Heska Corporation
Q3 2013 Earnings Call Transcript

Published: 7 Nov 2013

[Operator:]

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Heska Corporation's Third Quarter 2013 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Brett Maas, with Halden (sic) [Hayden] IR. Please go ahead, sir.

[Brett Maas:]

Thank you. Thank you all for joining us today on our conference call. On the call with us today are Heska's 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 third quarter of 2013 and provide an update on the first 9 months of 2013. 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 materially differ from 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 otherwise as 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.

[Robert B. Grieve:]

Thank you, Brett. I'd also like to thank everyone for joining the call today. Overall, we are very pleased with our third quarter results. The results are consistent with what we've told shareholders, investors and other interested parties. As we indicated, the last few quarters were a transition period for the company. In the first quarter, following the acquisition of a majority interest in Cuattro Vet USA in February, we took a hard look at our commercial infrastructure, sales leadership, strategy and tactics. This led to a series of reorganization initiatives in the second quarter. We indicated that the changes from this reorganization and the charges would begin to drive improved operations in the second half of the year. We're beginning to see that in the third quarter results. Revenue's improved year-over-year. Gross margin percentage is expanding, returning to a more normalized historical range, following a significant drop in gross margin percentage in the second quarter, a drop associated with onetime charges. We also continue to closely control expenses. And we returned to positive earnings per share. During the third quarter, we continued to focus on the evolution and enhancement of our entire organization, following our combination with Cuattro Vet USA. As that effort steadily progresses, we look forward to more growth and more predictable business. Let me reiterate where we've been, our transitional steps and the milestones that demonstrate that we are successfully executing the transformation of Heska. We had 1 month left in our first quarter when we closed the acquisition of a majority interest in Cuattro Vet USA, an imaging and cloud veterinary medical data hosting technology company. We acquire new product lines, new bundling opportunities, new technologies and significant new talent. This acquisition prompted us to fully reassess how best to structure the company for the long term and what the strategy and scope of the new Heska would be. As I described in our last call, because of the acquisition, Heska now has a best-in-class digital radiography, ultrasound and cloud-based veterinary medical data archival product suite. These products are complementary to Heska's own current advanced diagnostics products. Importantly, these products are a key to acquiring the interest and loyalty of the veterinary market's most coveted, high-volume veterinary practices. By combining with Heska's existing line of chemistry and hematology technologies, as well as our latest blood gas and electrolyte entry, we believe we now have bundling and cross-selling opportunities. The power of robust and complementary 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 through May of 2013, our new President and Chief Operating Officer, Kevin Wilson, began a comprehensive review of our sales strategies, costs, structure and go-to-market offerings, followed quickly with a commercial integration and turnaround plan. In our second quarter of 2013 conference call, we identified the following fundamental changes we had made

[Jason A. Napolitano:]

Thank you, Bob. Our consolidated third quarter 2013 revenue was $17.6 million, up 4.1% compared to $16.9 million in the prior year period. For the first 9 months of 2013, our revenue was $54.8 million, up approximately 1% when compared with $54.4 million in the prior year period. Core Companion Animal Health revenue was up 7.3% to $14.5 million in the third quarter of 2013 as compared to $13.5 million in the prior year period. The largest factor in the increase was $2.1 million in revenue from Heska Imaging. Another factor was increased year-over-year revenue related to domestic sales over a heartworm preventive through Merck Animal Health. These factors were somewhat offset by lower year-over-year revenue from domestic sales of our heartworm diagnostic tests and the impact of domestic placements of our chemistry instruments and our hematology instruments. Consistent with our observations in the first half of the year, competition in the domestic heartworm diagnostic test area remains fierce. A factor in lower revenue recognized from our chemistry and hematology instruments was the success of our rental reset program, for which placements are generally being accounted for as operating leases, and thus, do not have the upfront revenue recognition affiliated with the sale. For the third quarter, revenue from our Other Vaccines, Pharmaceuticals and Products segment, or OVP, declined by approximately 8.8% to $3.1 million as compared to $3.4 million in the prior year period. Lower sales of cattle vaccines under our contract with AgriLabs was a factor in the decline. We generated $7.4 million in gross profit in the third quarter of 2013, including $726,000 in gross profit from Heska Imaging compared to $6.7 million in gross profit in the third quarter of 2012. Gross margin was 42.1% in the third quarter of 2013 compared to 39.8% in the prior year period. A factor in the change was lower revenue and higher gross margin in our OVP segment, which tends to have lower gross margins than our Core Companion Animal Health segment. Total operating expenses were $7.3 million in the third quarter of 2013 or 41.7% of revenue compared with total operating expenses of $6.8 million or 39.9% of revenue in the prior year period. Selling and marketing expenses were $4.6 million in the third quarter of 2013, up 4.8% as compared to $4.4 million in the prior year period. For the 9-month period, selling and marketing expenses were $14.6 million compared to $14 million for the same period in 2012. Heska Imaging sales and marketing expense of $905,000 recognized in the third quarter of 2013, but not 2012, was the key factor in the quarterly change. This was somewhat offset by lower spending on salaries and benefits for members of our sales force in the third quarter 2013 as compared to the prior year period. Research and development expenses were $324,000 in the third quarter 2013, including approximately $49,000 from Heska Imaging. This was an increase of $144,000 from $180,000 in the prior year period. In addition to expenses affiliated with the consolidation of Heska Imaging, increased year-over-year expenses related to personnel, as well as the recognition of costs related to other research and development projects were factors in the increase. General and administrative expenses were $2.4 million in the third quarter of 2013, including $305,000 in expenses from Heska Imaging. This represents a 10.2% increase from $2.2 million in the prior year period. The largest factor in the change was increased general and administrative expenses affiliated with the consolidation of Heska Imaging. Operating income in the third quarter of 2013 was $75,000 compared to an operating loss of $27,000 in the prior year period. Operating loss for the first 9 months of 2013 was $4.2 million as compared to operating income of $1.4 million in the prior year period. Depreciation and amortization for the 9 months ended September 30, 2013, was $1.7 million as compared to $1.3 million in the prior year period. We had $93,000 of interest and other expense in the third quarter of 2013 which consisted of $47,000 in net interest expense and $46,000 in net foreign currency losses. In the prior year period, we had $16,000 in income from this line item, which consisted of $16,000 in net interest expense and $32,000 in net foreign currency gains. In the 2013 period, we have greater interest expense, primarily related to interest on debt at Heska Imaging. In the third quarter of 2013, we recognized $6,000 of current tax expense related to our Swiss subsidiary. We also recognized a deferred tax benefit of $6,000 so that we recognize no net tax expense for the quarter. Total tax expense was $21,000, including $16,000 in current tax expense in the prior year period. Net loss in the third quarter of 2013 was $18,000 as compared to a net loss of $32,000 in the prior year period. The net loss attributable to noncontrolling interest relates to the 45.4% interest, combined minority interest holders had and the financial performance of Heska Imaging. Net income attributable to Heska Corporation in the third quarter of 2013 was $241,000 or $0.04 per diluted share. This compares to a net loss attributable to Heska Corporation of $32,000 or $0.01 per diluted share in the prior year period. Net loss attributable to Heska Corporation for the 9 months ended September 30, 2013, was $2.4 million or $0.41 per diluted share. This compares to net income attributable to Heska Corporation of $814,000 or $0.15 per diluted share in the prior year period. As on our most recent earnings calls, we will not be providing guidance nor commenting on future financial results beyond the statements in our prepared remarks today. In summary, this quarter demonstrates progress in our business. Our recent efforts at improving our business are showing in our financial results. We look forward to future improvements. With that, I'll turn it back over to you, Bob.

[Robert B. Grieve:]

Thank you, Jason. As we transform Heska over the remainder of 2014, continue to optimize our sales force for greater efficiency and expand our product line to increase sales, we've 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 strength 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 recently announced relationship with Eli Lilly's Elanco organization provides us with a blue chip vaccine partner, aiding us in our OVP business. 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're 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. At this time, I would like to turn this over to the operator for purposes of conducting the question-and-answer session.

[Operator:]

[Operator Instructions] Our first question comes from the line of John Block with Stifel.

[Jonathan D. Block:]

Bob, maybe the first question, you gave some pretty compelling numbers on chemistry placements in the second quarter and the third quarter, I'm just running against those metrics again, some of the statistics that we compiled. And it looks like the 109 chemistry units were about 6% to 7% of new placements in the second quarter and the 151 units actually account for about 10% of new placements in the third quarter. So can you speak to the momentum? Do you think that's sustainable, and do you think you can actually sort of capture high single-digit 10% share going forward of new chemistry units?

[Robert B. Grieve:]

Yes. I think at some broad level, Jon, again, thanks for the -- your participation and your question here. But at some broad level, we have been saying that you're going to see the first evidence of our commercial traction as we reported the third quarter. I don't think we're anywhere close to getting to maximum velocity, if you will. There's a lot of great traction. It feels good. I think these sales programs have been very effective, they're great products. I'd also hasten to point out, this probably hasten [ph] your analysis again, I'd emphasize these are direct sales from Heska to customers. There's no selling and distribution here that counts in these numbers. This is very straightforward.

[Jonathan D. Block:]

Okay, that's certainly very helpful. And then you talked to that bundle and how it's strengthened and cross-training the Cuattro guys and the Heska guys. When we think out to 2014, is that bundle going to be further strengthened by a rapid assay offering? You alluded to that in the past. Is that still tracking toward the 2014 market introduction?

[Robert B. Grieve:]

Right. At this particular point, our guidance are -- we are referencing the Rapid Diagnostek alliance. At this particular point, I'm staying consistent with past remarks in saying that, that particular partner has said that we could timeline something in 2014 to be developed. We are not modeling that. We're not budgeting it. We need to wait and see because there's certainly a risk there. And as far as bundling is concerned, I think, as I described earlier, we've got a lot of momentum with imaging sales folks, generating momentum with the people in the legacy diagnostic, analyzer business generating momentum, but we are far from even achieving the opportunities in bundling across those product lines. That remains to come. So what you're seeing now, again, is just beginning days.

[Jonathan D. Block:]

Okay, great. And last question is a little bit more big picture rather than Heska-specific, but sitting here and reporting the first week of November, and of course, all of the fun political dysfunction that seemed to take place in mid-to-late October, can you just speak to -- I mean, you spoke to some compelling, again, big picture trends, but being a little bit more granular on what you've seen going into Washington dysfunction and coming out of it, how have trends been when you look back the past 4, 5 weeks.

[Robert B. Grieve:]

Yes, Jon, again -- and I hate to sound repetitious the past calls or flip here, but we're so small, that I think anything that we would have seen or we would imagine to be seeing may not be reliable with respect to those trends. And I think the way we think about the business is rather than imagining being whipsawed by those macro effects, we just take a lot of responsibility for executing, doing things right and growing regardless of the macro environment. That's our mentality.

[Operator:]

And our next question comes from the line of Ben Haynor with Feltl and Company.

[Ben C. Haynor:]

Just a couple of quick ones. Jon covered a lot that I was going to get at. Now it looks like the G&A came down pretty handily, sequentially. Is this a sustainable level going forward? Or would you expect that to tick back up a little bit?

[Robert B. Grieve:]

You want to comment, Jason?

[Jason A. Napolitano:]

Well, I think, there's a lot of leverage available. As the business grows, Ben, you're going to see pressure on all operating expenses. But I don't see a lot of short-term need for expansion in general, administrative expenses.

[Ben C. Haynor:]

Okay, that's helpful. And then I apologize if I missed this. Did you give up the Cuattro or Heska Imaging revenue?

[Jason A. Napolitano:]

Yes. 2-point -- let me get the exact figure, $2.1 million, yes.

[Ben C. Haynor:]

And what's the comparable last year, if you don't -- if you have that?

[Jason A. Napolitano:]

Yes, we generally don't disclose that. It's actually up -- it's up significantly, of course, consistent [ph] with the first 2 quarter trends.

[Operator:]

[Operator Instructions] And our next question comes from the line of Paul Nouri with Noble Equity Funds.

[Paul Nouri:]

Can you talk about how your relationship with MWI has evolved into the third quarter, and where you are with your inventory with them?

[Robert B. Grieve:]

Sure. I'll comment generally. As much the same, as I indicated here, comments, generally consistent with where we were 90 days ago. We're still evolving together, understanding what's best to go through their sales channels and what's best for us to manage directly, having settled on a final mix. We're working very well together. They're a great organization, and we're intending to optimize both of our respective businesses. From an inventory standpoint, there's nothing here material, nothing significant, nothing to be concerned about in the way of excess inventory and the channel that hasn't been recognized, accounted for in other ways.

[Operator:]

And our next question comes from the line of Joe Munda with Sidoti & Company.

[Joseph P. Munda:]

First off, I guess, I want to start off, Jason, you talked about gross margins normalizing at this 42% level here. Is that a gross margin level that we can -- will continue to ramp a little bit more smoothly? Is there room for expansion? And I know you don't give guidance, but on that expectation, do we expect this to continue to ramp into '14?

[Jason A. Napolitano:]

Well, Joe, we did stage we're not going to give guidance, and I don't want to give closet guidance in response to questions. So...

[Joseph P. Munda:]

Okay you can't blame me for trying.

[Jason A. Napolitano:]

Fair enough.

[Robert B. Grieve:]

That's why, Joe -- what Jason talked about was more normalized historical level and there wasn't any reference to the future there.

[Jason A. Napolitano:]

Obviously, Joe, we have the Roche flowing through in the second quarter. We had that adjustment for the Roche product line that we have now exited, and that had a big impact on gross margin in Q2 and obviously, in the 9-month result.

[Joseph P. Munda:]

Okay. So there really -- there was no onetime events when it comes to cost of goods that improved the gross margin to this level?

[Jason A. Napolitano:]

Yes, I wouldn't say anything material in there, Joe, There's always little things, but nothing material.

[Joseph P. Munda:]

Okay. Let me go through here. Can you give us a little bit more color on the new analyzer? You talked about ease of use and better patient outcomes, and I was wondering, were there any placements of this new analyzer in the quarter? I know you launched in September.

[Robert B. Grieve:]

The analyzer actually shifted -- I'm sorry, shipped in October for the first time. So on our next call, you'll be getting a lot more insight into the measurements about -- around the early success that I described.

[Joseph P. Munda:]

Okay. And I'm sorry, just a little bit more color on why it's a better analyzer than...

[Robert B. Grieve:]

Certainly. That's a multitude of reasons. One is, it's wireless, Bluetooth and WiFi enabled. It's ergonomically exceptional for use in the veterinary practice. It's -- the consumable is basically a single card, credit card size that I described, where there is no cold chain requirement. This can be stored at room temperature. The principal competitive handheld analyzer has -- you have to use multiple cartridges for different tests. There is a cold chain. There is shelf life concerns. And then again, pricing is pricing, we're able to do at a substantial discount to the leader.

[Joseph P. Munda:]

Is there any fear of cannibalization to your other analyzers or...

[Robert B. Grieve:]

Just the opposite. We think there are positive synergies as we put this together in bundles to go to the customer, very positive synergies. And as I indicated in my provisional remarks here about the launch, it's gone very well, and I would say we're already seeing those synergies at the point of the customer.

[Joseph P. Munda:]

Okay, just a few more here. As far as the placement model that you guys -- I like that you guys have gone that route. But can you give us a sense of the length of time on these leases to the docs as well as maybe what on average a monthly payment would be? I know you're bundling consumables along with the product here. So is there -- if you could, is there a sense of what an average monthly payment would be?

[Robert B. Grieve:]

Well, let me just start off by saying that the typical term here -- the prevailing term is a 5-year term. And the typical cost is going to be some place, substantially less than $1,000 a month, depending on the bundle and the arrangement.

[Joseph P. Munda:]

Okay. And how did you arrive at that -- I mean, was there some, I guess, feedback from doctors what they were willing to pay as far as the monthly fee? How did you arrive at the term, and as well as monthly payment?

[Jason A. Napolitano:]

Yes, I'd say that was our President studying some of the data from the deals we've done in the past to making a judgment where he felt it will be most attractive in the marketplace, Joe.

[Robert B. Grieve:]

But generally here, the economics for us are good, the economics for the customer are good. So it's -- if you'll forgive the colloquialism, it's a win-win. And it's again, greatly, greatly enhanced our placement activity.

[Joseph P. Munda:]

Okay. And then again, I guess, my final question, I know this might be a little bit off-kilter here, but there's a lot of talk about the Lone star tick and what it's doing to animals. Are you seeing any uptick in, I guess, utilization by some of these docs when it comes to testing the blood for these -- for dogs and cats in relation to this, I guess, this tick problem that's occurring and spreading?

[Robert B. Grieve:]

Right. I don't think that particular epidemic or epizootic, I guess, if you prefer, is really germane to our current business. It's where you would expect to see consequences of an increase in tickborne diseases that may be relevant to the veterinarians sorting through that differential diagnosis. We're not in that market at this point. It also may be relevant to neurologic diseases associated with the tick. And then finally, of course, those people that provide ectoparasiticides or insecticides that kill or work in the areas of fleas and ticks and so forth, they may see some type of impact, but that's, again, outside of our business.

[Operator:]

And our next question comes from the line of Nicholas Jansen with Raymond James.

[Nicholas Jansen:]

Most of mine have been answered, but thinking about the Heska Imaging business, is there any seasonality we should be thinking about going into the fourth quarter with capital equipment placements as we kind of look at revenue generation off of the $2.1 million you did this quarter?

[Robert B. Grieve:]

Yes, yes, Nick. In short, this is a seasonal business, and we expect a very robust fourth quarter in that business area.

[Nicholas Jansen:]

Okay. And then kind of thinking about -- going back to one of Jon's questions, thinking about this kind of rental model that you're doing. When should we think about cycling through the headwind from instrument sales from the prior year as to think about maybe a recovery into more robust growth on the top line heading into next year?

[Jason A. Napolitano:]

Yes, I think, we launched the program, Nick, late May or early June. So I'd say when we've rolled through Q2 '14, you're going to have a fairly normalized comparison, assuming the programs continue the same way that we've got them set up.

[Nicholas Jansen:]

And can you maybe remind us how much revenue from instrument sales were in the last couple of quarters or in 4Q and 1Q of last year, so we make sure we kind of model that appropriately?

[Jason A. Napolitano:]

Yes, I don't think we generally break it up by quarter. We're generally giving a running 12 in the Qs. Rough numbers, that's been about 10% of revenue. Well, at the top of my head, I just haven't brought the previous Qs in the room with me here. But that's the way I think of that segment of our business.

[Operator:]

There are no more questions at this time. I will turn the call back over to management for closing remarks.

[Robert B. Grieve:]

Thank you, Kelvin. As we wrap this call up, I'd like to reemphasize some points. I'd like to stress how encouraged we are as we begin to see the benefits in this commercial transition, as well as growth potential going into 2014. Companion Animal revenue in the quarter was up 7.3% year-over-year, gross margin percentage expanded by 2.3 percentage points year-over-year, and earnings per share has shifted positive by $0.05. We've just recently here discussed around questions our new Element POC handheld blood gas, electrolyte handheld analyzer that we began shipping last month. We're very excited about this product. We expect it to compete very favorably with our former i-STAT product line, which was, for Heska, about an $11 million consumable business in North America. In 2008, the final full fiscal year, we supported that product. Early indications in the launch are positive as we've just discussed. And we'd also say that most of the sales of this new Element POC are upgrade replacements of competitive systems. Our revenue pipeline is strong, going into the end of the year, and we expect a seasonally strong imaging business, as we've just discussed, to make a meaningful contribution in Q4. Thank you all for your interest in Heska and for joining our call today. The call has now concluded.

[Operator:]

Thank you, ladies and gentlemen. This concludes the conference call. Thank you for your participation. You may now disconnect.