Heska Corp (HSKA) 2013 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Heska Corporation's second-quarter 2013 earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and instructions will be provided at that time. (Operator Instructions). I would like to remind everyone that this conference call is being recorded today, August 7, 2013.

I will now turn the conference over to Brett Maas with Hayden IR.

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 second quarter of 2013 and provide an update on the first half of 2013. 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 is not intend to update any forward-looking statements to reflect events that occur after today's call.

I'd now like to 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. This has been an important year for Heska as we transition our entire organization following the acquisition of Cuattro Vet USA. We acquired a majority interest in Cuattro Vet USA, an imaging and cloud medical data hosting technology company, on February 24, 2013. This transaction set Heska on a transformative path that has changed the strategy, structure and scope of the Company for the long-term.

In making an acquisition investment, Heska sought to acquire new product lines, new bundling opportunities, new technologies and significant new talent. We believe we are in the early stages of realizing these benefits.

As I described in more detail on our last call, because of the acquisition, Heska now has a best-in-class digital radiography, ultrasound and cloud-based medical data archival product suite. These products are complementary to Heska's own current advanced diagnostic products. Importantly, these products are key to acquiring the interest and loyalty of the veterinary markets' most coveted, high-volume veterinary practices.

By combining with Heska's existing line of chemistry and hematology technologies, we believe we now have bundling and cross-selling opportunities. The power of two such strong product areas should give us better access to even better customers. Given that one of our key competitors lacks this opportunity and entry point, we believe the opportunity can be very meaningful.

In March, our new President and Chief Operating Officer, Mr. Kevin Wilson, who joined us from Cuattro Vet USA, made the decision to allow the existing sales strategy of Heska's traditional business to continue for the remaining month of the first quarter. In April, following the Q1 results, the combined commercial team under new leadership began a full review of our sales strategies, costs, structure and go-to-market offerings.

In May, a commercial integration and turnaround plan was initiated. Progress has been rapid, certain and robust. As of Q2, Cuattro Vet USA's imaging sales and management personnel have become Heska employees. Cuattro's main global operations have been physically relocated and integrated into Heska's corporate headquarters in Colorado. Cuattro Vet USA's imaging sales team has been trained on Heska's analyzer offerings. Heska's sales teams have been trained on Cuattro Vet USA's imaging and data archival products. Bundling programs and opportunity-sharing between the product lines began in earnest in June.

The combination of the two companies' marketing efforts has resulted in the identification of annual savings of approximately $600,000 through synergies and re-prioritization. The combination of the two companies' sales efforts has resulted in the identification of annual savings of approximately $1.3 million through synergies and reorganization.

The integration has gone extremely well and very quickly. The combination has significantly changed the trajectory of Heska, reduced the sales and marketing costs of Heska and we believe at the same time has enhanced our growth and sales opportunities.

We expect the remainder of 2013 to include optimizing our integration and driving the total transition of Heska into a more streamlined and focused commercial team.

A key part of the integration is the combination and reorganization of our newly-strengthened sales team. The two sales forces have no duplication. In Q2, we intensely focused on and retooled compensation for our field sales force to drive effectiveness in selling capital equipment. At the same time, we have increased the capacity of our inside sales team as they focus on consumable sales, single-use diagnostics, current customer account systems and opportunity identification across all product lines.

As part of this process and the integration of the Cuattro Vet USA imaging, enhancement chemistry and hematology sales teams, we reduced underperforming personnel headcount in the field. We now have an outside sales team of 36, supported by 18 inside sales representatives. This integration was completed in Q2 and the team is now hard at work. We believe this structure will maximize our cross-selling and bundling opportunities.

As part of this reorganization and refocus, we are incurring a one-time charge, mostly related to severance, of approximately $300,000 in Q2.

In addition, in May, we added Mr. [Steve Isle] to our management team as an Executive Vice President, Commercial Operations. Mr. Isle was most recently President of [Chronic Monitor] LLC. He also functioned as President of Sound Technologies beginning in 2000, and working with Mr. Wilson from 2000 to 2004, and following Mr. Wilson's departure until 2011. This timeframe included Sound's acquisition by VCA Antech in 2004. Mr. Isle has an extensive background in medical technology sales.

With the right culture of focus on measurable performance, personal customer contact and an intensity to win in sales, in June, we turned our attention to our go-to-market strategy in some blood analyzers. While we will continue to place these products with variety of strategies, in June, we added a new rental-based approach. This approach includes aggressively-priced consumables, service, support and analyzer usage for one low monthly payment.

This approach has shown early promise. In June alone, we placed 91 analyzers, 69 of which were chemistry analyzers. This compares favorably with the placement of 153 analyzers in all of Q2, 109 of which were chemistry analyzers. While it is too early to comment on the long-term viability of these new programs, the early results show promise. In fact, the trend seems to be accelerating so far into the third quarter.

At the end of Q2, we performed a complete review of our MWI Veterinary Supply strategy and the associated results for the first half of 2013. Competition in the blood analyzer market is fierce as Heska competes for MWI's attention with two strong competitors. In contrast to our direct sales efforts, we have struggled to gain traction in chemistry and hematology capital equipment placements through MWI, a scenario that reflects the risks we have discussed with investors in the past several quarters.

Notwithstanding the disappointment in capital equipment, uptake in unit volume in other Heska products through MWI, such as our Solo Step heartworm diagnostic products and IV pumps, has been more encouraging. In Q3, we will continue to evaluate how to better optimize our effectiveness in working with the MWI Veterinary Supply team.

While launching our reorganization and refocus on what we want to do in the future, in Q2, we implemented a number of decisions to stop or wind down certain less promising or less strategic business lines. We have discontinued long-term support for three such companion animal product lines -- our Feline Ultranasal Vaccines, our legacy SpotChem product line and our VitalPath blood gas electrolyte analyzer product line. Let me elaborate on these decisions.

Our Feline Ultranasal Vaccines work extremely well, but they are not core to our ongoing strategy, as we have no other vaccines that we sell directly. And we do not see either our product development strategy or our sales channel being aligned with additional vaccine business.

Just prior to the end of the quarter, we sold certain non-core assets, including some bovine vaccine seeds, as well as the vaccine seeds and trademarks associated with our Feline Ultranasal Vaccines, useful for the production of both bovine and feline vaccines, to Elanco Animal Health, a division of Eli Lilly and Company. We have had limited direct market involvement in the assets covered under this agreement with Elanco. Monetizing these nonstrategic assets has also helped us strengthen our balance sheet, which will allow us to invest in areas more closely aligned with our strategic focus. We see this as the first hopefully of a series of new opportunities to work with Elanco, which is the fourth-largest animal health company in the world.

Several years ago, we launched with FUJIFILM a series of new chemistry analyzers that replaced our older SpotChem line. For some time, we have sold SpotChem consumables in a tale period and serviced the analyzer for existing customers. Many of these customers have now been converted to our new chemistry analyzer products. As part of our reorganization and refocus, we are now discontinuing the sales of those consumables as we had planned for some time, as well as ongoing analyzer service.

In 2010, Heska reentered the blood gas and electrolyte market with a new product sourced from Roche, branded by Heska as VitalPath. The VitalPath has not been adequately suited for the veterinary market. While the technology works extremely well with a dedicated user and continuous in-clinic operation, that environment rarely occurs in veterinary practice. Accordingly, while we will continue to provide support for the currently installed products, as part of our reorganization and refocus, we've discontinued the further active sale of this product.

I will now turn this over to Jason. He will provide detailed information on our financial results for the second quarter of 2013.

Thank you, Bob. Before I turn to our financial results, I would like to take a moment to thank our Finance and Accounting group for their efforts in closing our books this quarter. Mike Bent, our Controller and Principal Accounting Officer, unexpectedly passed away last May. That the members of our Finance and Accounting group have met their responsibilities so well in Mike's absence is a testament to Mike's leadership and judgment and the quality of people he chose to hire.

I've been Chief Financial Officer here for over 11 years and this is the first quarter reported without Mike. He is sorely missed. As a colleague and as a friend, there was none better.

Our second-quarter 2013 revenue was $18.3 million, down slightly compared to the prior-year period. For the first six months of 2013, our revenue was $37.2 million, down 1% compared with $37.4 million in the prior-year period. Core Companion Animal Health revenue was $15.9 million in the second quarter of 2013, an increase of 1% as compared to $15.7 million in the prior-year period. The largest factor in the increase was $2.7 million in revenue from Heska Imaging.

Another factor was year-over-year revenue from international sales of our heartworm diagnostic test that increased. Investors will recall this business tends to be lumpy, which generally makes trends from year-over-year comparisons more difficult to draw conclusions. These factors were somewhat offset by lower year-over-year revenue from sales of our heartworm preventive, domestic sales of our heartworm diagnostic tests, our international allergy business, our instrument consumables and our hematology instruments.

In many areas, we are seeing the continuation of results we reported in the first quarter. Competition in the domestic heartworm diagnostic testing area remains fierce. We believe the same is true outside of the United States. Both US unit prices and purchases by end domestic users of heartworm diagnostic tests declined in the second quarter of 2013 as compared to the prior-year period in our estimation.

In addition, as occurred in the first quarter, MWI sold more of our heartworm diagnostic tests into the field than reordered from us. Similarly, MWI sold more instrument consumables into the field than were purchased from us in the second quarter after having done so in the first quarter. We believe total sales to end users of our instrument consumables, including from MWI, increased in the second quarter as compared to the prior-year period.

MWI took a large stocking order of our products in the fourth quarter of 2012, which we believe contributed to these ordering patterns. We expect that MWI's ordering pattern will normalize in the near future.

Our heartworm preventive sales were down, both due to lower sales to Merck and Phytopharm on a year-over-year basis. There has been no change in our disappointing outlook for the performance of Phytopharm, which we expect to be down significantly in 2013 from 2012. Our latest forecast for Merck indicates that our heartworm preventive sales to Merck in 2013 should be greater than in 2012, enough so that we expect total revenue from our heartworm preventive to increase slightly in 2013 compared to 2012, even when factoring in the Phytopharm shortfall.

As we mentioned on our first-quarter earnings call, our international allergy business lost a large customer last year, which is the key factor in the year-over-year decline in this area.

For the second quarter, revenue from our Other Vaccines, Pharmaceuticals and Products segment, or OVP, declined by approximately at least 6% to $2.4 million as compared to $2.6 million in the prior-year period. Lower sales of cattle vaccines under our contract with AgriLabs was a factor in the decline.

We generated $5 million in gross profit in the second quarter of 2013, including $691,000 in gross profit from Heska Imaging, which was less than the $8 million of gross profit we generated the second quarter of 2012.

Gross margin is 27.5% in the second quarter of 2013 compared to 44% in the prior-year period. A major factor in this year-over-year decline was an agreement with Roche, which we expect to formalize in the coming days, related to our VitalPath instrument, which Bob has previously discussed and which I will refer to as the VitalPath reserve.

Of the $1.1 million total reserve, $768,000 was recognized in cost of revenue related to the required purchase of new instruments from Roche under the agreement, for instruments already in inventory and for accelerated depreciation on service units. Other components of the VitalPath reserve are for $13,000 recognized in sales and marketing expenses related to accelerated depreciation on demonstration units, $99,000 recognized in research and development related to the purchase of research and development equipment required under the agreement with Roche we would not have otherwise purchased, and $243,000 recognized in general and administrative expenses for other anticipated costs related to this agreement.

Another factor in the year-over-year decline in gross margin is a reserve related to SpotChem that Bob mentioned. This reserve was for $453,000, all of which was recognized in cost of revenue and was for strips and other consumable accessories used with the SpotChem chemistry instrument. We did not have the large sales to distributors of these products we had hoped for and we ran a program to upgrade SpotChem users to our latest chemistry offering, which performed better than we had anticipated.

A third key factor in the year-over-year decline in gross margin was a relative shift in product mix to lower gross margin products. Total operating expenses were $8.6 million in the second quarter of 2013 or 47.1% of sales, compared with total operating expenses of $7.7 million or 42% of sales in the prior-year period.

Selling and marketing expenses were $4.8 million in the second quarter of 2013, a slight increase as compared to the prior-year period. Heska Imaging sales and marketing expense of $762,000 recognized in the second quarter of 2013, but not 2012, was the key factor in the change. This was somewhat offset by lower spending on salaries and travel for members of our sales force.

Research and development expenses were $483,000 in the second quarter of 2013, including approximately $50,000 from Heska Imaging. This was an increase of $280,000 from $203,000 in the prior-year period. Expenses related to the VitalPath reserve as well as the recognition of costs related to other research and development projects were other factors in the increase.

General and administrative expenses were $3.3 million in the second quarter of 2013, including $357,000 in expenses from Heska Imaging. This represents a 21% increase from $2.7 million in the prior-year period. In addition to the new expense related to Heska Imaging, approximately $300,000 in severance expense related to the termination of certain employees and expenses related to the VitalPath reserve were key factors in the increase. These were somewhat offset by lower legal expenses and expenses related to arbitration matters.

Our operating loss in the second quarter of 2013 was $3.6 million compared to operating income of $383,000 in the prior-year period. Operating loss for the first six months of 2013 was $4.3 million as compared to $1.5 million in the prior-year period. Depreciation and amortization for the six months ended June 30, 2013 was $1.1 million as compared to $861,000 in the prior-year period.

We had $52,000 in interest and other expense in the second quarter of 2013, which consisted of $62,000 in net interest expense and $9000 in net foreign currency gains. In the prior-year period, we had $57,000 in income from this line item, which consisted of $34,000 in net interest income and $23,000 in net foreign currency gains.

In the 2013 period, we had greater interest expense, primarily related to interest fund debts at Heska Imaging. And in the 2012 period, we had greater interest income due to interest recognized on overdue receivables, which did not recur in the 2013 period.

In the second quarter of 2013, we recognized $59,000 of current tax expense related to estimated alternative minimum tax payments and our Swiss subsidiary. We also recognized a deferred tax benefit of $1.2 million, which served to increase the total deferred tax asset on our balance sheet. Total tax benefit was $1.2 million as compared to a tax expense of $178,000 in the prior-year period. The change is related to a loss before income taxes in 2013 as compared to a gain before income taxes in 2012.

Net loss in the second quarter of 2013 was $2.5 million as compared to net income of $262,000 in the prior-year period. The net loss attributable to noncontrolling interest relates to the 45.4% interest combined minority interest holders had in the financial performance of Heska Imaging.

Net loss attributable to Heska Corporation in the second quarter of 2013 was $2.2 million or $0.38 loss per diluted share. This compares to net income attributable to Heska Corporation of $262,000 or $0.05 per diluted share in the prior-year period.

Net loss attributable to Heska Corporation for the six months ended June 30, 2013 was $2.6 million or $0.46 per diluted share. This compares to net income attributable to Heska Corporation of $846,000 or $0.15 per diluted share in the prior-year period.

I continue to be impressed with our new leadership and the corresponding willingness to make hard short-term decisions for long-term benefits. In my opinion, the consistent quality of our commercial economic decisions is as high as it has been in at least a decade.

As on our most recent earnings calls, we will not be providing guidance nor commenting on future financial results beyond the statement in our prepared remarks today. With that, I will turn the call back over to you, Bob.

Thank you, Jason. As we realign Heska over the remainder of 2013, continue to optimize our sales force for greater efficiency and expand our product line to increase sales, we have not lost sight of the fact that our primary goal is to provide diagnostic and specialty products to help veterinarians embrace change and develop their practices.

Market dynamics remain generally positive, with favorable trends in pet ownership and care, and we are providing increasingly robust solutions for the veterinary market with a superior and growing product portfolio.

We are realigning the organization to take advantage of our particular strengths in advanced diagnostics and allergy, and our Cuattro Vet USA majority acquisition has added talent and products that will allow us to accelerate our growth with bundling and cross-selling opportunities.

Our newest relationship with Eli Lilly's Elanco organization provides us with a blue-chip vaccine partner in our OVP revenue segment. And we are working to optimize our potential for the MWI Veterinary Supply distribution group.

We will continue to consider small strategic acquisitions that fit with our current product lines and sales channels. However, we do not want investors assuming that we are spending a great deal of time actively looking for acquisition candidates. We have plenty to do with the continuing integration of Cuattro Vet USA and operational execution, but we would consider a great opportunity.

Our redirection to the new Heska organization is not a straight line. We explained to investors that the second quarter specifically would contain unusual charges and reflect some of the transition and sales resources, strategy and structure. It will take additional time to see the results of our transformation. Yet we expect to see tangible signs of this improvement as we exit the second half of this year and look forward to an exciting 2014.

We firmly believe we are on the right path and that sales and financial leverage, growth in sustainable profitability will be the ultimate result of all these changes.

Thanks for your attention today and we appreciate your continued interest in and support of Heska. At this time, would like to turn this over to the operator for purposes of conducting the question-and-answer session.

(Operator Instructions). Nicholas Jansen, Raymond James & Associates.

A couple questions on the financials. Jason, maybe walk me through what you think about for the back half of the year with regards to expenses. I know there was a bunch of one-time charges in the third quarter, and I know you guys are taking a fair amount of costs out of the system with the synergies with the Cuattro Vet USA acquisition. So maybe if you could help us look at the OpEx profile going forward, now that we have a lot of the one-time costs out of the way.

Well, I think that we said that we have made about $1.3 million in cuts on an annualized basis on the sales side. Probably you are only going to see about $900,000 of that this year because they occurred in the second quarter and you are not going to have a full year of results on that front. And then about $600,000 we think we have cut out of marketing that otherwise we would have spent had we not made the cuts.

This quarter, we had a reserve related to VitalPath of about $242,000 that we recognized on the G&A side, and there was about $99,000 on the R&D side that are expenditures that we would not otherwise have made. We did that to come to agreement with Roche. Then there was a small piece, about $13,000, on the sales and marketing side related to accelerated depreciation on the demonstration units of the VitalPath.

So in putting all this together, you had $8.6 million of operating expenses in 2Q, and a bunch of those you just listed were kind of one-time in nature. Should we think about kind of a run rate going forward being closer to let's say $8 million a quarter, or is that too much relative to what you did in 2Q?

Yes, I think we said we weren't going to make any guidance or forward-looking statements on the call, and I think I'm going to want to stick to that.

Okay. And then looking at kind of the top line with regards to Cuattro Vet relative to expectations out of that $2.7 million track, and kind of where you are seeing the most opportunities as you kind of bundle these things together.

That's pretty much in line what we thought they would do. That's a high growth rate for them. If you look at last year, that's about a 47% increase over what they did last year, with the consistent accounting technique. So we had high expectations for them on the revenue growth side and they continue to meet them.

And then lastly, with regards to MWI, how confident are you that in the back half of the year you will get some inventory purchase from them or is that more upside in your mind?

Probably -- this is Bob, Nick -- probably a little bit more the latter, as we think about it. Again, you are aware as well as anybody is that for a few quarters I've been talking about managing the risks versus the opportunities there. And at a minimum -- we never saw this as a light-switch event. We are changing behavior and so forth.

They are a top-notch team and we are working with them to optimize outcomes, but we are not banking on a big surge in the back half of the year.

That's it for me. Thanks, guys.

Jon Block, Stifel.

Great. Thanks and good morning, guys. Maybe first one -- first question for you, Bob or Jason. I think you mentioned the revenue in Core Companion around $15.9 million, with about $2.7 million coming from the Imaging side of the business.

So if you were to back that out but then take into consideration what MWI sold out versus what they ordered from you guys, do you think you were flat year-over-year, up year-over-year? And then how would that compare to how you view the market in terms of market share? Thanks.

Good morning, Jon. what a set of questions. Do you want to try and tackle that, Jason?

Sure. I think we would have been down even with let's call it a normalized or equivalent MWI result. That did impact to some degree the heartworm diagnostic test and the instrument consumables. But the international allergy business and the heartworm preventive had nothing to do with MWI. So even with a normalized MWI, I think it would have been down.

And I would say notably with those two product segments that he's just described being down, the heartworm preventive and ex-US allergy business, those are areas that are managed through third parties, not through the direct sales force, obviously.

Right. In terms of share, on the instrument consumables side, I think if anything we probably picked up a little bit of share. On the heartworm diagnostic side, our units were down as we estimate at the end-user level, so we might have had a slight hit in share. I don't think anything dramatic though. I don't want to overstate that.

Okay, okay. Perfect. Bob, just to go back to some of your comments on the call, it seems like you are evaluating some parts of the MWI deal. Can you just give us maybe a little bit more detail? Is this something where you clearly feel like they are helping you outside of the chemistry/hematology, so maybe you'll try to claw that back, but still rely on them for the rapids? Is that a possibility on how this deal shakes out going forward?

I have no idea exactly right now. We are dialoguing with MWI. As I've said, they are a very good management team and everybody is aligned to optimize the mutual -- the business benefit.

I would say -- I would just emphasize again, their quality, the fact that we've said for some time this isn't a light-switch event. In effect, you are basically trying to change years and years of behavior in the field and that doesn't happen overnight, and I couldn't predict exactly what the outcome is. We just want to stress that the results are consistent with our forecasts and concerns, and we are managing it. As to -- again, I can't paint a picture for you as to what will eventually happen.

Okay, okay. Maybe last one or two for you. Just moving to the reagent rental program, it seems like some of your competitors have certainly gotten more aggressive there. So was this a situation where you wanted to see what you would be able to do from a capital sale perspective with some of your newer products, and then just felt, hey, everyone else is in reagent rentals, we're best off moving in that direction as well?

I suppose we've done some of that type of reagent rental even in the past. What we are talking about with this program is somewhat different, and it's really more of an encompassing rental-based program with a single monthly payment. And again, I would say, as I tried to emphasize in my remarks, it's really been remarkable, the uptake associated with that program.

I would just add that I think our new President has studied what we've done historically and tried to sort of paste together some different aspects of different historical programs into what he thinks is the most attractive package. And we've rolled it out and it's relatively early days, but we have been pleased with what we've seen the reaction to that being.

Okay, great. And very last one for you, just sort of big picture, how you are viewing the market, maybe from momentum. One of your competitors commented that throughout the second quarter, it seemed that trends got better as we worked our way throughout the quarter, exiting June with the highest momentum. Maybe if you can give us your thoughts and if that momentum is continuing into 3Q. Thanks, guys.

Well, it is hard to separate our new sales approaches from what's happening, but June was certainly robust. And as we intimated, so far into the quarter, we are seeing continued acceleration in those approaches.

I don't know if that's enough data to draw big conclusions about the broader market yet. I'm still watching people talking about 1% to 2% same-store sales in vet hospitals. We are saying, as I mentioned, general enthusiasm in the pet care market; that includes the retail piece, where I believe recent reports suggest that of the sort of 4% or 5% growth overall, the vast majority of it is outside the medical area. So I still think there's 1% to 2% off the bottom is the current normal.

I agree with Bob. It is tough to separate the two. There is definitely an enthusiasm in our commercial team and our sales force that we are picking up. Hard to separate how much is the new leadership and the new programs and some of the products.

I will also add that some of the indirect evidence we have, where we are talking about third parties that sell our products, like the heartworm preventive side and Bob mentioned the international allergy business, where we have third-party partners that sell those products, the data is not great there. So I'm a little bit more bearish perhaps on the overall economic picture.

But I also want to caveat that with Heska's window is actually quite a narrow window as a small company. But from what we are seeing, those are my thoughts.

Perfect, perfect. Guys, thanks for your time.

Paul Nouri, Noble Equity Fund.

Good morning, Bob. Looking at the MWI relationship, probably from the fourth quarter of 2012, since that's when they stocked, if we take these past three quarters and look at it compared to the prior year with the new instruments and the reagents that they have taken on, what does that look like? Because I think the past quarter or two has looked a lot worse than the overall picture, because they are selling more of the inventory than taking orders from you.

First of all, I will turn that over to Jason, but I would qualify to say it's really the last two quarters. We did the stocking order for sure in December, which created an artificial bump in revenue. But they have really been selling since, I think, January 2. Jason, would you like to talk about the comparisons in-house and all of that?

Yes, the stocking order was approximately $3 million in the fourth quarter of 2012. I don't think there was any material sales of product in the fourth quarter out of them that was sales from us to them, to their various locations throughout the country. And I think by contract they couldn't start selling our major competitive products with Idexx until January 2.

I don't know exactly where those numbers are going to normalize. I do think that there was more of an impact in Q1 from them selling into the field more than they bought from us than in Q2. So I see the trend diminishing.

I would estimate another quarter or two until we get to normalization. But you very rarely have an exact equivalence of the sales coming from Heska to the distributor and the distributor into the field. There is always -- even when you get to a normalized scenario, there's always a little bit of give on one side of that equation or the other.

Okay. And then looking at VitalPath and SpotChem, how much can we expect to come out of sales on a quarterly basis as you discontinue new sales of those products?

The VitalPath, unfortunately, never really was a very high-volume product for us. We put a lot of sales and marketing efforts into it and people tried really hard and made a really good faith effort, but it never got that much traction, which is why we ultimately wound up in the settlement that we did. So I don't think there will be a large impact from the VitalPath go-forward when you are looking at apples-to-apples, year-over-year.

And the SpotChem, of course, we stopped selling that product in 2007. And gradually, that installed base has undergone some attrition. And as I mentioned, we ran a pretty aggressive upgrade program to upgrade to our latest FUJIFILM chemistry-based analyzers. So I don't expect you'll see much of an impact from SpotChem either. That tail had really diminished. This was really more of a scenario we had more inventory than we thought we would, and we had hoped to maybe make some large distributor sales to mitigate it and that hasn't panned out.

Okay. And then when I ran the numbers, my adjusted gross margin was 36.5%, which is pretty low compared to the past couple of years that you guys have put up. And I know you are selling more on the imaging side now, which I believe is lower gross margin. Is there any room for this to improve the next couple of quarters or is it going to be here until sales pick up basically?

There's definitely room for gross margins to improve. Some of the margin pressure, as I said in my prepared remarks, is mix. You are correct that Heska Imaging tends to be a lower gross margin business than let's call it legacy Heska. And if you look at some of the year-over-year changes in our revenue streams, we lost some of higher-margin revenue on a relative basis. Heartworm preventive was one example. So if that turns around in the future, you could definitely see margins improve.

Okay. And then with the Elanco deal, does it affect your sales at all?

No, we don't anticipate it affecting our sales. Again, they will be taking over the trademarks and the vaccine seeds associated with the [CapExings]. we don't expect sales to any current third parties to change in the near-term. The cat vaccine was a minor product for us and we will, by the way, continue to manufacture it right there in Des Moines and make money on a manufacturing margin basis.

Okay. Thanks.

(Operator Instructions). Joe Munda, Sidoti & Co.

Good afternoon, Bob and Jason. I'm sorry, good morning. Thanks for taking the questions.

Bob, I believe in your prepared remarks you talked about consolidation of the sales force. Right now, you are sitting at 36 outside, 18 inside. I'm just wondering what the difference was quarter over quarter -- or from the beginning of this Cuattro integration.

Right, well, it gets to be a little bit imprecise because of open positions versus filled positions, the restructuring and so forth. But I would think of it in the following terms in general, just so you can get some directionality to what we have done here strategically.

There were a total of about 13 positions eliminated from the Heska legacy business outside sales. The inside sales has been burnished, has been added to, by a couple of positions since then. And the imaging sales force has been stable to up one or two in, say, the last 120 days or so.

Okay. Following up on that, it looks to me that Cuattro -- that the Heska Imaging -- I'm sorry -- continues to be a nice stable driver for you guys. Are there plans to add to that sales force number or are you happy with what you have right now?

When it becomes economic, there will be additions. The view of Mr. Wilson and his management team would be it's going to be pay-as-you-go, and expecting everyone to deliver to their maximum before we add.

I would emphasize -- or I would add on to your comments or reinforce your comments that, yes, this has been a great driver to growth, but I cannot overstate -- as Jason indicated in his remarks, I cannot overstate how different this approach has been to commercial execution and how enthusiastic we are about those contributions.

Bob and Jason, I also want to give you my condolences on Mike. I'm sorry for the loss. He seemed like a great friend to you guys.

Yes, absolutely. Thank you for the comments.

Thank you, that is kind of you.

Sorry. Where was I? Bob, also -- I mean, you're seeing the proliferation and the popularity of pet insurance policies here. And I just wanted to get your comment or your take on what you are seeing in the industry and how it relates to not only you as well as other players and where do you see the industry going due to this newfound popularity in pet insurance?

Right. Well, pet insurance and some of the really good pet insurance companies that are in existence today have been around for quite some time, a decade or so. And we have seen shifts and changes. We have seen people drop out and consolidation occur and sales from one entity to another.

Overall, I would say it is good, it should be good for the market, to the extent that most of these policies are -- or a lot of these policies at least are a combination of health savings accounts, conceptually, along with the catastrophic piece. But it should encourage more vet business traffic, we believe.

However, it's far fewer than 10% of pets out there still are covered by insurance. So we watch it, as you are, apparently, and we are excited about the trends. We think it's good for the industry and we are excited to see the marketing efforts by so many of them and their success.

Okay. Thank you.

Gentlemen, there are no further questions at this time. I will now turn the call back over to Bob Grieve for closing remarks.

Thank you, and 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. Goodbye.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.