plan assets: Fair value of plan assets, beginning .... 1,004 1,050 Actual return on plan assets ............ 115 (17) Employer contribution ................... -- -- Benefits paid ........................... (69) (62) ------- ------- Fair value of plan assets, ending ....... 1,050 971 ------- ------- Funded status ................................. (76) (200) Unrecognized net actuarial loss ............... 150 274 ------- ------- Prepaid benefit cost .......................... $ 74 $ 74 ======= ======= Additional minimum liability disclosures: Accrued benefit liability ............... $ (76) $ (200) ======= ======= Components of net periodic benefit costs: Service cost ............................ $ -- $ -- Interest cost ........................... 76 77 Expected return on plan assets .......... (75) (79) Recognized net actuarial loss ........... 3 2 ------- ------- Net periodic benefit cost ............... $ 4 $ -- ======= =======
Assumptions used by Diamond in the determination of the pension plan information consisted of the following:
DECEMBER 31, ------------------- 1998 1999 ---- ---- Discount rate ....................................... 7.00% 7.00% Expected long-term rate of return on plan assets .... 7.75% 7.75%
8. INCOME TAXES The Company accounts for income taxes under the provisions SFAS No. 109, Accounting for Income Taxes. As of December 31, 1999 the Company had approximately $127.5 million of net operating loss ("NOL") carryforwards for income tax purposes and approximately $2.7 million of research and development tax credits available to offset future federal income tax, subject to limitations for alternative minimum tax. The NOL and credit carryforwards are subject to examination by the tax authorities and expire in various years from 2003 through 2019. The Tax Reform Act of 1986 contains provisions that may limit the NOL and credit carryforwards available for use in any given year upon the occurrence of certain events, including significant changes in ownership interest. A change in ownership of a company of greater 48 49 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS than 50% within a three-year period results in an annual limitation on the Company's ability to utilize its NOL carryforwards from tax periods prior to the ownership change. The acquisition of Diamond in April 1996 resulted in such a change of ownership and the Company estimates that the resulting NOL carryforward limitation will be approximately $4.7 million per year for periods subsequent to April 19, 1996. The Company believes that this limitation may affect the eventual utilization of its total NOL carryforwards. The acquisition of Diamond was completed on a tax free basis. Accordingly, the basis of the assets for financial reporting purposes exceeds the basis of the assets for income tax purposes. The Company has recorded a deferred tax liability related to this basis difference. As the Company had previously recorded a valuation allowance against its deferred tax assets, the Company reduced its valuation allowance in an amount equal to the deferred tax liability at the date of the merger. The Company's NOL's represent a previously unrecognized tax benefit. Recognition of these benefits requires future taxable income, the attainment of which is uncertain, and therefore, a valuation allowance has been established for the entire tax benefit and no benefit for income taxes has been recognized in the accompanying consolidated statements of operations. Deferred tax assets and liabilities consist of the following (in thousands):
DECEMBER 31, DECEMBER 31, 1998 CHANGES 1999 ------------ -------- ------------ Deferred tax assets: Research and development credits ..... $ 2,318 $ 426 $ 2,744 Inventory valuation and reserves ..... 788 (506) 282 Deferred revenue ..................... 119 149 268 Pension liability .................... 29 48 77 Accrued compensation ................. 121 (10) 111 Amortization of intangible assets .... 315 396 711 Loss on assets held for sale ......... 492 102 594 Restructuring reserve ................ 624 (194) 430 Other ................................ 64 (13) 51 Net operating loss carryforwards ..... 36,154 12,632 48,786 -------- -------- -------- 41,024 13,030 54,054 Less valuation allowance ............. (40,470) (13,073) (53,543) -------- -------- -------- 554 (43) 511 Deferred tax liability: Property and equipment ............... (554) 43 (511) -------- -------- -------- (554) 43 (511) -------- -------- -------- Net deferred taxes ......... $ -- $ -- $ -- ======== ======== ========
9. COMMITMENTS AND CONTINGENCIES In November 1998, Synbiotics Corporation ("Synbiotics") filed a lawsuit against the Company in the United States District Court for the Southern District of California in which it alleges that the Company infringed a patent owned by Synbiotics relating to heartworm diagnostic technology. The Company has answered the complaint, discovery is proceeding and no trial date has been set. The Company has obtained legal opinions from outside patent counsel that its heartworm diagnostic products do not infringe the Synbiotics patent and that the patent is invalid. The opinions of non-infringement are consistent with the results of the Company's internal evaluations. While management believes that the Company has valid defenses to Synbiotics' allegations and intends to defend the action vigorously, there can be no assurance 49 50 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS that an adverse result or settlement would not have a material adverse effect on the Company's financial position, its results of operations or cash flow. The Company holds certain rights to market and manufacture all products developed or created under certain research, development and licensing agreements with various entities. In connection with such agreements, the Company has agreed to pay the entities royalties on net product sales. In the years ended December 31, 1997, 1998 and 1999, royalties of $15,000, $52,000 and $1.0 million became payable under these agreements, respectively. In connection with an equity investment by a pharmaceutical firm in April 1996 (the "Investor"), the Company granted the Investor the rights, co-exclusive with the Company's rights, to market two products under development by the Company, the flea control vaccine and feline heartworm vaccine. The Company and the Investor have a revenue sharing arrangement for net sales of these products through the year 2005. In addition to the marketing agreements described above, the Company entered into a pharmaceutical screening cooperation agreement with the Investor, pursuant to which the two parties may enter into joint development arrangements to develop pharmaceutical and vaccine products. In addition, to the extent that the Company decides to grant a license to any third party for any products or technology for companion or food animal applications, the Investor must be offered first right to negotiate to acquire such license. In connection with the acquisition of Center, the Company entered into a sales and marketing agreement with a domestic distribution company which grants the right to the distribution company to market and sell Center's allergenic extracts for human use, with sales commission rates which vary from 20% to 25%. The agreement expires in December 2002. The Company contracts with various parties that conduct research and development on the Company's behalf. In return, the Company generally receives the right to commercialize any products resulting from these contracts. In the event the Company licenses any technology developed under these contracts, the Company will generally be obligated to pay royalties at specified percentages of future sales of products utilizing the licensed technology. The Company has entered into operating leases for its office and research facilities and certain equipment with future minimum payments as of December 31, 1999 as follows (in thousands):
YEAR ENDING DECEMBER 31, - ------------ 2000................................................. $ 1,113 2001................................................. 1,124 2002................................................. 1,118 2003................................................. 1,118 2004................................................. 809 Thereafter........................................... 425 ------- $ 5,707 =======
The Company had rent expense of $1.4 million, $1.4 million and $1.1 million in 1997, 1998 and 1999, respectively. 50 51 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. CAPITAL STOCK Common Stock In December 1999, the Company completed a follow-on public offering of 6,500,000 shares of common stock at a price of $2.063 per share, providing the Company with net proceeds of approximately $13.3 million. In July 1998, the Company issued 1.165 million shares of the Company's common stock to Ralston Purina Company ("Ralston Purina"), for $14.75 million in cash, and also issued, for an additional cash payment of $250,000, warrants to purchase an additional 1.165 million shares of the Company's common stock. The exercise price of the warrants was $12.67 for the first year of the warrants, increasing by 20% per year for each of the second and third years of the warrants. The warrants were exercisable immediately as of July 30, 1998 and expire in three years with respect to any unexercised shares. In July 1998, the Company issued 205,619 shares of common stock to Bayer Corporation ("Bayer") in consideration for the acquisition by Diamond of certain assets, including land and buildings formerly leased by Diamond from Bayer, and as repayment in full of certain indebtedness of Diamond to Bayer, in a transaction valued at approximately $2.3 million. In March 1998, the Company completed its follow-on public offering of 5,750,000 shares of common stock (including 500,000 shares offered by a stockholder of the Company and an underwriters' over-allotment option exercised for 750,000 shares) at a price of $9.875 per share, providing the Company with net proceeds of approximately $48.6 million. In July 1997, the Company completed its IPO of 5,637,850 shares of common stock (including an underwriters' over-allotment option exercised for 637,850 shares) at a price of $8.50 per share, providing the Company with net proceeds of approximately $43.9 million. Upon closing of the IPO, all of the outstanding shares of Series A, B, C, D, E and F preferred stock were automatically converted into 11,289,388 shares of common stock. The Company has granted stock purchase rights to acquire 322,000 shares of common stock to key executives and Directors pursuant to the 1994 Key Executive Stock Plan. As of December 31, 1998, executives had exercised all of these stock purchase rights by executing promissory notes payable to the Company. The fair market value of the underlying common stock equaled the exercise price on the date of grant and exercise. The notes mature in six years, bear interest at 7.5% and are secured by a pledge of the underlying shares of common stock. Under the terms of the Key Executive Stock Plan, if the purchaser's relationship with the Company ceases for any reason within 48 months of the grant date, the Company may, within 90 days following termination, repurchase at the original exercise price all of the stock which has not vested. The stock vests ratably over a 48 month period. During the years ended December 31, 1998 and 1999, 310,520 and 316,760 shares had vested and been released from the purchase option, respectively. As of December 31, 1999, only one promissory note related to these shares remained outstanding. Stock Option Plans The Company has a stock option plan which authorizes granting of stock options and stock purchase rights to employees, officers, directors and consultants of the Company to purchase shares of common stock. In 1997, the board of directors adopted the 1997 Stock Incentive Plan (the "1997 Plan") and terminated two prior option plans. However, options granted and unexercised under the prior plans are still outstanding. All shares remaining available for grant under the terminated plans were rolled into the 1997 Plan. In addition, all shares which are subsequently cancelled under the prior plans are rolled into the 1997 Plan on a quarterly basis. The number of shares reserved for issuance under the 1997 Plan increases 51 52 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS automatically on January 1 of each year by a number equal to the lesser of (a) 1,500,000 shares or (b) 5% of the shares of common stock outstanding on the immediately preceding December 31. The number of shares reserved for issuance under all plans as of January 1, 2000 was 5,051,420. The stock options granted by the board of directors may be either incentive stock options ("ISOs") or nonstatutory stock options ("NSOs"). The purchase price for options under all of the plans may be no less than 100% of fair market value for ISOs or 85% of fair market value for NSOs. Options granted will expire no later than the tenth anniversary subsequent to the date of grant or 90 days following termination of employment, except in cases of death or disability, in which case the options will remain exercisable for up to twelve months. Under the terms of the 1997 Plan, in the event the Company is sold or merged, options granted will either be assumed by the surviving corporation or vest immediately. SFAS No. 123 ("SFAS 123") SFAS 123, Accounting for Stock-Based Compensation, defines a fair value based method of accounting for employee stock options, employee stock purchases, or similar equity instruments. However, SFAS 123 allows the continued measurement of compensation cost for such plans using the intrinsic value based method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), provided that pro forma disclosures are made of net income or loss, assuming the fair value based method of SFAS 123 had been applied. The Company has elected to account for its stock-based compensation plans under APB 25; accordingly, for purposes of the pro forma disclosures presented below, the Company has computed the fair values of all options granted during 1997, 1998 and 1999, using the Black-Scholes pricing model and the following weighted average assumptions:
1997 1998 1999 ---------- --------- --------- Risk-free interest rate..... 6.49% 5.28% 5.63% Expected lives.............. 4.93 years 3.8 years 3.5 years Expected volatility......... 72% 89% 91% Expected dividend yield..... 0% 0% 0%
To estimate expected lives of options for this valuation, it was assumed options will be exercised at varying schedules after becoming fully vested dependent upon the income level of the option holder. For measurement purposes, options have been segregated into three income groups, and estimated exercise behavior of option recipients varies from six months to one and one half years from the date of vesting, dependent on income group (less highly compensated employees are expected to have shorter holding periods). All options are initially assumed to vest. Cumulative compensation cost recognized in pro forma basic net income or loss with respect to options that are forfeited prior to vesting is adjusted as a reduction of pro forma compensation expense in the period of forfeiture. Fair value computations are highly sensitive to the volatility factor assumed; the greater the volatility, the higher the computed fair value of the options granted. The total fair value of options granted was computed to be approximately $5.0 million, $8.8 million and $3.8 million for the years ended December 31, 1997, 1998 and 1999, respectively. The amounts are amortized ratably over the vesting periods of the options. Pro forma stock-based compensation, net of the effect of forfeitures, was $1.8 million, $3.9 million and $3.6 million for 1997, 1998 and 1999, respectively. 52 53 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A summary of the Company's stock option plans is as follows:
YEAR ENDED DECEMBER 31, --------------------------------------------------------------------------------------- 1997 1998 1999 ------------------------- ------------------------- ------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE --------- ---------- --------- ---------- --------- ---------- Outstanding at beginning of period .... 2,008,942 $ 0.6814 2,570,533 $ 1.9053 3,209,317 $ 5.1203 Granted .......................... 1,060,196 $ 4.1842 1,304,443 $ 10.6166 1,725,480 $ 3.4876 Cancelled ........................ (100,265) $ 1.7630 (315,543) $ 5.9544 (329,820) $ 6.6815 Exercised ........................ (398,340) $ 0.3579 (350,116) $ 1.2188 (358,794) $ 0.8148 --------- --------- --------- Outstanding at end of period .......... 2,570,533 $ 1.9053 3,209,317 $ 5.1204 4,246,183 $ 4.6994 ========= ========= ========= Exercisable at end of period .......... 1,077,284 $ 0.9760 1,531,895 $ 2.9417 1,973,349 $ 4.1737 ========= ========= =========
The weighted average exercise prices and weighted average estimated fair value of options granted during the years ended December 31, 1997, 1998 and 1999 were as follows:
YEAR ENDED DECEMBER 31, 1997 ------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE NUMBER OF ESTIMATED EXERCISE OPTIONS FAIR VALUE PRICE --------- ---------- --------- Exercise price equal to estimated fair value ..... 167,400 $ 5.4622 $ 9.3684 Exercise price less than estimated fair value .... 892,796 $ 3.8469 $ 3.2122 --------- 1,060,196 $ 4.1019 $ 4.1842 =========
YEAR ENDED DECEMBER 31, 1998 ------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE NUMBER OF ESTIMATED EXERCISE OPTIONS FAIR VALUE PRICE --------- --------- ---------- Exercise price equal to estimated fair value ..... 1,304,443 $ 6.7635 $ 10.6166 Exercise price less than estimated fair value .... -0- -0- -0- --------- 1,304,443 $ 6.7635 $ 10.6166 =========
YEAR ENDED DECEMBER 31, 1999 ------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE NUMBER OF ESTIMATED EXERCISE OPTIONS FAIR VALUE PRICE --------- ---------- --------- Exercise price equal to estimated fair value ..... 1,725,480 $ 2.1814 $ 3.4876 Exercise price less than estimated fair value .... -0- -0- -0- --------- 1,725,480 $ 2.1814 $ 3.4876 =========
The Company recorded deferred compensation (as calculated under APB 25) of $1.5 million during the year ended December 31, 1997, representing the difference between the deemed value of the common stock for accounting purposes and the exercise price of such options at the date of grant. In 1998 the Company also granted stock options to non-employees in exchange for consulting services, recording 53 54 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS deferred compensation of $46,000 based on the estimated fair value of the options at the date of grant. Deferred compensation is being amortized over the applicable vesting periods. The amortization of deferred compensation resulted in a non-cash charge to operations of $645,000, $736,000 and $629,000 in the years ended December 31, 1997, 1998 and 1999, respectively. The following table summarizes information about stock options outstanding and exercisable at December 31, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE -------------------------------------- ------------------------ NUMBER OF NUMBER OF OPTIONS WEIGHTED OPTIONS OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED AT REMAINING AVERAGE AT AVERAGE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE EXERCISE PRICES 1999 LIFE IN YEARS PRICE 1999 PRICE ------------ ------------- --------- ------------ --------- $ 0.15 - $ 0.35 .... 375,930 4.37 $ 0.2929 370,576 $ 0.2921 $ 1.20 - $ 1.50 .... 806,045 7.42 $ 1.2260 684,165 $ 1.2260 $ 1.81 - $ 2.50 .... 562,948 10.08 $ 2.1639 32,357 $ 2.1639 $ 3.00 - $ 4.00 .... 626,811 8.97 $ 3.1315 154,135 $ 3.1315 $ 4.25 - $ 5.25 .... 526,904 8.57 $ 5.0729 166,947 $ 5.0729 $ 5.37 - $11.75 .... 696,994 8.67 $ 7.5531 246,740 $ 8.3571 $11.88 - $15.00 .... 650,551 8.07 $ 11.9912 318,429 $ 12.0202 --------- --------- $ 0.15 - $15.00 .... 4,246,183 8.18 $ 4.6994 1,973,349 $ 4.1737 ========= =========
Employee Stock Purchase Plan (the "ESPP") Under the 1997 Employee Stock Purchase Plan, the Company is authorized to issue up to 250,000 shares of common stock to its employees. Employees of the Company and its U.S. subsidiaries who are expected to work at least 20 hours per week and five months per year are eligible to participate. Under the terms of the plan, employees can choose to have up to 10% of their annual base earnings withheld to purchase the Company's common stock. The purchase price of the stock is 85% of the lower of its beginning-of-enrollment period or end-of-measurement period market price. Each enrollment period is two years, with six month measurement periods ending June 30 and December 31. The Company has computed the fair values of stock purchased under the ESPP in 1997, 1998 and 1999, using the Black-Scholes pricing model and the following weighted average assumptions:
1997 1998 1999 -------- -------- -------- Risk-free interest rate .... 5.69% 5.01% 5.67% Expected lives ............. 2 years 2 years 2 years Expected volatility ........ 72% 89% 91% Expected dividend yield .... 0% 0% 0%
The total fair value of stock sold under the ESPP was computed to be approximately $103,000, $268,000 and $111,000 for the years ended December 31, 1997, 1998 and 1999, with a weighted-average fair value of the purchase rights granted of $4.73, $4.57 and $1.24 per share, respectively. Pro forma stock-based compensation, net of the effect of forfeitures, was approximately $103,000, $268,000 and $96,000 in 1997, 1998 and 1999, respectively, for the ESPP. 54 55 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Pro Forma Basic Net Loss per Share under SFAS 123 If the Company had accounted for all of its stock-based compensation plans in accordance with SFAS 123, the Company's net loss would have been reported as follows (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31, --------------------------------------------- 1997 1998 1999 ----------- ----------- ----------- (RESTATED) Net loss: As reported .................................................. $ (38,864) $ (44,274) $ (35,836) =========== =========== =========== Pro forma (unaudited) ........................................ $ (40,767) $ (48,442) $ (39,564) =========== =========== =========== Basic net loss per share: As reported (unaudited pro forma basic net loss per share for 1997) ................................................ $ (2.42) $ (1.79) $ (1.31) =========== =========== =========== Pro forma (unaudited) ........................................ $ (2.54) $ (1.96) $ (1.45) =========== =========== ===========
Stock Warrants The Company had issued warrants to purchase 6,400 shares of Series C preferred stock at an exercise price of $2.50 per share and 6,225 shares, 267 shares and 18,500 shares of Series D preferred stock at an exercise price of $3.25 per share in connection with certain leases discussed in Note 4. Upon the closing of the IPO, the rights were converted to warrants to purchase the Company's common stock at the original exercise prices. In September 1997, the Company issued 5,323 shares of common stock in exchange for the warrant for 6,400 shares at an exercise price of $2.50 per share in a cashless "net" exercise. In April 1998, the Company issued 4,912 shares of common stock in exchange for the warrant for 6,225 shares at an exercise price of $3.25 per share in a cashless "net" exercise. In July 1998, the Company issued warrants to purchase 1.165 million shares of the Company's common stock in connection with the private placement with Ralston Purina described previously. The exercise price of the warrants was $12.67 for the first year of the warrants, increasing by 20% per year for each of the second and third years of the warrants. The warrants were exercisable immediately as of July 30, 1998 and expire in three years with respect to any unexercised shares. In May 1999, the Company issued an aggregate of 4,500 shares of common stock in exchange for the warrants to purchase 267 shares and 18,500 shares at an exercise price of $3.25 in a cashless "net" exercise. No warrants other than those described above had been exercised as of December 31, 1999. 11. MAJOR CUSTOMERS The Company had sales of greater than 10% of total revenue to only one customer during the years ended December 31, 1997, 1998 and 1999. This customer, which represented 21%, 15% and 12% of total revenues, respectively, purchased vaccines from Diamond. 55 56 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
YEAR ENDED DECEMBER 31, ---------------------------- 1997 1998 1999 ------ ------ ------ (IN THOUSANDS) Cash paid for interest ............................................................... $1,274 $1,999 $1,857 Non-cash investing and financing activities: Issuance of debt related to acquisitions ....................................... 3,465 -- -- Issuance of common and preferred stock related to acquisitions, net of cash acquired ..................................................................... 3,892 -- -- Issuance of common stock in exchange for assets and as repayment of debt ....... -- 2,262 -- Purchase of assets under direct capital lease financing ........................ 894 86 193
13. SEGMENT REPORTING During 1998, the Company adopted the provisions of SFAS No. 131, Disclosures About Segments of an Enterprise, which changes the way the Company reports information about its operating segments. The Company divides its operations into two reportable segments, Animal Health, which includes the operations of Heska, Diamond, Heska Waukesha, Heska UK and Heska AG, and Allergy Diagnostics and Treatment, which includes the operations of Center and CMG. Summarized financial information concerning the Company's reportable segments is shown in the following table (in thousands). The "Other" column includes the elimination of intercompany transactions and other items as noted.
ALLERGY ANIMAL DIAGNOSTICS AND HEALTH TREATMENT OTHER TOTAL --------- --------------- --------- --------- 1999: Revenues ......................... $ 47,430 $ 7,106 $ (3,360) $ 51,176 Operating income (loss) .......... (30,285) (499) (3,803)(a) (34,587) Total assets ..................... 110,566 7,194 (46,592) 71,168 Capital expenditures ............. 2,755 541 -- 3,296 Depreciation and amortization .... 3,364 500 -- 3,864
- ------------ (a) Includes the write-down of certain tangible and intangible assets to their expected net realizable values, resulting from a loss on assets held for disposition of $2.6 million and restructuring expenses of $1.2 million (See Note 5).
ALLERGY ANIMAL DIAGNOSTICS AND HEALTH TREATMENT OTHER TOTAL --------- --------------- --------- --------- 1998: Revenues ......................... $ 35,755 $ 8,479 $ (4,462) $ 39,772 Operating income (loss) .......... (38,768) (1,014) (6,174)(b) (45,956) Total assets ..................... 123,965 7,495 (33,406) 98,054 Capital expenditures ............. 5,602 868 -- 6,470 Depreciation and amortization .... 3,235 365 -- 3,600
- ------------- (b) Includes the write-down of certain tangible and intangible assets to their expected net realizable values, resulting from a loss on assets held for disposition of $1.3 million, restructuring expenses of $2.4 million (See Note 5) and inventory write-downs of $1.5 million. 56 57 HESKA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ALLERGY ANIMAL DIAGNOSTICS AND HEALTH TREATMENT OTHER TOTAL -------- --------------- -------- -------- 1997: Revenues ......................... $ 29,465 $ 3,273 $ (3,435) $ 29,303 Operating income (loss) .......... (38,825) (284) (53) (39,162) Total assets ..................... 82,105 8,670 (21,755) 69,020 Capital expenditures ............. 6,158 90 -- 6,248 Depreciation and amortization .... 2,230 161 -- 2,391
The Company manufactures and markets its products in two major geographic areas, North America and Europe. The Company's primary manufacturing facilities are located in North America. Revenues earned in North America are attributable to Heska, Diamond, Heska Waukesha and Center. Revenues earned in Europe are primarily attributable to Heska UK, CMG and Heska AG. There have been no significant exports from North America or Europe. During each of the years presented, European subsidiaries purchased products from North America for sale to European customers. Transfer prices to international subsidiaries are intended to allow the North American companies to produce profit margins commensurate with their sales and marketing efforts. Certain information by geographic area is shown in the following table (in thousands). The "Other" column includes the elimination of intercompany transactions.
NORTH AMERICA EUROPE OTHER TOTAL ------------- --------- --------- --------- 1999: Revenues ......................... $ 50,336 $ 4,200 $ (3,360) $ 51,176 Operating income (loss) .......... (27,431) (3,353) (3,803)(a) (34,587) Total assets ..................... 114,165 3,595 (46,592) 71,168 Capital expenditures ............. 3,292 4 -- 3,296 Depreciation and amortization .... 3,701 163 -- 3,864
- ---------- (a) Includes the write-down of certain tangible and intangible assets to their expected net realizable values, resulting from a loss on assets held for disposition of $2.6 million and restructuring expenses of $1.2 million (See Note 5).
NORTH AMERICA EUROPE OTHER TOTAL ------------- --------- --------- --------- 1998: Revenues ......................... $ 40,573 $ 3,661 $ (4,462) $ 39,772 Operating income (loss) .......... (37,386) (2,396) (6,174)(b) (45,956) Total assets ..................... 127,004 4,457 (33,407) 98,054 Capital expenditures ............. 6,190 280 -- 6,470 Depreciation and amortization .... 3,009 591 -- 3,600
- ---------- (b) Includes the write-down of certain tangible and intangible assets to their expected net realizable values, resulting from a loss on assets held for disposition of $1.3 million, restructuring expenses of $2.4 million (see Note 5) and inventory write-downs of $1.5 million.
NORTH AMERICA EUROPE OTHER TOTAL ------------- --------- --------- --------- 1997: Revenues ......................... $ 30,513 $ 2,225 $ (3,435) $ 29,303 Operating income (loss) .......... (38,325) (784) (53) (39,162) Total assets ..................... 86,262 4,513 (21,755) 69,020 Capital expenditures ............. 6,113 135 -- 6,248 Depreciation and amortization .... 2,254 137 -- 2,391
57 58 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. PART III Certain information required by Part III is incorporated by reference to the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the Company's 2000 Annual Meeting of Stockholders (the "Proxy Statement"). ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this section is incorporated by reference to the information in the sections entitled "Election of Directors--Directors and Nominees for Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement. The required information concerning executive officers of the Company is contained in the section entitled "Executive Officers of the Registrant" in Part I of this Form 10-K. ITEM 11. EXECUTIVE COMPENSATION. The information required by this section is incorporated by reference to the information in the sections entitled "Election of Directors--Directors' Compensation" and "Executive Compensation" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this section is incorporated by reference to the information in the section entitled "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this section is incorporated by reference to the information in the section entitled "Certain Transactions and Relationships" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) The following documents are filed as a part of this Form 10-K. (1) FINANCIAL STATEMENTS: Reference is made to the Index to Consolidated Financial Statements under Item 8 in Part II of this Form 10-K. (2) FINANCIAL STATEMENT SCHEDULES: Schedule II - Valuation and Qualifying Accounts. 58 59 SCHEDULE II HESKA CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS BALANCE AT CHARGED TO BEGINNING COSTS AND OTHER BALANCE AT OF YEAR EXPENSES ADDITIONS DEDUCTIONS END OF YEAR ---------- ---------- --------- ----------- ----------- ALLOWANCE FOR DOUBTFUL ACCOUNTS Year ended: December 31, 1997 ..................... $ 51 $ 45 -- $ -- $ 96 December 31, 1998 ..................... $ 96 $ 9 -- $ (12)(a) $ 93 December 31, 1999 ..................... $ 93 $ 122 -- $ (27)(a) $ 188 ALLOWANCE FOR RESTRUCTURING CHARGES Year ended: December 31, 1997 ..................... -- -- -- -- -- December 31, 1998 ..................... -- $ 2,356 -- $ (725)(a) $ 1,631 December 31, 1999 ..................... $ 1,631 $ 1,210 -- $(1,718)(a) $ 1,123
- ------------ (a) Write-offs of uncollectible accounts and payments for personnel severance costs and facility closing costs. 3) EXHIBITS: The exhibits listed below are required by Item 601 of Regulation S-K. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K has been identified.
Exhibit Number Notes Description of Document ------ ----- ----------------------- 3.(ii) Bylaws 4.2 (1) First Amended Investors' Rights Agreement by and among Registrant and certain stockholders of Registrant dated as of April 12, 1996. 4.2(a) (6) Waiver and Amendment to first Amended Investors' Rights Agreement among the Company and certain other parties. 4.2(b) (6) Second Waiver and Amendment to first Amended Investors' Rights Agreement among the Company and certain other parties. 4.2(c) (6) Third Waiver and Amendment to first Amended Investors' Rights Agreement among the Company and certain other parties. 4.3 (1) Form of warrant to purchase Series C Preferred Stock. 4.4 (1) Form of warrant to purchase Series D Preferred Stock. 4.5 (5) Company Stock Warrant Purchase Agreement dated as of July 29, 1998 between the Company and Ralston Purina Company. 9.1 (1) Voting Agreement by and among Registrant and certain stockholders of Registrant, dated as of April 12, 1996. 10.1H (1) Collaborative Agreement between Registrant and Eisai Co., Ltd. dated January 25, 1993. 10.2H (1) Canine Heartworm Cooperation Agreement between Registrant and Bayer AG dated as of June 10, 1994. 10.3H (1) Feline Toxoplasmosis Cooperation Agreement between Registrant and Bayer AG dated as of June 10, 1994. 10.4H (1) Product Supply and License Agreement between Registrant and Atrix Laboratories, Inc. dated May 1, 1995, as amended June 23, 1995.
59 60 10.5H (1) Screening and Development Agreement between Ciba-Geigy Limited and Registrant, dated as of April 12, 1996. 10.6 (1) Right of First Refusal Agreement between Ciba-Geigy Limited and Registrant, dated as of April 12, 1996. 10.7 (1) Marketing Agreement between Registrant and Ciba-Geigy Limited dated as of April 12, 1996. 10.8H (1) Marketing Agreement between Registrant and Ciba-Geigy Corporation dated as of April 12, 1996. 10.9H (1) Manufacturing and Supply Agreement between and among Diamond Animal Health, Inc., Agrion Corporation, Diamond Scientific Co. and Miles Inc. dated December 31, 1993 and Amendment and Extension thereto dated September 1, 1995. 10.9(a)H (5) Second Amendment to Manufacturing and Supply Agreement between Diamond Animal Health, Inc. and Bayer Corporation dated February 26, 1998. 10.10* (1) Employment Agreement between Registrant and Robert B. Grieve dated January 1, 1994, as amended March 4, 1997. 10.10(a)* Amended and Restated Employment Agreement with Robert B. Grieve dated as of February 22, 2000. 10.11* (1) Employment Agreement between Registrant and Fred M. Schwarzer dated November 1, 1994, as amended March 4, 1997. 10.12* (1) Employment Agreement between Registrant and R. Lee Seward dated October 17, 1994. 10.13* (1) Employment Agreement between Registrant and Louis G. Van Daele dated April 14, 1996. 10.14H (2) Supply Agreement between Registrant and Quidel Corporation dated July 3, 1997. 10.15* (1) Restricted Stock Purchase Agreement dated February 28, 1995 by and between Registrant and Fred M. Schwarzer. 10.16* (1) Restricted Stock Purchase Agreement dated February 28, 1995 by and between Registrant and R. Lee Seward. 10.17* (1) Restricted Stock Purchase Agreement dated January 11, 1997 by and between Registrant and Denis H. Pomroy. 10.18* (1) Form of Indemnification Agreement entered into between Registrant and its directors and certain officers. 10.19* (1) 1997 Incentive Stock Plan of Registrant. 10.20* (1) Forms of Option Agreement. 10.21* (1) 1997 Employee Stock Purchase Plan of Registrant. 10.22 (1) Lease Agreement dated March 8, 1994 between Sharp Point Properties, LLC and Registrant. 10.23 (1) Lease Agreement dated as of June 27, 1996 between GB Ventures and Registrant. 10.24 (1) Lease Agreement dated as of July 11, 1996 between GB Ventures and Registrant. 10.25 (1) Lease Agreement dated as of December 31, 1993 between Miles, Inc. and Diamond Animal Health, Inc., as amended September 1, 1995. 10.26* (3) Employment Agreement between Registrant and Giuseppe Miozzari dated July 1, 1997. 10.27* (4) Employment Agreement between Registrant and John A. Shadduck dated January 27, 1997. 10.28* (7) Employment Agreement between Registrant and Ronald L. Hendrick dated December 1, 1998. 10.29* (7) Employment Agreement between Registrant and James H. Fuller dated January 18, 1999. 10.30* (7) Separation Agreement between Registrant and Fred M. Schwarzer dated December 14, 1998. 10.31* (7) Consulting Services and Confidentiality Agreement between Registrant and Fred M. Schwarzer dated December 14, 1998.
60 61 10.32* (7) Separation Agreement between Registrant and John A. Shadduck dated December 14, 1998. 10.33* (7) Consulting Services and Confidentiality Agreement between Registrant and John A. Shadduck dated December 14, 1998. 10.34H (7) Exclusive Distribution Agreement dated as of August 18, 1998 between the Company and Novartis Agro K.K. 10.35 (7) Right of First Refusal Agreement dated as of August 18, 1998 between the Company and Novartis Animal Health, Inc. 10.36* Separation Agreement between Registrant and R. Lee Seward dated November 30, 1999. 10.37* Consultant Services and Confidentiality Agreement between Registrant and Seward Pharm, LLC dated December 1, 1999. 10.38* Executive Bonus Plan 21.1 Subsidiaries of the Company. 23.1 Consent of Arthur Andersen LLP. 24.1 Power of Attorney (See page 62 of this Form 10-K). 27.1 Financial Data Schedule.
Notes * Indicates management contract or compensatory plan or arrangement. H Confidential treatment has been granted with respect to certain portions of these agreements. (1) Filed with Registrant's Registration Statement on Form S-1 (File No. 333-25767). (2) Filed with the Registrant's Form 10-Q for the quarter ended September 30, 1997. (3) Filed with Registrant's Registration Statement on Form S-1 (File No. 333-44835). (4) Filed with the Registrant's Form 10-K for the year ended December 31, 1998. (5) Filed with the Registrant's Form 10-Q for the quarter ended March 31, 1998. (6) Filed with the Registrant's Form 10-Q for the quarter ended September 30, 1998. (7) Filed with the Registrant's Form 10-K for the year ended December 31, 1998. (b) Reports on Form 8-K: There were no Reports on Form 8-K filed by the Company during the quarter ended December 31, 1999. 61 62 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 23, 2000. HESKA CORPORATION By /s/ ROBERT B. GRIEVE ------------------------------------- Robert B. Grieve Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert B. Grieve, Ronald L. Hendrick, Michael A. Bent and A. Lynn DeGeorge, and each of them, his or her true and lawful attorneys-in-fact, each with full power of substitution, for him or her in any and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated:
NAME TITLE DATE ---- ----- ---- /s/ ROBERT B. GRIEVE Chief Executive Officer (Principal March 23, 2000 - -------------------------------------------- Executive Officer) and Director Robert B. Grieve /s/ RONALD L. HENDRICK Chief Financial Officer (Principal March 23, 2000 - -------------------------------------------- Financial and Accounting Officer) Ronald L. Hendrick /s/ JAMES H. FULLER President and Chief Operating Officer March 23, 2000 - -------------------------------------------- James H. Fuller /s/ FRED M. SCHWARZER Chairman of the Board March 23, 2000 - -------------------------------------------- Fred M. Schwarzer /s/ A. BARR DOLAN Director March 23, 2000 - -------------------------------------------- A. Barr Dolan /s/ LYLE A. HOHNKE Director March 23, 2000 - -------------------------------------------- Lyle A. Hohnke /s/ DENIS H. POMROY Director March 23, 2000 - -------------------------------------------- Denis H. Pomroy /s/ LYNNOR B. STEVENSON Director March 23, 2000 - -------------------------------------------- Lynnor B. Stevenson /s/ GUY L. TEBBIT Director March 23, 2000 - -------------------------------------------- Guy L. Tebbit /s/ JOHN F. SASEN, Sr. Director March 23, 2000 - -------------------------------------------- John F. Sasen, Sr.
63 EXHIBIT INDEX
Exhibit Number Notes Description of Document ------ ----- ----------------------- 3.(ii) Bylaws 4.2 (1) First Amended Investors' Rights Agreement by and among Registrant and certain stockholders of Registrant dated as of April 12, 1996. 4.2(a) (6) Waiver and Amendment to first Amended Investors' Rights Agreement among the Company and certain other parties. 4.2(b) (6) Second Waiver and Amendment to first Amended Investors' Rights Agreement among the Company and certain other parties. 4.2(c) (6) Third Waiver and Amendment to first Amended Investors' Rights Agreement among the Company and certain other parties. 4.3 (1) Form of warrant to purchase Series C Preferred Stock. 4.4 (1) Form of warrant to purchase Series D Preferred Stock. 4.5 (5) Company Stock Warrant Purchase Agreement dated as of July 29, 1998 between the Company and Ralston Purina Company. 9.1 (1) Voting Agreement by and among Registrant and certain stockholders of Registrant, dated as of April 12, 1996. 10.1H (1) Collaborative Agreement between Registrant and Eisai Co., Ltd. dated January 25, 1993. 10.2H (1) Canine Heartworm Cooperation Agreement between Registrant and Bayer AG dated as of June 10, 1994. 10.3H (1) Feline Toxoplasmosis Cooperation Agreement between Registrant and Bayer AG dated as of June 10, 1994. 10.4H (1) Product Supply and License Agreement between Registrant and Atrix Laboratories, Inc. dated May 1, 1995, as amended June 23, 1995.
64 10.5H (1) Screening and Development Agreement between Ciba-Geigy Limited and Registrant, dated as of April 12, 1996. 10.6 (1) Right of First Refusal Agreement between Ciba-Geigy Limited and Registrant, dated as of April 12, 1996. 10.7 (1) Marketing Agreement between Registrant and Ciba-Geigy Limited dated as of April 12, 1996. 10.8H (1) Marketing Agreement between Registrant and Ciba-Geigy Corporation dated as of April 12, 1996. 10.9H (1) Manufacturing and Supply Agreement between and among Diamond Animal Health, Inc., Agrion Corporation, Diamond Scientific Co. and Miles Inc. dated December 31, 1993 and Amendment and Extension thereto dated September 1, 1995. 10.9(a)H (5) Second Amendment to Manufacturing and Supply Agreement between Diamond Animal Health, Inc. and Bayer Corporation dated February 26, 1998. 10.10* (1) Employment Agreement between Registrant and Robert B. Grieve dated January 1, 1994, as amended March 4, 1997. 10.10(a)* Amended and Restated Employment Agreement with Robert B. Grieve dated as of February 22, 2000. 10.11* (1) Employment Agreement between Registrant and Fred M. Schwarzer dated November 1, 1994, as amended March 4, 1997. 10.12* (1) Employment Agreement between Registrant and R. Lee Seward dated October 17, 1994. 10.13* (1) Employment Agreement between Registrant and Louis G. Van Daele dated April 14, 1996. 10.14H (2) Supply Agreement between Registrant and Quidel Corporation dated July 3, 1997. 10.15* (1) Restricted Stock Purchase Agreement dated February 28, 1995 by and between Registrant and Fred M. Schwarzer. 10.16* (1) Restricted Stock Purchase Agreement dated February 28, 1995 by and between Registrant and R. Lee Seward. 10.17* (1) Restricted Stock Purchase Agreement dated January 11, 1997 by and between Registrant and Denis H. Pomroy. 10.18* (1) Form of Indemnification Agreement entered into between Registrant and its directors and certain officers. 10.19* (1) 1997 Incentive Stock Plan of Registrant. 10.20* (1) Forms of Option Agreement. 10.21* (1) 1997 Employee Stock Purchase Plan of Registrant. 10.22 (1) Lease Agreement dated March 8, 1994 between Sharp Point Properties, LLC and Registrant. 10.23 (1) Lease Agreement dated as of June 27, 1996 between GB Ventures and Registrant. 10.24 (1) Lease Agreement dated as of July 11, 1996 between GB Ventures and Registrant. 10.25 (1) Lease Agreement dated as of December 31, 1993 between Miles, Inc. and Diamond Animal Health, Inc., as amended September 1, 1995. 10.26* (3) Employment Agreement between Registrant and Giuseppe Miozzari dated July 1, 1997. 10.27* (4) Employment Agreement between Registrant and John A. Shadduck dated January 27, 1997. 10.28* (7) Employment Agreement between Registrant and Ronald L. Hendrick dated December 1, 1998. 10.29* (7) Employment Agreement between Registrant and James H. Fuller dated January 18, 1999. 10.30* (7) Separation Agreement between Registrant and Fred M. Schwarzer dated December 14, 1998. 10.31* (7) Consulting Services and Confidentiality Agreement between Registrant and Fred M. Schwarzer dated December 14, 1998.
65 10.32* (7) Separation Agreement between Registrant and John A. Shadduck dated December 14, 1998. 10.33* (7) Consulting Services and Confidentiality Agreement between Registrant and John A. Shadduck dated December 14, 1998. 10.34H (7) Exclusive Distribution Agreement dated as of August 18, 1998 between the Company and Novartis Agro K.K. 10.35 (7) Right of First Refusal Agreement dated as of August 18, 1998 between the Company and Novartis Animal Health, Inc. 10.36* Separation Agreement between Registrant and R. Lee Seward dated November 30, 1999. 10.37* Consultant Services and Confidentiality Agreement between Registrant and Seward Pharm, LLC dated December 1, 1999. 10.38* Executive Bonus Plan 21.1 Subsidiaries of the Company. 23.1 Consent of Arthur Andersen LLP. 24.1 Power of Attorney (See page 62 of this Form 10-K). 27.1 Financial Data Schedule.
Notes * Indicates management contract or compensatory plan or arrangement. H Confidential treatment has been granted with respect to certain portions of these agreements. (1) Filed with Registrant's Registration Statement on Form S-1 (File No. 333-25767). (2) Filed with the Registrant's Form 10-Q for the quarter ended September 30, 1997. (3) Filed with Registrant's Registration Statement on Form S-1 (File No. 333-44835). (4) Filed with the Registrant's Form 10-K for the year ended December 31, 1998. (5) Filed with the Registrant's Form 10-Q for the quarter ended March 31, 1998. (6) Filed with the Registrant's Form 10-Q for the quarter ended September 30, 1998. (7) Filed with the Registrant's Form 10-K for the year ended December 31, 1998. EX-3.(II) 2 BYLAWS OF HESKA CORPORATION 1 EXHIBIT 3(ii) B Y L A W S OF HESKA CORPORATION (A DELAWARE CORPORATION) 2 TABLE OF CONTENTS
Page ---- ARTICLE I.....................................................................1 1.1 Principal Office...................................................1 1.2 Additional Offices.................................................1 ARTICLE 2.....................................................................1 2.1 Place of Meeting...................................................1 2.2 Annual Meeting.....................................................1 2.3 Special Meetings...................................................2 2.4 Action Without a Meeting...........................................2 2.5 Notice of Meetings.................................................2 2.6 Business Matter of a Special Meeting...............................3 2.7 List of Stockholders...............................................3 2.8 Organization and Conduct of Business...............................3 2.9 Quorum and Adjournments............................................4 2.10 Voting Rights......................................................4 2.11 Majority Vote......................................................4 2.12 Record Date for Stockholder Notice and Voting......................4 2.13 Proxies............................................................5 2.14 Inspectors of Election.............................................5 ARTICLE 3.....................................................................5 3.1 Number, Election, Tenure and Qualifications........................5 3.2 Vacancies..........................................................7 3.3 Resignation and Removal............................................7 3.4 Powers.............................................................7 3.5 Place of Meetings..................................................7 3.6 Annual Meetings....................................................7 3.7 Regular Meetings...................................................7 3.8 Special Meetings...................................................7 3.9 Quorum and Adjournments............................................8 3.10 Action Without Meeting.............................................8 3.11 Telephone Meetings.................................................8 3.12 Waiver of Notice...................................................8 3.13 Fees and Compensation of Directors.................................8 3.14 Rights of Inspection...............................................8 ARTICLE 4.....................................................................9 4.1 Selection..........................................................9 4.2 Power..............................................................9 4.3 Committee Minutes..................................................9 ARTICLE 5.....................................................................9 5.1 Officers Designated................................................9 5.2 Appointment of Officers...........................................10
3 5.3 Subordinate Officers..............................................10 5.4 Removal and Resignation of Officers...............................10 5.5 Vacancies in Offices..............................................10 5.6 Compensation......................................................10 5.7 The Chairman of the Board.........................................10 5.8 The President.....................................................10 5.9 The Vice President................................................11 5.10 The Secretary.....................................................11 5.11 The Assistant Secretary...........................................11 5.12 The Chief Financial Officer.......................................11 ARTICLE 6....................................................................12 6.1 Certificates for Shares...........................................12 6.2 Signatures on Certificates........................................12 6.3 Transfer of Stock.................................................12 6.4 Registered Stockholders...........................................12 6.5 Lost, Stolen or Destroyed Certificates............................13 ARTICLE 7....................................................................13 7.1 Dividends.........................................................13 7.2 Dividend Reserve..................................................13 7.3 Checks............................................................13 7.4 Corporate Seal....................................................13 7.5 Execution of Corporate Contracts and Instruments..................13 7.6 Representation of Shares of Other Corporations....................14 ARTICLE 8....................................................................14 8.1 Stock Options.....................................................14 8.2 Amendments........................................................14
4 ARTICLE I Offices 1.1 Principal Office. The initial registered office of the corporation shall be 1209 Orange Street, Wilmington, Delaware, and the name of the initial registered agent in charge thereof is The Corporation Trust Company. 1.2 Additional Offices. The corporation may also have offices at such other places, either within or without the State of Delaware, as the Board of Directors (the "Board") may from time to time designate or the business of the corporation may require. ARTICLE 2 Meeting of Stockholders 2.1 Place of Meeting. Meetings of stockholders may be held at such place, either within or without of the State of Delaware, as may be designated by or in the manner provided in these Bylaws, or, if not so designated, at the registered office of the corporation or the principal executive offices of the corporation. 2.2 Annual Meeting. Annual meetings of stockholders shall be held each year at such date and time as shall be designated from time to time by the Board and stated in the notice of the meeting. At such annual meetings, the stockholders shall elect by a plurality vote the number of directors equal to the number of directors of the class whose term expires at such meetings (or, if fewer, the number of directors properly nominated and qualified for election) to hold office until the third succeeding annual meeting of stockholders after their election. The stockholders shall also transact such other business as may properly be brought before the meetings. To be properly brought before the annual meeting, business must be either (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors or the President, (b) otherwise properly brought before the meeting by or at the direction of the Board of Directors or the President, or (c) otherwise properly brought before the meeting by a stockholder of record. In addition to any other applicable requirements, for business to be properly brought before the annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the Secretary of the corporation. To be timely, a stockholder's notice must be delivered personally or deposited in the United States mail, or delivered to a common carrier for transmission to the recipient or actually transmitted by the person giving the notice by electronic means to the recipient or sent by other means of written communication, postage or delivery charges prepaid in all such cases, and received at the principal executive offices of the corporation, addressed to the attention of the Secretary of the corporation, not less than 60 days nor more than 90 days prior to the scheduled date of the meeting (regardless of any postponements, deferrals or adjournments of that meeting to a later date); provided, however, that in the event that less than 70 days' notice or prior public disclosure of the date of the scheduled meeting is given or made to stockholders, notice by the stockholder 1 5 to be timely must be so received not later than the earlier of (a) the close of business on the 10th day following the day on which such notice of the date of the scheduled annual meeting was mailed or such public disclosure was made, whichever first occurs, and (b) two days prior to the date of the scheduled meeting. A stockholder's notice to the Secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and record address of the stockholder proposing such business, (iii) the class, series and number of shares of the corporation that are owned beneficially by the stockholder, and (iv) any material interest of the stockholder in such business. Notwithstanding anything in these Bylaws to the contrary, no business shall be conducted at the annual meeting except in accordance with the procedures set forth in this Section; provided, however, that nothing in this Section shall be deemed to preclude discussion by any stockholder of any business properly brought before the annual meeting. The Chairman of the Board of the corporation (or such other person presiding at the meeting in accordance with these Bylaws) shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting in accordance with the provisions of this Section, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. 2.3 Special Meetings. Special meetings of the stockholders may be called for any purpose or purposes, unless otherwise prescribed by the statute or by the Restated Certificate of Incorporation, only at the request of the Chairman of the Board of Directors, by the President of the corporation or by a resolution duly adopted by the affirmative vote of a majority of the Board of Directors. Such request shall state the purpose or purposes of the proposed meeting. Business transacted at any special meeting shall be limited to matters relating to the purpose or purposes stated in the notice of meeting. 2.4 Action Without a Meeting. Any action which may be taken at any annual or special meeting of the stockholders of this corporation may be taken without a meeting, without prior notice, and without a vote, if a consent or consents in writing, setting forth the action or actions so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Such consent or consents shall be delivered to the corporation by hand or certified mail, return receipt requested, to its principal executive office, or to an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. 2.5 Notice of Meetings. Written notice of stockholders' meetings, stating the place, date and time of the meeting and, in the case of a special meeting, the purpose or purposes for which such special meeting is called, shall be given to each stockholder entitled to vote at such meeting not less than ten (10) nor more than sixty (60) days prior to the meeting. When a meeting is adjourned to another place, date or time, written notice need not be given of the adjourned meeting if the place, date and time thereof are announced at the meeting at 2 6 which the adjournment is taken; provided, however, that if the date of any adjourned meeting is more than thirty (30) days after the date for which the meeting was originally noticed, or if a new record date is fixed for the adjourned meeting, written notice of the place, date and time of the adjourned meeting shall be given in conformity herewith. At any adjourned meeting, any business may be transacted which might have been transacted at the original meeting. Whenever, under the provisions of Delaware law or of the Restated Certificate of Incorporation or of these Bylaws, notice is required to be given to any stockholder it shall not be construed to mean personal notice, but such notice may be given in writing, by mail, addressed to such director or stockholder, at his or her address as it appears on the records of the corporation, with postage thereon prepaid, and such notice shall be deemed to be given at the time when the same shall be deposited in the United States mail. Whenever any notice is required to be given under the provisions of Delaware law or of the Restated Certificate of Incorporation or of these Bylaws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto. 2.6 Business Matter of a Special Meeting. Business transacted at any special meeting of stockholders shall be limited to the purposes stated in the notice, except to the extent such notice is waived or is not required. 2.7 List of Stockholders. The officer in charge of the stock ledger of the corporation or the transfer agent shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to the meeting, at a place within the city where the meeting is to be held, which place, if other than the place of the meeting, shall be specified in the notice of the meeting. The list shall also be produced and kept at the place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present in person thereat. 2.8 Organization and Conduct of Business. The Chairman of the Board or, in his or her absence, the President of the corporation or, in their absence, such person as the Board may have designated or, in the absence of such a person, such person as may be chosen by the holders of a majority of the shares entitled to vote who are present, in person or by proxy, shall call to order any meeting of the stockholders and act as Chairman of the meeting. In the absence of the Secretary of the corporation, the Secretary of the meeting shall be such person as the Chairman appoints. The Chairman of any meeting of stockholders shall determine the order of business and the procedure at the meeting, including such regulation of the manner of voting and the conduct of discussion as seems to him or her in order. 3 7 2.9 Quorum and Adjournments. Except where otherwise provided by law or the Restated Certificate of Incorporation or these Bylaws, the holders of a majority of the stock issued and outstanding and entitled to vote, present in person or represented in proxy, shall constitute a quorum at all meetings of the stockholders. The stockholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough stockholders to have less than a quorum if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum. At such adjourned meeting at which a quorum is present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. If, however, a quorum shall not be present or represented at any meeting of the stockholders, the stockholders entitled to vote thereat who are present in person or represented by proxy shall have the power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. 2.10 Voting Rights. Unless otherwise provided in the Restated Certificate of Incorporation, each stockholder shall at every meeting of the stockholders be entitled to one vote in person or by proxy for each share of the capital stock having voting power held by such stockholder. 2.11 Majority Vote. When a quorum is present at any meeting, the vote of the holders of a majority of the stock having voting power present in person or represented by proxy shall decide any question brought before such meeting, unless the question is one upon which by express provision of the statutes or of the Restated Certificate of Incorporation or of these Bylaws, a different vote is required in which case such express provision shall govern and control the decision of such question. 2.12 Record Date for Stockholder Notice and Voting. (i) For purposes of determining the stockholders entitled to notice of any meeting or to vote, or entitled to receive payment of any dividend or other distribution, or entitled to exercise any right in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board may fix, in advance, a record date, which shall not be more than sixty (60) days nor less than ten (10) days before the date of any such meeting nor more than sixty (60) days before any other action. If the Board does not so fix a record date, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the business day next preceding the day on which notice is given or, if notice is waived, at the close of business on the business day next preceding the day on which the meeting is held. (ii) For purposes of determining the stockholders entitled to consent to corporate action in writing without a meeting, the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the board of directors, and which 4 8 date shall not be more than ten (10) days after the date upon which the resolution fixing such record date is adopted by the board of directors. If no record date has been fixed by the board of directors, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting, when no prior action by the board of directors is required under Delaware law, shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the corporation by hand or certified mail, return receipt requested, to its principal executive office, or to an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. If no record date has been fixed by the board of directors and prior action by the board of directors is required under Delaware law, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be the close of business on the day on which the board of directors adopts the resolution taking such prior action. 2.13 Proxies. Every person entitled to vote for directors or on any other matter shall have the right to do so either in person or by one or more agents authorized by a written proxy signed by the person and filed with the Secretary of the corporation. A proxy shall be deemed signed if the stockholder's name is placed on the proxy (whether by manual signature, typewriting, telegraphic transmission or otherwise) by the stockholder or the stockholder's attorney-in-fact. A validly executed proxy which does not state that it is irrevocable shall continue in full force and effect unless (i) revoked by the person executing it, before the vote pursuant to that proxy, by a writing delivered to the corporation stating that the proxy is revoked or by a subsequent proxy executed by, or attendance at the meeting and voting in person by, the person executing the proxy; or (ii) written notice of the death or incapacity of the maker of that proxy is received by the corporation before the vote pursuant to that proxy is counted; provided, however, that no proxy shall be valid after the expiration of three years from the date of the proxy, unless otherwise provided in the proxy. 2.14 Inspectors of Election. The corporation shall, in advance of any meeting of stockholders, appoint one or more inspectors of election to act at the meeting and make a written report thereof. The corporation may designate one or more persons to act as alternate inspectors to replace any inspector who fails to act. If no inspector or alternate is able to act at a meeting of stockholders, the person presiding at the meeting shall appoint one or more inspectors to act at the meeting. Each inspector, before entering upon the discharge of his or her duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of his or her ability. ARTICLE 3 Directors 3.1 Number, Election, Tenure and Qualifications. The Board of Directors of the corporation shall consist of not less than five (5) members nor more than nine (9) members and 5 9 shall be divided into three classes, designated as Class I, Class II and Class III, as nearly equal in number as possible. The initial Board of Directors shall consist of seven (7) members, with Class I consisting of two (2) directors, Class II consisting of two (2) directors and Class III consisting of three (3) directors, and the exact number of members of any future Board of Directors, and the exact number of directors in each Class, shall be determined from time to time by resolution of the Board of Directors. Notwithstanding the foregoing, additional directorships resulting from an increase in the number of directors shall be apportioned among the classes as equally as possible. Only persons who are nominated in accordance with the following procedures shall be eligible for election as directors. Nominations of persons for election to the Board of Directors at the annual meeting, by or at the direction of the Board of Directors, may be made by any nominating committee or person appointed by the Board of Directors; nominations may also be made by any stockholder of record of the corporation entitled to vote for the election of directors at the meeting who complies with the notice procedures set forth in this Section. Such nominations, other than those made by or at the direction of the Board of Directors, shall be made pursuant to timely notice in writing to the Secretary of the corporation. To be timely, a stockholder's notice shall be delivered personally or deposited in the United States mail, or delivered to a common carrier for transmission to the recipient or actually transmitted by the person giving the notice by electronic means to the recipient or sent by other means of written communication, postage or delivery charges prepaid in all such cases, and received at the principal executive offices of the corporation addressed to the attention of the Secretary of the corporation not less than 60 days nor more than 90 days prior to the scheduled date of the meeting (regardless of any postponements, deferrals or adjournments of that meeting to a later date); provided, however, that, in the case of an annual meeting and in the event that less than 70 days' notice or prior public disclosure of the date of the scheduled meeting is given or made to stockholders, notice by the stockholder to be timely must be so received not later than the earlier of (a) the close of business on the 10th day following the day on which such notice of the date of the scheduled meeting was mailed or such public disclosure was made, whichever first occurs, or (b) two days prior to the date of the scheduled meeting. Such stockholder's notice to the Secretary shall set forth (a) as to each person whom the stockholder proposes to nominate for election or reelection as a director, (i) the name, age, business address and residence address of the person, (ii) the principal occupation or employment of the person, (iii) the class, series and number of shares of capital stock of the corporation that are owned beneficially by the person, (iv) a statement as to the person's citizenship, and (v) any other information relating to the person that is required to be disclosed in solicitations for proxies for election of directors pursuant to Section 14 of the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder; and (b) as to the stockholder giving the notice, (i) the name and record address of the stockholder and (ii) the class, series and number of shares of capital stock of the corporation that are owned beneficially by the stockholder. The corporation may require any proposed nominee to furnish such other information as may reasonably be required by the corporation to determine the eligibility of such proposed nominee to serve as director of the corporation. No person shall be eligible for election as a director of the corporation unless nominated in accordance with the procedures set forth herein. 6 10 In connection with any annual meeting, the Chairman of the Board of Directors (or such other person presiding at such meeting in accordance with these Bylaws) shall, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the foregoing procedure, and if he should so determine, he shall so declare to the meeting and the defective nomination shall be disregarded. Directors shall serve as provided in the Restated Certificate of Incorporation of the corporation. Directors need not be stockholders. 3.2 Vacancies. Vacancies and newly created directorships resulting from any increase in the authorized number of directors may be filled by a majority of the directors then in office, though less than a quorum, or by a sole remaining director, and the directors so chosen shall hold office until the next annual election at which the term of the class to which they have been elected expires and until their successors are duly elected and shall qualify, unless sooner displaced. If there are no directors in office, then an election of directors may be held in the manner provided by statute. In the event of a vacancy in the Board of Directors, the remaining directors, except as otherwise provided by law or these bylaws, may exercise the powers of the full board until the vacancy is filled. 3.3 Resignation and Removal. Any director may resign at any time upon written notice to the corporation at its principal place of business or to the President or the Secretary. Such resignation shall be effective upon receipt of such notice unless the notice specifies such resignation to be effective at some other time or upon the happening of some other event. Any director or the entire Board of Directors may be removed, but only for cause, by the holders of a majority of the shares then entitled to vote at an election of directors, unless otherwise specified by law or the Restated Certificate of Incorporation. 3.4 Powers. The business of the corporation shall be managed by or under the direction of the Board which may exercise all such powers of the corporation and do all such lawful acts and things which are not by statute or by the Restated Certificate of Incorporation or by these Bylaws directed or required to be exercised or done by the stockholders. 3.5 Place of Meetings. The Board may hold meetings, both regular and special, either within or without the State of Delaware. 3.6 Annual Meetings. The annual meetings of the Board shall be held immediately following the annual meeting of stockholders, and no notice of such meeting shall be necessary to the Board, provided a quorum shall be present. The annual meetings shall be for the purposes of organization, and an election of officers and the transaction of other business. 3.7 Regular Meetings. Regular meetings of the Board may be held without notice at such time and place as may be determined from time to time by the Board. 3.8 Special Meetings. Special meetings of the Board may be called by the Chairman of the Board, the President or by a majority of the Board upon one (1) day's notice to each director 7 11 and can be delivered either personally, or by telephone, express delivery service (so that the scheduled delivery date of the notice is at least one (1) day in advance of the meeting), telegram or facsimile transmission, and on five (5) day's notice, by mail. The notice need not describe the purpose of the special meeting. 3.9 Quorum and Adjournments. At all meetings of the Board, a majority of the directors then in office shall constitute a quorum for the transaction of business, and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the Board, except as may otherwise be specifically provided by law or the Restated Certificate of Incorporation. If a quorum is not present at any meeting of the Board, the directors present may adjourn the meeting from time to time, without notice other than announcement at the meeting at which the adjournment is taken, until a quorum shall be present. A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved of by at least a majority of the required quorum for that meeting. 3.10 Action Without Meeting. Unless otherwise restricted by the Restated Certificate of Incorporation or these Bylaws, any action required or permitted to be taken at any meeting of the Board or of any committee thereof may be taken without a meeting, if all members of the Board or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board or committee. 3.11 Telephone Meetings. Unless otherwise restricted by the Restated Certificate of Incorporation or these Bylaws, any member of the Board or any committee may participate in a meeting by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at the meeting. 3.12 Waiver of Notice. Notice of a meeting need not be given to any director who signs a waiver of notice or a consent to holding the meeting or an approval of the minutes thereof, whether before or after the meeting, or who attends the meeting without protesting, prior thereto or at its commencement, the lack of notice to such director. All such waivers, consents and approvals shall be filed with the corporate records or made a part of the minutes of the meeting. 3.13 Fees and Compensation of Directors. Unless otherwise restricted by the Restated Certificate of Incorporation or these Bylaws, the Board shall have the authority to fix the compensation of directors. The directors may be paid their expenses, if any, of attendance at each meeting of the Board and may be paid a fixed sum for attendance at each meeting of the Board or a stated salary as director. No such payment shall preclude any director from serving the corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings. 3.14 Rights of Inspection. Any director shall have the right to examine the corporation's stock ledger, a list of its stockholders and its other books and records for a purpose reasonably related to his or her position as a director. 8 12 ARTICLE 4 Committees of Directors 4.1 Selection. The Board may, by resolution passed by a majority of the entire Board, designate one or more committees, each committee to consist of one or more of the directors of the corporation. The Board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or she or they constitute a quorum, may unanimously appoint another member of the Board to act at the meeting in the place of any such absent or disqualified member. 4.2 Power. Any such committee, to the extent provided in the resolution of the Board, shall have and may exercise all the powers and authority of the Board in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers which may require it; but no such committee shall have the power or authority in reference to amending the Restated Certificate of Incorporation (except that a committee may, to the extent authorized in the resolution or resolutions providing for the issuance of shares of stock adopted by the Board as provided in Section 151(a) of the General Corporation Law of Delaware, fix any of the preferences or rights of such shares relating to dividends, redemption, dissolution, any distribution of assets of the corporation or the conversion into, or the exchange of such shares for, shares of any other class or classes or any other series of the same or any other class or classes of stock of the corporation), adopting an agreement of merger or consolidation, recommending to the stockholders the sale, lease or exchange of all or substantially all of the corporation's property and assets, recommending to the stockholders a dissolution of the corporation or a revocation of dissolution, removing or indemnifying directors or amending the Bylaws of the corporation; and, unless the resolution or the Restated Certificate of Incorporation expressly so provides, no such committee shall have the power or authority to declare a dividend or to authorize the issuance of stock or to adopt a certificate of ownership and merger. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board. 4.3 Committee Minutes. Each committee shall keep regular minutes of its meetings and report the same to the Board when required. ARTICLE 5 Officers 5.1 Officers Designated. The officers of the corporation shall be chosen by the Board and shall be a President, a Secretary and a Chief Financial Officer. The Board may also choose a Chairman of the Board, one or more Vice Presidents, and one or more assistant Secretaries. Any number of offices may be held by the same person, unless the Restated Certificate of 9 13 Incorporation or these Bylaws otherwise provide. 5.2 Appointment of Officers. The officers of the corporation, except such officers as may be appointed in accordance with the provisions of Section 5.3 or 5.5 of this Article 5, shall be chosen in such manner and shall hold their offices for such terms as are prescribed by these Bylaws or determined by the board of directors. Each officer shall hold his or her office until his or her successor is elected and qualified or until his or her earlier resignation or removal. This section does not create any rights of employment or continued employment. The corporation may secure the fidelity of any or all of its officers or agents by bond or otherwise. 5.3 Subordinate Officers. The Board may appoint, and may empower the President to appoint, such other officers and agents as the business of the corporation may require, each of whom shall hold office for such period, have such authority and perform such duties as are provided in the Bylaws or as the Board may from time to time determine. 5.4 Removal and Resignation of Officers. Subject to the rights, if any, of an officer under any contract of employment, any officer may be removed, either with or without cause, by an affirmative vote of the majority of the Board, at any regular or special meeting of the Board, or, except in case of an officer chosen by the Board, by any officer upon whom such power of removal may be conferred by the Board. Any officer may resign at any time by giving written notice to the corporation. Any resignation shall take effect at the date of the receipt of that notice or at any later time specified in that notice; and, unless otherwise specified in that notice, the acceptance of the resignation shall not be necessary to make it effective. Any resignation is without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. 5.5 Vacancies in Offices. A vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled in the manner prescribed in these Bylaws for regular appointment to that office. 5.6 Compensation. The salaries of all officers of the corporation shall be fixed from time to time by the Board and no officer shall be prevented from receiving a salary because he is also a director of the corporation. 5.7 The Chairman of the Board. The Chairman of the Board, if such an officer be elected, shall, if present, perform such other powers and duties as may be assigned to him from time to time by the Board. If there is no President, the Chairman of the Board shall also be the Chief Executive Officer of the Corporation and shall have the powers and duties prescribed in Section 5.8 of this Article 5. 5.8 The President. Subject to such supervisory powers, if any, as may be given by the Board to the Chairman of the Board, if there be such an officer, the President shall be the Chief Executive Officer of the Corporation, shall preside at all meetings of the stockholders and in the absence of the Chairman of the Board, or if there be none, at all meetings of the Board, shall have 10 14 general and active management of the business of the Corporation and shall see that all orders and resolutions of the Board are carried into effect. He or she shall execute bonds, mortgages and other contracts requiring a seal, under the seal of the Corporation, except where required or permitted by law to be otherwise signed and executed and except where the signing and execution thereof shall be expressly delegated by the Board to some other officer or agent of the Corporation. 5.9 The Vice President. The Vice President (or in the event there be more than one, the Vice Presidents in the order designated by the directors, or in the absence of any designation, in the order of their election), shall, in the absence of the President or in the event of his or her disability or refusal to act, perform the duties of the President, and when so acting, shall have the powers of and subject to all the restrictions upon the President. The Vice President(s) shall perform such other duties and have such other powers as may from time to time be prescribed for them by the Board, President, the Chairman of the Board or these Bylaws. 5.10 The Secretary. The Secretary shall attend all meetings of the Board and the stockholders and record all votes and the proceedings of the meetings in a book to be kept for that purpose and shall perform like duties for the standing committees, when required. The Secretary shall give, or cause to be given, notice of all meetings of stockholders and special meetings of the Board, and shall perform such other duties as may from time to time be prescribed by the Board, the Chairman of the Board or the President, under whose supervision he or she shall act. The Secretary shall have custody of the seal of the corporation, and the Secretary, or an Assistant Secretary, shall have authority to affix the same to any instrument requiring it, and, when so affixed, the seal may be attested by his or her signature or by the signature of such Assistant Secretary. The Board may give general authority to any other officer to affix the seal of the corporation and to attest the affixing thereof by his or her signature. The Secretary shall keep, or cause to be kept, at the principal executive office or at the office of the corporation's transfer agent or registrar, as determined by resolution of the Board, a share register, or a duplicate share register, showing the names of all stockholders and their addresses, the number and classes of shares held by each, the number and date of certificates issued for the same and the number and date of cancellation of every certificate surrendered for cancellation. 5.11 The Assistant Secretary. The Assistant Secretary, or if there be more than one, the Assistant Secretaries in the order designated by the Board (or in the absence of any designation, in the order of their election) shall, in the absence of the Secretary or in the event of his or her inability or refusal to act, perform the duties and exercise the powers of the Secretary and shall perform such other duties and have such other powers as may from time to time be prescribed by the Board. 5.12 The Chief Financial Officer. The Chief Financial Officer shall have the custody of the Corporate funds and securities and shall keep full and accurate accounts of receipts and disbursements in books belonging to the corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the corporation in such depositories as may be designated by the Board. The Chief Financial Officer shall disburse the funds of the corporation as may be ordered by the Board, taking proper vouchers for such disbursements, and shall render 11 15 to the President and the Board, at its regular meetings, or when the Board so requires, an account of all his or her transactions as Chief Financial Officer and of the financial condition of the corporation. ARTICLE 6 Stock Certificates 6.1 Certificates for Shares. The shares of the corporation shall be represented by certificates or shall be uncertificated. Certificates shall be signed by, or in the name of the corporation by, the Chairman of the Board, the President or a Vice President and by the Chief Financial Officer, the Secretary or an Assistant Secretary of the corporation. Within a reasonable time after the issuance or transfer of uncertificated stock, the corporation shall send to the registered owner thereof a written notice containing the information required by the General Corporation Law of the State of Delaware or a statement that the corporation will furnish without charge to each stockholder who so requests the powers, designations, preferences and relative participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights. 6.2 Signatures on Certificates. Any or all of the signatures on a certificate may be a facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue. 6.3 Transfer of Stock. Upon surrender to the corporation or the transfer agent of the corporation of a certificate of shares duly endorsed or accompanied by proper evidence of succession, assignation or authority to transfer, it shall be the duty of the corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. Upon receipt of proper transfer instructions from the registered owner of uncertificated share, such uncertificated shares shall be canceled and issuance of new equivalent uncertificated shares or certificated shares shall be made to the person entitled thereto and the transaction shall be recorded upon the books of the corporation. 6.4 Registered Stockholders. The corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and to hold liable for calls and assessments a percent registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware. 12 16 6.5 Lost, Stolen or Destroyed Certificates. The Board may direct that a new certificate or certificates be issued to replace any certificate or certificates theretofore issued by the corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing the issue of a new certificate or certificates, the Board may, in its discretion and as a condition precedent to the issuance thereof, require the owner of the lost, stolen or destroyed certificate or certificates, or his or her legal representative, to advertise the same in such manner as it shall require, and/or to give the corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the corporation with respect to the certificate alleged to have been lost, stolen or destroyed. ARTICLE 7 General Provisions 7.1 Dividends. Dividends upon the capital stock of the corporation, subject to any restrictions contained in the General Corporation Law of the State of Delaware or the provisions of the Restated Certificate of Incorporation, if any, may be declared by the Board at any regular or special meeting. Dividends may be paid in cash, in property or in shares of the capital stock, subject to the provisions of the Restated Certificate of Incorporation. 7.2 Dividend Reserve. Before payment of any dividend, there may be set aside out of any funds of the corporation available for dividends such sum or sums as the directors from time to time, in their absolute discretion, think proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the corporation, or for such other purpose as the directors shall think conducive to the interest of the corporation, and the directors may modify or abolish any such reserve in the manner in which it was created. 7.3 Checks. All checks or demands for money and notes of the corporation shall be signed by such officer or officers or such other person or persons as the Board may from time to time designate. 7.4 Corporate Seal. The Board may provide a suitable seal, containing the name of the corporation, which seal shall be in charge of the Secretary. If and when so directed by the Board or a committee thereof, duplicates of the seal may be kept and used by the Chief Financial Officer or by any Assistant Secretary. 7.5 Execution of Corporate Contracts and Instruments. The Board, except as otherwise provided in these Bylaws, may authorize any officer or officers, or agent or agents, to enter into any contract or execute any instrument in the name of and on behalf of the corporation; such authority may be general or confined to specific instances. Unless so authorized or ratified by the Board or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or for any amount. 13 17 7.6 Representation of Shares of Other Corporations. The President or any Vice President or the Secretary or any Assistant Secretary of this corporation is authorized to vote, represent and exercise on behalf of this corporation all rights incident to any and all shares of any corporation or corporations standing in the name of this corporation. The authority herein granted to said officers to vote or represent on behalf of this corporation any and all shares held by this corporation in any other corporation or corporations may be exercised either by such officers in person or by any other person authorized so to do by proxy or power of attorney duly executed by said officers. ARTICLE 8 Miscellaneous 8.1 Stock Options. Without the affirmative vote of the holders of more than fifty percent (50%) of the voting power of all of the then outstanding shares of the stock of the corporation entitled to vote generally in the election of directors, voting together as a single class, the corporation shall not grant to any officer of the corporation any stock options at less than the closing market price on the date of grant or reduce the price of any options which either (i) were granted as a non-qualified stock option grant to an incoming employee or vendor or (ii) were granted under any of the corporation's existing or future stock option plans, provided, however, that the foregoing shall not preclude the corporation from issuing new, lower priced options issued from a stock option plan to persons holding higher priced options from such plan, provided further, however, that if such new lower priced options are granted in exchange for such higher priced options, the shares covered by such higher priced options shall be canceled or surrendered and not available for re-grant under such stock option plan. 8.2 Amendments. The Board of Directors is expressly empowered to adopt, amend or repeal these Bylaws, provided, however, that any adoption, amendment or repeal of these Bylaws by the Board of Directors shall require the approval of at least sixty-six and two-thirds percent (66-2/3%) of the total number of authorized directors (whether or not there exist any vacancies in previously authorized directorships at the time any resolution providing for adoption, amendment or repeal is presented to the board). The stockholders shall also have power to adopt, amend or repeal these Bylaws, provided, however, that in addition to any vote of the holders of any class or series of stock of this corporation required by law or by the Restated Certificate of Incorporation of this corporation, the affirmative vote of the holders of more than fifty percent (50%) of the voting power of all of the then outstanding shares of the stock of the corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required for such adoption, amendment or repeal by the stockholders of any provisions of these Bylaws. Notwithstanding the foregoing sentence, the affirmative vote of the holders of at least sixty-six and two-thirds percent (66 2/3%) of the voting power of all of the then outstanding shares of the stock of the corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required for the amendment or repeal of Article 3.1 of these Bylaws. Notwithstanding the foregoing paragraph or any provision of the Restated Certificate of 14 18 Incorporation, Section 8.1 of these Bylaws may only be amended by the affirmative vote of the holders of more than fifty percent (50%) of the voting power of all of the then outstanding shares of the stock of the corporation entitled to vote generally in the election of directors, voting together as a single class. 15 EX-10.10(A) 3 AMENDED EMPLOYMENT AGREEMENT 1 EXHIBIT 10.10(a) HESKA CORPORATION AMENDED AND RESTATED EMPLOYMENT AGREEMENT WITH ROBERT B. GRIEVE THIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT ("Agreement") is entered into effective as of February 23, 2000, by and between Heska Corporation, formerly Paravax, Inc. ("Company") and Robert B. Grieve ("Employee"). Company and Employee are collectively referred to herein as the "Parties." WHEREAS, effective as of January 1, 1994, Company and Employee entered into an Employment Agreement, as amended by Amendment No. 1 to Employment Agreement dated effective as of March 4, 1997 (together, the "Employment Agreement"); and WHEREAS, the Parties desire to restate the Employment Agreement for ease of reference and to further amend said agreement for the purpose of making certain provisions more consistent with current Company practice. NOW THEREFORE, in consideration of the foregoing, the Parties agree as follows: A. The Employment Agreement is hereby restated and amended as set forth below: 1. Employment. Company hereby employs Employee as its Vice Chairman of the Board of Directors and Chief Executive Officer, and Employee hereby accepts such employment. 2. Duties and Responsibilities. Employee shall serve as Vice Chairman of the Board of Directors and Chief Executive Officer, with such duties and responsibilities as may be assigned to him from time to time by or under the direction of the Board of Directors of Company, and with such on-going daily duties and responsibilities as are typically entailed in such position. Employee shall devote his full time and energies to such duties. 3. Compensation. Company shall pay Employee, as compensation for services rendered under this Agreement, a "base salary" per year, payable in accordance with the usual and customary payroll practices of Company. If for any reason during any given year, Employee does not work an entire year, other than normal vacations as provided hereunder, the compensation will be prorated to compensate only for the actual time worked. 2 4. Expenses. Company shall reimburse Employee for his reasonable out-of-pocket expenses incurred in connection with the business of Company, including travel away from the Company's facilities, upon presentation of appropriate written receipts and reports and subject to the customary practices of Company. 5. Employee Benefits. During the term of his employment hereunder, Employee shall be entitled to receive the same benefits that the Board of Directors establishes generally for the officers and other employees of Company. These may include from time to time, medical insurance, life insurance, paid vacation time and medical disability insurance. 6. Termination. (a) At-Will. This is an at-will employment agreement and does not bind either of the parties to any specific term or duration. (i) Employee is free to terminate employment with Company at any time, for any reason, or for no reason, and without any prior notice. (ii) Company is free to terminate the employment of Employee at any time, for any reason or for no reason, for cause or without cause, and without any prior notice. (b) Severance Pay. (i) Upon "Involuntary Termination" of his employment (as defined in subsections (ii) and (iii) below), Employee will be entitled to severance pay in the amount of one (1) year's "base salary" in not less than twelve equal monthly installments (subject to all applicable tax and other deductions), with the first installment being due 15 days after the date of termination and with the following installments due no later than monthly thereafter on Company's then regular payroll dates. Upon "Involuntary Termination" of his employment (as defined in subsections (ii) and (iii) below, Company also will pay (or reimburse Employee for) the health insurance premiums for the medical and dental insurance coverage maintained by Company at the time of termination for Employee and his eligible dependents for a period of one year after the date of termination, provided that, Company's obligations for such payments shall cease immediately if Employee becomes (and remains) covered under the medical and dental insurance plan of another employer with coverages and benefits comparable to those provided under Company's plans and the premiums for which are paid in full by such other employer. In 2 3 the event such benefits provided by the other employer shall cease at any time during the one-year period following Employee's termination from Company, Company's obligations for payment or reimbursement of premiums under this subsection shall resume for the remainder of such one-year period. Upon request by the Company, Employee will sign a release of claims against Company and its affiliates as a condition of receiving severance pay, payment or reimbursement of insurance premiums, or any other benefits or payments provided in Section 6(b) of this Agreement. If Employee's employment shall end for any reason(s) other than those described in subsections (ii) and (iii), below, as "Involuntary Termination," Employee shall only receive pay and benefits which Employee earned as of the date of termination. (ii) If the Employee is subjected to "Involuntary Termination" under this subsection (ii), Employee also shall be entitled to an additional twelve (12) months of vesting (calculated from the effective termination date, and not from the end of the severance pay period) under all stock option agreements, stock purchase agreements or other stock rights granted to Employee by Company prior to the effective termination date. "Involuntary termination" under this subsection (ii) shall mean any termination of Employee's employment by Company, other than a termination under one or more of the following circumstances: (A) any termination by Company or Employee following Employee's refusal to accept a reasonable transfer to a position with comparable responsibility and salary with any affiliated company that does not involve commuting more than fifty (50) miles each way from his home in the Fort Collins, Colorado area, unless such circumstances constitute a Change of Control Event as defined in subsection (iii), below; (B) Employee shall die, be adjudicated to be mentally incompetent or become mentally or physically disabled to such an extent that Employee is unable to perform his duties under this Employment Agreement for a period of ninety (90) consecutive days; (C) Employee shall commit any material breach of his obligations under this Agreement; (D) Employee shall commit any material breach of any fiduciary duty to Company; 3 4 (E) Employee shall be convicted of, or enter a plea of nolo contendere to, any crime involving moral turpitude or dishonesty, whether a felony or misdemeanor, or any crime which reflects so negatively on Company to be detrimental to Company's image or interests; (F) Employee shall commit repeated insubordination or refusal to comply with any reasonable request of the Board of Directors of Company related to the scope or performance of Employee's duties; (G) Employee shall possess any illegal drug on Company premises or Employee shall be under the influence of illegal drugs or abusing prescription drugs or alcohol while on Company business, attending Company-sponsored functions, or on Company premises; or (H) Employee shall conduct himself in a manner which, in the good faith and reasonable determination of the Board of Directors of Company demonstrates Employee's substantial unfitness to serve. (iii) For purposes of this Section 6(b), "Involuntary Termination" also shall include a "Change of Control Event." If Employee's employment shall end as the result of such "Change of Control Event", Employee also shall be entitled to the immediate vesting as of the effective date of termination, under all stock option agreements, stock purchase agreements, or other stock rights granted to Employee by Company prior to the effective termination date. A "Change of Control Event" shall occur when, in connection with the merger, acquisition or sale of Company or substantially all of Company's assets with, into or to a previously unaffiliated third party, (A) Employee declines to continue his employment with the acquiring company within 30 days following the consummation of such merger, acquisition, or sale; (B) Employee is not offered or continued in a position of employment with the acquiring entity with comparable pay, benefits, title, and responsibility, for a period of at least nine (9) months following the consummation of such merger, acquisition, or sale, and Employee resigns as a result, with such resignation being submitted no later than 4 5 ten (10) days after the date on which Employee is not offered or continued in such position; or (C) the acquiring company fails to assume or be bound by the terms of this Agreement. 7. Proprietary Information. Employee agrees that if he has not already done so, he will promptly execute Company's standard employee proprietary information and assignment of inventions agreement. 8. Attorneys' Fees. If any legal action arises under this Agreement or by reason of any asserted breach of it, the prevailing party shall be entitled to recover all costs and expenses, including reasonable attorney's fees, incurred in enforcing or attempting to enforce any of the terms, covenants or conditions, including costs incurred prior to commencement of legal action, and all costs and expenses, including reasonable attorney's fees, incurred in any appeal from an action brought to enforce any of the terms, covenants or conditions. For purposes of this section, "prevailing party" includes without limitation, a party who agrees to dismiss a suit or proceeding upon the other's payment or performance of substantially the relief sought. 9. Notices. Any notice to be given to Company under the terms of this Agreement shall be addressed to Company at the address of its principal place of business, and any notice to be given to Employee shall be addressed to him at his home address last shown on the records of Company, or to such other address as a party shall have given notice of hereunder. 10. Miscellaneous. This Agreement shall be governed by the laws of the State of Colorado as applied to contracts between residents of that state to be performed wholly within that state. This Agreement is the entire agreement of the Parties with respect to the subject matter hereof and supersedes all prior understandings and agreements. This Agreement may be modified only by a writing signed by both Parties. This Agreement shall be binding upon and shall inure to the benefit of the successors and assigns of the Parties. 5 6 IN WITNESS WHEREOF, the Parties hereto have executed this Agreement the day and year hereinabove written. HESKA CORPORATION By: /s/ Fred M. Schwarzer ------------------------------------- Its: Chairman of the Board ------------------------------------ EMPLOYEE Name: /s/ Robert B. Grieve ----------------------------------- Robert B. Grieve 6 EX-10.36 4 SEPARATION AGREEMENT 1 EXHIBIT 10.36 SEPARATION AGREEMENT This Separation Agreement is between Heska Corporation (the "Company") and Dr. R. Lee Seward ("Dr. Seward"). It is effective as of November 30, 1999. BACKGROUND A. Dr. Seward has been employed by the Company in the position of Executive Vice President. B. Dr. Seward's employment with the Company in that position has been terminated effective as of November 30, 1999. This Separation Agreement states the severance benefits that will be paid to Dr. Seward. C. The Company wants Dr. Seward to continue to perform some services for it as a consultant. Dr. Seward is willing to do so. The Company and Dr. Seward are also entering into a Consultant Services and Confidentiality Agreement on December 1, 1999 with respect to such future services. Dr. Seward and the Company hereby agree as follows: 1. Separation Benefits. (a) Dr. Seward will be paid his November 1999 monthly salary as customary and from December 1, 1999 through November 30, 2000 will be paid an amount equal to his 1999 base annual salary ($185,000). This separation pay will be paid in twelve equal monthly installments on the Company's regular payroll dates, with the first payment due on the payroll date on or about December 31, 1999. These payments will be subject to regular withholding for taxes. (b) Dr. Seward will continue to vest his currently outstanding stock options through November 30, 2000 as if still employed on a full-time basis through and including that date. (c) The Company will pay the health insurance premiums for the health insurance coverage previously maintained by the Company for Dr. Seward and his eligible dependents through November 30, 2000 or until Dr. Seward is provided or obtains health insurance coverage by another employer or entity, whichever first occurs. (d) Except for the benefits outlined above, Dr. Seward will not be entitled to any employee benefits provided to employees of the Company, or any other severance or similar benefits after November 30, 1999 and Dr. Seward waives any right to receive any such benefits. 2 (e) Dr. Seward will continue to be bound by the Employee Confidential Information and Inventions Agreement with respect to those inventions made by and confidential matters known by and to him during the time he was an employee and officer of the Company, except as stated in the Consultant Services and Confidentiality Agreement of December 1, 1999 as if it were entered into as of November 30, 1999. 2. General Provisions. (a) Any notice to be given to the Company will be addressed to the attention of the Chief Executive Officer at the Company's official mailing address. Any notice to be given to Dr. Seward will be addressed to him at his home address as shown on the Company's records. (b) This Separation Agreement shall be governed by the laws of the State of Colorado. This Separation Agreement is the entire agreement of the parties with respect to the subject matter hereof and supersedes all prior understandings and agreements. This Separation Agreement may be amended only by a written document signed by both the Company and Dr. Seward. (c) This Separation Agreement will be binding upon the parties and their successors and assigns. If, on any sale of the Company by merger, sale of assets or otherwise prior to November 30, 2000, the surviving entity refuses or fails to confirm in writing its obligation to perform this Separation Agreement, the Company shall use its reasonable efforts prior to the closing of such sale to pay to Dr. Seward all remaining severance payments due to him under Section 1. HESKA CORPORATION a Delaware corporation By: /s/ Robert B. Grieve /s/ R. Lee Seward ------------------------------- ------------------------------------ R. Lee Seward Title: Chief Executive Officer ---------------------------- -2- EX-10.37 5 CONSULTANT SERVICES 1 EXHIBIT 10.37 HESKA CORPORATION CONSULTANT SERVICES AND CONFIDENTIALITY AGREEMENT THIS AGREEMENT is made between SEWARD PHARM, LLC ("Consultant") and HESKA CORPORATION and its affiliates, (the "Company"), as of the 1st day of December, 1999. In consideration of mutual promises, it is hereby agreed as follows: ARTICLE I. CONSULTING Consultant agrees to be a consultant to the Company for the period commencing on December 1, 1999, and concluding November 30, 2000, subject to the termination of this agreement in accordance with Article VII. The period during which Consultant serves the Company is referred to as the "Consulting Period." This Agreement is subject to renewal on December 1, 2000, at the joint discretion of the Company and the Consultant. ARTICLE II. DUTIES During the term of this Agreement, Consultant agrees to be available to provide services to the Company on such projects as the Company may reasonably request from time to time. The parties agree that after November 30, 1999, Consultant is not expected to be available more than the equivalent of ten (10) full days in any month. The Company is not required to use any minimum amount of services. Consultant will report to the Chief Executive Officer or such other officer as the Chief Executive Officer directs. Consultant will report his time to the Company on a monthly basis. Consultant will be available for reasonable telephone consultation with the Company or the other parties with respect to services to be rendered. 2 ARTICLE III. COMPENSATION The parties agree that Consultant's compensation for services rendered pursuant to this Agreement shall be $1,200.00 per full day (or $150.00 per hour for less than a full day). Consultant shall keep records of time, shall invoice the Company no more frequently than monthly and shall be paid within 30 days of receipt of invoice. In lieu of compensation by cash or check, the Company may pay fifty percent (50%) of the compensation due by cash or check and the other fifty percent (50%) in shares of stock of the Company. If payment is made in shares, the price for the shares issued will be the average closing price for the shares during the month the services were rendered. The Company shall reimburse Consultant for all reasonable expenses incurred in connection with the performance of services per this Agreement. Consultant will not be compensated for travel time. ARTICLE IV. CONFIDENTIAL INFORMATION 1. Access to Confidential Information. Consultant understands that, during the Consulting Period with the Company, Consultant will be exposed, in the trust and confidence of the Company, to confidential information and data, including techniques, know-how, trade secrets, procedures, business matters or affairs, inventions, designs, methods, systems, improvements or other information designated as confidential (herein "Confidential Information") belonging to the Company or its subsidiaries or to its customers or others with whom the Company has a joint venture, research contract or other business relationship (all such subsidiaries, customers and other parties referred to herein as "affiliates") requiring the Company to maintain the confidentiality of such information. 2. Nondisclosure of Confidential Information. Consultant agrees that, during the Consulting Period or thereafter, Consultant will not, directly or indirectly, disclose any Confidential Information to any third party or use any Confidential Information for any purpose other than providing services to the Company without the prior written approval of the Company. For purposes of this Agreement, information shall 2 3 be considered to be confidential if not known by the trade generally even though such information has been disclosed to one or more third parties pursuant to distribution or licensing agreements, research agreements or other agreements or in connection with other business relationships. Such information will not be considered to be confidential, however, to the extent that it is or becomes, through no fault of Consultant, publicly known or to the extent that Consultant already knew such information at the time of its disclosure to the Consultant by the Company, as evidenced by written materials in the Consultant's files. 3. Confidential Information Property of the Company. Consultant understands that all data, including drawings, prints, specifications, designs, notes, notebooks, records, documents, reproductions or other papers or memoranda of every kind which come into Consultant's possession in the course of providing the consulting services are the sole property of the Company, and Consultant will surrender all such property to the Company upon request and in any event upon termination of Consultant's services. ARTICLE V. INVENTIONS 1. Maintenance of Records. Consultant agrees to keep separate and segregated from Consultant's other personal property, including any work Consultant is doing for any other party, all documents, records, notebooks and correspondence relating to Consultant's work for the Company, and to maintain notebooks and other records in such form as the Company reasonably requests. 2. Disclosure of Information. Consultant agrees to advise the Company in writing of possible product ideas that are within the Company's scope of business that Consultant becomes aware of during the course of consulting with the Company. If the Company does not elect to pursue the development of the product within 60 days after being advised, or elects to pursue but then within 6 months after electing does not make any good faith or reasonable effort toward development of the product, then Consultant shall be permitted to pursue development without any compensation to the Company. 3 4 ARTICLE VI. NO CONFLICTING OBLIGATION 1. No Conflicting Agreements. The Company understands and agrees that during the Consulting Period, Consultant may be retained by other companies, corporations, and/or commercial enterprises to perform consulting services; and that Consultant will be pursuing Consultant's own business interests. Consultant agrees, however, that, during the Consulting Period, Consultant will not, for Consultant's own account or as an officer, member, employee, director, consultant representative or advisor of another, engage in or contribute Consultant's knowledge to engineering, development, manufacturing, research, business analysis or sales relating to any Heska product, equipment, process or material of the Company that is known to Consultant, without the written permission of the Company. The foregoing provision, however, shall not prohibit Consultant from engaging in any work at any time during or after the Consulting Period, provided that Confidential Information will not be involved in such work. The provisions of this Article VI.1. will not be construed as limiting to any extent Consultant's obligations under any other section of this Agreement. 2. No Conflict With Prior Agreements. Consultant represents and warrants to the Company and its affiliates that Consultant's retention by the Company and Consultant's performance of Consultant's obligations under this Agreement do not conflict with any prior obligations to third parties, including others for whom Consultant performs consulting or other services. Consultant represents and warrants that the Company has not asked Consultant to reveal, nor will it do so, any trade secrets or other proprietary or confidential information that may have been gained by Consultant during previous employment or other consulting agreements which Consultant is under obligation not to disclose. ARTICLE VII. TERMINATION The Consulting Period may be terminated by Consultant or the Company for any reason upon ten days' written notice. 4 5 ARTICLE VIII. LEGAL RELATIONSHIP Consultant's relationship with the Company is that of an independent contractor and not as an employee or agent of the Company. Consultant will not be entitled to any benefits or compensation from the Company except as set forth in this Agreement or any separate agreement with the Company. The person to perform the consulting services will be R. Lee Seward. CONSULTANT AGREES THAT CONSULTANT IS NOT ENTITLED TO WORKERS' COMPENSATION BENEFITS AND THAT CONSULTANT IS RESPONSIBLE FOR DIRECT PAYMENT OF ANY FEDERAL OR STATE TAXES ON THE COMPENSATION PAID TO CONSULTANT UNDER THIS AGREEMENT, EXCEPT TO THE EXTENT THE COMPANY WITHHOLDS SUCH TAXES. Consultant understands that Consultant is not authorized to bind the Company or make any representations on its behalf in any matter. The Company is advised that the principal owner of Consultant is a licensed veterinarian, that Consultant is a separate company with the purpose to develop animal products. Consultant intends to discover, develop, manufacture, market, and sell products for companion animals, primarily horses. Products currently being developed or considered for development are an antiparasitic product for horses in a treat or top dress formulation, products based on transdermal and other delivery technologies, and horse supplements and feed. Consultant may pursue these and other products, subject to Article V.2., without being in a conflict of interest with the Company or being liable for any compensation to the Company. ARTICLE IX. ASSIGNMENT; BINDING EFFECT The services to be rendered under this Agreement are personal in nature, and Consultant's rights and obligations under this Agreement may not be assigned by Consultant without the prior written consent of the Company. Subject to this restriction, this Agreement shall be binding upon Consultant, its successors and assigns and shall inure to the benefit of the Company and its successors and assigns. 5 6 ARTICLE X. GOVERNING LAW This Agreement shall be governed by the laws of the state of Colorado. Each article shall be independent and separable from all other articles, and the invalidity of an article shall not affect the enforceability of any of the other articles. ARTICLE XI. REMEDIES Consultant recognizes that any violation of this Agreement by Consultant would cause the Company irreparable damage for which other remedies would be inadequate, and Consultant therefore agrees that the Company shall have the right to obtain, in addition to all other remedies, such injunctive and other equitable relief from a court of competent jurisdiction as may be necessary or appropriate to prevent any violation of this Agreement. ARTICLE XII. WAIVER The Company's waiver or failure to enforce the terms of this Agreement or any similar agreement in one instance shall not constitute a waiver of its rights hereunder with respect to other violations of this or any other Agreement. ARTICLE XIII. ENTIRE AGREEMENT This Agreement contains the entire agreement between the Company and Consultant relating to the subject matter hereof, and supersedes all prior and contemporaneous negotiations, correspondence, understandings and agreements between the parties relating to the subject matter hereof. This Agreement may be modified or amended only by mutual written consent of the parties. 6 7 IN WITNESS WHEREOF, all parties have signed this Agreement effective as of the date of this Agreement on page one hereof. CONSULTANT: SEWARD PHARM, LLC By: /s/ R. Lee Seward ------------------------------------- R. Lee Seward, Managing Director HESKA CORPORATION By: /s/ Robert B. Grieve ------------------------------------- Robert B. Grieve, Chief Executive Officer 7 EX-10.38 6 EXECUTIVE BONUS PLAN 1 EXHIBIT 10.38 HESKA CORPORATION EXECUTIVE BONUS PLAN DECEMBER 3, 1999 This bonus plan is intended to provide incentives and rewards for the senior management of Heska Corporation. The formulas set forth below are to be applied to the year 2000 and subsequent years, unless changed by the Board of Directors or the Compensation Committee of the Board of Directors, in their discretion, with respect to such years. It is expected that the actual dollar target for each such subsequent year will be agreed upon by the entire Board of Directors or the Compensation Committee prior to, or shortly after, the beginning of such year. As this has been a year of significant transition for Heska, it was impractical to put in place an executive bonus plan for 1999 prior to this time. As the bonus plan can not be applied retroactively to the portion of 1999 already completed, it will be applied exclusively to the 4th Quarter of 1999. All of the potential percentage awards for the Heska management with respect to 1999 will be 1/2 the amount that would be granted with respect to an entire year. So, for example, as the bonus percentage to be awarded to the CEO for a full year if all objectives are met is 60% of base salary, for the 4th Quarter of 1999 that percentage would be 30%. The components on which total bonuses will be determined and the percentage of total bonus that they represent are as follows: Net Income (Loss) 50% Total Revenue 25% Discretionary 25%
These components will be subject to various qualifications from time to time. Included in these qualifications will be a requirement that the Net Income target not be met by reducing Research and Development Expenses below a specified number or a specified percentage of revenue. In addition, the Net Revenue target will be subject to a minimum total gross margin percentage. Finally, the Discretionary component will be subject to a limitation that the total percentage awarded as a Discretionary award can not exceed 15% (as opposed to 25%) if the Net Income and Net Revenue targets are not both met. The total bonus payout for meeting all of these targets at the 100% level will be a cash payment equal to the percentage of the recipients' base salary set forth below: CEO 60% COO 50% CFO 35% EVP's 35% VP's 30% Directors 25%
2 Any bonus amounts will be paid out only after the Compensation Committee has reviewed the Management's calculations of such bonus amounts in conjunction with the audited financial statements for the year in question. In addition to these percentage bonuses, for every $1M by which the Net Income target is exceeded, the Net Income bonus percentages shall go up by 10%. For example, if the Net Income target is exceeded by $1M, the Net Income bonus percentage for the CEO would increase by 10%, from 30% (50% of 60%) to 33%. Similarly, if the Net Income target is exceeded by $1M, the Net Income bonus percentage for the COO would increase by 10%, from 25% (50% of 50%) to 27.5%. Exceeding the Total Revenue target will not result in any increase in that bonus percentage (25% of 60% in the case of the CEO) and the Discretionary bonus percentage can never be increased beyond 25% of the original bonus allocation (25% of 60% in the case of the CEO). For the 4th Quarter of 1999 the specific targets will be as follows: Net Income: The Company must achieve an operating loss of less than $6M in the 4th Quarter, exclusive of any restructuring charges, gains and/or losses on sales of businesses and interest income (expense). This must be achieved with Research and Development expense in the 4th Quarter of not less than $3.8M. Net Revenue: The Company must achieve total product and research revenue of at least $15M. This must be achieved with a minimum gross margin on product revenue of at least 33%. The specific targets for 2000 will be decided upon in December of 1999 or early in 2000. EX-21.1 7 SUBSIDIARIES 1 EXHIBIT 21.1 SUBSIDIARIES OF COMPANY Astarix Institute, Inc., a Delaware corporation Center Laboratories, Inc., a Delaware corporation CMG-Heska Allergy Products S.A., a corporation incorporated under the laws of Switzerland Diamond Animal Health, Inc., an Iowa corporation Heska AG, a corporation incorporated under the laws of Switzerland Heska EURL, a corporation incorporated under the laws of France Heska Holding AG, a corporation incorporated under the laws of Switzerland Sensor Devices, Inc., a Wisconsin corporation EX-23.1 8 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Annual Report on Form 10-K, into Heska Corporation's previously filed Registration Statement File No. 333-47129, Registration Statement File No. 333-30951, Registration Statement File No. 333-34111 and Registration Statement File No. 333-72155. /S/ ARTHUR ANDERSEN LLP Denver, Colorado March 23, 2000 EX-27.1 9 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION FROM THE REGISTRANT'S CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH CONSOLIDATED FINANCIAL STATEMENTS INCLUDED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999. 1,000 U.S. DOLLARS YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 1 1,499 22,482 9,840 (188) 13,957 48,617 30,574 (11,000) 71,168 20,383 0 0 0 199,189 (153,750) 71,168 50,291 51,176 36,386 85,763 (1,003) 0 (1,857) (35,836) 0 (35,836) 0 0 0 (35,836) (1.31) (1.31)
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