HESKA CORP - Annual Report: 2022 (Form 10-K)
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 | ||
FORM 10-K
(Mark One)
| ☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||||
For the fiscal year ended December 31, 2022
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||||
For the transition period from _________________ to _______________________
Commission file number: 000-22427
HESKA CORPORATION
(Exact name of registrant as specified in its charter)
| Delaware | 77-0192527 | |||||||||||||
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |||||||||||||
3760 Rocky Mountain Avenue Loveland, Colorado | 80538 | |||||||||||||
| (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: | ||||||||||||||
| Title of each class | Trading Symbol | Name of each exchange on which registered | ||||||||||||||||||
| Common stock, $0.01 par value | HSKA | The Nasdaq Stock Market LLC | ||||||||||||||||||
Securities registered pursuant to Section 12(g) of the Act: None | ||||||||||||||||||||
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☒
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated filer ☒ | Accelerated filer ☐ | ||||
Non-accelerated filer ☐ | Smaller Reporting Company ☐ | ||||
Emerging Growth Company ☐ | |||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C.7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
As of June 30, 2022, the last business day of the registrant's most recently completed second fiscal quarter, the aggregate market value of voting common stock held by non-affiliates of the registrant was approximately $930,762,767 based upon the closing price on the Nasdaq Capital Market reported for such date. This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purpose.
10,876,018 shares of the Registrant's Public Common Stock, $.01 par value, were outstanding at February 16, 2023.
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DOCUMENTS INCORPORATED BY REFERENCE
Items 10, 11, 12, 13 and 14 of Part III incorporate by reference information from the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the Registrant's 2023 Annual Meeting of Stockholders to be held on or about May 3, 2023.
TABLE OF CONTENTS
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HESKA, scil, ALLERCEPT, HemaTrue, Solo Step, Element DC, Element HT5, Element POC, Element i, Element i+, Element COAG, Element COAG+, Element DC5X and Element RC, Element RCX, Element RC3X, Element AIM, and scil vet, scil academy, scil vIP, scil ABC are registered trademarks of Heska Corporation. DRI-CHEM is a registered trademark of FUJIFILM Corporation. TRI-HEART is a registered trademark of Intervet Inc., d/b/a Merck Animal Health, formerly known as Schering-Plough Animal Health Corporation, which is a unit of Merck & Co., Inc., in the United States and is a registered trademark of Heska Corporation in other countries. Nu.Q is a registered trademark of Belgian Volition SPRL. This Annual Report on Form 10-K also refers to trademarks and trade names of other organizations.
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Our Certificate of Incorporation, as amended (the “Charter”), authorizes three classes of stock: Original Common Stock, Public Common Stock, and Preferred Stock. Pursuant to an NOL Protective Amendment to the Charter adopted in 2010, all shares of Original Common Stock then outstanding were automatically reclassified into shares of Public Common Stock. Our Public Common Stock trades on the Nasdaq Stock Market LLC. In this Annual Report on Form 10-K, references to “Public Common Stock” and “common stock” are references to our Public Common Stock, unless the context otherwise requires.
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Statement Regarding Forward Looking Statements
This Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). For this purpose, any statements contained herein that are not statements of current or historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as "scheduled," "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results could differ materially from those expressed or forecasted in any such forward-looking statements as a result of certain factors. Such factors are set forth in "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this Form 10-K and include, among others, risks and uncertainties related to:
•our business is subject to risk based on global economic conditions, including inflationary pressures and lingering economic effects of the COVID-19 pandemic;
•the success of third parties in marketing our products;
•our reliance on third party suppliers and collaborative partners;
•our dependence on key personnel and increased human capital costs;
•our dependence upon a number of significant customers;
•competitive conditions in our industry;
•our dependence on third parties to successfully develop new products;
•our ability to market and sell our products successfully;
•expansion of our international operations;
•the impact of regulation on our business;
•the success of our acquisitions and other strategic development opportunities;
•our ability to develop, commercialize and gain market acceptance of our products;
•cybersecurity incidents and related disruptions and our ability to protect our stakeholders’ privacy;
•product returns or liabilities;
•volatility of our stock price;
•our ability to service our convertible notes and comply with their terms.
Readers are cautioned not to place undue reliance on these forward-looking statements.
Although we believe that expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect the passage of time, any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based, except as otherwise required by applicable securities laws. These forward-looking statements apply only as of the date of this Form 10-K or for statements incorporated by reference from our 2023 proxy statement on Schedule 14A, as of the date of the Schedule 14A.
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PART I
Item 1. Business
Unless we state otherwise or the context otherwise requires, the terms "Heska," "we," "our," "us" and the "Company" refer to Heska Corporation and its consolidated subsidiaries.
Overview
We sell, manufacture, market and support diagnostic and specialty products and solutions for veterinary practitioners. Our portfolio includes point-of-care (“POC”) diagnostic laboratory instruments and consumables including rapid assay diagnostic products and digital cytology services; POC digital imaging diagnostic products; local and cloud-based data services; practice information management software (“PIMS”) and related software and support; reference laboratory testing; allergy testing and immunotherapy; heartworm preventive products; and vaccines. Our primary focus is on supporting companion animal veterinarians in providing care to their patients.
Our business is composed of two operating and reportable segments: North America and International. North America consists of the United States, Canada and Mexico. International consists of geographies outside of North America, primarily our operations in Germany, Italy, Spain, France, Switzerland, Australia and Malaysia. The Company's strategic focus on POC diagnostic laboratory and imaging products is included in both segments. The North America segment also includes the contract manufacturing of vaccines and pharmaceutical products and a small veterinary laboratory, and the International segment includes our PIMS business and veterinary laboratories.
For the year ended December 31, 2022, our North America and International segments represent approximately 60% and 40% of our total revenue, respectively.
Acquisitions have been, and we expect that they will continue to be, meaningful to our organization’s growth and results of operations. In 2020, we completed the acquisition of scil animal care company GmbH ("scil"). Like Heska, scil focuses on POC diagnostic solutions for companion animal veterinarians, primarily in Europe. The scil acquisition represented a key milestone in the Company's history, creating an international veterinary diagnostics company with leadership positions in key geographic markets including Germany, France, Italy, Spain, Canada, and Malaysia.
We believe that companion animal veterinarians look to us and other diagnostic providers to provide a portfolio of solutions for their varied diagnostic needs. The scil acquisition significantly expanded the geographies that we serve and our customer base with regard to our core offerings: POC laboratory and imaging diagnostic solutions. In addition, we have deployed capital to invest in other elements of our diagnostic portfolio further described under products and services and as follows:
•In 2021, we:
◦acquired BiEsse A-Laboratorio die Analisi Veterinarie S.r.l. (“BSA”), based in Milan, Italy, which expanded our reference laboratory capabilities;
◦acquired 65% of the equity of Biotech Laboratories U.S.A. LLC ("Biotech"), a developer of rapid assay diagnostic testing. In 2022, we incrementally increased our ownership to 75.50%; and
◦acquired Lacuna Diagnostics, Inc. ("Lacuna”) to expand our diagnostic offering to include digital cytology services.
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•On January 3, 2022, we acquired Veterinärmedizinisches Dienstleistungszentrum (VetZ) GmbH (“VetZ”). VetZ is a European leader in veterinary PIMS.
•On March 28, 2022, we entered into a Master License and Product Supply Agreement with Belgian Volition SRL to develop and commercialize a POC cancer screening and monitoring solution for dogs and cats under an exclusive arrangement.
•On January 3, 2023, the Company completed the acquisition of MBio Diagnostics, Inc., d/b/a LightDeck Diagnostics ("LightDeck"). The LightDeck acquisition represents a meaningful increase in our intellectual property portfolio as well as our manufacturing and research and development capabilities.
Major Products and Services
We offer a portfolio of veterinary POC (stationary and portable) laboratory diagnostic instruments for testing blood and other biological substances, for diagnostic imaging and for other uses, including those described below. We also market and sell consumable supplies and services for these instruments. Our portfolio of veterinary instruments includes the following:
POC Laboratory
Blood Chemistry. Element DC® Veterinary Chemistry Analyzer (the "Element DC") uses consumable, dry slide technology for blood chemistry and electrolyte analysis. The Element DC5x® Veterinary Chemistry Analyzer (the "Element DC5x"), launched during 2018, delivers faster run times, higher throughput, and allows simultaneous staging of five patient samples. The Element DCXTM Veterinary Chemistry Analyzer (the "Element DCX"), launched during 2021, is a chemistry analyzer that is positioned between the economical Element DC and the higher-capacity Element DC5x. The Element DC, Element DCX, and Element DC5x utilize the same consumable test slides. We are supplied with the Element DC, Element DCX, and Element DC5x, as well as the affiliated test slides and supplies under a contractual agreement with a single third-party supplier. These products are sold in the North America segment and Australia.
We also market and distribute the Element RC®, Element RCXTM, and Element RC3XTM compact chemistry systems that utilize load-and-go rotors (consumables) for blood chemistry and electrolyte analysis. Rotors of various test menus are available, providing results in some cases for up to 21 tests. We also market and distribute the scil Element DC®, compact chemistry system that utilizes load-and-go consumables for blood chemistry. We are supplied with the Element RC, the Element RCX, the Element RC3X, and the scil Element DC under contractual agreements with third-party suppliers. These products are sold and marketed in the International segment.
Hematology. The Element HT5® Hematology Analyzer (the "HT5") is a five-part hematology analyzer that measures key parameters such as white blood cell count, red blood cell count, platelet count and hemoglobin levels in animals, and it is sold in both the North America and International segments. We also market the scil Vet abc Plus +TM, a four-part hematology analyzer, in the International segment.
Blood Gases and Electrolytes. The Element POC® Blood Gas & Electrolyte Analyzer is a handheld, wireless analyzer which delivers rapid blood gas, electrolyte, metabolite and basic blood chemistry testing utilizing consumable test cards. We market this in the North America segment. In our International segment, mainly Europe, we market and sell Edan blood gas products.
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Immunodiagnostics. The Element i+® Immunodiagnostic Analyzer (the "Element i+"), which launched during 2020, and as of January 3, 2023 is part of our proprietary product offering, utilizes patented fluorescence waveguide immunoassay technology with laser evanescent illumination for in-clinic detection of Total T4, Cortisol, Progesterone, cCRP and cTSH. The Element i+ analyzer system has capability to run multiplexed assays in a consumable microfluidic cartridge, offering potential future menu expansions in endocrine, inflammatory, infectious disease, and other diagnostic target areas. We anticipate launching our proprietary cancer screen on the Element i+ platform. We market this in both the North America and International segments. The Cube-VetTM is a compact benchtop analyzer used for the determination of various immunodiagnostic parameters sold throughout Europe.
Coagulation. The Element COAG® Veterinary Analyzer (the "Element COAG") is a compact cartridge-based system used for coagulation and specialty testing. We currently offer five consumable test cartridges on the Element COAG. The Element COAG+® Veterinary Analyzer is a lightweight, handheld, battery-powered, wifi-capable cartridge-based system used for coagulation testing. We market this in both the North America and International segments.
Urine and Fecal Diagnostics. The Element AIM® Veterinary Analyzer (the "Element AIM") is a novel, proprietary automated fecal and urine combination POC laboratory analyzer launched in 2021. The Element AIM analyzes images using artificial intelligence that can be presented for rapid viewing during the patient visit, eliminating manual sample processing and time-consuming microscopic slide review. Cloud image capture and continuous machine learning software capabilities allow identification, classification, and quantitation improvements. We market this in both the North America and International segments.
Digital Cytology. The HeskaView™ Telecytology service provides in-clinic automated microscopic slide scanning and computing equipment that is seamlessly integrated with an online, on-demand network of board-certified clinical pathologists available 24 hours a day, 7 days a week, 365 days a year in North America. Patient samples can be evaluated, and a comprehensive pathology report returned to the veterinarian quickly, expediting patient diagnosis and treatment and elevating overall patient care.
Rapid Assay Diagnostics. We sell rapid POC tests to detect antigens and antibodies associated with infectious and parasitic diseases of animals. The trūRapid™ line of lateral flow tests are single-use consumables that are fast, accurate, and convenient for veterinarians. There are over 20 different tests available for use, but only marketed in countries with respective regulatory approval, to detect antigens and antibodies for a variety of infectious and parasitic diseases. Both individual and multiplex tests are available to give clinics flexibility in testing options. trūRapids™ can be used on a variety of samples, including feces, whole blood, serum, or plasma.
POC Imaging and Informatics
Digital Radiography. We sell equipment, including digital radiography detectors and related accessories for use in digital radiography imaging diagnostics in both of our segments. With this hardware, we also provide licensed embedded software, support, data hosting, warranty and other services. CloudDRTM solutions bring digital radiography detectors, acquisition workstations and acquisition software together to produce, review, archive and share radiographic image studies for our veterinary customers. We also sell mobile digital radiography products, primarily for equine use, such as the Cuattro Hub, a mobile digital radiography acquisition console that is capable of operating as a general wireless x-ray imager and as the control and display for DentiPodTM, an intraoral dental sensor, and SonoPodTM, a wireless ultrasound.
Ultrasound Systems. We sell ultrasound products, including affiliated probes and peripherals, with varying features and corresponding price points from various suppliers in both of our segments.
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Other Imaging Systems. We sell CT (computed tomography) and MRI (magnetic resonance imaging) products with varying features and corresponding price points in our International segment.
Diagnostic Data and Support. CloudbankTM is an automatic, secure, web-based image storage solution designed to interface with the imaging products we sell. HeskaView+TM is a Picture Archival and Communications Systems (PACS) for web or local viewing, reporting, planning and email sharing of studies on Internet-enabled devices, including personal computers, tablet devices and smartphones. SupportCloudTM is a support package including call center voice and remote diagnostics, recovery and other services, such as the provision of warranty-related loaner units. Access and operation between our imaging devices, CloudbankTM and SupportCloudTM is supported by the acquisition software used in the equipment we sell. The aforementioned solutions are available in both of our segments.
HeskaView and Heska’s Data Capture Utility (DCU) are PIMS applications for POC devices. The HeskaView software can be used as independent practice information reporting software for Heska analyzers. HeskaView and the DCU can be used as a middleware to bi-directionally connect Heska’s analyzers to a wide variety of veterinary PIMS platforms used throughout North America.
scil vIP® is software that enables connectivity for POC devices in our International segment. The software can be used as independent practice information software or as middleware to connect POC equipment to PIMS throughout Europe. It further provides a web interface allowing users to access the software easily.
VetZ is the name of our PIMS business. VetZ’s signature software offering is the “easyVET” product which is sold via license to veterinary practices and combines practice management, image management, communication and other functionality. VetZ also provides recurring support service (including updates, upgrades, and helpdesk) after sale. In addition, VetZ provides “easyIMAGE”, a PACS software package as part of easyVET as well as on a stand-alone basis, digital radiography systems (sourced from Heska), “vetsXL” which is connectivity software between veterinary practices and laboratory, insurance management and other providers to veterinary clinics, and “petsXL” which facilitates communication between veterinary clinics and pet owners. These software packages are offered primarily in Europe.
Heartworm Preventive Products
We have an agreement with Merck Animal Health granting Merck Animal Health the non-exclusive distribution and marketing rights for our canine heartworm prevention product, Tri-Heart® Plus Chewable Tablets, ultimately sold to or through veterinarians in the U.S. Tri-Heart Plus Chewable Tablets (ivermectin/pyrantel) are indicated for use as a monthly preventive treatment of canine heartworm infection and for treatment and control of ascarid and hookworm infections. We manufacture Tri-Heart Plus Chewable Tablets at our Des Moines, Iowa production facility.
Allergy Products and Services
Allergies are common in companion animals. Clinical symptoms of allergies are variable, but often manifest as persistent and serious skin disease in dogs and cats. Management of allergic disease is clinically problematic, as there are a large number of allergens that may give rise to these conditions. ALLERCEPT® Definitive Allergen Panels are used to determine the specific allergens to which an animal, such as a dog, cat or horse, is reacting. The test results often serve as the basis for prescription ALLERCEPT® Therapy Shots and ALLERCEPT® Therapy Drops. Our veterinary laboratories in Loveland, Colorado and Fribourg, Switzerland both offer blood testing using our ALLERCEPT® Definitive Allergen Panels.
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Other Vaccines and Pharmaceuticals ("OVP")
We manufacture biological and pharmaceutical products for a number of other animal health companies in our facility in Des Moines, Iowa. We manufacture products for livestock and companion animals. Our offerings range from providing a portfolio of services which include research, licensing, production, labeling and packaging of products to providing any one of these services as needed by our customers, as well as validation support and distribution services.
We developed a line of bovine vaccines that are regulated by the U.S. Department of Agriculture ("USDA"). In January 2015, we signed a long-term Master Supply Agreement related to these vaccines with Elanco Animal Health, Inc. ("Elanco"), which terminates on June 17, 2023.
Marketing, Sales and Customer Support
The acceptance of our products and solutions by veterinarians is critical to our success. In both of our segments, we sell and market our core products and solutions to veterinarians through our internal marketing organization, our field sales organization, a telephone sales force and independent third-party distributors. In our North America segment, our OVP products are marketed and sold by third parties under third-party labels. We market and sell outside our key countries through third-party veterinary diagnostic laboratories and independent third-party distributors. As of December 31, 2022, our customer facing sales, installed base support and utilization organization consisted of 156 and 187 individuals in our North America and International segments, respectively.
Manufacturing
The majority of our revenue is derived from sales of products manufactured by third parties. Third parties manufacture our veterinary instruments, including affiliated consumables and supplies. Our acquisition of LightDeck represented an investment in our manufacturing capabilities. Following our acquisition of LightDeck, we own the manufacturing rights to the Element i+ analyzer and related consumables.
Our facility in Des Moines, Iowa is a USDA, Food and Drug Administration ("FDA") and Drug Enforcement Agency ("DEA") licensed biological and pharmaceutical manufacturing facility. This facility currently has the capacity to manufacture more than 50 million doses of vaccine each year. We expect that we will, for the foreseeable future, manufacture most, or all of our pharmaceutical and biological products at this facility. We currently manufacture our canine heartworm prevention product, our allergy treatment products and our OVP products at this facility.
The OVP products for our North America segment are purchased in both finished and bulk format, and we perform all phases of manufacturing, including growth of the active bacterial and viral agents, sterile filling, lyophilization and packaging at this facility. We manufacture our various allergy products at our Des Moines facility, our Loveland facility and our Fribourg facility. We believe the raw materials for most of the products we manufacture are readily available from more than one source.
Product Development
We are committed to providing innovative products to address the health needs of companion animals. We may obtain such products from external sources, third-party collaboration arrangements or internal research and development.
We are committed to identifying external product opportunities and creating business and technical collaborations that lead to high value veterinary products and solutions. We believe that our active
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participation in scientific networks and our reputation for investing in research enhance our ability to develop and acquire new products and solutions. Our acquisition of LightDeck expanded our internal research and development capabilities.
Intellectual Property
We rely upon various forms of intellectual property, including trade secrets, patents, trademarks, copyrights, know-how, continuing technological innovations, and licenses and other proprietary rights to develop and maintain our competitive position. Our various agreements with third party manufacturers for POC products provide obligations to protect our intellectual property, as well as intellectual property associated with our products. The proprietary technologies of our OVP products are primarily protected through trade secret protection of, for example, our manufacturing processes in this area.
We actively seek patent protection both in the U.S. and abroad. Our issued patent portfolios primarily relate to allergy and diagnostic technologies. As of December 31, 2022, we owned, co-owned or had rights to one issued U.S. patent expiring in April 2024 and had one pending U.S. patent application. Our corresponding foreign patent portfolio as of December 31, 2022 included one issued patent in Canada expiring in August 2024.
We also have obtained exclusive and non-exclusive licenses for numerous other patents held by academic institutions and for-profit companies. Our material licenses include our exclusive license to develop and commercialize the Nu.Q® POC cancer screening and monitoring solution for dogs and cats.
Seasonality
We do not experience significant seasonal fluctuations in our sales throughout the year.
Government Regulation
Although the majority of our revenue is from the sale of unregulated items, many of our products or products that we may develop are, or may be, subject to extensive regulation by governmental authorities in the U.S., including the USDA, FDA and the EPA and by similar agencies in other countries. These regulations govern, among other things, the development, testing, manufacturing, labeling, storage, pre-market approval, advertising, promotion, sale and distribution of our products. Satisfaction of these requirements can take several years to achieve, and the time needed to satisfy them may vary substantially, based on the type, complexity, and novelty of the product. Any product that we develop must receive all relevant regulatory approval or clearances, if required, before it may be marketed in a particular country. The following summarizes the major U.S. government agencies that regulate animal health products:
•USDA. Vaccines and certain single use, POC diagnostics are considered veterinary biologics and are therefore regulated by the Center for Veterinary Biologics, or CVB, of the USDA. The USDA licensing process involves the submission of several data packages. These packages include information on how the product will be manufactured, information on the efficacy and safety of the product in laboratory and target animal studies and information on performance of the product in field conditions.
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•FDA. Pharmaceutical products, which typically include synthetic compounds, are approved and monitored by the Center for Veterinary Medicine of the FDA. Under the Federal Food, Drug and Cosmetic Act, the same statutory standard for FDA approval applies to both human and animal drugs: demonstrated safety, efficacy and compliance with FDA manufacturing standards. However, unlike human drugs, neither preclinical studies nor a sequential phase system of studies are required. Rather, for animal drugs, studies for safety and efficacy may be conducted immediately in the species for which the drug is intended. Thus, there is no required phased evaluation of drug performance, and the Center for Veterinary Medicine will review data at appropriate times in the drug development process.
•EPA. Products that are applied topically to animals or to premises to control external parasites are regulated by the Environmental Protection Agency, or EPA.
After we have received regulatory licensing or approval for our products, numerous regulatory requirements typically apply. Among the conditions for certain regulatory approvals is the requirement that our manufacturing facilities or those of our third-party manufacturers may need to conform to current Good Manufacturing Practices or other manufacturing regulations, which include requirements relating to quality control and quality assurance as well as maintenance of records and documentation. The USDA, FDA, EPA and foreign regulatory authorities strictly enforce manufacturing regulatory requirements through periodic inspections and/or reports.
A number of our animal health products are not regulated. For example, certain products such as our ALLERCEPT® panels are not regulated by either the USDA or FDA. Similarly, none of our veterinary instruments requires regulatory approval to be marketed and sold in the U.S.
We have pursued Conformité Européene (CE) Marking for certain POC laboratory instruments and imaging equipment and regulatory approval outside the U.S. based on market demographics of foreign countries. For marketing outside the U.S., we are subject to foreign regulatory requirements governing regulatory licensing and approval for many of our products. Licensing and approval by comparable regulatory authorities of foreign countries must be obtained before we can market products in those countries. Product licensing approval processes and requirements vary from country to country and the time required for such approvals may differ substantially from that required in the U.S. We cannot be certain that approval of any of our products in one country will result in approvals in any other country.
To date, we or our distributors have sought regulatory approval for certain of our products from the Canadian Center for Veterinary Biologics, or CCVB (Canada); the Japanese Ministry of Agriculture, Forestry and Fisheries, or MAFF (Japan); the Australian Department of Agriculture, Fisheries and Forestry, or ADAFF (Australia); the Republic of South Africa Department of Agriculture, or RSADA (South Africa); the Agriculture, Fisheries and Conservation Department, or ADCD (Hong Kong); the Macau Animal Health Division of Animal Control and Inspection, or IACM (Macau); the Spanish Ministry for Agriculture, Fisheries and Food; and from the relevant regulatory authorities in certain other countries requiring such approval.
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The heartworm and allergy products previously discussed which have received regulatory approval in the U.S. and/or elsewhere are summarized below:
| Products | Country | Regulated | Agency | Status | ||||||||||
| ALLERCEPT Allergy Treatment Sets | U.S. Canada | Yes Yes | USDA CCVB | Licensed Licensed | ||||||||||
| SOLO STEP CH | U.S. EU Canada | Yes No-in most countries Yes | USDA CCVB | Licensed Licensed | ||||||||||
| SOLO STEP FH | U.S. Canada | Yes Yes | USDA CCVB | Licensed Licensed | ||||||||||
| TRI-HEART Plus Heartworm Preventive | U.S. Hong Kong Macau | Yes Yes Yes | FDA AFCD IACM | Licensed Licensed Licensed | ||||||||||
| Heartworm Antigen Test Kit | U.S. | Yes | USDA | Licensed | ||||||||||
Competition
Our market is intensely competitive. Our competitors include animal health companies and major pharmaceutical companies that have animal health divisions as well as human health companies. We also compete with independent, third-party distributors and suppliers, including distributors and suppliers who sell products under their own private labels. In the POC diagnostic testing market, our major competitors include IDEXX Laboratories, Inc. ("IDEXX") and Zoetis Inc. ("Zoetis"). Each of IDEXX and Zoetis has a larger veterinary product and service offering than we do and a large sales infrastructure network and a well-established brand name. The primary business of IDEXX, like ours, is veterinary diagnostics while the primary business of Zoetis is veterinary pharmaceuticals.
In our North America segment, the OVP products we manufacture for sale by third parties compete with similar products offered by a number of other companies, some of which have substantially greater financial, technical, research and other resources than us and may have more established marketing, sales, distribution and service organizations than we do. Companies with a significant presence in the animal health market include C.H. Boehringer Sohn AG & Co. KG (Boehringer Ingelheim), CEVA Santé Animale, Elanco, Merck Animal Health, Sanofi, Vétoquinol S.A., and Virbac S.A. These and other competitors and potential competitors may have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than we do. Our competitors may offer broader product lines and have greater name recognition than we do.
Environmental Regulation
In connection with our product development activities and manufacturing of our biological, pharmaceutical, diagnostic and detection products, we are subject to federal, state and local laws, rules, regulations and policies governing the use, generation, manufacture, storage, handling and disposal of certain materials, biological specimens and wastes. Although we believe that we have complied with these laws, regulations and policies in all material respects and have not been required to take any significant action to correct any noncompliance, we may be required to incur significant costs to comply with environmental and health and safety regulations in the future. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be eliminated. In the event of such an accident, we could be held liable for any damages that result and any such liability could exceed our resources.
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Human Capital Resources
As of December 31, 2022, we employed approximately 808 persons, 428 in North America and 380 internationally. We employ temporary workers on a need only basis to maintain business flexibility and a dynamic workforce. We are committed to employee diversity and inclusion and the support of traditionally underrepresented groups in management. Our workforce is approximately 53% women and 47% men with 44% of our U.S. management team (defined as Director, Vice President, Senior Vice President and Executive Vice President) represented by women.
We believe that the current and future ability to execute on our strategic initiatives is highly dependent upon our ability to recruit, retain and reward our employees. We engage in targeted recruitment strategies to fill highly skilled positions. Our employees enjoy competitive compensation plans including market rate targeted salaries, robust benefits including retirement plans and employee stock purchase plan opportunities, and the opportunity for participation in short- and long-term incentive programs. Our compensation philosophy is designed to provide an appealing, market-based and rewarding compensation program that encourages high personal and company performance, strong cultural and ethical behavior, and incentives aligned with stockholder interests. Our aim is to attract, engage and retain highly qualified, motivated, and creative people who will fulfill our mission to be the “voice of the pet,” while delivering on Heska goals in a healthy, honest, and sustainable manner.
We are committed to providing a workplace that protects the health and well-being of our employees. All employees are required to abide by our Code of Conduct and Ethics, company health and safety parameters and contribute to a positive and friendly company culture. Due to the COVID-19 pandemic and in consideration of our employees’ safety, in March 2020, we implemented work from home policies for employees with the ability to work remotely, along with targeted on-site attendance for employees whose job requires their physical presence. At our Des Moines, Iowa manufacturing facility, we instituted staggered start times, designated building entry/exit protocols and closed common areas to maximize “social distancing” guidelines. We anticipate easing restrictions implemented during the height of the pandemic and continuing limited return to work procedures throughout 2023. Internationally, we continue to abide by local and country specific governmental requirements and follow local authority recommendations.
Where You Can Find Additional Information
Our principal executive offices are located at 3760 Rocky Mountain Avenue, Loveland, Colorado 80538. Our telephone number is 970-493-7272 and our Internet address is www.heska.com. References to our website in this Annual Report on Form 10-K are inactive textual references only and the content of our website should not be deemed incorporated by reference for any purpose.
Because we believe it provides useful information in a cost-effective manner to interested investors, we make available free of charge, via a link on our website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practical after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the "SEC").
In addition, you may also review and download a copy of this Annual Report on Form 10-K, including any exhibits and any schedules filed therewith, and our other periodic and current reports, proxy and information statements, and other information that we file with the SEC, without charge, by visiting the SEC's website (http://www.sec.gov).
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Information About Our Executive Officers
Our executive officers and their ages as of February 28, 2023 are as follows:
| Name | Age | Position | ||||||
| Kevin S. Wilson | 50 | Chief Executive Officer and President | ||||||
| Catherine Grassman | 47 | Executive Vice President, Chief Financial Officer | ||||||
| Nancy Wisnewski, Ph.D. | 60 | Executive Vice President, Chief Operating Officer | ||||||
| Steven M. Eyl | 57 | Executive Vice President, Chief Commercial Officer, and President, scil animal care company | ||||||
| Christopher Sveen | 40 | Executive Vice President, Chief Administrative Officer, General Counsel and Corporate Secretary, Heska and President, Diamond Animal Health | ||||||
| Eleanor Baker | 38 | Executive Vice President, Managing Director and Chief Operating Officer scil animal care company | ||||||
| Anthony Providenti | 56 | Executive Vice President, Corporate Development | ||||||
Kevin S. Wilson was appointed President and Chief Executive Officer effective March 31, 2014. He previously served as our President and Chief Operating Officer from February 2013. Mr. Wilson became a member of our Board of Directors in May 2014. Mr. Wilson is a founder, member and officer of Cuattro, LLC, an imaging and software company. Since 2008, he has been involved in developing technologies for radiographic imaging with Cuattro, LLC and as a founder of Cuattro Software, LLC, Cuattro Medical, LLC and Cuattro Veterinary, LLC. Mr. Wilson served on the board of various private, non-profit and educational organizations from 2005 to 2011. He was a founder of Sound Technologies, Inc., a diagnostic imaging company, in 1996. After Sound Technologies, Inc. was sold to VCA Antech, Inc. in 2004, Mr. Wilson served as Chief Strategy Officer for VCA Antech, Inc. until 2006. Mr. Wilson attended Saddleback College.
Catherine Grassman, CPA, was appointed Executive Vice President, Chief Financial Officer on May 6, 2019. She previously served as Vice President and Chief Accounting Officer from December 2017 to May 2019 and as Corporate Controller from January 2017 to December 2017. Prior to joining Heska, Ms. Grassman was Corporate Controller of KeyPoint Government Solutions, a mid-sized private-equity backed, background investigation services company. She also spent more than 15 years with PricewaterhouseCoopers, LLP as a senior manager in the audit practice. She is licensed in Colorado as a Certified Public Accountant and possesses a Master of Accountancy and a Bachelor of Business Administration from Stetson University.
Nancy Wisnewski, Ph.D. was appointed Executive Vice President, Chief Operating Officer in August 2019. She previously served as Executive Vice President, Diagnostic Operations and Product Development from September 2016 to August 2019, as Executive Vice President, Product Development and Customer Service from April 2011 to September 2016 and as Vice President, Product Development and Technical Customer Service from December 2006 to April 2011. From January 2006 to November 2006, Dr. Wisnewski was Vice President, Research and Development. Dr. Wisnewski held various positions in Heska's Research and Development organization between 1993 and 2005. She holds a Ph.D. in Parasitology/Biochemistry from the University of Notre Dame and a BS in Biology from Lafayette College. Dr. Wisnewski will step down from her current position effective March 31, 2023 and will remain with the Company in the position of Chief Science Advisor to the CEO, but will no longer serve as an executive officer as of such time.
Steven M. Eyl was appointed Executive Vice President, Global Sales and Marketing in September 2016. He previously served as our Executive Vice President, Commercial Operations from May 2013 to September 2016. Mr. Eyl was a principal of Eyl Business Services, a consulting firm, from January 2012 to May 2013. He was President of Sound Technologies, Inc. ("Sound") from 2000 to 2011, including after Sound's acquisition by VCA Antech, Inc. in 2004. Mr. Eyl has an extensive background in medical technology sales. He is a graduate of Indiana University.
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Christopher Sveen, Esq. was appointed Executive Vice President, Chief Administrative Officer, General Counsel and Corporate Secretary of Heska Corporation and President, Diamond Animal Health in April 2020, previously serving as Vice President, General Counsel from December 2018 to April 2020. Before joining Heska, Mr. Sveen served as a Private Banker at J.P. Morgan Private Bank in Chicago from August 2015 to May 2018 and prior to that as a civil litigation and trial attorney at a boutique litigation firm. Mr. Sveen received his Juris Doctor from Chicago-Kent College of Law in 2009 and his Master of Business Administration (MBA) from the Kelley School of Business at Indiana University in 2015. He is licensed to practice law in Illinois and Colorado.
Eleanor Baker was appointed Executive Vice President, Managing Director of scil in April 2020, previously serving as Vice President, General Counsel since November 2017. Previously, Ms. Baker worked at KPMG, LLP as a technology and innovation solutions consultant from 2015 to November 2017. Ms. Baker received her Juris Doctor from Wake Forest School of Law, a Master of Laws from University of Houston and her undergraduate degree from Texas A&M University. She is licensed to practice law in Texas and Colorado.
Anthony Providenti was appointed Executive Vice President, Corporate Development in September 2021. Mr. Providenti brings over 25 years of transactional experience and over 15 years of veterinary industry experience to this role. Prior to Heska, Mr. Providenti held key roles at prominent animal health companies, having served most recently as Executive Vice President, Corporate Development at Covetrus, Inc. He joined Covetrus in February 2019 as part of its formation after serving as Vice President, Corporate Business Development Group, Animal Health and Medical at Henry Schein, Inc. (NASDAQ: HSIC). Before joining Henry Schein, Mr. Providenti acted as a corporate attorney at Gibson, Dunn & Crutcher LLP. Mr. Providenti holds a Juris Doctor from Fordham University School of Law, where he served as an editor and a member of the Fordham Law Review and a BS in Accounting from Lehigh University.
Item 1A.Risk Factors
Risk Factors Summary
Pursuant to Item 105(b) of Regulation S-K, the following represents a summary of the principal factors that make an investment in our common stock speculative or risky. This summary does not address all of the risks that we face. Additional discussion of the risks summarized in this risk factor summary, and other risks that we face, can be found below under the heading “Risk Factors” and should be carefully considered, together with other information in this Form 10-K and our other filings with the SEC, before making an investment decision regarding our common stock.
Risks related to our business and industry
•Our business is subject to risk based on global economic conditions, including inflationary pressures and lingering economic effects of the COVID-19 pandemic.
•If third parties with substantial marketing rights for certain of our historical products, existing products, or future products under development are not successful in marketing those products, then our sales and financial position may suffer.
•We rely substantially on third party suppliers and rights under contracts with third parties. The loss of products, or rights under contracts, or delays in product availability from one or more third party suppliers could substantially harm our business.
•We depend on key personnel for our future success. If we lose our key personnel or are unable to attract and retain additional personnel, we may be unable to achieve our goals.
•We operate in a highly competitive industry, which could render our products obsolete or substantially limit the volume of products that we sell. This would limit our ability to compete and maintain sustained profitability.
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•We often depend on third parties for products we intend to introduce in the future. If our current relationships and collaborations are not successful, we may not be able to introduce the products we intend to introduce in the future.
•We may be unable to market and sell our products successfully.
•We face risks associated with our international operations and our international expansion may not generate the results we anticipate.
•We may face costly legal disputes, including disputes related to our intellectual property or technology or that of our suppliers or collaborators.
•Interpretation of existing legislation, regulations and rules, including financial accounting standards, or implementation of future legislation, regulations and rules could cause our costs to increase or could harm us in other ways.
•We are currently evaluating, and we intend to pursue, acquisitions, investments, licenses, joint ventures, and other strategic development opportunities, which may not have desired results and could be detrimental to our financial position.
•Obtaining and maintaining regulatory approvals in order to market our products may be costly and could delay the marketing and sales of our products. Failure to meet regulatory requirements could cause significant losses from affected inventory and the loss of market share.
•Our future revenues depend on successful product development, direct manufacturing, contract manufacturing, commercialization and/or market acceptance, any of which can be slower than we expect or may not occur.
•Many of our expenses are fixed and if factors beyond our control cause our revenue to fluctuate, this fluctuation could cause greater than expected losses, cash flow and liquidity shortfalls.
•Cyberattack related breaches of our information technology systems could have an adverse effect on our business.
•We may be unable to protect our stakeholders’ privacy or we may fail to comply with privacy laws.
•We may not be able to achieve sustained profitability or increase profitability on a quarterly or annual basis.
•We may face product returns and product liability litigation in excess of, or not covered by, our insurance coverage or indemnities and/or warranties from our suppliers. If we become subject to product liability claims resulting from defects in our products, we may fail to achieve market acceptance of our products and our sales could substantially decline.
•We may be held liable for the release of hazardous materials, which could result in extensive remediation costs or otherwise harm our business.
Risks related to our common stock
•Our stock price has historically experienced high volatility, and could do so in the future, including experiencing a material price decline resulting from a large sale in a short period of time. This volatility could affect the value of our common stock.
•Our NOL Protective Amendment could adversely impact the value and trading liquidity of our common stock.
•If securities analysts do not publish research or reports about our business, or if they downgrade our stock, the price of our stock could decline.
•We have not declared or paid any dividends on our common stock since 2012 and we do not anticipate paying any cash dividends in the foreseeable future.
•We have fewer than 200 holders of record, which could allow us to terminate voluntarily the registration of our common stock with the SEC and after which we would no longer be eligible to maintain the listing of our common stock on The Nasdaq Capital Market. We may also be unable to otherwise maintain our listing on The Nasdaq Capital Market.
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•Provisions in our Certificate of Incorporation and bylaws and under Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.
Risks related to the outstanding Notes
•Servicing our debt will require a significant amount of cash, and we may not have sufficient cash flow from our business to pay our substantial debt.
•We may not have the ability to raise the funds necessary to settle conversions of our convertible notes (the "Notes") in cash or to repurchase the Notes upon a fundamental change, and our future debt may contain limitations on our ability to pay cash upon conversion or repurchase of the Notes.
•The conditional conversion feature of the Notes, if triggered, may adversely affect our financial condition and operating results.
Risk Factors
Our future operating results may vary substantially from period to period due to a number of factors, many of which are beyond our control. The following discussion highlights the material factors and the possible impact of these factors on future results of operations. If any of the following factors actually occur, our business, financial condition or results of operations could be harmed. In that case, the price of our Public Common Stock could decline and investors in our Public Common Stock could experience losses on their investment.
Risks related to our business and industry
Our business is subject to risk based on global economic conditions, including inflationary pressures and lingering economic effects of the COVID-19 pandemic.
Macroeconomic, global inflationary pressures and pandemic-related disruptions could have a material adverse effect on our business, financial condition, results of operations and cash flows. Our veterinarians, their customers and the companion animals they serve could be affected by continuing local and global inflationary pressures, lingering economic effects of the COVID-19 pandemic, further or unexpected economic recessionary fears, increased political instability and threats of war and could suffer from increased borrowing costs that limit discretionary consumer spending, which could lead to decreased pet visits, demand for our products and delayed companion animal diagnostic testing and treatment.
The extent to which the COVID-19 pandemic will cause lingering economic effects on our business, results of operation and financial condition is difficult to predict and depends on numerous rapidly evolving factors, such as the severity and transmission rate of the virus, the emergence and spread of variants, infection rates in areas where we operate, the extent and effectiveness of containment actions, including the continued availability and effectiveness of vaccines in the markets where we operate, the impact of actions taken by governmental authorities and other third parties in response to the pandemic, and the impact of these and other factors on our employees, customers, and suppliers. We are also monitoring the effects of the COVID-19 pandemic on the operation of veterinary clinics, consumer discretionary spending on their pets’ health and wellbeing, research and development trends regarding animal health vis a vis human health, and the ability of our sales staff to travel and our manufacturing staff to operate in their normal capacities. However, the effect of the COVID-19 pandemic on the foregoing issues and numerous other potential issues is difficult to predict, both in the short-term and in the long-term, and any one of them could cause a material adverse effect on our business, results of operation and financial condition. Global economic conditions and the COVID-19 pandemic could also have the effect of heightening other risk factors described in this report.
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If third parties with substantial marketing rights for certain historical products, existing products or future products under development are not successful in marketing those products, then our sales and financial position may suffer.
We are party to agreements with Merck Animal Health for our canine heartworm preventive product, TRI-HEART Plus Chewable Tablets, and Elanco for certain bovine vaccines, which have been sold primarily under the Titanium and MasterGuard brands. Either of these marketing partners may not devote sufficient resources to marketing our products and our sales and financial position could suffer significantly as a result. For example, in 2019, Merck Animal Health failed to market, sell and support our heartworm preventive product, which resulted in depressed PVD product annual revenue in our North America segment. Furthermore, there may be nothing to prevent these partners from pursuing alternative technologies, products or supply arrangements, including as part of mergers, acquisitions or divestitures. Third party marketing assistance may not be available in the future on reasonable terms, if at all. If the third parties with marketing rights for our products were to merge or go out of business, the sale and promotion of our products could be diminished.
We rely substantially on third party suppliers and rights under contracts with third parties. The loss of products, or rights under contracts, or delays in product availability from one or more third party suppliers could substantially harm our business.
To be successful, we must contract for the supply of, or manufacture ourselves, current and future products of appropriate quantity, quality and cost. Such products must be available on a timely basis and be in compliance with any regulatory requirements. Similarly, we must provide ourselves, or contract for the supply of, certain services. Such services must be provided in a timely and appropriate manner. Failure to do any of the above could substantially harm our business.
We rely on third party suppliers to manufacture those products we do not manufacture ourselves and to provide services we do not provide ourselves. Proprietary products provided by these suppliers represent a majority of our revenue. We currently rely on these suppliers for our POC laboratory instruments and consumable supplies for these instruments, for our imaging products and related software and services, for key components of our POC diagnostic tests as well as for the manufacture of other products.
The loss of access to products from one or more suppliers could have a significant, negative impact on our business. Major suppliers that sell us proprietary products are FUJIFILM Corporation and Shenzen Mindray Bio-Medical Electronics Co., Ltd. We often purchase products from our suppliers under agreements that are of limited duration or potentially can be terminated on short notice subsequent to unfavorable legal action. In the case of our POC laboratory instruments and our digital radiography solutions, post-termination, we are typically entitled to non-exclusive access to consumable supplies, or ongoing non-exclusive access to products and services to meet the needs of an existing customer base, respectively, for a defined period upon expiration of exclusive rights, which could subject us to competitive pressures in the period of non-exclusive access. There can be no assurance that our suppliers will meet their obligations under any agreements we may have in place with them or that we will be able to compel them to do so. Risks of relying on suppliers include:
•Inability to meet minimum obligations. Current agreements, or agreements we may negotiate in the future, may commit us to certain minimum purchase or other spending obligations. It is possible we will not be able to create the market demand to meet such obligations, which could create a drain on our financial resources and liquidity. Some agreements may require minimum purchases and/or sales to maintain product rights and we may be significantly harmed if we are unable to meet such requirements and lose product rights.
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•Loss of exclusivity. In the case of our POC laboratory instruments, if we are entitled to non-exclusive access to consumable supplies for a defined period upon expiration of exclusive rights, we may face increased competition from a third party with similar non-exclusive access or our former supplier, which could cause us to lose customers and/or significantly decrease our margins and could significantly affect our financial results. In addition, current agreements, or agreements we may negotiate in the future, with suppliers may require us to meet minimum annual sales levels to maintain our position as the exclusive distributor of these products. We may not meet these minimum sales levels and maintain exclusivity over the distribution and sale of these products. If we are not the exclusive distributor of these products, competition may increase significantly, reducing our revenues and/or decreasing our margins.
•Changes in economics. An underlying change in the economics with a supplier, such as a large price increase or new requirement of large minimum purchase amounts, could have a significant, adverse effect on our business, particularly if we are unable to identify and implement an alternative source of supply in a timely manner.
•Supply chain constraints in raw materials to suppliers. Our suppliers rely on sourcing raw materials, instrument components and other items necessary to produce the supply of products we offer our customers. Supply chain constraints faced by our suppliers may delay a supplier’s ability to produce our products, which could create an interruption in our ability to fulfill orders.
•The loss of product rights upon expiration or termination of an existing agreement. Unless we are able to find an alternate supply of a similar product, we would not be able to continue to offer our customers the same breadth of products and our sales and operating results would likely suffer. In the case of an instrument supplier, we could also potentially suffer the loss of sales of consumable supplies, which would be significant in cases where we have built a significant installed base, further harming our sales prospects and opportunities. Even if we were able to find an alternate supply for a product to which we lost rights, we would likely face increased competition from the product whose rights we lost being marketed by a third party or the former supplier and it may take us additional time and expense to gain the necessary approvals and launch an alternative product.
•High switching costs. In our POC laboratory instrument products, we could face significant competition and lose all or some of the consumable revenues from the installed base of those instruments if we were to switch to a competitive instrument. If we need to change to other commercial manufacturing contractors for certain of our regulated products, additional regulatory licenses or approvals generally must be obtained for these contractors prior to our use. This would require new testing and compliance inspections prior to sale, thus resulting in potential delays. Any new manufacturer would have to be educated in, or develop, substantially equivalent processes necessary for the production of our products. We likely would have to train our sales force, distribution network employees and customer support organization on the new product and spend significant funds marketing the new product to our customer base.
•The involuntary or voluntary discontinuation of a product line. Unless we are able to find an alternate supply of a similar product in this or similar circumstances with any product, we would not be able to continue to offer our customers the same breadth of products and our sales would likely suffer. Even if we are able to identify an alternate supply, it may take us additional time and expense to gain the necessary approvals and launch an alternative product, especially if the product is discontinued unexpectedly.
•Inconsistent or inadequate quality control. We may not be able to control or adequately monitor the quality of products we receive from our suppliers. Poor quality items could damage our reputation with our customers.
•Limited capacity or ability to scale capacity. If market demand for our products increases suddenly, our current suppliers might not be able to fulfill our commercial needs, which would require us to seek new manufacturing arrangements and may result in substantial delays in meeting market demand. If we consistently generate more demand for a product than a given supplier is capable of
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handling, it could lead to large backorders and potentially lost sales to competitive products that are readily available. This could require us to seek or fund new sources of supply, which may be difficult to find or may require terms that are less advantageous if available at all.
•Regulatory risk. Our manufacturing facility and those of some of our third-party suppliers are subject to ongoing periodic unannounced inspection by regulatory authorities, including the FDA, USDA and other federal, state and foreign agencies for compliance with regulations and similar foreign standards. We do not have control over our suppliers’ compliance with these regulations and standards. Regulatory violations could potentially lead to interruptions in supply that could cause us to lose sales to readily available competitive products. If one of our suppliers is unable to provide a raw material or finished product due to regulatory issues, it could have a material adverse financial impact on our business and could expose us to legal action if we are unable to perform on contracts to our customers involving related products.
•Developmental delays. We may experience delays in the scale-up quantities needed for product development that could delay regulatory submissions and commercialization of our products in development, causing us to miss key opportunities.
•Limited geographic rights. We typically do not have global geographic rights to products supplied by third parties. If we were to determine a market opportunity in a geography where we did not have distribution rights and were unable to obtain such rights from the supplier, it might hamper our ability to succeed in such geography and our sales and profits would be lower than they otherwise would have been.
•Limited intellectual property rights. We typically do not have intellectual property rights, or may have to share intellectual property rights, to the products supplied by third parties and any improvements to the manufacturing processes or new manufacturing processes for these products.
•Changes to United States tariff and import/export regulations. Changes to United States trade policies, treaties and tariffs could have a material adverse effect on global trade. These changes could result in increased costs of goods imported into the United States for the Company and our third-party suppliers. Our third-party suppliers may limit their trade with companies in the United States, including us.
•Global human and animal health risk. Several of our suppliers have operations in areas that may be susceptible to public health emergencies that could restrict global trade generally, and our access to consumables and product, specifically. The risk of infectious disease in humans and animals may limit trade and product access with third party suppliers with companies inside and outside the United States, including us. In particular, the use of animal bi-product may affect our consumable supply as a result of global animal health risks.
Potential problems with suppliers such as those discussed above could substantially decrease sales, lead to higher costs and/or damage our reputation with our customers due to factors such as poor quality goods or delays in order fulfillment, resulting in our being unable to sell our products effectively and substantially harming our business.
We depend on key personnel for our future success. If we lose our key personnel or are unable to attract and retain additional personnel, we may be unable to achieve our goals.
Our future success is substantially dependent on the efforts of our senior management and other key personnel, including our Chief Executive Officer (“CEO”) and President, Kevin Wilson. The loss of the services of members of our senior management or other key personnel may significantly delay or prevent the achievement of our business objectives. Although we have employment agreements with many of these individuals, all are at-will employees, which means that either the employee or Heska may terminate employment at any time without prior notice. If we lose the services of, or fail to recruit, key personnel, the
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growth of our business could be substantially impaired. We do not maintain key person life insurance for any of our senior management or key personnel.
We also expect that we may incur increased compensation expenses and higher-than-normal employee turnover as we attempt to attract and retain skilled employees during a macro working environment where qualified labor is in short supply, job-mobility is high in part because of remote working arrangements, and the benefits of company culture and personal relationships are more difficult to realize outside of the traditional office setting.
We operate in a highly competitive industry, which could render our products obsolete or substantially limit the volume of products that we sell. This would limit our ability to compete and maintain sustained profitability.
The market in which we compete is intensely competitive. Our competitors include independent animal health companies and major pharmaceutical companies that have animal health divisions. We also compete with independent, third party distributors, including distributors that sell products under their own private labels. In the POC diagnostic testing market, our major competitors include IDEXX and Zoetis. The OVP products manufactured by our North America segment for sale by third parties compete with similar products offered by a number of other companies, some of which have substantially greater financial, technical, research and other resources than us and may have more established marketing, sales, distribution and service organizations than those of our OVP product customers. Competitors may have facilities with similar capabilities to our Des Moines, Iowa facility, which they may operate and sell at a lower unit price to customers than we sell our OVP products for, which could cause us to lose customers. Companies with a significant presence in the companion animal health market, such as CEVA Sante´ Animale, Elanco, Merck Animal Health, Sanofi, Vétoquinol S.A. and Virbac S.A. may be marketing or developing products that compete with our products or would compete with them if developed. These and other competitors and potential competitors may have substantially greater financial, technical, research and other resources and larger, more established marketing, sales and service organizations than we do. Our competitors may offer broader product lines and have greater name recognition than we do. Our competitors may also develop or market technologies or products that are more effective or commercially attractive than our current or future products or that would render our technologies and products obsolete. Further, additional competition could come from new entrants to the animal health care market. Moreover, we may not have the financial resources, technical expertise or marketing, sales or support capabilities to compete successfully.
If we fail to compete successfully, our ability to achieve sustained profitability will be limited and sustained profitability, or profitability at all, may not be possible.
We benefit from relationships or collaboration with third parties, including but not limited to, companies, buying groups, veterinary hospital groups and reference laboratory entities that operate in our markets. Beneficial third party, semi-competitive, directly competitive and cooperative relationships that affect how we go to market, develop products, generate leads and other commercial efforts of Heska may be negatively affected as a result of consolidation, acquisition, merger, exclusive arrangement or other agreements or activities between and amongst those third parties and others.
We may depend on third parties for products we intend to introduce in the future. If our current relationships and collaborations are not successful, we may not be able to introduce the products we intend to introduce in the future.
We are occasionally dependent on third parties and collaborative partners to perform research and development activities to successfully develop new products. We routinely discuss Heska marketing in the veterinary market instruments being developed by third parties for use in the human health care market. In the future, one or more of these third parties or collaborative partners may not complete research and
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development activities in a timely fashion, or at all. Even if these third parties are successful in their research and development activities, we may not be able to come to an economic agreement with them. If these third parties or collaborative partners fail to complete research and development activities or fail to complete them in a timely fashion, or if we are unable to negotiate economic agreements with such third parties or collaborative partners, our ability to introduce new products may be impacted negatively and our revenues may decline.
We may be unable to market and sell our products successfully.
We may not develop and maintain marketing and/or sales capabilities successfully, and we may not be able to make arrangements with third parties to perform these activities on satisfactory terms, or at all. If our marketing and sales strategy is unsuccessful, our ability to sell our products will be negatively impacted and our revenues will decrease. This could result in the loss of distribution rights for products or failure to gain access to new products and could cause damage to our reputation and adversely affect our business and future prospects. The market for companion animal healthcare products is highly fragmented. Because our proprietary products are generally available only to veterinarians or by prescription and our medical instruments require technical training to operate, we ultimately sell our products primarily to or through veterinarians. The acceptance of our products by veterinarians is critical to our success. Changes in our ability to obtain or maintain such acceptance or changes in veterinary medical practice could significantly decrease our anticipated sales. As the vast majority of cash flow to veterinarians ultimately is funded by pet owners without private insurance or government support, our business may be more susceptible to severe economic downturns than other health care businesses that rely less on individual consumers.
For our POC laboratory blood diagnostics products, we primarily rely on contracts with our veterinary customers for their use of our owned equipment and our consumable supplies over a multiple year period. If veterinarians under these contracts experience a significant downturn in their business, they may not fulfill their use and financial obligations under these contracts. If veterinarians breach our contracts, and we are unable to collect on default payment provisions or otherwise enforce the terms of our contracts, our business will be adversely affected. If we have to litigate against customers to enforce our contracts, our expenses may increase, our sales may decrease to those customers, and our reputation may suffer. If significant numbers of our customers under contracts for use of our equipment and consumable supplies do not renew their contracts, our business will be adversely affected.
We have entered into agreements with independent third party distributors who we anticipate will market and sell our products to a greater degree than in the recent past. Independent third party distributors may be effective in increasing sales of our products to veterinarians, although we would expect a corresponding lower gross margin as such distributors typically buy products from us at a discount to end user prices. It is possible new or existing independent third-party distributors could cannibalize our direct sales efforts and lower our total gross margin. For us to be effective when working with an independent third party distributor, the distributor must agree to market and/or sell our products and we must provide proper economic incentives to the distributor as well as contend effectively for the time, energy and focus of the employees of such distributor given other products the distributor may be carrying, potentially including those of our competitors. If we fail to be effective with new or existing independent third-party distributors, our financial performance may suffer.
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We face risks associated with our international operations and our international expansion may not generate the results we anticipate.
A core component of our future growth strategy is international expansion. As we continue to expand our international footprint, we will be increasingly susceptible to the risks associated with international operations including, but not limited to, the following:
•Increased competition from global market competitors;
•uncertain political and economic climates, including as a result of the conflict between Russia and the Ukraine;
•fluctuations in exchange rates, such as the strengthening of the U.S. Dollar, that may increase the volatility of foreign-based revenue and expense;
•burdens of complying with and unexpected changes in foreign laws, accounting and legal standards, regulatory requirements, taxes, tariffs and other barriers or trade restrictions;
•lack of experience in connection with the customs, cultures, languages and sales cycle;
•reduced or altered protection for intellectual property rights; and
•data privacy and cybersecurity laws in foreign countries, which may subject our data collection, storage and processing to different and more expansive requirements than the United States.
As a result of these and other factors, international expansion may be more difficult and not generate the results we anticipate, which could negatively impact our business.
We may face costly legal disputes, including disputes related to our intellectual property or technology or that of our suppliers or collaborators.
We have faced, and may face in the future, legal disputes related to our business. Even if meritless, these disputes may require significant expenditures on our part and could entail a significant distraction to members of our management team or other key employees. Insurance coverage may not cover any costs required to litigate a legal dispute or an unfavorable ruling or settlement. A legal dispute leading to an unfavorable ruling or settlement, whether or not insurance coverage may be available for any portion thereof, could have material adverse consequences on our business. Moreover, we may have to use legal means and incur affiliated costs to secure the benefits to which we are entitled under third party agreements, such as to collect payment for goods shipped to third parties, which would reduce our income as compared to what it otherwise would have been.
We may become subject to patent infringement claims and litigation in the United States or other countries or interference proceedings conducted in the United States Patent and Trademark Office, or USPTO, to determine the priority of inventions. The defense and prosecution of intellectual property suits, USPTO interference proceedings and related legal and administrative proceedings are likely to be costly, time-consuming and distracting. As is typical in our industry, from time to time we and our collaborators and suppliers have received, and may in the future receive, notices from third parties claiming infringement and invitations to take licenses under third-party patents. Any legal action against us or our collaborators or suppliers may require us or our collaborators or suppliers to obtain one or more licenses in order to market or manufacture affected products or services. We or our collaborators or suppliers may not, however, be able to obtain licenses for technology patented by others on commercially reasonable terms, or at all, or to develop alternative approaches to access or replace such technology if we or they are unable to obtain such licenses or if current and future licenses prove inadequate, any of which could substantially harm our business.
We may also need to pursue litigation to enforce any contractual rights or patents issued to us or our collaborative partners, to protect trade secrets or know-how owned by us or our collaborative partners, or to
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determine the enforceability, scope and validity of our contractual rights or the proprietary rights of others. Any litigation or interference proceedings will likely result in substantial expense to us and significant diversion of the efforts of our technical and management personnel. Any adverse determination in litigation or interference proceedings could subject us to significant liabilities to third parties. Further, as a result of litigation or other proceedings, we may be required to seek licenses from third parties which may not be available on commercially reasonable terms, or at all.
Interpretation of existing legislation, regulations and rules, including financial accounting standards, or implementation of future legislation, regulations and rules could cause our costs to increase or could harm us in other ways.
As a public company, we have incurred and will continue to incur significant legal, accounting and other expenses due to our compliance with regulations and disclosure obligations applicable to us, including compliance with the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as rules implemented by the SEC and the Nasdaq Stock Market. We prepare our financial statements in conformance with GAAP. These accounting principles are established by and are subject to interpretation by the SEC, the FASB and others which interpret and create accounting policies. These rules and regulations will continue to cause us to incur significant legal and financial compliance costs and will make some activities more time-consuming and costly. A change in those policies or how those policies are interpreted can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is made effective. Such changes may require us to incur additional compliance costs, adversely affect our reported financial results and the way we conduct our business or have a negative impact on us if we fail to track such changes.
If our regulators and/or auditors adopt or interpret more stringent standards than we anticipate, we could experience unanticipated changes in our reported financial statements, including but not limited to restatements, which could adversely affect our business due to litigation and investor confidence in our financial statements. In addition, changes in the underlying circumstances to which we apply given accounting standards and principles may affect our results of operations and have a negative impact on us. For example, we review goodwill recognized on our consolidated balance sheets at least annually and if we were to conclude there was an impairment of goodwill, we would reduce the corresponding goodwill to its estimated fair value and recognize a corresponding expense in our statement of operations. This impairment and corresponding expense could be as large as the total amount of goodwill recognized on our consolidated balance sheets, which was $135.9 million at December 31, 2022 and $118.8 million at December 31, 2021. There can be no assurance that future goodwill impairments will not occur if projected financial results are not met, or otherwise.
We regularly evaluate, and we intend to pursue, acquisitions, investments, licenses, joint ventures, and other strategic development opportunities, which may not have desired results and could be detrimental to our financial position.
We continue to evaluate, and we intend to pursue, acquisitions and other strategic development opportunities, including minority investments where strategic, such as our acquisition of scil in 2020, our acquisitions of Lacuna, BiEsseA, and Biotech in 2021, our acquisition of VetZ in 2022, and our acquisition of LightDeck in 2023. The ultimate business and financial performance of these opportunities may not create, and may end up adversely affecting materially, the value we hope to enhance by pursuing them. Any acquisition may significantly underperform relative to our financial expectations and may serve to diminish rather than enhance stockholder value. We may also diminish our cash resources or dilute stockholders in order to finance any such acquisition or other strategic transaction.
The success of any acquisition will depend on, among other things, our ability to integrate assets and personnel acquired in these transactions and to apply our internal controls process to these acquired businesses. The integration of acquisitions is likely to require significant attention from our management, and
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the diversion of management’s attention and resources could have a material adverse effect on our ability to manage our business. Furthermore, we may not realize the degree or timing of benefits we anticipated when we first entered into the acquisition transaction. If actual integration costs are higher than amounts originally anticipated, if we are unable to integrate the assets and personnel acquired in an acquisition as anticipated, or if we are unable to fully benefit from anticipated synergies, our business, financial condition, results of operations and cash flows could be materially adversely affected. Furthermore, it is possible we will use management time and resources to pursue opportunities we ultimately are unable or decide not to consummate, in which case, we may not be able to utilize such management time and resources on what may have proved to be more productive matters in other areas of our business.
We make investments into licenses, third parties, and contracts with legal, development and commercial rights and obligations. These investments may not produce positive results, economic or strategic value, or any benefits and may decline in value or have no value.
Obtaining and maintaining regulatory approvals in order to market our products may be costly and could delay the marketing and sales of our products. Failure to meet all regulatory requirements could cause significant losses from affected inventory and the loss of market share.
Many of the products we develop, market or manufacture may subject us to extensive regulation by one or more of the USDA, the FDA, the EPA and foreign and other regulatory authorities. These regulations govern, among other things, the development, testing, manufacturing, labeling, storage, pre-market approval, advertising, promotion and sale of some of our products. Satisfaction of these requirements can take several years and time needed to satisfy them may vary substantially, based on the type, complexity and novelty of the product. The decision by a regulatory authority to regulate a currently non-regulated product or product area could significantly impact our revenue and have a corresponding adverse impact on our financial performance and position while we attempt to comply with the new regulation, if such compliance is possible at all.
The effect of government regulation may be to delay or to prevent marketing of our products for a considerable period of time and to impose costly procedures upon our activities. We may not be able to estimate the time to obtain required regulatory approvals accurately and such approvals may require significantly more time than we anticipate. We have experienced in the past, and may experience in the future, difficulties that could delay or prevent us from obtaining the regulatory approval or license necessary to introduce or market our products. Such delays in approval may cause us to forego a significant portion of a new product’s sales in its first year due to seasonality and advanced booking periods associated with certain products. Regulatory approval of our products may also impose limitations on the indicated or intended uses for which our products may be marketed.
Difficulties in making established products to all regulatory specifications may lead to significant losses related to affected inventory as well as market share. Among the conditions for certain regulatory approvals is the requirement that our facilities and/or the facilities of our third party manufacturers conform to current Good Manufacturing Practices and other analogous or additional requirements. If any regulatory authority determines that our manufacturing facilities or those of our third party manufacturers do not conform to appropriate manufacturing requirements, we or the manufacturers of our products may be subject to sanctions, including, but not limited to, warning letters, manufacturing suspensions, product recalls or seizures, injunctions, refusal to permit products to be imported into or exported out of the United States, refusals of regulatory authorities to grant approval or to allow us to enter into government supply contracts, withdrawals of previously approved marketing applications, civil fines and criminal prosecutions. Furthermore, third parties may perceive procedures required to obtain regulatory approval objectionable and may attempt to
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disrupt or otherwise damage our business as a result. In addition, certain of our agreements may require us to pay penalties if we are unable to supply products, including for failure to maintain regulatory approvals.
Any of these events, alone or in combination with others, could significantly damage our business or results of operations.
Our future revenues depend on successful product development, direct manufacturing, contract manufacturing, commercialization and/or market acceptance, any of which can be slower than we expect or may not occur.
The product development and regulatory approval and maintenance process for many of our current and potential products is extensive and may take substantially longer than we anticipate. Research projects may fail. New products that we may be developing for the veterinary marketplace may not perform consistently within our expectations. Because we have limited resources to devote to product development and commercialization, any delay in the development of one product or reallocation of resources to product development efforts that prove unsuccessful may delay or jeopardize the development of other product candidates. If we fail to successfully develop new products and bring them to market in a timely manner, our ability to generate additional revenue will decrease.
Even if we are successful in the development of a product or obtain rights to a product from a third party supplier, we may experience delays or shortfalls in commercialization and/or market acceptance of the product. For example, veterinarians may be slow to adopt a product, a product may not achieve the anticipated technical performance in field use or there may be delays in producing large volumes of a product. The former is particularly likely where there is no comparable product available or historical precedent for such a product. The ultimate adoption of a new product by veterinarians, the rate of such adoption and the extent veterinarians choose to integrate such a product into their practice are all important factors in the economic success of any new products and are factors that we do not control to a large extent. If our products do not achieve a significant level of market acceptance, demand for our products will not develop as expected and our revenues will be lower than we anticipate.
Even if we are successful in the development of a product or obtain rights to a product from a third party supplier, we may not be able to, ourselves or through a third party, manufacture such product or continue to manufacture such product on an ongoing basis necessary to realize economic value or service customers, or manufacture such product economically or to the standard necessary to realize economic value or service customers.
Many of our expenses are fixed and if factors beyond our control cause our revenue to fluctuate, this fluctuation could cause greater than expected losses, cash flow and liquidity shortfalls.
We believe that our future operating results will fluctuate on a quarterly basis due to a variety of factors which are generally beyond our control, including:
•supply of products and components, including minimum purchase agreements, from third party suppliers or termination, cancellation or expiration of such relationships;
•competition and pricing pressures from competitive products;
•the introduction of new products or services by our competitors or by us;
•large customers failing to purchase at historical levels;
•fundamental shifts in market demand;
•manufacturing delays;
•shipment problems;
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•information technology problems, which may prevent us from conducting our business effectively, or at all, and may also raise our costs;
•regulatory and other delays in product development;
•product recalls or other issues which may raise our costs;
•changes in our reputation and/or market acceptance of our current or new products; and
•changes in the mix of products sold.
We have high operating expenses, including those related to personnel. Many of these expenses are fixed in the short term and may increase over time. If any of the factors listed above cause our revenues to decline, our operating results could be substantially harmed.
Cyberattack related breaches of our information technology systems could have an adverse effect on our business.
Cyberattacks are increasing in their frequency, sophistication and intensity, and have become increasingly difficult to detect and defend against, notwithstanding our ongoing evaluation of and improvements to the preventive measures we take on to reduce the risks associated with these threats based on our own experience and those observed in the broader market. Cyberattacks, ranging from the use of malware, computer viruses, dedicated denial of services attacks, credential harvesting, social engineering and other means for obtaining unauthorized access to our Company's confidential information or assets or disrupting our Company’s ability to operate normally, could have a material adverse effect on our business. Cyberattacks may cause equipment failures, loss of information or assets, including sensitive personal information of third-party vendors, customers or employees, or valuable technical and marketing information, as well as disruptions to our or our vendor or customers’ operations. These attacks may be committed by company employees or external actors operating in any geography, including jurisdictions where law enforcement measures to address such attacks are unavailable or ineffective. Cyberattacks may occur alone or in conjunction with physical attacks, especially where disruption of service is an objective of the attacker. The preventive actions we take on an ongoing basis to reduce the risks and mitigate the potential damages associated with cyberattacks, including protection of our systems, networks and assets and the retention of cybersecurity insurance policies, may be insufficient to repel or mitigate entirely the effects of a cyberattack.
We devote significant resources to network security, data encryption and other security measures to protect our systems and data, but these security measures cannot provide absolute security. To the extent we were to experience a breach of our systems and were unable to protect sensitive data in the wake of the breach, such a breach could materially damage business partner and customer relationships and reduce or otherwise negatively impact access to online services. Moreover, if a computer security breach affects our systems or results in the unauthorized release of Personally Identifiable Information (“PII”), our reputation and brand could be materially damaged; use of our products and services could decrease, we could suffer from reputational harm impacting sales revenue, and we could be faced with unforeseen regulatory investigation, remediation and litigation costs. Our cybersecurity insurance policies may not cover the full extent, or any, of the potential financial harm that could be caused by a breach of our systems, including in respect of theft or possible damages claims that may be brought against us by our business partners and customers in respect of any such breach.
The frequently changing attack techniques, along with the increased volume and sophistication of the attacks, create additional potential for us to be adversely impacted by this activity. This impact could result in reputational, competitive, operational or other business harm as well as management distraction, financial losses and costs, and regulatory action.
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We may be unable to protect our stakeholders’ privacy or we may fail to comply with privacy laws.
The protection of customer, employee, supplier and company data is critical and the regulatory environment surrounding information security, storage, use, processing, and disclosure of personal information is demanding. There is frequent imposition of new and changing requirements and enforcement risks, particularly as more U.S. states enact comprehensive privacy laws, including Colorado, which recently passed the Colorado Privacy Act, effective July 2023. In addition, our customers, employees and suppliers expect that we will protect their personal information. Any actual or perceived cyberattack, unauthorized access or acquisition of customer, employee or supplier data, or our failure to comply with federal, state, local and foreign privacy laws, such as the European Union’s General Data Protection Regulation (“GDPR”) and the Health Insurance Portability and Accountability Act, could result in lost sales, extensive remediation costs, and legal liability including severe penalties, regulatory action and reputational harm. The GDPR became effective in 2018, for example, and requires companies to meet enhanced requirements regarding the processing of personal data, and provides data subjects with various rights, including the right to request correction or deletion of their personal data. Failure to meet GDPR requirements could result in penalties of up to 4% of worldwide revenue. Despite implementation of reasonable technical, administrative, and physical safeguards, and our efforts and investments in technology to secure our ecosystem, no computer network or system can ever be 100% secure. Given the sophisticated and evolving threat landscape, system disruptions or data incidents can occur and result in the compromise or misappropriation of personal or confidential information. In addition, in the event of a data incident, failure to comply with applicable security requirements or timely rectify a security issue may result in fines and notice obligations to regulators, consumers, or third parties, and the imposition of restrictions on our ability to accept payment by credit or debit cards. In addition, the payment card industry (“PCI”) is controlled by a limited number of vendors that have the ability to impose changes in PCI’s fee structure and operational requirements on our payment processing vendors without negotiation. Such changes in fees and operational requirements may result in the failure to comply with PCI security standards, as well as significant unanticipated expenses. Such failures could materially adversely affect our operating results and financial condition. Furthermore, we maintain cybersecurity insurance coverage at levels that we believe are appropriate for our business. However, the costs related to significant security breaches or disruptions could be material and exceed the limits of the cybersecurity insurance we maintain against such risks, and given the increase in cyberattacks, cybersecurity insurance providers are increasingly raising premiums while narrowing the scope of coverage. If the amounts of our insurance coverage are inadequate to satisfy any damages and losses in the event of a cybersecurity incident, we may have to expend significant resources to mitigate the impact of such an incident, and to develop and implement protections to prevent future incidents from occurring. Such financial exposure could have a material adverse effect on our business.
We may not be able to achieve sustained profitability or increase profitability on a quarterly or annual basis.
As of December 31, 2022, we had an accumulated deficit of $168.5 million. Relatively small differences in our performance metrics may cause us to generate an operating or net loss in future periods. Our ability to be profitable in future periods will depend, in part, on our ability to increase sales, including maintaining and growing our installed base of instruments and related consumables, to maintain or increase gross margins and to limit the increase in our operating expenses to a reasonable level as well as avoid or effectively manage any unanticipated issues. We may not be able to generate, sustain or increase profitability on a quarterly or annual basis. If we cannot achieve or sustain profitability for an extended period, we may not be able to fund our expected cash needs, including the repayment of debt as it comes due, or continue our operations.
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We may face product returns and product liability litigation in excess of, or not covered by, our insurance coverage or indemnities and/or warranties from our suppliers. If we become subject to product liability claims resulting from defects in our products, we may fail to achieve market acceptance of our products and our sales could substantially decline.
The testing, manufacturing and marketing of our current products as well as those currently under development entail an inherent risk of product liability claims and associated adverse publicity. Following the introduction of a product, adverse side effects may be discovered. Adverse publicity regarding such effects could affect sales of our other products for an indeterminate time period. To date, we have not experienced any material product liability claims, but any claim arising in the future could substantially harm our business. Potential product liability claims may exceed the amount of our insurance coverage or may be excluded from coverage under the terms of the policy. We may not be able to continue to obtain adequate insurance at a reasonable cost, if at all. In the event that we are held liable for a claim against which we are not indemnified or for damages exceeding the $10 million limit of our insurance coverage or which results in significant adverse publicity against us, we may lose revenue, be required to make substantial payments which could exceed our financial capacity and/or lose or fail to achieve market acceptance.
We may be held liable for the release of hazardous materials, which could result in extensive remediation costs or otherwise harm our business.
Certain of our products and development programs produced at our Des Moines, Iowa facility involve the controlled use of hazardous and biohazardous materials, including chemicals and infectious disease agents. We cannot eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for any fines, penalties, remediation costs or other damages that result. Our liability for the release of hazardous materials could exceed our resources, which could lead to a shutdown of our operations, significant remediation costs and potential legal liability. In addition, we may incur substantial costs to comply with environmental regulations if we choose to expand our manufacturing capacity.
Risks related to our common stock
Our stock price has historically experienced high volatility, and could do so in the future, including experiencing a material price decline resulting from a large sale in a short period of time. This volatility could affect the value of our common stock.
Should a relatively large stockholder decide to sell a large number of shares in a short period of time, it could lead to an excess supply of our shares available for sale and correspondingly result in a significant decline in our stock price.
The securities markets have experienced significant price and volume fluctuations and the market prices of securities of many small cap companies have in the past been, and can in the future be expected to be, especially volatile. During the year ended December 31, 2022, the closing price of our common stock has ranged from a low of $60.21 to a high of $171.74, and the closing price of our common stock on February 16, 2023 was $83.41 per share. Fluctuations in the trading price or liquidity of our common stock may adversely affect our ability to raise capital through future equity financings. Factors that may have a significant impact on the market price and marketability of our common stock include:
•stock sales by large stockholders or by insiders;
•changes in the outlook for our business;
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•our quarterly operating results, including as compared to expected revenue or earnings and in comparison to historical results;
•termination, cancellation or expiration of our third-party supplier relationships;
•announcements of technological innovations or new products by our competitors or by us;
•litigation;
•regulatory developments, including delays in product introductions;
•developments or disputes concerning patents or proprietary rights;
•availability of our revolving line of credit and compliance with debt covenants;
•releases of reports by securities analysts;
•economic and other external factors;
•issuances of equity or equity-linked securities by us; and
•general market conditions
In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. If a securities class action suit is filed against us, it is likely we would incur substantial legal fees and our management’s attention and resources would be diverted from operating our business in order to respond to the litigation.
Our NOL Protective Amendment could adversely impact the value and trading liquidity of our common stock.
On May 4, 2010, our stockholders approved an amendment (the “NOL Protective Amendment”) to our Certificate of Incorporation. The NOL Protective Amendment places restrictions on the transfer of our common stock that could adversely affect our ability to use our domestic Federal Net Operating Loss carryforward (“NOL”). In particular, the NOL Protective Amendment prevents the transfer of shares without the approval of our board of directors if, as a consequence, an individual, entity or groups of individuals or entities would become a 5-percent holder under Section 382 of the Internal Revenue Code of 1986, as amended, and the related Treasury regulations, and also prevents any existing 5-percent holder from increasing his or her ownership position in the Company without the approval of our board of directors. Any transfer of shares in violation of the NOL Protective Amendment (a “Transfer Violation”) shall be void ab initio under the our Certificate of Incorporation and our board of directors has procedures under our Certificate of Incorporation to remedy a Transfer Violation including requiring the shares causing such Transfer Violation to be sold and any profit resulting from such sale to be transferred to a charitable entity chosen by the Company’s board of directors in specified circumstances. The NOL Protective Amendment could have an adverse impact on the value and trading liquidity of our stock if certain buyers who would otherwise have bid on or purchased our stock, including buyers who may not be comfortable owning stock with transfer restrictions, do not bid on or purchase our stock as a result of the NOL Protective Amendment. In addition, because some corporate takeovers occur through the acquirer’s purchase, in the public market or otherwise, of sufficient shares to give it control of a company, any provision that restricts the transfer of shares can have the effect of preventing a takeover. The NOL Protective Amendment could discourage or otherwise prevent accumulations of substantial blocks of shares in which our stockholders might receive a substantial premium above market value and might tend to insulate management and the board of directors against the possibility of removal to a greater degree than had the NOL Protective Amendment not passed.
In February 2018, our board of directors granted a waiver to a non-affiliated stockholder to allow the purchase, subject to certain limitations, of up to 730,000 shares of our common stock without causing a Transfer Violation. This waiver can be withdrawn by our board of directors at any time, in which case the non-affiliated stockholder is to only sell our stock until the non-affiliated stockholder ceases to be a Five Percent Stockholder (as defined in our Certificate of Incorporation). On August 7, 2019, our board of directors determined to waive the application of any NOL transfer restrictions contained in our Certificate of Incorporation with respect to the issuance and transfer of our Notes, any issuance of shares of the Company’s
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common stock upon conversion of any of the Notes, and any subsequent and further transfer of any such common stock, to the extent such restrictions would otherwise have been applicable thereto. In January 2020, our board of directors waived the application of any NOL transfer restrictions contained in our Certificate of Incorporation with respect to the issuance and sale of the shares of preferred stock and underlying common stock issued in connection with the financing of the scil acquisition. In February 2021, our board of directors waived the application of any NOL transfer restrictions contained in our Certificate of Incorporation with respect to the issuance and transfer of the shares of common stock in our March 2021 public offering, and any subsequent and further transfer of any such shares, to the extent such restrictions would otherwise have been applicable thereto. In July 2022, our board of directors granted a waiver to a non-affiliated stockholder with respect to the acquisition of shares by such stockholder in reliance on receipt of certain representations and covenants from such stockholder, to the extent such restrictions would have otherwise been applicable thereto. This waiver can be withdrawn with 90 days of notice to the stockholder. These waivers, and any similar waivers that our board of directors may grant in the future, may make it more likely that we have a “change of ownership” as defined under the provisions of Section 382 of the Internal Revenue Code of 1986, as amended, which could place a significant restriction on our ability to utilize our domestic Federal NOL in the future and materially adversely affect our results of operations. State net operating loss carryforwards may be similarly or more stringently limited. Any limitations on our ability to use our pre-change of ownership net operating losses to offset taxable income could potentially result in increased future tax liability to us.
If securities analysts do not publish research or reports about our business, or if they downgrade our stock, the price of our stock could decline.
The trading market for our common stock will likely be influenced by research and reports that securities or industry analysts publish about us or our business. In the event securities or industry analysts cover our company and one or more of these analysts downgrades our stock, lowers their price target, or publishes unfavorable or inaccurate research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.
We have not declared or paid any dividends on our common stock since 2012 and we do not anticipate paying any cash dividends in the foreseeable future.
We have not declared or paid any dividends on our common stock since October 2012. We intend to retain any earnings to finance the operation and expansion of our business, and we do not anticipate paying any cash dividends in the future. As a result, investors in our common stock may only receive a return on their investment in our common stock if the market price of our common stock increases.
We have fewer than 200 holders of record, which could allow us to terminate voluntarily the registration of our common stock with the SEC and after which we would no longer be eligible to maintain the listing of our common stock on The Nasdaq Capital Market. We may also be unable to otherwise maintain our listing on The Nasdaq Capital Market.
We have fewer than 200 holders of record as of our latest information, a fact which could make us eligible to terminate voluntarily the registration of our common stock with the SEC and therefore suspend our reporting obligations with the SEC under the Exchange Act and become a non-reporting company. If we were to cease reporting with the SEC, we would no longer be eligible to maintain the listing of our common stock on The Nasdaq Capital Market, which we would expect to materially adversely affect the liquidity and market price for our common stock. The Nasdaq Capital Market has several additional quantitative and qualitative requirements companies must comply with to maintain this listing. While we believe we are currently in compliance with Nasdaq requirements, there can be no assurance we will continue to meet Nasdaq listing requirements, that Nasdaq will interpret these requirements in the same manner we do if we believe we meet
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the requirements, or that Nasdaq will not change such requirements or add new requirements to include requirements we do not meet in the future.
If we were delisted from The Nasdaq Capital Market, our common stock may be considered a penny stock under the regulations of the SEC and would therefore be subject to rules that impose additional sales practice requirements on broker-dealers who sell our securities. The additional burdens imposed upon broker-dealers may discourage broker-dealers from effecting transactions in our common stock, which could severely limit market liquidity of the common stock and any stockholder’s ability to sell our securities in the secondary market. This lack of liquidity would also likely make it more difficult for us to raise capital in the future.
Provisions in our Certificate of Incorporation and bylaws and under Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.
Our Certificate of Incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change of control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:
•place restrictions on the transfer of our common stock that could adversely affect our ability to use our domestic NOL, which can have an effect of preventing a takeover;
•provide that our board of directors may, without stockholder approval, issue shares of preferred stock with special voting or economic rights;
•prohibit stockholders from calling a special meeting of our stockholders;
•provide that the board of directors is expressly authorized to make, alter or repeal our bylaws; and
•establish advance notice requirements for nominations for elections to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
Additionally, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder and which may discourage, delay, or prevent a change of control of our company.
Any provision of our Certificate of Incorporation, bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also negatively affect the price that some investors are willing to pay for our common stock.
Risks related to the outstanding Notes
Servicing our debt will require a significant amount of cash, and we may not have sufficient cash flow from our business to pay our substantial debt.
Our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness, including the amounts payable under the Notes, depends on our future performance, which is subject to economic, financial, competitive and other factors beyond our control. Our business may not continue to generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.
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We may not have the ability to raise the funds necessary to settle conversions of the Notes in cash or to repurchase the Notes upon a fundamental change, and our future debt may contain, limitations on our ability to pay cash upon conversion or repurchase of the Notes.
Holders of the Notes will have the right to require us to repurchase their notes upon the occurrence of a fundamental change at a fundamental change repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any. In addition, upon conversion of the Notes, unless we elect to deliver solely shares of our common stock to settle such conversion (other than paying cash in lieu of delivering any fractional share), we will be required to make cash payments in respect of the Notes being converted. However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of Notes surrendered therefor or Notes being converted. In addition, our ability to repurchase the Notes or to pay cash upon conversions of the Notes may be limited by law, by regulatory authority or by agreements governing our existing and future indebtedness. Our failure to repurchase Notes at a time when the repurchase is required by the indenture or to pay any cash payable on future conversions of the Notes as required by the indenture would constitute a default under the indenture. If a fundamental change occurs, or if the Notes are accelerated due to an event of default under the indenture, such events may lead to a default under agreements governing our future indebtedness. Any future indebtedness of ours may contain restrictions on our ability to pay cash upon conversion or repurchase of the Notes. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the Notes or make cash payments upon conversions thereof.
The conditional conversion feature of the Notes, if triggered, may adversely affect our financial condition and operating results.
In the event the conditional conversion feature of the Notes is triggered, holders of Notes will be entitled to convert the Notes at any time during specified periods at their option. If one or more holders elect to convert their Notes, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share) or by electing an exchange process for the Notes and a designated financial institution delivers the applicable conversion consideration, we would be required to settle a portion or all of our conversion obligation through the payment of cash, which could adversely affect our liquidity. In addition, even if holders of Notes do not elect to convert their Notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the Notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.
Item 1B.Unresolved Staff Comments
None.
Item 2.Properties
Our principal administrative and research and development activities are located in Loveland, Colorado. We lease approximately 60,000 square feet at a facility in Loveland, Colorado under an agreement that expires in 2023. On February 8, 2023, we signed a 10-year lease for a new facility in Loveland of approximately 60,000 square feet to replace the current building, which will commence in November 2023. Our principal production facility located in Des Moines, Iowa, consists of approximately 160,000 square feet of buildings on 34 acres of land, which we own. We also lease a building in Maryland that is used for research, development and manufacturing. Following the acquisition of LightDeck on January 3, 2023, we lease approximately 65,000 square feet at a manufacturing facility in Longmont, Colorado, and approximately 31,000 square feet at a facility in Boulder, Colorado.
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Our principal international administrative and research and development activities are located in Germany, France, Spain, Canada, Italy and Malaysia. In Germany, we own an office space and a warehouse that are approximately 45,000 and 15,000 square feet, respectively, and lease a showroom that totals approximately 3,000 square feet. In addition, in Germany, we lease approximately 25,000 square feet at a facility for VetZ's administrative and research and development activities. In Spain and Malaysia, we lease office spaces and warehouses. In Canada, we lease an office space. In Italy, we own an office space, warehouse, and showroom and lease an office and a reference lab facility. In France, we own an office space and lease an office space and warehouse.
Item 3.Legal Proceedings
From time to time, the Company may be involved in litigation relating to claims arising out of its operations. The Company records accruals for outstanding legal matters when it believes it is probable that a loss will be incurred, and the amount can be reasonably estimated.
As of December 31, 2022, we were not a party to any legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on our business, financial condition or operating results.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5.Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our Public Common Stock is quoted on the Nasdaq Capital Market under the symbol "HSKA".
As of February 16, 2023, there were approximately 177 holders of record of our Public Common Stock. We do not anticipate any dividend payments in the foreseeable future.
Issuer Purchases of Equity Securities
The following table sets forth information about the Company's purchases of our outstanding Public Common Stock during the quarter ended December 31, 2022:
| Period | Total Number of Shares Purchased (1) | Average Price Paid per Share (1) | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares that May Yet be Purchased Under Plans or Programs | ||||||||||||||||||||||
| October 2022 | — | $ | — | — | $ | — | ||||||||||||||||||||
| November 2022 | 717 | $ | 64.41 | — | $ | — | ||||||||||||||||||||
| December 2022 | — | $ | — | — | $ | — | ||||||||||||||||||||
| 717 | $ | 64.41 | — | $ | — | |||||||||||||||||||||
| (1) Shares of Public Common Stock we purchased between October 1, 2022 and December 31, 2022 were solely for the cancellation of shares of stock withheld for related tax obligations. | ||||||||||||||||||||||||||
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STOCK PRICE PERFORMANCE GRAPH
The following graph provides a comparison over the five-year period ended December 31, 2022 of the cumulative total shareholder return from a $100 investment in the Company's common stock with the NASDAQ Medical Supplies Index and the NASDAQ Composite Total Return:
| Dec-17 | Dec-18 | Dec-19 | Dec-20 | Dec-21 | Dec-22 | ||||||||||||||||||||||||||||||
| Heska Corporation | $ | 100 | $ | 107 | $ | 120 | $ | 182 | $ | 228 | $ | 77 | |||||||||||||||||||||||
| NASDAQ Medical Supplies Index | $ | 100 | $ | 107 | $ | 142 | $ | 180 | $ | 216 | $ | 141 | |||||||||||||||||||||||
| NASDAQ Composite Total Return Index | $ | 100 | $ | 97 | $ | 133 | $ | 192 | $ | 235 | $ | 159 | |||||||||||||||||||||||
Item 6. [Reserved]
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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 the Consolidated Financial Statements and related Notes included in Part II. Item 8 of this Form 10-K. This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties, and can generally be identified by our use of the words "scheduled," "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," and variations of such words and similar expressions. Such statements, which include statements concerning future revenue sources and concentration, international market expansion, gross margin, selling and marketing expenses, remaining minimum performance obligations, research and development expenses, general and administrative expenses, capital resources, financings or borrowings and additional losses, are subject to risks and uncertainties, including, but not limited to, those discussed below and elsewhere in this Form 10-K, particularly in Item 1A. "Risk Factors," that could cause actual results to differ materially from those projected. The forward-looking statements set forth in this Form 10-K are as of the close of business on February 27, 2023, and we undertake no duty and do not intend to update this information, except as required by applicable securities laws. If we updated one or more forward looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth above. See "Statement Regarding Forward Looking Statements."
On January 3, 2023, the Company completed the acquisition of MBio Diagnostics, Inc., d/b/a LightDeck Diagnostics ("LightDeck") which represents a meaningful increase in our intellectual property portfolio as well as our manufacturing and research and development capabilities. Refer to Note 4 - Investments in Unconsolidated Affiliates and Note 19 - Subsequent Events to the consolidated financial statements included in Part II. Item 8 of this Annual Report on Form 10-K.
A discussion of significant changes from the periods ending December 31, 2021 compared to December 31, 2020 can be found in Part II. Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2021.
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Overview
We sell, manufacture, market and support diagnostic and specialty products and solutions for veterinary practitioners. Our portfolio includes POC diagnostic laboratory instruments and consumables including rapid assay diagnostic products; digital cytology services; POC digital imaging diagnostic products; local and cloud-based data services; PIMS and related software and support; reference laboratory testing; allergy testing and immunotherapy; heartworm preventive products; and vaccines. Our primary focus is on supporting companion animal veterinarians in providing care to their patients.
Our business is composed of two operating and reportable segments: North America and International. North America consists of the United States, Canada and Mexico. International consists of geographies outside of North America, primarily our operations in Germany, Italy, Spain, France, Switzerland, Australia and Malaysia. The product groups described below are offered in both segments unless otherwise noted.
POC Laboratory Instruments and Other Sales include outright instrument sales, revenue recognized from sales-type lease treatment, and other revenue sources, such as charges for repairs and reference laboratory sales. Revenue from our POC laboratory consumables, a recurring revenue stream, primarily involves placing an instrument under contract in the field and generating future revenue from testing consumables, such as cartridges and reagents, as that instrument is used. Instruments placed under subscription agreements are considered operating or sales-type leases, depending on the duration and other factors of the underlying agreement. A loss of, or disruption in, the supply of consumables we are selling to an installed base of instruments could substantially harm our business. The majority of our POC laboratory and other non-imaging instruments and consumables are supplied by third parties, who typically own the product rights and supply the product to us under marketing and/or distribution agreements. Major products in this area include our instruments for chemistry, hematology, blood gas, urine fecal, and immunodiagnostic testing and their affiliated operating consumable as well as our rapid assay diagnostic tests and digital cytology services. More recently, the Company has developed and/or acquired product rights pertaining to our urine fecal and immunodiagnostic platforms.
Radiography is the largest product offering in POC Imaging and Informatics, which includes digital and computed radiography, ultrasound instruments, and diagnostic data and support. Radiography solutions typically consist of a combination of hardware and software placed with a customer, often combined with an ongoing service and support contract. Our experience has been that most of the revenue is generated at the time of sale, in contrast to the POC diagnostic laboratory placements discussed above where ongoing consumable revenue is often a larger component of economic value as a given instrument is used. In 2022, the Company acquired VetZ, a provider of PIMS and other clinical practice-related applications, which are primarily offered in our International segment.
Pharmaceuticals, Vaccines and Diagnostic ("PVD") revenue primarily includes pharmaceuticals and biologicals as well as research and development, licensing and royalty 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 heartworm preventives and allergy test kits, allergy immunotherapy and testing.
Other Vaccines and Pharmaceuticals ("OVP") revenue is generated in our USDA, FDA and DEA 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 of our U.S. inventory, excluding our imaging products, is stored at this facility and related fulfillment logistics are
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managed there. Our OVP revenue includes vaccines and pharmaceuticals produced for third parties. OVP is attributable only to the North America segment.
Our products are ultimately sold primarily to or through veterinarians. The acceptance of our products by veterinarians is critical to our success. These products are sold directly to end users by us as well as through distribution relationships, such as the sale of kits to conduct blood testing to third-party veterinary diagnostic laboratories and sales to independent third-party distributors. Revenue from direct sales and distribution relationships represented 78% and 22%, respectively, of revenue for the year ended December 31, 2022 and 72% and 28%, respectively, for both the years ended December 31, 2021 and December 31, 2020.
Effects of Certain Industry and Economic Factors and Trends on Results of Operations
Industry Trends - We continue to see demand for companion animal healthcare, which supported solid growth for POC diagnostic products and services compared to very strong prior year. We have a healthy liquidity position with cash of $156.6 million as of December 31, 2022. We continue to be active in mergers and acquisitions and other pursuits that support our growth in the companion animal healthcare space.
Supply Chain and Logistics - Due to our dependence on global suppliers, manufacturers and shipping routes, we are experiencing intermittent delays in receiving supply, increased shipping costs and some targeted increase in materials cost. Because our long-term subscription programs, the commercial program of our largest revenue category, POC laboratory instruments and consumables, include annual price adjustments at a greater of 4% or the consumer price index, we are able to mitigate some of these costs in this highly inflationary environment. Further, we have worked closely with our suppliers to evaluate and identify products with long-lead time parts and provided advanced purchase notification and have secured products in advance to further mitigate supply disruption.
Inflation, Foreign Currency, Interest Rate Risk Impact - Refer to Item 7A. Quantitative and Qualitative Disclosures about Market Risk of this form 10-K.
Critical Accounting Estimates
Note 1 - Operations and Summary of Significant Accounting Policies to the consolidated financial statements included in Part II. Item 8 of this Annual Report on Form 10-K describes the significant accounting policies used in preparation of these consolidated financial statements. We believe the following critical accounting estimates and assumptions may have a material impact on reported financial condition and operating performance and involve significant levels of judgment to account for highly uncertain matters or are susceptible to significant change. In each of these areas, management makes estimates based on historical results, current trends and future projections. Therefore, these are considered to be our critical accounting policies and estimates.
Business Combinations
We account for transactions that represent business combinations under the acquisition method of accounting, which requires us to allocate the total consideration paid for each acquisition to the assets we acquire and liabilities we assume based on their fair values as of the date of acquisition, including identifiable intangible assets. The allocation of the purchase price utilizes significant estimates in determining the fair values of identifiable assets acquired and liabilities assumed, especially with respect to intangible assets. We may refine our estimates and make adjustments to the assets acquired and liabilities assumed over a measurement period, not to exceed one year.
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The Company has financial liabilities resulting from our business combinations, including contingent consideration arrangements and notes payable. We estimate the fair value of these financial liabilities using Level 3 inputs that require the use of numerous assumptions and a probability-weighted outcome analysis, which may change based on the occurrence of future events and lead to increased or decreased operating income in future periods. Estimating the fair value at an acquisition date and in subsequent periods involves significant judgments, including projecting the future financial and product development performance of the acquired businesses. The Company will update its assumptions each reporting period based on new developments and record such amounts at fair value based on the revised assumptions. Changes in the fair value of these financial liabilities are recorded in the Consolidated Statements of Loss within general and administrative expenses.
Valuation of Goodwill and Intangibles
A significant portion of the purchase price for acquired businesses is generally assigned to intangible assets. Intangible assets other than goodwill are initially valued at fair value. If a quoted price in an active market for the identical asset is not readily available at the measurement date, the fair value of the intangible asset is estimated based on discounted cash flows using market participant assumptions, which are assumptions that are not specific to Heska. The selection of appropriate valuation methodologies and the estimation of discounted cash flows require significant assumptions about the timing and amounts of future cash flows, risks, appropriate discount rates, and the useful lives of intangible assets. When material, we utilize independent valuation experts to advise and assist us in determining the fair values of the identified intangible assets acquired in connection with a business acquisition and in determining appropriate amortization methods and periods for those intangible assets. Goodwill is initially valued based on the excess of the purchase price of a business combination over the fair value of acquired net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized.
We assess goodwill for impairment annually, at the reporting unit level, in the fourth quarter and whenever events or circumstances indicate impairment may exist. In evaluating goodwill for impairment, we have the option to first assess the qualitative factors to determine whether it is more-likely-than-not that the estimated fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the comparison of the estimated fair value of the reporting unit to the carrying value. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If, after assessing the totality of events or circumstances, we determine that is it more-likely-than-not that the estimated fair value of a reporting is less than its carrying amount, we would then estimate the fair value of the reporting unit and compare it to the carrying value. If the carrying value exceeds the estimated fair value we would recognize an impairment for the difference; otherwise, no further impairment test would be required. In contrast, we can opt to bypass the qualitative assessment for any reporting unit in any period and proceed directly to quantitative analysis. Doing so does not preclude us from performing the qualitative assessment in any subsequent period.
As part of our goodwill testing process, we evaluate factors specific to a reporting unit as well as industry and macroeconomic factors that are reasonably likely to have a material impact on the fair value of a reporting unit. Examples of the factors considered in assessing the fair value of a reporting unit include: the results of the most recent impairment test, the competitive environment, the regulatory environment, anticipated changes in product or labor costs, revenue growth trends, the consistency of operating margins and cash flows and current and long-range financial forecasts. The long-range financial forecasts of the reporting units, which are based upon management’s long-term view of our markets, are used by senior management and the Board of Directors to evaluate operating performance.
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In the fourth quarter we elected to bypass the qualitative approach and instead proceeded directly to assessing the fair value of all of our reporting units and comparing the fair value of each reporting unit to the carrying value to determine if any impairment exists. We estimate the fair values of the reporting units using an income approach based on discounted forecasted cash flows. The income approach involves making significant assumptions about the extent and timing of future cash flows, revenue growth rates, which incorporate the continued growth of some of the existing products as well as success rates of newly launched or future launches of products, and discount rates. Model assumptions are based on our projections and best estimates, using appropriate and customary market participant assumptions. Changes in forecasted cash flows or the discount rate would affect the estimated fair values of our reporting units and could result in a goodwill impairment loss in a future period. We also utilize a market approach utilizing the guideline public company method or guideline transaction method, or both, which incorporate subjectivity of management in determining appropriate comparable companies and transactions. Finally, the weighting of each approach is highly subjective and could result in an impairment in a future period. No impairment existed based on the analysis. We performed qualitative assessments in the fourth quarters of 2021 and 2020 and determined that no indications of impairment existed.
We assess the realizability of intangible assets other than goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If an impairment review is triggered, we evaluate the carrying value of intangible assets based on estimated undiscounted future cash flows over the remaining useful life of the primary asset of the asset group and compare that value to the carrying value of the asset group. The cash flows that are used contain our best estimates, using appropriate and customary assumptions and projections at the time. If the net carrying value of an intangible asset exceeds the related estimated undiscounted future cash flows, an impairment to adjust the intangible asset to its fair value would be reported as a non-cash charge to earnings. If necessary, we would calculate the fair value of an intangible asset using the present value of the estimated future cash flows to be generated by the intangible asset, and applying a risk-adjusted discount rate. We had a $0.2 million impairment of our intangible assets during the year ended December 31, 2022. We had no impairments of our intangible assets during the years ended December 31, 2021, and 2020.
These valuations require the use of management’s assumptions, which would not reflect unanticipated events and circumstances that may occur.
Share-Based Compensation Expense
We utilize share-based compensation arrangements as part of our long-term incentive plan. Our share-based compensation programs provide for grants of many types of awards, but we currently grant stock options, including performance stock options, restricted stock awards, and restricted stock units, along with the issuance of employee stock purchase rights. The total fair value of future awards may vary significantly from past awards based on a number of factors, including our share-based award practices. Therefore, share-based compensation expense is likely to fluctuate, possibly significantly, from year to year.
The majority of our currently issued restricted stock awards, restricted stock units, and performance stock options are tied to Company and market-related performance metrics and generally include a time vesting component. We also grant stock options and restricted stock awards tied to time vesting to employees and directors. All significant inputs into the determination of expense as well as the related expense are discussed further in Note 12 - Capital Stock to the consolidated financial statements included in Part II. Item 8 of this Annual Report on Form 10-K.
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Performance-Based Stock Compensation Awards
We grant restricted stock awards, restricted stock units, and performance stock options subject to performance vesting criteria, in addition to service, to our executive officers and other key employees. This type of grant consists of the right to receive shares of, or options to purchase, common stock, subject to achievement of time-based criteria and certain Company or market performance-related goals over a specified period, as established by the Compensation Committee of our Board of Directors. We recognize any related share-based compensation expense ratably over the requisite service period based on the probability assessment on the outcome of the performance condition related to company performance metrics. The fair value used in our expense recognition method is measured based on the number of shares granted and the closing market price of our common stock on the date of grant for restricted stock awards and units and the Black-Scholes model for performance stock options. The amount of share-based compensation expense recognized in any one period can vary based on the attainment or expected attainment of the performance goals. If such performance goals are not ultimately met, no compensation expense is recognized and any previously recognized compensation expense is reversed. We recognize any related share-based compensation expense ratably over the service period based on the most probable outcome of the performance condition related to market performance metrics. For awards related to market performance, the fair value used in our expense recognition method is measured based on the number of shares granted, and a Monte Carlo simulation model, which incorporates the probability of the achievement of the market-related performance goals as part of the grant date fair value. If such performance goals are not ultimately met, the expense is not reversed.
Recent Accounting Pronouncements
From time to time, the FASB or other standard setting bodies issue new accounting pronouncements. Updates to the FASB ASC are communicated through issuance of an ASU. Unless otherwise discussed, we believe that recently issued guidance, whether adopted or to be adopted in the future, is not expected to have a material impact on our Consolidated Financial Statements upon adoption.
To understand the impact of recently issued guidance, whether adopted or to be adopted, please review the information provided in Note 1 - Operations and Summary of Significant Accounting Policies to the consolidated financial statements included in Part II. Item 8 of this Annual Report on Form 10-K.
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Results of Operations
Our analysis presented below is organized to provide the information we believe will facilitate an understanding of our historical performance and relevant trends going forward. This discussion should be read in conjunction with our consolidated financial statements, including the notes thereto, in Part II. Item 8 of this Annual Report on Form 10-K.
The following table sets forth, for the periods indicated, certain data derived from our Consolidated Statements of Loss (in thousands):
| Year Ended December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Revenue, net | $ | 257,307 | $ | 253,739 | |||||||
| Gross profit | 111,167 | 105,794 | |||||||||
| Operating expenses | 131,465 | 106,787 | |||||||||
| Operating loss | (20,298) | (993) | |||||||||
| Interest and other expense, net | 1,536 | 2,448 | |||||||||
| Loss before income taxes and equity in losses of unconsolidated affiliates | (21,834) | (3,441) | |||||||||
| Income tax benefit | (3,410) | (3,573) | |||||||||
| Net (loss) income before equity in losses of unconsolidated affiliates | (18,424) | 132 | |||||||||
| Equity in losses of unconsolidated affiliates | (1,465) | (1,280) | |||||||||
| Net loss attributable to Heska Corporation | $ | (19,889) | $ | (1,148) | |||||||
Diluted loss per share attributable to Heska Corporation(1) | $ | (1.92) | $ | (0.11) | |||||||
Non-GAAP net income per diluted share (1)(2) | $ | 1.58 | $ | 1.61 | |||||||
Adjusted EBITDA (2) | $ | 27,203 | $ | 29,739 | |||||||
Net margin (2) | (7.2) | % | 0.1 | % | |||||||
Adjusted EBITDA margin (2) | 10.6 | % | 11.7 | % | |||||||
(1) Shares used in the diluted per share calculation for diluted loss per share attributable to Heska Corporation are (in thousands) 10,343 for the year ended December 31, 2022 and 10,015 for the year ended December 31, 2021. Shares used in the diluted per share calculation for non-GAAP net income per diluted share are (in thousands): 10,523 for the year ended December 31, 2022 compared to 10,407 for the year ended December 31, 2021.
(2) See “Non-GAAP Financial Measures” for a reconciliation of Adjusted EBITDA to net income, Non-GAAP net income per diluted share to Diluted loss per share attributable to Heska Corporation, and Adjusted EBITDA margin to Net margin, the closest comparable GAAP measures, for each of the periods presented.
Revenue
Total revenue increased 1.4% to $257.3 million in 2022 compared to $253.7 million in 2021. The increase in revenue is driven primarily by the acquisition of VetZ, which was completed on January 3, 2022, and which contributed $12.2 million for the year ended December 31, 2022 that was not included in the prior year period. Revenue growth was also driven by the global launch of Element AIM, increased capital lease placements globally and higher consumable sales mainly due to increased selling prices, particularly in North America. These were partially offset by a 11.7% decline in PVD due to decreased demand for the heartworm preventive, Tri-Heart, as well as a $10.2 million foreign exchange impact, primarily due to the weakening of the Euro, impacting the POC product lines.
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Gross Profit
Gross profit increased 5.1% to $111.2 million in 2022 compared to $105.8 million in 2021. Gross margin percent expanded to 43.2% in 2022 compared to 41.7% in 2021. The increase in both gross profit and gross margin percentage is driven by higher sales of consumables relative to total sales, which are our highest margin products, further strengthened by product rationalization and transition effort within our International segment and overall annual price increases. The acquisition of VetZ also favorably impacted gross profit and gross margin.
Operating Expenses
Selling and marketing expenses increased 5.2% to $47.7 million in 2022 compared to $45.3 million in 2021. The increase is driven by the acquisition of VetZ of $3.2 million, increased travel and trade show expenses due to relaxing COVID-19 restrictions, higher employee compensation costs, and higher non-recurring costs, partially offset by lower stock-based compensation of $2.2 million and favorable foreign exchange impacts.
Research and development expenses increased to $19.8 million in 2022 from $7.0 million in 2021. The increase is primarily related to a $10.0 million payment for an exclusive global supply and licensing agreement to develop and commercialize the Heska Nu.Q® vet cancer screening test, a POC cancer monitoring and screening test. The remaining increase is due to investment in new products and technologies acquired over the prior 18 months.
General and administrative expenses increased 17.5% to $64.1 million in 2022, compared to $54.5 million in 2021. The increase is driven by the $3.9 million provision for credit losses on a convertible note receivable, increased costs related to recent acquisitions and higher non-recurring items of $6.1 million, and increased cash and stock-based compensation costs, partially offset by lower incentive compensation and favorable foreign exchange impacts.
Interest and Other Expense, Net
Interest and other expense, net, was $1.5 million in 2022, compared to $2.4 million in 2021. The decrease was primarily driven by interest income earned in 2022 related to our investment in a money market fund that was not earned in 2021.
Income Tax (Benefit) Expense
In 2022, we had total income tax benefit of $3.4 million compared to a total income tax benefit in 2021 of $3.6 million. See Note 5 - Income Taxes to the consolidated financial statements included in Part II. Item 8 of this Annual Report on Form 10-K for additional information regarding our income taxes.
Net (Loss) Attributable to Heska Corporation
Net loss attributable to Heska Corporation was $19.9 million in 2022, compared to net loss attributable to Heska Corporation of $1.1 million in 2021 driven by the $10 million licensing payment, the $3.9 million provision for credit losses on the convertible note receivable, increased cash compensation costs as well as non-recurring and recurring costs associated with recent acquisitions, partially offset by increases in revenue and gross profit.
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Adjusted EBITDA
Adjusted earnings before interest, taxes, depreciation, and amortization ("EBITDA") in 2022 was $27.2 million (10.6% adjusted EBITDA margin), compared to $29.7 million (11.7% adjusted EBITDA margin) in 2021. The decrease is driven by increased investments in growth and new technologies, such as the ongoing development of a cloud-based PIMS and the new trūRapid™ portfolio, and higher cash compensation costs, partially offset by increased revenue and gross profit. See “Non-GAAP Financial Measures” for a reconciliation of adjusted EBITDA to net income and adjusted EBITDA margin to net loss margin, the closest comparable GAAP measures, for each of the periods presented.
Earnings Per Share
Diluted loss per share attributable to Heska was $1.92 in 2022 compared to loss of $0.11 per diluted share in 2021. The increased loss is due to increased operating expenses, partially offset by higher revenue and gross profit, as discussed above.
Non-GAAP Earnings Per Share
Non-GAAP EPS was income of $1.58 per diluted share in 2022 compared to income of $1.61 per diluted share in 2021. The decrease is primarily due to increased operating expenses, excluding non-recurring and acquisition-related costs, partially offset by higher revenue and gross profit as discussed above. See “Non-GAAP Financial Measures" for a reconciliation of non-GAAP EPS to net (loss) income attributable to Heska per diluted share, the closest comparable U.S. GAAP measure, in each of the periods presented.
Non-GAAP Financial Measures
In addition to financial measures presented on the basis of accounting principles generally accepted in the U.S. (“U.S. GAAP”), we also present EBITDA, adjusted EBITDA, adjusted EBITDA margin, and non-GAAP net income (loss) per diluted share, which are non-GAAP measures.
These measures should be viewed as a supplement to, not substitute for, our results of operations presented under U.S. GAAP. The non-GAAP financial measures presented may not be comparable to similarly titled measures of other companies because they may not calculate their measures in the same manner. Management uses EBITDA, adjusted EBITDA, adjusted EBITDA margin and non-GAAP net income (loss) per diluted share as key profitability measures, which are included in our quarterly analyses of our operating results to our senior management team, our annual budget and related goal setting and other performance measurements. We believe these non-GAAP measures enhance our investors' understanding of our business performance and that not adjusting for the items included in the reconciliations below would hinder comparison of the performance of our businesses on a period-over-period basis or with other businesses.
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The following tables reconcile our most directly comparable as-reported financial measures calculated in accordance with GAAP to our non-GAAP financial measures (in thousands, except percentages and per share amounts):
| Year Ended December 31, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
Net (loss) income (1) | $ | (18,424) | $ | 132 | ||||||||||
| Income tax (benefit) | (3,410) | (3,573) | ||||||||||||
| Interest expense, net | 613 | 2,404 | ||||||||||||
| Depreciation and amortization | 13,966 | 13,555 | ||||||||||||
| EBITDA | $ | (7,255) | $ | 12,518 | ||||||||||
Acquisition-related and other non-recurring/extraordinary costs (2) | $ | 19,919 | $ | 238 | ||||||||||
| Stock-based compensation | 16,004 | 18,263 | ||||||||||||
| Equity in losses of unconsolidated affiliates | (1,465) | (1,280) | ||||||||||||
| Adjusted EBITDA | $ | 27,203 | $ | 29,739 | ||||||||||
Net margin (3) | (7.2) | % | 0.1 | % | ||||||||||
Adjusted EBITDA margin (3) | 10.6 | % | 11.7 | % | ||||||||||
(1) Net (loss) income used for reconciliation represents the "Net income (loss) before equity in losses of unconsolidated affiliates."
(2) To exclude the effect of acquisition related costs, non-recurring items and extraordinary charges not indicative of ongoing operations of $19.9 million for the year ended December 31, 2022 compared to $0.2 million for the year ended December 31, 2021. These costs were incurred as a result of a $10.0 million licensing payment, the $3.9 million provision for credit losses for a convertible note receivable, the $1.0 million mark-to-market adjustment of the fair value of the embedded derivative on the convertible note receivable, $2.2 million related to the acquisitions of LightDeck and VetZ as well as other acquisition related and non-recurring charges, partially offset by a reduction in contingent consideration of $1.3 million for the year ended December 31, 2022.
(3) Net margin and adjusted EBITDA margin are calculated as the ratio of net (loss) income and adjusted EBITDA, respectively, to revenue.
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| Year Ended December 31, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
| GAAP net loss attributable to Heska per diluted share | $ | (1.92) | $ | (0.11) | ||||||||||
Acquisition related and other non-recurring/extraordinary costs(1) | 1.89 | 0.02 | ||||||||||||
Amortization of acquired intangibles(2) | 0.81 | 0.60 | ||||||||||||
Purchase accounting adjustments related to inventory and fixed asset step-up(3) | 0.22 | 0.03 | ||||||||||||
| Amortization of debt discount and issuance costs | — | 0.01 | ||||||||||||
| Stock-based compensation | 1.52 | 1.75 | ||||||||||||
| Loss on equity investee transactions | 0.14 | 0.12 | ||||||||||||
Estimated income tax effect of non-GAAP adjustments(4) | (1.08) | (0.81) | ||||||||||||
| Non-GAAP net income per diluted share | $ | 1.58 | $ | 1.61 | ||||||||||
| Shares used in diluted per share calculations | 10,523 | 10,407 | ||||||||||||
(1) To exclude the effect of acquisition related costs, non-recurring items and extraordinary charges not indicative of ongoing operations of $19.9 million for the year ended December 31, 2022 compared to $0.2 million for the year ended December 31, 2021. These costs were incurred as a result of a $10.0 million licensing payment, the $3.9 million provision for credit losses for a convertible note receivable, the $1.0 million mark-to-market adjustment of the fair value of the embedded derivative on the convertible note receivable, $2.2 million related to the acquisitions of LightDeck and VetZ as well as other acquisition related and non-recurring charges, partially offset by a reduction in contingent consideration of $1.3 million for the year ended December 31, 2022.
(2) To exclude the effect of amortization of acquired intangibles of $8.6 million in the year ended December 31, 2022, compared to $6.3 million in the year ended December 31, 2021. These costs were incurred as part of the purchase accounting adjustments for recent acquisitions.
(3) To exclude the effect of purchase accounting adjustments for inventory step up amortization and depreciation related to the step-up of fixed assets of $2.3 million for the year ended December 31, 2022, compared to $0.3 million for the year ended December 31, 2021.
(4) Represents income tax expense utilizing an estimated effective tax rate that adjusts for non-GAAP measures including: acquisition related, non-recurring and extraordinary costs (excluding charges which are not deductible for tax of $0.3 million for the year ended December 31, 2022 compared to benefits of $1.0 million for the year ended December 31, 2021), amortization of acquired intangibles, purchase accounting adjustments, amortization of debt discount and issuance costs, and stock-based compensation. This incorporates the tax expense related to stock-based compensation of $0.6 million for the year ended December 31, 2022 compared to $1.6 million benefit for the year ended December 31, 2021. Adjusted effective tax rates are approximately 25% for the years ended December 31, 2022 and December 31, 2021.
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Analysis by Segment
The North America segment includes sales and costs from the United States, Canada and Mexico. The International segment includes sales and costs from Australia, France, Germany, Italy, Malaysia, Spain and Switzerland.
The North America segment represented 62.9% of our revenue and the International segment represented 37.1% of our revenue for the year ended December 31, 2022.
The following sections and tables set forth, for the periods indicated, certain data derived from our Consolidated Statements of (Loss) Income (in thousands).
North America Segment
| Year Ended December 31, | Change | ||||||||||||||||||||||
| 2022 | 2021 | Dollar Change | % Change | ||||||||||||||||||||
| POC Laboratory: | $ | 95,480 | $ | 86,841 | $ | 8,639 | 9.9 | % | |||||||||||||||
| Instruments & Other | 17,178 | 14,837 | 2,341 | 15.8 | % | ||||||||||||||||||
| Consumables | 78,302 | 72,004 | 6,298 | 8.7 | % | ||||||||||||||||||
| POC Imaging & Informatics | 27,335 | 29,512 | (2,177) | (7.4) | % | ||||||||||||||||||
| PVD | 22,020 | 24,939 | (2,919) | (11.7) | % | ||||||||||||||||||
| OVP | 16,927 | 17,606 | (679) | (3.9) | % | ||||||||||||||||||
| Total North America revenue | $ | 161,762 | $ | 158,898 | $ | 2,864 | 1.8 | % | |||||||||||||||
| North America Gross Profit | $ | 75,528 | $ | 74,426 | $ | 1,102 | 1.5 | % | |||||||||||||||
| North America Gross Margin | 46.7 | % | 46.8 | % | |||||||||||||||||||
| North America Operating (Loss) Income | $ | (15,797) | $ | 650 | $ | (16,447) | NM | ||||||||||||||||
| North America Operating (Loss) Income Margin | (9.8) | % | 0.4 | % | |||||||||||||||||||
North America segment revenue increased 1.8% to $161.8 million for the year ended December 31, 2022, compared to $158.9 million for the year ended December 31, 2021 driven by a 9.9% increase in POC laboratory instruments and consumables, in part as a result of continued rollout of Element AIM, as well as increased capital lease placements and favorable price on consumables due to annual price escalators. This is partially offset by an 11.7% decline in PVD due to lower demand for the heartworm preventive, Tri-Heart, and a 7.4% decline in POC imaging & informatics.
Gross profit was $75.5 million compared to $74.4 million for the year ended December 31, 2022 and 2021, respectively. The increase in gross profit is primarily driven by increased revenue in the current year, specifically related to POC laboratory instruments and consumables. Gross margin was 46.7% for the year ended December 31, 2022, compared to 46.8% in the year ended December 31, 2021. The slight margin decline is driven by increased AIM instrument placements and unfavorable product mix, which offset consumable price increases.
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North America operating loss was $15.8 million in the year ended December 31, 2022 compared to operating income of $0.7 million for the year ended December 31, 2021. The loss in the year ended December 31, 2022 is driven by increased operating expenses, primarily due to higher acquisition related costs, non-recurring items and extraordinary charges not indicative of ongoing operations including a $10.0 million licensing payment, a $3.9 million provision for credit losses on a convertible note receivable, increased acquisition costs higher cash-based compensation expenses and increased travel, meals & trade show expenses due to easing COVID-19 restrictions. These are partially offset by increased revenue and gross profit as well as lower stock-based and incentive compensation.
International Segment
| Year Ended December 31, | Change | ||||||||||||||||||||||
| 2022 | 2021 | Dollar Change | % Change | ||||||||||||||||||||
| POC Laboratory: | $ | 56,865 | $ | 61,017 | $ | (4,152) | (6.8) | % | |||||||||||||||
| Instruments & Other | 15,660 | 15,001 | 659 | 4.4 | % | ||||||||||||||||||
| Consumables | 41,205 | 46,016 | (4,811) | (10.5) | % | ||||||||||||||||||
| POC Imaging & Informatics | 35,209 | 28,492 | 6,717 | 23.6 | % | ||||||||||||||||||
| PVD | 3,471 | 5,332 | (1,861) | (34.9) | % | ||||||||||||||||||
| Total International revenue | $ | 95,545 | $ | 94,841 | $ | 704 | 0.7 | % | |||||||||||||||
| International Gross Profit | $ | 35,639 | $ | 31,368 | $ | 4,271 | 13.6 | % | |||||||||||||||
| International Gross Margin | 37.3 | % | 33.1 | % | |||||||||||||||||||
| International Operating Loss | $ | (4,501) | $ | (1,643) | $ | (2,858) | (174.0) | % | |||||||||||||||
| International Operating Loss Margin | (4.7) | % | (1.7) | % | |||||||||||||||||||
International revenue was $95.5 million compared to $94.8 million for the year ended December 31, 2022 and 2021, respectively, driven by the acquisition of VetZ, which delivered $12.2 million that was not present in the prior year period, and the introduction of Element AIM, partially offset by $9.6 million of negative foreign currency impact.
Gross profit was $35.6 million compared to $31.4 million for the year ended December 31, 2022 and 2021, respectively. Gross margin for the International segment was 37.3% for the year ended December 31, 2022, compared to 33.1% for the year ended December 31, 2021. The increase in gross profit and gross margin for both periods is driven by increased revenue, excluding foreign exchange impacts, as well as favorable product mix, particularly within POC laboratory consumables. The acquisition of VetZ also favorably impacted gross margin while the introduction of Element AIM in the International segment unfavorably impacted gross margin.
International operating loss was $4.5 million for the year ended December 31, 2022 compared to a loss of $1.6 million for the year ended December 31, 2021, driven primarily by increased operating expenses for the development of new PIMS technology, partially offset by increased revenue and gross profit.
Liquidity, Capital Resources and Financial Condition
We believe that adequate liquidity and cash generation is important to the execution of our strategic initiatives. Our ability to fund our operations, acquisitions, capital expenditures, and product development efforts may depend on our ability to access other forms of capital as well as our ability to generate cash from operating activities, which is subject to future operating performance, as well as general economic, financial, competitive, legislative, regulatory, and other conditions, some of which may be beyond our control, including but not limited to effects of the COVID-19 pandemic. Our primary source of liquidity is our available cash of $156.6 million.
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A summary of our cash from operating, investing and financing activities is as follows (in thousands):
| December 31, | Change | ||||||||||||||||||||||
| 2022 | 2021 | Dollar Change | % Change | ||||||||||||||||||||
| Net cash (used in) provided by operating activities | $ | (21,813) | $ | 6,247 | $ | (28,060) | NM | ||||||||||||||||
| Net cash used in investing activities | (35,770) | (35,001) | (769) | (2.2) | % | ||||||||||||||||||
| Net cash (used in) provided by financing activities | (7,051) | 166,404 | (173,455) | NM | |||||||||||||||||||
| Foreign exchange effect on cash and cash equivalents | (2,322) | (410) | (1,912) | (466.3) | % | ||||||||||||||||||
| (Decrease) increase in cash and cash equivalents | (66,956) | 137,240 | (204,196) | NM | |||||||||||||||||||
| Cash and cash equivalents, beginning of the period | 223,574 | 86,334 | 137,240 | 159.0 | % | ||||||||||||||||||
| Cash and cash equivalents, end of the period | $ | 156,618 | $ | 223,574 | $ | (66,956) | (29.9) | % | |||||||||||||||
For the year ended December 31, 2022 and the year ended December 31, 2021, cash flow used in operations was $21.8 million and cash flow provided by operations was $6.2 million, respectively, which was primarily the result of (in thousands):
| December 31, | Change | ||||||||||||||||||||||
| 2022 | 2021 | Dollar Change | % Change | ||||||||||||||||||||
| Operating Activity: | $ | (19,889) | $ | (1,148) | $ | (18,741) | (1,632.5) | % | |||||||||||||||
| Non cash expenses and other adjustments | 33,528 | 30,842 | 2,686 | 8.7 | % | ||||||||||||||||||
| Change in accounts receivable | (1,494) | 2,193 | (3,687) | NM | |||||||||||||||||||
| Change in inventories, net | (13,981) | (14,905) | 924 | 6.2 | % | ||||||||||||||||||
| Change in lease receivables, net | (9,078) | (5,902) | (3,176) | (53.8) | % | ||||||||||||||||||
| Change in other assets | (1,887) | (4,329) | 2,442 | 56.4 | % | ||||||||||||||||||
| Change in accounts payable | 1,428 | 662 | 766 | 115.7 | % | ||||||||||||||||||
| Change in other liabilities | (10,440) | (1,166) | (9,274) | (795.4) | % | ||||||||||||||||||
| Net cash (used in) provided by operating activities | $ | (21,813) | $ | 6,247 | $ | (28,060) | NM | ||||||||||||||||
For the year ended December 31, 2022 and the year ended December 31, 2021, cash flow used in investing activities was $35.8 million and $35.0 million, respectively, which was primarily used for (in thousands):
| December 31, | Change | ||||||||||||||||||||||
| 2022 | 2021 | Dollar Change | % Change | ||||||||||||||||||||
| Acquisition of Biotech | $ | — | $ | (16,250) | $ | 16,250 | NM | ||||||||||||||||
| Acquisition of BiEssA, net of cash acquired | — | (4,513) | 4,513 | NM | |||||||||||||||||||
| Acquisition of Lacuna, net of cash acquired | — | (3,882) | 3,882 | NM | |||||||||||||||||||
| Acquisition of VetZ, net of cash acquired | (28,956) | — | (28,956) | NM | |||||||||||||||||||
| Promissory note receivable issuance | (4,700) | (9,000) | 4,300 | 47.8 | % | ||||||||||||||||||
| Purchases of property and equipment | (2,114) | (1,768) | (346) | (19.6) | % | ||||||||||||||||||
| Proceeds from disposition of property and equipment | — | 412 | (412) | NM | |||||||||||||||||||
| Net cash used in investing activities | $ | (35,770) | $ | (35,001) | $ | (769) | (2.2) | % | |||||||||||||||
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For the year ended December 31, 2022 and the year ended December 31, 2021, cash flow used in financing activities was $7.1 million and cash flows provided by financing activities was $166.4 million, respectively, which was the result of (in thousands):
| December 31, | Change | ||||||||||||||||||||||
| 2022 | 2021 | Dollar Change | % Change | ||||||||||||||||||||
| Proceeds from issuance of common stock | $ | 3,191 | $ | 169,230 | $ | (166,039) | (98.1) | % | |||||||||||||||
| Purchase of shares withheld for tax obligations | (5,269) | (1,629) | (3,640) | (223.4) | % | ||||||||||||||||||
| Payment of stock issuance costs | — | (314) | 314 | NM | |||||||||||||||||||
| Notes Payable | (4,770) | — | (4,770) | NM | |||||||||||||||||||
| Proceeds from line of credit borrowings | — | 7 | (7) | NM | |||||||||||||||||||
| Repayments of line of credit borrowings | (203) | (890) | 687 | 77.2 | % | ||||||||||||||||||
| Net cash provided by financing activities | $ | (7,051) | $ | 166,404 | $ | (173,455) | NM | ||||||||||||||||
We believe that our cash, cash equivalents and marketable securities balances, as well as the cash flows generated by our operations, will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures, including selling and marketing team expansion, investment in key corporate functions, product development initiatives, and the build out of our new leased office space in Loveland, Colorado (see Part I. Item 2. Properties), for at least the next 12 months. Our belief may prove to be incorrect, however, and we could utilize our available financial resources sooner than we currently expect. For example, we actively seek opportunities that are consistent with our strategic direction, which may require additional capital. Our future capital requirements and the adequacy of available funds will depend on many factors, including those set forth in Part I. Item 1A, "Risk Factors". We may seek additional equity or debt financing in order to meet these future capital requirements, even in the absence of any acquisitions. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us, or at all. If we are unable to raise additional capital when desired, our business, results of operations and financial condition would be adversely affected.
Effect of currency translation on cash
Net effect of foreign currency translations on cash changed $1.9 million to a $2.3 million negative impact in 2022, compared to a $0.4 million negative impact in 2021. The net effect of foreign currency translation on cash changed $1.2 million in 2021 from a $0.8 million positive impact in 2020. These effects are related to changes in exchange rates between the U.S. Dollar and the Swiss Franc, Euro, Canadian Dollar, Australian Dollar, and Malaysian Ringgit which are the functional currencies of our subsidiaries.
Material Cash Requirements
The Company has not entered into any transactions with unconsolidated entities whereby the Company has financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose the Company to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provided financing, liquidity, market risk or credit risk support to the Company, or engages in leasing, hedging or research and development services with the Company.
Purchase obligations represent contractual agreements to purchase goods or services that are legally binding; specify a fixed, minimum or range of quantities; specify a fixed, minimum, variable, or indexed price provision; and specify approximate timing of the transaction.
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The following table presents certain future payments due by the Company as of December 31, 2022 (in thousands):
| Total | Less Than 1 Year | 1 - 3 Years | 3 - 5 Years | After 5 Years | |||||||||||||||||||||||||
| Purchase obligations | $ | 55,291 | $ | 27,361 | $ | 24,065 | $ | 3,865 | $ | — | |||||||||||||||||||
| Operating lease obligations | 7,886 | 3,257 | 2,110 | 1,114 | 1,405 | ||||||||||||||||||||||||
| Finance lease obligations | 460 | 168 | 236 | 56 | — | ||||||||||||||||||||||||
Convertible senior notes (1) | 86,250 | — | — | 86,250 | — | ||||||||||||||||||||||||
Future interest obligations (2) | 11,994 | 3,234 | 6,469 | 2,291 | — | ||||||||||||||||||||||||
| Total | $ | 161,881 | $ | 34,020 | $ | 32,880 | $ | 93,576 | $ | 1,405 | |||||||||||||||||||
(1) Includes the principal amount of the convertible senior notes. Although the notes mature in 2026, they can be converted into cash and shares of our common stock prior to maturity if certain conditions are met. Any conversion prior to maturity can result in repayments of the principal amounts sooner than the scheduled repayments as indicated in the table. For additional information, refer to Note 16 - Convertible Notes to the consolidated financial statements included in Part II. Item 8 of this Annual Report on Form 10-K.
(2) Includes interest payments for both the convertible senior notes and other long term borrowings.
Net Operating Loss Carryforwards
As of December 31, 2022, we had a net operating loss carryforward (“NOL”) and domestic research and development tax credit carryforward. See Note 5 - Income Taxes to the consolidated financial statements included in Part II. Item 8 of this Annual Report on Form 10-K for additional information regarding our carryforwards.
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Item 7A.Quantitative and Qualitative Disclosures about Market Risk
Market risk represents the risk of loss that may impact the financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk in the areas of changes in U.S. and foreign interest rates and changes in foreign currency exchange rates as measured against the U.S. Dollar. These exposures are directly related to our normal operating and funding activities.
Interest Rate Risk
In September 2019, we issued $86.25 million aggregate principal amount of Notes. The fair market value of the Notes is affected by our common stock price. The fair value of the Notes will generally increase as our common stock price increases and will generally decrease as our common stock price declines in value. In addition, the fair market value of the Notes is exposed to interest rate risk. Generally, the fair market value of our fixed interest rate Notes will increase as interest rates fall and decrease as interest rates rise. Additionally, on our balance sheet we carry the Notes at face value less unamortized discount and debt issuance cost and we present the fair value for required disclosure purposes only. For additional information, refer to Note 16 - Convertible Notes to the consolidated financial statements included in Part II. Item 8 of this Annual Report on Form 10-K and to our consolidated financial statements included herein. We had no interest rate hedge transactions in place on December 31, 2022.
Foreign Currency Risk
Foreign currency risk may impact our revenue and results of operations. In cases where we purchase inventory in one currency and sell corresponding products in another, our gross margin percentage is typically at risk based on foreign currency exchange rates. In addition, in cases where we may be generating operating income in foreign currencies, the magnitude of such operating income when translated into U.S. Dollars will be at risk based on foreign currency exchange rates. We had no foreign currency hedge transactions in place on December 31, 2022. We do not currently consider foreign currency risk to be material to our business. However, to the extent that the U.S. Dollar is stronger in current or future periods relative to the exchange rates in effect in comparative periods presented, our growth rates will be negatively affected.
Inflation Risk
Inflation generally impacts us by increasing our costs of labor, energy, material, transportation, increased price from suppliers, and general overhead costs. The rates of inflation experienced in recent years have not had a material impact on our financial statements as inflationary cost increases have been offset by annual price increases and productivity gains. However, any price increases imposed may lead to declines in sales volume if competitors do not similarly adjust prices. We cannot reasonably estimate our ability to successfully recover any impact of inflation cost increases into the future.
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Item 8. Financial Statements and Supplementary Data
HESKA CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Heska Corporation
Opinion on the financial statements
We have audited the accompanying consolidated balance sheets of Heska Corporation (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2022 and 2021, the related consolidated statements of loss, comprehensive loss, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated February 28, 2023 expressed an unqualified opinion.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical audit matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Stock-based compensation – assessment of probability related to stock-based compensation subject to performance-based vesting requirements
As described further in Note 12 to the financial statements, the Company grants restricted stock awards, restricted stock units, and stock options to management and directors. Certain restricted stock awards,
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restricted stock units, and stock options have performance-based vesting conditions, which vest based on when performance targets are met. Performance-based awards are recognized as an expense based on the probability of achieving the underlying performance targets. We identified the probability assessment of achieving the performance targets as a critical audit matter.
The principal considerations for our determination that the probability assessment of achieving the performance targets is a critical audit matter is that the probability is based on a subjective assessment of the Company’s prospective financial information. The probability assessment requires management to estimate achievement of future financial performance for sales growth, margins, and operating performance. Changes in the subjective probability assessment can materially affect the amount and timing of stock-based compensation expense and the probability assessment requires significant auditor subjectivity in evaluating the reasonableness of those judgments and estimates.
Our audit procedures related to the probability assessment of achieving the performance targets included the following, among others.
–We tested the design and operating effectiveness of internal controls related to management’s determination of stock-based compensation expense, including testing management’s review control over the Company’s forecast and multi-year outlook to achieve those performance targets and the manual control over the calculation of performance-based stock compensation.
–We evaluated the reasonableness of management’s prospective financial information by comparing management’s previous forecasts to actual results to assess management’s ability to accurately forecast actual results. We also evaluated the reasonableness of forecasted revenue, margin, and operating performance by comparing each to current market and industry trends, historical information, and inquiring of individuals outside the finance department. We also evaluated the consistency of forecasts used in the probability assessment with other elements of the financial statements that use the forecast as an input.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2020.
Denver, Colorado
February 28, 2023
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Heska Corporation
Opinion on internal control over financial reporting
We have audited the internal control over financial reporting of Heska Corporation (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2022, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company as of and for the year ended December 31, 2022, and our report dated February 28, 2023 expressed an unqualified opinion on those financial statements.
Basis for opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and limitations of internal control over financial reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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/s/ GRANT THORNTON LLP
Denver, Colorado
February 28, 2023
-55-
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
| December 31, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
| ASSETS | ||||||||||||||
| Current assets: | ||||||||||||||
| Cash and cash equivalents | $ | 156,618 | $ | 223,574 | ||||||||||
| Accounts receivable, net of allowance for losses of $1,129 and $874, respectively | 29,493 | 27,995 | ||||||||||||
| Inventories | 60,050 | 49,361 | ||||||||||||
| Net investment in leases, current, net of allowance for losses of $182 and $137, respectively | 7,433 | 6,175 | ||||||||||||
| Prepaid expenses | 5,514 | 5,244 | ||||||||||||
| Other current assets | 5,926 | 7,206 | ||||||||||||
| Total current assets | 265,034 | 319,555 | ||||||||||||
| Property and equipment, net | 32,171 | 33,413 | ||||||||||||
| Operating lease right-of-use assets | 6,897 | 5,198 | ||||||||||||
| Goodwill | 135,918 | 118,826 | ||||||||||||
| Other intangible assets, net | 62,393 | 56,705 | ||||||||||||
| Deferred tax asset, net | 23,684 | 19,429 | ||||||||||||
| Net investment in leases, non-current | 27,499 | 20,128 | ||||||||||||
| Investments in unconsolidated affiliates | 3,959 | 5,424 | ||||||||||||
| Related party convertible note receivable, net | 2,224 | 6,800 | ||||||||||||
| Promissory note receivable from investee, net | 13,511 | 8,448 | ||||||||||||
| Other non-current assets | 12,526 | 10,146 | ||||||||||||
| Total assets | $ | 585,816 | $ | 604,072 | ||||||||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||||
| Current liabilities: | ||||||||||||||
| Accounts payable | $ | 16,403 | $ | 15,374 | ||||||||||
| Accrued liabilities | 15,149 | 19,424 | ||||||||||||
| Operating lease liabilities, current | 2,944 | 2,227 | ||||||||||||
| Deferred revenue, current, and other | 5,081 | 6,901 | ||||||||||||
| Total current liabilities | 39,577 | 43,926 | ||||||||||||
| Convertible note, non-current, net | 84,467 | 84,034 | ||||||||||||
| Notes payable | 11,130 | 15,900 | ||||||||||||
| Deferred revenue, non-current | 4,096 | 3,854 | ||||||||||||
| Operating lease liabilities, non-current | 4,528 | 3,509 | ||||||||||||
| Deferred tax liability | 16,438 | 12,667 | ||||||||||||
| Other liabilities | 3,372 | 4,328 | ||||||||||||
| Total liabilities | 163,608 | 168,218 | ||||||||||||
| Commitments and contingencies (Note 14) | ||||||||||||||
| Stockholders' equity: | ||||||||||||||
| Preferred stock, $0.01 par value, 2,500,000 shares authorized, none issued or outstanding | — | — | ||||||||||||
| Common stock, $0.01 par value, 20,000,000 shares authorized, none issued or outstanding | — | — | ||||||||||||
| Public common stock, $0.01 par value, 20,000,000 shares authorized, 10,829,518 and 10,712,347 shares issued and outstanding, respectively | 108 | 107 | ||||||||||||
| Additional paid-in capital | 597,139 | 579,354 | ||||||||||||
| Accumulated other comprehensive (loss) income | (6,506) | 5,037 | ||||||||||||
| Accumulated deficit | (168,533) | (148,644) | ||||||||||||
| Total stockholders' equity | 422,208 | 435,854 | ||||||||||||
| Total liabilities and stockholders' equity | $ | 585,816 | $ | 604,072 | ||||||||||
See accompanying notes to consolidated financial statements.
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HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF LOSS
(in thousands, except per share amounts)
| Year Ended December 31, | ||||||||||||||||||||
| 2022 | 2021 | 2020 | ||||||||||||||||||
| Revenue, net | $ | 257,307 | $ | 253,739 | $ | 197,323 | ||||||||||||||
| Cost of revenue | 146,140 | 147,945 | 116,033 | |||||||||||||||||
| Gross profit | 111,167 | 105,794 | 81,290 | |||||||||||||||||
| Operating expenses: | ||||||||||||||||||||
| Selling and marketing | 47,661 | 45,284 | 38,468 | |||||||||||||||||
| Research and development | 19,753 | 6,982 | 8,772 | |||||||||||||||||
| General and administrative | 64,051 | 54,521 | 42,242 | |||||||||||||||||
| Total operating expenses | 131,465 | 106,787 | 89,482 | |||||||||||||||||
| Operating loss | (20,298) | (993) | (8,192) | |||||||||||||||||
| Interest and other expense, net | 1,536 | 2,448 | 5,601 | |||||||||||||||||
| Net loss before income taxes and equity in losses of unconsolidated affiliates | (21,834) | (3,441) | (13,793) | |||||||||||||||||
| Income tax (benefit) expense: | ||||||||||||||||||||
| Current income tax expense | 1,288 | 891 | 1,780 | |||||||||||||||||
| Deferred income tax benefit | (4,698) | (4,464) | (1,541) | |||||||||||||||||
| Total income tax (benefit) expense | (3,410) | (3,573) | 239 | |||||||||||||||||
| Net (loss) income before equity in losses of unconsolidated affiliates | (18,424) | 132 | (14,032) | |||||||||||||||||
| Equity in losses of unconsolidated affiliates | (1,465) | (1,280) | (720) | |||||||||||||||||
| Net loss after equity in losses of unconsolidated affiliates | (19,889) | (1,148) | (14,752) | |||||||||||||||||
| Net loss attributable to redeemable non-controlling interest | — | — | (353) | |||||||||||||||||
| Net loss attributable to Heska Corporation | $ | (19,889) | $ | (1,148) | $ | (14,399) | ||||||||||||||
| Basic loss per share attributable to Heska Corporation | $ | (1.92) | $ | (0.11) | $ | (1.66) | ||||||||||||||
| Diluted loss per share attributable to Heska Corporation | $ | (1.92) | $ | (0.11) | $ | (1.66) | ||||||||||||||
| Weighted average outstanding shares used to compute basic loss per share attributable to Heska Corporation | 10,343 | 10,015 | 8,653 | |||||||||||||||||
| Weighted average outstanding shares used to compute diluted loss per share attributable to Heska Corporation | 10,343 | 10,015 | 8,653 | |||||||||||||||||
See accompanying notes to consolidated financial statements.
-57-
HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
| Year Ended December 31, | ||||||||||||||||||||
| 2022 | 2021 | 2020 | ||||||||||||||||||
| Net loss after equity in losses of unconsolidated affiliates | $ | (19,889) | $ | (1,148) | $ | (14,752) | ||||||||||||||
| Other comprehensive income (loss): | ||||||||||||||||||||
| Minimum pension benefit (liability) | 99 | 107 | (40) | |||||||||||||||||
| Translation adjustments and (losses) gains from intra-entity transactions | (11,642) | (9,239) | 13,696 | |||||||||||||||||
| Comprehensive loss | (31,432) | (10,280) | (1,096) | |||||||||||||||||
| Comprehensive loss attributable to redeemable non-controlling interest | — | — | (353) | |||||||||||||||||
| Comprehensive loss attributable to Heska Corporation | $ | (31,432) | $ | (10,280) | $ | (743) | ||||||||||||||
See accompanying notes to consolidated financial statements.
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HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
| Preferred Stock | Common Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Income (Loss) | Accumulated Deficit | Total Stockholders' Equity | |||||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | |||||||||||||||||||||||||||||||||||||||||||||||
| Balances, December 31, 2019 | — | $ | — | 7,882 | $ | 79 | $ | 290,216 | $ | 513 | $ | (136,444) | $ | 154,364 | ||||||||||||||||||||||||||||||||||||
| Adoption of accounting standards | — | — | — | — | — | — | (18) | (18) | ||||||||||||||||||||||||||||||||||||||||||
| Balances, January 1, 2020 | — | — | 7,882 | 79 | 290,216 | 513 | (136,462) | 154,346 | ||||||||||||||||||||||||||||||||||||||||||
| Net loss attributable to Heska Corporation | — | — | — | — | — | — | (14,399) | (14,399) | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock, net of shares withheld for employee taxes | — | — | 85 | 1 | 2,795 | — | — | 2,796 | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of preferred stock | 122 | 1 | — | — | 121,785 | — | — | 121,786 | ||||||||||||||||||||||||||||||||||||||||||
| Conversion to common stock | (122) | (1) | 1,509 | 15 | (14) | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | 9,490 | — | — | 9,490 | ||||||||||||||||||||||||||||||||||||||||||
| Purchase of minority interest | — | — | — | — | (622) | — | — | (622) | ||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | — | — | 13,656 | — | 13,656 | ||||||||||||||||||||||||||||||||||||||||||
| Balances, December 31, 2020 | — | $ | — | 9,476 | $ | 95 | $ | 423,650 | $ | 14,169 | $ | (150,861) | $ | 287,053 | ||||||||||||||||||||||||||||||||||||
| Adoption of accounting standards | — | — | — | — | (29,834) | — | 3,365 | (26,469) | ||||||||||||||||||||||||||||||||||||||||||
| Balances, January 1, 2021 | — | — | 9,476 | 95 | 393,816 | 14,169 | (147,496) | 260,584 | ||||||||||||||||||||||||||||||||||||||||||
| Net loss attributable to Heska Corporation | — | — | — | — | — | — | (1,148) | (1,148) | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock, net of shares withheld for employee taxes | — | — | 295 | 3 | 3,098 | — | — | 3,101 | ||||||||||||||||||||||||||||||||||||||||||
| Equity offering, net of issuance costs | — | — | 941 | 9 | 164,177 | — | — | 164,186 | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | 18,263 | — | — | 18,263 | ||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | — | (9,132) | — | (9,132) | ||||||||||||||||||||||||||||||||||||||||||
| Balances, December 31, 2021 | — | $ | — | 10,712 | $ | 107 | $ | 579,354 | $ | 5,037 | $ | (148,644) | $ | 435,854 | ||||||||||||||||||||||||||||||||||||
| Net loss attributable to Heska Corporation | — | — | — | — | — | — | (19,889) | (19,889) | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock, net of shares withheld for employee taxes | — | — | 118 | 1 | (2,079) | — | — | (2,078) | ||||||||||||||||||||||||||||||||||||||||||
| Equity contingent consideration | — | — | — | — | 3,860 | — | — | 3,860 | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | 16,004 | — | — | 16,004 | ||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | — | (11,543) | — | (11,543) | ||||||||||||||||||||||||||||||||||||||||||
| Balances, December 31, 2022 | — | $ | — | 10,830 | $ | 108 | $ | 597,139 | $ | (6,506) | $ | (168,533) | $ | 422,208 | ||||||||||||||||||||||||||||||||||||
See accompanying notes to consolidated financial statements.
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HESKA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| Year Ended December 31, | ||||||||||||||||||||
| 2022 | 2021 | 2020 | ||||||||||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||||||||||
| Net loss after equity in losses from unconsolidated affiliates | $ | (19,889) | $ | (1,148) | $ | (14,752) | ||||||||||||||
| Adjustments to reconcile net loss to cash provided by (used in) operating activities: | ||||||||||||||||||||
| Depreciation and amortization | 13,966 | 13,555 | 11,385 | |||||||||||||||||
| Non-cash impact of operating leases | 2,738 | 2,136 | 1,985 | |||||||||||||||||
| Deferred income tax benefit | (4,698) | (4,464) | (1,541) | |||||||||||||||||
| Stock-based compensation | 16,004 | 18,263 | 9,490 | |||||||||||||||||
| Provision for credit losses on convertible note receivable | 3,899 | — | — | |||||||||||||||||
| Change in fair value of contingent consideration | (1,641) | (1,607) | — | |||||||||||||||||
| Equity in losses of unconsolidated affiliates | 1,465 | 1,280 | 720 | |||||||||||||||||
| Accretion of discounts and issuance costs | 36 | 60 | 3,090 | |||||||||||||||||
| Provision for credit losses | — | 353 | 614 | |||||||||||||||||
| Other losses (gains) | 1,759 | 1,266 | (91) | |||||||||||||||||
| Changes in operating assets and liabilities (net of effect of acquisitions): | ||||||||||||||||||||
| Accounts receivable | (1,494) | 2,193 | (5,755) | |||||||||||||||||
| Inventories | (13,981) | (14,905) | (5,409) | |||||||||||||||||
| Lease receivables | (9,078) | (5,902) | (611) | |||||||||||||||||
| Other assets | (1,887) | (4,329) | 340 | |||||||||||||||||
| Accounts payable | 1,428 | 662 | (280) | |||||||||||||||||
| Other liabilities | (10,440) | (1,166) | 159 | |||||||||||||||||
| Net cash (used in) provided by operating activities | (21,813) | 6,247 | (656) | |||||||||||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||||||||||
| Acquisition of VetZ, net of cash acquired | (28,956) | — | — | |||||||||||||||||
| Acquisition of Biotech | — | (16,250) | — | |||||||||||||||||
| Acquisition of BiEssA, net of cash acquired | — | (4,513) | — | |||||||||||||||||
| Acquisition of Lacuna, net of cash acquired | — | (3,882) | — | |||||||||||||||||
| Acquisition of scil, net of cash acquired | — | — | (104,401) | |||||||||||||||||
| Acquisition of CVM | — | — | (14,420) | |||||||||||||||||
| Promissory note receivable issuance | (4,700) | (9,000) | — | |||||||||||||||||
| Convertible note receivable issuance | — | — | (6,650) | |||||||||||||||||
| Purchase of minority interest | — | — | (450) | |||||||||||||||||
| Purchases of property and equipment | (2,114) | (1,768) | (686) | |||||||||||||||||
| Proceeds from disposition of property and equipment | — | 412 | 10 | |||||||||||||||||
| Net cash used in investing activities | (35,770) | (35,001) | (126,597) | |||||||||||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||||||||||
| Proceeds from issuance of common stock | 3,191 | 169,230 | 4,273 | |||||||||||||||||
| Payments for taxes related to shares withheld for employee taxes | (5,269) | (1,629) | (1,477) | |||||||||||||||||
| Payment of stock issuance costs | — | (314) | (214) | |||||||||||||||||
| Proceeds from issuance of preferred stock | — | — | 122,000 | |||||||||||||||||
| Payments of related party debts | — | — | (1,140) | |||||||||||||||||
| Borrowings on line of credit and other debts | — | 7 | 613 | |||||||||||||||||
| Repayments of line of credit borrowings and other debts | (203) | (890) | (291) | |||||||||||||||||
| Notes Payable | (4,770) | — | — | |||||||||||||||||
| Net cash (used in) provided by financing activities | (7,051) | 166,404 | 123,764 | |||||||||||||||||
| FOREIGN EXCHANGE EFFECT ON CASH AND CASH EQUIVALENTS | (2,322) | (410) | 793 | |||||||||||||||||
| NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS | (66,956) | 137,240 | (2,696) | |||||||||||||||||
| CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR | 223,574 | 86,334 | 89,030 | |||||||||||||||||
| CASH AND CASH EQUIVALENTS, END OF YEAR | $ | 156,618 | $ | 223,574 | $ | 86,334 | ||||||||||||||
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| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | ||||||||||||||||||||
| Non-cash transfers of equipment between inventory and property and equipment, net | $ | 2,563 | $ | 4,600 | $ | 4,437 | ||||||||||||||
| Non-cash conversion of preferred stock to common stock | $ | — | $ | — | $ | 122,000 | ||||||||||||||
| Contingent consideration for acquisitions | $ | 3,860 | $ | 4,034 | $ | — | ||||||||||||||
| Notes payable issued in acquisition | $ | — | $ | 15,900 | $ | — | ||||||||||||||
| Indemnity holdback for acquisition | $ | 1,420 | $ | 346 | $ | — | ||||||||||||||
See accompanying notes to consolidated financial statements.
-61-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Heska Corporation and its wholly-owned subsidiaries ("Heska", the "Company", "we" or "our") sell, manufacture, market and support diagnostic and specialty products and solutions for veterinary practitioners. Our portfolio includes POC diagnostic laboratory instruments and consumables including rapid assay diagnostic products and digital cytology services; POC digital imaging diagnostic products; local and cloud-based data services; PIMS and related software and support; reference laboratory testing; allergy testing and immunotherapy; heartworm preventive products; and vaccines. Our primary focus is on supporting companion animal veterinarians in providing care to their patients.
Basis of Presentation and Consolidation
In the opinion of management, the accompanying Consolidated Financial Statements contain all adjustments, consisting of normal, recurring adjustments, necessary to present fairly the financial position of the Company as of December 31, 2022 and 2021, as well as the results of our operations, statements of stockholders' equity and cash flows for the years ended December 31, 2022, 2021 and 2020.
The audited Consolidated Financial Statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Our audited Consolidated Financial Statements include our accounts and the accounts of our wholly-owned subsidiaries since their respective dates of acquisitions. All intercompany accounts and transactions have been eliminated in consolidation. Where our ownership of a subsidiary was less than 100%, the non-controlling interest is reported on our consolidated balance sheets. The non-controlling interest in our consolidated net loss is reported as "Net loss attributable to non-controlling interest" on our Consolidated Statements of Loss. Our audited Consolidated Financial Statements are stated in U.S. Dollars and have been prepared in accordance with accounting principles generally accepted in the U.S. ("GAAP").
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates are required when establishing the allowance for credit losses and the net realizable value of inventory; determining future costs associated with warranties provided; determining the period over which our obligations are fulfilled under agreements to license product rights and/or technology rights; evaluating long-lived and intangible assets and investments for estimated useful lives and impairment; estimating the useful lives and standalone selling prices of instruments under leasing arrangements; determining the allocation of purchase price under purchase accounting; estimating the expense associated with the granting of stock; determining the need for, and the amount of a valuation allowance on deferred tax assets; determining the fair value of our embedded derivatives; determining the value of the contingent consideration in a business combination and determining the value of the non-controlling interest in a business combination. Our actual results may differ from these estimates and there may be changes to those estimates in future periods.
-62-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Concentration of Credit Risk
Financial instruments that potentially subject us to a concentration of credit risk consist of cash and cash equivalents and accounts receivable. We maintain the majority of our cash and cash equivalents with high credit quality financial institutions, and at times may have cash levels that exceed federally insured limits. We have no off-balance-sheet concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign currency hedging arrangements. Our accounts receivable balances are due largely from distribution partners, domestic veterinary clinics and individual veterinarians and other animal health companies.
No customer accounted for more than 10% of our consolidated accounts receivable at December 31, 2022 or 2021.
We have established an allowance for credit losses based upon factors surrounding the credit risk of specific customers, historical trends and other information.
Accounts Receivable
Accounts receivable are recorded net of an allowance for credit losses. From time to time, our customers are unable to meet their payment obligations. We continuously monitor our customers' credit worthiness and establish allowances for estimated credit losses related to our accounts receivable, net investment in leases, contract assets, and promissory notes. Our allowances are established based on factors surrounding the credit risk of specific customers, historical experience including collections and write-off history, and current economic conditions. Account balances are considered past due if payments have not been received within agreed upon invoice and/or contract terms and the Company may employ collection agencies and legal counsel to pursue recovery of defaulted amounts. Account balances are written off against the allowance after all collection efforts have been exhausted and it is probable the receivable will not be recovered. The Company also performs a qualitative assessment, on a quarterly basis, to monitor economic factors and other uncertainties that may require additional adjustments for the expected credit loss allowance.
While such credit losses have historically been within our expectations and the provisions established, there is no assurance that we will continue to experience the same credit loss rates that we have in the past. A significant change in the liquidity or financial position of our customers could have a material adverse impact on the collectability of accounts receivable and our future operating results.
Changes in the allowance for credit losses are summarized as follows (in thousands):
| Years Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Balances at beginning of period | $ | 874 | $ | 769 | $ | 186 | |||||||||||
| Additions from acquisitions | — | 3 | 90 | ||||||||||||||
| Additions - charged to expense | 485 | 353 | 614 | ||||||||||||||
| Deductions - write offs, net of recoveries | (214) | (248) | (121) | ||||||||||||||
| Foreign exchange effects | (16) | (3) | — | ||||||||||||||
| Balances at end of period | $ | 1,129 | $ | 874 | $ | 769 | |||||||||||
-63-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The balance of accounts receivable, net of allowance for credit losses was $29.5 million, $28.0 million and $31.1 million as of December 31, 2022, December 31, 2021 and December 31, 2020, respectively.
As discussed in Note 17, Notes Receivable, the Company also recorded an allowance for expected credit losses on our long-term notes receivable. Inherent in the assessment of the allowance are certain judgments and estimates including, among others, the borrower’s access to capital, the borrower’s willingness or ability to pay, general economic conditions and industry default rates, and the ongoing relationship with the borrower.
Cash and Cash Equivalents
Cash and cash equivalents are stated at cost, which approximates market value, and include short-term, highly liquid investments with original maturities of less than three months. We valued our foreign cash accounts at the spot market foreign exchange rate as of each balance sheet date, with changes due to foreign exchange fluctuations recorded in Accumulated other comprehensive income in the Consolidated Balance Sheets. The majority of our cash and cash equivalents are held in accounts not insured by governmental entities. The foreign cash balances are summarized as follows (denominated in foreign currency, in thousands):
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| European Union Euros | 12,497 | 5,497 | |||||||||
| Swiss Francs | 1,342 | 224 | |||||||||
| Canadian Dollars | 1,854 | 4,191 | |||||||||
| GB Pounds | 104 | — | |||||||||
| Australian Dollars | 564 | 676 | |||||||||
| Malaysian Ringgit | 1,369 | 1,412 | |||||||||
Fair Value of Financial Instruments
In accordance with ASC 820, Fair Value Measurements (“ASC 820”), the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Quoted prices in active markets for similar assets and liabilities, quoted prices for identically similar assets or liabilities in markets that are not active and models for which all significant inputs are observable either directly or indirectly.
Level 3: Unobservable inputs reflecting the reporting entity’s own assumptions or external inputs for inactive markets.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company's financial instruments consist of cash, short-term trade receivables and payables, a long-term note receivable with an embedded derivative asset, and its 3.75% Convertible Senior Notes due 2026 (the "Notes"). The carrying values of cash and cash equivalents and short-term trade receivables and payables approximate fair value because of the short-term nature of the instruments.
The fair values of our financial instruments at December 31, 2022 and December 31, 2021 were (in thousands):
| Total | Level 1 | Level 2 | Level 3 | |||||||||||||||||||||||
| 2022 | ||||||||||||||||||||||||||
| Financial Assets | ||||||||||||||||||||||||||
| Money market fund | $ | 95,000 | $ | 95,000 | $ | — | $ | — | ||||||||||||||||||
| Convertible note receivable embedded derivative | 177 | — | — | 177 | ||||||||||||||||||||||
| Financial Liabilities | ||||||||||||||||||||||||||
| BiEsseA Contingent Consideration | 438 | — | — | 438 | ||||||||||||||||||||||
| Balances, December 31, 2022 | $ | 95,615 | $ | 95,000 | $ | — | $ | 615 | ||||||||||||||||||
| 2021 | Total | Level 1 | Level 2 | Level 3 | ||||||||||||||||||||||
| Financial Assets | ||||||||||||||||||||||||||
| Convertible note receivable embedded derivative | $ | 888 | $ | — | $ | — | $ | 888 | ||||||||||||||||||
| Promissory note receivable embedded derivative | 337 | — | — | 337 | ||||||||||||||||||||||
| Financial Liabilities | ||||||||||||||||||||||||||
BiEsseA Contingent Consideration | 2,334 | — | — | 2,334 | ||||||||||||||||||||||
| Balances, December 31, 2021 | $ | 3,559 | $ | — | $ | — | $ | 3,559 | ||||||||||||||||||
The Company's financial assets based upon Level 3 inputs include embedded derivatives relating to its notes receivable. The Company determined the redemption features of its convertible note receivable represents an embedded derivative. The estimated fair value of the embedded derivative asset is evaluated through Level 3 inputs using a probability-weighted scenario analysis. The Company determined the warrant associated with its promissory note receivable represents a derivative. The estimated fair value of the derivative asset is evaluated through Level 3 inputs, using an enterprise valuation model. For additional information regarding the Company's note receivables and derivatives, refer to Note 17, Notes Receivable.
The estimated fair value of the Company's 3.75% Convertible Senior Notes due in 2026 (the "Notes"), is disclosed at each reporting period and is evaluated through Level 2 inputs with consideration of quoted market prices in less active markets. For additional information regarding the Company's accounting treatment for the issuance of the Notes, refer to Note 16, Convertible Notes.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company's financial liabilities based upon Level 3 inputs include contingent consideration arrangements and notes payable relating to its acquisitions of Lacuna Diagnostics, Inc. ("Lacuna"), BiEsse A-Laboratorio die Analisi Veterinarie S.r.l. (“BSA”), and Biotech Laboratories U.S.A. LLC ("Biotech"). The Company is obligated to pay contingent consideration payments of $2.0 million in connection with the Lacuna acquisition based on the achievement of certain performance metrics within a twelve month period ("Initial Earn Out Period"), reducing to $1.0 million if such metrics were met in a twelve month period subsequent to the Initial Earn Out Period. The fair value of the Lacuna contingent consideration was $0 as of both December 31, 2021 and 2022. The Company is obligated to pay contingent consideration payments of $2.7 million in connection with the BSA acquisition based on the achievement of certain revenue metrics within three annual periods after 2021. Refer to Note 3, Acquisitions and Related Party Items for further discussion.
The fair value of our contingent consideration and notes payable arrangements was determined at inception based on a probability-weighted outcome analysis. The fair value of the contingent consideration and notes payable liabilities associated with future payments were based on several factors, the most significant of which are the financial and product development performance of the acquired businesses. For the contingent consideration liabilities, the Company will update its assumptions each reporting period based on new developments and record such amounts at fair value based on the revised assumptions until the agreements expire. Changes in fair value are recorded in the Consolidated Statements of Loss within general and administrative expenses. The note payable associated with the Biotech acquisition is not adjusted to fair value each period.
The following table presents the changes of our recurring Level 3 assets and liabilities as of December 31, 2022 (in thousands):
| Derivative Assets | Contingent Consideration Liabilities | ||||||||||||||||||||||||||||
| Convertible note receivable | Promissory note receivable | Lacuna | BiEsseA | ||||||||||||||||||||||||||
| Balances, December 31, 2021 | $ | 888 | $ | 337 | $ | — | $ | 2,334 | |||||||||||||||||||||
| Changes in fair value | (711) | (337) | — | (1,641) | |||||||||||||||||||||||||
| Foreign currency impact | — | — | — | (255) | |||||||||||||||||||||||||
| Balances, December 31, 2022 | $ | 177 | $ | — | $ | — | $ | 438 | |||||||||||||||||||||
Options Embedded in Non-controlling Interest
In connection with the Biotech acquisition, the Company applied the guidance in ASC 480, Distinguishing Liabilities from Equity, to determine whether the put and call options embedded in shares representing a non-controlling interest represent a liability. If the fixed price of the embedded put and call options are identical at a stated future date, the embedded options and the non-controlling interest are accounted for on a combined basis as a financing arrangement of the purchase of the non-controlling interest and are recorded as a liability at fair value on the reporting date. The Company fully consolidates the subsidiary, including 100 percent of the subsidiary net income or loss, in its Consolidated Statements of Loss.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Property and Equipment
Property and equipment is stated at cost, net of accumulated depreciation. The costs of additions and improvements are capitalized, while maintenance and repairs are charged to expense as incurred. When an item is sold or retired, the cost and related accumulated depreciation is relieved and the resulting gain or loss, if any, is recognized in the Consolidated Statements of Loss. We provide for depreciation primarily using the straight-line method by charges to income in amounts that allocate the cost of property and equipment over their estimated useful lives as follows:
| Asset Classification | Estimated Useful Life | ||||
| Building | 10 to 43 years | ||||
| Machinery and equipment | 2 to 10 years | ||||
| Office furniture and equipment | 3 to 13 years | ||||
| Computer hardware and software | 3 to 5 years | ||||
| Leasehold and building improvements | 5 to 30 years | ||||
We capitalize certain costs incurred in connection with developing or obtaining software designated for internal use based on three distinct stages of development. Qualifying costs incurred during the application development stage, which consist primarily of internal payroll and direct fringe benefits and external direct project costs, including labor and travel, are capitalized and amortized on a straight-line basis over the estimated useful life of the asset, which range from to five years. Costs incurred during the preliminary project and post-implementation and operation phases are expensed as incurred. These costs are general and administrative in nature and related primarily to the determination of performance requirements, data conversion and training. Costs capitalized in connection with internal-use software were immaterial for the years ended December 31, 2022, 2021, and 2020.
Inventories
Inventories are stated at the lower of cost or net realizable value using the first-in, first-out method. Inventory we manufacture includes the cost of material, labor and overhead. We write down the carrying value of inventory for estimated obsolescence by an amount equal to the difference between the cost of inventory and the estimated market value when warranted based on assumptions of future demand, market conditions, remaining shelf life, or product functionality.
Investments in Unconsolidated Affiliates
Investments in unconsolidated affiliates are measured and recorded as either non-marketable equity securities or equity method investments. Non-marketable equity securities are equity securities without readily determinable fair value that are measured and recorded using a measurement alternative which measures the securities at cost minus impairment, if any, plus or minus changes from qualifying observable price changes. Equity method investments are equity securities in investees we do not control but over which we have the ability to exercise significant influence. When the equity method of accounting is determined to be appropriate, the initial measurement of the investment includes the cost of the investment and all direct transaction costs incurred to acquire the investment. Equity method investments are measured at cost minus impairment, if any, plus or minus our share of equity method investee income or loss, which is recorded as a separate line on the income statement. Both types of investments are evaluated for impairment if a triggering event occurs.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Goodwill, Intangible and Other Long-Lived Assets
Goodwill is initially valued based on the excess of the purchase price of a business combination over the fair value of acquired net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Intangible assets other than goodwill are initially valued at fair value. If a quoted price in an active market for the identical asset is not readily available at the measurement date, the fair value of the intangible asset is estimated based on discounted cash flows using market participant assumptions, which are assumptions that are not specific to the Company. The selection of appropriate valuation methodologies and the estimation of discounted cash flows require significant assumptions about the timing and amounts of future cash flows, risks, appropriate discount rates, and the useful lives of intangible assets. When material, we utilize independent valuation experts to advise and assist us in determining the fair values of the identified intangible assets acquired in connection with a business acquisition and in determining appropriate amortization methods and periods for those intangible assets.
We assess goodwill for impairment annually, at the reporting unit level, in the fourth quarter and whenever events or circumstances indicate impairment may exist. In evaluating goodwill for impairment, we have the option to first assess the qualitative factors to determine whether it is more-likely-than-not that the estimated fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the comparison of the estimated fair value of the reporting unit to the carrying value. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If, after assessing the totality of events or circumstances, we determine that it is more-likely-than-not that the estimated fair value of a reporting is less than its carrying amount, we would then estimate the fair value of the reporting unit and compare it to the carrying value. If the carrying value exceeds the estimated fair value we would recognize an impairment for the difference; otherwise, no further impairment test would be required. In contrast, we can opt to bypass the qualitative assessment for any reporting unit in any period and proceed directly to quantitative analysis. Doing so does not preclude us from performing the qualitative assessment in any subsequent period. Following the acquisition of scil in April 2020, we restructured our operating segments based on how the Chief Operating Decision Maker (“CODM”) manages the business, allocates resources, makes operating decisions and evaluates operating performance. As further discussed in Note 18, our new reporting segments are North America and International. As a result of the change in operating segments, we also revised our reporting units to aggregate our legal entities based on similarities in economic characteristics.
As a result of the recent global economic disruption and uncertainty due to the COVID-19 pandemic, the Company performed a qualitative assessment during the first quarter of 2020. Based on the interim assessment performed, we concluded that there was no triggering event and additionally, no indications of impairment existed. We performed qualitative assessments in the fourth quarters of 2021 and 2020 and determined that no indications of impairment existed. Despite no indication of a triggering event or indications of impairment throughout 2022, in the fourth quarter, we elected to bypass the qualitative approach and instead proceeded directly to assessing the fair value of all of our reporting units and comparing the fair value of each reporting unit to the carrying value to determine if any impairment exists. We estimate the fair values of the reporting units using an income approach based on discounted forecasted cash flows. The income approach involves making significant assumptions about the extent and timing of future cash flows, growth rates and discount rates. Model assumptions are based on our projections and best estimates, using appropriate and customary market participant assumptions. Changes in forecasted cash flows or the discount rate would affect the estimated fair values of our reporting units and could result in a goodwill impairment loss in a future period. We also utilize a market approach utilizing guideline public company method or guideline transaction method, or both.
No goodwill impairment was identified during the year ended December 31, 2022.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
We assess the realizability of intangible assets other than goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If an impairment review is triggered, we evaluate the carrying value of intangible assets based on estimated undiscounted future cash flows over the remaining useful life of the primary asset of the asset group and compare that value to the carrying value of the asset group. The cash flows that are used contain our best estimates, using appropriate and customary assumptions and projections at the time. If the net carrying value of an intangible asset exceeds the related estimated undiscounted future cash flows, an impairment to adjust the intangible asset to its fair value would be reported as a non-cash charge to earnings. If necessary, we would calculate the fair value of an intangible asset using the present value of the estimated future cash flows to be generated by the intangible asset, and applying a risk-adjusted discount rate. We had a $0.2 million impairment of our intangible assets during the year ended December 31, 2022. We had no impairments of our intangible assets during the years ended December 31, 2021 and 2020.
Revenue Recognition
We generate revenue through the sale of products, either by outright purchase by our customers or through a subscription agreement whereby our customers receive instruments and pay us a monthly fee for the consumables needed to conduct testing. Subscription placement is the majority of our POC laboratory transactions while outright sales to customers are the majority of both POC imaging diagnostic transactions and Pharmaceuticals, Vaccines and Diagnostic ("PVD") revenue.
With the acquisition of VetZ on January 3, 2022, the Company entered the market for veterinary PIMS. Revenue for the sale of software licenses is recognized at a point in time upon delivery of the software. The software has significant stand-alone functionality, and provides the customer with the right to use the intellectual property as it exists at the point in time at which the license is granted. Revenue for support services, cloud-based services, and installation and training is recognized over time as the services are performed. Refer to Note 3 for further details regarding the VetZ acquisition.
For outright sales of products, revenue is recognized when control of the promised product or service is transferred to our customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those products or services (the transaction price). Taxes assessed by governmental authorities and collected from the customer are excluded from our revenue recognition. A performance obligation is a promise in a contract to transfer a distinct product or service to a customer and is the unit of account under ASC 606. For instruments, consumables and most software licenses sold by the Company, control transfers to the customer at a point in time. To indicate the transfer of control, the Company must have a present right to payment, legal title must have passed to the customer, the customer must have the significant risks and rewards of ownership and where acceptance is not a formality, the customer must have accepted the product or service. Heska’s principal terms of sale are FOB Shipping Point, or equivalent, and, as such, we primarily transfer control and record revenue for product sales upon shipment. If a performance obligation to the customer with respect to a sales transaction remains unfulfilled following shipment (typically owed installation), revenue recognition for that performance obligation is deferred until such commitments have been fulfilled. For extended warranty and service plans, control transfers to the customer over the term of the arrangement and as such the revenue is recognized ratably based upon the period of time elapsed under the arrangement.
The Company may enter into contracts that represent a bill-and hold-arrangement, under which the Company bills a customer for product but retains physical possession of the product until some future point in time. For bill-and-hold arrangements, the Company recognizes revenue when control of the product transfers to the customer in accordance with the additional criteria in ASC 606-10-55-83.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Our revenue under subscription agreements relates to operating-type lease ("OTL") arrangements or sales-type lease ("STL") arrangements. Classification of an OTL or STL is primarily determined as a result of the length of the contract as compared to the estimated economic life of the instrument, among other factors. Leases are outside of the scope of ASC 606 and are therefore accounted for in accordance with ASC 842, Leases. An STL would result in earlier recognition of instrument revenue as compared to an OTL, which is generally upon installation of the instruments. Instrument lease revenue for our OTL subscription agreements is recognized on a straight-line basis over the life of the lease and is included with the predominant non-lease components in consumables revenue. For instrument only OTL agreements, operating lease income is recognized on a straight-line basis over the term of the lease. The cash collected under both arrangements is over the term of the contract. The OTLs and STLs are not cancellable until after an initial term. See below for additional information on our lease accounting policies.
For contracts with both lease and non-lease components, the Company allocates the contracts' transaction price for each component on a relative standalone selling price basis using our best estimate of the standalone selling price of each distinct product or service in the contract. When available, the method used to estimate the standalone selling price is the price observed in standalone sales to customers. When prices in standalone sales are not available, we use a cost-plus margin approach. Changes in these values can impact the amount of consideration allocated to each component of the contract. Allocation of the transaction price is determined at the contracts' inception. The Company does not adjust the transaction price for the effects of a significant financing component when the period between the transfer of the promised good or service to the customer and payment for that good or service by the customer is expected to be one year or less.
To the extent the transaction price includes variable consideration, such as future payments based on consumable usage over time, we apply judgment to determine if the variable consideration should be constrained. As the variable consideration is highly susceptible to factors outside of the Company’s influence, and the potential values contain a broad range of possible outcomes given all potential amounts of consumption that could occur, it is likely that a significant revenue reversal would occur should the variable consideration be estimated at an amount greater than the minimum stated amount until such a time as the uncertainty is resolved. For our subscription agreements with variable consideration based on consumable usage over time, the variable consideration is allocated to the non-lease components upon resolution of the uncertainty and is included in consumables revenue.
We generate Other Vaccines and Pharmaceuticals ("OVP") revenue through contract manufacturing agreements with customers. Revenue from these customer contracts is generally recognized upon shipment or acceptance by our customer, under the same guidelines noted above for other outright product sales. Heska assessed the over-time criteria within ASC 606 and concluded that while products within this segment have no alternative use to Heska, as Heska is contractually prohibited to redirect the product to other customers, Heska does not have right to payment for performance to date. Therefore, point in time revenue recognition has been determined to be appropriate.
Recording revenue from the sale of products involves the use of estimates and management's judgment. We must make a determination at the time of sale whether the customer has the ability and intent to make payments in accordance with arrangements. For contracts with multiple performance obligations, we exercise judgment in allocating the transaction price for each performance obligation based on an estimated standalone selling price for each distinct product or service. We do not generally allow return of products or instruments. Distributor rebates are recorded as a reduction to revenue.
Refer to Note 2 for additional disclosures required by ASC 606.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Leases
The Company acts as a lessee and a lessor. As a lessee, the Company leases buildings, office equipment, and vehicles. As a lessor, the Company enters into sales-type and operating leases as part of its subscription agreements.
The Company determines if an arrangement is a lease at inception based on whether control of an identified asset is transferred. For leases where the Company is the lessee, ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent an obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. The measurement of future lease payments includes fixed payments, as well as fixed rate increases that are initially measured at the lease commencement date. Variable lease payments, typically based on the usage of the underlying asset or changes in an index or rate, are excluded from the measurement of ROU assets and lease liabilities and are expensed as incurred.
As most of the Company’s leases do not provide an implicit interest rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The lease terms used to calculate the ROU asset and related lease liability include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for operating leases is recognized on a straight-line basis over the lease term as an operating expense while the expense for finance leases is recognized as amortization expense and interest expense. The Company has lease agreements which require payments for lease and non-lease components and has elected to account for these as a single lease component for our building and office equipment leases, but as separate components for our vehicle leases.
As a lessor, our subscription agreements relate to both OTL arrangements and STL arrangements. For a STL, instrument revenue is generally recorded upon installation of the instruments and the cost of the customer-leased instruments is removed from inventory and recognized in the Consolidated Statements of Loss. There is no residual value taken into consideration as it does not meet our capitalization requirements. There is no option for a lessee to purchase the underlying asset and the lease term does not include an assumption that the lease will be extended or terminated. For our OTL agreements that include both lease and non-lease components, revenue is recognized on a straight-line basis over the term of the lease and is included with the predominant non-lease components in consumables revenue. For instrument only OTL agreements, operating lease income is recognized on a straight-line basis over the term of the lease. For an OTL, the costs of customer-leased instruments are recorded within property and equipment in the accompanying Consolidated Balance Sheets and depreciated over the instrument’s estimated useful life. The depreciation expense is reflected in cost of revenue in the accompanying Consolidated Statements of Loss.
For leases that commenced before the January 1, 2019 effective date of ASC 842, the Company elected the permitted practical expedients to not reassess the following: (i) whether any expired or existing contracts contain leases; (ii) the lease classification for any expired or existing leases; and (iii) initial direct costs for any existing leases. The Company also elected to exclude leases with a term of 12 months or less from the recognized ROU assets and lease liabilities.
Stock-based Compensation
Stock-based compensation expense is measured at the grant date based upon the estimated fair value of the portion of the award that is ultimately expected to vest and is recognized as expense over the applicable requisite service period of the award generally using the straight-line method.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Advertising Costs
Advertising costs are expensed as incurred and are included in sales and marketing expenses. Advertising expenses were $1.4 million for the year ended December 31, 2022, $0.6 million for the year ended December 31, 2021, and $0.4 million for the year ended December 31, 2020.
Income Taxes
The Company records a current provision for income taxes based on estimated amounts payable or refundable on tax returns filed or to be filed each year. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates, in each tax jurisdiction, expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date. The overall change in deferred tax assets and liabilities for the period measures the deferred tax expense or benefit for the period. Deferred tax assets are reduced by a valuation allowance based on a judgmental assessment of available evidence if the Company is unable to conclude that it is more likely than not that some or all of the deferred tax assets will be realized.
Earnings Per Share
Basic earnings per share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued.
Foreign Currency Translation
The functional currency of certain foreign subsidiaries is the local currency. Accordingly, assets and liabilities of these subsidiaries are translated using the exchange rate in effect at the balance sheet date. Revenue and expense accounts and cash flows are translated using an average of exchange rates in effect during the period. Cumulative translation gains and losses are shown in the Consolidated Balance Sheets as a separate component of stockholders' equity. Exchange gains and losses arising from transactions denominated in foreign currencies (i.e., transaction gains and losses) are recognized as a component of other income (expense) in current operations, as are exchange gains and losses on intercompany transactions expected to be settled in the near term. Gains and losses arising from intercompany foreign currency transactions that are of a long-term investment nature are reported as a component of Accumulated other comprehensive income in the Consolidated Balance Sheets.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Warranty Costs
The Company generally provides for the estimated cost of hardware and software warranties in the period the related revenue is recognized. The Company assesses the adequacy of its accrued warranty liabilities and adjusts the amounts as necessary based on actual experience and changes in future estimates. Should product failure rates differ from our estimates, actual costs could vary significantly from our expectations. Extended warranties are sold to our customers and revenue is recognized over the term of the warranty agreement, as expected costs are incurred.
Adoption of New Accounting Pronouncements
Effective January 1, 2022, we adopted ASU 2021-05, Leases (Topic 842), Lessors- Certain Leases with Variable Lease Payments. This guidance amends the lease classification accounting for lessors for certain leases with variable lease payments that do not depend on a reference index or a rate and would have resulted in the recognition of a loss at lease commencement if classified as a sale-type or direct financing lease. Under the new guidance, these leases will be classified as an operating lease. We evaluated the impact of the standard on our consolidated financial statements and the adoption of this ASU did not have a material impact on our consolidated financial statements and disclosures.
Effective January 1, 2022, we early adopted ASU 2021-08, Business Combinations (Topic 805), Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. This guidance requires an acquiring entity to recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. At the acquisition date, the acquirer should account for the related revenue contracts in accordance with Topic 606 as if it had originated the contracts. We evaluated the impact of the standard on our consolidated financial statements and the adoption of this ASU did not have a material
impact on our consolidated financial statements and disclosures.
2. REVENUE
We separate our goods and services among two reportable segments, North America and International. The two segments consist of revenue originating from:
•North America: including the United States, Canada and Mexico
•International: all geographies outside North America, currently consisting primarily of Australia, France, Germany, Italy, Malaysia, Spain and Switzerland
Refer to Note 18 for further detail regarding the Company's reportable segments.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes our segment revenue (in thousands):
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| North America Revenue: | |||||||||||||||||
| POC Lab Instruments & Other | $ | 17,178 | $ | 14,837 | $ | 13,663 | |||||||||||
| POC Lab Consumables | 78,302 | 72,004 | 59,247 | ||||||||||||||
| POC Imaging & Informatics | 27,335 | 29,512 | 20,651 | ||||||||||||||
| PVD | 22,020 | 24,939 | 19,810 | ||||||||||||||
| OVP | 16,927 | 17,606 | 17,695 | ||||||||||||||
| Total North America Revenue | $ | 161,762 | $ | 158,898 | $ | 131,066 | |||||||||||
| International Revenue: | |||||||||||||||||
| POC Lab Instruments & Other | $ | 15,660 | $ | 15,001 | $ | 7,782 | |||||||||||
| POC Lab Consumables | 41,205 | 46,016 | 32,354 | ||||||||||||||
| POC Imaging & Informatics | 35,209 | 28,492 | 22,537 | ||||||||||||||
| PVD | 3,471 | 5,332 | 3,584 | ||||||||||||||
| Total International Revenue | $ | 95,545 | $ | 94,841 | $ | 66,257 | |||||||||||
| Total Revenue | $ | 257,307 | $ | 253,739 | $ | 197,323 | |||||||||||
Remaining Performance Obligations
Remaining performance obligations represent the aggregate transaction price allocated to performance obligations with an original contract term greater than one year which are fully or partially unsatisfied at the end of the period. Remaining performance obligations include noncancellable purchase orders, the non-lease portion of minimum purchase commitments under long-term supply arrangements, extended warranty, service and other long-term contracts. Remaining performance obligations do not include revenue from contracts with customers with an original term of one year or less, revenue from long-term supply arrangements with no minimum purchase requirements, revenue expected from purchases made in excess of the minimum purchase requirements, or revenue from instruments leased to customers. While the remaining performance obligation disclosure is similar in concept to backlog, the definition of remaining performance obligations excludes leases and contracts that provide the customer with the right to cancel or terminate for convenience with no substantial penalty, even if historical experience indicates the likelihood of cancellation or termination is remote. Additionally, the Company has elected to exclude contracts with customers with an original term of one year or less from remaining performance obligations.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of December 31, 2022, the aggregate amount of the transaction price allocated to remaining minimum performance obligations was approximately $219.2 million. As of December 31, 2022, the Company expects to recognize revenue as follows (in thousands):
| Year Ending December 31, | Revenue | ||||
| 2023 | $ | 51,556 | |||
| 2024 | 47,923 | ||||
| 2025 | 41,660 | ||||
| 2026 | 36,428 | ||||
| 2027 | 22,720 | ||||
| Thereafter | 18,941 | ||||
| $ | 219,228 | ||||
Contract Balances
The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled contract assets, deferred revenue, and customer deposits and billings in excess of revenue recognized. In addition, the Company defers certain costs incurred to obtain contracts.
Contract Assets
Certain unbilled amounts related to long-term contracts for which we provide a free term to the customer are recorded in Other current assets and Other non-current assets on the accompanying Consolidated Balance Sheets. The collection of these balances occurs over the term of the underlying contract. The balances as of December 31, 2022 were $1.8 million and $5.9 million for current and non-current assets, respectively, shown net of related unearned interest. The balances as of December 31, 2021 were $1.5 million and $5.1 million for current and non-current assets, respectively, shown net of related unearned interest. The increase in contract assets for the twelve-month period ended December 31, 2022 is primarily related to additional contract assets recorded for contracts with a free term, partially offset by payments received. The balances as of December 31, 2020 were $1.2 million and $4.1 million for current and non-current assets, respectively, shown net of related unearned interest.
Contract Liabilities
The Company receives cash payments from customers for licensing fees or other arrangements that extend for a specified term. These contract liabilities are classified as either current or long-term in the Consolidated Balance Sheets based on the timing of when the Company expects to recognize revenue. As of December 31, 2022, 2021 and 2020 contract liabilities were $8.3 million, $9.6 million and $9.9 million respectively, and are included within Deferred revenue, current, and other and Deferred revenue, non-current in the accompanying Consolidated Balance Sheets. The decrease in the contract liability balance during the year ended December 31, 2022 is attributable to approximately $10.9 million of revenue recognized during the period and an exchange rate impact of $0.1 million, partially offset by approximately $8.8 million of additional deferred sales in 2022, and the acquisition of VetZ contract liabilities of approximately $0.9 million. The decrease in the contract liability balance during the year ended December 31, 2021 is $6.8 million of revenue recognized during the period, offset by $6.5 million of additional deferred sales. Contract liabilities are reported on the accompanying Consolidated Balance Sheets on a contract-by-contract basis.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Contract Costs
The Company capitalizes certain direct incremental costs incurred to obtain customer contracts, typically sales-related commissions, where the recognition period for the related revenue is greater than one year. Contract costs are classified as current or non-current, and are included in "Other current assets" and "Other non-current assets" in the Consolidated Balance Sheets based on the timing of when the Company expects to recognize the expense. Contract costs are generally amortized into selling and marketing expense with a certain percentage recognized immediately based upon placement of the instrument with the remainder recognized on a straight-line basis (which is consistent with the transfer of control for the related goods or services) over the average term of the underlying contracts, approximately 6 years. Management assesses these costs for impairment at least quarterly on a portfolio basis and as “triggering” events occur that indicate it is more-likely-than-not that an impairment exists. The balances of contract costs as of December 31, 2022, 2021 and 2020 were $5.0 million, $4.1 million and $3.0 million respectively. The increase in contract costs for the year ended December 31, 2022 is due to approximately $2.4 million of additional contract cost capitalization, offset by amortization expense of approximately $1.5 million. In the year ended December 31, 2021, approximately $2.2 million of additional contract costs were capitalized, offset by amortization expense of approximately $1.1 million. Contract costs are calculated and reported on a portfolio basis.
3. ACQUISITION AND RELATED PARTY ITEMS
VetZ Acquisition
On January 3, 2022, the Company acquired 100% of the equity of VetZ, a European leader in veterinary PIMS, for an aggregate purchase price of approximately $35.5 million. The purchase price consisted of approximately $31.6 million in cash as well as contingent consideration as described below. The cash purchase price includes a general indemnity holdback of approximately $1.4 million to be released within 18 months of closing. The cash purchase price was also reduced by a negative net working capital adjustment of approximately $0.6 million.
As additional consideration for the acquisition, the Company agreed to a contingent earn-out of 91,039 shares of Heska stock, with a total value of $15.5 million, which will be issued in tranches based on future financial and non-financial milestones. The fair value of the contingent consideration as of the acquisition date was approximately $3.9 million, determined using a Monte-Carlo simulation model. The Company evaluated whether the contingent earn-out should be treated as a liability or equity in accordance with ASC 480, Distinguishing Liabilities from Equity (“ASC 480”), and ASC 815, Derivatives and Hedging (“ASC 815”). The contingent earn-out did not meet the ASC 480 definition of a liability as it is not mandatorily redeemable, is not an obligation to repurchase the Company’s shares, and it can only be settled with a fixed number of shares. Additionally, the Company noted the contingent earn-out met the scope exception in ASC 815-10 as the earn-out is indexed to the Company’s own shares, and also met the criteria in ASC 815-40 to be classified in equity as the Company has sufficient authorized and unissued shares, the earn-out has an explicit share limit, there are no required cash payments. As such the contingent earn-out is classified in equity, and is not subsequently remeasured each reporting period. Subsequent settlement of the obligation will be accounted for within equity.
The purchase price exceeded the fair value of the identifiable net assets, resulting in goodwill of $22.0 million, all of which is attributable to our International segment. The goodwill resulting from this acquisition consists of new product offerings from entering the PIMS market. All of the goodwill is tax deductible for purposes of calculating Controlled Foreign Corporation tested income, which may result in a decrease to the Company's future U.S. federal tax liability.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The acquisition was accounted for as a business combination in accordance with ASC 805, Business Combinations. As such, the total purchase consideration was allocated to the assets acquired and liabilities assumed based on their fair values as of January 3, 2022. The total purchase consideration is subject to customary working capital adjustments.
The information below represents the purchase price allocation as of the acquisition date (in thousands):
| January 3, 2022 | |||||
| Purchase price in cash | $ | 31,627 | |||
| Fair value of equity contingent consideration | 3,860 | ||||
| Total purchase consideration | $ | 35,487 | |||
| Cash and cash equivalents | $ | 1,251 | |||
| Inventory | 359 | ||||
| Accounts receivable | 824 | ||||
| Prepaid expenses and other assets | 318 | ||||
| Property and equipment, net | 602 | ||||
| Operating lease right-of-use assets | 2,962 | ||||
| Intangible assets | 18,504 | ||||
| Total assets acquired | 24,820 | ||||
| Accounts payable | 520 | ||||
| Accrued liabilities | 1,260 | ||||
| Operating lease liabilities, current | 247 | ||||
| Deferred revenue, current, and other | 1,014 | ||||
| Operating lease liabilities, non-current | 2,714 | ||||
| Deferred tax liabilities | 5,246 | ||||
| Other liabilities | 318 | ||||
| Net assets acquired | 13,501 | ||||
| Goodwill | 21,986 | ||||
| Total fair value of consideration transferred | $ | 35,487 | |||
During the year ended December 31, 2022, the Company made certain valuation adjustments to provisional amounts previously recognized. These measurement period adjustments resulted in a net $584 thousand decrease of goodwill, primarily due to fair value adjustments and a change in municipality tax rate resulting in an increase in net identifiable assets acquired. The Company finalized the accounting for the VetZ acquisition in the fourth quarter of 2022.
Intangible assets acquired, amortization method and estimated useful life as of January 3, 2022, were as follows (dollars in thousands):
| Weighted- Average Useful Life | Amortization Method | Fair Value | |||||||||||||||
| Customer relationships | 12 years | Straight-line | $ | 12,941 | |||||||||||||
| Trade name | 8 years | Straight-line | 1,816 | ||||||||||||||
| Developed technology | 4.3 years | Straight-line | 3,747 | ||||||||||||||
| Total intangible assets acquired | $ | 18,504 | |||||||||||||||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
VetZ generated net revenue of $12.2 million and a net loss of $1.5 million for the period from January 3, 2022 to December 31, 2022.
The Company incurred acquisition related costs of approximately $0.7 million and $0.6 million for the twelve months ended December 31, 2022 and 2021, respectively, which are included within general and administrative expenses on our Consolidated Statements of Loss.
Unaudited Pro Forma Financial Information
The following table presents unaudited supplemental pro forma financial information as if the acquisition had occurred on January 1, 2021 (in thousands):
| Year Ended December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Revenue, net | $ | 257,307 | $ | 265,093 | |||||||
| Net (loss) income before equity in losses of unconsolidated affiliates | $ | (18,424) | $ | 940 | |||||||
| Net loss attributable to Heska Corporation | $ | (19,889) | $ | (340) | |||||||
Biotech Acquisition
On September 1, 2021, Heska acquired 65% of the equity of Biotech Laboratories U.S.A. LLC ("Biotech"), a developer of rapid assay diagnostic testing, in exchange for approximately $16.3 million in cash. As part of the purchase, Heska entered into put and call options in order to purchase the remaining 35% ownership in future years. The counterparty, Chinta Lamichhane, DVM, Ph.D, maintains an interest in Biotech and is an employee of the Company, thus commencing a related party relationship. Aside from the acquisition described herein, there were no financial or non-financial transactions between the Company and the counterparty.
In conjunction with the acquisition, the Company entered into various put and call options which are classified on the Consolidated Balance Sheets as Notes payable. The Company is obligated to pay contingent notes of up to $17.5 million based on the achievement of certain product development milestones or at a predetermined date in the future. The written put options can be exercised after June 30, 2024, at a valuation identical to the initial purchase price. The written call options can be exercised at any time prior to June 30, 2026, at an amount equal to two times the initial valuation or after June 30, 2026, at a valuation identical to the initial purchase price. Additionally, if certain product development milestones are met, the shares may be bought in various tranches at two times the initial valuation. The Company evaluated the put and call options embedded in the shares representing the non-controlling interest under the guidance in ASC 480, Distinguishing Liabilities from Equity, and determined the instrument met the criteria to be recorded as a liability because the fixed price of the put and call options are identical starting after June 30, 2026. As a result, the Company recorded the transaction as a financing arrangement of the purchase of the non-controlling interest, and will record 100% of the income and loss of Biotech in our Consolidated Statements of Loss. The options were not redeemable as of the acquisition date. As of the period ending December 31, 2022, two of the product development milestones were achieved. During the year ended December 31, 2022, the Company made payments of $5.3 million. $4.8 million was a reduction to Notes payable and $0.5 million was recorded to interest expense. The Company acquired an additional 10.50% interest for a majority interest ownership of 75.50%. The counterparty owns the remaining minority interest of 24.50%. The estimated fair value of the Notes Payable as of the acquisition date of $15.9 million is inclusive of the probability weighted outcomes of the options described herein and was determined using Level 3 inputs. As of the period ending December 31, 2022, the remaining value of the Notes Payable is $11.1 million.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The total purchase consideration exceeded the fair value of the identifiable net assets acquired, resulting in goodwill of $25.8 million, all of which is attributable to our North America segment and primarily consists of opportunities to expand product offerings and the experienced workforce acquired. In connection with the acquisition and pursuant to the elections under Section 754 of the Internal Revenue Code, the Company expects to obtain an increase with respect to the tax basis in the assets of Biotech.
The acquisition was accounted for as a business combination in accordance with ASC 805, Business Combinations. As such, the total purchase consideration was allocated to the assets acquired and liabilities assumed based on their fair values as of September 1, 2021. The total purchase consideration is subject to customary working capital adjustments, which were finalized as of September 1, 2022.
The information below represents the purchase price allocation as of the acquisition date (in thousands):
| September 1, 2021 | |||||
| Purchase price in cash | $ | 16,250 | |||
| Notes payable | 15,900 | ||||
| Total purchase consideration | $ | 32,150 | |||
| Accounts receivables | $ | 18 | |||
| Other current assets | 1 | ||||
| Inventories | 190 | ||||
| Property and equipment, net | 148 | ||||
| Operating lease right-of-use assets | 1,033 | ||||
| Other intangible assets, net | 6,000 | ||||
| Other non-current assets | 15 | ||||
| Total assets acquired | 7,405 | ||||
| Accounts payable | 11 | ||||
| Accrued liabilities | 33 | ||||
| Operating lease liabilities, current | 188 | ||||
| Operating lease liabilities, non-current | 845 | ||||
| Net assets acquired | 6,328 | ||||
| Goodwill | 25,822 | ||||
| Total fair value of consideration transferred | $ | 32,150 | |||
Intangible assets acquired, amortization method and estimated useful life as of September 1, 2021, was as follows (dollars in thousands):
| Useful Life | Amortization Method | Fair Value | |||||||||||||||
| Developed technology | 6 years | Straight-line | $ | 6,000 | |||||||||||||
| Total intangible assets acquired | $ | 6,000 | |||||||||||||||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company incurred acquisition related costs of approximately $0.6 thousand and $0.4 million for the years ended December 31, 2022 and 2021, respectively, which are included within general and administrative expenses on our Consolidated Statements of Loss.
Pro forma financial information related to the acquisition of Biotech has not been provided as it is not material to our consolidated results of operations.
BiEsseA Acquisition
On July 1, 2021, the Company completed the acquisition of BiEsse A-Laboratorio die Analisi Veterinarie S.r.l. (“BSA”). The Company acquired 100% of the issued and outstanding shares of BSA for an aggregate purchase price of $7.2 million, consisting of $4.8 million in cash and contingent consideration described below. On January 1, 2022, BSA was merged into scil animal care company Srl, a wholly owned subsidiary of scil animal care company GmbH ("scil").
As additional consideration for the shares, the Company agreed to a contingent earn-out of an additional $2.7 million based on the achievement of certain performance metrics within three annual periods after 2021, each of which can pay up to one third of the total earn-out. The fair value of the contingent consideration was $2.3 million as of the acquisition date and as of December 31, 2021, and subsequently decreased to $0.4 million as of December 31, 2022.
The total purchase consideration exceeded the fair value of the identifiable net assets acquired, resulting in $4.6 million of goodwill, all of which is attributable to our International segment. The goodwill resulting from this acquisition consists largely of the Company's expected future product sales and synergies from combining operations. All of the goodwill is tax deductible for purposes of calculating Controlled Foreign Corporation tested income, which may result in a decrease to the Company's future U.S. federal income tax liability.
The acquisition was accounted for as a business combination in accordance with ASC 805, Business Combinations. As such, the total purchase consideration was allocated to the assets acquired and liabilities assumed based on their fair values as of July 1, 2021. The total purchase consideration is subject to customary working capital adjustments, which were finalized as of December 31, 2021.
Per the tax indemnification included in the purchase agreement of BSA, the seller has indemnified the Company for $0.5 million related to uncertain tax positions taken in prior years. The outcome of this arrangement will either be settled or expire due to lapse of statute of limitations by 2025. As of December 31, 2022, approximately $0.3 million of the indemnification agreement remains outstanding.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The information below represents the purchase price allocation as of the acquisition date (in thousands):
| July 1, 2021 | |||||
| Purchase price in cash | $ | 4,835 | |||
| Fair value of contingent consideration | 2,334 | ||||
| Total purchase consideration | $ | 7,169 | |||
| Cash and cash equivalents | $ | 322 | |||
| Accounts receivables | 152 | ||||
| Other receivables | 497 | ||||
| Prepaid expenses | 8 | ||||
| Other current assets | 275 | ||||
| Property and equipment, net | 89 | ||||
| Operating lease right-of-use assets | 44 | ||||
| Other intangible assets, net | 3,329 | ||||
| Total assets acquired | 4,716 | ||||
| Accounts payable | 208 | ||||
| Accrued liabilities | 334 | ||||
| Operating lease liabilities, current | 37 | ||||
| Deferred revenue, current, and other | 85 | ||||
| Operating lease liabilities, non-current | 20 | ||||
| Deferred tax liability, net | 925 | ||||
| Other liabilities | 500 | ||||
| Net assets acquired | 2,607 | ||||
| Goodwill | 4,562 | ||||
| Total fair value of consideration transferred | $ | 7,169 | |||
Intangible assets acquired, amortization method and estimated useful life as of July 1, 2021, was as follows (dollars in thousands):
| Useful Life | Amortization Method | Fair Value | |||||||||||||||
| Customer relationships | 14 years | Straight-line | $ | 3,329 | |||||||||||||
| Total intangible assets acquired | $ | 3,329 | |||||||||||||||
The Company incurred acquisition related costs of approximately $0 and $0.3 million for the years ended December 31, 2022 and 2021, respectively, which are included within general and administrative expenses on our Consolidated Statements of Loss.
Pro forma financial information related to the acquisition of BSA has not been provided as it is not material to our consolidated results of operations.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Lacuna Acquisition
On February 1, 2021, the Company completed the acquisition of Lacuna Diagnostics, Inc. ("Lacuna"), a veterinary digital cytology company, to broaden the Company's POC diagnostic offerings. The Company acquired 100% of the issued and outstanding shares of Lacuna for a purchase price of $4.3 million. The Company then dissolved Lacuna on February 1, 2021. In accordance with the purchase agreement, the Company is required to hold a $0.4 million general indemnity holdback that is intended to provide a non-exclusive source of funds for the payment of any losses identified and shall be released within 18 months of closing. $0.3 million and $0.1 million of the indemnification holdback was released for licensing fees during the twelve months ended December 31, 2022 and 2021, respectively. As of December 31, 2022, $0.0 million of the indemnification holdback remains outstanding.
As additional consideration for the shares, the Company agreed to a contingent earn-out of an additional $2.0 million based on the achievement of certain performance metrics within a twelve month period ("Initial Earn Out Period"), reducing to $1.0 million if such metrics were met in a twelve month period subsequent to the Initial Earn Out Period. The fair value of the contingent consideration as of the acquisition date was $1.7 million, and subsequently decreased to $0 as of December 31, 2022 and 2021, which resulted in a $1.7 million gain included within general and administrative expenses in the Consolidated Statement of Loss for the year ended December 31, 2021.
The total purchase consideration exceeded the fair value of the identifiable net assets acquired, resulting in $4.2 million of goodwill, primarily related to expanded opportunities with our offerings. All of the goodwill is allocated to the North America segment and is not tax deductible for income tax purposes.
The acquisition was accounted for as a business combination in accordance with ASC 805, Business Combinations. As such, the total purchase consideration was allocated to the assets acquired and liabilities assumed based on their fair values as of February 1, 2021. The total purchase consideration is subject to customary working capital adjustments, which were finalized as of February 1, 2022.
The information below represents the purchase price allocation as of the acquisition date (in thousands):
| February 1, 2021 | |||||
| Purchase price in cash | $ | 4,255 | |||
| Fair value of contingent consideration | 1,700 | ||||
| Total purchase consideration | $ | 5,955 | |||
| Cash and cash equivalents | $ | 3 | |||
| Accounts receivable | 170 | ||||
| Property and equipment, net | 530 | ||||
| Other intangible assets, net | 1,185 | ||||
| Total assets acquired | 1,888 | ||||
| Deferred tax liability | 133 | ||||
| Net assets acquired | 1,755 | ||||
| Goodwill | 4,200 | ||||
| Total fair value of consideration transferred | $ | 5,955 | |||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Intangible assets acquired, amortization method and estimated useful life as of February 1, 2021, was as follows (dollars in thousands):
| Useful Life | Amortization Method | Fair Value | |||||||||||||||
| Developed technology | 3 years | Straight-line | $ | 1,000 | |||||||||||||
| Customer relationships | 6 months | Straight-line | 150 | ||||||||||||||
| Trade name | 11 months | Straight-line | 35 | ||||||||||||||
| Total intangible assets acquired | $ | 1,185 | |||||||||||||||
The Company incurred acquisition related costs of approximately $0 and $0.1 million for the years ended December 31, 2022 and 2021, respectively, which are included within general and administrative expenses on our Consolidated Statements of Loss.
Pro forma financial information related to the acquisition of Lacuna has not been provided as it is not material to our consolidated results of operations.
scil Acquisition
On April 1, 2020, the Company completed the acquisition of scil animal care company GmbH (“scil”) from Covetrus, Inc. The Company purchased 100% of the capital stock of scil for an aggregate purchase price of $110.3 million in cash. The acquisition represents a key milestone in the Company's long-term strategic plan, creating a global veterinary diagnostics company with leadership positions in key geographic markets. The purchase price exceeded the identifiable net assets, resulting in goodwill of $46.0 million, primarily attributable to the synergies expected from the expanded market opportunities with our offerings and the experienced workforce acquired. Of the goodwill acquired, $37.3 million is allocated to our International segment and $8.7 million is allocated to our North America segment. All of the goodwill is tax deductible for purposes of calculating Controlled Foreign Corporation ("CFC") tested income, which may result in a decrease to the Company's future U.S. federal tax liability.
The acquisition was accounted for using the acquisition method of accounting in accordance with ASC 805, Business Combinations, which requires, among other things, that assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. As such, the total purchase consideration was allocated to the assets acquired and liabilities assumed based on a preliminary estimate of their fair values as of April 1, 2020. The Company finalized the accounting for the acquisition as of March 31, 2021.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The information below represents the final purchase price allocation of scil (in thousands):
| April 1, 2020 | |||||
| Total purchase consideration | $ | 110,290 | |||
| Cash and cash equivalents | $ | 5,889 | |||
| Accounts receivable | 10,707 | ||||
| Inventories | 11,278 | ||||
| Net investment in leases, current | 311 | ||||
| Prepaid expenses | 1,692 | ||||
| Other current assets | 1,338 | ||||
| Property and equipment, net | 19,320 | ||||
| Operating lease right-of-use assets | 877 | ||||
| Other intangible assets, net | 44,517 | ||||
| Net investment in leases, non-current | 1,027 | ||||
| Investments in unconsolidated affiliates | 55 | ||||
| Other non-current assets | 291 | ||||
| Total assets acquired | 97,302 | ||||
| Accounts payable | 8,221 | ||||
| Accrued liabilities | 7,067 | ||||
| Operating lease liabilities, current | 356 | ||||
| Deferred revenue, current, and other | 3,220 | ||||
| Deferred revenue, non-current | 94 | ||||
| Operating lease liabilities, non-current | 529 | ||||
| Deferred tax liability | 13,249 | ||||
| Other liabilities | 276 | ||||
| Net assets acquired | 64,290 | ||||
| Goodwill | 46,000 | ||||
| Total fair value of consideration transferred | $ | 110,290 | |||
Per the tax indemnification included in the purchase agreement of scil, the seller has indemnified the Company for $1.1 million related to uncertain tax positions taken in prior years. The outcome of this arrangement will either be settled or expire due to lapse of statute of limitations by 2027. As of December 31, 2022, approximately $0.1 million of the indemnification agreement remains outstanding.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Intangible assets acquired, amortization method and estimated useful life as of April 1, 2020, was as follows (dollars in thousands):
| Useful Life | Amortization Method | Fair Value | |||||||||||||||
| Customer relationships | 10 years | Straight-line | $ | 36,272 | |||||||||||||
| Internally developed software | 7 years | Straight-line | 353 | ||||||||||||||
| Backlog | 0.2 years | Straight-line | 210 | ||||||||||||||
| Non-compete agreements | 2 years | Straight-line | 60 | ||||||||||||||
| Trade name subject to amortization | 0.8 years | Straight-line | 66 | ||||||||||||||
| Trademarks and trade names not subject to amortization | n/a | Indefinite | 7,556 | ||||||||||||||
| Total intangible assets acquired | $ | 44,517 | |||||||||||||||
scil generated net revenue of $61.3 million and a net loss of $1.1 million for the period from April 1, 2020 to December 31, 2020.
The Company incurred acquisition related costs of approximately $0, $0 and $6.3 million for the years ended December 31, 2022, 2021 and 2020, respectively, which are included within general and administrative expenses on our Consolidated Statements of Loss.
Unaudited Pro Forma Financial Information
The following tables present unaudited supplemental pro forma financial information as if the acquisition had occurred on January 1, 2020 (in thousands):
| Year Ended | ||||||||
| December 31, 2020 | ||||||||
| Revenue, net | $ | 215,874 | ||||||
| Net loss before equity in losses of unconsolidated affiliates | $ | (14,848) | ||||||
| Net loss attributable to Heska Corporation | $ | (15,215) | ||||||
The pro forma financial information presented above has been prepared by combining our historical results and the historical results of scil and further reflects the effect of purchase accounting adjustments, including: (i) amortization of acquired intangible assets, (ii) the impact of certain fair value adjustments such as depreciation on the acquired property, plant and equipment, and (iii) historical intercompany sales between the Company and scil. The unaudited pro forma results are presented for informational purposes only and are not necessarily indicative of what actual results of operations would have been if the acquisition had occurred as the beginning of the period presented, nor are they indicative of future results of operations.
Other Related Party Activities
In connection with the VetZ acquisition, the Company entered into a related party building lease agreement with the former owners, who are now employees of the Company. The Company recorded operating lease expense of $284 thousand related to this lease for the twelve months ended December 31, 2022. The right-of-use asset and lease liability related to the building lease were approximately $2.3 million and $2.3 million as of December 31, 2022, respectively.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Prior to the closing of the VetZ acquisition, the former owners who are now employees of the Company purchased vehicles and bicycles from VetZ. As of January 3, 2022, a receivable of approximately $165 thousand was included in the preliminary purchase price allocation related to these transactions. These receivables were settled in full on January 7, 2022.
4. INVESTMENTS IN UNCONSOLIDATED AFFILIATES
The carrying values of investments in unconsolidated affiliates, categorized by type of investment, is as follows (in thousands):
| December 31, 2022 | December 31, 2021 | ||||||||||
| Equity method investment | $ | 941 | $ | 2,406 | |||||||
| Non-marketable equity security investment | 3,018 | 3,018 | |||||||||
| Investment in Unconsolidated Affiliates | $ | 3,959 | $ | 5,424 | |||||||
Equity Method Investment
On September 24, 2018, we invested approximately $5.1 million, including costs, to acquire an equity interest in a business as part of our product development strategy. As of December 31, 2022, our ownership interest in the business was 26.0%. In connection with the investment, the Company entered into a Manufacturing Supply Agreement that grants the Company global exclusivity to specified products to be delivered under the agreement for a 15-year period that begins upon the Company's receipt and acceptance of an initial order under the agreement. The Company accounts for this investment using the equity method of accounting. Under the equity method, the carrying value of the investment is adjusted for the Company's proportionate share of the investee's reported earnings or losses with the corresponding share of earnings or losses reported as Equity in losses of unconsolidated affiliates, listed below Net income before equity in losses of unconsolidated affiliates within the Consolidated Statements of Loss. The Company has a note receivable from the equity method investee. Refer to Note 17, Notes Receivable, for additional details.
Non-Marketable Equity Security Investment
On August 8, 2018, the Company invested approximately $3.0 million, including costs, in exchange for preferred stock of LightDeck. The Company's investment is a non-marketable equity security, recorded using the measurement alternative of cost minus impairment, if any, plus or minus changes resulting from qualifying observable price changes.
As part of the agreement, the Company entered into a Supply and License Agreement, which provides that the LightDeck produce and commercialize products that will enhance the Company's diagnostic portfolio. As part of this agreement, the Company made an upfront payment of $1.0 million related to a worldwide exclusive license agreement over a 20-year period, recorded in both short and long-term other assets. In addition, the agreement provides for an additional contingent payment of $10.0 million, relating to the successful achievement of sales milestones. This potential future milestone payment has not yet been accrued as it is not deemed by the Company to be probable at this time.
Both parties in this arrangement are active participants and are exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. The parties are actively working on developing and testing the product as well as funding the research and development. Heska classifies the amounts paid for research and development work within the North America segment research and
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
development operating expenses. Expense is recognized ratably when incurred and in accordance with the development plan.
On January 3, 2023 (the "closing date"), the Company acquired 100% of the shares of LightDeck for approximately $37 million, of which $13.7 million was the reacquisition of the Company's previously held promissory notes discussed further below and in Note 17. The agreement also included a general indemnity holdback of approximately $2.6 million. The preliminary cash purchase price is subject to potential purchase price adjustments, and the holdback must be released within 18 months of the closing date. The preliminary allocation of the cash purchase price to the fair value of assets acquired and liabilities assumed has not yet been completed. It is not practicable to disclose the preliminary purchase price allocation for this acquisition given the short period of time between the acquisition date and the issuance of these consolidated financial statements.
The Company evaluated the investment in LightDeck as well as a First Promissory Note and Second Promissory Note, discussed in Note 17, to determine whether we met the requirement for consolidation prior to the acquisition within the Variable Interest Entity ("VIE") and Voting Interest Entity ("VOE") models. In accordance with both the VIE and VOE models, it was concluded that while the Company does have a variable interest in LightDeck, the Company does not assert control over LightDeck and therefore should not consolidate their financial results prior to closing a merger transaction.
5. INCOME TAXES
The components of income before income taxes were as follows (in thousands):
| Year Ended December 31, | ||||||||||||||||||||
| 2022 | 2021 | 2020 | ||||||||||||||||||
| Domestic | $ | (13,465) | $ | 2,347 | $ | (9,441) | ||||||||||||||
| Foreign | (8,369) | (5,788) | (4,352) | |||||||||||||||||
| $ | (21,834) | $ | (3,441) | $ | (13,793) | |||||||||||||||
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Temporary differences that give rise to the components of net deferred tax assets (liabilities) are as follows (in thousands):
| December 31, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
| Inventory | $ | 6,995 | $ | 4,616 | ||||||||||
| Accrued compensation | 182 | (70) | ||||||||||||
| Stock options | 3,882 | 3,581 | ||||||||||||
| Research and development tax credit | 1,803 | 1,276 | ||||||||||||
| Research and development expense | 6,387 | 3,291 | ||||||||||||
| Deferred revenue | 1,411 | 1,390 | ||||||||||||
| Property and equipment | 1,533 | 524 | ||||||||||||
| Net operating loss carryforwards | 3,764 | 4,401 | ||||||||||||
| Foreign tax credit carryforward | — | 64 | ||||||||||||
| Sales-type leases | 1,800 | 2,494 | ||||||||||||
| Foreign intangible | (14,098) | (11,477) | ||||||||||||
| Foreign net investment in leases | (2,474) | — | ||||||||||||
| Allowance for bad debt | 1,319 | 219 | ||||||||||||
| Interest expense limitation | 807 | — | ||||||||||||
| Other | (598) | (759) | ||||||||||||
| 12,713 | 9,550 | |||||||||||||
| Valuation allowance | (4,997) | (2,788) | ||||||||||||
| Total net deferred tax assets | $ | 7,716 | $ | 6,762 | ||||||||||
The components of the income tax (benefit) expense are as follows (in thousands):
| Year Ended December 31, | ||||||||||||||||||||
| 2022 | 2021 | 2020 | ||||||||||||||||||
| Current income tax expense (benefit) : | ||||||||||||||||||||
| Federal | $ | 273 | $ | — | $ | (24) | ||||||||||||||
| State | 1,041 | 666 | 339 | |||||||||||||||||
| Foreign | (26) | 225 | 1,465 | |||||||||||||||||
| Total current expense | $ | 1,288 | $ | 891 | $ | 1,780 | ||||||||||||||
| Deferred income tax (benefit) expense: | ||||||||||||||||||||
| Federal | $ | (2,930) | $ | (4,364) | $ | 369 | ||||||||||||||
| State | (1,223) | (813) | 289 | |||||||||||||||||
| Foreign | (545) | 713 | (2,199) | |||||||||||||||||
| Total deferred benefit | (4,698) | (4,464) | (1,541) | |||||||||||||||||
| Total income tax (benefit) expense | $ | (3,410) | $ | (3,573) | $ | 239 | ||||||||||||||
-88-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company's income tax (benefit) expense relating to income (loss) for the periods presented differs from the amounts that would result from applying the federal statutory rate to that income (loss) as follows:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Statutory federal tax rate | 21 | % | 21 | % | 21 | % | |||||||||||
| State income taxes, net of federal benefit | 1 | % | 3 | % | (4) | % | |||||||||||
| Non-consolidated investment income | 1 | % | 8 | % | 1 | % | |||||||||||
| Foreign income inclusion | — | % | — | % | (12) | % | |||||||||||
| Non-temporary stock option benefit | 4 | % | 49 | % | 6 | % | |||||||||||
| Other permanent differences | (1) | % | — | % | 1 | % | |||||||||||
| Foreign tax rate differences | 3 | % | 10 | % | 2 | % | |||||||||||
| Change in tax rate | — | % | 8 | % | 1 | % | |||||||||||
| Change in valuation allowance | (11) | % | 88 | % | (4) | % | |||||||||||
| Other deferred differences | (1) | % | (25) | % | (2) | % | |||||||||||
| Transaction costs | — | % | (4) | % | (6) | % | |||||||||||
| Executive compensation limitation | (9) | % | (65) | % | (6) | % | |||||||||||
| Research & development credit | 6 | % | (1) | % | 2 | % | |||||||||||
| Equity investment | (1) | % | (8) | % | (4) | % | |||||||||||
| Change in uncertain tax benefits | — | % | 11 | % | 3 | % | |||||||||||
| Contingent consideration | 2 | % | 10 | % | — | % | |||||||||||
| Other foreign income taxes due | — | % | (2) | % | — | % | |||||||||||
| Other | 1 | % | 1 | % | (1) | % | |||||||||||
| Effective income tax rate | 16 | % | 104 | % | (2) | % | |||||||||||
In 2022, we had total income tax benefit of $3.4 million, including $4.2 million in domestic deferred income tax benefit and $0.5 million in foreign deferred income tax benefit, and $1.3 million in current income tax expense. In 2021, we had total income tax benefit of $3.6 million, including approximately $5.2 million in domestic deferred income tax benefit and $0.7 million of foreign deferred income tax expense, and $0.9 million in current income tax expense. In 2020, we had total income tax expense of $0.2 million, including approximately $0.6 million in domestic deferred income tax expense and $2.2 million of foreign deferred income tax benefit, and approximately $1.8 million in current income tax expense. Income tax benefit decreased in 2022 from 2021 due to income tax expense related to change in valuation allowance offset by the additional tax benefit from financial reporting loss and research and development credits. Income tax expense decreased in 2021 from 2020 due to change in valuation allowance, stock option benefits, and executive compensation limitation.
Cash paid for income taxes for the years ended December 31, 2022, 2021 and 2020 was $2.7 million, $2.4 million and $993 thousand, respectively.
-89-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company is subject to income taxes in the U.S. federal jurisdiction, and various foreign, state and local jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. Although the U.S. and many states generally have statutes of limitations ranging from 3 to 5 years, those statutes could be extended due to the Company’s net operating loss and tax credit carryforward positions in several of the Company's tax jurisdictions. In the U.S., the tax years 2019 - 2021 remain open to examination by the Internal Revenue Service.
As of December 31, 2022, the Company had a domestic research and development tax credit carryforward of approximately $1.8 million for federal tax purposes, which is offset by the uncertain tax position of $0.5 million, discussed below. All federal net operating loss carryforwards (“NOL”) are expected to be utilized in 2022. Our foreign NOL of $13.1 million and foreign interest expense limitation carryforward of $0.8 million do not have an expiration date.
The Company considered multiple factors in assessing the need for an increase in the partial valuation allowance against the Company’s deferred tax assets as of December 31, 2022. Due to future projected income and IRC §174 research and development capitalization requirements, the Company believes it will be able to utilize the remaining research and development tax credits before they expire. For foreign purposes, the Company believes due to projected losses and historical three year cumulative losses in Germany, France, Italy and Spain, all statutory deferred tax assets will not be utilized and therefore increased the valuation allowance against all statutory deferred balances. As a result, the Company recorded an additional $2.2 million tax effected increase to the current partial valuation allowance against the Company's statutory foreign assets for the year ended December 31, 2022. As of December 31, 2022, the Company had a deferred tax asset of approximately $6.4 million from net operating losses, interest expense limitation carryforward, and tax credits and a net partial valuation allowance of approximately $5.0 million recorded against these deferred tax assets. The Company will continue to closely monitor the need for an additional valuation allowance against its deferred tax assets in each subsequent reporting period, which can be impacted by actual operating results compared to the Company's forecast.
ASC Topic 740 prescribes the accounting for uncertainty in income taxes recognized in the financial statements in accordance with the other provisions contained within this guidance. This topic prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely or being realized upon ultimate audit settlement. In the normal course of business, the Company's tax returns are subject to examination by various taxing authorities. Such examination may result in future tax and interest assessments by these taxing authorities for uncertain tax positions taken in respect to certain matters.
The following provides a reconciliation of unrecognized tax benefits (in thousands):
| Year Ended December 31, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
| Balance at beginning of period | $ | (893) | $ | (808) | ||||||||||
Additions based on prior year tax positions | (378) | (508) | ||||||||||||
| Additions based on current year tax position | (104) | — | ||||||||||||
| Reductions from lapse in statues of limitation | 436 | 404 | ||||||||||||
| Currency translation adjustment | 47 | 19 | ||||||||||||
| Other adjustment | 28 | — | ||||||||||||
| Balance at the end of period | $ | (864) | $ | (893) | ||||||||||
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The total amount of unrecognized tax benefits as of December 31, 2022 was approximately $0.9 million, which may impact the effective tax rate if recognized. Historically, these unrecognized tax benefits were recognized as part of the acquisition of scil animal care company GmbH ("scil") in 2020 and BiEssA A-Laboratorio die Analisi Veterinarie S.r.l ("BSA") in 2021. Per the tax indemnification included in the purchase agreements of scil and BSA, the sellers have indemnified the Company for these other liabilities, which would reduce the economic impact to the Company if these positions were settled with tax authorities. In 2022, the Company increased unrecognized tax benefits of $0.5 million related to the 2019 - 2022 domestic research and development tax credits. These credits often receive challenge and include controversy in the Internal Revenue Service's interpretation of both facts and law that may differ from that of the Company. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, the Company does not expect the change to have a material impact on the combined financial statements. The Company recognizes interest and penalties related to uncertain tax positions in income tax (benefit)/expense. Interest and penalties accrued as of December 31, 2022 are $28 thousand.
As of December 31, 2022, the Company had accumulated undistributed earnings generated by foreign subsidiaries of approximately $4.1 million, which would be subject to U.S. taxes and foreign withholding taxes of approximately $0.2 million if repatriated. If the Company decides to repatriate these foreign earnings, it would need to adjust its income tax provision in the period it determined that the earnings would no longer be indefinitely invested outside the United States.
6. LEASES
Lessee Accounting
The Company leases buildings, office equipment, and vehicles. The following table summarizes the Company's operating and finance lease balances (in thousands):
| Leases | Balance Sheet Location | December 31, 2022 | December 31, 2021 | |||||||||||||||||
| Assets | ||||||||||||||||||||
| Operating | Operating lease right-of-use assets | $ | 6,897 | $ | 5,198 | |||||||||||||||
| Finance | 1,471 | 1,650 | ||||||||||||||||||
| Total Leased Assets | $ | 8,368 | $ | 6,848 | ||||||||||||||||
| Liabilities | ||||||||||||||||||||
| Operating | Operating lease liabilities, current | $ | 2,944 | $ | 2,227 | |||||||||||||||
| Operating lease liabilities, non-current | 4,528 | 3,509 | ||||||||||||||||||
| Finance | 127 | 200 | ||||||||||||||||||
| 307 | 331 | |||||||||||||||||||
| Total Lease Liabilities | $ | 7,906 | $ | 6,267 | ||||||||||||||||
For the year ended December 31, 2022, operating lease expense was approximately $3.2 million, including immaterial variable lease costs. For the year ended December 31, 2021, operating lease expense was approximately $3.1 million, including immaterial variable lease costs. For the year ended December 31, 2020, operating lease expense was approximately $2.8 million, including immaterial variable lease costs.
Finance lease amortization expense was $0.2 million, $0.4 million, and $0.3 million for the years ended December 31, 2022, 2021 and 2020, respectively. Finance lease interest expense was $15 thousand, $12 thousand, and $10 thousand for the years ended December 31, 2022, 2021 and 2020, respectively.
-91-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Supplemental cash flow information related to the Company's operating and finance leases for the years ended December 31, 2022, 2021, and 2020 respectively, was as follows (in thousands):
| Year Ended | |||||||||||||||||
| December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Cash paid for amounts included in the measurement of lease liabilities: | |||||||||||||||||
| Operating cash outflows - operating leases | $ | 2,984 | $ | 2,315 | $ | 2,213 | |||||||||||
| Operating cash outflows - finance leases | $ | 15 | $ | 12 | $ | 10 | |||||||||||
| Financing cash outflows - finance leases | $ | 199 | $ | 290 | $ | 250 | |||||||||||
| ROU assets obtained in exchange for new lease obligations: | |||||||||||||||||
| Operating leases | $ | 1,781 | $ | 1,028 | $ | 788 | |||||||||||
| Finance leases | $ | 122 | $ | 310 | $ | 159 | |||||||||||
The following table presents the weighted average remaining lease term and weighted average discount rate related to the Company's leases:
| December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Weighted average remaining lease term: | |||||||||||
| Operating | 4.8 years | 3.0 years | |||||||||
| Finance | 3.2 years | 3.5 years | |||||||||
| Weighted average discount rate: | |||||||||||
| Operating | 3.7 | % | 4.2 | % | |||||||
| Finance | 3.5 | % | 3.0 | % | |||||||
The following table presents the maturity of the Company's lease liabilities as of December 31, 2022 (in thousands):
| Year Ending December 31, | Operating Leases | Finance Leases | |||||||||
| 2023 | $ | 3,255 | $ | 168 | |||||||
| 2024 | 1,212 | 134 | |||||||||
| 2025 | 898 | 102 | |||||||||
| 2026 | 653 | 50 | |||||||||
| 2027 | 461 | 5 | |||||||||
| Thereafter | 1,405 | — | |||||||||
| Total lease payments | 7,884 | 459 | |||||||||
| Less: imputed interest | 412 | 25 | |||||||||
| Total lease liabilities | $ | 7,472 | $ | 434 | |||||||
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Lessor Accounting
The Company enters into sales-type leases as part of our subscription agreements. The following table presents the maturity of the Company's lease receivables as of December 31, 2022 (in thousands):
| Year Ending December 31, | Sales-Type Leases | ||||
| 2023 | $ | 7,674 | |||
| 2024 | 7,451 | ||||
| 2025 | 6,636 | ||||
| 2026 | 5,888 | ||||
| 2027 | 4,335 | ||||
| Thereafter | 2,948 | ||||
| Total lease receivables | $ | 34,932 | |||
The following table summarizes the profit recognized on the commencement date for sales-type leases and lease income for equipment-only operating leases (in thousands):
| Year Ended | |||||||||||||||||
| December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Sales-type lease revenue | $ | 16,273 | $ | 12,243 | $ | 5,617 | |||||||||||
| Sales-type lease cost of revenue | 13,553 | 9,925 | 3,951 | ||||||||||||||
| Profit recognized at commencement for sales-type leases | $ | 2,720 | $ | 2,318 | $ | 1,666 | |||||||||||
| Operating lease income | $ | 1,669 | $ | 2,110 | $ | 1,012 | |||||||||||
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing net loss attributable to the Company by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that the numerator is increased to exclude charges that would not have been incurred, and the denominator is increased to include the number of additional common shares that would have been outstanding (using the if-converted and treasury stock methods), if securities containing potentially dilutive common shares (stock options and restricted stock awards but excluding options to purchase fractional shares resulting from the Company's December 2010 1-for-10 reverse stock split) had been converted to common shares, and if such assumed conversion is dilutive.
The following is a reconciliation of the weighted-average shares outstanding used in the calculation of basic and diluted earnings per share ("EPS") for the years ended December 31, 2022, 2021 and 2020 (in thousands, except per share data):
| Years ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Net loss attributable to Heska Corporation | $ | (19,889) | $ | (1,148) | $ | (14,399) | |||||||||||
| Basic weighted-average common shares outstanding | 10,343 | 10,015 | 8,653 | ||||||||||||||
| Assumed exercise of dilutive stock options and restricted shares | — | — | — | ||||||||||||||
| Diluted weighted-average common shares outstanding | 10,343 | 10,015 | 8,653 | ||||||||||||||
| Basic loss per share attributable to Heska Corporation | $ | (1.92) | $ | (0.11) | $ | (1.66) | |||||||||||
| Diluted loss per share attributable to Heska Corporation | $ | (1.92) | $ | (0.11) | $ | (1.66) | |||||||||||
The following potentially outstanding common shares from convertible preferred stock, convertible senior notes, stock options and restricted stock awards were excluded from the computation of diluted EPS because the effect would have been antidilutive (in thousands):
| Years ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Convertible preferred stock | — | — | 458 | ||||||||||||||
| Convertible senior notes | 996 | 996 | 118 | ||||||||||||||
| Stock options and restricted shares | 278 | 404 | 328 | ||||||||||||||
| 1,274 | 1,400 | 904 | |||||||||||||||
As more fully described in Note 16, the Notes are convertible under certain circumstances, as defined in the indenture, into a combination of cash and shares of the Company's common stock. As discussed in Note 1, the Company early adopted ASU 2020-06, effective January 1, 2021, which amends certain guidance on the computation of EPS for convertible instruments. Prior to the adoption of ASU 2020-06, the Company used the treasury stock method when calculating the potential dilutive effect of the conversion feature of the Notes on earnings per share, if any. Under ASU 2020-06, the treasury stock method is no longer available, and entities must apply the if-converted method for convertible instruments and the effect of potential share settlement must be included in the diluted earnings per share calculation when an instrument may be settled in cash or shares. To determine the dilutive effect to earnings per share using the if-converted method, interest expense on the outstanding Notes is added back to the diluted earnings per share numerator and all of the potentially dilutive shares are included in the diluted earnings per share denominator. For year ended December 31, 2022, all of the potentially issuable shares with respect to the Notes were excluded from the
-94-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
calculation of diluted net earnings per share because the effect was anti-dilutive. The Company has elected to apply the modified retrospective method of adoption and will not restate EPS for the prior period.
As discussed in Note 12, the Company issued and sold an aggregate of 122,000 shares of its Preferred Stock to certain investors in a private placement offering. The shares were converted into 1,508,964 shares of Public Common Stock, effective on April 21, 2020. The potential dilutive effect of the convertible preferred stock was calculated using the if-converted method for the period the preferred shares were outstanding. For the year ended December 31, 2020, these shares were excluded from the computation of diluted EPS because the effect would have been antidilutive.
8. GOODWILL AND OTHER INTANGIBLES
The following summarizes the changes in goodwill during the years ended December 31, 2022 and 2021 (in thousands):
| North America | International | Total | |||||||||||||||
| Carrying amount, December 31, 2020 | $ | 35,414 | $ | 52,862 | $ | 88,276 | |||||||||||
| Goodwill attributable to acquisitions | 30,039 | 4,562 | 34,601 | ||||||||||||||
| Foreign currency adjustments | 82 | (4,133) | (4,051) | ||||||||||||||
| Carrying amount, December 31, 2021 | $ | 65,535 | $ | 53,291 | $ | 118,826 | |||||||||||
| Goodwill attributable to acquisitions | — | 21,986 | 21,986 | ||||||||||||||
| Measurement period adjustment to prior year acquisition | (17) | — | (17) | ||||||||||||||
| Foreign currency adjustments | (606) | (4,271) | (4,877) | ||||||||||||||
| Carrying amount, December 31, 2022 | $ | 64,912 | $ | 71,006 | $ | 135,918 | |||||||||||
Other intangibles assets, net consisted of the following as of December 31, 2022 and 2021 (in thousands):
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||||||||||||||||||||||
| Intangible assets subject to amortization: | |||||||||||||||||||||||||||||||||||
| Customer relationships and other | $ | 56,900 | $ | (16,002) | $ | 40,898 | $ | 47,629 | $ | (11,145) | $ | 36,484 | |||||||||||||||||||||||
| Developed technology | 19,143 | (6,462) | 12,681 | 15,633 | (3,218) | 12,415 | |||||||||||||||||||||||||||||
| Trade names | 1,818 | (319) | 1,499 | 223 | (166) | 57 | |||||||||||||||||||||||||||||
| Intangible assets not subject to amortization: | |||||||||||||||||||||||||||||||||||
| Trade names | 7,315 | — | 7,315 | 7,749 | — | 7,749 | |||||||||||||||||||||||||||||
| Total intangible assets | $ | 85,176 | $ | (22,783) | $ | 62,393 | $ | 71,234 | $ | (14,529) | $ | 56,705 | |||||||||||||||||||||||
Amortization expense relating to other intangibles is as follows (in thousands):
| Years Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Amortization expense | $ | 8,559 | $ | 6,291 | $ | 5,196 | |||||||||||
-95-
HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During the twelve months ended December 31, 2022, the Company impaired customer relationship and trade name intangible assets as a result of entity rationalization due to acquisition activity. Impairment expense of $0.2 million was recorded to Sales and marketing within operating expenses.
The remaining weighted-average amortization period for intangible assets is approximately 7.6 years.
Estimated amortization expense related to intangibles for each of the five years from 2023 through 2027 and thereafter is as follows (in thousands):
| Year Ending December 31, | |||||
| 2023 | $ | 8,470 | |||
| 2024 | 7,870 | ||||
| 2025 | 7,826 | ||||
| 2026 | 7,432 | ||||
| 2027 | 6,505 | ||||
| Thereafter | 16,975 | ||||
| Total amortization related to finite-lived intangible assets | 55,078 | ||||
| Indefinite-lived intangible assets | 7,315 | ||||
| Net intangible assets | $ | 62,393 | |||
9. PROPERTY AND EQUIPMENT, NET
Property and equipment, net, consisted of the following (in thousands):
| December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Land | $ | 2,182 | $ | 2,959 | |||||||
| Building | 11,558 | 11,288 | |||||||||
| Machinery and equipment | 39,141 | 39,851 | |||||||||
| Office furniture and equipment | 1,951 | 1,732 | |||||||||
| Computer hardware and software | 5,923 | 5,285 | |||||||||
| Leasehold and building improvements | 10,854 | 10,796 | |||||||||
| Construction in progress | 283 | 286 | |||||||||
| Property and equipment, gross | 71,892 | 72,197 | |||||||||
| Less accumulated depreciation | (39,721) | (38,784) | |||||||||
| Total property and equipment, net | $ | 32,171 | $ | 33,413 | |||||||
The Company has subscription agreements whereby its instruments in inventory may be placed at a customer's location on a rental basis. For instruments classified as operating leases, the cost of these instruments is transferred to machinery and equipment and depreciated, typically over a 5 to 7 year period depending on the circumstance under which the instrument is placed with the customer. Our cost of instruments under operating leases as of December 31, 2022 and 2021 was $15.7 million and $15.1 million, respectively, before accumulated depreciation of $6.5 million and $5.8 million, respectively.
Depreciation expense for property and equipment was $4.7 million, $6.4 million and $6.2 million for the years ended December 31, 2022, 2021 and 2020, respectively.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
10. INVENTORIES
Inventories consisted of the following (in thousands):
| December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Raw materials | $ | 20,978 | $ | 16,094 | |||||||
| Work in process | 4,102 | 3,656 | |||||||||
| Finished goods | 34,970 | 29,611 | |||||||||
| Total inventories | $ | 60,050 | $ | 49,361 | |||||||
Inventories are measured on a first-in, first-out basis and stated at lower of cost or net realizable value.
11. ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
| December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Accrued payroll and employee benefits | $ | 7,908 | $ | 9,392 | |||||||
| Accrued property taxes | 670 | 656 | |||||||||
| Accrued purchase orders | 203 | 552 | |||||||||
| Accrued taxes | 2,123 | 3,574 | |||||||||
| Other | 4,245 | 5,250 | |||||||||
| Total accrued liabilities | $ | 15,149 | $ | 19,424 | |||||||
Other accrued liabilities consist of items that are individually less than 5% of total current liabilities.
12. CAPITAL STOCK
Stock Plans
The Company has stock incentive plans which authorize granting of stock options, restricted stock awards, restricted stock units, and stock purchase rights to our employees, officers, directors and consultants. In 1997, the board of directors adopted the 1997 Stock Incentive Plan (the "1997 Plan"), which was later amended in December 2018 to be renamed the "Stock Incentive Plan." In May 2012, stockholders approved an amendment allowing for an increase of 250,000 shares and an annual increase through 2016 based on the number of non-employee directors serving as of our Annual Meeting of Stockholders, subject to a maximum of 45,000 shares per year. The plan was further amended in May 2016, May 2018, and April 2020 to increase the number of shares authorized for issuance by 500,000, 250,000, and 300,000 shares, respectively. In May 2003, the stockholders approved a new plan, the 2003 Equity Incentive Plan (the "2003 Plan"), which allows for the granting of stock options/restricted stock for up to 239,050 shares of the Company's common stock. In May 2021, stockholders approved the Heska Corporation Equity Incentive Plan (the "Stock Plan") that replaced the Stock Incentive Plan and the 2003 Plan and includes a reserve for an additional 250,000 shares of common stock along with any shares that remained available for grant under the prior plans. The total number of shares reserved for issuance as of December 31, 2022 was 132,024.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Stock Options
The stock options granted by the Board of Directors may be either incentive stock options ("ISOs") or non-qualified stock options ("NQs") and may include time-based vesting terms and/or be tied to Company and market-related performance metrics. The exercise price for options under all of the plans may be no less than 100% of the fair value of the underlying common stock. Options granted will expire no later than the tenth anniversary subsequent to the date of grant or three months following termination of employment, except in cases of death or disability, in which case the options will remain exercisable for up to twelve months. Under the terms of the Stock Incentive Plan, in the event we are sold or merged, outstanding options will either be assumed by the surviving corporation or vest immediately.
We use the Black-Scholes option-pricing model to estimate the fair value of time-vested and performance stock options granted, which includes four key inputs: expected term, expected volatility, risk-free interest rate and expected dividends. Our expected term is estimated based on historical exercise patterns. Our expected volatility input was estimated based on our historical stock price volatility. Our risk-free interest rate input was determined based on the U.S. Treasury yield curve at the time of option issuance. Our expected dividends inputs were zero in all periods as we did not anticipate paying dividends in the foreseeable future. For options tied to market performance, the fair value used in our expense recognition method is measured based on the number of shares granted, and a Monte Carlo simulation model, which incorporates the probability of the achievement of the market-related performance goals as part of the grant date fair value. We recognize forfeitures as they occur. No stock options were granted during 2022.
Time Vesting Stock Options
The fair value of each time vesting option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
| 2021 | 2020 | |||||||||||||
| Risk-free interest rate | 0.98% | 3.64% | ||||||||||||
| Expected lives | 5.6 years | 5.3 years | ||||||||||||
| Expected volatility | 47% | 46% | ||||||||||||
| Expected dividend yield | 0% | 0% | ||||||||||||
A summary of our time vesting stock option activity is as follows:
| Year Ended December 31, | |||||||||||
| 2022 | |||||||||||
| Options | Weighted Average Exercise Price | ||||||||||
| Outstanding at beginning of period | 420,202 | $ | 64.06 | ||||||||
| Granted at market | — | $ | — | ||||||||
| Forfeited | (7,416) | $ | 122.56 | ||||||||
| Expired | (291) | $ | 150.29 | ||||||||
| Exercised | (72,457) | $ | 25.87 | ||||||||
| Outstanding at end of period | 340,038 | $ | 70.84 | ||||||||
| Exercisable at end of period | 322,662 | $ | 66.18 | ||||||||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The total estimated fair value of time vesting stock options granted was computed to be approximately $1.6 million and $2.4 million during the years ended December 31, 2021 and 2020, respectively. The amounts are amortized ratably over the requisite service periods of the options. The weighted average estimated fair value per option of options granted was computed to be approximately $82.77 and $28.66 during the years ended December 31, 2021 and 2020, respectively. The total intrinsic value of options exercised was $7.2 million, $9.9 million and $5.0 million during the years ended December 31, 2022, 2021 and 2020, respectively. The cash proceeds from options exercised were $2.2 million, $3.3 million and $3.4 million during the years ended December 31, 2022, 2021 and 2020, respectively.
The following table summarizes information about time vesting stock options outstanding and exercisable at December 31, 2022.
| Options Outstanding | Options Exercisable | |||||||||||||||||||||||||||||||||||||
| Exercise Prices | Number of Options Outstanding | Weighted Average Remaining Contractual Life in Years | Weighted Average Exercise Price | Number of Options Exercisable | Weighted Average Remaining Contractual Life in Years | Weighted Average Exercise Price | ||||||||||||||||||||||||||||||||
| $7.36 - $21.09 | 36,148 | 1.41 | $ | 12.49 | 36,148 | 1.41 | $ | 12.49 | ||||||||||||||||||||||||||||||
| $21.10 - $69.76 | 89,717 | 6.11 | $ | 54.97 | 89,717 | 6.11 | $ | 54.97 | ||||||||||||||||||||||||||||||
| $69.77 - $71.83 | 80,851 | 5.33 | $ | 69.81 | 80,851 | 5.33 | $ | 69.81 | ||||||||||||||||||||||||||||||
| $71.84 - $95.65 | 86,131 | 5.80 | $ | 79.59 | 86,131 | 5.80 | $ | 79.59 | ||||||||||||||||||||||||||||||
| $95.66 - $188.62 | 47,191 | 7.05 | $ | 131.51 | 29,815 | 6.46 | $ | 116.40 | ||||||||||||||||||||||||||||||
| $7.36 - $188.62 | 340,038 | 5.48 | $ | 70.84 | 322,662 | 5.34 | $ | 66.18 | ||||||||||||||||||||||||||||||
As of December 31, 2022, there was approximately $0.8 million of total unrecognized compensation cost related to outstanding time vesting stock options. That cost is expected to be recognized over a weighted-average period of 1.1 years with all cost to be recognized by the end of May 2024, assuming all options vest according to the vesting schedules in place at December 31, 2022. As of December 31, 2022, the aggregate intrinsic value of outstanding options was approximately $2.4 million and the aggregate intrinsic value of exercisable options was approximately $2.4 million.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Performance Stock Options
Our performance-based stock options are tied to either market-related vesting conditions or Company performance metrics, including future product launches, future sales targets, operating performance, and EBITDA.
A summary of our performance-based stock option activity is as follows:
| Year Ended December 31, | |||||||||||
| 2022 | |||||||||||
| Options | Weighted Average Exercise Price | ||||||||||
| Outstanding at beginning of period | 254,800 | $ | 79.71 | ||||||||
| Granted at market | — | $ | — | ||||||||
| Forfeited | (5,000) | $ | 60.94 | ||||||||
| Exercised | (5,000) | $ | 60.94 | ||||||||
| Outstanding at end of period | 244,800 | $ | 80.48 | ||||||||
| Exercisable at end of period | 93,750 | $ | 60.94 | ||||||||
The total estimated fair value of performance-based stock options granted was computed to be approximately $2.6 million and $6.0 million during the years ended December 31, 2021 and 2020, respectively. The weighted-average estimated fair value per option of options granted was computed to be approximately $75.62 and $25.04 during the years ended December 31, 2021 and 2020, respectively. As of December 31, 2022, the aggregate intrinsic value of outstanding options was approximately $0.3 million and the aggregate intrinsic value of exercisable options was approximately $0.1 million. As of December 31, 2022, there was approximately $0.4 million of total unrecognized compensation cost related to outstanding performance-based stock options that is expected to be recognized over a weighted-average period of 0.7 years.
| Options Outstanding | Options Exercisable | |||||||||||||||||||||||||||||||||||||
| Exercise Prices | Number of Options Outstanding at December 31, 2022 | Weighted Average Remaining Contractual Life in Years | Weighted Average Outstanding Price | Number of Options Exercisable at December 31, 2022 | Weighted Average Remaining Contractual Life in Years | Weighted Average Exercise Price | ||||||||||||||||||||||||||||||||
| $60.94 | 210,000 | 7.29 | $ | 60.94 | 93,750 | 7.29 | $ | 60.94 | ||||||||||||||||||||||||||||||
| $198.40 | 34,800 | 3.44 | $ | 198.40 | — | — | $ | — | ||||||||||||||||||||||||||||||
| $60.94 - $198.40 | 244,800 | 6.75 | $ | 80.48 | 93,750 | 7.29 | $ | 60.94 | ||||||||||||||||||||||||||||||
As of December 31, 2022, we reviewed each of the underlying corporate performance targets and determined that approximately 75,000 shares were related to corporate performance targets of which we did not deem achievement probable. The unrecognized compensation cost associated with the performance options not deemed probable, based on grant date fair value, is approximately $1.9 million. Any change in the probability determination could accelerate the recognition of this expense.
Restricted Stock Awards and Units
We have granted unvested restricted stock awards and restricted stock units (collectively, “restricted stock”) to management and directors pursuant to the Stock Incentive Plan. The restricted stock awards and units have varying vesting periods, but generally become fully vested between and seven years after the grant date, depending on the specific award, performance targets met for performance based awards granted to management, and vesting period for time based awards. Management performance based awards are granted
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
at the target amount of shares that may be earned and are tied to future sales targets, product development, profitability measures such as gross margin and operating profit, and/or non-GAAP measures such as EBITDA and adjusted EBITDA margin. We value the restricted stock awards and units related to service and/or company performance targets based on grant date fair value and expense over the period when achievement of those conditions is deemed probable. For restricted stock awards related to market conditions, we utilize a Monte Carlo simulation model to estimate grant date fair value and expense over the requisite period. We recognize forfeitures as they occur.
The following table summarizes restricted stock transactions for the year ended December 31, 2022:
| Restricted Stock Awards | Restricted Stock Units | |||||||||||||||||||||||||
| Restricted Stock | Weighted-Average Grant Date Fair Value Per Award | Restricted Stock | Weighted-Average Grant Date Fair Value Per Award | |||||||||||||||||||||||
| Non-vested as of December 31, 2021 | 493,513 | $ | 141.98 | 6,000 | $ | 172.11 | ||||||||||||||||||||
| Granted | 78,236 | $ | 115.91 | 26,173 | $ | 100.97 | ||||||||||||||||||||
| Vested | (114,991) | $ | 90.57 | — | $ | — | ||||||||||||||||||||
| Forfeited | (14,239) | $ | 91.17 | (243) | $ | 127.09 | ||||||||||||||||||||
| Non-vested as of December 31, 2022 | 442,519 | $ | 152.36 | 31,930 | $ | 114.14 | ||||||||||||||||||||
The weighted average grant date fair value per share of awards granted during the year was $115.91, $207.24, and $87.29 for the years ended December 31, 2022, 2021 and 2020, respectively. Fair value of restricted stock vested was $15.8 million, $5.6 million, and $5.0 million for the years ended December 31, 2022, 2021 and 2020, respectively.
As of December 31, 2022, there was approximately $16.1 million and $2.1 million of total unrecognized compensation cost related to restricted stock awards and restricted stock units, respectively, with probable Company performance targets, as well as market and time vesting conditions. The Company expects to recognize this expense over a weighted average period of 1.7 years for restricted stock awards and 2.0 years for restricted stock units. As of December 31, 2022, we reviewed each of the underlying corporate performance targets and determined that approximately 222,000 shares of common stock for restricted stock awards and approximately 3,000 shares of common stock for restricted stock units were related to corporate performance targets of which we did not deem achievement probable. The unrecognized compensation cost associated with the restricted stock awards and restricted stock units not deemed probable, based on grant date fair value, is approximately $33.5 million and $0.6 million, respectively. Any change in the probability determination could accelerate the recognition of this expense.
Employee Stock Purchase Plan
Under the 2020 Employee Stock Purchase Plan (the "ESPP"), we are authorized to issue up to 200,000 shares of common stock to our employees, of which 21,484 had been issued as of December 31, 2022. The ESPP provides for the issuance of shares of our common stock to participating employees. At the end of each designated offering period, which occurs every six months on June 30 and December 31, employees can elect to purchase shares of our common stock with contributions of up to 10% of their base pay, accumulated via payroll deductions, at an amount equal to 85% of the lower of our stock price on (i) the first trading day of the offering period, or (ii) the last trading day of the offering period.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
We issued 12,188, 5,437 and 3,859 shares under the ESPP for the years ended December 31, 2022, 2021 and 2020, respectively. In the year ended December 31, 2020, we also issued 6,210 shares under a previous ESPP. The weighted-average fair value of the purchase rights granted was $14.43, $29.56 and $16.19 per share for the years ended December 31, 2022, 2021 and 2020, respectively.
Series X Convertible Preferred Stock
On March 30, 2020, the Company completed a private placement offering in which the Company issued and sold an aggregate of 122,000 shares of its Series X Convertible Preferred Stock, par value $0.01 per share (the "Preferred Stock"). The shares of Preferred Stock issued and sold were priced at $1,000 per share (the “Stated Value”), resulting in gross proceeds of $122.0 million, less issuance costs of $0.2 million. The Company used approximately $111.0 million of the proceeds from the offering to fund the April 1, 2020 acquisition of scil and plans to use the remaining proceeds for working capital and general corporate purposes.
The offering was made pursuant to the Securities Purchase Agreement (the “Securities Purchase Agreement”), dated as of January 12, 2020, by and among the Company and certain investors, and subsequent amendment (the “Securities Purchase Agreement Amendment”) to the Securities Purchase Agreement, entered into by the Company and each investor on March 30, 2020 (the Securities Purchase Agreement as amended by the Securities Purchase Agreement Amendment, the “Amended Securities Purchase Agreement”).
The shares of Preferred Stock were convertible into shares of the Company’s Common Stock at an initial ratio of approximately 12.4 shares of Common Stock for each share of Preferred Stock (equivalent to a conversion price of approximately $80.85 per share of common stock), at the option of the holders of the Preferred Stock or the Company, subject to the Company possessing sufficient unissued and otherwise unreserved shares of Common Stock under the Company’s Restated Certificate of Incorporation, as amended (the “Certificate of Incorporation”). On April 14, 2020, the Company gave notice of its exercise of its right to convert the 122,000 shares of Preferred Stock into 1,508,964 shares of Public Common Stock (the "Conversion Shares") and the conversion was effective on April 21, 2020. The conversion resulted in dilution of less than 20% of total shares of the Company’s Public Common Stock currently issued and outstanding. A registration statement on Form S-3 (File No. 333-238005) registering the Conversion Shares for resale was filed by us with the SEC on May 5, 2020.
2021 Equity Offering
On March 5, 2021, the Company completed a public offering of 940,860 shares of common stock, $0.01 par value per share, at a public offering price of $186.00 per share. The Company received net proceeds of approximately $164.2 million after deducting underwriting discounts and commissions and issuance costs. The Company granted the underwriters an option to purchase up to an additional 141,129 shares of common stock from the Company at the offering price of $186.00 per share (less the underwriting discounts and commissions), within 30 days of the Prospectus Supplement dated March 2, 2021. The Company evaluated the accounting treatment of the option under ASC 815-40, Derivatives and Hedging - Contracts on an Entity's Own Equity, and determined that it met the criteria for equity treatment thereunder. The underwriters’ option was not exercised and expired on April 1, 2021. The Company is using the net proceeds of the offering for general corporate purposes, including working capital, further development and potential commercialization of current and future product initiatives, collaborations, and capital expenditures. The Company may also use a portion of the net proceeds of this offering to fund possible investments in or acquisitions of complementary businesses, products or technologies, or to repay indebtedness. See the Consolidated Statements of Cash Flows for further details regarding investing activities completed thus far.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
13. ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income (loss) consisted of the following (in thousands):
| Pension Adjustments | Foreign Currency Translation1 | Foreign Currency Gain on Intra-Entity Transactions2 | Total Accumulated Other Comprehensive Income | ||||||||||||||||||||
| Balances at December 31, 2020 | $ | (386) | $ | 5,872 | $ | 8,683 | $ | 14,169 | |||||||||||||||
| Other comprehensive income (loss) | 107 | (3,898) | (5,341) | (9,132) | |||||||||||||||||||
| Balances at December 31, 2021 | (279) | 1,974 | 3,342 | 5,037 | |||||||||||||||||||
| Other comprehensive income (loss) | 99 | (6,874) | (4,768) | (11,543) | |||||||||||||||||||
| Balances at December 31, 2022 | $ | (180) | $ | (4,900) | $ | (1,426) | $ | (6,506) | |||||||||||||||
1 Foreign currency gains and losses related to translation of foreign subsidiary financial statements.
2 The Company has intercompany loans of a long-term investment nature that are denominated in a foreign currency. These transactions are considered to be of a long-term nature if settlement is not planned or anticipated in the foreseeable future.
14. COMMITMENTS AND CONTINGENCIES
Warranties
The Company's current terms and conditions of sale include a limited warranty that its products and services will conform to published specifications at the time of shipment and a more extensive warranty related to certain products. The Company also sells a renewal warranty for certain of its products. The typical remedy for breach of warranty is to correct or replace any defective product. Historically, the Company has incurred minimal warranty costs. The Company's warranty reserve was $0.3 million and $0.5 million as of December 31, 2022 and 2021.
Litigation
From time to time, the Company may be involved in litigation relating to claims arising out of its operations. The Company records accruals for outstanding legal matters when it believes it is probable that a loss will be incurred, and the amount can be reasonably estimated.
On February 18, 2020, a former managing director of scil filed a claim disputing the effective date of the termination of his management service agreement and the validity of the Company´s waiver of his two-year post-contractual non-compete obligation. The Company defended itself from the claim but ultimately reached a settlement agreement and paid $0.8 million to the defendant on April 28, 2022. The Company is indemnified by the scil acquisition agreement for this claim.
At December 31, 2022, the Company was not a party to any other legal proceedings that were expected, individually or in the aggregate, to have a material adverse effect on our business, financial condition or operating results.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Global Supply and Licensing Agreement
On March 28, 2022, the Company entered into a global supply and licensing agreement with VolitionRx Limited (“Volition”) to adapt and commercialize the Nu.Q® Vet Cancer Screening Test at the POC for canines and felines on Heska’s technology. On March 30, 2022, the Company made an upfront milestone payment of $10 million to Volition in exchange for exclusive rights to develop the Nu.Q® Vet Cancer Screening Test for the POC and non-exclusive rights for central reference lab testing. The $10 million payment was expensed to Research and development on the Consolidated Statements of Loss for the year ended December 31, 2022. The Company is obligated to pay an additional $13 million on or before December 31, 2024, if certain milestones are met, or to obtain an extended timeline to meet those milestones. If those milestones are not met by the agreed upon extension, the agreement may be terminated. However, if the $13 million milestones are met, the agreement will have a total term of 22 years for exclusivity in POC testing. If the first milestones are met and the agreement does not terminate, there will be another $5 million payment due upon the achievement of an additional milestone within the remaining term of the agreement. These potential future milestone payments have not yet been accrued, as the Company has not deemed them probable at this time.
Off-Balance Sheet Commitments
We have no off-balance sheet arrangements. Refer to Note 4 for discussion of our variable interest entity.
Purchase Obligations
The Company has contractual obligations with suppliers for unconditional annual minimum inventory purchases through 2026 in the aggregate amount of $55.3 million as of December 31, 2022.
15. INTEREST AND OTHER EXPENSE, NET
Interest and other expense, net, consisted of the following (in thousands):
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Interest income | $ | (3,578) | $ | (1,797) | $ | (607) | |||||||||||
| Interest expense | 4,191 | 4,201 | 6,374 | ||||||||||||||
| Other expense (income), net | 923 | 44 | (166) | ||||||||||||||
| Interest and other expense, net | $ | 1,536 | $ | 2,448 | $ | 5,601 | |||||||||||
Cash paid for interest was $4.3 million, $3.3 million and $3.2 million for the years ended December 31, 2022, 2021 and 2020, respectively.
16. CONVERTIBLE NOTES
Convertible Notes
On September 17, 2019, the Company issued $86.25 million aggregate principal amount of 3.750% Convertible Senior Notes due 2026 (the "Notes"), which included the exercise in full of an $11.25 million purchase option, to certain financial institutions as the initial purchasers of the Notes (the "Initial Purchasers"). The Notes are senior unsecured obligations of the Company. The Notes were issued pursuant to an Indenture, dated September 17, 2019 (the “Indenture”), between the Company and U.S. Bank National Association, as trustee.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The net proceeds from the sale of the Notes were approximately $83.7 million after deducting the initial purchasers’ discounts and the offering expenses payable by the Company. The Company used approximately $12.8 million of the net proceeds from the Notes to repay all outstanding indebtedness on its existing Credit Facility with JPMorgan Chase Bank, N.A., and an additional $2.0 million to fully fund a cash collateralized, letter of credit facility under a new Credit Facility. The Company subsequently terminated the Credit Facility with JPMorgan Chase Bank, N.A. on December 31, 2019. The Company expects to use the remainder of the net proceeds from the sale of the Notes to fund our intended expansion efforts, including through acquisitions of complementary businesses or technologies or other strategic transactions, and for working capital and other general corporate purposes.
The Notes are senior unsecured obligations of the Company and will rank senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the Notes; equal in right of payment to any of our unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness to the extent of the value of assets securing such indebtedness; and structurally junior to all indebtedness and other liabilities (including trade payables) of our subsidiaries.
The Company pays interest on the Notes semiannually in arrears at a rate of 3.750% per annum on March 15 and September 15 of each year. The Notes are convertible based upon an initial conversion rate of 11.5434 shares of the Company’s common stock per $1,000 principal amount of Notes (equivalent to a conversion price of approximately $86.63 per share of common stock). The Notes would convert in full into 995,618 shares of common stock based on the initial conversion rate. The conversion rate will be subject to standard anti-dilution adjustments upon the occurrence of certain events but will not be adjusted for accrued and unpaid interest. The interest rate on the Notes may be increased by up to 0.50% upon the occurrence of certain events of default or non-timely filings until such matter has been cured.
The Indenture includes customary covenants, but no financial or operating covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities, and sets forth certain events of default and certain types of bankruptcy or insolvency events of default involving the Company after which the Notes become automatically due and payable. The Company can settle any conversions of the Notes in cash, shares of the Company’s common stock or a combination thereof, with the form of consideration determined at the Company’s election. The Company intends to settle the principal value of the Notes in cash and issue shares of the Company’s common stock to settle the intrinsic value of the conversion feature. There can be no guarantee, however, that any settlement will be affected by the Company as currently intended, and the timing and other factors of any settlement, many of which may be outside the Company's control, could impact the actual amounts to be settled in either cash or common stock.
The Notes will mature on September 15, 2026, unless earlier repurchased, redeemed or converted. Prior to March 15, 2026, holders may convert all or a portion of their Notes only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on December 31, 2019 (and only during such calendar quarter), if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the 5 business day period after any 5 consecutive trading day period (the "Notes measurement period") in which the trading price per $1,000 principal amount of Notes for each trading day of the Notes measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day; (3) with respect to any Notes called for redemption by the Company, at any time prior to the close of business on the scheduled trading day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events. On and after March 15, 2026 until the close of business on the scheduled trading day immediately preceding the maturity date, holders may convert their
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Notes at any time, regardless of the foregoing circumstances. Holders of Notes who convert their Notes in connection with a notice of a redemption or a make-whole fundamental change (each as defined in the Indenture) may be entitled to a premium in the form of an increase in the conversion rate of the Notes.
The Company may not redeem the Notes prior to September 20, 2023. On or after September 20, 2023, the Company may redeem for cash all or part of the Notes if the last reported sale price of the Company’s common stock equals or exceeds 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which the Company provides notice of the redemption. The redemption price will be 100% of the principal amount of the Notes to be redeemed, plus accrued and unpaid interest, if any. No sinking fund is provided for the Notes.
Upon the occurrence of a fundamental change (as defined in the Indenture), holders may require the Company to repurchase all or a portion of their Notes for cash at a price equal to 100% of the principal amount of the Notes to be repurchased plus any accrued but unpaid interest to, but excluding, the fundamental change repurchase date.
In accounting for the issuance of the Notes prior to the adoption of ASU 2020-06, the Company initially separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, representing the conversion option, which does not meet the criteria for separate accounting as a derivative as it is indexed to the Company's own stock, was determined by deducting the fair value of the liability component from the par value of the Notes. The difference between the principal amount of the Notes and the liability component represented the debt discount, which was recorded as a direct deduction from the related debt liability in the Consolidated Balance Sheet and amortized to interest expense using the effective interest method over the term of the Notes. The effective interest rate of the Notes was 15.3% per annum prior to adopting ASU 2020-06. The equity component of the Notes was approximately $39.5 million, net of allocated issuance costs of $1.5 million. The Company allocated transaction costs related to the Notes using the same proportions as the proceeds from the Notes. Transaction costs attributable to the liability component were recorded as a direct deduction from the related debt liability in the Consolidated Balance Sheet and amortized to interest expense over the term of the Notes, and transaction costs attributable to the equity component were netted with the equity component in shareholders’ equity.
In addition, the Company determined that the additional interest that could be due to the holders of the Notes upon an event of default or non-timely filing represented an embedded derivative feature that should be bifurcated from the Notes. The Company concluded that the fair value of this embedded derivative feature was de minimis upon the issuance of the Notes and at December 31, 2022.
The Company early adopted ASU 2020-06, effective January 1, 2021, which simplifies the accounting for certain convertible instruments. Under the new standard, qualifying convertible debt is accounted for as a single liability measured at its amortized cost, as long as no other features require bifurcation and recognition as derivatives. As a result of ASU 2020-06, the Company's cash interest expense is not impacted, however, the Company's non-cash interest accretion is limited to the amortization of debt issuance costs under ASC 835-30. The new effective interest rate of the Notes post-adoption is 4.35%. The Company also reversed the conversion feature amount recorded in APIC and reversed the difference in non-cash interest expense via retained earnings.
During the years ended December 31, 2022 and 2021, no portion of the Notes was converted and the liability was classified as long-term debt on the Company's Consolidated Balance Sheet as of December 31, 2022.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes the net carrying amount of the Notes as of December 31, 2022 (in thousands):
| December 31, 2022 | December 31, 2021 | ||||||||||
| Principal amount of the Notes | $ | 86,250 | $ | 86,250 | |||||||
| Unamortized debt discount | (1,783) | (2,216) | |||||||||
| Net carrying amount | $ | 84,467 | $ | 84,034 | |||||||
Interest expense related to the Notes is comprised of the amortization of debt discount and debt issuance costs and the contractual coupon interest as follows (in thousands):
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
Interest expense related to contractual coupon interest2 | $ | 3,234 | $ | 3,755 | $ | 3,234 | |||||||||||
Interest expense related to amortization of debt discount1 | 434 | 415 | 3,111 | ||||||||||||||
| Total interest expense | $ | 3,668 | $ | 4,170 | $ | 6,345 | |||||||||||
1 Immaterial out of period error correction of non-cash interest identified and recorded during the fourth fiscal quarter of 2020.
2The year ended December 31, 2021 includes $0.5 million of additional interest expense related to the restrictive legend on the Notes. The legend was removed as of December 31, 2021 and the Notes will not accrue additional interest in future periods.
As of December 31, 2022, the remaining period over which the unamortized discount will be amortized is 3.8 years.
The estimated fair value of the Notes was $89.1 million and $194.3 million as of December 31, 2022 and 2021, respectively, determined through consideration of quoted market prices in less active markets. The fair value measurement is classified as Level 2 in the fair value hierarchy, which is defined in ASC 820 as inputs other than quoted prices in active markets that are either directly or indirectly observable. Based on our closing stock price of $62.16 on December 31, 2022, the if-converted value did not exceed the aggregate principal amount of the Notes.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
17. NOTES RECEIVABLE
Convertible Promissory Note
On December 9, 2020, the Company's equity method investee (the “Equity Method Investee”), issued a Convertible Promissory Note to the Company (the “Convertible Promissory Note”) with a principal amount of $6.65 million and a stated interest rate of 3.0% per annum that is payable monthly. The Convertible Promissory Note has a maturity date of December 9, 2023, or otherwise upon qualified redemption event or in the event of a default. Refer to Note 4 for additional information on our equity method investment.
The conversion of the Convertible Promissory Note is contingent upon certain events. Due to the convertible debt features included in the Convertible Promissory Note, it is not an equity security and is therefore not considered an additional investment in our Equity Method Investee. The Company accounted for the transaction as a note receivable, included in Related party convertible note receivable, net on the Consolidated Balance Sheets. The note receivable will be measured at amortized cost and evaluated for credit losses each reporting period. The Company determined that the redemption features described above met the definition of an embedded derivative that requires bifurcation from the note receivable host. The Company measured the redemption features at fair value, with the residual proceeds paid allocated to the note receivable host, creating a discount to the note receivable. The discount will be amortized over the contractual term of the Convertible Promissory Note using the effective interest method. The effective interest rate of the Convertible Promissory Note is 8.69%, and the amortization of the discount will be included as interest income within Interest and other (income) expense, net on the Consolidated Statements of Loss. The fair value of the derivative will be remeasured each reporting period, with the mark-to-market adjustment to be included in Interest and other (income) expense, net on the Consolidated Statements of Loss.
The following table summarizes the net carrying amount of the note receivable, including the unamortized discount and allowance for expected credit losses, as well as the fair value of the embedded derivative asset (in thousands):
| December 31, 2022 | December 31, 2021 | |||||||||||||
| Principal amount | $ | 6,650 | $ | 6,650 | ||||||||||
| Unamortized discount | (339) | (672) | ||||||||||||
| Allowance for expected credit losses | (4,264) | (66) | ||||||||||||
| Net carrying amount | $ | 2,047 | $ | 5,912 | ||||||||||
| Embedded derivative asset | 177 | 888 | ||||||||||||
| Related party convertible note receivable, net | $ | 2,224 | $ | 6,800 | ||||||||||
The Company recorded an allowance for expected credit losses on the promissory note of $4.3 million as of December 31, 2022. The allowance for expected credit losses increased $4.2 million from December 31, 2021. The change reflects increased risk of collectability given the investee's current financial position and ability to achieve certain events required for conversion of the note, which are largely driven by more recent challenges and uncertainties in the macro-economic environment. These factors increased the probability of default.
Promissory Notes
On February 1, 2021, one of the Company's equity investees, LightDeck, which the Company accounts for as a non-marketable equity security, issued a Promissory Note to the Company (the “First Promissory Note”) with a principal amount of $9.0 million and a stated interest rate of 10.0% per annum that is payable monthly.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The First Promissory Note has a maturity date of December 1, 2024 and provides for interest only payments through December 1, 2023. Beginning on January 1, 2024, the First Promissory Note requires repayment of the principal and interest over twelve consecutive monthly payments. As additional consideration, the Company was also issued a warrant to acquire securities of LightDeck that expires December 31, 2034. On September 19, 2022, a second Promissory Note (the "Second Promissory Note") was issued to the Company with a principal amount of $4.7 million and a stated interest rate of 10.0% per annum that is payable on December 31, 2023. The Second Promissory Note has a maturity date of the earlier of December 31, 2023 and a merger transaction with LightDeck. Refer to Note 4 for additional information on our equity investments and the acquisition of LightDeck.
The Company evaluated the accounting treatment of the warrant to acquire securities and determined it is a freestanding instrument that meets the definition of a derivative under ASC 815 and requires bifurcation from the note receivable host. The Company measured the warrant at fair value, with the residual proceeds paid allocated to the note receivable host, creating a discount to the note receivable. The discount will be amortized over the contractual term of the First Promissory Note using the effective interest method. The effective interest rate of the Promissory Note is 10.99%, and the amortization of the discount will be included as interest income within Interest and other (income) expense, net on the Consolidated Statements of Loss. The fair value of the derivative was $0.3 million at issuance and $0 as of December 31, 2022, and is included in Other non-current assets on the Consolidated Balance Sheets. The fair value of the derivative will be remeasured each reporting period, with the mark-to-market adjustment to be included in other Interest and other expense, net on the Consolidated Statements of Loss.
The following table summarizes the carrying value of the notes receivable, including the unamortized discount and allowance for expected credit losses (in thousands):
| December 31, 2022 | December 31, 2021 | |||||||||||||
| Principal amount | $ | 13,700 | $ | 9,000 | ||||||||||
| Unamortized discount | (189) | (254) | ||||||||||||
| Allowance for expected credit loss | — | (298) | ||||||||||||
| Net carrying amount | $ | 13,511 | $ | 8,448 | ||||||||||
18. SEGMENT REPORTING
The Company’s two segments are North America and International. The North America segment is comprised of the Company's operations in the United States, Canada and Mexico and the International segment is comprised of geographies outside of North America, which are the Company's operations primarily in Australia, France, Germany, Italy, Malaysia, Spain and Switzerland. Certain expenses incurred at the Company’s headquarters located in the North America segment are allocated to each segment in a manner consistent with where the benefits from the expenses are derived. However, there are certain corporate expenses included in the North America segment that the Company does not allocate. Such expenses include research and development, and certain selling, marketing, general, and administrative costs that support the global organization. Sales and transfers between operating segments are accounted for at market-based transaction prices and are eliminated in consolidation. The Company's sales are determined by the country of origin where the sale occurred.
Our Chief Operating Decision Maker ("CODM") evaluates segment performance and allocates resources based on Revenue, Cost of Revenue, Gross Profit, Gross Margin and Operating Income. The CODM does not evaluate operating segments using asset information; however, we have included total asset information by segment below as there was a material change in total assets by segment as of December 31, 2022, due to the acquisition of VetZ on January 3, 2022.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Summarized financial information concerning the Company's reportable segments is shown in the following tables (in thousands):
| Year Ended December 31, 2022 | North America | International | Total | |||||||||||||||||
| Total revenue | $ | 161,762 | $ | 95,545 | $ | 257,307 | ||||||||||||||
| Cost of revenue | 86,234 | 59,906 | 146,140 | |||||||||||||||||
| Gross profit | 75,528 | 35,639 | 111,167 | |||||||||||||||||
| Gross margin | 47% | 37% | 43% | |||||||||||||||||
| Operating loss | (15,797) | (4,501) | (20,298) | |||||||||||||||||
| Loss before income taxes | (13,830) | (8,004) | (21,834) | |||||||||||||||||
| Investments in unconsolidated affiliates | 3,959 | — | 3,959 | |||||||||||||||||
| Total assets | 374,737 | 211,079 | 585,816 | |||||||||||||||||
| Net assets | 248,882 | 173,326 | 422,208 | |||||||||||||||||
| Capital expenditures | 837 | 1,277 | 2,114 | |||||||||||||||||
| Depreciation and amortization | 5,216 | 8,750 | 13,966 | |||||||||||||||||
| Year Ended December 31, 2021 | North America | International | Total | |||||||||||||||||
| Total revenue | $ | 158,898 | $ | 94,841 | $ | 253,739 | ||||||||||||||
| Cost of revenue | 84,472 | 63,473 | 147,945 | |||||||||||||||||
| Gross profit | 74,426 | 31,368 | 105,794 | |||||||||||||||||
| Gross margin | 47% | 33% | 42% | |||||||||||||||||
| Operating income (loss) | 650 | (1,643) | (993) | |||||||||||||||||
| Income (loss) before income taxes | 2,072 | (5,513) | (3,441) | |||||||||||||||||
| Investments in unconsolidated affiliates | 5,424 | — | 5,424 | |||||||||||||||||
| Total assets | 441,234 | 162,838 | 604,072 | |||||||||||||||||
| Net assets | 308,973 | 126,881 | 435,854 | |||||||||||||||||
| Capital expenditures | 700 | 1,068 | 1,768 | |||||||||||||||||
| Depreciation and amortization | 5,673 | 7,882 | 13,555 | |||||||||||||||||
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
| Year Ended December 31, 2020 | North America | International | Total | |||||||||||||||||
| Total revenue | $ | 131,066 | $ | 66,257 | $ | 197,323 | ||||||||||||||
| Cost of revenue | 70,163 | 45,870 | 116,033 | |||||||||||||||||
| Gross profit | 60,903 | 20,387 | 81,290 | |||||||||||||||||
| Gross margin | 46% | 31% | 41% | |||||||||||||||||
| Operating loss | (4,977) | (3,215) | (8,192) | |||||||||||||||||
| Loss before income taxes | (7,871) | (5,922) | (13,793) | |||||||||||||||||
| Investments in unconsolidated affiliates | 6,704 | — | 6,704 | |||||||||||||||||
| Total assets | 238,550 | 161,289 | 399,839 | |||||||||||||||||
| Net assets | 156,931 | 130,122 | 287,053 | |||||||||||||||||
| Capital expenditures | 443 | 243 | 686 | |||||||||||||||||
| Depreciation and amortization | 4,735 | 6,650 | 11,385 | |||||||||||||||||
The Company measures its geographic revenue information based on the country of origin where the sale occurred. The geographic classification is independent of where the customer resides or where the customer is physically located while using the Company's product. Total revenue by principal geographic area was as follows (in thousands):
| For the Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| United States | $ | 145,014 | $ | 141,588 | $ | 120,244 | |||||||||||
| Canada | 16,748 | 17,310 | 10,822 | ||||||||||||||
| Germany | 53,529 | 44,148 | 29,543 | ||||||||||||||
| France | 13,607 | 18,671 | 12,615 | ||||||||||||||
| Spain | 11,106 | 14,071 | 12,995 | ||||||||||||||
| Italy | 9,128 | 10,145 | 5,850 | ||||||||||||||
| Switzerland | 3,472 | 3,885 | 3,343 | ||||||||||||||
| Other International | 4,703 | 3,921 | 1,911 | ||||||||||||||
| Total | $ | 257,307 | $ | 253,739 | $ | 197,323 | |||||||||||
Total long-lived assets by principal geographic areas were as follows (in thousands):
| As of December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| United States | $ | 14,351 | $ | 12,502 | $ | 11,805 | |||||||||||
| Canada | 1,274 | 719 | 643 | ||||||||||||||
| Germany | 15,429 | 12,795 | 14,630 | ||||||||||||||
| France | 3,362 | 3,127 | 4,205 | ||||||||||||||
| Spain | 1,167 | 1,051 | 1,209 | ||||||||||||||
| Italy | 2,090 | 1,966 | 1,944 | ||||||||||||||
| Switzerland | 87 | 63 | 46 | ||||||||||||||
| Other International | 1,308 | 1,190 | 1,060 | ||||||||||||||
| Total | $ | 39,068 | $ | 33,413 | $ | 35,542 | |||||||||||
No customers accounted for more than 10% of our consolidated revenue for the years ended December 31, 2022, 2021 or 2020.
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HESKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
19. SUBSEQUENT EVENTS
LightDeck Acquisition
On January 3, 2023, the Company completed the acquisition of MBio Diagnostics, Inc., d/b/a LightDeck Diagnostics ("LightDeck"). The LightDeck acquisition represents a meaningful increase in our intellectual property portfolio as well as our manufacturing and research and development capabilities. Total acquisition related expense for the year ended December 31, 2022 was $1.4 million and is recorded within General and administrative in the Consolidated statements of loss. See Note 4 for further discussion.
Stock Issuances
On January 11, 2023, the Compensation Committee of the Company's Board of Directors authorized the issuance of 47,400 performance-based restricted stock awards to executive officers . The vesting of the restricted stock awards is subject to the achievement of certain Company performance conditions. The performance conditions must be achieved by December 31, 2026, otherwise the restricted stock awards are forfeited.
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our principal executive officer and our principal financial officer, evaluated the effectiveness of our disclosure controls and procedures, as defined by Rule 13a-15 of the Exchange Act, as of December 31, 2022. Based on this evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the SEC's rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding disclosure.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, the Company's management has concluded that the Company's internal control over financial reporting was effective as of December 31, 2022.
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Accordingly, even an effective system of internal control will provide only reasonable assurance that the objectives of the internal control system are met.
Grant Thornton, an independent registered public accounting firm, has audited our Consolidated Financial Statements included in this Form 10-K, and as part of the audit, has issued a report, included herein, on the effectiveness of our internal control over financial reporting as of December 31, 2022.
Changes in Internal Control over Financial Reporting
We evaluated our internal controls over financial reporting in relation to recurring performance and changes to the control environment due to COVID-19. Based on the assessment, we determined there was no change in our internal control over financial reporting that occurred during the fourth quarter of 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.Other Information
None.
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections
Not applicable.
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PART III
Certain information required by Part III is incorporated by reference to our definitive Proxy Statement to be filed with the SEC in connection with the solicitation of proxies for our 2023 Annual Meeting of Stockholders.
Item 10.Directors, Executive Officers and Corporate Governance
Executive Officers
The information required by this item with respect to executive officers is incorporated by reference to Item 1 of this report and can be found under the caption "Information About Our Executive Officers."
Directors
The information required by this section with respect to our directors will be incorporated by reference to the information in the sections entitled Proposal No. 1 "Election of Directors" in the Proxy Statement.
Code of Ethics
Our Board of Directors has adopted a code of conduct and ethics for our senior executive and financial officers (including our principal executive officer, principal financial officer and principal accounting officer). The code of conduct and ethics is available on our website at www.heska.com under the Corporate Governance section under the Company Information section under the "Investors" tab. We intend to disclose any amendments to or waivers from the code of conduct and ethics at that location.
Audit Committee
The information required by this section with respect to our Audit Committee will be incorporated by reference to the information in the section entitled "Board Structure and Committees" in the Proxy Statement.
Item 11.Executive Compensation
The information required by this section will be incorporated by reference to the information in the sections entitled "Director Compensation," "Executive Compensation," "Compensation Committee Report" in the Proxy Statement.
Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The other information required by this section will be incorporated by reference to the information in the section entitled "Ownership of Securities - Common Stock Ownership of Certain Beneficial Owners and Management" in the Proxy Statement.
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Equity Compensation Plan Information
The following table sets forth information about our common stock that may be issued upon exercise of options and rights under all of our equity compensation plans as of December 31, 2022, including the Equity Incentive Plan, the Stock Incentive Plan, as amended and restated, the 2003 Stock Incentive Plan, as amended and the 2020 Employee Stock Purchase Plan. Our stockholders have approved all of these plans.
| Plan Category | (a) Number of Securities to be Issued Upon Exercise of Outstanding Options and Rights | (b) Weighted-Average Exercise Price of Outstanding Options and Rights | (c) Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (excluding securities reflected in column (a)) | ||||||||||||||
Equity Compensation Plans Approved by Stockholders | 584,838 | $74.88 | 310,540 | ||||||||||||||
| Equity Compensation Plans Not Approved by Stockholders | None | None | None | ||||||||||||||
| Total | 584,838 | $74.88 | 310,540 | ||||||||||||||
Item 13. Certain Relationships and Related Transactions and Director Independence
The information required by this section will be incorporated by reference to the information in the sections entitled "Board Structure and Committees" and "Significant Relationships and Transactions with Directors, Officers or Principal Stockholders" in the Proxy Statement.
Item 14.Principal Accountant Fees and Services
The information required by this section will be incorporated by reference to the information in the section entitled "Auditor Fees and Services" in the Proxy Statement.
The information required by Part III to the extent not set forth herein, will be incorporated herein by reference to our definitive Proxy Statement for the 2023 Annual Meeting of Stockholders.
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PART IV
Item 15.Exhibits and Financial Statement Schedules
(a) The following documents are filed as a part of this Form 10-K.
(1) Financial Statements:
Reference is made to the Index to Consolidated Financial Statements under Item 8 in Part II of this Form 10-K.
(2) Financial Statement Schedules:
NOTE: All schedules have been omitted because they are either not required or the information is included in the financial statements and notes thereto.
(3) Exhibits:
The exhibits listed below are required by Item 601 of Regulation S-K. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K has been identified.
| Exhibit Number | Notes | Description of Document | |||||||||||||||
| 2.1#++ | (19) | ||||||||||||||||
| 2.2# | (22) | ||||||||||||||||
| 2.3 | (27) | ||||||||||||||||
| 2.4#++ | (28) | ||||||||||||||||
| 2.5# | (28) | ||||||||||||||||
| 3(i) | (4) | ||||||||||||||||
| 3(ii) | (4) | ||||||||||||||||
| 3(iii) | (4) | ||||||||||||||||
| 3(iv) | (9) | ||||||||||||||||
| 3(v) | (10) | ||||||||||||||||
| 3(vi) | (13) | ||||||||||||||||
| 3(vii) | (15) | ||||||||||||||||
| 3(viii) | (20) | ||||||||||||||||
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| 3(ix) | (27) | ||||||||||||||||
| 3(x)# | (22) | ||||||||||||||||
| 3(xi) | (15) | ||||||||||||||||
| 4.1 | (18) | ||||||||||||||||
| 4.2 | (29) | ||||||||||||||||
| 10.1* | (23) | ||||||||||||||||
| 10.2* | (20) | ||||||||||||||||
| 10.3* | (17) | ||||||||||||||||
| 10.4* | (17) | ||||||||||||||||
| 10.5* | (17) | ||||||||||||||||
| 10.6* | (17) | ||||||||||||||||
| 10.7* | (17) | ||||||||||||||||
| 10.8* | (17) | ||||||||||||||||
| 10.09* | (3) | ||||||||||||||||
| 10.10* | (9) | ||||||||||||||||
| 10.11* | (9) | ||||||||||||||||
| 10.12* | (9) | ||||||||||||||||
| 10.13* | (9) | ||||||||||||||||
| 10.14* | (9) | ||||||||||||||||
| 10.15* | (20) | ||||||||||||||||
| 10.16* | (26) | ||||||||||||||||
| 10.17* | (19) | ||||||||||||||||
| 10.18* | (2) | ||||||||||||||||
| 10.19* | (24) | ||||||||||||||||
| 10.20* | (5) | ||||||||||||||||
| 10.21* | (7) | ||||||||||||||||
| 10.22* | (11) | ||||||||||||||||
| 10.23* | (12) | ||||||||||||||||
| 10.24* | (14) | ||||||||||||||||
| 10.25* | (16) | ||||||||||||||||
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| 10.26* | (1) | ||||||||||||||||
| 10.27* | (2) | ||||||||||||||||
| 10.28* | (21) | ||||||||||||||||
| 10.29* | (26) | ||||||||||||||||
| 10.30* | (26) | ||||||||||||||||
| 10.31* | |||||||||||||||||
| 10.32* | (12) | ||||||||||||||||
| 10.33* | (12) | ||||||||||||||||
| 10.34+ | (6) | ||||||||||||||||
| 10.35 | (8) | ||||||||||||||||
| 10.36++ | (19) | ||||||||||||||||
| 10.37#++ | (25) | ||||||||||||||||
| 10.38+ | (11) | ||||||||||||||||
| 10.39++ | (21) | ||||||||||||||||
| 10.40+ | (21) | ||||||||||||||||
| 10.41+ | (11) | ||||||||||||||||
| 10.42* | (30) | ||||||||||||||||
| 21.1 | |||||||||||||||||
| 23.1 | |||||||||||||||||
| 24.2 | |||||||||||||||||
| 31.1 | |||||||||||||||||
| 31.2 | |||||||||||||||||
| 32.1** | |||||||||||||||||
| 101.INS | XBRL Instance Document. | ||||||||||||||||
| 101.SCH | XBRL Taxonomy Extension Schema Document. | ||||||||||||||||
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| 101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document. | ||||||||||||||||
| 101.DEF | XBRL Taxonomy Extension Definition Linkbase Document. | ||||||||||||||||
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document. | ||||||||||||||||
| 101.LAB | XBRL Taxonomy Extension Label Linkbase Document. | ||||||||||||||||
| 104.0 | Cover Page Interactive Data File (embedded within the Inline XBRL document contained in Exhibit 101) | ||||||||||||||||
| Notes | |||||
| * | Indicates management contract or compensatory plan or arrangement. | ||||
| + | Portions of the exhibit have been omitted pursuant to a request for confidential treatment. | ||||
| ++ | Certain confidential information contained in this exhibit has been omitted because it is both (i) not material and (ii) would be competitively harmful if publicly disclosed. | ||||
| # | Certain personally identifiable information has been omitted from this exhibit pursuant to Item 601(a)(6) under Regulation S-K. | ||||
| ** | Furnished herewith but not filed. | ||||
| (1) | Filed with the Registrant's Form 10-K for the year ended December 31, 2006. | ||||
| (2) | Filed with the Registrant's Form 10-K for the year ended December 31, 2007. | ||||
| (3) | Filed with the Registrant's Form 10-K for the year ended December 31, 2008. | ||||
| (4) | Filed with the Registrant's Form 10-K for the year ended December 31, 2012. | ||||
| (5) | Filed with the Registrant's Form 10-K for the year ended December 31, 2013. | ||||
| (6) | Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2014. | ||||
| (7) | Filed with the Registrant's Form 10-K for the year ended December 31, 2014. | ||||
| (8) | Filed with the Registrant's Form 10-Q for the quarter ended March 31, 2015. | ||||
| (9) | Filed with the Registrant's Form 10-K for the year ended December 31, 2016. | ||||
| (10) | Filed with the Registrant's Form 10-Q for the quarter ended March 31, 2017. | ||||
| (11) | Filed with the Registrant's Form 10-K for the year ended December 31, 2017. | ||||
| (12) | Filed with the Registrant's Form 10-Q for the quarter ended March 31, 2018. | ||||
| (13) | Filed with the Registrant's Form 8-K on May 9, 2018. | ||||
| (14) | Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2018. | ||||
| (15) | Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2019. | ||||
| (16) | Filed with the Registrant's Form 8-K on June 1, 2019. | ||||
| (17) | Filed with the Registrant's Form 10-K for the year ended December 31, 2018. | ||||
| (18) | Filed with the Registrant's Form 8-K on September 17, 2019. | ||||
| (19) | Filed with the Registrant's Form 10-K for the year ended December 31, 2019. | ||||
| (20) | Filed with the Registrant’s Form 10-Q for the quarter ended March 31, 2020. | ||||
| (21) | Filed with the Registrant’s Form 10-Q for the quarter ended June 30, 2020. | ||||
| (22) | Filed with the Registrant’s Form 8-K on April 1, 2020. | ||||
| (23) | Filed with the Registrant's Form 10-Q for the quarter ended June 30, 2021. | ||||
| (24) | Filed with the Registrant's Form 8-K on June 10, 2021. | ||||
| (25) | Filed with the Registrant's Form 10-Q for the quarter ended March 31, 2021. | ||||
| (26) | Filed with the Registrant's Form 10-K for the year ended December 31, 2020. | ||||
| (27) | Filed with the Registrant’s S-3 on February 16, 2022, File Number 333-262795. | ||||
| (28) | Filed with the Registrant’s Form 10-Q for the quarter ended September 30, 2022. | ||||
| (29) | Filed with the Registrant’s Form 10-K for the year ended December 31, 2021. | ||||
| (30) | Filed with the Registrant’s Form 10-Q for the quarter ended June 30, 2022. | ||||
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Item 16. Form 10-K Summary
Registrants may voluntarily include a summary of information required by Form 10-K under this Item 16. The Registrant has elected not to include such summary information.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 28, 2023.
| HESKA CORPORATION | |||||
By: /s/ KEVIN S. WILSON Kevin S. Wilson Chief Executive Officer and President | |||||
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Catherine Grassman his or her true and lawful attorneys-in-fact, with full power of substitution, for him or her in any and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all of said attorney-in-fact or their substitute may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
| Signature | Title | Date | ||||||
/s/ KEVIN S. WILSON Kevin S. Wilson | Chief Executive Officer, President and Director (Principal Executive Officer) | February 28, 2023 | ||||||
/s/ CATHERINE GRASSMAN Catherine Grassman | Executive Vice President, Chief Financial Officer (Principal Financial and Accounting Officer) | February 28, 2023 | ||||||
/s/ SCOTT HUMPHREY Scott Humphrey | Chair | February 28, 2023 | ||||||
/s/ ROBERT L. ANTIN Robert L. Antin | Director | February 28, 2023 | ||||||
/s/ STEPHEN L. DAVIS Stephen L. Davis | Director | February 28, 2023 | ||||||
/s/ MARK F. FURLONG Mark F. Furlong | Director | February 28, 2023 | ||||||
/s/ JOACHIM HASENMAIER Joachim Hasenmaier | Director | February 28, 2023 | ||||||
/s/ SHARON J. MAPLES Sharon J. Maples | Director | February 28, 2023 | ||||||
/s/ DAVID E. SVEEN David E. Sveen, Ph.D. | Director | February 28, 2023 | ||||||
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