Heska Corp (HSKA) 2012 Q2 法說會逐字稿

Ladies and gentlemen, welcome to the Heska Corporation second quarter 2012 earnings conference call on the tenth of August 2012. Throughout today's recorded 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 to Mr. Brett Maas of Hayden IR. Please go ahead, sir.

Thank you all for joining us today for our conference call. We would like to welcome everyone to the call. On the call today with us are Heska Corporation's Chairman and Chief Executive Officer, Bob Grieve, and Jason Napolitano, Heska's Chief Financial Officer. We appreciate having the opportunity to interview the results of the second quarter 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 or performance to be 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 and other filings statements 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.

Thank you, Brett. I would also like to thank everyone for joining the call today. There were a number of positives to take away from our second quarter. Importantly, we generated 12% revenue growth year-over-year, in our Core Companion Animal Health segment. In that regard, we saw a notable progress from our expanded and enhanced sales organization, and this progress was demonstrated by the strong resurgence in placements of our chemistry analyzers during the quarter.

In the first half of 2012, we placed over 80% of the total number we placed in all of 2011. This is an important data point for both management and investors to conclude that our sales force is gaining traction. The momentum in chemistry analyzers sales is particularly encouraging, given the softness in the overall economy, and considering the second half of the calendar year is usually a period for increased capital equipment sales activity.

Various competitors and industry participants have reported relatively soft second quarter results, and we are seeing less than robust growth reported by a wide range of consumer-facing companies. A slow economy, particularly in the consumer sector tends to impact the companion animal health industry, and we believe we experienced some of this in the quarter. As the economy stabilizes and pet owners are more comfortable with the expense of a routine visit to the veterinarian, we expect our larger analyzer footprint will benefit our recurring revenue from consumable sales in future periods.

In addition to these modest economic headwinds factors, competition is also a factor. We continue to compete with two direct competitors that bundle reference lab services and in-clinic analyzers. Our efforts to expand relationships with independent laboratories to create partnering, co-promoted bundles as needed, is a high priority and is progressing very well. We remain very excited about these evolving opportunities. It is, however, important to note that not every customer wants a bundle deal. We are in a position to have ongoing success in those cases, as well. Flexibility in offering non-bundled deals, as well as co-promoted bundles works very well. We continue to believe in the value of these collaborative relationships, as opposed to building a separate national reference laboratory network.

In addition, the analyzer business remains highly competitive with low or no initial costs, an important factor with many customers. We have been placing more Heska-owned analyzers with our customers, which we believe is a wise use of our capital. This is in contrast to capital lease agreements, where a leasing company buys the analyzer from Heska and has an arrangement with the veterinarian with little or no initial cost, but a required monthly payment. Heska will generally recognize the revenue upon the sale of the instrument to the leasing company in this scenario.

If Heska retains ownership of the analyzer, however, as we are doing more frequently, no revenue is recognized upon the placement, only as the analyzers is used over time. While investors may see in the short-term, and absence of initial revenue from an analyzer sale, we expect these Heska-owned placements to lead to long-term, recurring, highly profitable consumable revenue.

While this progress was encouraging and I remain confident in the long-term growth potential of our Company, the second quarter financial results were hampered by slower than expected results from the PetTrust Plus product that launched by FidoPharm in March, and the anticipated slow quarter in our other vaccines, pharmaceuticals and products or OVP revenue segment.

Early revenue results with PetTrust have not met our forecast, or the expectations provided by FidoPharm, the marketing partner for this product. Their feedback is the behavior change on the part of retail pharmacists, veterinarians, and pet owners has been slower than anticipated. Longer-term, however, they remain encouraged, as does their principal current retail pharmacy partner, Wal-Mart. The marketing commitment remains in place and we expect additional channels will be engaged in the coming months.

We have previously described quarterly revenue generation in our OVP segment as lumpy. Where revenue was down about 25% year-over-year in this segment, it was very close to our expectations and guidance. Again, we do not believe this is the beginning of a trend, but rather the result of a relatively small number of customers moving orders in and out of a given period. This is very consistent with our historical OVP revenue generation.

Our sublingual, or SLIT allergy therapy rollout is proceeding nicely. This product was formerly named ALLERCEPT therapy drops. We have very encouraging exposure to this product, as well as our overall allergy product franchise at the recent World Veterinary Dermatology Congress in Vancouver. In fact, ALLERCEPT therapy drops were so well received by the international community, that we will be proceeding with product registrations as appropriate, on a global basis. Allergy is an area where we have a preeminent brand, and we are very excited about leveraging that brand and our know-how into future product opportunities.

Unfortunately, we have experienced some setbacks in our hopes to launch more new products. One product we hoped to launch this year has been delayed with no firm timeline commitment from the third-party conducting the development work. Another product we planned to launch by now should be announced and available next month, a delay of two months to three months from our original budget plans. We are particularly excited about this opportunity. Yet as has been our practice, we will not go into any further detail on what -- on that product until the launch announcement.

As investors may recall, that we announced an agreement with Rapid Diagnostek or RDI for a new diagnostic platform technology in mid-2011. As we noted in our last call, our colleagues at RDI were working toward a completed initial product by year-end. We also noted that no 2012 revenue was forecast for these products. 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 that 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.

For a number of reasons, we now believe those initial RDI products will launch around the second quarter of next year. While we are very pleased with the progress, it has simply been somewhat slower than had been expected.

I would now turn this over to Jason. He will provide detailed information on our financial results, and future financial expectations.

Thank you, Bo, and thanks to everyone who joined the call.

Our second quarter 2012 revenue was $18.3 million. This compares to $17.4 million in the prior-year period. Revenue for the six months ended June 30, 2012 was $37.4 million, compared to revenue of $37 million in the prior-year period. Core Companion Animal Health revenue was $15.7 million in the second quarter 2012, a 12% increase as compared to $14 million in the prior-year period. Greater sales of our heartworm preventive to a unit of Merck and increased instrument consumable sales, as compared to the second quarter of 2011 were factors in the increase.

Revenue for our other vaccines, pharmaceuticals, and product segment or OVP was $2.6 million, a decrease of $854,000 or 24.9%, as compared to $3.4 million in the prior-year period. This was consistent with the guidance we gave on our last earnings call. Declines in sales of both bovine biologicals, research and development revenue, and a customer who ordered in the second quarter of 2011 but not 2012, were factors in the change.

Our second quarter 2012 gross profit was $8 million, compared with the gross profit of $7.5 million in the second quarter of 2011. Gross margin was 44% in the second quarter of 2012, an increase of 1.2 percentage points from 42.8% in the prior-year period. A shift in product mix to relatively higher margin products was a factor in the improvement, which was somewhat offset by lower gross margins in our OVP segment, primarily related to the lower throughput in the facility.

Our first half 2012 gross profit was $17 million, compared with the gross profit of $15.8 million in the same period of 2011. Gross margin was around 45.3%, an increase of 2.6 percentage points from 42.7% in the prior-year period. Total operating expenses for the second quarter of 2012 were $7.7 million, or 42% of sales, compared with total operating expenses of $6.6 million or 37.7% of sales in the prior-year period.

Selling and marketing expenses were $4.8 million in the second quarter of 2012, an increase of 33.1%, as compared to $3.6 million in the prior-year period. Increased costs related to greater sales force personnel were a key factor in the increase. Research and development expenses were $203,000 in the second quarter of 2012, a decline of approximately $500,000 from $703,000 in the prior-year period. The largest factor in the change was a payment made to a third-party related to a product line we are collaborating to develop with that company, which occurred in the second quarter 2011, but not 2012.

General and administrative expenses were $2.7 million in the three months ended June 30, 2012, an increase of approximately $400,000 from $2.3 million in the prior-year period. Legal spending and expenses related to arbitration matters were a factor in the increase. Total operating expenses for the six months ended June 30, 2012 were $15.5 million, or 41.4% of sales, compared with total operating expenses of $13.3 million or 36.1% of sales in the prior-year period.

For the six months ended June 30, 2012, depreciation and amortization was $861,000, as compared to $1.1 million in the prior-year period. In the second quarter of 2012, operating income was $383,000, compared to $887,000 in the prior-year period. In the first six months of 2012 operating income was $1.5 million, compared to $2.4 million in the same period in 2011.

In the second quarter of 2012, we had $57,000 in income from interest and other items. This primarily relates to interest recognized on overdue receivables from a customer, and a net foreign currency gain. This compares favorably to 2011, when we experienced a $136,000 expense, due primarily to currency losses as well as a slight net interest expense.

In the second quarter of 2012, income before income taxes was $440,000 compared to $745,000 in the second quarter of 2011. Total income tax for the second quarter of 2012 was $178,000, as compared to $288,000 in the second quarter of 2011. 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 favorable income taxes we would otherwise pay.

Net income in the second quarter of 2012 was $262,000 or $0.05 per diluted share. This compares to net income of $457,000 or $0.09 per diluted share in the prior-year period. Our second-quarter 2012 net income is also inclusive of a $144,000 deferred income tax expense, or approximately $0.03 per diluted share. Net income for the first half of 2012, inclusive of a $452,000 deferred income tax expense was $846,000 or $0.15 per diluted share. This compares to net income of $1.4 million or $0.26 per diluted share in the prior-year period. The first six months of last year's net income is also inclusive of a $730,000 deferred income tax expense.

Turning to the balance sheet, we had $7.6 million in cash. This translates to $1.43 per basic share in cash. Working capital was $19.2 million as of June 30, 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 2012 -- excuse me -- second-quarter of 2011. You will also note that our balance sheet included $534,000 in dividends payable, which related to Heska's ongoing dividend payment which we announced in May of 2012. A dividend of $0.10 per share was paid on July 10, 2012 to shareholders of record, as of June 29, 2012.

We have a dividend payable entry on our balance sheet, as the actual payment was not made until 10 days after the quarter closed. The slow start for PetTrust Plus, (technical difficulties) disappointing performance on Tri-Heart Plus, the slight delay in our next product, the indefinite delay of another product, and the somewhat slower late ramp of sales productivity than expected, as well as the emerging concerns about macroeconomic weakness have affected our future outlook.

Let me turn to our guidance for the third quarter of 2012. I want to remind investors our business remains a difficult one to project, in particular, in light of recent events. Our guidance for the third quarter of 2012 is for a little over $20 million in revenue, including about $3.7 million in OVP revenue, gross margin of approximately 42%, operating expenses of approximately $7.5 million, operating income of approximately $900,000, net interest and other expense of approximately $25,000, and an income of more a little more than $500,000. 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 $0.09 in earnings per diluted share.

Our guidance for full-year 2012 is a little over $77 million in revenue, including approximately $11.5 million in OVP revenue, gross margin of a little over 44%, operating expenses of a bit over $30 million, operating income of approximately $4 million, approximately $135,000 in interest and other expense, and net income of approximately $2.4 million. Based on current diluted shares, this guidance translates into approximately $0.43 in diluted earnings per share. This figure is inclusive of approximately $1.25 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 $0.22 per diluted share.

With that, I will 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 outlook for the future. In our recent calls, we had discussed the potential change in the competitive landscape that we believe has the potential to benefit us in the future. By way of reminder, recently in light of an FTC investigation, our largest competitor in the diagnostic base, IDEXX Laboratories announced their intention to change one of their exclusive distributor relationships to a non-exclusive partner.

Historically, these distributors were, in effect precluded from carrying products competitive to the IDEXX product line. I mentioned that while the situation is uncertain, if Heska were to gain access to a high quality national distributor sales channel, there should be future upside potential for our Business. Our most recent information was obtained yesterday afternoon, in press releases from IDEXX and MWI It was disclosed that IDEXX and MWI intended to move to a non-exclusive relationship, and that they expected their current contractual and business relationship to remain in place through year-end It remains unclear whether this action will satisfy the FTC, and if it does not, what potential outcomes might occur.

If the action meets with regulatory approval, there are a number of ongoing uncertainties around future business relationships with MWI and other manufacturing partners, including Heska. In the absence of further information, it would be impossible to quantify the potential impact on Heska. It does appear, however, after being blocked from these channels for many, many years, that access may finally become available. To that end, we have been conducting extensive internal planning toward multiple potential scenarios.

I want to spend a little more time talking about our sales force. As many listeners know, the enhancements of our sales force has been a key focus of our management team for the last year. Under new leadership, we set out to replace underperforming personnel, recruit additional talent, and restructure our organization in a more efficient, and hopefully more effective way. This quarter demonstrated the initial results of those efforts, in the form of a notable increase in analyzer placements.

There are other metrics which encourage us, as well. If it takes two or three quarters for a sales person to be productive, turnover is an area of concern. Under the new leadership and structure, we have seen a sharp decrease in turnover, and this bodes well for future efficiencies. By way of comparison, our turnover rate for the full year 2011 was approximately 68% in outside sales. In the last five months, we had only two positions turnover in outside sales, turnover of less than 6%.

We manage -- we expect to manage to optimize financial results, despite on growing certainties in the broader economy. In that regard, we will be mindful of all discretionary expense opportunities to optimize our bottom line in 2012. But we remain committed to key investments in our sales force and product development opportunities for growth into the future. We like our cash position, and the absence of debt We remain committed to our quarterly dividends, subject to changes in tax law in 2013 that could disadvantage our shareholders.

With the various economic and business uncertainties, as well as the confusion around the emerging picture with potential national distribution relationships, we will be reluctant to comment on a specific 2013 outlook at this time. We have discussed our longer-term goal of $1 per share in GAAP earnings, we continue to focus on this goal, and believe it remains achievable, although likely on a longer time frame than we had initially anticipated.

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.

(Operator Instructions)

Our first question comes from Chris Armbruster from B. Riley & Company. Please go ahead with your question.

Hi, thanks for taking my call.

Hi, Chris.

So we have heard a couple of competitors in this space talk about additional hiring that they are going to need to do to service the new distributor. I know you have gone through some expansion in your sales force, but do you expect any incremental expenses there, to maybe ramp-up to support the new distributor?

Well, I would say, Chris, that is premature to comment on that. We really don't know what's going to be available in the way of distribution access still. If you read press releases and listen to calls and try to interpret, it seems the -- I think the definitive solution has not yet arrived. And we are certainly -- can't really comment on anything like that at this time.

Okay.

Maybe on the next call.

All right. And then on the R&D that's being done on the new products. What's kind of the break down of responsibilities for the R&D? Are the delays kind of on your side, or on their side, or kind of both?

I would say it is primarily associated with third-party developers. It is situations that have been out of our control, directly -- are out of our control, directly. We collaborate, we work with them. And then, at the same time, we are directly responsible for their timelines -- or timeline sequence.

Got it. And then on the FidoPharm update, is there -- as far as the sales not meeting expectations, is there any more color that you can give us on what might be behind that?

I think I would just embellish what I said in my prepared comments. I think that the channel partner there, has described to FidoPharm that they been surprised by the change in -- the time it's taken, and change in behavior, both in their internal -- with their internal employees, the retail pharmacists, the veterinarians, and then for that matter, the pet owners.

I would say also, again, I would emphasize that their feedback has been -- through FidoPharm -- has been that, continued enthusiasm for the product and the opportunity, continued investment in marketing and outreach as well. And again, we remain encouraged long-term there.

Okay. Just one more. On the placing of analyzers that you are doing, instead of the leasing companies. Do you have -- is there any way to quantify maybe the percentage of those versus kind of where it's been historically, that you are placing, instead of going through leasing company for example?

I don't think we will do that. Again, we have avoided that sort of thing. I would say, in terms of the total number of analyzers, I would say the delta in the quarter -- or if you look at our ASP for these analyzers, and if you look at those that we placed, Heska-owned into those clinics, look at that delta in the current period, that was something on the order of $300,000 or a little bit more in revenue that wasn't recognized.

Okay. Sounds good. Thanks.

Sure.

Thank you. Our next question comes from Ken Tbrovich from C.K. Cooper. Please go ahead.

Thanks for taking the question. Just I wanted to go back -- I guess, Bob, you just mentioned on these -- it's really a deferred recognition, if I am hearing you right on these Heska-placed instruments?

Right. The idea is, as you would appreciate, Ken, is you -- is to get them in place and get them used, and pulling through high-margin consumables. And so the benefit then, is to get them into a clinic where you generally have long-term multi-year commitments, then enjoy those revenue streams. So that is generally the idea, deploy our capital, own the analyzer, put in place, and then enjoy the revenue stream -- the recurring revenue stream.

Sure. And I guess the reason I am asking the question about the deferral, is over that multi-year period, would the revenues that you recognize from the placement, equal or exceed what you would normally recognize from a sale?

I will let Jason comment on that financial number.

Could you repeat the question, Ken? I want to be sure I get it right.

Yes. So, Jason, just specifically with regard to ones being placed as Heska-owned instruments. It sounds as though essentially, you are going to recognize some -- some portion of revenue from that analyzer being in the vet office on a monthly or quarterly basis. And I am trying to get a sense over the life of the agreement that you have that results in that instrument being placed, is the revenue equal to or greater than what you would normally recognize on a sale?

Yes. The revenue we are recognizing is mostly related to the consumable usage only. Think of this, Ken, as a rental agreement where -- sort of like renting a car where an instrument goes in, Heska the retains ownership. And as it is used, and as it generates those consumables, Heska is getting the benefit, and that's the revenue we are recognizing.

Is a commitment larger on average than our other placements? I think there's a good chance it is. I haven't studied the detail. I don't want to speak out of school, but I -- my -- knowing what I know sitting here -- probably those are higher usage opportunities than the average placement.

Okay. But you are not necessarily then, recognizing a rental fee associated with the instrument, itself?

In most cases, there is no rental fee, no.

Okay. And then, just as it relates to the outlook for new products, has your experience with these delays -- and again not speaking of the RDI product because obviously, you have got a launch plan there. But that the one in particular, that there is an uncertain future date, does this change the way you look at collaborations going forward? How do you adjust for this, as it relates to the your own expectations to drive the top line?

I think that's a fair -- a really a very fair question, and Chris addressed it, and also tangentially earlier. I think the -- going forward notionally, what we were try -- what we tried to do is embed further and further into these relationships, and make them more pure OEM, where we have got more responsibility, more proprietary access and so forth -- gives us more control. We are always proportionally more satisfied when we have more control, and we will be seeking those sorts of relationships go forward.

Okay. And then -- it just seems as though -- obviously with the instrument placements being up, there had to be some other areas of weakness within the business that sort of accounted for some of the shortfall on the core companion animal side. Was any of that related to IDEXX's decision to go forward with GREER on the allergy side? I mean, had you look at that as a business opportunity for you, in terms of the allergy testing with them on the reference lab?

It's not -- we don't see that as having materially impact our business at all. I think the shortfalls we addressed, in the way of -- disappointment earlier on. We can expand on that later on, if you would like. But no, we don't see that, the relationship between IDEXX and GREER having impacted our business to this point.

Okay.

So we are definitely still, we have as I said, the preeminent brand in this space, and are moving forward, and real happy with that business.

Okay. And then just last question, on the RDI side, obviously, it's a slight delay. But is there anything from a technology standpoint that changes your view on the outlook for that opportunity itself, once the device is available?

No, not at all. It's in -- probably in its -- and the simplest way to describe the scenario, Ken, it's been just a matter of how many hands could get on the development team at one time, with our colleagues at RDI. And it's -- there is no technology obstacles that we know of at this time. It's just a simple matter of grinding out the development.

Okay. Thanks again for taking the questions.

We appreciate them. Thanks, Ken.

Thanks, Ken.

Thank you.

(Operator Instructions)

Thank you. There appear to be no questions at this time. Please continue.

Very well, then. I would just express our thanks. 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.

Thank you. This does conclude the Heska Corporation second quarter 2012 earnings conference call. Thank you for your participation. You may now disconnect.