HESKA CORPORATION The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Selected Financial Data" and the Consolidated Financial Statements and related Notes included in Items 6 and 8, respectively, of this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Such statements, which include statements concerning future revenue sources and concentration, gross profit margins, selling and marketing expenses, research and development expenses, general and administrative expenses, capital resources, additional financings or borrowings and additional losses, are subject to risks and uncertainties, including, but not limited to, those discussed below and elsewhere in this Form 10-K, particularly in Item 1A. "Risk Factors," that could cause actual results to differ materially from those projected. The forward-looking statements set forth in this Form 10-K are as of the close of business onFebruary 27, 2020 , and we undertake no duty and do not intend to update this information, except as required by applicable securities laws. Overview We sell advanced veterinary diagnostic and specialty products. Our offerings include Point of Care laboratory instruments and consumables; Point of Care digital imaging diagnostic instruments; vaccines; local and cloud-based data services; allergy testing and immunotherapy; and single-use offerings such as in-clinic diagnostic tests and heartworm preventive products. Our core focus is on supporting veterinarians in the canine and feline healthcare space. Our business is composed of two reportable segments, CCA and OVP. The CCA segment includes, primarily for canine and feline use, Point of Care laboratory instruments and consumables; digital imaging diagnostic instruments, software and services; local and cloud-based data services; allergy testing and immunotherapy; and single use offerings such as in-clinic diagnostic tests and heartworm preventive products. The OVP segment includes private label vaccine and pharmaceutical production, primarily for cattle but also for other species including equine, porcine, avian, feline and canine. OVP products are sold by third parties under third party labels. CCA represented approximately 87% of our 2019 revenue. OVP represented approximately 13% of our 2019 revenue. CCA Segment Revenue from Point of Care laboratory including instruments, consumables and other revenue such as service represented$67.1 million ,$57.4 million and$54.9 million of our 2019, 2018 and 2017 revenue, respectively. Revenue in this area primarily involves placing an instrument under contract in the field and generating future revenue from testing consumables, such as cartridges and reagents, as that instrument is used. Approximately$53.6 million ,$44.8 million and$39.2 million of our 2019, 2018 and 2017 revenue, respectively, resulted from the sale of such testing consumables to an installed base of instruments. Approximately$12.1 million ,$10.8 million and$13.8 million of our 2019, 2018 and 2017 revenue, respectively, was from instrument sales, including revenue recognized from sales-type lease treatment. Included in instrument sales are sales of infusion pumps, which are sold outright through distribution. Sales of infusion pumps were$3.0 million ,$2.7 million , and$4.0 million for 2019, 2018 and 2017, respectively. Approximately$1.4 million ,$1.8 million and$1.9 million of our 2019, 2018 and 2017 revenue, respectively, was from other revenue sources, such as charges for repairs. Instruments placed under subscription agreements are considered operating or sales-type leases, depending on the duration and other factors of the underlying agreement. A loss of, or disruption in, the supply of consumables we are selling to an installed base of instruments could substantially harm our business. All of our Point of Care laboratory and other non-imaging instruments and consumables are supplied by third parties, who typically own the product rights and -34- -------------------------------------------------------------------------------- supply the product to us under marketing and/or distribution agreements. In many cases, we have collaborated with a third party to adapt a human instrument for veterinary use. Major products in this area include our instruments for chemistry, hematology, blood gas and immunodiagnostic testing and their affiliated operating consumables. Point of Care digital imaging hardware, software and services represented approximately$25.7 million ,$22.8 million and$21.9 million of 2019, 2018 and 2017 revenue, respectively. Digital radiography is the largest product offering in this area, which also includes ultrasound instruments. Digital radiography solutions typically consist of a combination of hardware and software placed with a customer, often combined with an ongoing service and support contract. We sell our imaging solutions both in theU.S. and internationally. Our experience has been that most of the revenue is generated at the time of sale in this area, in contrast to the Point of Care diagnostics laboratory placements discussed above where ongoing consumable revenue is often a larger component of economic value as a given instrument is used. Other CCA revenue, including single use diagnostic and other tests, pharmaceuticals and biologicals, as well as research and development, licensing and royalty revenue, represented$13.8 million ,$28.7 million and$28.4 million of our 2019, 2018 and 2017 revenue, respectively. Since items in this area are often single use by their nature, our typical aim is to build customer satisfaction and loyalty for each product, generate repeat annual sales from existing customers and expand our customer base in the future. Products in this area are both supplied by third parties and provided by us. Major products and services in this area include heartworm diagnostic tests and preventives, and allergy test kits, allergy immunotherapy and testing. Of our annual revenue, heartworm produced primarily for private-label accounted for approximately$1.7 million in 2019 and$16.8 million in both 2018 and 2017, respectively. The decrease in Other CCA revenue in 2019 was driven primarily by a$14.9 million decrease from contract manufactured heartworm preventive, Tri-Heart, as a result of reduced customer demand. We consider the CCA segment to be our core business and devote most of our management time and other resources to improving the prospects for this segment. Maintaining a continuing, reliable and economic supply of products we currently obtain from third parties is critical to our success in this area. Virtually all of our sales and marketing expenses occur in the CCA segment. The majority of our research and development spending is dedicated to this segment as well. All of our CCA products are ultimately sold primarily to or through veterinarians. In many cases, veterinarians will mark up their costs to their customer. The acceptance of our products by veterinarians is critical to our success. CCA products are sold directly to end users by us as well as through distribution relationships, such as the sale of kits to conduct blood testing to third-party veterinary diagnostic laboratories and independent third-party distributors. Revenue from direct sales and distribution relationships represented approximately 74% and 26%, respectively, of CCA 2019 revenue, 57% and 43%, respectively, of CCA 2018 revenue and 58% and 42%, respectively, of CCA 2017 revenue. OVP Segment The OVP segment includes our approximately 160,000 square footUSDA and FDA licensed production facility inDes 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 ourU.S. inventory, excluding our imaging products, is now stored at this facility and related fulfillment logistics are managed there. CCA segment products manufactured at this facility are transferred at cost and are not recorded as revenue for our OVP segment. -35- -------------------------------------------------------------------------------- Historically, a significant portion of our OVP segment's revenue has been generated from the sale of certain bovine vaccines, which have been sold primarily under the Titanium® and MasterGuard® brands. We have an agreement withElanco for the production of these vaccines (the "Elanco Agreement"). Our OVP segment also produces vaccines and pharmaceuticals for other third parties. Critical Accounting Estimates The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. "Part II, Item 8. Note 1. Summary of Significant Accounting Policies" to the consolidated financial statements included in this Annual Report on Form 10-K describes the significant accounting policies used in preparation of these consolidated financial statements. We believe the following critical accounting estimates and assumptions may have a material impact on reported financial condition and operating performance and involve significant levels of judgment to account for highly uncertain matters or are susceptible to significant change. Revenue Recognition EffectiveJanuary 1, 2018 , we adopted FASB Accounting Standards Codification ("ASC") Topic 606, Revenue from Contracts with Customers (the "New Revenue Standard"), using the modified retrospective method for all contracts not completed as of the date of adoption. Under the New Revenue Standard, revenue is recognized when, or as, performance obligations under the terms of a contract are satisfied, which occurs when control of the promised products or services is transferred to a customer. We exclude sales, use, value-added, and other taxes we collect on behalf of third parties from revenue. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or services to a customer. To meet the requirements of the New Revenue Standard and accurately present the consideration received in exchange for promised products or services, we applied the prescribed five-step model outlined below: 1. Identification of a contract or agreement with a customer 2. Identification of our performance obligations in the contract or agreement 3. Determination of the transaction price 4. Allocation of the transaction price to the performance obligations 5. Recognition of revenue when, or as, we satisfy a performance obligation See "Part II. Item 8. Financial Statements and Supplementary Data, Note 2. Revenue Recognition" to the consolidated financial statements for the year endedDecember 31, 2019 , included in this Annual Report on Form 10-K for additional information about our revenue recognition policy and criteria for recognizing revenue. Application of the various accounting principles in GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, our subscription arrangements related to our Point of Care laboratory products provide our customers the right to use our instruments upon entering into multi-year agreements to purchase a minimum amount of consumables. These types of agreements include an embedded lease, designated as either an operating-type lease ("OTL") or a sales-type lease ("STL"), dependent upon individual contract terms, most often relating to the term of the contract relative to the life of the underlying instruments being placed under that contract. The determination of the amounts -36- -------------------------------------------------------------------------------- allocated to each component of the contract are based upon fair value. Changes in fair value in any period of the underlying components will impact that amount of revenue recognized. Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts receivable based on client-specific allowances, as well as a general allowance. Specific allowances are maintained for clients which are determined to have a high degree of collectability risk based on such factors, among others, as: (i) the aging of the accounts receivable balance; (ii) the client's past payment history; and (iii) a deterioration in the client's financial condition, evidenced by weak financial condition and/or continued poor operating results, reduced credit ratings and/or a bankruptcy filing. In addition to the specific allowance, the Company maintains a general allowance for credit risk in its accounts receivable which is not covered by a specific allowance. The general allowance is established based on such factors, among others, as: (i) the total balance of the outstanding accounts receivable, including considerations of the aging categories of those accounts receivable; (ii) past history of uncollectable accounts receivable write-offs; and (iii) the overall creditworthiness of the client base. A considerable amount of judgment is required in assessing the realizability of accounts receivable. Should any of the factors considered in determining the adequacy of the overall allowance change, an adjustment to the provision for doubtful accounts receivable may be necessary. Inventory Valuation We write down the carrying value of inventory for estimated obsolescence by an amount equal to the difference between the cost of inventory and the estimated market value when warranted based on assumptions of future demand, market conditions, remaining shelf life or product functionality. If actual market conditions or results of estimated functionality are less favorable than those we estimated, additional inventory write-downs may be required, which would have a negative effect on results of operations. The inventory allowance was$1.3 million and$1.6 million as ofDecember 31, 2019 and 2018, respectively. Deferred Tax Assets - Valuation Allowance We evaluate our ability to realize the tax benefits associated with a deferred tax asset ("DTA") by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. As ofDecember 31, 2019 and 2018, we had valuation allowances of approximately$5.7 million and$10.2 million , respectively. The change in the valuation allowance resulted from the expiration of deferred tax assets which were offset with a valuation allowance atDecember 31, 2018 . See "Part II. Item 8. Financial Statements and Supplementary Data, Note 5. Income Taxes" to the consolidated financial statements for additional information regarding our income taxes.
Business Combinations
We account for transactions that represent business combinations under the
acquisition method of accounting, which requires us to allocate the total
consideration paid for each acquisition to the assets we acquire and liabilities
we assume based on their fair values as of the date of acquisition, including
identifiable intangible assets. The allocation of the purchase price utilizes
significant estimates in determining the fair values of identifiable assets
acquired and liabilities assumed, especially with respect to intangible
assets. We may refine our estimates and make adjustments to the assets acquired
and liabilities assumed over a measurement period, not to exceed one year.
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Valuation of
We assess goodwill for impairment annually, at the reporting unit level, in the fourth quarter and whenever events or circumstances indicate impairment may exist. In evaluating goodwill for impairment, we have the option to first assess the qualitative factors to determine whether it is more-likely-than-not that the estimated fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the comparison of the estimated fair value of the reporting unit to the carrying value. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If, after assessing the totality of events or circumstances, we determine that is it more-likely-than-not that the estimated fair value of a reporting is less than its carrying amount, we would then estimate the fair value of the reporting unit and compare it to the carrying value. If the carrying value exceeds the estimated fair value we would recognize an impairment for the difference; otherwise, no further impairment test would be required. In contrast, we can opt to bypass the qualitative assessment for any reporting unit in any period and proceed directly to quantitative analysis. Doing so does not preclude us from performing the qualitative assessment in any subsequent period. We performed qualitative assessments in the fourth quarters of 2019, 2018 and 2017 and determined that no indications of impairment existed. We assess the realizability of intangible assets other than goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If an impairment review is triggered, we evaluate the carrying value of intangible assets based on estimated undiscounted future cash flows over the remaining useful life of the primary asset of the asset group and compare that value to the carrying value of the asset group. The cash flows that are used contain our best estimates, using appropriate and customary assumptions and projections at the time. If the net carrying value of an intangible asset exceeds the related estimated undiscounted future cash flows, an impairment to adjust the intangible asset to its fair value would be reported as a non-cash charge to earnings. If necessary, we would calculate the fair value of an intangible asset using the present value of the estimated future cash flows to be generated by the intangible asset, and applying a risk-adjusted discount rate. We had no impairments of our intangible assets during the years endedDecember 31, 2019 , 2018 and 2017.
These valuations require the use of management's assumptions, which would not reflect unanticipated events and circumstances that may occur.
Share-Based Compensation Expense
We utilize share-based compensation arrangements as part of our long-term incentive plan. Under these incentive arrangements, we currently issue restricted stock awards, both tied to time vesting or performance and time vesting to employees and directors. We also issue stock options awards to employees. All significant inputs into the determination of expense as well as the related expense are discussed further in "Part II. Item 8. Financial Statements and Supplementary Data, Note 12. Capital Stock".
Restricted Stock Awards (Time Vesting)
The fair value of restricted stock awards with only time-based vesting terms
used in our expense recognition method is measured based on the number of shares
granted and the closing market price of our common stock on the date of grant.
Such value is recognized as an expense over the corresponding requisite service
period. Forfeitures are accounted for as they occur.
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--------------------------------------------------------------------------------Restricted Stock Awards (Performance Vesting)
We also grant restricted stock awards subject to performance vesting criteria, in addition to service to our executive officers and other key employees. This type of grant consists of the right to receive shares of common stock, subject to achievement of time-based criteria and certain company and market performance-related goals over a specified period, as established by the Compensation Committee of our Board of Directors. We recognize any related share-based compensation expense ratably over the service period based on the probability assessment on the outcome of the performance condition related to company performance metrics. The fair value used in our expense recognition method is measured based on the number of shares granted and the closing market price of our common stock on the date of grant. The amount of share-based compensation expense recognized in any one period can vary based on the attainment or expected attainment of the performance goals. If such performance goals are not ultimately met, no compensation expense is recognized and any previously recognized compensation expense is reversed. We recognize any related share-based compensation expense ratably over the service period based on the most probable outcome of the performance condition related to market performance metrics. The fair value used in our expense recognition method is measured based on the number of shares granted, and a Monte Carlo simulation model, which incorporates the probability of the achievement of the market-related performance goals as part of the grant date fair value. If such performance goals are not ultimately met, the expense is not reversed. As ofDecember 31, 2019 , we reviewed each of the underlying corporate performance targets and determined that approximately 219,000 shares of common stock were related to corporate performance targets in which we did not deem achievement probable. No compensation expense had been recorded at any period prior toDecember 31, 2019 . The unrecognized compensation cost associated with the restricted stock awards not deemed probable, based on grant date fair value, is approximately$17.8 million . Any change in the probability determination could accelerate the recognition of this expense.
Recent Accounting Pronouncements
In addition to the impacts from new accounting pronouncements included above, see "Part II. Item 8. Financial Statements and Supplementary Data, Note 1. Summary of Significant Accounting Policies" to the consolidated financial statements for the year endedDecember 31, 2019 , included in this Annual Report on Form 10-K for a complete discussion of recent accounting pronouncements adopted and not adopted. -39- -------------------------------------------------------------------------------- Results of Operations Our analysis presented below is organized to provide the information we believe will facilitate an understanding of our historical performance and relevant trends going forward. This discussion should be read in conjunction with our consolidated financial statements, including the notes thereto, in Item 8 of this annual report on Form 10-K. The following table sets forth, for the periods indicated, certain data derived from our Consolidated Statements of Income (in thousands): Year Ended December 31, 2019 2018 2017 Revenue$ 122,661 $ 127,446 $ 129,341 Gross profit 54,449 56,638 58,261 Operating expenses 54,122 52,844 40,042 Operating income 327 3,794 18,219 Interest and other expense (income), net 2,910 (13 ) (150 ) (Loss) income before income taxes and equity in losses of unconsolidated affiliates (2,583 ) 3,807
18,369
Income tax (benefit) expense (1,446 ) (2,115 )
8,913
Net (loss) income before equity in losses of unconsolidated affiliates (1,137 ) 5,922
9,456
Equity in losses of unconsolidated affiliates (594 ) (72 ) - Net (loss) income, after equity in losses of unconsolidated affiliates (1,731 ) 5,850
9,456
Net (loss) income attributable to non-controlling interest (266 ) - (497 ) Net (loss) income attributable to Heska Corporation$ (1,465 ) $ 5,850 $ 9,953
The following tables set forth, for the periods indicated, segment data derived from our Consolidated Statements of Income (in thousands):
CCA Segment
Year Ended December 31 , Change
2019 2018 2017 Dollar Change % Change Dollar Change % Change
Point of Care
Laboratory: $ 67,132 $ 57,375 $ 54,855 $ 9,757 17% $ 2,520 5%
Consumables 53,590 44,771 39,161 8,819 20% 5,610 14%
Instruments 12,137 10,810 13,773 1,327 12% (2,963 ) (22)%
Other 1,405 1,794 1,921 (389 ) (22)% (127 ) (7)%
Point of Care
Imaging 25,652 22,832 21,907 2,820 12% 925 4%
Other CCA
Revenue 13,786 28,717 28,429 (14,931 ) (52)% 288 1%
Total CCA
Revenue $ 106,570 $ 108,924 $ 105,191 $ (2,354 ) (2)% $ 3,733 4%
Percent of Total
Revenue 86.9 % 85.5 % 81.3 %
Cost of Revenue 52,923 56,326 54,509 (3,403 ) (6)% 1,817 3%
Gross Profit 53,647 52,598 50,682 1,049 2% 1,916 4%
Operating Income
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OVP Segment
Year Ended December 31, Change
2019 2018 2017 Dollar Change % Change Dollar Change % Change
Revenue $ 16,091 $ 18,522 $ 24,150 $
(2,431 ) (13)%
15,289 14,482 16,570 807 6% (2,088 ) (13)%
Gross Profit 802 4,040 7,580
(3,238 ) (80)% (3,540 ) (47)%
Operating (Loss) Income
Revenue
Total revenue decreased 4% to$122.7 million in 2019 compared to$127.4 million in 2018. Total revenue decreased 1% to$127.4 million in 2018 compared to$129.3 million in 2017. CCA segment revenue decreased 2% to$106.6 million in 2019 compared to$108.9 million in 2018. The decrease was driven by an anticipated reduction in sales to Merck for a heartworm preventive as previously disclosed on our 2018 fourth quarter earnings release. The decline was offset by a 20% increase in Point of Care laboratory consumables, as well as a 12% increase from Point of Care imaging revenue primarily due to the Optomed acquisition. CCA segment revenue increased 4% to$108.9 million in 2018 compared to$105.2 million in 2017. The increase was driven primarily by a 14% increase in revenue from Point of Care laboratory consumables, as well as a 4% increase in revenue from Point of Care imaging products due to increased sales of digital radiography systems. This was partially offset by a 22% decrease in revenue from Point of Care laboratory instruments due to lower sales-type lease instrument revenue recognition of$1.5 million and lower infusion pump sales of$1.3 million . OVP segment revenue decreased 13% to$16.1 million in 2019 compared to$18.5 million in 2018. The decrease was driven primarily by reduced customer requirements and supply issues with materials. OVP segment revenue decreased 23% to$18.5 million in 2018 compared to$24.2 million in 2017. The decrease was driven by decreased volume of sales under contract manufacturing arrangements. Gross Profit Gross profit decreased 4% to$54.4 million in 2019 compared to$56.6 million in 2018. Gross margin percent remained consistent at 44.4% in 2019 compared to 44.4% in 2018. Gross profit decreased 3% to$56.6 million in 2018 compared to$58.3 million in 2017. Gross margin percent decreased to 44.4% in 2018 compared to 45.0% in 2017. The decrease in both gross profit and gross margin percentage was driven primarily by unfavorable product mix and plant utilization charges in our OVP segment. Operating Expenses Selling and marketing expenses increased 12% to$27.7 million in 2019 compared to$24.7 million in 2018. Selling and marketing expenses increased 6% to$24.7 million in 2018 compared to$23.2 million in 2017. The increase in both periods was primarily driven by an increase in compensation, including stock-based compensation, benefits and commissions expense, which is mostly related to our commercial team expansion both domestically and internationally. The increase is in line with management expectations as we continue to invest in future growth and expanding the footprint of the Company. Research and development expenses increased 147% to$8.2 million in 2019, compared to$3.3 million in 2018. Research and development increased 66% to$3.3 million in 2018, as compared to$2.0 million in 2017. The increase in both periods was primarily driven by spending on product development for urine and -41- -------------------------------------------------------------------------------- fecal diagnostic analyzer and enhanced immunodiagnostic offerings. As we invest in future growth of the Company, the increased research and development expenses is consistent with the spending initiatives of management. General and administrative expenses decreased 27% to$18.2 million in 2019, compared to$24.8 million in 2018. The decrease was primarily driven by a$7.0 million settlement accrual and related legal expenses in the prior year; partially offset by increased expenses associated with international expansion. General and administrative expenses increased 68% to$24.8 million in 2018, as compared to$14.8 million in 2017. The increase was driven by a$7.0 million settlement accrual and related legal expenses, a$1.4 million increase in stock-based compensation, a$0.6 million increase in compensation and benefits, a$0.5 million increase in legal fees and a$0.5 million increase in consulting fees. Interest and Other Expense (Income), Net Interest and other expense (income), net, was expense of$2.9 million in 2019, compared to income of$13 thousand in 2018 and income of$150 thousand in 2017. The increase in other expense in 2019 was primarily driven by interest expense as a result of the Notes. The decrease in other income in 2018, compared to 2017, was primarily driven by an increase in net foreign currency losses, and an increase in interest expense, partially offset by an increase in interest income and other gains. Income Tax (Benefit) Expense In 2019, we had total income tax benefit of$1.4 million compared to a total income tax benefit in 2018 of$2.1 million and total income tax expense of$8.9 million in 2017. See "Part II, Item 8. Financial Statements and Supplementary Data, Note 5. Income Taxes" in the accompanying notes to the consolidated financial statements for additional information regarding our income taxes. Net (Loss) Income Attributable toHeska Corporation Net loss attributable toHeska Corporation was$1.5 million in 2019, compared to net income attributable toHeska Corporation of$5.9 million in 2018 and net income attributable toHeska Corporation of$10.0 million in 2017. The difference between this line item and "Net (loss) income after equity in losses of unconsolidated affiliates" is the net income or loss attributable to our minority interest in our French subsidiary, which we purchased inFebruary 2019 . The difference between these line items was a gain of$0.3 million for 2019. There was no difference between these line items in 2018, and a gain of$0.5 million in 2017. Non-GAAP Financial Measures In addition to financial measures presented on the basis of accounting principles generally accepted in theU.S. ("U.S. GAAP"), we also present fourth quarter and full year 2019 operating income, operating margin, net income attributable to Heska, earnings per diluted share, Adjusted EBITDA, Adjusted EBITDA margin, and the effective tax rate, excluding acquisition and other one-time charges, which are non-GAAP measures. We also present fourth quarter and full year 2018 operating income, operating margin, net income attributable to Heska, earnings per diluted share, Adjusted EBITDA, Adjusted EBITDA margin, and the effective tax rate, excluding TCPA Settlement, which are non-GAAP measures. These measures should be viewed as a supplement to (not substitute for) our results of operations presented underU.S. GAAP. The non-GAAP financial measures presented may not be comparable to similarly titled measures of other companies because they may not calculate their measures in the same manner. Our management has included these measures to assist in comparing performance from period to period on a consistent basis. -42- -------------------------------------------------------------------------------- The following tables reconcile our adjusted non-GAAP financial measures to our most directly comparable as-reported financial measures calculated in accordance with GAAP (in thousands, except per share amounts): Three Months Ended Year Ended December 31, December 31, 2019 2018 2019 2018 Operating income$ 775 $ 3,314 $ 327 $ 3,794 Acquisition-related costs(1) 674 - 674 - Litigation and other one-time costs(2) - 232 - 7,407 Non-GAAP operating income$ 1,449 $ 3,546 $ 1,001 $ 11,201 Non-GAAP operating margin 4.3 % 10.4 % 0.8 % 8.8 % Net (loss) income attributable to Heska Corporation$ (1,728 ) $ 3,468 $ (1,465 ) $ 5,850 Income tax expense (benefit) 520 (175 ) (1,446 ) (2,115 ) Interest expense (income) 2,075 4 2,428 49 Depreciation and amortization 1,157 1,122 4,916 4,595 EBITDA$ 2,024 $ 4,419 $ 4,433 $ 8,379 Acquisition-related costs(1) 674 - 674 - Litigation and other one-time costs(3) (250 ) 232 307 7,407 Stock-based compensation 1,343 1,453 4,968 5,227 Adjusted EBITDA$ 3,791 $ 6,104 $ 10,382 $ 21,013 Adjusted EBITDA margin(4) 11.2 % 17.9 % 8.5 % 16.5 %
(1) To exclude the effect of one-time charges of
(2) To exclude$0.2 million and$7.4 million in the fourth quarter of 2018 and for the full year 2018, respectively, due to the agreement in principle to settle the complaint filed against the Company for$6.75 million , approximately$0.6 million of legal costs incurred in relation to the settlement negotiation, and other one-time costs. (3)To exclude the effect of one-time benefit of$0.3 million for the fourth quarter of 2019 related to the insurance recovery of cyber incident and a net charge of$0.3 million for the full year of 2019 related to the costs associated with the cyber incident. In addition, this excludes$0.2 million and$7.4 million in the fourth quarter of 2018 and for the full year 2018, respectively, as noted above.
(4) Adjusted EBITDA margin is calculated as the ratio of adjusted EBITDA to revenue.
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Three Months Ended Year Ended
December 31, December 31,
2019 2018 2019 2018
GAAP net income attributable to
Heska per diluted share $ (0.23 ) $ 0.44 $ (0.20 ) $ 0.74
Acquisition-related costs(1) 0.08 - 0.08 -
Litigation and other one-time
costs(2) (0.03 ) 0.03 0.04 0.94
Amortization of debt discount
and issuance costs 0.19 - 0.23 0.01
Stock-based compensation 0.17 0.18 0.62 0.67
Gain (loss) on equity investee
transactions 0.02 0.01 0.07 0.01
Estimated income tax effect of
above non-GAAP adjustments(3) (0.11 ) (0.06 ) (0.26 ) (0.40 )
Discrete tax benefits associated
with stock-based compensation
activity (0.02 ) (0.06 ) (0.21 ) (0.33 )
Non-GAAP net income per diluted
share $ 0.07 $ 0.54 $
0.37
Shares used in diluted per share calculations 8,036 7,947 7,977 7,856
(1) To exclude the effect of one-time charges of
(2) To exclude the effect of a one-time benefit of$0.3 million for the fourth quarter of 2019 of insurance recovery relating to the cyber incident disclosed in the third quarter 2019, and a net charge of$0.3 million for the full year of 2019 related to the net loss after insurance recovery associated with the cyber incident. In addition, this also excludes$0.2 million and$7.4 million in the fourth quarter of 2018 and for the full year 2018, respectively, due to the agreement in principle to settle the complaint filed against the Company for$6.75 million , approximately$0.6 million of legal costs incurred in relation to the settlement negotiation, and other one-time costs. (3) Represents income tax expense utilizing an estimated effective tax rate that adjusts for non-GAAP measures including: acquisition-related costs, litigation and other one-time costs, amortization of debt discount and issuance costs, and stock-based compensation. Adjusted effective tax rates are 25% for the fourth quarter and full year 2019 and 24% for the fourth quarter and full year 2018. Impact of Inflation In recent years, inflation has not had a significant impact on our operations. Liquidity, Capital Resources and Financial Condition We believe that adequate liquidity and cash generation is important to the execution of our strategic initiatives. Our ability to fund our operations, acquisitions, capital expenditures, and product development efforts may depend on our ability to generate cash from operating activities, which is subject to future operating performance, as well as general economic, financial, competitive, legislative, regulatory, and other conditions, some of which may be beyond our control. Our primary sources of liquidity are our available cash, including$70.9 million from the issuance and sale of the Notes, after deducting the initial purchasers' discounts, debt issuance costs paid or payable by us, and the repayment in full of our Credit Facility, as described in Note 16 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, and cash generated from current operations. Subsequent toDecember 31, 2019 , the Company transferred$14.6 million of consideration for the purchase of the CVM companies. Refer to Part II. Item 8. Financial Statements and Supplementary Data, Note 3. Acquisition and Related Party Items. Additionally, we announced our intention to acquire scil and finance the transaction through a private placement of convertible preferred equity. Refer to Part II. Item 8. Financial Statements and Supplementary Data, Note 19. Subsequent Events. -44- -------------------------------------------------------------------------------- For the year endedDecember 31, 2019 , we had a net loss after equity in losses of unconsolidated affiliates of$1.7 million and net cash provided by operations of$3.3 million . AtDecember 31, 2019 , we had$89.0 million of cash and cash equivalents and working capital of$107.7 million . A summary of our cash provided by and used in operating, investing and financing activities is as follows (in thousands): Year Ended
2019 2018 2017
Net cash provided by operating activities
$ 10,409 Net cash used in investing activities (1,923 ) (12,174 ) (17,169 ) Net cash provided by financing activities 74,264 2,627
5,551
Effect of currency translation on cash 4 (10 )
74
Increase (decrease) in cash and cash equivalents 75,641 3,730
(1,135 )
Cash and cash equivalents, beginning of the period 13,389 9,659 10,794
Cash and cash equivalents, end of the period
Net cash provided by operating activities was$3.3 million in 2019, compared to net cash provided by operating activities of$13.3 million in 2018, a decrease of approximately$10.0 million . Net cash provided by operating activities decreased due to significant working capital fluctuations such as a$12.0 million decrease in cash provided by accrued liabilities, primarily driven by a$6.8 million settlement payment and$0.3 million in related legal fees in 2019 (see Note 14. Commitments and Contingencies in our Consolidated Financial Statements included in Item 8 of this Form 10-K) and a$5.1 million decrease in cash provided by inventories, due to the timing of purchases and lower sales in the current year. Additionally, net cash from operating activities was$7.6 million less in 2019 due to the decrease in net income compared to 2018. These factors were partially offset by a$9.7 million decrease in cash used by the aggregate of accounts receivable, accounts payable, related party balances, deferred revenue and other current and non-current assets, due to the timing of collections and payments in the ordinary course of business. Non-cash transactions impacting cash provided by operating activities included a$1.8 million increase related to the amortization of debt discount and issuance costs and$1.6 million increase from our leases and rights of use asset amortization. Net cash provided by operating activities was$13.3 million in 2018, compared to net cash provided by operating activities of$10.4 million in 2017, an increase of approximately$2.9 million . Net cash provided by operating activities increased due to significant working capital fluctuations such as a$19.9 million increase in cash provided by inventories, due to the timing of inventory purchases in 2017; a$7.5 million increase in cash provided by accrued liabilities, largely due to a preliminary settlement agreement relating to outstanding litigation in the amount of$6.8 million which we paid in the first half of 2019 (see Note 14. Commitments and Contingencies in our Consolidated Financial Statements included in Item 8 of this Form 10-K); and a$2.8 million increase in cash provided by current and non-current lease receivables due to a lower level of sales-type lease placements and timing of collections on existing leases. These factors were partially offset by a$3.6 million decrease in net income, as well as a$15.2 million increase in cash used by the aggregate of accounts receivable, accounts payable, related party balances, deferred revenue and other current assets, due to the timing of collections and payments in the ordinary course of business. Non-cash transactions impacting cash provided by operating activities included a$11.1 million increase in our deferred tax benefit, net, offset by a$2.5 million increase in stock-based compensation.
Net cash used in investing activities was
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investing activities was mainly driven by the 2018 investments made in
unconsolidated affiliates for $8.1 million and 2018 intangible asset acquisition
for $2.8 million (cash portion). This was partially offset by $1.2 million
increase in cash used for the Optomed real estate asset acquisition; and $0.9
million increase in acquired cash from the acquisition of CVM. Net cash used in
investing activities was $12.2 million in 2018, compared to net cash used in
investing activities of $17.2 million in 2017, a decrease of approximately $5.0
million . The decrease in cash used for investing activities was mainly driven by
the 2017 purchase of the Heska Imaging minority for $13.8 million , compared to
the 2018 investments made in unconsolidated affiliates for $8.1 million and 2018
intangible asset acquisition for $2.8 million (cash portion). Additionally, we
had a $2.1 million decrease in cash used for purchases of property and
equipment.
Net cash provided by financing activities was $74.3 million in 2019, compared to
net cash provided by financing activities of $2.6 million in 2018, an increase
of approximately $71.6 million . The change was driven primarily by an $86.3
million increase in proceeds from the convertible notes offering (see Note 16.
Convertible Notes and Credit Facility in our Consolidated Financial Statements
included in Item 8 of this Form 10-K). The increase in proceeds from the notes
was partially offset by a $6.0 million decrease in net borrowings as a result of
the repayment in full of our Credit Facility; $3.2 million of cash used to pay
debt issuance costs; and $2.2 million decrease in proceeds from issuance of
common stock, net of distributions. Net cash provided by financing activities
was $2.6 million in 2018, compared to net cash provided by financing activities
of $5.6 million in 2017, a decrease of approximately $2.9 million . The change
was driven primarily by a $5.3 million decrease in borrowings, net of
repayments. This was partially offset by a $1.6 million increase in proceeds
from issuance of common stock, net of distributions, and a $0.8 million decrease
in distributions to non-controlling interest members.
We believe that our cash, cash equivalents and marketable securities balances,
as well as the cash flows generated by our operations, will be sufficient to
satisfy our anticipated cash needs for working capital and capital expenditures,
including selling and marketing team expansion and product development
initiatives, for at least the next 12 months. Our belief may prove to be
incorrect, however, and we could utilize our available financial resources
sooner the we currently expect. For example, we are actively seeking
acquisitions that are consistent with our strategic direction, which may require
additional capital. Our future capital requirements and the adequacy of
available funds will depend on many factors, including those set forth in Part
I, Item 1A, "Risk Factors", of this Form 10-K. We may be required to seek
additional equity or debt financing in order to meet these future capital
requirements, even in the absence of any acquisitions. In the event that
additional financing is required from outside sources, we may not be able to
raise it on terms acceptable to us, or at all. If we are unable to raise
additional capital when desired, our business, results of operations and
financial condition would be adversely affected.
Effect of currency translation on cash
Net effect of foreign currency translations on cash changed $14 thousand to a $4
thousand positive impact in 2019, compared to a $10 thousand negative impact in
2018. The net effect of foreign currency translation on cash changed $84
thousand to a $10 thousand negative impact in 2018 from a $74 thousand positive
impact in 2017. These effects are related to changes in exchange rates between
the U.S. Dollar and the Swiss Franc, Euro, and Australian Dollar which are the
functional currencies of our subsidiaries.
Off Balance Sheet Arrangements
We have no off balance sheet arrangements or variable interest entities.
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Contractual Obligations
The Company has not entered into any transactions with unconsolidated entities
whereby the Company has financial guarantees, subordinated retained interests,
derivative instruments, or other contingent arrangements that expose the Company
to material continuing risks, contingent liabilities, or any other obligation
under a variable interest in an unconsolidated entity that provided financing,
liquidity, market risk or credit risk support to the Company, or engages in
leasing, hedging or research and development services with the Company.
Purchase obligations represent contractual agreements to purchase goods or
services that are legally binding; specify a fixed, minimum or range of
quantities; specify a fixed, minimum, variable, or indexed price provision; and
specify approximate timing of the transaction.
See "Part II, Item 8. Financial Statements and Supplementary Data, Note 6.
Leases", included in this Form 10-K for a description of our operating lease
obligations, and "Part II, Item 8. Financial Statements and Supplementary Data,
Note 1. Operations and Summary of Significant Accounting Policies", for a
discussion of the impact of the adoption of FASB Accounting Standards
Codification ("ASC") Topic 842, Leases.
The following table presents certain future payments due by the Company as of
December 31, 2019 (in thousands):
Less Than 1
Total Year 1 - 3 Years 3 - 5 Years After 5 Years
Purchase obligations $ 13,539 $ 9,122 $ 3,329 $ 1,088 $ -
Consideration payable for
acquisition(1) 14,579 14,579 - - -
Operating lease obligations 6,727 1,792 3,052 1,826 57
Finance lease obligations 82 46 34 2 -
Other long term borrowings 1,121 - - 673 448
Convertible senior notes
(2) 86,250 - - - 86,250
Future interest obligations
(3) 22,650 3,237 6,475 6,473 6,465
Total $ 144,948 $ 28,776 $ 12,890 $ 10,062 $ 93,220
(1) Relates to acquisition of CVM companies. For additional information, refer
to Part II, Item 8. Financial Statements and Supplementary Data, Note 3.
Acquisition and Related Party Items.
(2) Includes the principal amount of the convertible senior notes. Although the
notes mature in 2026, they can be converted into cash and shares of our common
stock prior to maturity if certain conditions are met. Any conversion prior to
maturity can result in repayments of the principal amounts sooner than the
scheduled repayments as indicated in the table. For additional information,
refer to Part II, Item 8. Financial Statements and Supplementary Data, Note 16.
Convertible Notes and Credit Facility.
(3) Includes interest payments for both the convertible senior notes and other
long term borrowings.
Net Operating Loss Carryforwards
As of December 31, 2019 , we had a net operating loss carryforward ("NOL") and
domestic research and development tax credit carryforward. See "Part II, Item 8.
Financial Statements and Supplementary Data, Note 5. Income Taxes" in our
Consolidated Financial Statements for additional information regarding our
carryforwards.
Recent Accounting Pronouncements
From time to time, the FASB or other standard setting bodies issue new
accounting pronouncements. Updates
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to the FASB ASC are communicated through issuance of an ASU. Unless otherwise
discussed, we believe that the impact of recently issued guidance, whether
adopted or to be adopted in the future, is not expected to have a material
impact on our Consolidated Financial Statements upon adoption.
To understand the impact of recently issued guidance, whether adopted or to be
adopted, please review the information provided in Note 1. Operations and
Summary of Significant Accounting Policies to our Consolidated Financial
Statements included in Item 8 of this Form 10-K.
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