Heska Corp (HSKA) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Heska Corporation third-quarter 2010 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions.

(Operator Instructions)

This conference is being recorded today, Monday, November 15, 2010. I would now like to turn the conference over to Bob Grieve. Please go ahead.

Thank you, Marisa, and thank you all for joining us today on our conference call. I'm joined by Jason Napolitano, our Chief Financial Officer. We appreciate having the opportunity to review the results for the third quarter of 2010.

Prior to discussing our results I'd 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 pleased to have reported our first profitable quarter in 2010. Consolidated revenue was stronger than we'd expected, and we carefully managed operating expenses. Relative to our line of credit borrowings, you can note in our balance sheet, that we were net cash positive at the end of the quarter. Revenue in our Other Vaccines, Pharmaceuticals and Products segment, or OVP, was particularly robust in the third quarter.

The USDA validated our improved manufacturing process and we were able to produce and ship much of the backlog on those current orders. We expect to be caught up by the end of this current fourth quarter. This has been a long process and we are certainly pleased with its outcome. As we've been describing over the course of the last year or so, we've experienced difficult year-over-year comparisons in our Core Companion Animal business due the loss of revenue from the old handheld analyzer franchise that we built over many years. And just the consumable supplies for that business, revenue was down nearly $2.5 million in the third quarter year-over-year. Despite concerns expressed about our viability following a loss of this product we find ourselves for the majority of this year-over-year comparison in describing a profitable quarter. While there was minimal revenue from this product line in last year's fourth quarter, we are essentially past this confusion.

The VitalPath blood gas electrolyte analyzer offers veterinarians many of the same test menu alternatives as the old handheld line. Among the 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 offers solid solutions, particularly for high volume practices.

For a variety of reasons, however, we are not seeing the rate of uptake in this product that we had hoped. It is a product is unique in this category and we're gaining insights on how to better position its attributes in veterinary practice. As we optimize these strategies and hopefully see the return of a more robust capital equipment market overall, we anticipate more success.

We are frequently asked about the effects of the overall economic environment on our business. We are a relatively small business, so investors should be careful about drawing conclusions on the overall economy from our experience. That being said, we believe that there has definitely been a negative effect on our business due to the weak economy this year, particularly in the sales of analyzers earlier in the year. I will also say, we saw some encouraging signs in different parts of the country related to analyzer placements late in the quarter that we are reporting today.

As I noted at our last earnings call, that there was concern over the potential for the so called double dip recession. Today, the consensus seems to be that the likelihood of such a double dip recession is being discounted. Rather, we hear most often, of a prolonged and slow recovery. As I've said before, we tend to watch the unemployment rate as a proxy for anticipated discretionary spending at the veterinary practice. It would be safe to say that our primary customer, the veterinarian, is also watching these trends as well as the political uncertainty about their near future tax rates. Given all the appropriate concern about the economy on the part of our investors, is our intention to be as forthcoming as possible about how this economic environment appears to us. However, we do not intend to use this as an excuse for suboptimal performance.

Accordingly, we are making a change in our sales leadership with the intent of enhancing our performance. A difficult decision was made very recently to terminate the employment of our long-standing Vice President of Sales. He worked very hard and made many important contributions over many years, including in this difficult macroeconomic environment. We are well into the process of recruiting a new leader with different experience, new perspectives, and ideas. 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 finished the third quarter of 2010 strong, with $17.6 million of total revenue. This is down from $19.6 million in total revenue in the third quarter of 2009. For the nine months ended September 30, 2010, our total revenue was $50.4 million, down from $58.3 million in the prior year period.

Our Core Companion Animal Health segment generated $14.1 million of revenue in the third quarter of 2010, down 16% compared to the third quarter of 2009. The largest factor in the decline was lower sales of consumables for our previous handheld blood analysis instrument line in the third quarter of 2010, which represented a decline of over $2.4 million. If we include other revenue, such as hardware sales, the year-over-year decline from this product area is over $2.7 million.

In May 2009, our supplier of this product line, and affiliated consumables, cancelled our underlying contract. The contract only contained a six month, nonexclusive supply of consumables for the installed base of instruments we had built, a considerably shorter period than the periods in our remaining major diagnostic instrument contracts. As provided for in the contract, our supplier of handheld diagnostic instrument consumables chose to purchase the bulk of our related consumable inventory on November 1, 2009. As a result, while we still face a difficult year-over-year comparison in our upcoming quarter due to this situation, it will not be as severe as the past few quarters, because the bulk of our sales were generated in the first month of the fourth quarter of 2009.

Another factor in the decline were lower sales of domestic canine heartworm preventive. Schering-Plough Animal Health Corporation, or SPAH, a unit of Merck, has an exclusive contract to sell and market this product in the United States. As we discussed in more detail in our latest 10-Q, SPAH is currently involved in a publicly announced merger. We have made attempts to contact Merck animal health management to discuss the situation, but unfortunately, have been told very little about Merck's future plans or their view of the underlying contract.

We've been told, as of the last discussion, that sales of our heartworm preventive product are growing. As we discussed on our last earnings call, we received a very high growth forecast for domestic sales of this product earlier this year, which was apparently too aggressive as SPAH placed purchase orders below its original forecast, including two months with no orders in the second half of the year. While sales in this area were down in the third quarter of 2010, as compared to 2009, and we expect fourth-quarter 2010 sales to be lower than fourth quarter 2009 sales, we still anticipate growth for domestic sales of this product in 2010 as a whole, compared to full year 2009. The latest forecast we have received from SPAH shows growth for 2011, as compared to 2010.

Declines in third-quarter revenue related to our previous line of handheld instruments and domestic sales of our heartworm preventive were somewhat offset by greater domestic revenue from our chemistry instruments and consumables, where we had a strong performance near the end of the quarter. Third-quarter 2010 revenue in our Other Vaccines, Pharmaceuticals and Products segment, or OVP, were $3.5 million, a 31% increase, as compared to the third quarter of 2009. The largest factor in the increase was greater sales of cattle vaccines under our contract with AgriLabs. Greater sales of bulk bovine biologicals was also a factor in the increase.

As Bob mentioned, the USDA validated an improved manufacturing process for the line of cattle vaccines we sell under contract to AgriLabs and we began shipping product in this area, again, in the third quarter of 2010. The status of cattle vaccines produced prior to the USDA validation of our improved manufacturing process which we previously estimated, ultimately to be salable but which have not yet received USDA approval remain uncertain. We recognized a $1 million reserve in the first quarter of 2010, based on our estimate of product which would need to be destroyed and replaced. This reserve may require a positive or negative adjustment, based on the level of related product USDA ultimately approves for sale, if any. This product does have limited dating, however, and we are approaching the point where a discount would be required to sell short-dated product, even if approved. Such a discount would likely increase the cost to us beyond our current reserve. We hope to have a final resolution of this situation prior to year-end.

Gross margin, that is gross profit divided by total revenue, was 37.4% in the third quarter of 2010, down from 38% in the third quarter of 2009. Greater revenue and lower gross margin in our OVP segment was a factor in the decline. Selling and marketing expenses were $3.9 million in the third quarter of 2010, a 6% increase from the prior year period. Increased commissions and costs related to the full launch of our new blood gas analyzer in 2010 were factors in the increase.

Third-quarter 2010 research and development expenses were $455,000, down a bit from $457,000 in the third quarter of 2009. Spending on research and development resources declined year-over-year in this area. General and administrative expenses were $1.9 million in the three months ended September 30, 2010, a 12% decline from the prior year period. A lower accrual related to our management incentive plan in the 2010 period was a factor in the decline. We do not expect to make payments under a 2010 management incentive plan, and thus, have no related accrual on September 30, 2010.

Total operating expenses were $6.2 million in the third quarter of 2010, down 1% from the prior year period. We generated operating income of $365,000 in the third quarter of 2010, as opposed to $1.2 million in the third quarter of 2009. For the nine months ended September 30, 2010, we experienced an operating loss of $330,000, as compared to operating income of $3.2 million in the prior year period. Depreciation and amortization was $1.7 million in the nine months ended September 30, 2010, as compared to $2 million in the prior year period.

We had net interest expense of $28,000 in the third quarter of 2010, which was more than offset by $146,000 gain due to foreign currency. In the third quarter of 2009, net interest expense of $64,000 was more than offset by a $77,000 foreign currency gain. Lower loan balances and a negotiated decrease in our borrowing rate were factors in the decline in net interest expense from the 2009 period to the 2010 period. Income tax expense, or benefit, in the case of the nine months ended September 30, 2010, is primarily a non-cash item due to our large domestic net operating loss position.

We generated net income of $241,000 in the third quarter of 2010, down from $743,000 in the prior year period. We had a net loss of $254,000 for the nine months ended September 30, 2010, as compared to net income of $1.8 million in the prior year period. We continue to be pleased with our balance sheet position. You will note, we once again, are in a net cash position with our cash exceeding total debt outstanding. This is a situation we have not been in for some time prior to 2010, and we are pleased with the financial progress we have made.

On Friday, we filed a preliminary proxy statement for a 1 for 10 reverse stock split. We are pursuing this so that we may maintain our listing on the NASDAQ capital market. We discussed NASDAQ compliance requirements in greater detail in our latest 10-Q. One of NASDAQ's requirements to maintain listing, is a minimum bid price of $1. We have not been in compliance with this criteria for some time. On July 29, 2010, we received a communication from NASDAQ that we were not in compliance with the minimum bid price requirement, that we had used all available time to regain compliance and that we would be delisted from NASDAQ unless we appealed this determination. We appealed and a hearing was held on September 16, 2010. Based on our commitment to pursue this reverse stock split, the hearing panel allowed us to remain listed. We may remain listed provided that on or before January 25, 2011, the closing bid price of our shares are at or above $1, for a minimum of 10 consecutive trading days.

The mechanics of a 1 for 10 reverse stock split are simple. One share will be issued for every 10 shares an investor currently holds. This will reduce the number of shares outstanding by a factor of 10 or from about 52 million shares currently outstanding, to about 5.2 million shares immediately following the reverse split. If we have reduced shares outstanding by a factor of 10 one would theoretically expect the price for each new share to be about 10 times the price of an old share. As well, a number well in excess of NASDAQ's minimum bid price based on our latest trading levels.

The new shares are to have identical rights and responsibilities to current shares and each holder should continue to own basically the same percentage of the Company pre- and post-reverse split as all shareholders are having their shares reduced by a proportional amount. The process should be transparent for those who hold electronic shares. We will not issue fractional shares, so holders who hold shares other than in multiples of ten will receive a small cash payment for any partial shares they may be entitled to.

Under Delaware law the reverse stock split will require the affirmative vote of an absolute majority of shares outstanding. We have a special meeting planned for December 29, to vote on this proposal. As an absolute majority is a fairly high standard, if many of our investors do not return their proxy cards or vote in person we have placed a second item on the agenda for the special meeting, which will allow us to adjourn the special meeting and solicit more votes if we are short of an absolute majority. We have until January 25, to regain compliance, so we could obtain the necessary shareholder vote in early January and still maintain our listing if the situation required it. Of course, we intend to obtain the necessary vote and complete the reverse stock split prior to year-end, and the second proposal is a back stop we hope we never have to implement.

We chose a 1 for 10 ratio due in part to technical trading levels, we have heard various investors, including large investors indicate are important, specifically, $1, $2, $3, $5 and $10 per share. Our recent trading levels would put us close to four of five of these benchmarks. And we are hopeful we can obtain the $10 per share benchmark, equivalent of $1 per share today, in the near future. A 1 for 10 reverse split also keeps the math relatively straightforward. Our three largest shareholders have indicated support for this idea in preliminary discussions we have had with them. Of course, these discussions are not binding and all shareholders are free to vote as they choose.

Before we discuss guidance, I think it is appropriate to say that our recent guidance experience demonstrates how difficult our business is to project, in particular, in this difficult economic environment. Investors should keep this in mind when contemplating our guidance. In addition, the guidance we are about to give excludes any additional reserve or reversal of reserve related to the OVP vaccine situation we have discussed and any potential costs in the quarter of hiring a new sales leader, as Bob has mentioned.

Our guidance for the fourth quarter of 2010 is for revenue of about $15 million, including about $2.5 million in OVP revenue, gross margin of about 40%, operating expenses a little under $6 million, and a slight operating profit. We have currency gains through the end of October that should net our interest expense and income to about zero assuming currency gains and losses through year end cancel each other out.

Our guidance is for a slight profit, say, net income of about $5,000 for the fourth quarter of 2010. If you add this guidance to our nine month results, you obtain 2010 guidance of about $65 million in revenue, gross margin comparable to 2009 gross margin, operating expenses of a little under $25 million, an operating loss a bit above $300,000, net interest and other expense equal to the amount through September 30, and a net loss of about $250,000.

As far as 2011 goes, we believe it will be a better year than 2010 and profitable. We will have no further comment on guidance for 2011 or beyond, until we complete our budget process later this year. In summary, we are pleased to report this profitable quarter. I look forward to continuing to improve our business results. With that, I'll turn it back over to you, Bob.

Thank you, Jason. As we've just reviewed, we are pleased to have produced this profitable third quarter. The production and shipments of our bovine vaccines in Des Moines has resumed. A year-over-year comparison with the old handheld analyzer franchise is nearly behind us.

Our concerns about ongoing NASDAQ listing are being addressed with the reverse stock split proposal, and we are now particularly looking forward to returning to growth in our business and a better year in 2011. We remain committed to optimal operation of our base business, future growth through new product introductions and continual exploration of unique sales channel opportunities. 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.

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions)

And our first question comes from the line of Jonathan Block, please go ahead.

Thanks and good morning, guys.

Good morning, Jonathan.

Good morning.

Maybe just a handful of small questions. The first one, just on the reverse stock split of the 1 for 10. I believe you mentioned a vote was scheduled to take place before year-end. Just wanted to get that confirmed. And then, if the vote's in the affirmative, if you would, when would we actually see that take hold and know that we're sort of in the clear from a compliance standpoint regarding NASDAQ?

The answer is, yes, we expect it to happen before year-end. I expect within a day or two of the vote, we'll file with the Delaware Secretary of State and you'll see the reverse stock split impact, i.e., a stock price about 10 times higher than it is currently. The shares will trade for 20 days, Jonathan, under the symbol HSKAD, so that everybody knows there's been an impact of a reverse stock split and we will file within four business days of a final vote with an 8-K. I expect, probably that day, assuming everything goes smoothly, so that will be December 29. You'll see the 8-K hit and you'll know that the vote's in the affirmative and we're going to implement the reverse split, Jonathan.

Great. And then just trying to look at the core underlying part of the business, you mentioned on the Core Companion Animal Health, I believe the Heska stub -- excuse me, the i-STAT stub was down about $2.7 million year-over-year, so if I strip that our it looks like your core companion was essentially flat year-over-year and that's more in line with what we're hearing from the industry, as of September. So, do you think that's the right way to look at that, if you strip that out you guys were essentially flat year-over-year?

I think that's a very reasonable way to look at it. Jason also addressed in his comments the lumpiness in this TRI-HEART revenue. If you just pull that out, you're probably looking at underlying organic growth in the order of 4% to 5%. Let's call it 4% to be safe.

Okay. Great. And maybe last one, Bob. You mentioned toward the end of the quarter, you saw maybe a bit of a better buying environment. I just wanted to push you. Was that specific to just the capital equipment side of the business, or did you see maybe underlying volumes in terms of patient visits starting to improve? And then the last one would be, did that continue into, with what you can say, here in the early parts of the fourth quarter? Thanks, guys.

I would say mostly what we're addressing there, Jonathan, is capital equipment sales. I would also say, with all due caution, that we've seen periods during this -- well, economic downturn, if you will, where we felt we were seeing the -- seeing improvements only to see it slow down again. So, we're still a little bit on the edge of our chair with respect to the economy and some of those comments we offered earlier. So yes, I think we saw it with -- what we're particularly addressing is -- are the installed base there and it's probably still too early in the current quarter to say much, and I wouldn't be able to comment on veterinary visits at this time.

Okay. Great. Thanks for your time, guys.

Thank you for the good questions.

Thanks, Jonathan.

Thank you.

(Operator Instructions)

One moment, please. And I'm not showing any further questions at this time.

Okay. If there are no further questions, I'd like to repeat thanks, thank you all for your interest in Heska and for taking the time to join us today. Good bye.

Thank you. Ladies and gentlemen, that does conclude our conference call for today. If you would like to listen to the replay of today's conference, you may do so by dialing 303-590-3030, or 1-800-406-7325, using the access code, 4371990. Thanks for your participation. You may now disconnect.