Heska Corp (HSKA) 2012 Q1 法說會逐字稿

Good afternoon ladies and gentlemen, and thank you for standing by. Welcome to the Heska Corporation first-quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and instructions will be provided at that time.

(Operator Instructions)

I would like to remind everyone that this conference call is being recorded today, Thursday, May 10, 2012, at 2.30 PM Mountain Time. I will now turn the conference over to Mr. Brett Maas, Managing Partner of Hayden IR. Please go ahead, sir.

Thank you all for joining us today. We would like to welcome everyone to the call. On the call with us today are Heska's Corporation Chairman and Chief Executive Officer, Bob Grieve, and Jason Napolitano Heska's Chief Financial Officer. We appreciate having the opportunity to review the results from the quarter of 2012. 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 current beliefs and expectations, and involve known and unknown risks and uncertainties, which may cause actual results to differ or performance to materially different than what is expressed or implied by these 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. I would like to now turn the call over to Bob Grieve, Heska's chairman and CEO, to provide opening remarks. Bob, congratulations on a strong first quarter.

Thank you, Brett. I would also like to thank everyone for joining the call today. The first quarter represented a solid start to what we believe will be a record year. We exceeded guidance across the board, beginning with revenue of $19.2 million. We also had strong gross margins, exceeding our guidance by approximately 43%, by 350 basis points, and delivering 46.5% margins, primarily due to a more favorable product mix.

We also enjoyed greater utilization and gross margin at our Des Moines facility. This resulted in net income of $584,000, or $0.11 per diluted share. This was approximately $509,000, or $0.10 per diluted share, better than our guidance.

We continue to build for expected acceleration and growth in profitability in the remainder of 2012. We have described the investment in our direct sales resource, both in restructuring and expansion, primarily in the second half of 2011 and earlier this year. That work is largely complete, and we are very excited about the momentum and enthusiasm we are seeing with our sales force.

Further, the sales force production, we are encouraged by signs of more pet owner traffic through veterinary clinics here in the United States. We know recent reports by others in the industry that improvements are being seen in the range of 3% to 5%. With our talented direct sales team, and the likely secular improvements in pet owner business to veterinarians, plus the new products that we will be adding into the future, we are particularly optimistic about our growth potential in 2012 and beyond.

Earlier this year, we announced an advance in allergy immune therapy in the form of sublingual immunotherapy, or SLIT. The new SLIT product is now fully integrated into our Des Moines manufacturing operation, thereby completing the process we started in 2011 to control the manufacturing of all of our allergy therapeutic products.

In addition, we have now received the required regulatory approvals for SLIT, and are proceeding as planned with an expanded rollout to key opinion leader specialists and veterinary dermatology. We are very pleased with this progress. Our overall allergy franchise is growing, both in terms of revenue and profitability contributions.

During the quarter, the Company shipped the initial stocking order of PetTrust Plus to Fido Farms Brands, LLC, a company focused on retail sales channels. This product, a heartworm preventive product based on an existing FDA-approved product, is manufactured exclusively for Fido Farm at our facility in Des Moines. As a Fido Farm labeled product, it is now available on the shelves of select major retailers in the United States. The product is fulfilled at the retail pharmacy, yet it requires a prescription by a veterinarian.

In practice, that veterinarian will likely conduct an exam on that animal, including a heartworm diagnostic test, prior to providing the prescription. The potential reach to consumers through access to a convenient channel, including the requisite veterinary relationship, is very exciting.

Many of these consumers may not currently test or provide preventive for their pets. This is an evolving paradigm for pet owners, veterinarians, and pharmacists, so it may be some time before we adequately understand the true potential of the opportunity. Within recent years, the industry has been experiencing this shift of access to pharmaceutical products, both in the retail pharmacy and over the counter. It is increasingly appreciated that such channel access can grow the overall market.

Our next product launch should be announced in the August, September timeframe. We are excited about this opportunity, yet as has been our practice, we will not go into further detail on that product until the launch announcement. We have learned that it serves no useful purpose to provide that detail to our competitors any earlier than necessary.

Many investors will recall that we announced an agreement with Rapid Diagnostek, or RDI, for a new diagnostic platform technology almost exactly a year ago. This is an exciting new biosensor platform that enables highly sensitive measurement of various categories of biomolecules in a variety of fluids. A small analyzer will accommodate an array of different diagnostic tests. Each test effectively serving as a consumable product for the same analyzer.

We see this as a generational shift in diagnostic platform, with the ability to port many different tests to the platform over the coming years. We believe this platform will be very important to our product pipeline. Since we introduced our exclusive global rights to this platform in companion animal health in May 2011, RDI has made substantial progress towards project milestones. The analyzer has progressed from a research black box to finalization of specifications, CAD drawings on the first production prototype, and definition of user Interface screens.

Sensor design and optimization is progressing, and the initial cartridge designs have been made, produced, and [fluidly] demonstrated. Proof of principal of the first two assays have been shown, and RDI continues to drive towards commercialization in 2012.

In the last conference call I addressed our efforts to bundle our products with reference lab services, as some of our competitors do successfully. Specifically, when our competitors have both in-clinic diagnostic analyzers and their own captive reference laboratory services, they can provide economically compelling combinations of products and services.

By way of update, we have elected to compete with these offerings by collaborating with independent reference laboratory businesses. Specifically, we can work with partners toward providing customers with their reference laboratory offerings alongside our in-clinic analyzers.

In recent weeks, we have been more formally engaged in developing relations with reference laboratory partners in these bundling deals. We are working closely with these partners to effectively meet the needs of veterinarians by leveraging the strengths of each business. We think this collaborative approach is far superior to any attempt to either acquire or build a reference laboratory business primarily for the sake of competitive product bundling opportunities.

The strong start to the first quarter 2012 reflects the confidence we felt in the last half of 2011, as we were laying the foundation for growth. I would now like to turn this over to Jason. He will provide detailed information and our financial results and future financial expectations.

Thank you Bob, and thanks to everyone who joined the call. Our first-quarter 2012 revenue was $19.2 million, which exceeded our guidance of $18.9 million. This compares to $19.5 million in the prior-year period. Core companion animal health revenue was $16.6 million in the first quarter of 2012, an increase as compared to $16.4 million in the prior-year period.

Greater revenue from our instrument consumables, international allergy business, and IV pumps contributed to the increase. We were able to achieve revenue growth in this area, despite an anticipated $2.1 million year-over-year decline in revenue from our heartworm preventive sold to a unit of Merck.

Merck's current purchase orders and forecasts for the balance of 2012 shows growth versus the last nine months of 2011, although the year as a whole is down from 2011, due to the low first quarter 2012 order level. We understand the heartworm preventive of a major competitor, Novartis, is currently not available in the market, and we remain hopeful Merck will gain market share as a result.

Historically, our counterparts in this relationship have been aware of our disclosure obligations as a small public company and were often hesitant to inform us of commercially sensitive developments which they did not want to reach their competitors through our required public disclosures. The best source of information for us is Merck's forecast, which we will continue to monitor.

Revenue for our other vaccines, pharmaceuticals, and product segment, or OVP, was $2.6 million, a decrease of $469,000 as compared to $3.1 million in the prior-year period. Lower sales of cattle vaccines to new 2011 customers were a factor in the change. Our first-quarter 2012 gross profit was $8.9 million, compared with a gross profit of $8.3 million in the first quarter of 2011.

Gross margin was 46.5% in the first quarter of 2012, an increase of 4 percentage points from 42.5% in the prior-year period. A shift in product mix to relatively higher margin products was a factor in the improvement. Our actual gross margin also significantly exceeded our guidance, which was for about 43%, with the actual result about 350 basis points better than the guidance.

Total operating expenses for the first quarter of 2012 were $7.8 million, or 40.9% of sales, compared with total operating expenses of $6.8 million, or 34.6% of sales, in the prior-year period. Our guidance for first-quarter 2012 total operating expenses were a little less than $8 million, so we outperformed our guidance in this area as well.

Selling and marketing expenses were the largest factor in the year-over-year change. Selling and marketing expenses were $4.9 million in the first quarter of 2012, an increase of 23.4%, as compared to $4 million in the prior year period. Increased personnel costs and travel costs were factors in the increase.

Depreciation and amortization was $413,000 in the first quarter of 2012, a decline from $608,000 in the first quarter of 2011. Anticipated lower depreciation on instrument units available for customer rental was a key factor in the decline.

In the first quarter of 2012, operating income was $1.1 million, which significantly exceeded our guidance of $150,000. Interest and other expense net was $142,000 in the first quarter of 2012, an increase as compared to $23,000 in the prior-year period. The largest factor in the change was larger currency loss recognition in the first quarter of 2012.

In the first quarter of 2012, income before income taxes was $940,000, compared to $1.5 million in the first quarter of 2011. Total tax for the first quarter of 2012 was $356,000, as compared to $601,000 in the first quarter of 2011. The lower ratio of total tax expense to income before income taxes in the 2012 period results from the impact of nontax deductible expenses, such as incentive stock option amortization, which tend to increase the ratio at lower income levels.

As we believe we will experience significantly higher profitability levels in 2012 than we enjoyed in 2011, this ratio is accordingly lower in the 2012 period. The largest component of our tax expense in both periods is deferred tax expense. It is important to remember that this is a noncash accounting charge only, and primarily relates to our large domestic net operating loss deferred tax asset position, which provides a tax shield for most federal income taxes we would otherwise pay.

Net income in the first quarter of 2012 was $584,000, or $0.11 per diluted share, which far exceeded our guidance of $75,000 in net income. Our first-quarter 2012 net income is also inclusive of a $308,000 deferred income tax expense, or approximately $0.06 per diluted share.

Turning to the balance sheet, we had $6 million in cash on March 31, 2012. This translates to $1.14 per basic share in cash. Working capital was $19.6 million as of March 31, 2012. We continue to have zero debt at the end of the reporting period, after fully repaying our line of credit during the second quarter of 2011.

You will also note that our balance sheet includes $532,000 in dividends payable, which related to Heska's first-ever dividend payment, announced last February. A dividend of $0.10 per share was paid on April 10 to shareholders of record as of March 30, 2012. We have a dividend payable entry on our balance sheet, as the actual payment did not go out until 10 days after the quarter closed. Earlier this week, we announced our Board had declared our second-ever quarterly dividend payment to shareholders of record as of June 29, payable on July 10.

Before I turn to guidance, I think it is worth noting, as was announced yesterday, that we will be presenting at the Bank of America Merrill Lynch Healthcare Conference this coming Wednesday. This is the first time we have been invited to this Conference, and are eager to discuss our progress with the high quality investors we expect to be in attendance. We intend to continue to tell our story, and investors should anticipate our attendance at future investor conferences toward this end.

Let me turn to the outlook for the second quarter of 2012. I want to remind our investors, our business remains a difficult one to project, in particular in times of economic uncertainty, although as Bob has indicated, the macro environment exhibited positive trends during the first quarter, and we hope that continues in upcoming quarters.

Our guidance for the second quarter of 2012 is for approximately $19.8 million in revenue, including about $2.6 million in OVP revenue. Gross margin of between 44% and 45%, approximately $7.8 million in operating expenses, operating income of approximately $1 million, currency gains roughly washing with net interest, and net income of approximately $620,000.

Based on yesterday's closing stock price and currently outstanding shares and stock options, which I will refer to as current diluted shares, this guidance translates into approximately $0.11 in earnings per diluted share. For full-year 2012, our guidance is for about $85 million in revenue, including approximately $11.5 million in OVP revenue.

Gross margin of approximately 44%, operating expense a little over $31 million, operating income of approximately $6 million, a little under $200,000 in interest and other expense, and net income of approximately $3.6 million. Based on current diluted shares, this guidance translates into approximately $0.64 in diluted earnings per share.

This figure is inclusive of approximately $1.9 million in deferred income tax expense, which again, is a noncash accounting charge primarily related to our large domestic deferred tax asset. Based on current diluted shares, this translates to approximately $0.34 per diluted share.

This guidance is essentially the same operating guidance as on our previous call, although we have adjusted for approximately $100,000 of recognized currency losses we experience in the first quarter, as well as share count changes related to option exercises and changes in our share price. We expect there always will be some variance in our results due to these items.

In the case of currency effects, we expect that gains and losses will tend to balance each other out over time, and that over any short period, we may experience one or the other. We have not made an effort to project currency moves for the year beyond today's call. In summary, we are pleased to report another strong quarter and we plan for momentum that will continue throughout this year and beyond. With that, I'll turn the call back over to Bob.

Thank you, Jason. I would like to close our comments by making a few summary points about our financial performance. We exceeded all guidance for our identified metrics for growth and revenue, gross profit, gross margin percentage, and on the bottom line.

Our balance sheet remains excellent. No term debt, no balance on our line of credit, ample cash, available borrowings to fund our operations and to be opportunistic with potential M&A activity. As a result of our solid financial performance, and to create long-term value for shareholders, we just announced our second quarterly dividend.

We are proceeding with our launch of SLIT allergy immunotherapy. The initial stocking order of PetTrust Plus for Fido Farm was manufactured in our Des Moines facility and shipped in March, and we intend to announce our next 2012 product introduction in the August/September timeframe. Our alliance with the Rapid Diagnostek is steadily proceeding toward additional products.

I would like to reiterate what I said on our last call. Our outlook is for notable revenue growth in 2012, an increase of nearly $15 million. Our revenue number of about $85 million is our established guidance for 2012 and we remain committed to that. We expect growth to come from new products and consumable revenue growth, some of which will be driven from analyzer placements that occurred in the course of 2011.

Whether our opportunities for revenue growth in the international business through third-party relationships, as well as potential growth in the OVP business, we believe that the balance of the growth we have described will primarily come from our restructured and expanded sales force. As Jason stated, our operating guidance remains essentially unchanged. Based on shares and options currently outstanding, this translates to approximately $0.64 per diluted share.

As in 2011, we expect the bulk of income tax expense, or a little under $2 million, to be noncash deferred tax expense, primarily related to our domestic net operating loss asset. Based on shares and options currently outstanding and Thursday's closing stock price, this translates to approximately $0.34 per diluted share.

During our last several calls, we've discussed management's focus on achieving 12-month earnings of $1 a share, while we are simultaneously making underlying investments toward sustained long-term growth. We believe it is realistic that we will be able to meet this goal on a GAAP basis by the end of 2013.

To do this, we need to continue growing our revenue. I'm encouraged by the fact that we have the most professional sales force we have ever had, and a sales force that continues to improve under capable leadership. We have a renewed focus on product development, which has produced new products that help drive our growth.

We believe our gross margin should continue to improve as we sell higher margin products, and including a greater relative volume of consumables for our analyzers. Increasingly, we are integrating our Des Moines manufacturing capacity into more of our key products, thus absorbing idle plant costs and contributing to improved consolidated gross margins.

We also expect more leverage out of our current operating expense base overall, even including somewhat higher investments in R&D and sales and marketing. We firmly believe revenue growth and gross profit growth will significantly exceed expense growth, resulting in accelerated profitability.

By way of illustration, our 2012 guidance anticipates EPS growth significantly in excess of revenue growth, and of course, remember that I am describing an after-tax GAAP target, and that because of our NOL carry-forward, we pay significantly less cash tax than the tax expense reflected in our financial statements. I would remind listeners that our business remains a difficult one to project, and the current fluid economic climate doesn't make that any easier.

On a final note, I'd like to briefly discuss some industry changes that could benefit Heska going forward. Recently, in light of an FTC investigation, our largest competitor in the diagnostic products space, IDEXX Laboratories, announced their intention to change one of their exclusive distributor relationships to a nonexclusive generalist partner. Historically, these distributors were, in effect, precluded from carrying products competitive to the IDEXX product line.

The situation remains quite uncertain. However, if Heska gained access to a high-quality national distributor sales channel, there should be future upside to our business. In the absence of more specific information, it is impossible to quantify the potential upside, or when the benefit might begin. Access to these channels has been denied since before our IPO, and at a minimum, that access would be good news for our investors.

Thanks for your attention today. We appreciate your continued interest and support of Heska. At this time, I'd like to turn this over to our moderator for purposes of conducting our question-and-answer session.

(Operator Instructions)

Chris Armbruster.

On the cost of revenue, I know that a lot of that's being driven by the new products and the leverage of the Des Moines facility, but maybe where can we expect that to go, or do you have any guidance for incrementally, kind of where we're getting to on that number?

Yes. I think we said our guidance was 44% for the year, Chris, gross margin, and we've got a great variance in the margins and products. We've got some products as high as about 80% gross margin, and we've got some other products on the lower end. We actually sell at a slightly negative gross margin as part of an overall customer relationship, at a positive gross margin, but we think when you balance that all out, for the year it's going to be about 44%.

Okay, and a longer-term target, there's still room for upside to that number as we go into 2013 and maybe '14?

Sure, yes.

Certainly, as I've tried to describe as consumables grow and outstrip the Analyzer business, and product mix improves, we would expect upside to that number in the future periods.

Okay, and then on the first shipment of the PetTrust Plus, what kind of supply is that, and when do you get additional shipments for that?

Certainly. We work off of forecasts and binding purchase orders that are fairly short-term. I would say with respect to the relationship, the partnership, and everybody involved, we're not going to disclose specific numbers, but I would say that the initial stocking order was modest. This is something, as I've said, is an evolving paradigm. It's a product with a finite shelf life, and everybody's wanting to make certain that we understand the uptake and the potential before we ramp a lot of inventory here.

Okay, and then on the heartworm preventive from Merck, the decline of $2.1 million, was that driven by price or volume?

The $2.1 million decline was revenue year-over-year, is what we're referring to there.

Yes, those are less units.

Less units, okay.

That shipped this year. It's not really a price variance year-over-year, that's any materiality, and as I said on the call, we don't have great insight into their ordering pattern, how they're managing their inventory. We were surprised to see the decline, and we know that the Novartis product's still not on the market, and we're hopeful that they're burning down their inventory pretty close to zero, and hopefully there's some upside in the forecast we've got.

Okay, and then on the veterinarian traffic, and I know that you guys talked a little bit about that, the increase to 3% to 5%. Can you maybe put it in a broader picture of where we are now versus where we've been over the last couple of years? Is this increase something we haven't seen in a long time, and if there's some, maybe, I don't know, pent-up demand or something that we could see the traffic actually, and the purchases by pet owners actually, accelerating in a couple years?

Well, I really couldn't imagine, I don't know exactly how to address that or I don't have any data to address the pent-up demand question, Chris. I would say, yes, this 3% to 5% range that's been reported in the industry is encouraging. I believe at the time, we were plunging headlong into this recession those numbers were negative on year-over-year and sequential quarter basis for some time. Only in the recent, very recent past that we've seen the positive uptick in the range of about 1%, I believe, and again, probably the most salient proxy here is Wolf, with their cross-section of practices across the US. And they've moved, then, from this more of 1% range to 3% in the most recent period, which I would consider to be good data and encouraging, as we said.

(Operator Instructions)

Jonathan Block.

Maybe the first one, Bob, just on RDI, and I guess I want to be respectful to the level of disclosure that you're comfortable in providing, but you do expect that product to be commercialized this year, in 2012? Then can you give us any more detail on what that's about? Maybe I'm a little bit unclear, but is that what the multi-assay testing is going to be predicated on?

Right, it's a couple of things. I said in the call that RDI is certainly working toward 2012 commercialization. I'd also say, in the spirit of transparency, that we haven't loaded revenue into our forecast or budget associated with that product, as there's still development uncertainty. But the product developments as they are occurring are milestones in themselves. Yes, this is a product that will allow you to use a single test, or the multiplex, with the same sample, and the same assay consumable, to get to your specific question.

Okay, great. So it will, same sample, multianalyzer. I guess the only difference is that this would be run off of an analyzer, if you would?

That's correct. That's correct, but I would encourage us all to sort of not think about your sort of large tabletop, five-figure type analyzer. This is going to be extremely affordable, very robust, and again, very important to understand that there are a whole string of potential single and multiplex tests can be developed over the course of years to fit into this same analyzer.

Okay, and just a follow-up going down the road, it would be to commercialize the analyzer first, and then do you have to go through sort of the regulatory process of getting anilide by anilide approved? Is that how you would move forward there?

Yes, and you could imagine going into the future, again without a lot of, is you appreciate the sensitivity in disclosure, there'll be certain tests on there that will be regulated, and some tests are possibly not regulated. It'll all depends on the nature of the claims, Jonathan.

Okay, perfect, and then maybe just to shift gears, and you addressed it at the end of the prepared remarks, but the channel, and what's going on with distribution. And I certainly understand it's a pretty fluid situation. It's impossible to predict, but can you help me, Bob, just in terms of when I look at your revenue stream and when you break out between Core Companion Animal Health and then other vaccines, the impact, if at least one national distributor were to become a generalist, would really be specific to the Core Companion Animal Health, and then really sort of the 50% item, approximating which is largely the diagnostic instruments and supplies. Is that the right way to think about the impact?

I don't understand the part about the 50%. What was that?

I'm sorry. Within sort of your Core Companion Animal Health, you've got the revenue stream that's more diagnostic.

Yes. So, I think anything that's directly competitive with the IDEXX product line as it exists today will benefit from this. Now, back in the Core Companion Animal Health segment, the OVP revenue segment, much of that, some of that's sold to individual customers across the industry, but much of that revenue is sold into an organization that distributes, through distributors, under their private label. So, this is not something that will benefit.

It's really the Core Companion Animal piece, and again, that piece, which is directly competitive. I would also say, however, that I would think there would be some reasonable synergy across the product line, even where they may not have been motivated to carry a fairly small or partial line of our products, or to pay much attention to it. It's possible with a broader line, we would have more service and more relationship.

Okay, very helpful. Then just last question, and this sort of follows up on one of the questions earlier. But clearly, trends seem to have picked up from your results, and those of the other major players in the industry, but there's always some chatter about what weather may have contributed to the first quarter strength. So, can you just give us your thoughts there, and then maybe even a little bit more granularity on what you've seen over the first four to five weeks of the second quarter, which may make you believe, hey, this is for real and not just inflated by weather in 1Q? Thanks, guys.

Sure, Jonathan. I'd say we don't really have, I'd say, enough data, enough certainty to comment on the weather and how that would have affected the Business. We do believe there's an upbeat attitude out there at veterinary hospitals in terms of the customer traffic. I also say that we think of that market, the ex-Heska market and Core Companion Animals, particularly on the instrumentation side, as being a couple of different -- well, there are a couple of different market aspects there. One would be that foot traffic is going to drive consumable growth, and the other is the veterinarian and the Capital Equipment business and purchase decisions.

So, those are coordinated clearly, but they operate, to some extent, a little independently. And in then the instrument side, and again, we've been encouraged by what we see. It's an extremely competitive universe, as I've just described with these bundling deals, but we look at both of those, both those aspects to the Core Companion Animal market.

(Operator Instructions)

There are no further questions at this time. Please continue.

Well, in that event, I want to thank everyone again. In summary, I believe Heska's position for a record 2012, and we look forward to sharing our progress with you in the coming months. Thank you all for your interest in Heska and for taking the time to join us today. Good-bye.

Ladies and gentlemen, this concludes the conference call for today. Thank you for your participation. You may now disconnect your lines.