Heska Corp (HSKA) 2012 Q3 法說會逐字稿

Good day ladies and gentlemen thank you for standing by. Welcome to the Heska Corporation third-quarter 2012 earnings conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened to questions.

(Operator Instructions)

This conference is being recorded today November 13, 2012. I would now like to turn the conference over to Brett Maas, of Hayden IR.

Hayden IR, thanks. Thank you all for joining us today on our conference call. On the call today with us are Heska's Corporation Chairman and Chief Executive Officer, Bob Grieve, and Jason Napolitano, our Chief Financial Officer. We appreciate having the opportunity to review the results for the third 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 results, 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 and performance to be materially different than what is 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. 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'd also like to thank everyone for joining the call today. This was a challenging quarter, but we continue to see positive signs as we did last quarter and remain confident in our long-term strategy. The third-quarter financial results were hindered by slower sales, specifically in the Core Companion Animal Health segment.

Core Companion Animal Health revenue was down about 5%. The decreases primarily in our canine heartworm diagnostic product, Solo Step CH, and Tri-Heart Plus. We expected Solo Step revenue to be slightly higher year over year, but yet that did not happen. As in Q2 we had multiple competitors playing the price game. We tried to resist these pricing pressures as much as possible while retaining market share. Anecdotally we've also heard that due to the unusually hot summer in much of the US, many veterinarians opted to book diagnostic tests for multiple vector-borne diseases, including Lyme disease and Elichia. Over the longer term we would expect to add similar testing to our product offerings.

OVP revenue was essentially flat as we expected, yet gross margins were well below our expectations, which affected our consolidated margins. This outcome is not unusual for both product mix and idle plant costs, particularly the lower activity in manufacturing our canine heartworm preventative pharmaceuticals will have negative FX. Subsequent orders with more manufacturing activity and a more profitable product mix will likely have more positive effects on consolidated gross margin.

We will continue to tightly manage discretionary expenses in view of lower-than-expected revenue. However, we still have year-over-year increases due to sales force investment. Very positively, we continue to see an increase in chemistry analyzer placements as we did in the first and second quarter. In the third quarter, year-over-year chemistry analyzer placements improved by 95%. Through the first three quarters of this year we have placed 130% of all analyzer -- of all chemistry analyzers placed during all of last year. Momentum in chemistry analyzer sales is encouraging given the softness in the overall economy as well as the profitability associated with chemistry consumables.

While we've expected a more rapid increase in sales efficiency, and performance is slightly below our expectations, we are encouraged by the trend. We are continuing to refine our sales organization and continue to monitor performance at a very granular level to ensure that we optimize the investments we have made in the sales force. A very positive development was yesterday's announcement of an important new distribution relationship with MWI Veterinary Supply. This will give us the first access to a national distributor in a very long time. MWI is a leading distributor of animal health products to veterinarians in the United States and United kingdom. Our strategic view is that this relationship is very good news for our business.

MWI sells more than 30,000 products, of which over 15,000 our stocked in its distribution centers. These our sourced from over 500 vendors and shipped to more than 20,000 veterinary practices nationwide from 12 strategically located distribution centers. Since the MWI relationship is quite new, the scale of this opportunity and the associated economics are still imprecise. We look forward to updating you on this relationship as it evolves over the coming quarters. In the meantime, training at many of the MWI locations is complete and training in all locations is scheduled to be complete in the coming weeks. Again we would emphasize that this is the first distribution relationship of this scale that we've ever enjoyed. Importantly, we've had no regional distributor relationships for quite some time, so it will not be necessary for us to manage those business relationships in light of the MWI opportunity.

Another positive development was the October launch of our new state-of-the-art Element DC Veterinary Chemistry Analyzer. Our sales organization has hit the ground running with this new analyzer, and initial response from the marketplace has been encouraging. We continue to believe blood chemistry represents the largest in-clinic testing market, and the Element DC creates a meaningful competitive advantage for Heska. This analyzer provides the speed and ease of use advantages which we believe are exciting in this market. It is faster than our base analyzer, the DC 4000. For example, with panels the Element DC is up to 40% faster. It has a color LCD touchscreen with an onboard step-by-step guide providing simple user operation for all staff members. Enhanced patient staging allows the initiation of a new sample analysis before the current results are complete, a compelling convenience and efficiency boost for busy clinics.

Finally, it utilizes the same consumables as the 4000 and the 7000. We've been looking forward to the launch of the Element DC for some time and are excited it is finally available to the veterinary market. Importantly, it should be noted that this is yet another outgrowth of our relationship with FUJIFILM.

Our sublingual or SLIT allergy therapy rollout has proceeded nicely. This product is formally named ALLERCEPT therapy drugs. We are seeing nice growth potential for this product and positive synergies with our ALLERCEPT diagnostic products. In fact, we are pleased to see modest growth across our entire allergy business both diagnostic and therapeutic products, and we expect more growth in this product area in the future. Allergy is an area where we have a preeminent brand and we expect to strongly leverage our brand and our know how into future product opportunities.

Product development with our Rapid Diagnostek alliance is proceeding. There remains the expectation that the initial product offering can be completed next year. However, in our preliminary budget work we have not planned on 2013 revenue associated with this product platform. 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. While we are pleased with the relationship, progress has simply been slower than expected.

Further to growth, we are currently in exclusive negotiations toward acquisition of two different entities. In both cases, there our products involved that fit directly into our strategy of providing advanced diagnostic and specialty product solutions. Both acquisitions would include new product offerings and revenue. We intend for both transactions to be accretive in 2013. The first of these transactions, the largest, could be done by the end of this month. And the second transaction could be complete by the end of next month. We have no need to do an additional capital raise for either of these transactions. I will now turn this over to Jason, he'll provide detailed information on our financial results.

Thank you, Bob and thanks to everyone who joined the call. Our third-quarter 2012 revenue was $16.9 million. This compares to $17.6 million in the prior-year period. Revenue for the nine months ended September 30, 2012 was $54.4 million, compared to revenue of $54.6 million in the prior-year period. Core Companion Animal Health revenue was $13.5 million in the third quarter of 2012, a 5% decrease as compared to $14.3 million in the prior-year period.

Key factors in the changes were lower revenue from our canine heartworm preventives and our heartworm diagnostics in the United States. Revenue for our Other Vaccines, Pharmaceutical and Product segment, or OVP was $3.4 million, an increase of approximately 1% as compared to the prior-year period. Greater sales of both bovine biologicals, somewhat offset by lower sales of cattle vaccines for distribution in Mexico, was a factor in the increase. Gross margin was 39.8% in the third quarter of 2012, an increase of 1 percentage point from 38.8% 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 as Bob has already mentioned.

Total operating expenses for the third quarter of 2012 were $6.8 million or 39.8% of sales, compared with total operating expenses of $6.4 million or 36.5% of sales in the prior-year period. Selling and marketing expenses were $4.4 million in the third quarter of 2012, an increase of 16.7% as compared to $3.8 million in the prior-year period. Increased costs related to more sales force personnel was a key factor in the increase.

Research and development expenses were $180,000 in the third quarter of 2012, a decline of approximately $131,000 from $311,000 in the prior-year period. The largest factor in the change was lower payments to third parties related to product collaborations in the 2012 period as compared to the 2011 period.

General and administrative expenses were $2.2 million in the quarter, a decrease of approximately $163,000 from $2.4 million in the prior-year period. A reversal of accrued expense related to our Management Incentive Plan, or MIP, recognized in the 2012 period as compared to an accrued MIP expense recognized in the 2011 period was a key factor in the decline.

Total operating expenses for the nine months were $22.3 million, or 41% of sales, compared with total operating expenses of $19.8 million or 36.2% of sales in the prior-year period. In the quarter, the operating loss was $27,000 compared to operating income of $408,000 in the prior-year period. In the first nine months of 2012 operating income was $1.4 million compared to $2.8 million in the same period of 2011.

For the nine months depreciation and amortization was $1.3 million as compared to $1.6 million in the prior-year period. The change relates to instruments for customer rental which were fully depreciated in the 2011 period. In the third quarter of 2012, we had $16,000 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 to the prior-year period when we had $64,000 in income on this line item. A lower foreign currency gain was a key factor in the change.

In the third quarter of 2012 loss before income taxes was $11,000, compared to income before income taxes of $472,000 in the third quarter of 2011. Total income tax for the third quarter of 2012 was $21,000 as compared to $184,000 in the third quarter of 2011. We recognized a tax expense for the 2012 period due to the impact of nondeductible expenses at low profitability levels. Net loss in the third quarter of 2012 was $32,000 or $0.01 loss per diluted share. This compares to net income of $288,000 or $0.05 per diluted share in the prior-year period.

Net income for the first nine months of 2012 inclusive of a $457,000 deferred income tax expense was $814,000 or $0.15 per diluted share. The largest component of our tax expense in this period is a deferred tax expense. It is important to remember that this is a non-cash 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.

In the first nine months of 2011 we had net income of $1.7 million or $0.31 per diluted share in the first nine months of 2011. The first nine months of 2011's net income is also inclusive of an $884,000 deferred income tax expense.

Turning to the balance sheet, we had $5.7 million in cash. This translates to $1.07 per basic share in cash. Working capital was $18.1 million as of September 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 of 2011.

During the third quarter of 2012 we announced both an odd lot tender offer and a dividend payment. The odd lot tender offer expired on October 22, 2012 with approximately 4,000 shares tendered. A $0.10 per share dividend was paid on October 10, 2012. As you can see on the summary balance sheet this dividend payment totaled $536,000.

Other than to say we expect revenue and gross margin to increase in 2012 as compared to 2011 we will not be giving any guidance on this call. We've not finalize the details around our initial stocking order with MWI and the potential impact of the two acquisition opportunities that Bob just described make this a wise course of action. We will have no comment on the two acquisition opportunities other than to say that we are operating under the exclusive right to negotiate on both. We believe it will be possible to close one in November and one prior to year end assuming we agree on economic terms with the third parties involved, and that one would represent an expansion of our diagnostic product offerings. We believe this later acquisition would lead to a significant and exciting commercial opportunity for our Company going forward. With that, I'll turn the call back over to Bob.

Thank you, Jason. I would just like to close our comments by making a few summary points about our outlook for the future. Various competitors and industry participants continue to report relatively soft third-quarter results. We've seen reports of around 1% improvement in veterinary clinic same-store sales in Q3. This suggests growth that is positive but not robust. We've also seen slower revenue growth trends with competitors from the ex-manufacture perspective. However stagnant the overall market appears to be, we intend to get more efficiency out of our sales force and create growth opportunities.

In addition to these macro factors competition is also a factor. We continue to compete with two direct competitors that bundle reference lab services and in-clinic analyzers. That competition is as significant as ever. We continue to expand our relationships with independent laboratories to create intercompany bundles as needed. However not every customer wants a bundle deal and we have success in those cases as well. We continue to believe in the value of these collaborative relationships as opposed to building a new national reference laboratory network alone.

The analyzer business remains highly competitive with low or no initial cost, an important factor with many customers. We've 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 required monthly payment. Heska will generally recognized 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're doing more frequently no revenue is recognized upon the placement It will be recognized only if the analyzer is used over time.

While investors may see an absence of initial revenue from an analyzer sale in the short-term, we expect these Heska-owned placements to lead to long-term recurring highly-profitable consumable revenue. This scenario played out in our third quarter as we placed initial analyzers in this way but have not yet recognized the associated revenue.

We expect to manage toward optimal financial results despite growing uncertainties in the broader economy. In that regard we will be mindful of all discretionary expense opportunities to optimize our bottom line in 2012. We remain committed to key investments in our sales force, product development opportunities, and appropriate acquisitions, all to our growth into the future. 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)

Chris Armbruster, B Riley and Company.

This is actually Marcelo Choi in for Chris. First question, competition has really intensified in the last few quarters with increased bundling. And pressure due to fund the placement of some instruments? When you look at what differentiates your product, why a customer would go with your offerings, what are some of the Heska selling points for customers?

Sure. Again, it's hard -- this is a conversation that we'll need to make -- I'll condense it. The longer discussion is obviously a great deal longer, but let's focus for example just on the Element DC that we just launched. I mentioned that it was 40% faster than our prior offering with the 4000, the base level analyzer speed is a big deal in this market we believe as well as cost. I would say that in this regard we are significantly faster for example in the bed scan as well as significantly faster than our 4000, and I would say the cost of entry is really very, very acceptable and also cost per test is either comparable to or better than the direct competitors with this analyzer.

I talked about the various other benefits and features in the course of the call, I won't plow back through those, but again speed, cost of use are both appreciated in hospital and both are featured. I think that also in our case we continue to believe and encourage others to listen to the commitment that we've made in service. We've got a really world-class service organization, great systems around that area, and as a result a lot of trust with our brand that wraps around both the speed and value piece that I described.

Great. Thank you for that color. Unrelated questionnaire, how does that MWI distribution agreement affect your internal sales and marketing efforts, and the team you've assembled so far? And how should we think about that line item expense on the income statement changing as we move forward?

Sure. And again, I'll just have to go in general terms as Jason said for the various reasons he described we are not talking specific numbers.

Sure.

I see it sort of as a force multiplier of the direct sales effort. We've got, as we described before, we've got a number of positions out there some three dozen people out doing direct sales in the field with inside sales and if you overlay the MWI expertise and their geographies, again a force multiplier. As you think about it from say an income statement standpoint, as we think about it internally we think about a higher than otherwise expected revenue trajectory with a lower than historical gross margin, pro forma, because of the discount that we'll pay to them and as we report net revenue. But if you'll forgive the expression net, net the top line should benefit. And again it's very good news for our business and for investors alike.

Great. And just last question. Do you have an update on PetTrust Plus and what has FidoPharm done to sort of adjust the product's disappointing start so far?

I'm not sure what they've done entirely, I know they're talking to other distribution channels. Frankly we don't have access to that dialogue but I would say that it has remained a disappointment, Chris, from the original forecast that we were given. Very significant disappointment. And we're not seen any uptick to date.

Great. Thank you so much for your time.

Joe Munda, Sidoti.

Real quick, how many analyzers did you place in the quarter?

We don't disclose, as a third player in a three ended market we just don't get into disclosing analyzer placements, we don't see it as providing any competitive advantage, just the opposite.

Okay. Can you talk about the new consumables that are associated with the analyzer? Are we going to see similar margins on these consumables?

Right exactly you're talking with respect to the Element DC, the new chemistry analyzer offering. I mentioned in the course of the call in my remarks and I might've gone over too quickly, we're using exactly the same consumables with the same economics that we've used for the 4000 and the 7000. And I think with respect to analyzer placements, again get you focused on the remarks that I made about year-over-year third-quarter analyzer, chemistry analyzer placements were up 95% in '12 as compared to '11.

Okay. So really what the improvement here is speed and ease of use like you are saying, is there any price difference? Are we seeing a higher unit price or I mean how can we look at that?

Right. No I think with volumes -- at some level, if you just look at our financial statements, look at our income statement into the future, as we get more and more of the trailing effect of these consumables with greater aggregate placements, you will see in that mix a growth in consolidated gross margin.

Okay. And then, I think also in your prepared remarks you guys mentioned revenue and gross margin in 2012 will be higher than it was in 2011. What are you guys seeing in the fourth quarter? Can you guys give us a little bit more color on what you anticipate? Are you seeing I guess more customers coming in? What are you guys seeing where you're expecting revenue to be higher year over year?

Sure. I don't -- again we didn't have any formal comments around guidance for the fourth quarter, but I would just -- if you are new to the story, you'd appreciate the impact of a new analyzer and the fact that analyzer placements tend to be heavy in the fourth quarter, capital purchases tend to be greater toward the end of the year in this particular market. And I think -- I also made remarks about our allergy franchise continuing to grow. Those are a couple of things that you could think about.

Okay, thanks, guys.

(Operator Instructions)

Ben Haynor, Feltl and Company.

So I know you said you wouldn't comment on these potential acquisitions, but you did mention that you wouldn't have to turn to the capital markets. Should we read into that, that, that will be funded out of cash and a line of credit? Or a stock transaction?

I think those would all be on the menu. But the transaction isn't done and the terms haven't been settled but those would be on the menu, Ben.

Okay. Thank you. And then on the gross margin during the quarter, do you kind of see this as maybe a baseline to improve from in terms of gross margin going forward?

Well, it gets a bit tricky with the advent of a distribution relationship. As I said we're trying -- we're watching this MWI relationship expand, evolve. I mentioned that there a bit -- we will reflect the discount that they take on the income statement as a net revenue so there will be downward pressure on consolidated gross margin as a result of that. But otherwise after this prior quarter we noted a lot of pressure from the OVP margin on our consolidated gross margin we've been trending up pretty nicely on a regular basis. So no straight remark there and no straight conclusion, but those are the things that I would think you would want to take into account.

Okay, great. And the training with MWI that should be wrapped up pretty quickly? How many locations do you have left, or meetings do you have left?

At this moment I couldn't tell you exactly. It's something lightly less than half were done three or four days ago, but we're on a pace to finish them comfortably before the end of the year.

Okay, great. That's all I had. Thank you very much, guys.

Ken Trbovich, CK Cooper and Company.

Just curious, I know obviously you've given some stats on the analyzer placements. Can you give us some color on the consumables side? There's obviously been a lot of concern industry-wide about the outlook for vet visits, trying to get a sense to whether that's had any impact on the consumable growth.

Right. We're still working on that and a lot of these higher impact numbers that we talked about in placements are relatively recent, so it's hard to sort of capture a really responsible equation for you, Ken. But I would say off the top of my head that anecdotally, semi-quantitatively if you prefer our sense is that consumable usage isn't robust as you might've expected in prior years or prior periods. There is probably an effect of foot traffic to the veterinary hospital there.

Okay. And then just as a follow-up -

It's still a robust proposition I would add, though.

Sure, because of the installed base there's obviously a large installed base and potential to grow with Element?

Yes, absolutely.

Okay, and just as it relates to the launch of Element, the timing of the launch certainly it looks as though it slipped into the fourth quarter, can you give us some color and maybe a comparison between these launch delays some of which you can control and others you can't and give us some color around those? Because I understand obviously with RDI it's a research project that obviously at some point we expect to come to market but has been set back. The Element seems like it's maybe a different scenario and was curious if you can give us some color on the?

Well I would say, in terms of specific color I would say that the Element DC was delayed a number of months beyond what we'd expected say a year ago at this point. We would have expected it in the spring and rather we got it in October. I think it's also very definitely affected in the development side of it in Japan by the Tsunami and all of the associated power issues and closures. That certainly had an effect. But I think just broadly as we've talked before and begin to talk more openly last quarter, we're going to be a lot more circumspect about projecting completion dates whenever a third party is involved. And whether it is research or whether it's in development and whether it's an act of nature like that or simply company situations and priorities.

Got it. And then just with regards to the product launches, does this sort of with the launch of the Element does this round out the planned launches you had for this year?

Yes.

Okay. Thank you.

(Operator Instructions)

Jonathan Block, Stifel Nicholas.

Bob, maybe just the first one and my apologies I was sort of jumping on and off the call, but on the Rapid side, I believe you said that, that's delayed from what had been I believe maybe a second-quarter timeline to hopefully sometime in '13, but you're not going to go ahead and detail it as something to be 2013, is that correct?

I think that sort of this is a derivative conversation from the one I just had with Ken. Yes, I am taking -- we're gauging a lot more conservatively the timelines that were provided by third-party developers.

Okay.

Put it that way.

Fair. And if you can speak to the distribution opportunity, is this something that you need? I think people feel by and large that the Rapid market is going to be a little bit easier to penetrate than that of chemistry just because of call it the sunk cost on the analyzer and replacement market et cetera, is there something that you feel like you needed the multiplexing to go ahead and successfully change the landscape there with MWIV or do you think you can still have some success in the Rapid market even absent that new product?

I think we definitely can. We definitely can. There's a great market for it out there, it's got the heartworm test if you're talking about that, the Solo Step CH has had a great brand, a great following for years, just the shear numbers if you will feet on the street it's going to be very, very helpful with a product like that where there isn't a big detailed sale but what you need is reach. And I think that and similar products, our health screen line for example, even awareness around allergy and the like would be good. And I wouldn't really discount too much the eyes and ears of those distributor reps in the various hospitals where there may be sunk cost to some degree or another but there may be a lot of dissatisfaction with competitive product offerings.

Okay. Very helpful. Maybe just two more if I can. Just to be clear I'm not -- wasn't too familiar with how your pricing on the chemistry side, so if you got someone like MWIV who now with an open channel they're going to possibly have an IDEXX in the back just analyzer and they've got yours. You're saying arguably yours is going to be the one that carries no upfront cost and it's more the consumable stream thereafter?

No, no I'm sorry if that was confusing, I'm just saying are cost of entry is very reasonable and comparable to others, arguably lower than Catalyst simply on a retail basis. On a comparable cost or on a cost per test we are either very comparable or better than IDEXX or VACIS. That's a broad brush way to look at the economics here.

Understood. Perfect. And the last one for you, just sitting here in the middle of November and obviously a lot of noise at least recently unfortunately on the East Coast as what's going on from a weather perspective. Is it just more of the same? I know you don't want to detail by week and I don't expect you or want to do that but, just in terms of trends what you are seeing out there, is it more of the same? Has the noise picked up unfortunately due to some adverse weather recently? Can you speak to what's going on recently out there?

Well, sure. Let me make sure I understand what you mean by noise.

I'm sorry just underlying demand if you would in the vet practices and then maybe taking into account the noise or bad word I should say adverse weather that we've experienced recently on the East Coast?

Sure. Again it still feels like it was -- I don't know how to go back, this is lots of anecdotes, lots of metaphors, adverbs, what have you. But if you go back to first quarter, it felt like we were pulling out of a trough, and then in second quarter it felt like it slipped back, this still feels a lot like second quarter I would say. And as I try to characterize in my remarks 1% same-store sales a couple of different lenses to see that as they've been reported. It's positive but it's not particularly robust and the challenge is just up to us to make sure that we do better than that average. It's not exciting out there right now. There's concern as you mentioned the weather, certainly there our places that our going to be closed down for a long, long time, and quite some number of them, there were delays in shipping et cetera, there at the end of October as a result.

Understood. Okay, Bob, thanks for your time.

We have no further questions at this time I will turn it back to Management for any closing remarks.

Thank you, sir and I would like to express our thanks to the participants. We look forward to sharing our progress with you in the coming months. Thanks all of you for your interest in Heska and for taking the time to join us today. Goodbye.

Ladies and gentlemen this concludes the Heska Corporation third-quarter 2012 earnings conference call. If you would like to listen to replay of today's conference please dial 1800-406-7325 or 303-590-3030 with the access code of 457-4481. AT&T would like to thank you for your participation. You may now disconnect.