Heska Corp (HSKA) 2007 Q3 法說會逐字稿

Good morning ladies and gentlemen and thank you for standing by. Welcome to the Heska Corporation's third quarter 2007 earnings call. At this time all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions. (Operator instructions). I would like to remind everyone that this conference call is being recorded on Wednesday, 7th of November, 2007 at 9:00 a.m. Mountain Time. I will now turn the conference over to Dr. Bob Grieve, Chairman and Chief Executive Officer. Please go ahead, sir.

Thank you, Yvonne, and thank you all for joining us today for our conference call. I'm joined today by Jason Napolitano, our Chief Financial Officer. We appreciate having the opportunity to review the results for the third 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 and 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. I want to reemphasize the point that I've made in our most recent investor calls. This is the ninth consecutive quarter with operating income and the sixth consecutive quarter of profitability. These quarterly results follow two consecutive years of full year profitability. We generated these operating results despite the fact that in many ways this was a transition quarter as we worked to move existing inventory in anticipation of the launch of new products.

For the quarter, we generated net income of over $1 million which exceeded our guidance of $900,000. And our revenue would have exceeded guidance had it not been for an unanticipated backorder situation with our supplier that Jason will discuss later in the call.

Regarding new product introductions, we've 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 our new i-STAT 1 handheld clinical analyzer. Early in the third quarter, we introduced our new HemaTrue hematology analyzer with a formal launch at the annual convention of the American Veterinary Medical Association in July. This analyzer is fast, delivering accurate reproducible blood cell results for our customers in just 55 seconds.

In addition to providing these new state of the art features is very user friendly, with a color touch screen, simple menus, an on-board mixer and bar code reader. Heska has been known and trusted in veterinary hematology, yet we have just raised in-hospital hematology to the next level. The formal launch was less than four months ago, but we are encouraged by market receptivity and early sales.

Although we communicated an expectation for two product launches this year, on Monday this week, we announced our third major product launch of 2007. As has been the case with our other recently launched products, we have not talked publicly about this product at all. In fact, we had originally planned to launch this product in January as a major 2008 product launch, but decided to accelerate that timetable based on market conditions.

Just the same, this is an extraordinary product that we've been working on for some time in partnership with FUJIFILM Corporation. The new chemistry analyzer Dri-Chem 4000 can run multiple test panels as well as the flexibility to conduct individual tests. It also has a broader menu of tests available then our previous chemistry offering, a product that was increasingly dated. It was limited to running nine tests at one time, the least among our major competitors. By contrast, a Dri-Chem user can run up to 21 tests with a single blood sample. Also, the customer can add any tests to any panel. Of course, we will continue to supply consumables and service for our previous chemistry analyzer, but as in the case of our recent HemaTrue launch, for example, we are determined to always provide state-of-the-art and the best analyzer in any category to our customer, the veterinarian.

We intend to continually modernize our product line and raise the bar in our industry. As detailed in our Monday press release, we are delighted with the prospects for the Dri-Chem 4000 and with the partnership with FUJIFILM.

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 recorded $19.5 million of revenue in the third quarter of 2007. This was the highest revenue quarter Heska has generated in any third quarter in its history, including the third quarter of 2006 when we generated $18.6 million in total revenue. For the nine months ended September 30, 2007, we generated $62.3 million in total revenue, an increase of approximately 14% from the prior year period. We generated $15.6 million in product revenue in our Core Companion Animal Health segment in the third quarter of 2007, down slightly from the prior year period.

As we discussed on our last earnings call, we anticipated a decline in revenue from our heart worm preventive due to lower third quarter purchase orders from Schering-Plough Animal Health Corporation, who has exclusive marketing and distribution rights to this product in the United States. As is publicly known, Schering Plough is in the process of acquiring the pharmaceuticals business of Akzo Nobel, which includes Intervet, a large animal health player. We expect Schering Plough Animal Health will combine with Intervet to produce what will be the largest animal health company in the world based on last year's sales data. We believe this will be positive long term, but that we should also expect some short term distractions as the planning process continues and ultimately becomes an integration process.

Our heart worm preventive was a leading factor in the revenue decline on a period over period basis and was somewhat offset by increased sales of our heart worm diagnostic tests in the United States and increased revenue from our instrument consumables.

We also closed the quarter with approximately $756,000 in customer orders for our new HemaTrue hematology analyzer, which we did not have the inventory to fulfill as our supplier did not deliver on the schedule we anticipated. We have now shipped the analyzers under those orders and are not on back order for this product. We have been pleased with the early feedback from the field on the HemaTrue, which we believe is competing quite effectively versus the in-clinic hematology alternatives.

For the nine months ended September 30, 2007, Core Companion Animal Health product revenue was $48.8 million, approximately a 10% increase from the prior year period. In the third quarter of 2007, our other vaccines, pharmaceuticals and products segment or OVP, had $3.4 million in revenue, a 33% increase from prior year period. The largest factor in the increase was greater sales of our fish vaccine which was somewhat offset by lower sales of our equine influenza vaccine and Canadian bovine vaccine sales.

We licensed our equine influenza vaccine to Intervet, Inc. in July 2002 and we manufactured the product for Intervet after that time. Intervet is now producing the product themselves and the last shipment we sent them was in the third quarter of 2006.

For the nine months ended September 30, 2007, OVP product revenue was $12.3 million, a 40% increase compared to the prior year period. A key factor in this increase was greater sales of our fish vaccine. Another key factor in the increase was approximately $1.6 million recognized upon receipt of a payment for products 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. or United, 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.

Research, development and other revenue was $491,000 in the third quarter of 2007, up from $432,000 in the prior year period. A key factor in the increase was the recognition of $150,000 under a service agreement. In December 2006, we sold the world wide patent portfolio covering a number of major allergens and the genes that encode them, which I will refer to as the Allergopharma portfolio. We signed a service agreement related to the Allergopharma portfolio with the buyer. That service agreement is now completed and the $150,000 I have discussed represents the final payment due us under that agreement.

This revenue was somewhat offset by lower deferred licensing fees related to the Allergopharma portfolio which were recognized as revenue in the third quarter of 2006, but not 2007 as a result of the acceleration of revenue recognition for deferred licensing fees upon completion of the Allergopharma portfolio sale.

Research, development and other revenue was approximately $1.2 million in the nine months ended September 30, 2007 as compared to approximately $1.3 million in the prior year period. As we have noted in the past, revenue related to the sale of the Allergopharma portfolio and recognized from United will present a difficult comparison for us in the fourth quarter of this year and the first quarter of next year, respectively.

Gross margin, that is gross profit divided by total revenue, was 39% in the third quarter of 2007, down from 42.7% in the third quarter of 2006. Lower sales of our canine heartworm preventative, aggressive sales and marketing programs related to our diagnostic instruments, which were to be supplanted by newer instruments for major product launches and higher sales at our OVP segment were key factors in the decline. Our heartworm preventive represents a relatively high margin product area and our OVP segment is a relatively low margin product area.

As Bob has discussed, our Dri-Chem analyzer was launched earlier this week and this product will supplant the SPOTCHEM, an older model analyzer as our core chemistry offering. We will offer SPOTCHEM analyzers remaining in our inventory for sale and will, of course, continue to service and support those customers who have our SPOTCHEM analyzers. We have an agreement with the SPOTCHEM supplier for consumables and spare parts throughout October of 2012, although we will not be purchasing any new SPOTCHEM for sale to our customers.

As we knew we wanted our sales force to focus on the Dri-Chem upon its launch, we offered aggressive sales and marketing programs on the SPOTCHEM to place SPOTCHEM inventory in the hands of our customers as quickly as we could. We went through a similar process around the time we launched the HemaTrue analyzer. We supplanted the CBC analyzer as our core hematology offering. In the case of the SPOTCHEM, we had a great deal of success with the program where a customer could obtain a rental unit, of which Heska maintained ownership for a relatively low initial purchase of consumables from Heska.

Our gross margin for the nine months ended September 30, 2007 was 42.2%, up from 41% in the prior year period. The largest factor in the increase was the United revenue previously discussed. Our operating expenses were $6.5 million in the third quarter of 2007, a decline of 5% compared to the prior year period. Traveling and marketing expense was $3.8 million in the third quarter of 2007, up about 9% from the prior year period. A key factor in the increase was expenditure related to the launch our new hematology analyzer.

Research and development expense was $663,000 in the third quarter of 2007, down $151,000 from the prior year period. A factor in the decline was a decrease in accrual expense related to our management incentive program recognized in the third quarter of 2007 as compared to the third quarter of 2006. General and administrative expenses were $2 million in the third quarter of 2007, down about 19% compared to the prior year period. The largest factor in the decline was a decrease in legal expenses primarily related to litigation with United in the third quarter of 2007 as compared to the third quarter of 2006.

In the nine months ended September 30, 2007, total operating expenses were $21.4 million, as opposed to $20.6 million in the prior year period. The former includes a $47,000 gain on sale of assets from the sale of certain patents, net of legal expenses which are netted against other operating expenses. Depreciation and amortization was $1.4 million the nine months ended September 30, 2007, an increase of approximately $189,000 compared to the prior year period.

Income from operations was $1.1 million in the third quarter of 2007, down about $17,000 from the prior year period. Income from operations was $5 million for the nine months ended September 30, 2007, up over $3 million compared to the prior year period. Interest and other expense net was $94,000 in the third quarter of 2007, down $169,000 compared to the prior year period. This decrease was primarily due to lower interest expense resulting from lower debt balances at lower interest rates in the third quarter of 2007.

The loan balances with our bank were lower in 2007 than they were in 2006 and in May 2007, we repaid the remaining $500,000 on the subordinated note to a customer for facilities improvements. In addition, the interest rate on borrowings from our bank were at prime flat in the third quarter of 2007, as compared to prime plus 2% in the prior year period. We obtained a more favorable rate as a result of meeting certain performance criteria previously agreed to with our bank.

We recognized $27,000 in income tax expense in the third 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 third quarter of 2006, all $23,000 of income tax expense recognized was related to our Swiss operations. We recognize lower tax expense in Switzerland in 2007 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 and 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 carry-forward 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 and the resulting valuation allowance was released resulting in an income tax benefit and a corresponding deferred tax asset. At the end of 2006, we increase the valuation allowance due to certain agreements obtained from the tax authorities in the Canton of Fribourg resulting in an income tax expense and reduction of the corresponding deferred tax assets. In either case, the Canton rules dictate that we 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 deferred tax asset on our balance sheet.

It is worth noting that a similar situation could arise related to our U.S. NOLs in 2007, although the magnitude of such a result would be much larger than that related to our Swiss NOLs. We are currently considering this matter and as we continue to have operating success, the likelihood of this outcome increases. I note that if such an event were to occur, it would only create a net tax benefit and increase our net income in 2007 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, our third quarter 2007 net income was just over $1 million, which beat our guidance of $900,000 and was a 17% increase from the prior year period. For the nine months ended September 30, 2007, our net income was $4.4 million, an increase of approximately $3.5 million from the prior year period.

In terms of liquidity in our balance sheet, you will note from the summary balance sheet in the press release that our quarter end cash of $5.3 million was up slightly from year end and our quarter end revolving line of credit balance of $7.9 million was down nearly $100,000 compared to year end. You can also see that our combined long term debt and capital lease balance is down over $1 million since year end. In addition, we closed the quarter with over $4 million in borrowing capacity under our bank agreement.

Predicting future results is not easy for our business, even for a quarter ahead and our recent major product launches make it particularly difficult this order. With that caveat, we are offering fourth quarter 2007 guidance for Core Companion Animal Health product revenue in excess of $18 million, approximately $2.75 million in OVP product revenue and approximately $275,000 in research, development and other revenue. These items add to guidance for revenue in excess of $21 million for the fourth quarter of 2007.

I note our Core Companion Animal Health revenue guidance represents a 17% increase from the fourth quarter of 2006 and our research, development and other revenue guidance represent a $1.6 million decrease from the fourth quarter of 2006 as a result of the difficult comparison from the revenue related to the sale of the Allergopharma portfolio discussed earlier.

We are guiding for gross margin in the fourth quarter of 2007 to be between 38% and the 39% we reported this quarter. We are also guiding for operating expenses of approximately $6.7 million, $130,000 in interest and other expense, and approximately $30,000 in income tax expense in the fourth quarter of 2007. On the bottom line, we are guiding for net income of greater than $1.2 million in the fourth quarter of 2007. If you mathematically add this guidance to our nine month results, you obtain our full year guidance of over $83 million in revenue including approximately $15 million in OVP product revenue and approximately $1.5 million in research development and other revenue. Gross margin of a little more than 41%, operating expenses of approximately $28 million, interest and other expense of approximately $560,000, $150,000 in income tax expense and net income of over $5.6 million.

I note that based on our currently outstanding shares, options 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-and earnings call and consistent with our practice, we will have no comment on our 2008 financial performance expectations at this time.

In summary, we have continued to make progress in this transitional quarter and are very excited about the future prospect of the two major new products we have launched since the beginning of the third quarter of 2007; our HemaTrue hematology analyzer and our Dri-Chem chemistry analyzer. With that, Ill turn it back over to you, Bob.

Thank you, Jason. With three new and enhanced products in each of the major diagnostic instrument categories we've offered historically, this has been a remarkably busy year. We are particularly excited by the launch of the Dri-Chem, our new chemistry analyzer. We believe this diagnostic instrument represents the best value available to veterinarians for in-clinic blood chemistry testing and are excited about our prospects to attract new customers with this product. We've continued to make financial progress while transitioning each of our major analyzer product lines to new, improved offerings and we very much look forward to generating our operating results in our current fourth quarter and in 2008.

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

Thank you. Ladies and gentleman, we will now conduct the question and answer session. (Operator instruction). Your first question comes from Kirk Fox with State of Wisconsin Investment. Please go ahead.

Hi guys. How are you doing this morning?

Fine, thanks, Kirk.

Congrats on the record third quarter.

Thank you.

Could you guys talk a little bit about the FUJIFILM announcement during that relationship and, I guess, what that means overall to your business?

Certainly. As I mentioned in my narrative, Kirk - this is Bob Grieve responding - our previous product has been very successful. We had a lot placements, but was increasingly dated competitively speaking. And so for some time we've been looking to an alternative that would not only improve our offering in that area, but it would also trump existing competitive offerings. We've been working on that for some time. FUJIFILM Corporation has been our partner in that regard. They'll manufacture the analyzer. We will market, sell, distribute the analyzer. And again, as we've just announced, that Monday it's still very early days. We're very excited both about the product, its benefits and features competitively speaking. And we're also very excited about the partnership with FUJIFILM.

Are you able to talk about the economics of that at all?

About the economics of the analyzer?

Of the analyzer, right and just the relationship with FUJI?

Actually, in terms of the analyzer, I guess frankly, I would just say that other than what I've said here about the fact that the product can run multiple test panels, it's extremely flexible and we can add any test to any panel. We don't really want to talk much about pricing or other competitive issues because again, frankly, those same competitors are listening to this call as well. We don't want to telegraph anything competitively any earlier than they would otherwise get it.

Understandable. How about with i=STAT? That's been on the market for a while. Are we able to identify any trends there or surprises on your end?

No real surprises. It's a very robust analyzer. It's well received. It has enhanced benefits and features, again, really well received by veterinarians.

Okay. And then it looks like in Q3 you had some type of, I guess, capacity constraint there. Now that's resolved looking into Q4 and going into '08?

That's right. That's right. It was just some of the earlier analyzers. As I indicated earlier, the early sales results were encouraging. We sold a number of analyzers and the supplier couldn't provide them quite on time to get them shipped and recognize the revenue before quarter end, but their supply issue has been resolved to this point and we're caught up.

Okay. And maybe you could talk about a little more macro. Is anything happening, I guess, within your environment in the competitive environment and also tying that into, I guess, the economy and if we see a potential slowdown there. Is that going to affect your customer spend at all?

I think that, again, we caveat everything about the uncertainty going forward. We haven't seen anything that would be a direct indication of a slowing economy affecting our business. I think in previous investor relations presentations, for example Kirk, we pointed out that surveys have been held, documented, published that indicate that the vast majority, in excess of 90% of customers in the most recent economic downturn, said that that economic downturn has no effect on their spending patterns with their pets and the veterinarian. That's historical. We don't know going forward what might happen, but we can't communicate any of that right now.

Okay. And maybe just one more admin type question. Any changes to head counted all or anything happening there from a sales standpoint?

Nothing material at this point.

Okay. I'll hop back in line.

Thank you.

We have no further questions at this time. Please continue.

I believe Mr. Fox said that he was hopping back in line. I don't know if he has another question or not.

(Operator instructions). Your next question is a follow up question from Kirk Fox of State of Wisconsin Investments. Please go ahead.

Thank you. Maybe Jason could address this or you as well Bob. But just looking at your R&D spending that seems to be somewhat volatile. I guess how should we look at that going forward and then I guess kind of the returns that we should be looking for something on R&D there?

Certainly. In terms of returns, again, hard to forecast. Anything with certainty, again, it's been our practice not to talk about products until they launch. We continue to work toward a pipeline so that we can have growth in the business. The volatility is really volatility around relatively small numbers, I would say. I wouldn't consider that to be meaningful, in any single point in time and it could fluctuate very little and still have a fairly significant percentage impact. It's going to fluctuate depending on anything from accruals, as Jason indicated, to allocations, to how much work we're doing say -- field work on all these analyzers in a given quarter, whereas the year subsequent quarter or the previous quarter there wouldn't be that work going on. It's just going to fluctuate like that, Kirk.

And then, Bob, you made a comment about the FUJI product that you thought was going to be an introduction in '08 and due to market environment you had moved that up to '07.

That's right.

What was that environment that you were discussing?

We believe that the largest competitor in this area will be introducing another analyzer sometime in 2008 and we wanted to preempt that with our own competitive offering.

Okay. Understandable. Thank you and again congratulations. We'll talk to you again next quarter.

Thank you, Kirk.

Thank you, Kirk.

Dr. Grieve that was our last question. Please continue.

Okay, well again, thank you all one more time for your interest in Heska and for taking the time to join us today. Goodbye.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating and please disconnect your lines.