Search the web
Welcome, Guest
[Sign Out, My Account]
EDGAR_Online

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
HSKA > SEC Filings for HSKA > Form 10-Q on 5-Aug-2014All Recent SEC Filings

Show all filings for HESKA CORP

Form 10-Q for HESKA CORP


5-Aug-2014

Quarterly Report


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 Unaudited Condensed Consolidated Financial Statements and related Notes included in Part I Item 1 of this Form 10-Q.

This discussion contains forward-looking statements that involve risks and uncertainties. Such statements, which include statements concerning future revenue sources and concentration, gross profit margins, selling and marketing expenses, general and administrative expenses, research and development expenses, capital resources, capital expenditures and additional financings or borrowings, are subject to risks and uncertainties, including, but not limited to, those discussed below and elsewhere in this Form 10-Q, particularly in Part II Item 1A. "Risk Factors," that could cause actual results to differ materially from those projected. The forward-looking statements set forth in this Form 10-Q are as of the close of business on August 4, 2014, and we do not intend to update this forward-looking information.

Overview

We develop, manufacture, market, sell and support veterinary products. Our business is comprised of two reportable segments, Core Companion Animal Health ("CCA"), which represented 82% of our revenue for the twelve months ended June 30, 2014 (which we define as "LTM") and Other Vaccines, Pharmaceuticals and Products ("OVP"), which represented 18% of LTM revenue.

The CCA segment includes, primarily for canine and feline use, blood testing instruments and supplies, digital imaging products, software and services, and single use products and services such as heartworm diagnostic tests, heartworm preventive products, allergy immunotherapy products and allergy testing.

Blood testing and other non-imaging instruments and supplies represented approximately 34% of our LTM revenue. Many products in this area involve placing an instrument in the field and generating future revenue from consumables, including items such as supplies and service, as that instrument is used. Approximately 29% of our LTM revenue resulted from the sale of such consumables to an installed base of instruments and approximately 5% of our LTM revenue was from hardware revenue. A loss of or disruption in supply of consumables we are selling to an installed base of instruments could substantially harm our business. All of our blood testing and other non-imaging instruments and supplies are supplied by third parties, who typically own the product rights and supply the product to us under marketing and/or distribution agreements. In many cases, we have collaborated with a third party to adapt a human instrument for veterinary use. Major products in this area include our chemistry instruments, our hematology instruments and our blood gas instruments and their affiliated operating consumables. Revenue from products in these three areas, including revenues from consumables, represented approximately 30% of our LTM revenue.

Imaging hardware, software and services represented approximately 16% of LTM revenue. Digital radiography is the largest product offering in this area, which also includes ultrasound instruments. Digital radiography solutions typically consist of a combination of hardware and software placed with a customer, often combined with an ongoing service and support contract. It has been our experience that most of the economic benefit is generated at the time of sale in this area, in contrast to the blood testing category discussed above where ongoing consumable revenue is often a larger component of economic value.

-12-

Other CCA revenue, including single use diagnostic and other tests, pharmaceuticals and biologicals as well as research and development, licensing and royalty revenue, represented approximately 33% of our LTM revenue. Since items in this area are often single use by their nature, our typical aim is to build customer satisfaction and loyalty for each product, generate repeat annual sales from existing customers and expand our customer base in the future. Products in this area are both supplied by third parties and provided by us. Major products and services in this area include our heartworm diagnostic tests, our heartworm preventives, our allergy test kits, our allergy immunotherapy and our allergy testing. Combined revenue from heartworm-related products and allergy-related products represented 30% of our LTM revenue.

We consider the CCA segment to be our core business and devote most of our management time and other resources to improving the prospects for this segment. Maintaining a continuing, reliable and economic supply of products we currently obtain from third parties is critical to our success in this area. Virtually all of our sales and marketing expenses occur in the CCA segment. The majority of our research and development spending is dedicated to this segment as well.

All our CCA products are ultimately sold primarily to or through veterinarians. In many cases, veterinarians will mark up their costs to the end user. The acceptance of our products by veterinarians is critical to our success. CCA products are sold directly to end users by us as well as through distribution relationships, such as our corporate agreement with Merck Animal Health, the sale of kits to conduct blood testing to third-party veterinary diagnostic laboratories and independent third-party distributors. Revenue from direct sales and distribution relationships represented approximately 69% and 31%, respectively, of CCA LTM revenue.

We intend to sustain profitability over the long term through a combination of revenue growth, gross margin improvement and expense control. Accordingly, we closely monitor revenue growth trends in our CCA segment. LTM revenue in this segment increased 2% as compared to pro forma revenue for the twelve months ended June 30, 2013 assuming we had consolidated Heska Imaging for the entire period.

The OVP segment includes our 168,000 square foot USDA- and FDA-licensed production facility in Des Moines, Iowa. We view this facility as an asset which could allow us to control our cost of goods on any pharmaceuticals and vaccines that we may commercialize in the future. We have increased integration of this facility with our operations elsewhere. For example, virtually all our U.S. inventory, excluding Heska Imaging, is now stored at this facility and fulfillment logistics are managed there. CCA segment products manufactured at this facility are transferred at cost and are not recorded as revenue for our OVP segment. We view OVP reported revenue as revenue primarily to cover the overhead costs of the facility and to generate incremental cash flow to fund our CCA segment.

Our OVP segment includes private label vaccine and pharmaceutical production, primarily for cattle but also for other animals such as small mammals. All OVP products are sold by third parties under third-party labels.

We developed a line of bovine vaccines that are licensed by the USDA. We have an agreement which was assigned by a previous distributor, Agri Laboratories, Ltd., ("AgriLabs") to, and assumed by, Eli Lilly and Company ("Eli Lilly") acting through its Elanco Animal Health division ("Elanco") in November 2013, for the marketing and sale of certain of these vaccines which AgriLabs sold primarily under the Titanium“and MasterGuard“ brands. This agreement has historically generated a significant portion of our OVP segment's revenue. Our OVP segment also produces vaccines and pharmaceuticals for other third parties.

-13-

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon the consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenue and expense during the periods. These estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. We have identified those critical accounting policies used in reporting our financial position and results of operations based upon a consideration of those accounting policies that involve the most complex or subjective decisions or assessment. We consider the following to be our critical policies.

Revenue Recognition

We generate our revenue through the sale of products, as well as through licensing of technology product rights, royalties and sponsored research and development. Our policy is to recognize revenue when the applicable revenue recognition criteria have been met, which generally include the following:

∑ Persuasive evidence of an arrangement exists;

∑ Delivery has occurred or services rendered;

∑ Price is fixed or determinable; and

∑ Collectability is reasonably assured.

Revenue from the sale of products is recognized after both the goods are shipped to the customer and acceptance has been received, if required, with an appropriate provision for estimated returns and allowances. We do not permit general returns of products sold. Certain of our products have expiration dates. Our policy is to exchange certain outdated, expired product with the same product. We record an accrual for the estimated cost of replacing the expired product expected to be returned in the future, based on our historical experience, adjusted for any known factors that reasonably could be expected to change historical patterns, such as regulatory actions which allow us to extend the shelf lives of our products. Revenue from both direct sales to veterinarians and sales to independent third-party distributors are generally recognized when goods are shipped. Our products are shipped complete and ready to use by the customer. The terms of the customer arrangements generally pass title and risk of ownership to the customer at the time of shipment. Certain customer arrangements provide for acceptance provisions. Revenue for these arrangements is not recognized until the acceptance has been received or the acceptance period has lapsed. We reduce our revenue by the estimated cost of any rebates, allowances or similar programs, which are used as promotional programs.

Recording revenue from the sale of products involves the use of estimates and management judgment. We must make a determination at the time of sale whether the customer has the ability to make payments in accordance with arrangements. While we do utilize past payment history, and, to the extent available for new customers, public credit information in making our assessment, the determination of whether collectability is reasonably assured is ultimately a judgment decision that must be made by management. We must also make estimates regarding our future obligation relating to returns, rebates, allowances and similar other programs.

License revenue under arrangements to sell or license product rights or technology rights is recognized as obligations under the agreement are satisfied, which generally occurs over a period of time. Generally, licensing revenue is deferred and recognized over the estimated life of the related agreements, products, patents or technology. Nonrefundable licensing fees, marketing rights and milestone payments received under contractual arrangements are deferred and recognized over the remaining contractual term using the straight-line method.

-14-

Recording revenue from license arrangements involves the use of estimates. The primary estimate made by management is determining the useful life of the related agreement, product, patent or technology. We evaluate all of our licensing arrangements by estimating the useful life of either the product or the technology, the length of the agreement or the legal patent life and defer the revenue for recognition over the appropriate period.

We may enter into arrangements that include multiple elements. Such arrangements may include the licensing of technology and manufacturing of product. In these situations we must determine whether the various elements meet the criteria to be accounted for as separate elements. If the elements cannot be separated, revenue is recognized once revenue recognition criteria for the entire arrangement have been met or over the period that the Company's obligations to the customer are fulfilled, as appropriate. If the elements are determined to be separable, the revenue is allocated to the separate elements based on relative fair value and recognized separately for each element when the applicable revenue recognition criteria have been met, subject to revenue deferred estimated to be sufficient to cover the cost of servicing such revenue. In accounting for these multiple element arrangements, we must make determinations about whether elements can be accounted for separately and make estimates regarding their relative fair values.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts receivable based on client-specific allowances, as well as a general allowance. Specific allowances are maintained for clients which are determined to have a high degree of collectability risk based on such factors, among others, as: (i) the aging of the accounts receivable balance; (ii) the client's past payment history; (iii) a deterioration in the client's financial condition, evidenced by weak financial condition and/or continued poor operating results, reduced credit ratings, and/or a bankruptcy filing. In addition to the specific allowance, the Company maintains a general allowance for credit risk in its accounts receivable which is not covered by a specific allowance. The general allowance is established based on such factors, among others, as: (i) the total balance of the outstanding accounts receivable, including considerations of the aging categories of those accounts receivable; (ii) past history of uncollectable accounts receivable write-offs; and (iii) the overall creditworthiness of the client base. A considerable amount of judgment is required in assessing the realizability of accounts receivable. Should any of the factors considered in determining the adequacy of the overall allowance change, an adjustment to the provision for doubtful accounts receivable may be necessary.

Inventories

Inventories are stated at the lower of cost or market, cost being determined on the first-in, first-out method. Inventories are written down if the estimated net realizable value of an inventory item is less than its recorded value. We review the carrying cost of our inventories by product each quarter to determine the adequacy of our reserves for excess/obsolescence inventory. In accounting for inventories we must make estimates regarding the estimated net realizable value of our inventory. This estimate is based, in part, on our forecasts of future sales and shelf life of product.

Deferred Tax Assets - Valuation Allowance

Our deferred tax assets, such as a domestic Net Operating Loss ("NOL"), are reduced by an offsetting valuation allowance based on judgmental assessment of available evidence if we are unable to conclude that it is more likely than not that some or all of the related deferred tax assets will be realized. If we are able to conclude it is more likely than not that we will realize a future benefit from a deferred tax asset, we will reduce the related valuation allowance by an amount equal to the estimated quantity of income taxes we would pay in cash if we were not to utilize the deferred tax asset in the future. The first time this occurs in a given jurisdiction, it will result in a net deferred tax asset on our consolidated balance sheets and an income tax benefit of equal magnitude in our statement of operations in the period we make the determination. In future periods, we will then recognize as income tax expense the estimated quantity of income taxes we would have paid in cash

-15-

had we not utilized the related deferred tax asset. The corresponding journal entry will be a reduction of our deferred tax asset. If there is a change regarding our tax position in the future, we will make a corresponding adjustment to the related valuation allowance. For example, if we were to conclude we were not more likely than not to utilize deferred tax assets recognized on our consolidated balance sheets, we would increase the valuation allowance affiliated with these deferred tax assets and recognize an income tax expense of an equal magnitude in our statement of operations. If we were to experience a loss before income taxes in 2014, we expect we would conclude we were not more likely than not to utilize deferred tax assets recognized on our consolidated balance sheets, increase our valuation allowance affiliated with these deferred tax assets to an amount equal to the deferred tax assets and recognize an income tax expense of equal magnitude in our statement of operations.

Results of Operations

Revenue

Total revenue was $43.7 million for the six months ended June 30, 2014, an increase of 17% as compared to $37.2 million in the corresponding period in 2013. Total revenue was $22.9 million for the three months ended June 30, 2014, a 25% increase as compared to the corresponding period in 2013.

Revenue from our CCA segment was $34.9 million, including $5.3 million recognized from Heska Imaging, for the six months ended June 30, 2014, an increase of 11% as compared to $31.5 million, including $4.6 million recognized from Heska Imaging, for the corresponding period in 2013. Revenue from our CCA segment was $17.5 million, including $3.2 million recognized from Heska Imaging, for the three months ended June 30, 2014, an increase of 10% as compared to $15.9 million, including $2.7 million recognized from Heska Imaging, for the corresponding period in 2013. In both cases, key factors in the increase were greater revenue from sales of our heartworm preventive domestically, our instrument consumables and our digital imaging products, somewhat offset by lower revenue from our heartworm diagnostic tests, both domestically and internationally.

Revenue from our OVP segment was $8.9 million for the six months ended June 30, 2014, an increase of 54% as compared to $5.7 million in the corresponding period in 2013. Revenue from our OVP segment was $5.4 million for the three months ended June 30, 2014, an increase of 125% as compared to $2.4 million in the corresponding period in 2013. The largest factor in the increase in both cases was greater revenue from the contract Elanco Animal Health assumed from AgriLabs in 2013.

Cost of Revenue

Cost of revenue totaled $26.4 million for the six months ended June 30, 2014, as compared to $24.4 million for the corresponding period in 2013. Gross profit was $17.4 million, including $1.2 million recognized from Heska Imaging, for the six months ended June 30, 2014 as compared to $12.8 million, including $1.4 million recognized from Heska Imaging, in the prior year period, an increase of $4.5 million. Gross Margin, i.e. gross profit divided by total revenue, increased to 39.7% for the six months ended June 30, 2014 from 34.4% in the prior year period. At June 30, 2013, we recognized a reserve (the "Roche Reserve") related to an anticipated agreement (the "Roche Agreement") with Roche Diagnostics Corporation ("Roche") related to our previous blood gas instrument offering under which we would be relieved of any minimum purchase obligations other than the Roche Agreement and Roche would be obligated to supply us with consumables and spare parts for a shortened period of time. The Roche Reserve recognized as of June 30, 2013 was $1.1 million, as follows: $600 thousand recognized in cost of revenue related to required purchase of new instruments under the Roche Agreement, $168 thousand recognized in cost of revenue related to instruments already in inventory and accelerated depreciation on service units, $13 thousand recognized in sales and marketing expenses related to accelerated depreciation on demonstration units, $99 thousand recognized in research and development expenses related to the purchase of research and development equipment required under the Roche Agreement we would not have otherwise purchased and $243 thousand recognized in general and administrative expenses related to other anticipated costs related to the Roche Agreement. In addition, at June 30, 2013, we recognized a reserve (the "SpotChem Reserve") related to consumable and accessory inventory which we did not expect to

-16-

sell. The SpotChem Reserve recognized as of June 30, 2013 was $453 thousand, was recognized in cost of revenue and the related inventory was for use in a previously sold chemistry instrument. The Roche Reserve and the SpotChem Reserve, as well as product mix, were key factors in the increase in Gross Margin for the six months ended June 30, 2014 as compared to the prior year period. This was somewhat offset by a higher relative revenue contribution at a lower Gross Margin from Heska Imaging in the 2014 period as compared to the 2013 period.

Cost of revenue totaled $13.8 million for the three months ended June 30, 2014 an increase of $598 thousand or 5% as compared to $13.2 million for the corresponding period in 2013. Gross profit increased by $4.1 million to $9.1 million for the three months ended June 30, 2014, including $882 thousand recognized from Heska Imaging from $5.0 million, including $691 thousand recognized from Heska Imaging, in the prior year period. Gross Margin increased to 39.6% for the three months ended June 30, 2014 from 27.5% in the prior year period. The Roche Reserve and the SpotChem Reserve, as well as the impact of a greater relative revenue contribution at improved Gross Margin from our OVP segment,were key factors in the increase.

Operating Expenses

Total operating expenses decreased 3% to $16.5 million in the six months ended June 30, 2014 from $17.1 million in the prior year period. Total operating expenses decreased 5% to $8.2 million in the three months ended June 30, 2014 from $8.6 million in the prior year period.

Selling and marketing expenses were $9.7 million, including $2.1 million recognized from Heska Imaging, in the six months ended June 30, 2014, as compared to $10.0 million, including $1.2 million recognized from Heska Imaging, in the six months ended June 30, 2013, a year-over-year decline of 3%. Key factors in the decrease were lower advertising and promotional expenses, as well as lower spending on fleet auto rentals. Selling and marketing expenses were $4.8 million, including $1.1 million recognized from Heska Imaging in the three months ended June 30, 2014, a slight decrease as compared to the corresponding period in 2013, which included $762 thousand from Heska Imaging. Lower advertising and promotional expenses were a key factor in the decline.

Research and development expenses were $762 thousand, including $139 thousand in expense recognized from Heska Imaging in the six months ended June 30, 2014 as compared to $873 thousand, including $66 thousand recognized from Heska Imaging, in the corresponding period in 2013, a 13% decline. Factors in the change include a reserve for equipment that had been previously used in a project that was discontinued and expenses related to the Roche Reserve in the 2013 period, which did not recur in the 2014 period. This was somewhat offset by increased expenses recognized from Heska Imaging in the 2014 period as compared to the 2013 period. Research and development expenses were $374 thousand, including $78 thousand recognized from Heska Imaging in the three months ended June 30, 2014, a decrease of $109 thousand as compared to $483 thousand, including $50 thousand recognized from Heska Imaging, in the corresponding period in 2013. Expenses related to the Roche Reserve was a factor in the increase.

General and administrative expenses were $6.1 million, including $524 thousand recognized from Heska Imaging, in the six months ended June 30, 2014, down 3% from $6.2 million, including $510 thousand recognized from Heska Imaging, in the prior year period. General and administrative expenses were $3.0 million and included approximately $291 thousand in expense from Heska Imaging in the three months ended June 30, 2014, down 7% from $3.3 million, including $357 thousand recognized from Heska Imaging, in the prior year period. In both cases, lower expenses related to the Roche Reserve and severance costs were factors in the decline, somewhat offset by increased non-cash compensation expense related to new employment agreements for our Chief Executive Officer and our Executive Chair which were signed in March 2014.

-17-

Interest and Other (Income) Expense, Net

In the six months ended June 30, 2014, this line item was a $9 thousand expense as opposed to $41 thousand in expense in the prior year period. This line item was represented by $7 thousand of income in the three months ended June 30, 2014, an improvement of $59 thousand as compared to $52 thousand of expense in the prior year period. A factor in the change in both cases was greater interest income related to outstanding balances as well as a full year of interest as opposed to a partial year of interest on a note receivable in the 2014 period as compared to the 2013 period.

Income Tax Expense

We recognized $302 thousand net income tax expense in the six months ended June 30, 2014, as opposed to a tax benefit of $1.5 million in the prior year period. We recognized an income tax expense of

$146 thousand in the three months ended June 30, 2014, a $1.3 million increase as compared to a tax benefit of $1.2 million in the prior year period.

Current tax expense was $53 thousand in the six months ended June 30, 2014, a decrease of $12 thousand as compared to $65 thousand in the six months ended June 30, 2013. Current tax expense was $32 thousand in the three months ended June 30, 2014, a decrease of $27 thousand as compared to $59 thousand in the prior year period. In both cases, a lower estimate of cash taxes payable in the 2014 period was responsible for the change.

For the six months ended June 30, 2014, deferred tax expense was $249 thousand, a $1.8 million change from $1.5 million in tax benefit in the six months ended June 30, 2013. For the three months ended June 30, 2014, deferred tax expense was $114 thousand, a $1.3 million change from $1.2 million in deferred tax benefit in the prior year period. In both cases, the change is due to income before income taxes in the 2014 period as opposed to a loss before income taxes in the 2013 period.

Net Income (Loss)

Net income was $505 thousand in the six months ended June 30, 2014, an improvement of approximately $3.3 million compared to a net loss of $2.8 million in the prior year period. Net income was $778 thousand in the three months ended June 30, 2014, an increase of approximately $3.2 million compared to a $2.5 million net loss in the prior year period. In both cases, greater revenue, increased Gross Margin and lower operating expenses were key factors in the change.

Net Income (Loss) attributable to Heska Corporation

Net income attributable to Heska Corporation was $1.3 million in the six months ended June 30, 2014, an increase of approximately $3.9 million compared to $2.6 million net loss attributable to Heska Corporation in the prior year period. Net income attributable to Heska Corporation was $1.1 million in the three months ended June 30, 2014, an increase of approximately $3.3 million compared to $2.2 million net loss in the prior year period. The difference between this line item and "Net Income (Loss)" above is the net income or loss attributable to the minority interest in Heska Imaging, which was a net loss of $756 thousand in the six months ended June 30, 2014 and a net loss of $291 thousand in the three months ended June 30, 2014 compared to a net loss of $205 thousand in the six months ended June 30, 2013 and a net loss of $239 thousand in the three months ended June 30, 2013.

Liquidity and Capital Resources

We have incurred net cumulative negative cash flow from operations since our . . .

  Add HSKA to Portfolio     Set Alert         Email to a Friend  
Get SEC Filings for Another Symbol: Symbol Lookup
Quotes & Info for HSKA - All Recent SEC Filings
Copyright © 2014 Yahoo! Inc. All rights reserved. Privacy Policy - Terms of Service
SEC Filing data and information provided by EDGAR Online, Inc. (1-800-416-6651). All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.