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MarketScreener Homepage  >  Equities  >  Nasdaq  >  Heska Corporation    HSKA

HESKA CORPORATION

(HSKA)
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HESKA : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-K)

02/28/2020 | 12:54pm EST
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with "Selected Financial Data" and the
Consolidated Financial Statements and related Notes included in Items 6 and 8,
respectively, of this Form 10-K. This discussion contains forward-looking
statements that involve risks and uncertainties. Such statements, which include
statements concerning future revenue sources and concentration, gross profit
margins, selling and marketing expenses, research and development expenses,
general and administrative expenses, capital resources, additional financings or
borrowings and additional losses, are subject to risks and uncertainties,
including, but not limited to, those discussed below and elsewhere in this Form
10-K, particularly in Item 1A. "Risk Factors," that could cause actual results
to differ materially from those projected. The forward-looking statements set
forth in this Form 10-K are as of the close of business on February 27, 2020,
and we undertake no duty and do not intend to update this information, except as
required by applicable securities laws.
Overview
We sell advanced veterinary diagnostic and specialty products. Our offerings
include Point of Care laboratory instruments and consumables; Point of Care
digital imaging diagnostic instruments; vaccines; local and cloud-based data
services; allergy testing and immunotherapy; and single-use offerings such as
in-clinic diagnostic tests and heartworm preventive products. Our core focus is
on supporting veterinarians in the canine and feline healthcare space.
Our business is composed of two reportable segments, CCA and OVP. The CCA
segment includes, primarily for canine and feline use, Point of Care laboratory
instruments and consumables; digital imaging diagnostic instruments, software
and services; local and cloud-based data services; allergy testing and
immunotherapy; and single use offerings such as in-clinic diagnostic tests and
heartworm preventive products. The OVP segment includes private label vaccine
and pharmaceutical production, primarily for cattle but also for other species
including equine, porcine, avian, feline and canine. OVP products are sold by
third parties under third party labels.
CCA represented approximately 87% of our 2019 revenue. OVP represented
approximately 13% of our 2019 revenue.
CCA Segment
Revenue from Point of Care laboratory including instruments, consumables and
other revenue such as service represented $67.1 million, $57.4 million and $54.9
million of our 2019, 2018 and 2017 revenue, respectively. Revenue in this area
primarily involves placing an instrument under contract in the field and
generating future revenue from testing consumables, such as cartridges and
reagents, as that instrument is used. Approximately $53.6 million, $44.8 million
and $39.2 million of our 2019, 2018 and 2017 revenue, respectively, resulted
from the sale of such testing consumables to an installed base of instruments.
Approximately $12.1 million, $10.8 million and $13.8 million of our 2019, 2018
and 2017 revenue, respectively, was from instrument sales, including revenue
recognized from sales-type lease treatment. Included in instrument sales are
sales of infusion pumps, which are sold outright through distribution. Sales of
infusion pumps were $3.0 million, $2.7 million, and $4.0 million for 2019, 2018
and 2017, respectively. Approximately $1.4 million, $1.8 million and $1.9
million of our 2019, 2018 and 2017 revenue, respectively, was from other revenue
sources, such as charges for repairs. Instruments placed under subscription
agreements are considered operating or sales-type leases, depending on the
duration and other factors of the underlying agreement. A loss of, or disruption
in, the supply of consumables we are selling to an installed base of instruments
could substantially harm our business. All of our Point of Care laboratory and
other non-imaging instruments and consumables are supplied by third parties, who
typically own the product rights and

                                      -34-
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supply the product to us under marketing and/or distribution agreements. In many
cases, we have collaborated with a third party to adapt a human instrument for
veterinary use. Major products in this area include our instruments for
chemistry, hematology, blood gas and immunodiagnostic testing and their
affiliated operating consumables.
Point of Care digital imaging hardware, software and services represented
approximately $25.7 million, $22.8 million and $21.9 million of 2019, 2018 and
2017 revenue, respectively. Digital radiography is the largest product offering
in this area, which also includes ultrasound instruments. Digital radiography
solutions typically consist of a combination of hardware and software placed
with a customer, often combined with an ongoing service and support contract. We
sell our imaging solutions both in the U.S. and internationally. Our experience
has been that most of the revenue is generated at the time of sale in this area,
in contrast to the Point of Care diagnostics laboratory placements discussed
above where ongoing consumable revenue is often a larger component of economic
value as a given instrument is used.
Other CCA revenue, including single use diagnostic and other tests,
pharmaceuticals and biologicals, as well as research and development, licensing
and royalty revenue, represented $13.8 million, $28.7 million and $28.4 million
of our 2019, 2018 and 2017 revenue, respectively. Since items in this area are
often single use by their nature, our typical aim is to build customer
satisfaction and loyalty for each product, generate repeat annual sales from
existing customers and expand our customer base in the future. Products in this
area are both supplied by third parties and provided by us. Major products and
services in this area include heartworm diagnostic tests and preventives, and
allergy test kits, allergy immunotherapy and testing. Of our annual revenue,
heartworm produced primarily for private-label accounted for approximately $1.7
million in 2019 and $16.8 million in both 2018 and 2017, respectively. The
decrease in Other CCA revenue in 2019 was driven primarily by a $14.9 million
decrease from contract manufactured heartworm preventive, Tri-Heart, as a result
of reduced customer demand.
We consider the CCA segment to be our core business and devote most of our
management time and other resources to improving the prospects for this segment.
Maintaining a continuing, reliable and economic supply of products we currently
obtain from third parties is critical to our success in this area. Virtually all
of our sales and marketing expenses occur in the CCA segment. The majority of
our research and development spending is dedicated to this segment as well.
All of our CCA products are ultimately sold primarily to or through
veterinarians. In many cases, veterinarians will mark up their costs to their
customer. The acceptance of our products by veterinarians is critical to our
success. CCA products are sold directly to end users by us as well as through
distribution relationships, such as the sale of kits to conduct blood testing to
third-party veterinary diagnostic laboratories and independent third-party
distributors. Revenue from direct sales and distribution relationships
represented approximately 74% and 26%, respectively, of CCA 2019 revenue, 57%
and 43%, respectively, of CCA 2018 revenue and 58% and 42%, respectively, of CCA
2017 revenue.
OVP Segment
The OVP segment includes our approximately 160,000 square foot USDA and FDA
licensed production facility in Des Moines, Iowa. We view this facility as an
asset which could allow us to control our cost of goods on any pharmaceuticals
and vaccines that we may commercialize in the future. We have increased
integration of this facility with our operations elsewhere. For example,
virtually all our U.S. inventory, excluding our imaging products, is now stored
at this facility and related fulfillment logistics are managed there. CCA
segment products manufactured at this facility are transferred at cost and are
not recorded as revenue for our OVP segment.

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Historically, a significant portion of our OVP segment's revenue has been
generated from the sale of certain bovine vaccines, which have been sold
primarily under the Titanium® and MasterGuard® brands. We have an agreement with
Elanco for the production of these vaccines (the "Elanco Agreement"). Our OVP
segment also produces vaccines and pharmaceuticals for other third parties.
Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations
is based upon our consolidated financial statements, which have been prepared in
accordance with GAAP. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. We evaluate our estimates on an ongoing basis. We base our
estimates on historical experience and on various assumptions that we believe to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates. "Part II, Item 8. Note 1. Summary of Significant Accounting Policies"
to the consolidated financial statements included in this Annual Report on Form
10-K describes the significant accounting policies used in preparation of these
consolidated financial statements. We believe the following critical accounting
estimates and assumptions may have a material impact on reported financial
condition and operating performance and involve significant levels of judgment
to account for highly uncertain matters or are susceptible to significant
change.
Revenue Recognition
Effective January 1, 2018, we adopted FASB Accounting Standards Codification
("ASC") Topic 606, Revenue from Contracts with Customers (the "New Revenue
Standard"), using the modified retrospective method for all contracts not
completed as of the date of adoption. Under the New Revenue Standard, revenue is
recognized when, or as, performance obligations under the terms of a contract
are satisfied, which occurs when control of the promised products or services is
transferred to a customer. We exclude sales, use, value-added, and other taxes
we collect on behalf of third parties from revenue. Revenue is measured as the
amount of consideration we expect to receive in exchange for transferring
products or services to a customer. To meet the requirements of the New Revenue
Standard and accurately present the consideration received in exchange for
promised products or services, we applied the prescribed five-step model
outlined below:

1. Identification of a contract or agreement with a customer
2. Identification of our performance obligations in the contract or agreement
3. Determination of the transaction price
4. Allocation of the transaction price to the performance obligations
5. Recognition of revenue when, or as, we satisfy a performance obligation

See "Part II. Item 8. Financial Statements and Supplementary Data,
Note 2. Revenue Recognition" to the consolidated financial statements for the
year ended December 31, 2019, included in this Annual Report on Form 10-K for
additional information about our revenue recognition policy and criteria for
recognizing revenue.
Application of the various accounting principles in GAAP related to the
measurement and recognition of revenue requires us to make judgments and
estimates. Specifically, our subscription arrangements related to our Point of
Care laboratory products provide our customers the right to use our instruments
upon entering into multi-year agreements to purchase a minimum amount of
consumables. These types of agreements include an embedded lease, designated as
either an operating-type lease ("OTL") or a sales-type lease ("STL"), dependent
upon individual contract terms, most often relating to the term of the contract
relative to the life of the underlying instruments being placed under that
contract. The determination of the amounts

                                      -36-

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

We write down the carrying value of inventory for estimated obsolescence by an
amount equal to the difference between the cost of inventory and the estimated
market value when warranted based on assumptions of future demand, market
conditions, remaining shelf life or product functionality. If actual market
conditions or results of estimated functionality are less favorable than those
we estimated, additional inventory write-downs may be required, which would have
a negative effect on results of operations. The inventory allowance was $1.3
million and $1.6 million as of December 31, 2019 and 2018, respectively.
Deferred Tax Assets - Valuation Allowance

We evaluate our ability to realize the tax benefits associated with a deferred
tax asset ("DTA") by analyzing our forecasted taxable income using both
historical and projected future operating results, the reversal of existing
temporary differences, taxable income in prior carry back years (if permitted)
and the availability of tax planning strategies. A valuation allowance is
required to be established unless management determines that it is more likely
than not that we will ultimately realize the tax benefit associated with a
deferred tax asset. As of December 31, 2019 and 2018, we had valuation
allowances of approximately $5.7 million and $10.2 million, respectively. The
change in the valuation allowance resulted from the expiration of deferred tax
assets which were offset with a valuation allowance at December 31, 2018. See
"Part II. Item 8. Financial Statements and Supplementary Data, Note 5. Income
Taxes" to the consolidated financial statements for additional information
regarding our income taxes.

Business Combinations


We account for transactions that represent business combinations under the
acquisition method of accounting, which requires us to allocate the total
consideration paid for each acquisition to the assets we acquire and liabilities
we assume based on their fair values as of the date of acquisition, including
identifiable intangible assets. The allocation of the purchase price utilizes
significant estimates in determining the fair values of identifiable assets
acquired and liabilities assumed, especially with respect to intangible
assets. We may refine our estimates and make adjustments to the assets acquired
and liabilities assumed over a measurement period, not to exceed one year.


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Valuation of Goodwill and Intangibles


We assess goodwill for impairment annually, at the reporting unit level, in the
fourth quarter and whenever events or circumstances indicate impairment may
exist. In evaluating goodwill for impairment, we have the option to first assess
the qualitative factors to determine whether it is more-likely-than-not that the
estimated fair value of the reporting unit is less than its carrying amount as a
basis for determining whether it is necessary to perform the comparison of the
estimated fair value of the reporting unit to the carrying value. The
more-likely-than-not threshold is defined as having a likelihood of more than 50
percent. If, after assessing the totality of events or circumstances, we
determine that is it more-likely-than-not that the estimated fair value of a
reporting is less than its carrying amount, we would then estimate the fair
value of the reporting unit and compare it to the carrying value. If the
carrying value exceeds the estimated fair value we would recognize an impairment
for the difference; otherwise, no further impairment test would be required. In
contrast, we can opt to bypass the qualitative assessment for any reporting unit
in any period and proceed directly to quantitative analysis. Doing so does not
preclude us from performing the qualitative assessment in any subsequent period.
We performed qualitative assessments in the fourth quarters of 2019, 2018 and
2017 and determined that no indications of impairment existed.

We assess the realizability of intangible assets other than goodwill whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. If an impairment review is triggered, we evaluate the carrying
value of intangible assets based on estimated undiscounted future cash flows
over the remaining useful life of the primary asset of the asset group and
compare that value to the carrying value of the asset group. The cash flows that
are used contain our best estimates, using appropriate and customary assumptions
and projections at the time. If the net carrying value of an intangible asset
exceeds the related estimated undiscounted future cash flows, an impairment
to adjust the intangible asset to its fair value would be reported as a non-cash
charge to earnings. If necessary, we would calculate the fair value of an
intangible asset using the present value of the estimated future cash flows to
be generated by the intangible asset, and applying a risk-adjusted discount
rate. We had no impairments of our intangible assets during the years ended
December 31, 2019, 2018 and 2017.

These valuations require the use of management's assumptions, which would not reflect unanticipated events and circumstances that may occur.

Share-Based Compensation Expense

We utilize share-based compensation arrangements as part of our long-term incentive plan. Under these incentive arrangements, we currently issue restricted stock awards, both tied to time vesting or performance and time vesting to employees and directors. We also issue stock options awards to employees. All significant inputs into the determination of expense as well as the related expense are discussed further in "Part II. Item 8. Financial Statements and Supplementary Data, Note 12. Capital Stock".

Restricted Stock Awards (Time Vesting)


The fair value of restricted stock awards with only time-based vesting terms
used in our expense recognition method is measured based on the number of shares
granted and the closing market price of our common stock on the date of grant.
Such value is recognized as an expense over the corresponding requisite service
period. Forfeitures are accounted for as they occur.


                                      -38-

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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 of December 31, 2019, we reviewed each of the underlying corporate
performance targets and determined that approximately 219,000 shares of common
stock were related to corporate performance targets in which we did not deem
achievement probable. No compensation expense had been recorded at any period
prior to December 31, 2019. The unrecognized compensation cost associated with
the restricted stock awards not deemed probable, based on grant date fair value,
is approximately $17.8 million. Any change in the probability determination
could accelerate the recognition of this expense.

Recent Accounting Pronouncements


In addition to the impacts from new accounting pronouncements included above,
see "Part II. Item 8. Financial Statements and Supplementary Data, Note 1.
Summary of Significant Accounting Policies" to the consolidated financial
statements for the year ended December 31, 2019, included in this Annual Report
on Form 10-K for a complete discussion of recent accounting pronouncements
adopted and not adopted.

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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 Item 8 of
this annual report on Form 10-K.
The following table sets forth, for the periods indicated, certain data derived
from our Consolidated Statements of Income (in thousands):
                                                       Year Ended December 31,
                                                2019             2018             2017
Revenue                                    $    122,661$    127,446$    129,341
Gross profit                                     54,449           56,638           58,261
Operating expenses                               54,122           52,844           40,042
Operating income                                    327            3,794           18,219
Interest and other expense (income), net          2,910              (13 )           (150 )
(Loss) income before income taxes and
equity in losses of unconsolidated
affiliates                                       (2,583 )          3,807    

18,369

Income tax (benefit) expense                     (1,446 )         (2,115 )  

8,913

Net (loss) income before equity in losses
of unconsolidated affiliates                     (1,137 )          5,922    

9,456

Equity in losses of unconsolidated
affiliates                                         (594 )            (72 )              -
Net (loss) income, after equity in losses
of unconsolidated affiliates                     (1,731 )          5,850    

9,456

Net (loss) income attributable to
non-controlling interest                           (266 )              -             (497 )
Net (loss) income attributable to Heska
Corporation                                $     (1,465 )$      5,850$      9,953

The following tables set forth, for the periods indicated, segment data derived from our Consolidated Statements of Income (in thousands):

CCA Segment

                          Year Ended December 31,                           

Change

                     2019           2018           2017        Dollar Change  % Change  Dollar Change   % Change
Point of Care
Laboratory:      $   67,132$   57,375$   54,855$       9,757     17%    $        2,520      5%
  Consumables        53,590         44,771         39,161             8,819     20%             5,610     14%
  Instruments        12,137         10,810         13,773             1,327     12%            (2,963 )  (22)%
  Other               1,405          1,794          1,921              (389 )  (22)%             (127 )   (7)%
Point of Care
Imaging              25,652         22,832         21,907             2,820     12%               925      4%
Other CCA
Revenue              13,786         28,717         28,429           (14,931 )  (52)%              288      1%
Total CCA
Revenue          $  106,570$  108,924$  105,191$      (2,354 )   (2)%   $        3,733      4%
Percent of Total
Revenue                86.9 %         85.5 %         81.3 %
Cost of Revenue      52,923         56,326         54,509            (3,403 )   (6)%            1,817      3%
Gross Profit         53,647         52,598         50,682             1,049      2%             1,916      4%

Operating Income $ 1,358$ 2,040$ 12,656$ (682 ) (33)% $ (10,616 ) (84)%




                                      -40-

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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)% $ (5,628 ) (23)% Percent of Total Revenue 13.1 % 14.5 % 18.7 % Cost of Revenue

             15,289        14,482        16,570               807      6%           (2,088 )  (13)%
Gross Profit                   802         4,040         7,580            

(3,238 ) (80)% (3,540 ) (47)% Operating (Loss) Income $ (1,031 )$ 1,754$ 5,563$ (2,785 ) (159)% $ (3,809 ) (68)%

Revenue

Total revenue decreased 4% to $122.7 million in 2019 compared to $127.4 million
in 2018. Total revenue decreased 1% to $127.4 million in 2018 compared to $129.3
million in 2017.
CCA segment revenue decreased 2% to $106.6 million in 2019 compared to $108.9
million in 2018. The decrease was driven by an anticipated reduction in sales to
Merck for a heartworm preventive as previously disclosed on our 2018 fourth
quarter earnings release. The decline was offset by a 20% increase in Point of
Care laboratory consumables, as well as a 12% increase from Point of Care
imaging revenue primarily due to the Optomed acquisition. CCA segment revenue
increased 4% to $108.9 million in 2018 compared to $105.2 million in 2017. The
increase was driven primarily by a 14% increase in revenue from Point of Care
laboratory consumables, as well as a 4% increase in revenue from Point of Care
imaging products due to increased sales of digital radiography systems. This was
partially offset by a 22% decrease in revenue from Point of Care laboratory
instruments due to lower sales-type lease instrument revenue recognition of $1.5
million and lower infusion pump sales of $1.3 million.
OVP segment revenue decreased 13% to $16.1 million in 2019 compared to $18.5
million in 2018. The decrease was driven primarily by reduced customer
requirements and supply issues with materials. OVP segment revenue decreased 23%
to $18.5 million in 2018 compared to $24.2 million in 2017. The decrease was
driven by decreased volume of sales under contract manufacturing arrangements.
Gross Profit
Gross profit decreased 4% to $54.4 million in 2019 compared to $56.6 million in
2018.  Gross margin percent remained consistent at 44.4% in 2019 compared to
44.4% in 2018. Gross profit decreased 3% to $56.6 million in 2018 compared to
$58.3 million in 2017. Gross margin percent decreased to 44.4% in 2018 compared
to 45.0% in 2017. The decrease in both gross profit and gross margin percentage
was driven primarily by unfavorable product mix and plant utilization charges in
our OVP segment.
Operating Expenses
Selling and marketing expenses increased 12% to $27.7 million in 2019 compared
to $24.7 million in 2018. Selling and marketing expenses increased 6% to $24.7
million in 2018 compared to $23.2 million in 2017. The increase in both periods
was primarily driven by an increase in compensation, including stock-based
compensation, benefits and commissions expense, which is mostly related to our
commercial team expansion both domestically and internationally. The increase is
in line with management expectations as we continue to invest in future growth
and expanding the footprint of the Company.
Research and development expenses increased 147% to $8.2 million in 2019,
compared to $3.3 million in 2018. Research and development increased 66% to $3.3
million in 2018, as compared to $2.0 million in 2017. The increase in both
periods was primarily driven by spending on product development for urine and

                                      -41-

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fecal diagnostic analyzer and enhanced immunodiagnostic offerings. As we invest
in future growth of the Company, the increased research and development expenses
is consistent with the spending initiatives of management.
General and administrative expenses decreased 27% to $18.2 million in 2019,
compared to $24.8 million in 2018. The decrease was primarily driven by a $7.0
million settlement accrual and related legal expenses in the prior year;
partially offset by increased expenses associated with international expansion.
General and administrative expenses increased 68% to $24.8 million in 2018, as
compared to $14.8 million in 2017. The increase was driven by a $7.0 million
settlement accrual and related legal expenses, a $1.4 million increase in
stock-based compensation, a $0.6 million increase in compensation and benefits,
a $0.5 million increase in legal fees and a $0.5 million increase in consulting
fees.
Interest and Other Expense (Income), Net
Interest and other expense (income), net, was expense of $2.9 million in 2019,
compared to income of $13 thousand in 2018 and income of $150 thousand in 2017.
The increase in other expense in 2019 was primarily driven by interest expense
as a result of the Notes. The decrease in other income in 2018, compared to
2017, was primarily driven by an increase in net foreign currency losses, and an
increase in interest expense, partially offset by an increase in interest income
and other gains.
Income Tax (Benefit) Expense

In 2019, we had total income tax benefit of $1.4 million compared to a total
income tax benefit in 2018 of $2.1 million and total income tax expense of $8.9
million in 2017. See "Part II, Item 8. Financial Statements and Supplementary
Data, Note 5. Income Taxes" in the accompanying notes to the consolidated
financial statements for additional information regarding our income taxes.

Net (Loss) Income Attributable to Heska Corporation
Net loss attributable to Heska Corporation was $1.5 million in 2019, compared to
net income attributable to Heska Corporation of $5.9 million in 2018 and net
income attributable to Heska Corporation of $10.0 million in 2017. The
difference between this line item and "Net (loss) income after equity in losses
of unconsolidated affiliates" is the net income or loss attributable to our
minority interest in our French subsidiary, which we purchased in February 2019.
The difference between these line items was a gain of $0.3 million for 2019.
There was no difference between these line items in 2018, and a gain of $0.5
million in 2017.

Non-GAAP Financial Measures

In addition to financial measures presented on the basis of accounting
principles generally accepted in the U.S. ("U.S. GAAP"), we also present fourth
quarter and full year 2019 operating income, operating margin, net income
attributable to Heska, earnings per diluted share, Adjusted EBITDA, Adjusted
EBITDA margin, and the effective tax rate, excluding acquisition and other
one-time charges, which are non-GAAP measures. We also present fourth quarter
and full year 2018 operating income, operating margin, net income attributable
to Heska, earnings per diluted share, Adjusted EBITDA, Adjusted EBITDA margin,
and the effective tax rate, excluding TCPA Settlement, which are non-GAAP
measures.
These measures should be viewed as a supplement to (not substitute for) our
results of operations presented under U.S. GAAP. The non-GAAP financial measures
presented may not be comparable to similarly titled measures of other companies
because they may not calculate their measures in the same manner. Our management
has included these measures to assist in comparing performance from period to
period on a consistent basis.


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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 $0.7 million in the fourth quarter and for the full year 2019 incurred as part of the expected acquisition of scil animal care company GmbH.


(2) To exclude $0.2 million and $7.4 million in the fourth quarter of 2018 and
for the full year 2018, respectively, due to the agreement in principle to
settle the complaint filed against the Company for $6.75 million, approximately
$0.6 million of legal costs incurred in relation to the settlement negotiation,
and other one-time costs.

(3)To exclude the effect of one-time benefit of $0.3 million for the fourth
quarter of 2019 related to the insurance recovery of cyber incident and a net
charge of $0.3 million for the full year of 2019 related to the costs associated
with the cyber incident. In addition, this excludes $0.2 million and $7.4
million in the fourth quarter of 2018 and for the full year 2018, respectively,
as noted above.

(4) Adjusted EBITDA margin is calculated as the ratio of adjusted EBITDA to revenue.




                                      -43-

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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 $ 1.64


Shares used in diluted per share
calculations                             8,036            7,947           7,977           7,856


(1) To exclude the effect of one-time charges of $0.7 million in the fourth quarter and for the full year 2019 incurred as part of the expected acquisition of scil animal care company GmbH.


(2) To exclude the effect of a one-time benefit of $0.3 million for the fourth
quarter of 2019 of insurance recovery relating to the cyber incident disclosed
in the third quarter 2019, and a net charge of $0.3 million for the full year of
2019 related to the net loss after insurance recovery associated with the cyber
incident. In addition, this also excludes $0.2 million and $7.4 million in the
fourth quarter of 2018 and for the full year 2018, respectively, due to the
agreement in principle to settle the complaint filed against the Company for
$6.75 million, approximately $0.6 million of legal costs incurred in relation to
the settlement negotiation, and other one-time costs.

(3) Represents income tax expense utilizing an estimated effective tax rate that
adjusts for non-GAAP measures including: acquisition-related costs, litigation
and other one-time costs, amortization of debt discount and issuance costs, and
stock-based compensation. Adjusted effective tax rates are 25% for the fourth
quarter and full year 2019 and 24% for the fourth quarter and full year 2018.
Impact of Inflation
In recent years, inflation has not had a significant impact on our operations.
Liquidity, Capital Resources and Financial Condition
We believe that adequate liquidity and cash generation is important to the
execution of our strategic initiatives. Our ability to fund our operations,
acquisitions, capital expenditures, and product development efforts may depend
on our ability to generate cash from operating activities, which is subject to
future operating performance, as well as general economic, financial,
competitive, legislative, regulatory, and other conditions, some of which may be
beyond our control. Our primary sources of liquidity are our available cash,
including $70.9 million from the issuance and sale of the Notes, after deducting
the initial purchasers' discounts, debt issuance costs paid or payable by us,
and the repayment in full of our Credit Facility, as described in Note 16 to our
consolidated financial statements included elsewhere in this Annual Report on
Form 10-K, and cash generated from current operations. Subsequent to December
31, 2019, the Company transferred $14.6 million of consideration for the
purchase of the CVM companies. Refer to Part II. Item 8. Financial Statements
and Supplementary Data, Note 3. Acquisition and Related Party Items.
Additionally, we announced our intention to acquire scil and finance the
transaction through a private placement of convertible preferred equity. Refer
to Part II. Item 8. Financial Statements and Supplementary Data, Note 19.
Subsequent Events.

                                      -44-

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For the year ended December 31, 2019, we had a net loss after equity in losses
of unconsolidated affiliates of $1.7 million and net cash provided by operations
of $3.3 million. At December 31, 2019, we had $89.0 million of cash and cash
equivalents and working capital of $107.7 million.
A summary of our cash provided by and used in operating, investing and financing
activities is as follows (in thousands):
                                                         Year Ended 

December 31,

                                                      2019         2018     

2017

Net cash provided by operating activities $ 3,296$ 13,287

  $ 10,409
Net cash used in investing activities                (1,923 )    (12,174 )    (17,169 )
Net cash provided by financing activities            74,264        2,627    

5,551

Effect of currency translation on cash                    4          (10 )  

74

Increase (decrease) in cash and cash equivalents 75,641 3,730

    (1,135 )
Cash and cash equivalents, beginning of the period   13,389        9,659    

10,794

Cash and cash equivalents, end of the period $ 89,030$ 13,389

$ 9,659




Net cash provided by operating activities was $3.3 million in 2019, compared to
net cash provided by operating activities of $13.3 million in 2018, a decrease
of approximately $10.0 million. Net cash provided by operating activities
decreased due to significant working capital fluctuations such as a $12.0
million decrease in cash provided by accrued liabilities, primarily driven by a
$6.8 million settlement payment and $0.3 million in related legal fees in 2019
(see Note 14. Commitments and Contingencies in our Consolidated Financial
Statements included in Item 8 of this Form 10-K) and a $5.1 million decrease in
cash provided by inventories, due to the timing of purchases and lower sales in
the current year. Additionally, net cash from operating activities was $7.6
million less in 2019 due to the decrease in net income compared to 2018. These
factors were partially offset by a $9.7 million decrease in cash used by the
aggregate of accounts receivable, accounts payable, related party balances,
deferred revenue and other current and non-current assets, due to the timing of
collections and payments in the ordinary course of business. Non-cash
transactions impacting cash provided by operating activities included a $1.8
million increase related to the amortization of debt discount and issuance costs
and $1.6 million increase from our leases and rights of use asset amortization.

Net cash provided by operating activities was $13.3 million in 2018, compared to
net cash provided by operating activities of $10.4 million in 2017, an increase
of approximately $2.9 million. Net cash provided by operating activities
increased due to significant working capital fluctuations such as a $19.9
million increase in cash provided by inventories, due to the timing of inventory
purchases in 2017; a $7.5 million increase in cash provided by accrued
liabilities, largely due to a preliminary settlement agreement relating to
outstanding litigation in the amount of $6.8 million which we paid in the first
half of 2019 (see Note 14. Commitments and Contingencies in our Consolidated
Financial Statements included in Item 8 of this Form 10-K); and a $2.8 million
increase in cash provided by current and non-current lease receivables due to a
lower level of sales-type lease placements and timing of collections on existing
leases. These factors were partially offset by a $3.6 million decrease in net
income, as well as a $15.2 million increase in cash used by the aggregate of
accounts receivable, accounts payable, related party balances, deferred revenue
and other current assets, due to the timing of collections and payments in the
ordinary course of business. Non-cash transactions impacting cash provided by
operating activities included a $11.1 million increase in our deferred tax
benefit, net, offset by a $2.5 million increase in stock-based compensation.

Net cash used in investing activities was $1.9 million in 2019, compared to net cash used in investing activities of $12.2 million in 2018, a decrease of approximately $10.3 million. The decrease in cash used for

                                      -45-

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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.

                                      -46-

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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

                                      -47-

--------------------------------------------------------------------------------



to the FASB ASC are communicated through issuance of an ASU. Unless otherwise
discussed, we believe that the impact of recently issued guidance, whether
adopted or to be adopted in the future, is not expected to have a material
impact on our Consolidated Financial Statements upon adoption.
To understand the impact of recently issued guidance, whether adopted or to be
adopted, please review the information provided in Note 1. Operations and
Summary of Significant Accounting Policies to our Consolidated Financial
Statements included in Item 8 of this Form 10-K.

                                      -48-

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