Heska Corp (HSKA) 2013 Q1 法說會逐字稿

Welcome to Heska Corporation's First Quarter 2013 Earnings Conference Call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for your questions. (Operator Instructions) Today's conference is being recorded, May 14, 2013. I would now like to turn the conference over to Brett Maas of Hayden IR. Please go ahead.

Thank you all for joining us today on our conference call. On the call today with us are Heska Corporation's Chairman and Chief Executive Officer, Dr. Bob Grieve, and Jason Napolitano, Heska's Chief Financial Officer. We appreciate having the opportunity to review the results for the first quarter 2013 and provide an update on the acquisition of Cuattro Veterinary USA. Prior to discussing our results, I'd like to remind you that during the course of this call, we may make certain forward-looking statements regarding future 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'd like to now turn the call over to Bob Grieve, Heska's Chairman and CEO, to provide opening remarks. Bob, the floor is yours.

Thank you, Brett. I'd also like to thank everyone for joining the call today. Our first quarter of 2013 was a significant start to what we expect be will be a year of integration, as well as transition to a newly transformed company that will encompass the highly efficient and scalable operational systems of Heska with a rapidly expanding imaging and cloud data hosting technology that we acquired with the Cuattro Vet acquisition. This combination will provide structure and strategies for our commercial team, all focused on future growth and sustainable profitability. In my opinion, this merger significantly changed the trajectory of Heska. As we navigate the integration process, I believe we will emerge in a far stronger competitive position. As I described in more detail in our last call, this acquisition is a unique opportunity to accelerate our growth, augment our product lines, and solidify our team with exceptional and proven talent.

More specifically, Cuattro Vet provided Heska with a best in class digital radiography product line; one that is complementary to Heska's own current advanced diagnostic product suite. As a result, this acquisition allows us to bundle solutions in a way we could not before. For the first time, Heska will be able to bundle outside our core lab offering, elevating our competitive position. One of our key competitors in the analyzer business lacks both ultrasound and digital x-ray products, while the other does not have an ultrasound offering. Heska now has a complete solution and we believe we have the superior digital radiography offering in head to head comparisons. We see other strategic benefits of this acquisition as well. We see the potential for cost efficiencies as the integration progresses.

We believe this combination bolsters our opportunity to develop and enhance pipeline of products. Finally, we see powerful cross-selling potential. Each time a customer is touched, there are now more offerings to present. The key part of the integration, which is proceeding according to our plan, is the combination and re-organization of our newly strengthened sales team. The two sales forces have little to no duplication and we are hard at work to develop a structure, arrange areas of responsibility, and train both teams to maximize what we believe are compelling cross-selling opportunities. I'm happy to report that this new important integration of the Cuattro sales team and the transition new strategies and tactics are both well underway. All Cuattro Vet sales personnel are now Heska employees, focused on the Heska imaging business.

We have completed the initial training of former Cuattro Vet personnel in Heska products. As a result of this effort and thanks to the professionalism of both teams, mutual lead generation and the cross-selling opportunities I just spoke of are already being realized. As part of this re-organization and consolidation, we've reduced the field sales team by 13 positions at the end of April; retaining those people who demonstrated top talent and capital equipment sales. This streamlined organization will focus on sales of our blood analyzers, working directly with Heska Imaging sales personnel. As a result of this transition, our combined field sales headcount is now 31, with approximately 20 inside salespeople focusing on lead generation, consumable sales for blood analyzers, and our single use products, such as our Solo Step heartworm diagnostics and our health screen products. Integrating the two sales organizations and making sure our personnel, strategy, and tactics are all aligned is critically important for our management team. I began this call speaking about a period of transition here in 2013.

This effort regarding our sales organization is of paramount importance to that transition as it will be the primary driver of growth in 2014 and beyond. When evaluating the Cuattro Vet acquisition, access to top talent, both in senior leadership and in sales execution around capital equipment, was a powerful consideration. Heska has struggled for some time to create the optimal go-to-market strategies with capital equipment. By contrast, the Cuattro Vet team has done this creatively and successfully over many years. Now, we are providing this proven team a more comprehensive solution, bundling, and cross-selling opportunities and sophisticated support. Leveraging this new advantage is our primary focus. Another area of focus is our new relationship with MWI Veterinary Supply, a leading distributor of animal health products across the United States and the United Kingdom.

MWI sells more than 30,000 products; of which, over 15,000 are stocked in its distribution centers. These are a source from over 500 vendors and shipped to more than 20,000 veterinary practices nationwide, from 12 strategically located distribution centers. I will now turn this over to Jason. He'll provide detailed information on our financial results for the first quarter of 2013.

Thank you, Bob, and thanks to everyone who joined the call. Our first quarter 2013 revenue was $19 million, down 1% compared to $19.2 million in the prior-year period. On February 24, 2013, we completed the acquisition of Cuattro Veterinary USA, LLC, which was subsequently re-named Heska Imaging US, LLC and which I will refer as either Heska Imaging or Cuattro Vet USA. Heska Imaging's financial results are included in our consolidated first quarter 2013 financial statements from February 24 to the end of the quarter on March 31. In this period, Heska Imaging contributed approximately $1.9 million in revenue and $75,000 in income before income taxes. We've calculated Heska Imaging's historical results using our more conservative accounting standards, which we intend to apply and report post acquisition. Using this approach, Heska Imaging had approximately $1.65 million of revenue in the first quarter of 2012.

For the full first quarter of 2013, Heska Imaging's revenue was $2.75 million. This represents a 66% increase year over year, so we continue to be pleased with the performance of Heska Imaging. We do not expect to comment further on Heska Imaging's historical performance prior to acquisition on today's call. Core Companion Animal Health revenue, which included the results from Heska Imaging after February 24, was $15.6 million in the first quarter; approximately a 6% decrease as compared to $16.6 million in the prior-year period. Key factors in the decline were lower revenue from both international and domestic sales of our heartworm diagnostic tests, dramatically lower sales of our heartworm preventive to FidoPharm, lower revenue from our international allergy business, and lower sales of our instrument consumables. This was somewhat offset by Heska Imaging revenue and revenue from domestic sales of our heartworm preventive to a unit of Merck; the latter of which almost fully offset the year over year shortfall in sales from FidoPharm. Our unit volume for domestic sales of our heartworm diagnostic tests was essentially flat year over year, with price declines almost exclusively responsible for the year over year change.

MWI, a large national distributor who took a large stocking order of our products in the fourth quarter of 2012, sold more of our heartworm diagnostic tests into the field than it reordered from us. We believe our unit volume actually increased over 20% year over year with end users; although, again, pricing pressure led to a total revenue decline using this metric. We believe there are similar competitive pressures on our Japanese distributor, Novartis. However, it is important to remember that Novartis purchase patterns tend to be lumpy in this area and are not consistently made in the same quarter year over year. We've already shipped a large order of our heartworm diagnostic tests to Novartis in the second quarter, which will make up a large portion of the year over year shortfall we saw in the first quarter. We continue to be disappointed by the performance of FidoPharm with our heartworm preventive. Although FidoPharm was purchased last month by [Parago], there's been no visibility on their future plans with PetTrust Plus.

Accordingly, we are not planning on future material purchases from FidoPharm. The year over year decline in our international allergy business is related to the loss of a large customer. We believe our decline in instrument consumables was related to ordering patterns from MWI, where MWI sold more consumables into the install base than it reordered from us. Our consumable revenue increased when measured at the end user level. We believe MWI's ordering patterns will normalize in the near future.

For the first quarter, revenue for our Other Vaccines, Pharmaceuticals, and Product segment, or OVP, grew approximately 28% at $3.3 million compared to $2.6 million in the prior-year period. Sales of cattle products for international distribution and sales to a new customer contributed to the increase. We generated $7.8 million in gross profit in the first quarter of 2013; including approximately $683,000 in gross profit from Heska Imaging, which was less than the $8.9 million in gross margin we generated in the first quarter of 2012. Gross margin was 41.1% in the first quarter compared to 46.5% in the prior-year period. A shift in product mix was a factor in the decline.

Total operating expenses were $8.5 million, or 44.7% of sales, compared with total operating expenses of $7.8 million or 40.9% of sales in the prior-year period. Selling and marketing expenses were $5.1 million in the first quarter; an increase of 4.6% as compared to $4.9 million in the prior-year period. Heska Imaging sales and marketing expense of $416,000 recognized in the first quarter of 2013 but not 2012 was the key factor in the change. Research and development expenses were $390,000, which included approximately $17,000 in expense from Heska Imaging in the first quarter of 2013. This represented an increase of 16.8% or approximately $56,000 from $334,000 in the prior-year period. The largest factor in the change was the reserve for equipment that had been previously used in a project that was recently discontinued.

First quarter 2012 general and administrative expenses were $3 million, including approximately $153,000 in expenses from Heska Imaging. This represents an increase of approximately $350,000 from $2.6 million in the prior-year period. For first quarter 2013, general and administrative expenses were $3 million, including approximately $153,000 from Heska Imaging, and that compares to $2.6 million in the first quarter of 2012. Expenses related to the acquisition of Cuattro Vet USA on February 24, 2013, were a factor in the increase. We had depreciation and amortization of $474,000 in the current quarter, the first quarter of 2013, up from $413,000 in the prior-year period.

In the first quarter of 2013, our operating loss was $682,000 compared to operating income of $1.1 million in the prior-year period. In the first quarter of 2013, we had $11,000 in net interest and other income. This primarily relates to currency gains. This compares to the prior-year period when we had $142,000 in net expense on this line item, which was primarily related to currency losses. We recognized $6,000 of current tax expense in the first quarter of 2013 related to our Swiss subsidiary.

We also recognized a deferred tax benefit of $325,000, which served to increase the total deferred tax asset on our balance sheet. Total tax benefit was $319,000, as compared to a tax expense of $356,000 in the prior-year period. The changes related to a loss before income taxes in 2013 as compared to a gain before income taxes in 2012. Net loss in the first quarter of 2013 was $352,000. This compares to net income of $584,000 in the prior-year period.

Investors will notice we have two line items related to our acquisition of Heska Imaging -- net income or loss attributable to non-controlling interest and income or loss attributable to Heska Corporation. The former relates to the 45.4% interest combined minority interest holders have in the taxable income of Heska Imaging. In contrast to the 54.6% interest Heska Corporation has in this taxable income, which can be used to absorb Heska Corporation's large federal domestic net operating loss position for tax purposes and which is recognized as taxed at Heska Corporation's estimated tax rate for GAAP purposes, the 45.4% minority interest is not reported as taxed at the corporate level as all tax on this income is to be paid at the individual level. Net income or loss attributable to Heska Corporation is calculated by deducting the net income attributable to these minority holders from net income. Net loss attributable to Heska Corporation in the first quarter of 2013 was $386,000 or $0.07 loss per diluted share. This compares to net income attributable to Heska Corporation of $584,000 or $0.11 per diluted share in the prior-year period.

Turning to the balance sheet, you will notice we added several line items for which we had a zero balance at year-end; all of which relate to the acquisition of Cuattro Vet USA. As part of the acquisition, we obtained a $1.4 million note payable from Cuattro Veterinary LLC, Cuattro Vet USA's former international affiliate, which has international rights to sell the same digital radiography products as Cuattro Vet USA does in the United States. The note payer's interest at the same rate is our revolving line of credit with Wells Fargo and is due on March 15, 2016. We also have approximately $1.5 million in notes and other short-term borrowings currently on Heska Imaging's balance sheet; $468,000 of which is classified as long-term, as it is due more than a year from the closing balance sheet date.

You will note we have a non-controlling interest line item on our balance sheet of $12 million. This number represents the value of the minority holders' position in Heska Imaging. We estimated a weighted average valuation for this position and are a creating to this value over three-year period using a weighted average cost of capital of 18.65%, which was provided to us by a third party. This accretion does not flow through the income statement, rather, the offsetting debit is to retained earnings. We intend to evaluate the ultimate valuation every reporting period and adjust the accretion accordingly, if necessary.

Beneath the non-controlling interest line, you'll note we have a line item entitled public common stock subject to redemption. This represents the stock we issued to acquire our position in Cuattro Vet USA, which may be used to meet the purchase obligation if a call for convenience is exercised. We intend to mark this line item to market every reporting period with a corresponding debit or credit to additional paid-in capital. A third party estimated the value of the Cuattro brand at $688,000 and an amortization period of 2.75 years for this asset. This intangible asset is valued on our balance sheet as of March 31, 2013.

The annual amortization is estimated to be approximately $275,000 based on these values. This is the only intangible asset we intend to amortize related to the acquisition of Cuattro Vet USA. We closed the quarter with $5.5 million in cash. This translates to $0.94 per basic share in cash at quarter end. Working capital was $12.2 million as of March 31, 2013. Our short-term debt was $6.1 million. This included $5.1 million on our line of credit; up since year-end, due in part due to the cash paid in the acquisition of Cuattro Vet.

Following the acquisition, our new President consciously took a hands-off approach to the quarter, so as not to hinder results, but also so all relevant individuals owned the results and could be held accountable accordingly. Following the end of the first quarter of 2013, we terminated employment of several individuals in our sales area, at an estimated severance cost of approximately $300,000, which will be included in our second quarter results. We estimate that this will result in annual savings of approximately $1.4 million, although we only expect to generate approximately $900,000 of such savings in 2013, as the impact will not occur over a full year. In addition to lowering our sales costs, we anticipate lowering our marketing spend by approximately $600,000 this year over what it previously would have been.

Essentially, the quarter we just reported is not representative of the benefit of our new leadership. We are very excited to continue to pursue efficiencies and synergies in our business, to enhance our profitability, and set the stage for future success. The integration of Cuattro Vet USA and changes in our commercial structure strategies and tactics are anticipated to be very helpful to the business, but these changes also make it difficult to project financial results. Accordingly, as we announced on our last call, we will not be providing guidance nor commenting on future financial results today. With that, I'll turn the call back over to you, Bob.

Thank you, Jason. In January, we launched an important distribution relationship with MWI Veterinary Supply. We have found them on a capable partner, a professional organization that is well-led and well-managed. They give us in additional feet on the street and augment our eyes and ears when talking to customers. Though this relationship is in its infancy, already MWI has been insightful and responsive with our well-recognized and strongly branded products, such as our Solo Step heartworm tests. They have been helpful in retaining existing customers and finding entirely new accounts who could successfully use our products.

As this relationship evolves, we are still working to find the best way to accommodate analyzer and consumable products with them. Competition in this arena is fierce, but we are hopeful that, by working with MWI, we will have more opportunity to get our analyzer products in front of more potential customers. As we have discussed since the time of our November 2012 announcement of this relationship, we must manage both this new opportunity and the associated risk to our business; particularly in the area of consumable sales. Simply put, we need the value of analyzer placements with affiliated consumable sales through this channel to exceed the consumable margin that we risk losing by sending our previous base consumable business through their warehousing and fulfillment processes. We and MWI management are aware of the need to find that balance to optimize growth for both companies. Nevertheless, we're pleased to have such an excellent partner, one with creative and innovative ideas.

I'm confident that we will mutually optimize the relationship as it continues to evolve. As we focus on aligning our commercial organization with the appropriate sales channels, we continue to have a proactive strategy to develop and deliver new products to enhance and expand our existing product lines, as well as those that will fill demand in the new channels. We have entered probably one the most notable and challenging periods in Heska's corporate history. As a team, we are tremendously energized and excited to create an entity that will enhance shareholder value. For the remainder of 2013, we look forward to transforming Heska, leveraging the assets we have acquired with Cuattro Vet USA, as well new sales channels like the MWI relationship.

Heska maintains strong, well-recognized, and well-regarded brand and best in class products and service that will meet customer needs. As we work to achieve our integration and transition goals, we look forward to pursuing the many opportunities for growth in 2014 and beyond. Thanks for your attention today and we appreciate your continued interest in and support of Heska. At this time, I would like to turn this over to our moderator for purposes of conducting the question and answer session.

(Operator Instructions)

Chris Armbruster, B Riley and Company.

A lot to digest in this release. My first question is going to be, are you able to talk to us about operating margin goals for the out years? How accretive do you think the Cuattro Vet acquisition could be over time? I understand that this year is maybe a transition year, but have you talked about any kind of longer term goals about where you think it can help the business get to?

Short answer is no. We have said that we expected this acquisition to be accretive and we can reaffirm that, but, to the extent that we haven't been able to give guidance, it's due in large measure for the reasons that we outlined. Until we get to steady state here and have a look into the future, we just haven't had that, we haven't done that modeling, and any suppositions would be reckless there, Chris.

Okay.

Chris, we did say on the last call that if you look at that operating agreement, the year three data was there.

Yes.

Estimated financial results at that time, their projected financial results at the time of acquisition. I'd refer you to that operating agreement which was filed with our K if you want to get a sense of some of the numbers we were looking at.

Right. Okay. On the MWI agreement, I know you got the initial stocking order. How much of, and I know you talked about some of the additional orders not happening yet, but can you quantify what impact they had on orders for the quarter?

Again, I think what we've said before and [guess] before or we're assuming before it's played out, that reorders are varying by different product lines and various of these different strategically located distribution centers, Chris, I would say we called out a couple of instances where they sold out more than they reordered. I still think, I described it as being, this relationship in its infancy, it's going to be another quarter or so, maybe longer, maybe two quarters, before we get a sense of equilibrium here on this reorder rate.

But I would expect this quarter to be the most pronounced, Chris, and we expect it will normalize fairly soon.

Right. On the gross margins, definitely a mix movement here. The gross margin level, would you expect it to be down around this range, because historically it's been a little bit higher? Are we looking at a new dynamic as far as gross margins go, being a little bit lower over time?

I would say, again, it's too hard to say just yet for the reasons that I've described before, but also point out, as Jason did in his narrative, that in the prior-year period, we had a substantial PetTrust order at very high gross margin that basically did not reproduce in the current quarter, which affected both revenue and gross margin in the quarter. We and you have discussed that product and it's disappointments in the past.

Right. Okay. Sounds good. Thanks, guys.

(Operator Instructions)

Ben Haynor, Feltl and Company.

You said that the Cuattro people have had their training done on Heska products. Have the Heska people not had their training done on the Cuattro products or is that in process? Where are we at on that or did I just mishear?

No, that's a great question. It's a very good question. The exposure that the Heska field salespeople have had have been, I would say, more -- it's been briefer and more superficial than the other way around. Specifically, all the imaging people who have been here at Heska headquarters in Colorado have gone through intensive training, whereas the people out doing field sales on the Heska legacy business, the analyzers and so forth, have not been brought in to the office for similar training on the digital imaging products. However, certainly, they've been exposed and again, customer lists are being shared, lead generations, et cetera, as we described.

Is there a plan to have them do some in-depth training there or is the Cuattro sales force going to focus on the Cuattro sales having the people or the Heska field sales force bring in the Cuattro people when they have a hot lead so to speak?

Right. What we're seeking here at some point is get more exposure and more information, technical information, to the analyzer people, Heska analyzer sales reps. In each case, these teams, as I said, will share sales leads and cross-sell and cross support, but I don't see the imaging people diving as deeply on the blood analyzers and vice versa, I don't see the blood analyzer people diving as deeply on the imaging products as well. There's an appropriate degree of very deep specialization here.

Okay. That makes sense. In terms of placements during the quarter, could you comment on the chemistry side, by any chance?

I'll comment qualitatively.

Okay.

On the chemistry side, the analyzer placements were up year-over-year. But, again, we'll restrict the comments to those sorts of qualitative remarks.

Obviously the weather was a bit difficult in Q1 for a lot of guys. Do you think some of that comes back in Q2? Have you seen the warmer weather we've been having improve trends in the last few weeks?

It depends on where you are in the country, I suppose, with regard to weather and what week and what month. I would say a couple of things. First, as I said, those analyzer replacements were up year-over-year on the chemistry side in the first quarter of 2013 and we were happy about that. I would say also, to the extent that weather patterns shift around and certainly blizzards as you expect, we've enjoyed here in Colorado in the last month or so, that certainly deters sales, but we don't see that as an excuse or a material reason for any sales shifts.

Even on the rapid test, maybe pushing off the vet visits from earlier in Q1 to Q2?

Again, I suppose you could make that case, but let's just isolate on the Solo Step heartworm test, for example. So much of that revenue recognition today would have been booked in the fourth quarter and MWI, they would have sold out. As we said, our unit sales were up 20% in the first quarter to the end user, as you measure it that way. Revenue was challenged because of pricing on that product, but actually unit sales were up. Again, I would also say, so you've got the revenue recognition element in the prior quarter, the use is certainly there in the current quarter, and even as veterinarians, they're going to buy and shelf some of it some of this, not use it immediately, we'll continue to see them use it as they bring in patients and prepare for the heartworm season. It's more seasonal in the north, but certainly year-round in the south. It used to be pretty darn hard to dissect it all, Ben.

Sure.

But we're not going to go with any weather excuses here is the punch line.

Okay. All right. That's all I had for the moment. Thank you very much.

(Operator Instructions)

Molly Armbrister, Northern Colorado Business Report.

I just have a couple quick questions about employment numbers. How many do you employ worldwide and then here in Loveland? Of the staff reduction that you did on the sales team, where, geographically, were those located?

All right. I'd say first, I'd welcome you to call me back on the local land line and we can get into all the granular detail that you want on the northern Colorado numbers. Numbers as fresh as this morning, globally we have, my recollection is, 296 employees. We have more than 100 here in the Loveland headquarters, but, again, if you want to contact me back on the general line, 493-7272, area code 970, I can break it all down for you. As far as the reduction in headcount, it was across the United States. Again, there were four positions that were not filled, that were left unfilled and a total of nine people in field sales and one in management that their employment was terminated. It's not a big number and it was spread across the US.

Okay. Thank you. That's all I have.

(Operator Instructions)

I'm showing no further questions in the queue at this time. I'd like to turn the conference back to management for any final remarks.

Thank you, Alicia. Thanks to all of you for your interest in Heska and for taking the time to join us today. We look forward to sharing our progress with you in the coming quarters. Good-bye.

Ladies and gentlemen, this concludes our conference for today. If you'd like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030 and enter the access code of 4613897, followed by the pound sign. Thank you for your participation. You may disconnect.