Heska Corp (HSKA) 2010 Q4 法說會逐字稿

Welcome to the Heska Corporation Fourth Quarter and Year End 2010 Earnings Conference Call on March 9, 2011. (Operator Instructions) I will now hand the conference over to Bob Grieve.

Thank you, Holly, 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 from the fourth quarter and full year 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 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 to have reported a profitable fourth quarter and full year 2010. Consolidated revenue was stronger than we had expected, and we carefully managed operating expenses. In the quarter, it was good to see an uptick in gross margin percentage, achieving nearly 41%. On a full year basis, we experienced a tough first half of the year, particularly with a stop sale of some of our cattle vaccine products in the OVP business. However, as that problem was ultimately resolved, we moved to profitability for the second half of the year.

Relative to our line of credit borrowings, you can note on our balance sheet that we remain net cash positive at the end of the quarter. From an annual perspective, all term debt was paid off in June. To fully appreciate our enthusiasm in achieving this milestone, we remember a time when the Company was losing money and term debt was just over $17 million. Our balance sheet has not been this strong for sometime.

Fourth quarter revenue and our other vaccines, pharmaceuticals, and products segment, or OVP, was relatively strong. We caught up on purchase orders for cattle vaccines, giving credit against new purchase orders to customers, who are holding inventory, pending regulatory approval. We had hoped for the regulatory release of certain inventory we had been holding at our facility and in the field. Repeated delays in getting answers on a product with a finite shelf life, however, dictated that we abandoned much of that inventory. The good news is that this issue and its associated costs are behind us and we are in full production of these vaccines.

As we have discussed for more than a year, we've experienced confusing year-over-year comparisons in our core companion animal business, due to loss of revenue from the old hand-held analyzer franchise that we had built over many years. On a full year basis, revenue was down in 2010 over $10 million, just due to loss of the instrument in consumable part of that franchise. Reflective in the fourth quarter, the year-over-year comparison and the associated confusion are now behind us. Having weathered this transition, we are extremely pleased, not to have the ongoing technical support issues with a dated product line or the short dating problems associated with the consumable part of that business.

Earlier this month, we announced the launch of a new lactate analyzer, a product manufactured by one of our partners, Roche Diagnostics. Lactate is a blood chemistry testing parameter primarily used for critical care, for example, shock and trauma cases, as well as performance animal monitoring, where we're looking at lactic acid balance and performance horses or performance dogs, for that matter. This is a hand-held portable analyzer ideal for both in-clinic and field use. The rapid lactate assay solution will be a great compliment to our VitalPath and dry chem analyzers, providing the potential for complete blood chemistry analysis. Among its many features, the analyzer employs single-use strips that are stored at room temperature. Results are provided in 60 seconds with only one to two drops of blood required. While we do not expect this product to be a large source of revenue in its own right, it fills a very important gap in our chemistry product range. Its primary importance is to help drive the placement of both the VitalPath and dry chem analyzers.

In addition to expanding our install base of current analyzers and working to gain more market share, wherever possible, all to generate top line growth, we remain committed to growth through new products. Beyond this new lactate analyzers, investors should know we plan to launch at least one more new product this year. In fact, we are working on a number of new alliances and other opportunities to bring new products to the market. As we can talk with certainty about new product opportunities, we will keep you informed. In the meantime, be assured that we are focused on growth.

At our third quarter earnings call, I described the need to make a change in our sales leadership and that we had initiated a process to identify a new leader. This is a very critical role and accordingly, we have set high standards. We are quite far along in that process and hope to have someone named in the coming weeks. 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 are pleased to report a profitable performance for both fourth quarter and full year 2010. We were also successful in implementing a one for 10 reverse stock split effective December 30, 2010. We are pleased our stock has consistently traded higher since. All share-related numbers in today's earnings release have been adjusted to reflect the reverse split.

Fourth quarter 2010 revenue was $15 million, a decline of $2.3 million compared to the prior year period. Full year 2010 revenue was $65.5 million, a decline of $10.2 million compared to 2009. In our Core Companion Animal Health segment, we generated $12 million in revenue in the fourth quarter of 2010, a decline of $2.6 million compared to the prior year period. More than half of this decline was related to the loss of a line of hand-held products and affiliated cartridges from Abbott Point of Care, which I will refer to as the I-Stat line. We had sales of these products in the fourth quarter of 2009 and none in the fourth quarter of 2010. Other areas that contributed to the decline were domestic sales of our canine heartworm preventive, international sales of our heartworm diagnostic tests and revenue from sales of our dry chem 7000 chemistry instrument. Revenue in our Core Companion Animal Health segment, excluding the I-Stat line and these three product areas, increased in the fourth quarter of 2010 as compared to the fourth quarter of 2009.

Schering-Plough Animal Health Corporation, or SPA, a unit of Merck, has an exclusive contract to sell and market our canine heartworm preventive in the United States. As we discuss in more detail in our latest Q and expect to in our upcoming 10-K, SPA is currently involved in a publicly announced merger. We have had only preliminary discussions with Merck personnel regarding our contract, the change in their position resulting from the merger and the potential that they may request an assignment of our contract with them to a third party in order to complete the merger. In the past, SPA personnel have been aware of our public disclosure obligation and have been correspondingly cautious about sharing information with us they do not want in the public domain. As we have publicly disclosed in the past, we received a very high growth forecast for domestic sales of this product in 2010, which was apparently too aggressive, as SPA placed purchase orders below its original forecast, including several months with no orders later in the year. Sales of this product in the fourth quarter of 2010 were down as compared to the fourth quarter of 2009. For the full year, sales of this product were down only slightly. The latest forecast we have received from SPA shows significant growth for 2011 as compared to 2010. It is difficult to know if SPA is seeing underlying growth from past investments, if they are trying to make the product attractive for an assignee, or if there is some other reason for the increase in forecast. We have no contractual right to review inventory levels at SPA or SPA's distributors, so we have little insight into current market activity. We've assumed this forecast will come to fruition in the guidance we will give later on the call.

The period over period decline in international sales of our heartworm diagnostic products primarily relates to sales to Japan, where a unit of Novartis, which I refer to as Novartis Japan, has exclusive marketing rights. Novartis Japan tends to give us orders which do not consistently occur at the same magnitude in the same month year-over-year. This can introduce a certain lumpiness into our financial results, when reviewing quarter over quarter results, and in this case, year-over-year results. We did not have a large shipment of our heartworm diagnostic tests in Novartis Japan in December 2010, as we did in December 2009. If you were to look at total sales in this area for the five months ended February 2011, as compared to the five months ended February 2010, sales are actually up. So we don't believe there is any indication of a demand problem for this product from Novartis Japan going forward.

The first shipments of our dry chem 7000 chemistry analyzer occurred in the fourth quarter of 2009, although we had been taking orders for the product earlier in the year. This product area thus presented a difficult year-over-year comparison in the fourth quarter of 2010 as compared to the fourth quarter of 2009. 2010 revenue in our Core Companion Animal Health segment was $55.7 million, down $10.8 million from $66.4 million in 2009. The largest factor in the decline was the loss of the I-Stat line. Another factor in the decline was lower revenue from international sales of our heartworm diagnostic tests, which we have already discussed. A third factor in the decline was lower sales of our IV pumps. We gave notice of contract termination to most domestic distributors who carried our full product line in January 2010. As IV pumps were a product with which we have had historical success selling through distribution, it is not surprising sales in this low margin product area would suffer after canceling a large portion of our distribution contract. Excluding the I-Stat line and international sales of our heartworm diagnostic tests, Core Companion Animal Health revenue increased in 2010 as compared to 2009.

OVP revenue in the fourth quarter of 2010 was $3 million, an increase of 7% compared to $2.8 million in the prior year period. Full year 2010 OVP revenue was $9.8 million, up 6% compared to $9.2 million in 2009. Key factors in both cases were greater sales of bulk bovine biologicals and international sales of cattle vaccines to a new customer. These were somewhat offset by lower revenue recognized under our contractual relationship with Agri Labs. Many of the cattle vaccines Agri Labs purchases from us were affected by the regulatory situation Bob discussed. As Bob mentioned was our process, Agri Labs was holding inventory, pending regulatory approval, and we gave them full credit against inventory to be returned when fulfilling existing purchase orders. Since we booked no revenue upon shipment of these products, we recognized less revenue under our contract with Agri Labs than we otherwise would have in 2010.

Gross margin, that is gross profit divided by revenue was 40.9% in the fourth quarter of 2010, an increase of 2.7 percentage points as compared to 38.2% in the fourth quarter of 2009. For full year 2010, gross profit was 37.9%, up slightly from 37.6% in 2009. In both cases, a key factor in the increase was product mix, with the overall sales shift was toward higher margin products. In both cases, this was somewhat offset by costs in our OVP segment regarding regulatory issues with certain of our cattle vaccines. In 2010, we recognized $1.4 million in net costs for destroyed product, replacement product, and related reserves in this area. We recognized a $1 million reserve related to this situation in the first quarter of 2010 and incurred incremental net costs of $400,000 in the fourth quarter of 2010.

Selling and marketing expenses were $3.1 million in the fourth quarter of 2010, down 9% from the prior year period. Lower sales bonuses were a key factor in the decline. For full year 2010, selling and marketing expenses were $14.7 million, an increase of approximately 1% compared to 2009. Spending related to the launch of our new VitalPath instrument was a factor in the increase. In the fourth quarter of 2010, research and development expenses were $297,000, down $113,000 as compared to the fourth quarter of 2009. Lower spending related to the development of an improved process for producing certain cattle vaccines was a factor in the decline. Research and development expenses were $1.6 million in 2010, down $121,000 as compared to 2009. Lower spending on resources, such as laboratory supplies, was a factor in the change.

General and administrative expenses were $2 million in the fourth quarter of 2010, up 6% as compared to $1.9 million in the prior year period. We experienced fees related to our fourth quarter proxy and shareholder meeting required to effect our reverse stock split and legal fees related to arbitration against former distributors over past-due amounts in the 2010 period. Neither of these issues occurred in the 2009 period. For full year 2010, general and administrative expenses were $8.1 million, down 1% as compared to $8.2 million in 2009. A factor in the decline was no management incentive plan, or MIP payouts were earned in 2010, while there was an MIP payout earned in 2009. Depreciation and amortization was $2.3 million in 2010, down from $2.6 million in 2009. Lower depreciation related to instrument rental units was a factor in the decline. We had depreciation related to I-Stat line instruments in 2009, but not in 2010, which was partially responsible for the decline in instrument depreciation.

Operating income in the fourth quarter of 2010 was $688,000, a decline of $170,000 as compared to $858,000 in the fourth quarter of 2009. We generated full year operating income of $358,000 in 2010, a decline of approximately $3.7 million compared to $4 million in 2009. Interest and other expense net was $112,000 in the fourth quarter of 2010 as compared to $113,000 in the prior year period. This line item can be broken into two components; net interest expense and net foreign currency gains or losses. We had net interest expense of approximately $12,000 and a net currency loss of approximately $100,000 in the fourth quarter of 2010. In the fourth quarter of 2009, we had net interest expense of approximately $37,000 and a net currency loss of approximately $76,000. For full year 2010, interest and other expense net was $289,000 as compared to $306,000 in 2009. In 2010, net interest expense was $131,000, and net currency loss was $158,000. 2009 net interest expense was $343,000, and we experienced a net currency gain of $37,000.

Declines in interest rate expense in both the fourth quarter of and full year 2010 were related to lower loan balances and lower interest rates. We negotiated an extension of our revolving credit agreement with Wells Fargo in December. We extended the term of the agreement by one year to December 31, 2013. We also negotiated a 25-basis point reduction in each of the interest rate spreads charged under the agreement based on financial performance. We expect our interest rate spread to be calculated on this basis beginning April 1. In return, we agreed to pay a $25,000 up front fee, and through an increase to our borrowing rate to three-month LIBOR plus 5.75% beginning December 1, 2010.

In both the fourth quarter of and full year 2010, implied tax rates were higher than normally expected, due primarily to the effect of permanent differences between United States tax and GAAP accounting, such as incentive stock option amortization at low profitability levels. In both the fourth quarter of and full year 2009, most tax expense was non cash, as we utilized our significant domestic deferred tax assets. For the fourth quarter of 2010, we generated net income of $272,000, down $460,000 from the prior year period. We generated $18,000 in 2010 net income, down from $2.2 million in 2009.

Before I give formal guidance, I think it is worth commenting that our business has become more difficult to project than in the past. For example, we believe the US economy will recover in the coming year, which is assumed in our guidance, but this remains a significant risk. As in the past, we have continued to search for new opportunities to grow our business. We have had discussions with several entities who could offer us new product and product development opportunities, which are exciting to us, but not appropriate for public disclosure at this point. In some cases, this will require funding or other commitments on our part, which will necessarily change our financial outlook. We know from experience many of these opportunities will not work out, despite everyone's best efforts. Accordingly, consistent with our historical approach, we have derived our guidance generally excluding these opportunities. We will continue to use our best efforts to turn these opportunities into reality and intend to update our guidance in future calls accordingly. Investors should also be aware that we intend to invest in our business and people in 2011 to set ourselves up for future growth and the earnings targets Bob will discuss later in the call.

We expect an increase in our operating expenses in 2011 as compared to 2010 as a result. Our guidance for the first quarter of 2011 is for revenue of approximately $19 million, including approximately $3 million in OVP revenue. Gross margin of around 40%, operating expenses of approximately $7 million, operating income of approximately $600,000, interest and other expense net of about $25,000, and accounting income tax rate of approximately 40%, and just under $350,000 in net income. Our guidance for full year 2011 is for revenue of approximately $72 million, including approximately $10 million in OVP revenue. Gross margin of around 40%, operating expenses of approximately $27 million, operating income of approximately $1.8 million, interest and other expense net of about $125,000, and accounting income tax rate of approximately 40%, and approximately $1 million in net income. Based on our share price as of yesterday's close, and shares and options currently outstanding, this guidance translates into approximately $6.19 in earnings per share in the first quarter of 2011, and for full year 2011 respectively. It is important to remember that we expect most of our tax expense to be non-cash, due to the utilization of our large domestic deferred tax asset. Based on our share price as of yesterday's close and shares and options currently outstanding, our guidance translates into approximately $0.04 and $0.13 in tax expense per share in the first quarter of 2011 and for full year 2011 respectively.

In summary, we have overcome challenges in 2010 to produce another profitable year. This is the fifth year of the past six that we have been able to report a profitable year to our investors. We look forward to doing even better in 2011 and beyond. With that, I'll turn it back over to you, Bob.

Thank you, Jason. To recap some of the points we have made here, the reverse stock split and the associated concern with ongoing NASDAQ listing are behind us. The year-over-year revenue confusion associated with the old hand-held analyzer franchise is finished. The unusual experience for the cattle vaccine and the associated regulatory delays were finished before year end. We have the strongest balance sheet that we've had for sometime, including the fact that we have no term debt. We've introduced one new product already in 2011 and we will launch at least one more this year. We are actively working on new product opportunities.

Our guidance for 2011 includes double-digit revenue growth, gross margin percentage improvements, and earnings growth. Cash from operations will continue to benefit from our NOL asset, specifically our guidance of $0.19 per share, includes substantial non cash tax expense. Finally, from an economic performance standpoint and a single metric, our management team is focused on how fast we can get to earnings of $1 per share while we are simultaneously making underlying investments towards sustained long-term growth. Thanks for your attention today. We appreciate your continued interest and support of Heska. At this time, I would like to turn this over to our moderator for purposes of conducting our question and answer session.

(Operator Instructions) Thank you, the first question comes from Jonathan Block. Please go ahead with your question.

Thank you. Hello guys, this is Maggie Lovett in for John. Just a first question would be on your feeling of the overall environment in the core companion animal segment. If you could just give us very general thoughts on what you're seeing now, what you kind of expect in 2011 in terms of the consumer coming, or walking back into the vet office.

Certainly, thanks Molly. Appreciate the question. I caveat this to some degree and the way that Jason did in his comments about the guidance, there's a lot of uncertainty in the future macro economic environment. I'd also stress beyond that caveat that while we've been asked questions about the economy before and we've expressed concerns, by no means do we consider this an excuse for suboptimal performance. We just see it as an additional challenge. Turning to the specifics, I think you're probably aware that VCA Antech reported just a few weeks ago their full year results, and for those who aren't as tuned into the industry as SunTrust might be, they reported same-store sales in their veterinary hospitals across the country, down 2.2% on a full year basis. I think that's generally consistent with anecdotal comments we've heard across the country. I would also say that we believe we see encouraging signs out there on a regional basis, where we're seeing more life in the economy, more traffic, and more business in the veterinary hospitals. And again, how all that works out as we look forward, we pay attention to proxies, like unemployment, reports like those from VCA Antech, which are nice cross cut of veterinary practices across the country. We are hopeful and at the same time, very watchful of the trends in the economy.

That's very helpful. And then you gave a lot of detail on the lactate meter analyzer. I'm afraid I'm not that familiar with that kind of test. I was wondering if you could try to, probably difficult, but just kind of the market opportunity with that test?

Sure. Well, we're not going to size the market opportunity per se. I think the way we see it as a very strategically important opportunity bridging a final gap in our chemistry offerings between blood gas, electrolyte, analyzer that we saw now, VitalPath, and then the dry chem 7000 in 4000. So it's really important in helping us place those analyzers. In and of itself, the analyzers stand alone, arguably under $1 million a year in total revenue. Its real quantitative significance is how it helps you place those analyzers in a full product range concept.

Okay, great. and then my final question would just be, again on kind of a bigger picture level, what your sense is in terms of testing being done at the in-clinic site versus lab testing. Are you seeing any shifts, or do you expect continued movement towards the point of care market, just kind of big picture thoughts would be helpful.

Certainly. Well, I would say that it is very hard to say. In general, there is always--it is a very, very big market in the reference lab business and veterinarians seem to tend to continue to use that. We believe there may be a slight shift in the point of care market, where we're seeing more in-clinic analyzer use, and we also think this is consistent with beliefs we've articulated in the past. For example, in investor relations presentations where we believe there's a change in practice behavior overall that drives this in-clinic or point of care opportunity even further and faster.

Great, thank you

Certainly, thank you for the question

Thank you, madam. The nest question comes from John Nelson.

Hello. First off, I want to say you and Jason and all of your employees at Heska have done an excellent job of putting the house in order and getting ready to grow again over the last year, and I'm a bit baffled by the abbreviated press release that you had. I think the you've done an excellent job of explaining in great detail on this call what's happened and I think that your press release is kind of representative of what you want to convey to not only existing investors, but potential investors, and the one paragraph was I think in my opinion, was grossly inadequate. So please work on that in future press releases for the quarters. My questions are related to the dry chem analyzer sales. Can you talk in anyway--Can you give me any more details on how the sales are progressing and any new additions of tests to the line that might fuel additional demand for that product and the consumables?

Certainly, John. I'll try. And I acknowledge your comments about our deficiencies or your views on our deficiencies in our press release. Noted. Second, as far as dry chem is concerned, dry chem analyzer product line, the prior products-- the status of the products we currently offer have been pretty much the status for sometime now. We don't see broad increases in offerings on those lines. Rather, we see adding incremental product lines to extend and supplement those lines. Again, this lactate analyzer is a great example for that, bridging and adding unique new testing parameters to help sell full product lines. I would say overall, the analyzer environment and the sales in the analyzer environment have been slow and, again, we've said this repeatedly in the past, there's a lot of resistance to capital equipment expenditures out there in the marketplace right now, a lot of concerns about, again, the economy, and probably even reluctance that exceeds any sort of warranted reluctance, if you will, just excessive conservatism in our specific market with our customer. So they have been steady and slow, and just the same with every new placement, we create a new annuity and consumable. We like that. I would also say that we believe we've seen trends over the past year where there's slightly less consumable usage per analyzer over the past while and that's a reflection, again, of less foot traffic to the veterinary hospital, less case load, and probably correlates to what I talked about VCA Antech being down 2.2% year-over-year same-store sales. I hope that's helpful, John.

Yes, very much so. Also, later in the conference call, the comments were that one of your goals was $1 per share in earnings.

That's correct.

And what timeframe, I mean, I know you didn't give a timeframe, but would you be willing to give us the timeframe on that goal?

No, John. I won't. I mean, it's just -- other than to say it's a tangible, it's a tangible, real goal that we're going to be focused on every day, and it's really important to understand that -- I mean, this isn't something we're talking about in 10 years or five years, for example. It's got to be nearer term to be real to our management team. But I think it's very important to understand we're not going to get there by stripping out growth potential, say, in our R&D and partnership expenses or alliances and licensing fees. We're going to get there while we're also making investments to sustain long-term growth. And I think that's consistent with your introductory comments about appreciating us positioning ourselves for growth. So we're going to have to find a way to continue to invest and to get to that $1 a share.

Okay, and the last question would be again, related to that, is the compensation of management or the employee-- and the employee tied in any way to that goal?

Oh, absolutely. Not the specific $1 a share, but in the short-term compensation and in our MIP plan, for example, the management level is tied to financial performance, as well as growth goals. Going forward, and I would encourage you to read the CD and N as it becomes available.

Okay. Thank you very much, and keep up the good work.

Thank you John, we appreciate your support.

Thank you, sir.(Operator Instructions)Thank you, the next question comes from John Curti. Please go ahead with your question.

Good morning. The $1.4 million in expenses that were taken, the $1 million I think in the first quarter and the $400,000 in the fourth quarter related to the bovine vaccine. Were all those costs absorbed in the cost of revenue?

Yes.

In your forecast for 2011, you've got operating expenses rising up to about $27 million on a revenue base of $72 million compared to expenses of about $24.5 million on revenues of a little over $75 million in 2009. Is most of the cost increase on the operating expense side going to be in selling and marketing expenses in 2011?

We would expect increases in selling and marketing expenses certainly. Again product launch associated issues as well as the expansion of infrastructure as we discussed for growth. That certainly is a key point. So it's a good observation.

I would say on an absolute basis, yes, although we also expect the R&D and probably even the G&A line to increase. R&D of course on a percentage basis because the absolute number's relatively small for 2010.

And then what do you anticipate CapEx and D and A to be for 2011?

Well, we haven't given specific guidance on CapEx and I'm reluctant to do so right now. The D and A we expect to trend downward. I'm not going to speak out of school without reviewing that specifically for you today. I would expect CapEx --I can say I think CapEx will be up from what we did in 2010.

Okay, and what was it for 2010?

$650,000. I'll give you a specific number. Hang on one second. $620,000.

Okay. Thank you.

Thank you.

Thank you sir. (Operator Instructions)Thank you sir. There appear to be no further audio questions at this time.

In view of the fact there are no further questions, just let me take the opportunity on behalf of both Jason and myself to thank you all for your interest in Heska and for taking the time to join us today. Good-bye.

Thank you, sir. Ladies and gentlemen, this concludes the Heska Corporation Fourth Quarter and Year End 2010 Earnings Conference Call. Thanks for participating. You may now disconnect.