Heska Corp (HSKA) 2009 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Heska Corporation fourth quarter and year-end 2009 earnings conference call.

(Operator Instructions). This conference is being recorded today, Monday, February 22 of 2010.

At this time I would like the to turn the conference over to Bob Grieve, Chief Executive Officer. Please go ahead, sir.

Thank you, Vince, and thank you all for joining us today for our conference call. I'm joined by Jason Napolitano, our Chief Financial Officer.

We appreciate having the opportunity to review the results from the fourth quarter and full-year 2009. 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's call.

We are very pleased with the continuing progress in our financial results. In our release earlier today, we called attention to the fact that this was our fourth consecutive profitable quarter, and of course we were profitable on a full-year basis. Revenue in the quarter was up 12% year-over-year. Gross profit margin percentage was up 10 basis points. Operating expenses were much lower, even after last year's one-time expenses in the quarter are subtracted. And, we had dramatically positive swings in both operating and net income, both in the quarter and for the full-year. If you looked at the balance sheet, you will note that our cash exceeded the total of both our remaining current term debt and our line of credit. While, operating capital requirements will certainly cause our line of credit to fluctuate over the course of the coming year, our term debt is scheduled to be paid completely in the coming months. These are important balance sheet milestones for us to have achieved.

Finally, from a financial standpoint, as you had the opportunity to read our 10-K, you will note that we have generated over $8 million in cash from operations. When shareholders consider our financial performance in 2009, a tough year from a macroeconomic standpoint, along with the news of or amended and extended agreement with Wells Fargo, you can appreciate that we are in the strongest financial position that we have been in for a very long time, likely the best situation we've been in as a public Company. When our veterinary customers consider these same positive financial facts, you will realize, and maybe even laugh a little, at our competitors' attempt to create rumors about our eminent demise, demise, as it turns out, that was greatly exaggerated.

In mid-December we announced the installation of our first DRI-CHEM 7000 Chemistry Analyzer, signaling the full launch of that product. This is a high-end extension to our DRI-CHEM 4000 Analyzer, and should compete very effectively with the highest end of any competitive offering in the marketplace today. We believe this product will have higher throughput capability for multi-patient testing, and unique automated features that are superior to those found on analyzers offered by our major competitors. In short, we believe this is the fastest multi-patient clinical chemistry analyzer available to the veterinary end clinic market. There was very positive feedback from field-based beta testing and the product has been well-received by our veterinary customers. In November, we announced an agreement with Roche Diagnostics, which has resulted in the development of an advanced blood gas and electrolyte analyzer for the veterinary market. In November, we announced an agreement with Roche Diagnostics, which has resulted in the development of an advanced blood gas and electrolyte analyzer for the veterinary market. The VitalPath blood, gas and electrolyte analyzer is the latest in a series of advanced diagnostic instruments Heska has launched in the last two years. We expect to begin shipping these analyzers to customers in the near future.

Before I turn the call over to Jason, I think it's appropriate to comment on questions we have seen in investor forums, questions we are occasionally asked directly, as well, about insider purchases of Heska stock. In short, investors ask why we insiders have not purchased Heska stock on the open market this past year. In general, Heska does not have a formal policy regarding stock ownership by insiders. Our view is that directors' and executive officers' investment decisions are solely their own and not a matter of public disclosure beyond the governmental filing requirements. We maintain an insider trading policy with specific window periods where insiders may trade in Heska stocks. Our policy is designed to prevent transactions in Heska stock which may appear inappropriate in retrospect. We will not open the window in periods where we believe there is some reasonable likelihood of material inside information. In this context, on our earnings calls over the past year, I have described extensive discussions with potential strategic partners regarding sales channel opportunities. These discussions with these large potential partners have often become broader involving corporate level strategic transactions including change of control related discussions. Accordingly, we did not open our trading window, and in fact our trading window has not been opened for over a year. We are not actively involved in any such discussions currently, and while it is possible such discussions could reoccur at any time, we are certainly not planning on that. In general, we will not comment further on our trading window policies or on any strategic discussions, but as long as we are in an (inaudible) environment, I wanted to clarify the issue of insider share transaction activity over the past year.

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 both the fourth quarter and the full-year 2009, which exceeded our profitability expectations in both cases. Total revenue was $17.4 million in the fourth quarter of 2009, an increase of 12% as compared to the prior year period. Despite the difficult economic and other conditions we faced in the fourth quarter, which I will expand on in a moment, we experienced revenue growth in both of our operating segments. For the full-year 2009, we generated revenue of $70.5 - $75.7 million, down from $81.7 million in 2008.

Revenue in our Core Companion Animal Health segment was $14.5 million in the fourth quarter of 2009, which I will refer to as the current quarter. This was an increase of 6% as compared to the prior year period. The largest factor in the increase was greater revenue from heartworm-related products. Our heartworm diagnostic tests, both internationally and domestically, and our heartworm preventive. Schering-Plough Animal Health Corporation, or Schering, has exclusive rights to market our heartworm preventive in the United States.

Other factors in the increase were revenue from our new chemistry unit, the DRI-CHEM 7000, which we began to place with customers in December, as well as increased sales of consumables not related to our handheld instruments.

These gains were somewhat offset by a $1.8 million decline in sales of cartridges for our handheld instruments. We sold $2.9 million of such cartridges in the fourth quarter of 2008, as compared to only $1.1 million of such cartridges in the fourth quarter of 2009. This is the result of a difficult condition I have already referred to. As we have previously disclosed, the supplier of our handheld instruments canceled our contract as of November 1, 2009, and as per our contract, purchased the bulk of our cartridge inventory soon thereafter. This situation will present a difficult comparison for us throughout 2010, although the comparison should be less difficult with each successive quarter.

We will compare our first quarter to a period where we had exclusive access to this product line. Our second quarter to a period where we had exclusive access for a portion of the quarter. Our third quarter to a period of nonexclusive access. And our fourth quarter, to a period of partial access.

In 2009, we generated $9.4 million of cartridge sales with a gross margin of 37.8%, significantly lower than for other instrument consumables and our expectations for an attractive product line. This was actually better than gross margin for these cartridges in 2008 and 2007. These cartridges have notoriously short dating, leading to relatively high levels in expired products, especially in periods where one plans for high growth that does not materialize. Given that we actually experienced a negative gross profit on hardware sales in this product area in each of the past three years, gross margin related to this product area was actually slightly lower than our consolidated results in 2009. While loss of access to this product line will challenge us in 2010, long-term we believe it will be positive for our Company, as it frees sales time to focus on products expected to meet our profitability goals and frees us of competitive restrictions in terms of future product opportunities.

For full-year 2009, Core Companion Animal Health revenue was $66.4 million, down 3% from $68.1 million in 2008. The largest factor in the decrease was a $2.9 million decline in cartridge sales related to our handheld instruments from $12.2 million in 2009 to $9.4 million in 2008. Other factors in the decline were lower sales of our chemistry instruments and our microalbumin laboratory packs. We believe VCA Antech, who purchases our microalbumin laboratory packs, is using new instruments which yield a greater number of tests per pack.

These declines in our annual revenue were somewhat offset by greater sales of our non-handheld related consumables, international sales of our heartworm diagnostic tests and our heartworm preventive. On our 2008 year-end earnings call, we discussed how we were disappointed with sales of our heartworm preventive product to Schering in 2008. We mentioned that we met with Schering to discuss the situation in early 2009. At that meeting, Schering convinced us of their interest in and commitment to the product. They explained to us how they had successfully integrated Intervet, the animal health business of Akzo Nobel, which had been acquired in November 2007. Following this acquisition, Schering was one of the three largest players in animal health and we were excited by what this market presence could mean for our product sales.

We are pleased the to report we saw a sales increase in this area, consistent with this outlook. We are even more pleased with the latest forecast from Schering, which calls for a significant increase in sales of our heartworm preventive.

It is our understanding that Schering is capitalizing on some new distribution opportunities. On March 9, 2009, a few days after our meeting with Schering, Merck and Schering's parent company, announced that they were planning to merge, a transaction which subsequently closed. Prior to the merger closing, Merck announced that it was selling its 50% interest in Merial, a leading animal health company, to Sanofi-Aventis, the other 50% holder. As part of this agreement, Sanofi-Aventis acquired the right to combine Merial with Schering in a new equally-owned joint venture.

Merial is the market leader in heartworm prevention and sells a product directly competitive with ours. If Sanofi-Aventis exercises this option and Schering stops or is forced to stop selling our heartworm product as a result, it could create some short-term challenges for us. This would also potentially create long-term opportunities, however, if we reobtained domestic rights to this product, we believe we have exciting alternatives. No fewer than six entities have approached us inquiring about distribution opportunities for this product. And of course, we could always sell and market the product directly using our existing direct sales force.

In our Other Vaccines, Pharmaceuticals and Products segment, or OVP, current quarter sales were $2.8 million, a 59% increase compared to $1.8 million in the prior year period. The primary reason for the increase was greater sales of bovine vaccines under our contract with AgriLabs in the current quarter. For full-year 2009, OVP revenue was $9.2 million, down $4.3 million from 2008. The largest factor in this change was a loss of fish vaccine revenue from Aqua Health, a unit of Novartis, who, as we have previously disclosed, informed us they were taking production in-house, and accordingly ordered no product from us in 2009.

Lower revenue under our contract with AgriLabs, and lower sales of bovine biologicals, also contributed to the year-over-year decline.

Gross margin, that is gross profit divided by total revenue, was 38.2% in the current quarter, up over 10 percentage points as compared to 28.1% in the prior year period. Key factors in the increases were significantly improved gross margin in our OVP segment, where we experienced greater manufacturing volume over which to spread our overhead, and lower inventory reserves against inventory we expect to expire prior to sale, primarily related to slides for our chemistry instruments. 2009 gross margin was 37.6%, up more than two percentage points from 35.3% in 2008. Lower reserves taken against inventory we expect to expire prior to sale, primarily related to consumables for our chemistry instruments and our handheld diagnostic instruments, were a factor in the increase.

Another factor in the increase was revenue mix as a lower percentage of our revenue in 2009 was related to our OVP segment which tends to generate lower gross margin than our Core Companion Animal Health segment.

In January, we gave notice of contract termination to most third party distributors who carry our full product line. We took this action because we expect it will enhance our profitability and allow greater investment in our direct sales efforts, which we expect will yield a greater return than continuing in these agreements. Despite contractual obligations to the contrary, most of these distributors purchased cartridges related to our handheld instruments from a competitor rather than us when we had nonexclusive rights. We believe this was an indication to us of the importance of our relationship to these distributors and the seriousness with which they take their commitments. As sales to these distributors have historically been made at a discount to market, we anticipate this action will contribute to an increase in 2010 gross margin as compared to 2009.

Sales and marketing expenses in the current quarter were $3.4 million, a 5% decline from the prior year period. Lower expense related to a customer loyalty program and lower marketing personnel were factors in the decline. 2009 sales and marketing expenses were $14.5 million, a $3.1 million decline as compared to $17.6 million in 2008. Key factors in the decline were lower expenses related to product launches, decreased expenditures on market research and lower commissions.

Current quarter research and development expenses were $410,000, down $79,000 from $489,000 in the prior year period. 2009 research and development expenses were $1.7 million, a $233,000 decline from $2 million in 2008. Lower spending on research and development resources, such as laboratory supplies, was a factor in the decline in both cases.

General and administrative expenses were $1.9 million in the current quarter, down 11% compared to the prior year period. Lower bad debt expense and expenses related to expatriate taxes were factors in the decline 2009 general and administrative expenses were $8.2 million, an 8% decline compared to the prior year period. A key factor in the decline was savings resulting from our restructuring at the end of 2008.

In the fourth quarter of 2008 we recorded $785,000 in restructuring expenses. We recorded no other restructuring expenses in any other quarter of 2008 or in 2009. Of the $785,000 we recorded, approximately $621,000 related primarily to personnel severance and other costs for certain individuals affected by our restructuring, and $164,000 of inventory related to discontinued products. Of the expense related to inventory, approximately $75,000 was related to remaining inventory of our Vet/Ox G2 digital monitor. with the manufacturer, Dolphin Medical, Inc., majority-owned subsidiary of OSI Systems, Inc., had informed us they would no longer support or provide sensors to the product and we did not pursue any legal remedies. Remaining $89,000 of expense related to inventory was for discontinued products we made a concerted effort to sell in 2008 but were unable to.

We recorded $232,000 in other operating expenses in the fourth quarter of 2008, and recorded no other corresponding expenses in any other quarter of 2008 or in 2009. This was a non-cash asset impairment expense related to certain handheld blood analysis instruments, capitalized as rental units for use by our customers. The majority of these units were being depreciated over a four-year life. As we were unsure as to our ongoing access to cartridges for these units, we concluded that the appropriate depreciation period for these units was through year-end 2009. Based on average usage assumptions, we calculated the future cash flows associated with usage of these units and recorded an impairment to reduce their carrying amount to this level.

Current quarter total operating expenses were $5.8 million, a 21% decline from the prior year period. 2009 total operating expenses were $24.4 million, down 17% from $29.5 million in the prior year period. This is the lowest level of operating expenses we have recorded for any full year as a public Company. Depreciation and amortization was $2.6 million in 2009.

Current quarter operating income was $858,000, a significant improvement from a loss of $2.9 million in the prior year period. 2009 operating income was $4 million, a $4.7 million improvement from a loss of $681,000 in 2008. 2009 operating income was the second best result in our Company's history.

Interest and other expense, net, which includes net interest expense and currency gains or losses was $113,000 in the current quarter, down $27,000 from $140,000 in the prior year period. Lower loan balances outstanding was the primary reason for the decline. This was somewhat offset by negative currency effects, and a higher interest rate spread with our bank, which we agreed to at year-end 2008.

2009 interest and other expense, net, was $306,000, a reduction of over 50% compared to $640,000 in 2008. The largest factor in the decline was lower loan balances and lower market interest rates, somewhat offset by the aforementioned increase in interest rate spread. We renegotiated covenants with our bank last November and based on our 2009 performance, we expect we will be borrowing at a rate of three month LIBOR plus 4% beginning on March 1. Based on current market rates, we estimate that this will lower our cost of borrowing by approximately 150 basis points.

Income tax expense was $285,000 in the current quarter, that's compared to a benefit of $1.2 million in the prior year period. 2009 income tax expense was $1.5 million, as compared to a benefit of $471,000 in 2008. In all cases, the vast majority of expense or benefit is non-cash. This is a result of our large net operating loss position in the United States, which shields us from most cash taxes. For 2009, we had $205,000 in current tax expense, which represents what we expect to actually pay in cash taxes and $1.3 million in deferred income tax expense, primarily related to non-cash net operating loss usage. Based on our 2009 weighted average outstanding shares, used to compute diluted net income per share, this represents about $0.03 per share of deferred income tax expense.

We generated net income of $460,000 in the current quarter, an improvement from a $1.9 million net loss in the prior year period. For full year 2009, we reported net income of $2.2 million, an improvement from an $850,000 loss in 2008.

In terms of our balance sheet, we closed the year with $5.4 million in cash, up from $4.7 million in cash at year-end 2008. More impressively, we had only $4.2 million outstanding on our line of credit, down $6.8 million from $11 million at year-end 2008, and term debt of only $381,000, a decline of $770,000 from $1.2 million at the end of last year.

This is the first time Heska has been in a quarter-end net cash position since June 2001. I believe Heska has never been in a stronger financial position in its history.

Before I turn to guidance, I'd like to comment on our investor relations efforts. We spent 2009 largely focused on our -- on enhancing our commercial efforts, in light of our restructuring and the challenging economic environment. We believe the results of these efforts are clear. Partially as a result of this focus, we also spent literally nothing on investor relations in 2009. Now that we have reported these strong results, we intend to get our story out more effectively.

Investors should expect a particularly strong push in this area beginning in early March through our shareholder meeting in May, to be followed by a continued effort in line with our historical efforts. On March 3 and 4, we will be presenting at LDV's Capital Management Growth & Value Investor Conference in Fort Lauderdale, Florida.. As we have done in the past, we also intend to host luncheons for investors and stockbrokers and take advantage of our presence at these events to meet with institutional investors in the area of th event. Investors should stay tuned for press releases on investor relations public events in the future.

For the first quarter of 2010, our guidance is for revenue of $18.5 million, including approximately $3 million in OVP revenue. Gross margin of around 40%, about $7.25 million in operating expenses, about $150,000 in operating income, about $60,000 in net interest and other expense, and about $50,000 in net income. For full-year 2010, our guidance is for a slight increase in total revenue as compared to 2009. Gross margin of around 41%, $26.5 million to $27 million in operating expenses, about $2.4 million in depreciation and amortization, operating income slightly better than in 2009, about $175,000 in net interest and other expense, approximately $1.5 million in tax expense and slightly over $2.4 million in net income. Based on current shares and options outstanding and Friday's closing share price, which I will refer to as current diluted shares, this translates into $0.05 per share in diluted earnings.

Going forward, due to investor interest, we intend to report current and deferred tax expense separately. It is important to remember that only current income tax expense represents taxes we expect to have to pay in cash for the period reported. Our guidance is for deferred income tax expense, which relates primarily to our net operating loss position of approximately $1.4 million in 2010. Based on current diluted shares, this is approximately $0.03 per share.

Based on investor interest, we are also going to give preliminary guidance for 2011, although with the caveat that our business is difficult to project, in particular, as we try to project further into the future as well as for periods such as 2011, where we have taken a top-down approach and not built a bottom-up budget, and that our guidance assumes a return to a strong economy in 2011, with corresponding increase in capital goods purchases, such as our instruments.

Given this, our preliminary guidance for 2011 is for between $85 million and $90 million in revenue, a slightly improved gross margin as compared to 2010, operating expenses between $28 million and $29 million, $2.2 million in depreciation and amortization, about $7 million in operating income, slight net interest income, and about $4.6 million in net income. Based on current diluted shares, this translates into approximately $0.09 per share in diluted earnings. Our guidance is for deferred income tax expense, which relates primarily to our net operating loss position of approximately $2.5 million in 2011. Based on current diluted shares, this is approximately $0.05 per share.

In conclusion, we have reported a strong fourth quarter and overall 2009 performance, especially given the overall economic environment. I believe we have placed Heska in its strongest financial position ever as we enter 2010.

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

Thanks, Jason.

While we acknowledge that persisting uncertainty associated with the overall external economic conditions, we remain enthusiastic for the business opportunities over the long-term. As a team, we worked hard and smart to produce good results in 2009, and as Jason has just described, we are optimistic about 2010 and 2011. We remain committed to efficient operation of our base business, future growth through new product introductions, and continual exploration of unique sales channel opportunities, all with the goal of creating value for our shareholders.

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

At this time, I'd like to turn it over to Vince for purpose of conducting our question-and-answer session.

Thank you, sir.

Ladies and gentlemen, we'll now begin the question-and-answer session. (Operator Instructions).

Our first question is from the line of John Nelson with state of Wisconsin Investment. Please go ahead.

Hi, guys. Very good job on the quarter, very impressive cost controls. So I want to thank you for that and your team.

Thanks, John.

You're welcome.

My question relates to the -- what's happening to your customer base. Does it seem to be growing? Staying the same? Shrinking a little bit? Anything significant going on there? And also, the composition of the customer base seem to be changing much as far as larger size operations versus smaller operations?

Sure.

I would say, well, first, I would note, John, that we'll be filing a K just a little bit later and in there we call out the number of hospitals, clinics, customers that we build into, and it's in the same order of magnitude as it has been in prior years. I would say the trends for us, and our market focus, has been for some larger hospitals that benefit from our higher throughput capacity, analyzers, particularly the ones that we just recently introduced, and that one that I described that we plan to introduce in the near future.

Overall, in a conference as recent as a week ago, we're hearing that in terms of veterinary hospitals, about one-third had year-over-year business up in 2009. A third had it flat and a third were down, so you're seeing some sort of partitioning there, and probably some favorings to multi-doctor practices, at least that would be the lens that we're seeing through today.

Okay.

And one other question. Can you comment a little bit on why you think your heartworm treatment and tests seem to be -- are doing well or are in demand, even if Schering decides to evacuate from that product?

Right.

Well, I think the business in that particular market has generally grown, it's several hundred million dollars, it's a robust market, the heartworm preventive market. Again, if they don't carry the product forward, it will probably be at least in part as a result of regulatory activities, as Jason I think thoroughly described. But yet there's so many other interested parties outside of ourselves, Jason said no fewer than six.

Yes.

Because of the size of the market and because of the opportunities. Again, the heartworm disease is extremely serious, can be fatal for animals, often is fatal and so it's often considered an essential rather than a luxury item. So we just see that market as continuing to be quite robust.

Okay. Thanks very much.

My pleasure. Thanks, John. Thanks for your support.

Thank you. (Operator Instructions).

Mr. Grieve, I'm showing no further questions at this time, sir.

Okay. Well, I want to thank you then all again for your interest in Heska and for taking the time to join us today.

Goodbye.

Ladies and gentlemen, if you would like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030, using the access code of 421-8183 followed by the #.

This does conclude the Heska Corporation fourth quarter and year-end 2009 earnings conference call. Thank you very much for your participation. You may now disconnect.