Heska Corp (HSKA) 2008 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Heska Corporation first quarter 2008 earnings conference call. (OPERATOR INSTRUCTIONS). This conference is being recorded today, May 12, 2008.

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

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 first quarter of 2008.

Prior to discussing our results, I would like to remind you that during the course of this call we may be 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 current beliefs and expectations, and involve known and unknown risks and uncertainties which may cause actual results or 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. 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 performance. You will have noted in this morning's release that we were pleased to report record product revenue from our Core Companion Animal Health segment.

For some time we have been telling investors that the first quarter would present some very difficult year-over-year comparisons. Notably, we have very significant favorable onetime revenue events in last year's Q1 that Jason will detail in a few minutes. Also, we have significant unfavorable and unanticipated expenses in the first quarter of this year. For example, we learned late in the quarter of a very significant property tax increase on our Colorado corporate headquarters.

As I described in our last two investor calls, we believe strongly in regularly upgrading product offerings as technology improvements create the opportunity to meet our customers' needs. Of course, such replacements invariably lead to associated transition effects. In particular, we have very aggressive programs to place our new Dri-Chem 4000 chemistry analyzer in the first quarter. Placement of analyzers with high-volume customers at low cost or no cost [exploit] long-term business sense.

In the short term there is a negative gross margin impact. Similarly, using the enhanced benefits and features of a new analyzer, current and high-volume customers currently using competitive products provides a great opportunity to capture market share, but there are negative implications to gross margins in the short term. We will see that gross margin effect in the results we released this morning. Again, this is another case where we remain committed to offering the best product possible and focusing on the best overall business solutions for enhancing shareholder value over the long term.

We're continuing with aggressive Dri-Chem 4000 placement programs in the near term; however, we are considering a return to more market normal pricing, as it becomes evident that the newly launched competitive chemistry analyzer is available at commercial inventory scale.

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

In the first quarter of 2008 we generated record Core Companion Animal Health product revenue of $17.4 million, and continued to move our business forward. While the year-over-year results may not appear to demonstrate forward progress in our business goals, it is important remember that we faced a difficult comparison in this quarter due to certain events that occurred in 2007 that we did not expect to recur in 2008.

We have pointed this out repeatedly on past earnings calls and in our disclosures, so that our core investors would not be surprised when this quarter's results were reported.

We recognized over $2 million in revenue in the first quarter of 2007 that did not recur in the first quarter of 2008. As we discussed in the past, this revenue shortfall affected each of our three reported revenue line items, Core Companion Animal Health segment product revenue; Other Vaccines, Pharmaceuticals and Products segment, or OVP, product revenue; and research, development and other revenue.

The largest of these impacts occurred in our OVP segment, where we recognize product revenue, which I will refer to as the United revenue, of approximately $1.6 million in the first quarter of 2007 upon receipt of a payment for product previously shipped, and take-or-pay minimum 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. Cost of products related to this revenue had been reported in prior periods so the gross margin on it was virtually 100%.

As United has ceased operation, we do not generate any revenue or gross profit corresponding to the United revenue in the first quarter of 2008.

In our Core Companion Animal Health segment we recognized over $575,000 in product revenue from sales of our heartworm preventive to Novartis for distribution in Japan in the first quarter of 2007. This product sale was at relatively high gross margin. Novartis subsequently acquired a business with a product competitive to our heartworm preventive, and informed us that they would no longer market and distribute our product. So we knew we would have no corresponding revenue for this product in the first quarter of 2008.

Finally, in the first quarter of 2007 on our research, development and other revenue line items we reported approximately $100,000 in relatively high gross margin revenue from a service contract related to the December 2006 sale of a worldwide patent portfolio, which I will refer to as the Allergopharma service revenue.

This service contract was completed in the third quarter of 2007 when we recognized the final $150,000 of high gross margin revenue. We recognized no revenue under this contract in the second quarter of 2007. Since the contract was completed more than one quarter earlier, we did not have any revenue corresponding to the Allergopharma service revenue in the first quarter of 2008.

All-in, the revenue from these three items was nearly $2.25 million, with a corresponding gross profit which rounds up to $2 million. In a sense, we started the quarter with a revenue and gross profit shortfall of this magnitude.

As Bob mentioned, we also had some unanticipated charges in the first quarter of 2008. We reserved approximately $300,000 of inventory for product we expect to expire prior to sale. The bulk of this reserve relates to cartridges for use with our i-STAT and i-STAT 1 handheld analyzers. We also had some quality issues with newly produced analyzers in this area, which we hope will be addressed by a new software upgrade from the manufacturer, a unit of Abbott Laboratories.

We believe these quality issues had an impact on placement in this area which were lowered anticipated, and obviously hurt our ability to use inventory on hand. We also experienced about $216,000 in unanticipated expense related to an increase in assessed value and therefore property taxes on our facility in Loveland. As our lease is triple net, we are responsible for the property taxes on the facility, even though it is a landlord who receives official notification of any increases.

Getting into some more detail on the specific numbers, in the first quarter of 2008 Core Companion Animal Health product revenue grew by 2% compared to $17 million in the prior year period. Key factors in the increase were greater revenue from our heartworm diagnostic tests, both internationally and domestically, and our chemistry instruments. In the U.S. we ran aggressive sales and marketing programs for both of these products.

With our new chemistry instrument we gained some accounts we historically have not been able to win. Although I think it is fair to say we were more aggressive with our sales and marketing programs and our placements were lower than we had anticipated.

We believe it is early in this product's lifecycle to draw any conclusions. Anecdotally we are not hearing about significant opportunities lost to competitive instruments, but there does seem to be a reluctance on the part of the account to close with a preference to delay the decision. Whether this is due to the overall economic outlook or for some other reason it is hard to say.

It is important to remember that this is a product which we believe will allow us to compete with the higher end customer. So in many ways this requires a new approach for our sales force and distribution partners, and we have done some training in this regard. It may take some time for our individual reps and their distributor partners to work out the selling approach that works best for them. In any case, we have raised the performance expectations of our sales people.

The revenue gains related to our heartworm diagnostic tests and our chemistry instruments were somewhat offset by the decrease in our international TRI-HEART sales due to the situation in Japan I have discussed, as well as lower domestic sales of our heartworm preventive, our IV pumps, and our handheld diagnostic instruments.

I have already discussed some of the quality issues we have seen with our handheld diagnostic instruments, which we believe had an impact on first quarter sales. Schering-Plough Animal Health, or SPAH, has exclusive sales and marketing rights to our heartworm preventive in the United States, and their parent company recently closed the acquisition of the pharmaceuticals business of Akzo Nobel, which includes the large animal health company, Intervet.

We have heard of some organizational changes resulting from the combination of SPAH and Intervet. When considering the decrease in pump sales it is worth noting that we ran an aggressive program on our IV pumps last year which we did not repeat this year.

Product revenue on our OVP segment was $4.3 million in the first quarter of 2008, a decrease of about $1 million from prior year period. United revenue, which was approximately $1.6 million, represented the largest factor in the decline. We also experienced lower sales of both bovine biologicals, which was somewhat offset by increased sales of fish vaccine in this segment.

Research, development and other revenue was $282,000 in the first quarter of 2008, down $119,000 from the prior year period. The key factor in the decline was the Allergopharma service revenue I have already discussed.

Total revenue was $21.9 million in the first quarter of 2008, down 4% from the prior year period. Gross margin was 34.7% in the first quarter of 2008, down from 45.1% in the prior year period. The largest factor in the decline was the United revenue and the corresponding impact on margin I have already described.

Inventory reserves I have discussed, product mix and aggressive sales and marketing programs related to our diagnostics product also contributed to the decline.

Selling and marketing expenses were $4.9 million in the first quarter of 2008, an increase of 11% compared to the prior year period. A key factor in the increase was increased expenses related to training and the recent launch of new instrument offerings.

Research and development expenses were $539,000 in the first quarter of 2008, down $165,000 compared to the corresponding 2007 period. The key factor in the decrease was less space at our corporate headquarters being used for research and development activity.

In late 2007 we implemented a plan to move and expand space for certain activities within our corporate headquarters, such as our service, which reduced the space dedicated to research and development activity. The nature of Heska's business is changing from our research boutique roots to more of a traditional commercial enterprise. Perhaps not surprising how we use our facility and what our people are doing are changing along with it, and our financial statements will reflect these changes going forward.

In the first quarter of 2008 our general and administrative expenses were $2.5 million, down 5% from the prior year period. The key factor in the decline was a lower accrual related to our management incentive plan, or MIP, payout in 2008 as compared to 2007.

In the first quarter of 2007 we recognized a gain of approximately $47,000 in the sale of certain patents we held, net of cost. We had no corresponding gain on asset sales in the 2008 period. Operating expenses were $8 million in the first quarter of 2008, up from $7.7 million in the prior year period. We experienced a loss from operations of $223,000 as compared to income from operations of $2.65 million in the prior year period.

Depreciation and amortization was $775,000 in the first quarter of 2008, up from $422,000 in the prior year period. Increased appreciation for instruments used by our customers on a rental basis and capitalized as property and equipment was a factor in the increase.

Interest and other expense net was $166,000 in the first quarter of 2008, down from $180,000 in the prior year period. 2008 period consisted of $188,000 in net interest expense, somewhat offset by $22,000 in net foreign currency gains. 2007 period had $232,000 in net interest expense, which was somewhat offset by $52,000 in net foreign currency gains. Despite higher borrowings year-over-year, net interest expense declined as we had more than offsetting interest rate decline.

Interest rate declines resulted from the overall market, with the primary debentures decreasing, and as a result of our achieving negotiated milestone under our credit and security agreement with Wells Fargo to obtain lower spreads to prime.

We reported a tax benefit of $163,000 in the first quarter of 2008 compared to a tax expense of $76,000 in the prior year period. It is important to note that the accounting approach is fundamentally different regarding our domestic deferred tax assets position, which consists largely of our $165 million net operating loss in the two periods. This is a result of our conclusion in the fourth quarter of 2007 that a portion of our domestic deferred tax assets was realizable on a more likely than not basis, with our corresponding $30 million reduction of valuations allowance and $30 million domestic deferred tax asset on our year-end balance sheet.

As we generate taxable income and utilize our net operating loss, or NOL, we will reduce this deferred tax asset and report a corresponding income tax expense as if we had no such an NOL. This is what we have been doing for our Swiss operating subsidiary for a couple of years. The first quarter of 2007 impairment tax expense, we expected to pay in cash of $74,000 and $2,000 in an NOL usage related to our Swiss operating subsidiary.

In the first quarter of 2008 we recorded a tax benefit, along with the corresponding deferred tax asset, as we believe it is more likely than not that we will generate taxable income in 2008 to more than offset the tax loss we experienced in the first quarter.

You will note we have attached a pro forma page which reports our 2007 results as if we had reduced the valuations allowance at year-end 2006, rather than year-end 2007. We believe this will be of aid to investors would like to compare financial statements on apples-to-apples basis.

You will note that under the pro forma scenario we would have reported additional tax expense of $896,000 for net operating loss usage, net of alternative minimum tax, or AMT benefit, all of which would have been related to our domestic NOL.

I think it is important to stress the pro forma changes would be non-cash accounting consequences only, and that they would not affect the amount of tax we would not pay as a result of our NOL position.

We expect to report profitable periods, using at least the two-line detailed breakout you see in the pro forma statement, as we believe that will most easily allow interested investors to track the impact of our domestic NOL usage.

In the first quarter of 2008 we had a net loss of $226,000, down from net income of $2.4 million in the prior year period. I note net income was $1.5 million on the pro forma page attached to the press release.

Before I turn to guidance, I think it is worth noting the difficulty in projecting our business at this time. We've launched three major new products at the beginning of 2007. We believe our suite of products will allow us access to a higher end customer than before, but this introduces new variables into our outlook.

Is the selling cycle the same for these customers? How many of our reps will adapt well to the new product suite and how many will not? What will the learning curve be like? In addition, one of our major competitors has announced it has begun commercial deliveries of a new chemistry unit competitive with ours. How will this unit be received initially? What will its reputation become over time? It is very difficult to say, especially before we have even seen a working unit.

The answers to all these questions and more are critical to projecting our business, especially in the short term. But they are difficult to answer and it may be impossible to know for sure at this stage.

Another variable is the short-term sales and marketing decisions we make. We believe our strategy of aggressive offers to gain share while our competitor's new unit is not widely commercially available is a wise one. As a competitor has announced the commercial launch of its new unit, we would expect to see commercial quantities available in the near future. When this happens, we would expect to return to more value-based offers with corresponding, higher short-term margins and lower share gains. Similarly, if there are continued delays in commercially available supply of this competitor product, we would expect more aggressive offers to be more widely used, with corresponding lower short-term margins and higher share gains.

This is a very fluid situation and we change programs intraquarter more frequently than in the past to try to optimize our opportunities. The very fluidity of the process makes guidance difficult, especially short term.

In summary, all of these effects make it difficult to project with any accuracy. And as ours is difficult to project in the first place, we really don't know exactly how things with turn out.

For the second quarter of 2008 our guidance for Core Companion Animal Health product revenue is approximately $17.75 million. OVP product revenue is about $4.75 million. And research, development and other revenue is about $300,000.

We're guiding for gross margin of somewhere around 38 to 39%, and approximately $7.5 million in operating expenses. We're guiding for income from operations of over $1.25 million, and about $175,000 in net interest and other expense.

Our guidance regarding tax rate is for 39.5% total, including approximately 37.5% for net operating loss usage, net of AMT benefit, and a corresponding net income of over $650,000.

For the full year we are guiding for Core Companion Animal Health product revenue growth of over 15%, OVP product revenue of $14.5 million, and research, development and other revenue of approximately $1.2 million.

Our total revenue guidance is for total revenue in the low 90s. We're guiding for gross margin to approach 39% for the full year, and operating expenses of about $30 million.

Our 2008 guidance is for income from operations to be just below $5 million, with approximately $3.25 million in depreciation and amortization. Our guidance regarding tax rate is for 39.5% total, including approximately 37.5% for net operating loss usage, net of AMT benefit.

We're guiding for net income of approximately $3 million, which obviously excludes a little over $1.8 million in non-cash net operating loss usage I just described. Although the metric seems to be a decreasing utility for our investors, based on our currently outstanding shares and options and yesterday's closing share price, $3 million of net income translates to approximately $0.06 in diluted earnings per share on a GAAP pacings.

In summary, we're glad to have some of the difficult year-over-year comparisons behind us. We intend to continue to make the best decisions we can to drive long-term value for our shareholders. With that, I will turn it back over to you, Bob.

We remain enthusiastic for the business opportunities this year. As Jason has discussed, we plan to return to profitability in the present quarter, and we plan to deliver the highest annual revenue results in the history of our Company.

Thanks for your attention today. We appreciate your continued interest and support of 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.

Just a couple of questions on the products, the new introduction of the recent products here. Can you talk about the life cycle of those a little bit, and then maybe when you see those at maturity within your customer base?

Could you please restate that? I didn't quite understand the question there?

Well, Bob, just looking as your reps are selling those products into the market, when do you think those will reach a full penetration rate and we will see really the top line advance towards that?

That sounds sort of perhaps too conservative, or hedging too much. It is just very hard to say for some of the reasons Jason has mentioned. We've got unknowns with respect to competitive product offerings, unknowns with respect to the macroeconomy, things like that. But I would certainly say you should think in terms of a number of quarters or short years, rather than a very short time frame.

Can you talk about the volume of -- mainly the Dri-Chem, and just what has happened with that as that has been reduced introduced and being sold into the market?

You mean the unit placement?

Right.

I let Jason address that.

Yes, I think I said in my comments it was a little lighter than we had anticipated. But there is a lot of variability in this, as I said in my comments that it is difficult to predict. It is I think a sale that allows us to squeak to an higher end-user than we have been used to, and therefore we have less history really that we could rely on to project.

I would also add, just again just to reinforce some of his earlier comments, the wins -- a lot of the wins that we had with the analyzers were with high-volume customers, so we are pleased with that. Then again anecdotally we have heard that in the field that there is a certain amount of reluctance to make decisions on capital equipment at this time, given the overall concern about the economy.

That is much more of a macro -- that is not more competitive-related with the decisions maybe being held off for awhile?

That's correct. Just to expand on the comment that Jason made in his narrative. Again anecdotally, small sample size and all those qualifiers, Kirk, we hear from the field -- we didn't lose very many opportunities to competition at all. The bulk of them in this, again, small sample size -- plus the delays.

Then the Abbott relationship there, any charges or expenses we might see on that?

Hopefully we have taken all we're going to have to take. That is certainly our current expectation. We think these quality issues are being cleared up. Then we have programs in place to move the existing inventory we have. But you never know with something like this. You never say never.

Just a couple of questions towards guidance, Jason. You mentioned gross margins for '08 to be in the 38 to 39 range.

I think I said approaching 39 for the full year.

Approaching 39?

Yes.

What was the net income number you had mentioned?

It was $3 million after the net operating loss. I think some people look at that as well. I think -- let me pull the number up. I think it is $1.8 million I said for net operating loss usage.

Then income from operations, that number I missed.

We said just below $5 million.

Just below $5 million. Okay, I will hop back in the queue. Thanks guys.

(OPERATOR INSTRUCTIONS). That does conclude our question and answer session for today. I will turn the conference back to management for closing remarks. Please go ahead.

I would just simply restate again, thank you all for your interest in Heska, and for taking the time to join us today. Bye.

Ladies and gentlemen, that does conclude the Heska Corporation first quarter 2008 earnings call. ACT would like to thank you for your participation. Have a pleasant day. You may now disconnect.