Heska Corp (HSKA) 2008 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Heska Corporation second-quarter 2008 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). This conference is being recorded today, Monday, August 11, 2008. I would now like to turn the conference over to Bob Grieve, Chairman and CEO. Please go ahead, sir.

Thank you, Britney, and thank you all for joining us today for our conference call. I am joined by Jason Napolitano, our Chief Financial Officer. We appreciate having the opportunity to review the results for the second-quarter 2008. 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 points. You will have noted in this morning's release that we recorded our highest second-quarter revenue ever with total revenue of $22.6 million, an increase of 13% from the second quarter of last year. Revenue from placements of our new Dri-Chem 4000 chemistry analyzer was an important driver in our Core Companion Animal Health segment product revenue growth.

We also produced record second-quarter operating income of $1.4 million. Another important point was made in the release regarding our income tax expenses. We have previously discussed that beginning this year we are reporting our domestic net operating loss usage and other deferred tax items as income tax expense, as a result of the deferred tax asset recognized in the fourth quarter of 2007. This presents a confusing year-over-year comparison because we did not report these items as income expense in 2007.

As a result, investors will see a large increase in year-over-year tax expense and a corresponding decrease in net income. Both internally and as you will note in our release, we are focused on income from operations as a more consistent year-over-year measure of performance. It would be surprising if investors were not concerned about the potential effects of the current macroeconomic environment on our business. Historically it has been well documented that companion animals spending was generally unaffected by economic downturns.

However, every downturn to some extent has its own unique characteristics and it would be hard to extrapolate from one period to another. We have been unable to reliably determine any such effects on our current business with any precision. We do know, however, that two of our major competitors have recently reported second-quarter results and have noted the negative affect the economy has had on their business. They have reported somewhat slower than expected use of consumables for blood analyzers, I believe.

I recall reviewing a recent trade periodical which described a survey where over 50% of responding veterinarians believe the economy was having a negative affect on their practice. Anecdotally reports from the field would suggest that to the extent there is a negative affect it is uneven, perhaps somewhat geographic and even individual practice specific. We believe some practices may be seeing fewer pet owners and patients; in other cases there are situations where individual veterinarians despite a very successful business will be conservative in buying capital equipment just because of the broad awareness of a poor economy and the resultant uncertainty.

In that situation analyzer sales may be affected, but other products may not. Industrywide data are hard to obtain. It is difficult or perhaps impossible to separate the effect of a weak economy from underlying trends in our business. Be assured however that we are vigilant in our observations on economic affects. Also until there is more certainty in this regard we will be more conservative as we consider discretionary operating and capital expenditures.

Finally, I think it is worth commenting on one of our former directors, Barr Dolan. Mr. Dolan is a venture capitalist and was a cofounder of Heska in 1988. He served on our Board from Heska's inception until stepping down at the time of our annual meeting in May of this year. Under our option agreements individuals have three months after they leave the service of the company to exercise any remaining options. As you might imagine, Mr. Dolan had accumulated a number of stock options in his 20 plus years on Heska's Board. I understand there were public filings made regarding his intent to sell shares, which has caused concern with some of our investors.

It is important to know that this was after Mr. Dolan had left our board and he had to either exercise his options or lose them. In any case, all of Mr. Dolan's options to acquire Heska stock have been exercised or have expired at this point. We certainly express our gratitude to Mr. Dolan for helping turn Heska from an idea into a business reality.

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

Thank you, Bob. We posted solid results in the second quarter of 2008. We had record operating income of $1.4 million as compared to guidance for operating income of above $1.25 million and net income of $666,000 as compared to guidance for net income of above $650,000.

In addition, our second-quarter 2008 total revenue was $22.6 million, a 13% increase from the prior year period and a second-quarter record result. For the first half of the year total revenue was $44.5 million, up from $42.8 million in the prior year period. Product revenue for our Core Companion Animal Health segment was $17.3 million, up 7% from the corresponding period in 2007.

Higher sales of our chemistry instruments, our instrument consumables and our heartworm preventive domestically somewhat offset by lower sales of our handheld diagnostic instruments and our IV pumps were key factors in the increase.

For the first half of the year product revenue in this area was $34.7 million, up from $33.2 million in the prior year period. It is important to note as we have for some time that we faced a difficult comparison in this period due to sales of our heartworm preventive to Novartis in Japan.

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

In our other vaccines, pharmaceuticals and product segment or OVP, product revenue was $4.8 million in the second quarter of 2008, up 38% from $3.5 million in the prior year period. Better sales of our fish vaccines was the largest factor in the increase with greater sales of bulk bovine biologicals also contributing to the change. Unfortunately Aqua Health, a unit of Novartis who is responsible for all of our fish vaccine revenue since the beginning of 2007 has informed us they are taking production of their fish vaccines in-house beginning immediately and intend to use us only as surge capacity.

This appeared to be a relatively difficult product to make to spec, but as a result offered relatively high margins if added spec and destroyed production could be kept to a minimum. We generated $2.3 million in product revenue from sales of fish vaccines to Aqua Health in 2007, including $1.2 million in the second half of the year and over $900,000 in the third quarter. In the first half of 2008 we generated $2.8 million in product revenue from the sale of fish vaccines to Aqua Health. We do not expect to replace this with revenue from fish vaccines in the near term.

Obviously, this will cause difficult year-over-year comparisons in our OVP segment for the coming 12 months. In addition, this will put pressure on our gross margin as we now expect to have less revenue to spread our fixed costs over and will likely have a section of our facility sitting idle. Reallocating the space used for these fish vaccines is a decision we will consider over time.

While we are disappointed with this outcome, it is part of the natural lumpiness of our OVP segment revenue which we have led investors to anticipate and where the addition of a large customer can cause a large percentage difference on a year-over-year basis, which should tend to balance out over time.

For the first half of the year product revenue from our OVP segment was $9.2 million, up 3% as compared to $8.9 million in the first half of 2007. The largest factor in the increase was greater sales of the aforementioned fish vaccines. This was largely offset by a period over period decline of approximately $1.6 million in product revenue which I will refer to as the United revenue and which we have discussed to a large degree previously.

In the first quarter of 2007 upon receipt of payment for product previously shipped and take or pay minimums for 2005 and 2006 which previously had not been paid is part of a now settled dispute with United Vaccines, Inc. or United, a former customer. The cost of products related to this revenue have been reported in prior periods for the gross margin on it was virtually 100%. United has ceased operations and we recognize no corresponding product revenue in 2008.

Research development and other revenue was $417,000 in the second quarter of 2008, up $106,000 from $311,000 in the prior year period. A key factor in the increase was revenue recognized from sponsored research and development, an activity which tends to yield below average margin. For the first half of 2008 research, development and other revenue was $699,000, down slightly from $712,000 in the first half of 2007. As we discussed on our last earnings call, we faced a difficult comparison in this area due to approximately $100,000 in relatively high gross margin revenue from a service contract related to the December 2006 sale of 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 high gross margin revenue which will present another difficult comparison for us when we report our results for the third quarter of 2008.

As the contract was completed in 2007, we do not have any revenue corresponding to the Allergopharma service revenue in 2008. Gross margin that is gross profit divided by total revenue, was 37.9% for the second quarter of 2008 down from 41.3% in the prior year period. A key factor in the decline was lower margins on higher revenue in our OVP segment.

Net positive production variances in 2007 as compared to net negative production variances in 2008 increased idle plant charge and increased scrap inventory charges were all factors in the lower year-over-year margins in the segment. Gross margin was 36.3% in the first half of 2008, down from 43.6% in the first half of 2007. The largest factor in the decline was the impact of the United revenue I have already discussed.

Operating expenses were $7.2 million in the second quarter of 2008, up slightly from $7.1 million in the prior year period. Selling and marketing expenses were $4.6 million in the second quarter of 2008, a 17% increase from $4 million in the prior year period. An increase in personnel and greater advertising expenses were key factors in the change.

Research and development expenses were $417,000 in the second quarter of 2008, down $325,000 from $742,000 in the prior year period. A key factor in the decrease was less space at our corporate headquarters being used for research and development activities. In late 2007 we implemented a plan to move and expand space for certain activities within our corporate headquarters, such as service which reduced the space dedicated to research and development activities.

General and administrative expenses were $2.1 million in the second quarter of 2008, a decrease of 11% compared to the corresponding period in 2007. A key factor in the decline was a lower expense accrual related to management bonuses. For the first half of 2008 operating expenses were $15.1 million, an increase of 2% as compared to $14.8 million in the first half of 2007.

Income from operations was $1.4 million in the second quarter of 2008, a second-quarter record result and up 15% from $1.2 million in the prior year period. Income from operations was $1.2 million in the first half of 2008, down from $3.9 million in the first half of 2007.

Depreciation and amortization was $1.6 million in the first half of 2008, up from $902,000 in the first half of 2007. Increased depreciation for instruments used by our customers on a rental basis and capitalized is property and equipment was a key factor in the increase. Interest and other expense net was $181,000 in the second quarter of 2008, an increase of $22,000 as compared to $159,000 in the prior year period. The increase was due to greater borrowings under our revolving line of credit, somewhat offset by decreases in the prime rate. For the first half of 2008 interest and other expense net was $347,000, a slight increase from $339,000 in the prior year period.

Income tax expense was $539,000 in the second quarter of 2008, up $521,000 from $18,000 in the prior year period. Current income tax expense was $83,000 in the second quarter of 2008 up from $15,000 in the prior year period. The primary reason for the change was the recognition of certain state income taxes in the 2008 period.

Net operating loss usage and other deferred tax expense was $456,000 in the second quarter of 2008, an increase of $453,000 from $3,000 in the second quarter of 2007. The key reason for the change is our recognition of income tax expense related to our domestic deferred tax assets in the first half of 2008 but not 2007. 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. Our domestic deferred tax assets consisted primarily of our $165 million net operating loss or NOL position at year end 2007.

We have been reporting income tax expense related to our Swiss deferred tax assets for a couple of years, and this is a source of the $3000 net operating loss usage and other deferred tax expense in the second quarter of 2007. I think it is important to stress these are accounting changes only which do not affect the amount of tax we must actually pay in cash. We expect our large domestic net operating loss to continue to shield us from federal cash taxes to a large degree for the foreseeable future.

We have attached a pro forma page which estimates our 2007 results as if we had reduced the valuation allowance at year end 2006 rather than year end 2007. We believe this will be of aid to investors who would like to compare our financial statements on an apples to apples basis. For the first half of 2008 income tax expense increased to $376,000 from $94,000 in the prior year period, primarily due to the recognition of income tax expense related to our domestic deferred tax assets in 2008 as I have already discussed.

In the second quarter of 2008 net income was $666,000, a decline from $1 million in the prior year period primarily due to the increase in income tax expense I have discussed. For the first half of 2008 net income was $440,000, down from $3.5 million in the first half of 2007. In terms of guidance I think it is important first to note how difficult our business has been to forecast recently as evidenced by our recent annual guidance versus currently expected results. We have launched several new products in the past 18 months which are especially challenging to project. It is difficult if not impossible to parse out the overall affect of the economy on our business, and we are operating in an uncertain economic environment.

There is always the potential for unexpected negative surprises such as anticipated regulatory approvals failing to materialize in the timetable expected or large customer unexpectedly informing us they will no longer be buying from us.

Finally, we cannot have certainty regarding our competitors' future actions and/or the effect of a relative success or failure on our operating results. Investors should consider this as they contemplate our guidance for the coming quarter and 2008 as a whole. Our guidance for the third quarter of 2008 is for Core Companion Animal Health product revenue of approximately $19.5 million, approximately $2.4 million in OVP product revenue and $300,000 in research, development and other revenue. These figures add to over $22 million in total revenue in the third quarter of 2008. And our guidance is for gross margin and total operating expenses for this period to be in line with what we reported in the second quarter of 2008.

Our guidance for net interest and other expense net is approximately $150,000 and for income tax expense is approximately 39.5% of pretax income, including net operating loss usage and other deferred of approximately 37.5%.

On the bottom line our guidance is for net income of approximately $650,000 in the third quarter of 2008, which is obviously after approximately $400,000 in net operating loss usage and other deferred tax expense.

For the full year our guidance is for total revenue of approximately $90 million, including approximately $13.5 million in OVP product revenue and $1.3 million in research, development and other revenue. Gross margin in the 36% to 37% area, operating excesses between $29 million and $30 million, approximately $650,000 in interest and other expense net and income tax expense of approximately 39.5% of pretax income, including net operating loss usage and other deferred of approximately 37.5%.

On the bottom line our guidance is for net income of approximately $1.5 million in 2008, which obviously is after approximately $1 million in net operating loss usage and other deferred tax expense. Although the metric seems to be of decreasing utility for our investors based on currently outstanding shares and auction and Friday's closing share price, $1.5 million in net income translates to approximately $0.03 in diluted earnings per share on a GAAP basis.

Before I turn the call over to Bob, I believe it is worth a brief discussion regarding our stock price and delisting. Our stock closed at $1.02 on Friday. While this is obviously a difficult year for the equity market in general and animal health stocks in particular, we are disappointed to see our stock at these levels despite all the progress we have made. Inevitably I will get questions about our stock being delisted from NASDAQ if it falls below $1 as it has today, and I think it is worth clarifying the rules as we understand them to prevent any unnecessary anxiety among our investors.

If our stock has a closing bid price below $1 for 30 consecutive trading days, NASDAQ will send us a deficiency notice advising us we have been granted a 180-day compliance period to regain compliance with all NASDAQ standards. We can regain compliance with 10 consecutive trading days with a closing bid price of $1 or more although NASDAQ has discretion to extend this period.

If we fail to regain compliance within the initial 180-day period, we can receive an additional 180-day compliance period if we meet all the initial inclusion requirements for the NASDAQ capital market, other than the minimum bid price. As we believe we currently meet and will meet these criteria in the future, we expect to have up to 360 days from any NASDAQ deficiency notice to regain compliance, double the amount of time we had when we received such a notice in 2005.

If we have still not regained compliance by the end of the second compliance period, we can pursue a reverse stock split to regain compliance with the minimum bid price requirement and maintain our NASDAQ listing. We would prefer to maintain our listing without any such action, which, in the worst case, should be more than a year away.

Our stock price is obviously something we cannot control, where situations such as a former director selling shares to fund option exercises prior to expiration or a large seller deciding to liquidate his position can trump the underlying business performance, especially in the short term. However, we continue to believe generating growth and solid operating results in our business is the most effective way to increase investment in our stock and ultimately raise its price. That is what we intend to do.

In summary, we generated solid results in the second quarter of 2008 and we hope no one will be confused by the year-over-year tax accounting change. We intend to take actions to further strengthen our business in the second half of 2008 and beyond. With that, I will turn it back over to you, Bob.

Thanks, Jason. While we acknowledge the uncertainty associated with the overall external economic conditions and how those conditions may affect our business, we remain enthusiastic for the business opportunities this year. We have just described a profitable second quarter with record second-quarter revenue and record operating income. And in 2008, we plan to deliver the highest annual revenue results in the history of our Company, while laying the groundwork for future growth.

Thanks for your attention today. We appreciate your continued interest in 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) Eugene Peysakh, Sivik.

A couple quick questions today of numbers you typically disclose in your queue -- for details. What percentage of your revs that I think were just instrument consumables? I think last quarter, it was [$0.40]. And what is that at this point?

Hang on one second. 32% of product revenue.

32% of product revenue. And of total revenue?

That is just math. We generally report it as product revenue.

Okay. And what percentage then is the diagnostics and other test pharmaceuticals and vaccines?

35% of product revenue.

And the last --. Okay, that's good. And of the 32% -- or rather whatever the total number was, what came from existing customers versus the new hardware sales?

New heartworm sales?

Hardware.

Hardware.

Oh. Well, 32% was consumables and 15% of product revenue was new hardware sales. So that is 47% combined is the instrumentation and consumables. Usually the three buckets we report in, Eugene, is instrumentation and consumables, single use and the OVP, which was 18% of product revenue.

Yes, those are the numbers that are liquid. Thanks. Let me just ask them the next question from there, which is it seems like you guys had very strong growth in the quarter, and I was looking at the growth that your competitors saw. And they reported that there was some impact of economy, one person at one company saw more than the other. Was there any disruption in terms of market share gains or market share losses?

I think it would be too early to say for sure in terms of gains or losses in market share. We have obviously a much smaller share than our largest competitor, and I think again we just draw your attention to the fact that we said that one of the major drivers for revenue in the quarter were placements of the new Dri-Chem 4000 chemistry analyzer. So that product was well received. As to the economic effects we've been careful to point out it is very, very hard to discern those affects.

It seems to keep growing much faster than the market which kind of imply that some, maybe there were customer conversions, I mean if people that were with other customers came to you that you didn't see that or you didn't see any kind of affect from that outside of economic effects?

I think that strictly speaking we know that we did win some existing competitive customers to our side with this Dri-Chem 4000 but to sit and quantitate it in terms of share, again it is a little bit too early.

That is the idea, Eugene, behind launching the Dri-Chem that allows us to get into a customer that we probably weren't able to effectively target with our previous offering.

Even anecdotally receiving feedback from your end customers or from your sales reps, that their customers were talking about the economy or kind of blamed it for maybe either cutting or thinking about consumables usage going forward?

Again, I alluded to some of this during some of my narrative, Jason did to some degree, as well. I would say as I have mentioned the trade periodical, I believe it was Veterinary Practice News, indicated in their mail survey that my recollection is about 52% of veterinarians said that they thought the economy was affecting their practice. Again, we stress anecdotally at least from the field and salesforce, that it seems to be there is some geographic affects. There are parts of the country that are certainly more negatively affected right now than other parts.

Some practices where the most successful businesses and the most progressive practitioners, they seem to be unfazed right now. Yet in other places where there are successful business in veterinary practice where they are generating cash and really successful, they have sort of metaphorically they've crossed their arms. They are waiting to see what happens with the economy before they make any more capital spending decisions. I think that is not different, as I mentioned here, in our business until we have more clarity on the longer-term view and the economics, we are going to be really conservative in any discretionary expenditures along the way.

Are they postponing those capital equipment decisions to the fourth quarter when they get kind of a tax shelter or tax -- when it is more helpful for them from a tax perspective or are they just postponing it indefinitely?

We don't know for sure. We just know that there are a lot of rolling postponements. You could argue -- again it gets to be a bit reckless -- you could argue that they are watching the markets, they are waiting for the fourth quarter and see where their own individual balance sheets looks like. Maybe get through the election cycle, wait for the credit crunch to obviously dissipate or bottom out. It is just again it borderlines reckless because there is -- we hear basically the same things you do, Gene.

And just on the geographic comment, could you elaborate on that in terms of maybe where you saw what?

Sure. For example here, in the Rocky Mountain West or in Colorado our economy has been relatively undamaged as relative to the rest of the company. Whereas, for example, in Michigan in the Detroit area, would be an example where there has been a lot of economic pressure for a long time with layoffs and so forth. So those would be two I would say polar contrasts in how the customer might be feeling these economic pinches.

What about the West Coast or East Coast or Texas?

Again, it is very, very hard to break that out. And I stress as I did in my formal comments that some of this is geographic specific as we has just been discussing but some of it is practice specific. It has to do with the business attitudes and the risk tolerance or frankly the progressiveness of the individual customer. So we have literally seen practices that were unfazed it seems by these concerns that were very successful, and we've seen other successful practices that are very conservative and concerned.

Have you seen any changes to your seasonality or to the mix of products that people are demanding?

Not at this point. We will know more in another probably two quarters when we get through fourth quarter and we can look back on the full year, Eugene, we can understand how the capital expenditure trends for fourth quarter progress, we can probably comment with a little more alacrity.

Okay and just one last question. Sorry to take up so much of your time. I was just wondering if you can give the breakout between US, Europe and rest of world on a percent basis.

I don't know if I have that handy, Eugene. No, I don't have that handy, and I don't think -- I don't want to estimate that just sitting here. I'm sorry.

Thanks very much for answering my questions.

Thank you for your thoughtful questions.

(Operator Instructions) There are no further questions in the queue. I would like to turn the call back to Bob Grieve for any closing remarks.

Again, at this point I would like to thank all of you for your interest in Heska and for taking the time to join us today. Goodbye.

Thank you. Ladies and gentlemen, this concludes the Heska Corporation second-quarter 2008 earnings conference call. If you would like to listen to a replay of today's conference please dial 303-590-3000 or 800-405-2236 and enter pass code 11116661, followed by the pound sign. TCT would like to thank you for your participation. You may now disconnect.