Heska Corp (HSKA) 2010 Q2 法說會逐字稿

Ladies and gentlemen, welcome to the Heska Corporation second-quarter 2010 earnings conference call on Tuesday, 20th of July, 2010. Throughout today's presentation, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. (Operator Instructions). I will now hand the conference over to Bob Grieve. Please go ahead, sir.

Thank you, Kirsten, 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 second quarter of 2010.

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 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 on 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.

If you examine the balance sheet we released this morning, you will note that our long-term debt has been paid completely in the second quarter. Given the magnitude of our historical long-term debt, we believe this is an important balance sheet milestone for us to have achieved, particularly in light of some of the short-term business challenges.

As we've been describing for some time and asked investors to participate, we've experienced difficult year-over-year comparisons in our core companion animal business due to the loss of revenue from the handheld analyzer franchise that we have built over many years. And [just] the consumable supplies for that business, revenue was down over $3 million in the second quarter year over year. This will continue to be a difficult comparison through 2010.

Despite the loss of that revenue, it is important to note that our core companion animal revenue, excluding that handheld analyzer product line, increased year over year, both in the second quarter and the year to date.

Last year, we announced that Heska has entered into a partnership with a well-established and respected company, Roche Diagnostics. The first result of this collaboration is in analyzing the blood gas and electrolyte categories. The VitalPath Blood Gas & Electrolyte Analyzer is our alternative offering to the discontinued handheld analyzer, and it advances how the industry previously viewed this product area.

Among other key advantages, the VitalPath provides rapid results in only 50 seconds for over 35 parameters, a color LCD touchscreen, simplified operation and minimal maintenance. We believe this analyzer will offer solid solutions, particularly for high-volume practices.

The first of these analyzers were installed mid quarter as part of a complete launch. As we gain traction with this product, you should think of this as a future offset to some of the revenue loss with the handheld analyzer.

It is entirely too early to comment on any commercial success, but we are very pleased to offer a product of this quality in the blood gas and electrolyte category.

We described in our last earnings call that we took a $1 million reserve in the first quarter for certain cattle vaccine products manufactured at our Des Moines facility. As part of our regular control processes, we became concerned that we were experiencing problems in our manufacturing of those products, and we voluntarily took action to stop the further manufacturing and sale of those products until we could determine exactly what was happening and how to remediate any potential problem.

First principal dictates that we cannot jeopardize the quality reputation of either Heska or our customers. While we have not yet resumed shipment of these products, we feel confident that we have addressed our technical and process concerns. The remaining tasks necessary for resuming shipments are focused in the area of regulatory dialogue.

Finally, since we're frequently asked about the effects of the overall economic environment in our business, we believe that there has definitely been a negative effect, particularly in the sales of analyzers. While we have had our share of sales successes with analyzers, it remains a difficult environment.

We had expected, as many people did, a more robust recovery this year. It certainly is not evident, and we are concerned we may be headed to a double-dip recession. When our sales representatives have to communicate a lost opportunity to management, rather than describing a competitor, they frequently describe losing to a non-decision or analyzers that have been paid for, however technically inferior they may be.

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. Our results this quarter exceeded the revenue and profitability guidance we gave on our last call.

In our Core Companion Animal Health segment, we generated second-quarter 2010 revenue of $13.7 million, a decline of $3.1 million as compared to $16.9 million in the prior-year period. The largest factor in the decline was a decrease in sales in instruments and consumables related to the handheld analyzer we previously sold. We anticipated this difficult comparison and discussed it on our last earnings call. Last May, the supplier of these products informed us they were canceling the underlying contract with us. As was their contractual right, the supplier repurchased the bulk of our related consumable inventory last November.

We expect difficult year-over-year comparisons for the next two quarters due to this situation. Although the third quarter of 2010 will present a more difficult comparison because we had a full quarter of nonexclusive consumable access in the third quarter of 2009 as opposed to a partial quarter in the fourth quarter of 2009.

Second-quarter 2010 revenue in our Other Vaccines, Pharmaceuticals and Products segment, or OVP, was $1.4 million, a decline of $374,000 as compared to the prior-year period. The key component of the decline was lower revenue from cattle vaccine sales, due primarily to the regulatory issues Bob has outlined.

The guidance we will give later on the call assumes we will obtain the necessary approvals to produce and ship these products this quarter, as we have a high degree of confidence in our technical experts in this area. Investors should understand, however, that this remains a fluid situation with no guarantee we will obtain these approvals this quarter or in the future.

While we do not believe any change in our reserve for this situation is merited at this time, based on potential regulatory outcomes, we believe an additional future reserve on the order of $0.5 million could be necessary on one side of the spectrum, and that the ultimate reversal of the bulk of the reserve we already have could occur on the other end of the spectrum.

The year-over-year decline in cattle sales was somewhat offset by increased sales of small mammal products.

Total revenue in the second quarter of 2010 was $15.1 million, a decline of approximately $3.5 million as compared to $18.6 million in the prior-year period.

For the six months ended June 30, 2010, total revenue was $32.8 million, a decline of $6 million from $38.8 million in the prior-year period.

Revenue, excluding our former health handheld instruments and related consumables, increased on a year-over-year basis, as did revenue from domestic sales of our heartworm preventative to Schering-Plough Animal Health Corporation, or SPAH, a unit of Merck. As we discussed on our last earnings call, SPAH has canceled near-term purchase orders, and we expect minimal shipments in this product area in the third quarter of 2010.

The guidance I will give later on the call assumes SPAH buys to its latest forecast to us. As we discussed on our last earnings call, and in our latest 10-Q filed with the Securities and Exchange Commission, this is a fluid situation, as SPAH is currently involved in a publicly announced merger.

Gross margin, that is gross profit divided by total revenue, was 38.7% in the second quarter of 2010, AN increase of approximately 1 percentage point as compared to 37.7% in the prior-year period. Increased gross margin on the domestic sale of our instrument consumables, which we no longer sell through independent third-party distributors, was a factor in the increase.

This was somewhat offset by lower gross margin and our OVP segment, primarily due to increased idle plant expanse related to the cattle vaccine situation we have discussed.

In the second quarter of 2010, selling and marketing expenses were up slightly to $3.7 million, about a 1% increase compared to the prior-year period. Spending related to the full launch of our new blood gas analyzer in 2010 was a factor in the increase.

Research and development expenses were $388,000 in the second quarter of 2010, a decline of about 4% compared to $405,000 in the prior-year period. Lower spending on research and development resources was a factor in the decline.

In the second quarter of 2010, general and administrative expenses were $2 million, up about 1% compared to the prior-year period. Greater spending related to legal matters was a factor in the increase.

Total operating expenses in the second quarter of 2010 were $6.1 million, an increase of about 1% compared to the prior-year period. We had an operating loss of $207,000 in the second quarter of 2010 compared to our guidance for an operating loss of $750,000.

In the prior-year period, we generated just over $1 million in operating income.

For the six months ended June 30, 2010, we had an operating loss of $695,000 as compared to operating income of just over $2 million in the prior-year period.

Depreciation and amortization for the six months ended June 30, 2010 was $1.2 million, down slightly from $1.3 million in the prior-year period.

Net interest and other expense can be broken in two components, net interest expense and foreign currency gains or losses. Net interest expense in the second quarter of 2010 was $55,000, down as compared to $103,000 in the prior-year period. Lower balances and a negotiated decrease in our borrowing rate were factors in the decline.

However, we had a foreign currency loss of $67,000 in the second quarter of 2010 as compared to a gain of $61,000 in the prior-year period, which is the reason for the year-over-year increase in this line item.

We recognized a tax benefit of $164,000 in the second quarter of 2010 due to the loss before income taxes we reported for the period. This compares to a tax expense of $390,000 in the prior-year period. It is important to remember that this line item is primarily non-cash in both cases due to our large domestic net operating loss position.

Our net loss for the second quarter of 2010 was $165,000 as compared to our guidance for a loss of $350,000. This compares to net income of $579,000 in the prior-year period. For the six months ended June 30, 2010, we had a net loss of $495,000. This compares to net income of just over $1 million in the prior-year period.

Before I turn to guidance, I would like to comment on our status with NASDAQ. One of the NASDAQ Capital Market's listing criteria is a minimum stock bid price of $1 or more, a criteria we do not currently meet, although we believe we meet all other NASDAQ criteria for listing.

NASDAQ has indicated that if we are not in full compliance by July 28, they will provide written notification that our stock is to be delisted, which we may then appeal. NASDAQ has also informed us that if we appeal, we will be asked to submit a plan of compliance and that historically, and near-term reverse stock split has been viewed as the only plan acceptable to resolve a bid price deficiency.

At a meeting of our board's audit committee yesterday, a majority of our Board of Directors indicated they would support such a plan. Under Delaware law, we are required to obtain the affirmative vote of a majority of our stockholders to implement a reverse stock split. Subject to NASDAQ and formal board approval, we anticipate such a shareholder vote within the next six months.

In terms of guidance, it is important for investors to remember that ours is a difficult business to project, especially in these challenging economic times.

Our guidance for the third quarter of 2010 is for approximately $17.5 million in revenue, including approximately $15 million in Core Companion Animal Health revenue and $2.5 million in OVP revenue. We're guiding for gross margin of around 38%, operating expenses of around $6 million, operating income of around $650,000, $50,000 in interest and other expense, and approximately $300,000 in net income.

Our guidance for full year 2010 is for revenue of between $65 million and $70 million, including approximately $9 million in OVP revenue; gross margin of around 37%; operating expenses of around $24.5 million; operating income of approximately $600,000; interest and other expense of around $400,000; and net income of around $100,000.

Of course, we hope to exceed this guidance, just as we did with the results we have reported today.

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

Thank you, Jason. While we continue to acknowledge the uncertainty associated with the overall external economic conditions, we remain enthusiastic for the business opportunities over the long term. As Jason has just described, we're resolved to produce the best possible results in 2010 despite the challenges we've just described. And we are particularly looking forward to returning to solid growth in 2011.

We remain committed to the 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, Kirsten, we'd like to turn this over for purposes of conducting our question-and-answer session.

(Operator Instructions). Jonathan Block, SunTrust.

Thanks and good morning, guys. Maybe the first question for you; if you can just speak broadly to what you saw maybe throughout the June quarter. And the reason why I ask is, there seemed to be some chatter in March and April that things were picking up. I think you expressed an optimism was growing maybe earlier in the year. Did things deteriorate throughout the quarter that gives you a little bit more hesitancy that things are improving or then you actually do have the word double-dip?

Yes, that's right. I don't know if double-dip is the technically correct way to address this thing. And again, it's just -- the [coin] is that one hears, I would say that our optimism for the year, has diminished over the course of the second quarter, the June quarter, as you call it.

As I described earlier, it's just an extremely difficult environment -- capital equipment sales particularly. People are reluctant to make any commitments. And as I said most frequently, you hear from sales rep that there's a lot of opportunity in the funnel or the pipeline. They're saying it's basically wait and see, come back later, or they're competing with something that, as I said, may be technically inferior, but it's been bought and paid for. So, it's a very reluctant, probably almost stagnant environment, it feels like at times it. It takes a heck of a lot of work to do what we've done.

Okay, great. And then maybe to shift gears a little bit, you mentioned the new blood gas analyzer I think in conjunction with Roche. And how do you plan to price that? How does it compare to the i-STAT? Obviously the i-STAT is a handheld. And then maybe you can just walk through the main benefits of your new blood gas versus the former i-STAT?

Certainly. I would just -- I'm not going to discuss pricing here now. It wouldn't be our practice, Jonathan. But I would say that it addresses an overlapping but different market to some extent. The i-STAT handheld, as you point out, is different than a bench-based analyzer. We believe ours has a lot of advantages, particularly for high-volume practice; advantages that I mentioned earlier in the call, in terms of speed; a lot of flexibility, user interface, compatibility and comfort; very simplified operation; very simplified maintenance. And on a per-unit basis, and [it's like] only in practices does it cost less in these hardly ideal former i-STAT product of those cartridges.

I'd also say that, again, maintenance is minimal. You aren't burdened with the biannual software updates into a large installed base, which is quite a quagmire. And you are also not dealing with the short-dated cartridge problem, both at our level and at the level of the customer. So, great advantages from that standpoint; avoid a lot of the frustration in customer service that we had to manage previously.

Perfect. And then, last one for you, you mentioned the practices pulling back a bit on capital equipment purchases. Do you think that's moving in tandem with overall vet visits and volume into the hospitals? In other words, what are your guys hearing? Is it possible that volumes are actually hanging in there and just the practices themselves have reigned back on spending? Or do you think one is a function of the other? Again, practices pulling back on spending because vet visits continue to deteriorate?

I think that, again, we've said on our other earnings call, this is very hard to generalize because different parts of the country are experiencing different regional economies, I'm sure. But in general, we believe that vets are pulling back out of conservatism. We believe that visits are probably down as well. And I -- at the risk of sounding glib, I suppose, we, as a benefit of reading your report yesterday, I would say our views would be consistent with yours on vet visits.

Perfect. Thanks very much, guys.

John Nelson, Wisconsin Investment Board.

I wanted to just give you kind of a chance to lay out a little bit more information on your long-term game plan. How do you see the industry evolving over the next three to five years? And what changes do you think you have to make if any at your Company to be a successful long-term competitor?

Right. Well, I think that -- that's a discussion that could take a couple of hours, John. But I will try and be brief. And if I've missed something, I'll ask Jason to jump in. But based on all the independent third-party research I've seen for animal health overall, over the next five years, you are looking at growth in the Core Companion Animal area, in the area of 2.5% to 3% compounded annual growth.

It's not nearly as robust as it has been in prior years. I think people are beginning to bake in these recessionary effects. I think there has been a great deal of consolidation in our industry. When again, you contemplate the largest player now as a result of the Intervet/Schering-Plough Merial merger.

Pre-regulatory action is about a $5.4 billion industry. They're a company. And Heska still sits in the top 15. That gives you a sense of how much consolidation has occurred in the industry.

I think go forward, we might see just a bit more of that, surprisingly. I think we've described in the past and those in the industry have described consolidation of the independent distributors and wholesalers as well. So the big are getting bigger. For us to compete on a continuous basis, we have to continue to operate as efficiently as we can, offer great, high-quality products and find ways to grow.

And I would say also, despite the size of some of these entities, the $5 billion to $3 billion in the case of Pfizer plus -- despite these size, these people are not presently in our space. So we are competing with those folks. In fact, the whole diagnostics area is a white space in their strategy. And it remains to be seen how Heska plays into those scenarios.

Okay. And changes, as far as -- do you have to -- do you think Heska needs to make any significant changes over that period of time other than the possibly participating in some type of consolidation, do you foresee increasing -- having to increase significantly, for example, either the R&D budget or the sales and marketing budget over that period of time in order to successfully compete?

I think that, again, I go back to -- I talk on the earnings call about our most recent partnership with Roche Diagnostics. We have a great partnership with them, with FUJIFILM, and with Boule Medical. And with all of these people we talk about pipeline, and you'll recall this is core to our strategy to partner -- to work with people that are in the human device business, modified product and enjoy that -- staying on the leading edge of technology as a result.

And that as a result of those collaborations, your P&L shows a generally lower gross margin percentage on revenue, but we have an offsetting lower R&D spend as well. Of course, we would expect to grow R&D into the future. We would like to see it growing up into the mid-to high single digits as a percentage of revenue over time. We think that will be an even greater growth opportunity. But again, just the same, there is great to come.

As far as sales and marketing expansion, that's going to be something that's very much on our mind, and it's very much right now pay-as-you-go mentality. We have to have the opportunity to create new territories; going to do that by generating more operating income and more profit. And that's again, we will see expansion in that commercial area as well. So those will be the principal changes, John.

Okay. Well, thank you very much.

Thanks, as always, John.

(Operator Instructions). Thank you, sir. We have no further questions at this time. Please continue with any further points you wish to raise.

Okay, Kirsten. Again, I'd just thank you again, all of you, for your interest in Heska, and for taking the time to join us today. Good bye.

Ladies and gentlemen, that concludes today's Heska Corporation second-quarter 2010 earnings conference call. Thank you for participating. You may now disconnect.