Heska Corp (HSKA) 2007 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you so much for standing by, and welcome to the Heska Corporation second-quarter 2007 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today, Tuesday the 24th of July, 2007.

I would now like to turn the conference over to Mr. Bob Grieve, Chairman and CEO. Please go ahead.

Thank you and thank you all for joining us today for conference call. I'm joined by Jason Napolitano, our Chief Financial Officer. We appreciate having the opportunity to review the results of the second quarter of 2007. We continued our series of profitable quarters with year-over-year improvements in both revenue and net income.

Prior to discussing our results, I would like to remind you that during the course of this call, we may make certain forward-looking statements regarding future events or future financial performance of the Company. We need to caution you that any such forward-looking statements are based on our current beliefs and expectations and involve known and unknown risks and uncertainties which may cause actual results performance to be materially different from that expressed or implied by those forward-looking statements. Factors that could cause or contribute to such differences are detailed in our press releases or in our annual quarterly or other filings with the SEC. These forward-looking statements speak only as of today and, except as otherwise required by law, Heska does not intend to update any forward-looking statements to reflect events that occur after today.

Before I turn the call over to Jason, I want to make a few key points about our recent performance. First, I would reemphasize a point that I have made in our two most recent investor calls. That is the overarching theme to our financial results is steady progress. This is the eighth consecutive quarter with operating income and the fifth consecutive quarter of profitability. These quarterly results follow two consecutive years of full-year profitability.

We continue to see nice growth in our Core Companion Animal Health revenue, up 11% compared to the second quarter last year. This is where we have made our principal investments in our product pipeline and our commercial infrastructure. We see the benefits of those investments.

Regarding new product introductions, we have been stating for some time that investors should expect us to launch two new products in 2007. We started the year by announcing the launch of our new i-STAT 1 Handheld Clinical Analyzer. Now, we have just introduced our new HemaTrue Hematology Analyzer with a formal launch at the annual convention of the American Veterinary Medical Association. This analyzer is fast, delivering accurate, reproducible blood cell results to our customers in just 55 seconds.

In addition to providing these new, state-of-the-art features, it is very user-friendly with a color touch screen, simple menus, an onboard mixer and bar-code reader. Heska has been known and trusted in veterinary hematology, yet we have just raised in-house hematology to the next level. The formal launch was only 10 days ago, but we are encouraged by early reports of customer enthusiasm.

I would now like to turn this over to Jason. He will provide detailed information on our financial results and future financial expectations.

Thank you, Bob. We had a strong performance in the second quarter of 2007. We posted another profitable quarter and grew our Core Companion Animal Health product revenue by 11% to $16.2 million. Key factors in the increase were greater revenue from instrument consumables, our IV pumps, our handheld diagnostic instruments and our hematology instruments, somewhat offset by lower revenue from our chemistry instruments.

We are pleased with the sales performance of the i-STAT 1, a product we released in January 2007 which was responsible for the increase in sales over our handheld diagnostic instruments.

On the hematology side, we had a strong quarter and sold all available CBC analyzers. As we knew we were launching a new hematology unit, we were open with our customers at the end of the second quarter and sold CBCs at a discount, accordingly. This put some downward pressure on gross margin.

We believe the CBC was the best hematology instrument available in the veterinary market prior to the launch of HemaTrue. We are excited by the prospects for the recently launched HemaTrue, which we believe offers clear improvements from the CBC and unmatched speed, accuracy and reproduceability.

For the six-month period, Core Companion Animal Health product revenue grew 15% to $33.2 million, as compared to the first six months of 2006. In the second quarter of 2007, product revenue in our Other Vaccine Pharmaceutical and Product segment or OVP was $3.5 million, consistent with our guidance and up slightly as compared to the prior-year period.

Key factors in the increase were greater sales of cattle vaccines under our contract with AgriLabs and our fish vaccines, somewhat offset by lower sales of bulk bovine biologicals. In addition, our equine influenza vaccine was the product area with the greatest period-over-period decline after bulk bovine biologicals. We licensed our equine influenza vaccine to Intervet, Inc. in July 2002. While we produced and sold equine influenza vaccine to Intervet in 2006, Intervet is now manufacturing the product to themselves, so we have no corresponding revenue for this product in 2007.

For the six-month period, OVP product revenue was $8.9 million, up $2.7 million as compared to the first six months of 2006. The largest factor in this increase was approximately $1.6 million in revenue, recognized upon receipt of a payment for product previously shipped and take-or-pay minimums for 2005 and 2006, which previously had not been paid as part of a now settled dispute with United Vaccines, Inc., a former customer. The affiliated cost of this revenue had been recognized in periods prior to 2007. As United has ceased operations, we do not expect to generate any future revenue from United.

In the second quarter of 2007, research, development and other revenue was $311,000, consistent with our guidance of $300,000, and down $54,000 as compared to the prior-year period. A key factor in the decline was certain deferred licensing fees which were recognized as revenue in the second quarter of 2006 but not 2007, as a result of the acceleration of revenue recognition for related deferred licensing fees upon completion of the sale of a worldwide patent portfolio and the genes that encode them, which I will refer to as the Allergopharma Portfolio, in December 2006. Another key factor in the decline was lower sponsored research and development revenue.

For the six-month period, research, development and other revenue was $712,000, down $185,000 as compared to the prior-year period. Consistent with our guidance, total revenue was $20.1 million for the second quarter and $42.8 million for half-year 2007, as compared to $18.5 million and $36 million, respectively, in the corresponding periods in 2006.

The second quarter of 2007, gross margin -- that is, gross profit divided by total revenue -- was 41.3%, up slightly from 41.2% in the prior-year period. This is consistent with our guidance of gross margin between 41% and 42% for the quarter. For the six-month period, gross margin was 43.6%, up from 40.2% in the prior-year period. The largest factor in the increase was the United revenue previously discussed.

In the second quarter of 2007, selling and marketing expenses were approximately $4 million, up 10% from the prior-year period. Key factors in the increase were increased sales compensation expense and spending on marketing programs. In the second quarter of 2007, research and development expense was $742,000, down $362,000 from the prior-year period. A key factor in the decrease was lower expenses recognized on research and development projects on a period-over-period basis.

For the three months ended June 30, 2007, general and administrative expenses were $2.4 million, up $94,000 from the prior-year period. A key factor in the increase was higher audit fees.

Total operating expenses for the second quarter of 2007 were approximately $7.1 million, up only 1% compared to prior-year period, despite our revenue growth, and below our guidance of $7.4 million.

Income from operations was $1.2 million in the second quarter of 2007, nearly double the $622,000 result we reported in the second quarter of 2006. Total operating expenses for the six months ended June 30, 2007 were $14.8 million versus $13.8 million in the prior-year period. Depreciation and amortization was $902,000 in the first half of 2007, as compared to $829,000 in the prior-year period. Income from operations was approximately $3.9 million in the first half of 2007, as compared to $664,000 in the first half of 2006.

Interest and other expense net was $159,000 in the second quarter of 2007, down approximately $127,000 compared to the prior-year period. This line item can be broken into three components -- interest expense, interest income and foreign currency gains or losses. Interest income was $22,000 in the second quarter of 2007, as compared to $18,000 in the prior-year period. Foreign currency losses were $30,000 in the second quarter 2007, as compared to $17,000 in the prior-year period.

Obviously, the largest component on the period-over-period change was in interest expense. Interest expense in the three months ended June 30, 2007 was $151,000, a decrease of $136,000 compared to the prior-year period.

The largest factor in the decrease was lower borrowings under our credit agreement with Wells Fargo, but we also benefited from lower interest rate spreads, as we have achieved the required milestones under the agreement with Wells Fargo to borrow at prime flat, our interest rate since the beginning of the second quarter.

We recognized $18,000 in income tax expense in the second quarter of 2007, primarily related to the accrual of domestic federal alternative minimum tax, but also including some recognition of tax expense related to our Swiss operations.

In the second quarter of 2006, all $34,000 of income tax expense recognized was related to our Swiss operations. We recognized lower tax expense in Switzerland as a result of agreements obtained from the tax authorities in the canton of Fribourg, which we believe will reduce our taxable income in Switzerland in the future. It is important to note that income taxes related to our Swiss operations were an accounting consequence only, in that we did not pay cash taxes in Switzerland in 2006 and we do not expect to pay cash taxes in Switzerland in 2007, due to our net operating loss carryforward or NOL position in Switzerland.

It is probably worth a quick review of the accounting, so everyone is clear. At the end of 2005, based on the profitable operating performance of our Swiss operating subsidiary, we determined that our NOLs in Switzerland were realizable on a more-likely-than-not basis. The resulting valuation allowance was released, resulting in an income tax benefit and a corresponding deferred tax asset.

At the end of 2006, we increased the valuation allowance due to certain agreements obtained from the tax authorities in the canton of Fribourg, resulting in income tax expense and a reduction of the corresponding deferred tax asset. In either case, accounting rules dictate that we are to recognize an income tax expense equal to the tax we would have paid had we not had any NOLs, with the offsetting journal entry being a reduction in the related deferred tax asset on our balance sheet.

It is worth noting that a similar situation could arise related to our US NOLs in 2007, although the magnitude of such a result would be much larger than that related to our Swiss NOLs. I note that if such an event were to occur, it would only create a net tax benefit and increase our 2007 net income from what it otherwise would have been. Such an effect is not included in the guidance I will give later in the call.

On the bottom line, we reported net income of over $1 million in the second quarter of 2007, as compared to guidance for net income of over $800,000 and more than a threefold increase compared to the prior-year period. For the six months ended June 30, 2007, net income was $3.4 million as compared to $63,000 in the prior-year period.

We believe one of the strengths of our business is the breadth of our product offering. We try to plan for success in all areas, knowing that we are unlikely to thrive across the board and hoping that areas where we do succeed outperform our expectations by enough to make up for areas with unexpected shortfalls. As an example, we were pleased that both the i-STAT 1 and CBC sales performance exceeded our expectations in the second quarter of 2007 and more than made up for the revenue shortfall versus expectations for our SPOTCHEM chemistry analyzer.

It is important to recognize that ours is a fluid business, and we are looking to develop new products and gain new customers all the time. While we aim to build a solid business, the concept of recurring revenue streams is somewhat illusory. No customer product or revenue stream is viable forever. When we lose such things, we do our best to make up the shortfall, although we may be faced with difficult year-over-year comparisons as a result.

For example, revenue recognized from United and related to the sale of the Allergopharma Portfolio will present a difficult comparison for us in the first quarter of next year and the fourth quarter of this year, respectively. In many cases, we will not be able to make up the revenue directly, but we will look to other customers' products or areas of our business to cover the shortfall.

The situation with our equine influenza vaccine I discussed earlier represents a good example, where Intervet is perfectly within their rights to manufacture the product themselves. As we have granted Intervet an exclusive license to this product, we really couldn't make up the revenue directly, but we did find a way to make it up overall.

We expect sales of our canine heartworm preventive to decline in the third quarter as compared to prior-year periods. Schering-Plough Animal Health has exclusive distribution and marketing rights to this product in the United States. According to the latest forecast we have received from Schering-Plough, we will increase their sales of this product in 2007, although it will not be the gross driver it has been in the past. The forecast also shows growth in early 2008 as compared to 2007.

The forecasts are nonbinding, and Schering-Plough is not required to give us anything beyond these forecasts in terms of future outlook. A competitive product has gained additional claims beyond those of our product recently. I note that Schering-Plough is also in the process of acquiring the pharmaceuticals business of Akzo Nobel, which includes Intervet, a large animal health player. We understand that Schering-Plough Animal Health is too combine with Intervet under the current Schering-Plough Animal Health leadership.

Based on last year's sales data, when combined with Intervet, Schering-Plough Animal Health will be the largest company in animal health. While we believe this is positive long-term, we believe we should plan for this to cause some short-term distractions within Schering-Plough Animal Health, as the planning and ultimately integration processes occur.

I think it is worth a quick review of our balance sheet. You'll note that, while cash is up slightly since year end, we have reduced our debt balance by over $1.5 million. We also had approximately $3.5 million in borrowing capacity at quarter end. In addition, we had shareholders' equity of $10.7 million, a level we have not seen in five years.

In terms of guidance for the third quarter of 2007, we expect revenue of above $20 million, including approximately $3 million in OVP product revenue and $0.5 million in research, development and other revenue. We are guiding for gross margin of about 42%, $7.4 million in operating expenses, $125,000 of net interest and other expense and $25,000 in income tax expense. On the bottom line, we are guiding to net income of approximately $900,000 in the third quarter of 2007.

For full year 2007, we expect Core Companion Animal Health product revenue to grow between 11% and 15%, $15 million in OVP product revenue and $1.5 million in research, development and other revenue. These numbers add to between $83 million and $86 million in 2007 total revenue. I note that both ends of the range are higher than the $80 million to $85 million total revenue guidance range we discussed on our last earnings call for 2007.

We are guiding for full-year gross margin to be close to 43%, operating expenses to be between $29 million and $30 million, net interest and other expense of approximately $575,000 and $150,000 in income tax expense. On the bottom line, we are guiding to between $5.5 million and $6 million in 2007 net income. On our last earnings call, we discussed a $5 million to $6 million guidance range.

I note that, based on our currently outstanding shares, option-to-purchase shares and yesterday's closing share price, this translates to approximately $0.10 in diluted earnings per share. As we explained on our year-end earnings call, and consistent with her practice, we will have no comment on 2008 financial performance expectations at this time.

In summary, the second quarter of 2007 was our fifth consecutive quarter of profitability. Our Core Companion Animal Health segment grew consistent with our expectations. We generated net income of over $1 million, as compared to guidance for net income of over $800,000. We look forward to continuing to improve our business in the future, and are particularly excited about the official introduction of HemaTrue, our new hematology analyzer, earlier this month.

With that, I'll turn it back over to you, Bob.

Thank you, Jason. We are very pleased with our second-quarter results, and we remain excited about the prospects for the full year 2007. Please carefully considered Jason's remarks on guidance. We plan to grow revenue, driven particularly by a relatively higher gross margin in Companion Animal product sales, and we expect to see significant year-over-year growth in net income.

Thanks for your attention today. We appreciate your continuing interest and support in Heska. At this time,I would like to turn this over to our moderator for purposes of conducting our question-and-answer session.

(OPERATOR INSTRUCTIONS). Kirk Fox, State of Wisconsin Investment Board.

First of all, congrats to Bob on the CEO award from DeMarche Associates. Then also congrats on the solid quarter and then the update on the guidance; that's nice to see.

My first question is coming from the 11% increase on a year-over-year basis. Could you give us a little more details, if possible, on where that is coming from?

Then you mention kind of the 11% to 15% as a sustainable run rate. Could you just give some more details there at all?

11% to 15% was for the full year, if you're comparing 2006 to 2007. What we've said in the past four intermediate-term is low double-digit growth for the Core Companion Animal Health business.

In terms of the 11% for this quarter, the instrument consumables was the biggest piece, IV pumps was also big, and then we had a real good quarter with the i-STAT 1 and the CBC closeout. Those are really the four main product areas that drove the growth.

Could you give us any more information on the new product introduction? When will this be commercially available, if it already is? Then I guess just market opportunities there?

I'll address the technical particulars of the product and the launch. The launch was about 10 days ago now at the annual convention of the AVMA, the American Veterinary Medical Association, in Washington DC. The sales force has been in and trained completely on the analyzer, and the analyzer is commercially available now and will be shipping this quarter.

This is really a replacement for the CBC. It's really an upgrade and, we think, a superior product to the CBC, which we thought was really top-notch in the industry as it was. That's being sold through our sales force through our full-line distributors to the 20,000 vet clinic target market here in the US.

Then also on the i-STAT, that's been on the market for about six months now. Are you seeing any trends within that at all, or anything that has surprised you guys?

I think it had, certainly, a good first six months. As we said earlier, it outperformed our expectations this quarter. We had a real strong quarter with placements with that instrument. It's hard to call that a long-term trend. I think usually it takes several years before you really know if this is going to be sustainable over the long haul, or whether it's just an exciting new product launch. But we like what we see so far.

Congratulations again.

[Michael Shank], a private investor.

It's another good year for Heska. I enjoyed seeing your clip on the AOL that you did, the video clip, so I know who you are. I saw your image, after all these years -- not just a voice.

I just had another question. Isn't the third quarter going to be the strongest quarter for Heska, which in the past it has been?

Let me defer that, and give it to Jason. He can speak to this a little bit more, in more detail.

I would say probably not. The seasonality of our business has diminished greatly than it was a few years ago, even. It's definitely smoothing out. But we still expect the fourth quarter will be stronger than the other quarters of the year, although the magnitude of that difference is going to be reduced from history.

Congratulations on another great quarter.

(OPERATOR INSTRUCTIONS). Kirk Fox.

That was another one of my additional questions, on the seasonality, but as I see the lumpiness kind of taken out are. Also, on the staff, Jason, you made some comments in regards to your sales force. Have there been any, I guess, headcount changes there along with your staff in its entirety?

No, the sales force has been fairly stable in the first half of the year. It's really the same number, both inside and outside, and we don't have any near-term expectations to grow that demonstrably or precipitately. Again, no other material changes in staff anywhere.

Gentlemen, I don't have any further questions at this time.

Again, I'd like to thank you all once more for your interest in Heska and for taking the time this morning to join us. Goodbye.

Thank you, ladies and gentlemen. This does conclude the Heska Corporation second-quarter 2007 earnings conference call. At this time, you may now disconnect. Thank you for using AT&T Conferencing and have a very pleasant day.