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Abaxis, Inc. (NASDAQ:ABAX)

F2Q09 (Qtr End 09/30/08) Earnings Call Transcript

October 27, 2008, 4:15 pm ET

Executives

Joe Dorame – IR, Lytham Partners

Clint Severson – Chairman, President and CEO

Martin Mulroy – VP, North American Veterinary Sales and Marketing

Christopher Bernard – VP, Sales and Marketing, Domestic Medical Market

Al Santa Ines – VP of Finance and CFO

Analysts

James Sidoti – Sidoti & Company

Ross Taylor – C.L. King

Jonathan Block – SunTrust Robinson Humphrey

Scott Gleason – Stephens Inc

Bill Gibson – Nollenberger

David Clair – Piper Jaffray

Neal Goldman – Goldman Capital Management

Lenn Vieux [ph] – State Partners

Dave Tuckley [ph] – SIG

Tilton Gardner – Mutual Securities

Albert Olmund [ph]

Operator

Good afternoon. My name is Brook, and I will be your conference operator today. At this time, I would like to welcome everyone to the Abaxis second quarter 2009 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator instructions) Thank you. I will now turn the call over to Joe Dorame with Lytham Partners. Thank you. Mr. Dorame, you may begin your conference.

Joe Dorame

Good afternoon. Thank you for joining us today to review the financial results for Abaxis for the second quarter of fiscal year 2009 ended September 30th, 2008. As Brook indicated, my name is Joe Dorame. I’m with Lytham Partners. And we are the financial relations consulting firm for Abaxis.

With us today, representing the company are, Mr. Clint Severson, Chairman and Chief Executive Officer; Mr. Al Santa Ines, Chief Financial Officer; Mr. Martin Mulroy, Vice President North American Veterinary Sales; Mr. Christopher Bernard, Vice President North American Medical Sales and Marketing; and, Mr. Donald Wood, Vice President of Operations.

At the conclusion of today’s prepared remarks, we will open the call for Q&A session.

Before we begin, I’d like to remind everyone this conference call includes statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Abaxis claims the protection of the Safe Harbor for forward-looking statements contained in the Reform Act. These forward-looking statements are often characterized by the terms may, believe, projects, expects, or anticipates, and do not reflect historical facts.

Specific forward-looking statements contained in this conference call maybe affected by risks and uncertainties including, but not limited to, those related to the market acceptance of the company's products and the continued development of its products, required United States Food and Drug Administration clearance and other government approvals, risks associated with manufacturing and distributing its products on a commercial scale free of defects, risks related to the introduction of new instruments manufactured by third parties, risks associated with entering the human diagnostic market on a larger scale, risks associated with liquidity concerns related to our auction right securities, risks related to the protection of the company's intellectual property or claims of infringement of intellectual property asserted by third parties, predictions related to the condition of the United States economy, risks involved in carrying of inventory, and other risks detailed from time to time in the company’s periodic reports filed with the United States Securities and Exchange Commission.

Forward-looking statements speak only as of the date the statement was made. Abaxis does not undertake and specifically disclaims any obligation to update any forward-looking statements.

With that having been said, I would like to turn the call over to Mr. Clint Severson, Chairman and Chief Executive Officer of Abaxis. Clint?

Clint Severson

Thank you very much, Joe, and good afternoon, everybody. I will spend the first few minutes in this conference to review new accomplishments and the challenges for Q2 SY ’09 and some of our goals for Q3. After my short presentation, I’ll ask Martin Mulroy, our VP of North American Vet Sales and Marketing, and then Chris Bernard, our VP North American Medical Sales and Marketing, to give an update on their respective businesses. We’ll then take questions.

Despite a difficult environment, we had a great quarter, and had fewer challenges than quarters’ past. The primary challenge for Q2 was lower hematology and Piccolo instrument sales compared to Q2 ’08.

Total instrument sales of 734 units were down about 37 units versus Q2 last year. We sold 206 hematology instruments versus 296 Q2 of last year. Last year, we launched our 5-Part Diff unit, the HM5, in September ’07. And with the pent up demand, we had close to a record unit sales in Q2 FY ’08. We sold 167 Piccolos versus 178 the same period of last year. Six quarters of instrument problems along with uncertainty due to the economy were the reasons for fewer Piccolo instrument sales.

With the manufacturing problem fixed, we are now in a position to add more purchase options, expand our market coverage, and more aggressively add people, and we expect to see higher unit sales going forward. The bright spot for instrument sales last quarter was the VetScan. We sold a total of 361 units of 22% or 64 units, compared to Q2 last years’ total of 297 units.

Lower total instrument sales had a negative effect on gross margin due to the fact that fixed manufacturing costs were spread over fewer units. But total gross margin, however, was up year-over-year and quarter-over-quarter. Quarter-over-quarter total instrument sales were down about 70 units or about 9%.

Even though we sold fewer instruments, we had record total sales finishing at about $27.7 million, up 10% year-over-year and 13% quarter-over-quarter. Total vet sales at just under $20 million, $19.9 million, were also at record levels, up 11% year-over-year and 20% quarter-over-quarter. While domestic medical sales were at record levels, finishing at about $4.5 million, worldwide medical sales at about $6 million brought only 7% year-over-year and down about 9% quarter-over-quarter due to fewer Piccolo instrument sales.

We did, however, record medical disc sales of 434,113 units, up 28% year-over-year and up 8% quarter-over-quarter. Record vet disc sales finished, for the first time ever, at over one million units or 1,003,408 units, up 11% year-over-year and up 29% over last quarter’s depressed performance. In dollars, vet disc sales finished at $13.7 million, up 18% year-over-year and up 32% quarter-over-quarter. With record vet and medical disc sales, total disc sales of $1,437,521, the highest ever for a quarter, and were up 16% year-over-year and 22% quarter-over-quarter.

North American sales of $22.5 million, also a record, were up about 7% year-over-year and 11% quarter-over-quarter. Record international sales of $5.2 million were up 26% year-over-year and 22% quarter-over-quarter. The strength was in Europe, with total sales finishing at $4.3 million, up 37% compared to Q2 last year, and up 28% over the last quarter.

Government or military sales about $1.1 million were flat year-over-year and down about 300,000 quarter-over-quarter. We now have assigned a full time person who will be responsible for government sales, and he’ll focus on expanding our position in this large market.

Domestic sales made up 81% of the total for Q2 ’09, and international made 19% of the total. This compares with 84%, 16% Q2 last year; and 83%, 17% last quarter. Capital sales made up 25% of total sales, while consumables came in at 75%. This compares with 30%, 70% Q2 last year; and 32%, 68% last quarter.

Medical sales made up 22% of total sales for Q2 ’09, vet sales were 72% of the total, and other made up 6%. This compares with 22%, 71%, 7% Q2 last year, and 26%, 68%, 6% the last quarter.

The disc average selling price beat our long term goal of $12, finishing at $12.14, up 2% or $0.28 year-over-year and up 2% or $0.24 quarter-over-quarter. Mix and the domestic vet price increase effective this last April were the main reasons for these results. Disc cost at $4.14 was down $0.28 year-over-year or about 6%. Quarter-over-quarter, disc cost finished down $0.01. Gross profit for discs finished up $0.25 quarter-over-quarter and $0.56 year-over-year. This is a new record for gross margin on disc at 66% or about $8 per disc.

Even though chemistry instrument margins finished in the low 40% range, total gross margins for Q2 at 55.4% were up 40 basis points year-over-year and quarter-over-quarter.

Operating expenses as percent of sales finished at 38% versus 38.7% of sales Q2 last year, and 38.6% of sales last quarter. Sales of marketing expenses $6,494,000 or 23.5% of sales were down from Q2s last year’s level of 25.3% of sales, and also down from last quarter’s 23.7% of sales. On the expenses of $2,082,000 or about 7.5% sales were up slightly over Q2 last year’s level of 7.2% of sales, but down versus last quarter’s 8.1% of sales. Admin expenses of $1,952,000 of 7% of sales were up from 6.8% of sales last quarter and 6.1% of sales Q2 last year.

Improvements in gross margin and lower operating expenses as a percent of sales led to record operating income of $4,814,000 or about 17.4% of sales. This is up 17% year-over-year and 20% quarter-over-quarter.

Pretax earnings of $5,140,000 were up 15% quarter-over-quarter, and 10.6% year-over-year.

Net income of $3,297,000 was up 14.2% over Q2 last year, and up 18.8% over last quarter, or $0.15 a share compared to $0.13 Q2 last year and $0.12 a share last quarter.

We have cut in all the new parts for our new – from our new vendors for both the VS2 and the Piccolo xpress. These improvements have resulted in a big reduction in infant mortality problems, and should result in higher sales force productivity. We are now making improvements to these new products with the addition of a cooling system that was cut in October 1st.

Goals for Q3 include starting the clinical trial for our new CRP test as well as the modifications to the heartworm submissions suggested by the USDA that was submitted last week. Once our clinical trial protocol for the heartworm is approved, we’ll start the trials, which should take about 30 days. We will then submit the data to the USDA for clearance. The clear wave status for CK and phosphorous has not changed. And the latest message to us from the FDA is any day.

Q3 is usually a big instrument quarter for us, so we have set aggressive goals for our sales folks worldwide. Marty and Chris will cover some of the programs for the domestic group. And we know our products help customers – our customers save money and make them more productive. So in this tough economy, we have a timing solution.

Now, before I introduce Marty, I want to let everybody know I started the first of the process in exercising a stock option of 69,900 shares due to expire in January. I took out a short term loan of about $500,000 from a bank, exercised the options, and paid the taxes. So over the next couple of quarters, I may have to sell some of these shares to pay back the loan. So with that, Marty.

Martin Mulroy

Thanks, Clint. The North American varied base contributed a record of – record revenues of $15 million Q2 FY ’09, up 6% year-over-year, and up 16% quarter-over-quarter. Year-over-year sales of chemistry units were 31%, having sold 266 instruments Q2 ’09 versus 203 units in Q2 ’08. Chemistry units revenue was up 34% year-over-year, at recording $2.1 million of revenue for Q2 ’09 versus $1.5 million Q2 ’08.

The consumable business is also again very strong at a record $11.3 million in revenue, up 14% from a year ago, and up $2.4 million or 27% from last quarter. Reacting quickly to market conditions, we just launched a huge 3-Part Differential hematology analyzer to complement our HM5 product release last year. This low cost instrument addresses the more price sensitive market, while providing Abaxis essentially the same margin. Abaxis is now the only one of the three major players in veterinary diagnostics to offer the veterinary clinic a choice in hematology instruments.

A key goal for the current quarter is continued emphasis and focus by our marketing team and sales force on the economic advantages and efficiencies provided by the Abaxis laboratory relative to the occurrences. Sales management has programs in place for intense training along these lines, for our field sales force. And these will be marketing this core message in the coming months. As Clint indicated, our Q3 is typically a strong instrument quarter. And we will be working towards some pretty aggressive internal goals despite economy concerns.

We also will be following a year reagent resin program that will provide for incremental chemistry placements, drive rotor business, and increase profit margins. Finally, we’ve been working diligently on deepening existing relationships and developing new ones that will provide the synergy to further growth in the North American veterinary business, revenue, margins, and customer base.

And with that, I’ll turn it back over to Clint.

Clint Severson

Thank you, Marty. Okay. Chris, you’re next.

Christopher Bernard

Thanks, Clint. Good afternoon, folks. For the quarter, US medical sales minus the military were up 12% at $4.5 million year-over-year, and up 5% quarter-over-quarter. US medical disc sales minus the military were up 45% at 362,000 units, which returned a 46,000 a year ago, and up 15% quarter-over-quarter.

With the current economy affecting routine office business, we continue to focus on the higher volume account seeking sick patients, particularly oncology and urgent care. The average daily rotor usage amongst all customers remain steady at 5.2 panels per day.

In the US, we sold 111 Piccolos, and had a total placement of 84 systems in Q2 versus placing 97 Piccolos a year ago. In light of the economic pressures, particularly (inaudible) capital purchases and distributor reagent price increases to the offices, we are currently reviewing programs that would mitigate the initial commitment and risk concerns that the offices have expressed.

(inaudible) by segment last quarter were 18 FPGP, and then continued strength in the urgent care at 13 and 13 walk-in clinics, for a total of 26 urgent care/walk-in clinics. Two high profile placements was mentioned last quarter. We installed two evaluation units in the two separate LabCorp facilities, and sold our first units to the Kaiser and Cleveland, Ohio. Our top rep recorded 70 Piccolo placements in Q2.

From an instrument standpoint, the core was somewhat challenging with the known slowdown of summer coupled with the economy lagging and instrument challenges lease, and just however, continued to remain strong quarter-over-quarter.

Goals and marketing strategies for Q3 include our second half of the published national clear list, 55,000 sites received the initial mailing last Wednesday, and the responses are beginning to come in currently. In conjunction with this mail, we’ve targeted the initial 18,000 role offices who daily battle the turnaround time and efficiencies and commercial laboratories. We are six weeks in the PCCS’ lab zone, and the past lab zone has proved to be the backbone to our strong Q3 capital quarter.

A recently hired Director of Business Development will be coming onboard this week. He’s solely focused on the health screening, ops, and employee health arena.

Recap into Q3, I will be visiting with our top distributors in the coming weeks to discuss additional capital acquisition programs for our POL markets to reduce the commitment and risk initially upfront. Our focus remains heavy on the specialty arena, with an emphasis on the urgent care walk-in clinics. And lastly, we’re in the process of building our 15th sales inventory, which I believe gives us adequate geographic and distribution coverage at the present time.

And Clint, that’s (inaudible).

Clint Severson

Great. Thank you, Chris. And now we’re open for questions.

Question-and-Answer Session

Operator

Operator instructions) Your first question comes from James Sidoti with Sidoti & Company.

James Sidoti – Sidoti & Company

Good afternoon, Clint. Good afternoon, Al.

Al Santa Ines

Thank you.

Clint Severson

Good afternoon, James.

James Sidoti – Sidoti & Company

On the vet sales, it was a little bit better than I thought. Can you quantify how much was left over from last quarter? Or can you give us some sense if you think this is a sustainable run rate?

Clint Severson

Well, clearly we had – on the consumable side, we had a low quarter last quarter, of somewhere between the middle year and then the middle end of the quarter, or something like that because of problems with distributors. But clearly, the distributors now are paying their bills. Yes. I think our direct business continues to grow nicely. And yes, well we don’t forecast what the business is going to be. We think that – yes. It’s doing fine.

James Sidoti – Sidoti & Company

Okay. I know you don’t like to forecast, but you think the single-digit revenue growth for the vet sales despite the economy is reasonable or you think that’s aggressive?

Clint Severson

No. I think it should be more than single-digit myself. Personally, I think it ought to be double digits.

James Sidoti – Sidoti & Company

I hope there. All right, and then, Al, on the interest income that was down, is that due to rates?

Al Santa Ines

Yes.

James Sidoti – Sidoti & Company

Okay.

Al Santa Ines

Yes. You shouldn’t expect that, though. With the interest holding, you should project a much lower investment income.

James Sidoti – Sidoti & Company

Okay. And then, how about the R&D tax credit, was there any benefit from that in the quarter or will that help you next quarter?

Al Santa Ines

You should expect some adjustments on the tax provision for next quarter, which will be December reporting. Okay?

James Sidoti – Sidoti & Company

And will you catch up for the whole year then?

Clint Severson

That’s correct.

James Sidoti – Sidoti & Company

Okay. Then, on the cooling system you’re adding to the unit, can you give us a sense – will that impact the margin?

Clint Severson

The margins on the machines now are you going to be tied to the volume of the machines that we sell. And then, of course, working our way through the tail end of all the problems we had from – the mess we had in instrument manufacturing over the last six, seven quarters. So this cooling system is minimal cost. And yes, the cooler the machine runs, of course the longer it’ll last. And yes, the better it is for everybody, so.

James Sidoti – Sidoti & Company

So we shouldn’t see a big change in margins because you’re adding the cooling?

Clint Severson

No.

James Sidoti – Sidoti & Company

Okay. On the modifications of the heartworm, when do you think you’ll get those resubmitted.

Clint Severson

We resubmitted it. We submitted the recommended changes that the USDA made to us. And it went out last week.

James Sidoti – Sidoti & Company

Okay. So it’s back in the USDA’s court then?

Clint Severson

It is.

James Sidoti – Sidoti & Company

Okay, all right. And then, on the royalty revenue, Al, a lot of announcements from (inaudible) regarding some of their programs. Should we refer from this that you should be concerned with the royalty revenue going forward?

Al Santa Ines

This is flat. In Finland, they send their product. You never know, right?

James Sidoti – Sidoti & Company

Okay, okay. And then, on clear wave, if you said any day now for CK and phosphorous?

Clint Severson

That’s what they tell us.

James Sidoti – Sidoti & Company

And now, how about reimbursement? Will take that a few months before that kicks in for those panels with that? You have to wait for something?

Clint Severson

Well, they do it every quarter, so. But once it’s effective, yes, the customers will get reimbursed. They just have to wait until it gets loaded in the computer, so.

James Sidoti – Sidoti & Company

That’s probably about a three-month lag there?

Clint Severson

Yes. It should not be a material issue.

James Sidoti – Sidoti & Company

Okay. And then the last question I had was, Marty mentioned there are we (inaudible) rental program? I assume you are renting the chemistry unit out on agreement for a minimum use of discs.

Clint Severson

Yes.

James Sidoti – Sidoti & Company

Okay. Is there a similar program for the medical side? Or are you considering one for the medical side?

Christopher Bernard

We’re looking at all possibilities, James. We’ve got, clearly, in the medical offices, the upfront commitment, whether it’s on a lease payment or the length of term or lease rental. It’s a little bit challenging. So we would look at it at a slightly different rental program than in the true reagent rental and mitigate the risk upfront for them.

James Sidoti – Sidoti & Company

And then, Chris, can you – I’m sorry. Clint, went through the numbers kind of fast. Can you tell me what the total Piccolo pricing for this quarter over the last quarter, and what the pricings were minus the military?

Clint Severson

Okay. So we sold a total of 161 Piccolo – or 167 Piccolos in Q2 of this year, and breakdown was 111 domestic, 24 Euro, 6 Asia, and 26 government.

James Sidoti – Sidoti & Company

And what was it last year?

Clint Severson

125, 29, 4, and 20.

James Sidoti – Sidoti & Company

Thank you very much.

Clint Severson

Thank you.

Operator

Your next question comes from Ross Taylor with C.L. King.

Ross Taylor – C.L. King

Hi. Maybe that’s a couple of questions related to the performance of the instruments now that you’ve implemented a lot of these changes in your manufacturing. And do you have any statistics as to what the infant mortality looks like on that side at this point in time?

Clint Severson

Well, of course, on the vet instrument, it’s gone down to the double digits, down to the low single digits. On the Piccolo, most of the machines have been just recently shipped out. So it’s hard to tell until we have some – yes, a track record for a couple of months, anyway. But clearly, the number of infant mortality failures has gone way down.

Ross Taylor – C.L. King

Okay. And I know in the past you talked about maybe being able to realize some fairly significant cost savings in your manufacturing because of some of the changes you’ve put through. And is the number still around $3 million, I think you talked about before, still reasonable to expect over the long term?

Clint Severson

It is. Yes.

Ross Taylor – C.L. King

Okay. And final question, any commentary or feedback you’ve gotten from the field with regard to just the strength or health of the veterinary market at this point given the economic slowdown?

Clint Severson

Yes. I think that most people, the biggest problem they have is fear. Everybody’s afraid, all the bad news. But are business here appears to be strong. I mean, we’ve continued to sell machines. We’ve continued to ship consumables. And the distributors, as we understand today, plan on meeting their numbers for the quarter coming up. And yes, so we’re counting on that. And certainly, we are in touch with everybody on a day to day basis. So if there’s a change, we’re able to respond to it. But right now, I think things look pretty good.

And of course, Q3 for us is a strong instrument quarter. It has been in the past. And yes. But I think if there was issues out there, we probably – we’d probably see it in Q3, I mean. But right now, we think it looks pretty good.

Ross Taylor – C.L. King

Okay. Thanks. And just one other question, the new hematology analyzer that Marty mentioned, I mean is that something you expect to attack a new segment of the market? Or does that have any potential to cannibalize the HM5 sales?

Clint Severson

Okay. So I’ll answer, then I’ll turn it over to Marty. I’ll give you my point of view. And then, of course, Marty’s the most important one because he’s out there and doing it everyday.

But clearly, there are customers out there that resist a higher priced machine, for whatever reason. They’d say, “You know what, I want to do hematology, but I really don’t need 5-Part Diff and I don’t want to spend that much money. Do you have an alternative?” And so by providing an alternative for hematology that’s $6,000 to $7,000 lower on equipment cost will help us sell VetScan as well as our hematology machine.

So we wanted to have that flexibility going into this tougher time. So we negotiated a deal with our supplier for a lower cost 3-Part Diff machine that would meet the requirements for this lower end of the market. And yes. And I don’t think somebody that want the 5-Part Diff is going to care about the lower price on the 3-Part Diff. They’re going to want a 5-Part Diff. So I think it will expand our ability to penetrate the market.

So Marty, give us something else.

Martin Mulroy

No. I think that’s a good question in terms of could the lower instrument potentially cannibalize sales of the higher end. But if we execute the plan as designed, ours having two instruments, hematology product line, our intention is to actually use that instrument to grow, and sell more of the higher end instruments. So we believe they are having a – hematology pipeline will get us into more clinics, generate more sales, and actually at the end of the day, sell more of the by far instrument, not less.

Ross Taylor – C.L. King

Okay. I guess also, you have probably more VetScans as Clint mentioned.

Clint Severson

Absolutely.

Ross Taylor – C.L. King

Okay, okay. That’s all my questions. Thank you.

Clint Severson

Thank you.

Operator

Your next question comes from Jonathan Block with SunTrust Robinson Humphrey.

Jonathan Block – SunTrust Robinson Humphrey

Hey, guys. Good afternoon.

Clint Severson

Good afternoon.

Jonathan Block – SunTrust Robinson Humphrey

Maybe just three or four questions. I think first one for either Clint or Marty, clearly you had the distributor issues last quarter. But if I normalize for the first half of the year, I get worldwide that is maybe down about maybe, I don’t know, somewhere between 3% and 5%. So I just would love your thoughts there. Has market growth gone negative? Or do you think you guys might be loosing a little bit of share.

Clint Severson

Yes. Well, I don’t think they’re down. I’ll have to do some calculating here. We can talk about that later. But for the first half of FY ’09, we’re about $1.8 million (inaudible). And last year, Al, you have to tell me last year what it was after the first half.

Al Santa Ines

We’ll calculate that.

Clint Severson

Yes. So what’s your other question, Jonathan? Then we’ll –

Jonathan Block – SunTrust Robinson Humphrey

Well maybe we’ll just move on. I guess since we moved on, I was going to ask you about trends, Clint. So in other words, clearly, we’re getting the numbers as of September 30th. There are a lot of moving parts intra-week, intra-month. How’s October shaping up so far?

Clint Severson

Yes, well we can’t tell by one month, one way or the other that’s for sure. But what I can tell you is that the VetScan saves our customers money because we eliminate the overhead, anybody in the office can run it, and yes. So there are a lot of advantages to buying the VetScan. So in the end, what’s going to drive the business is for the placements of VetScans to continue as they have been over the last few quarters.

We keep adding more VetScans, and we sell more consumables. And there are going to be fluctuations quarter by quarter because of ordering patterns, and distributors, and the economy, and all that kind of stuff. But we use a 12-month basis that the rotors and discs should go up tied to selling of the machines. That’s the bottom line.

Al Santa Ines

So Jonathan, the first six months year-over-year is flat. It’s slightly up by 9,000 units.

Jonathan Block – SunTrust Robinson Humphrey

So it’s up 9,000 units.

Al Santa Ines

That’s about it.

Jonathan Block – SunTrust Robinson Humphrey

Okay. So my apologies, actually, you’re right. I’ve got a 0.5%. But sort of the same question applies. I mean that’s market growth or do you think there are some market share moves in there?

Clint Severson

Well clearly, the economy is going to have an effect on business, routine business of the veterinarian. I covered that last quarter in the call. That it’s true. It does have an effect, no doubt about it. But again, it’s all – the growth is going to be tied to adding more instruments out there.

Jonathan Block – SunTrust Robinson Humphrey

Okay, okay. And then maybe to move on to medical, Chris for you, I’ve got – I think you said 111 in the US. That’s one of the lowest I’ve gotten I think several quarters. I think maybe even going back to June of 2006. So again, your thoughts on this, is this all economy? Is this a situation where maybe you had the low hanging through, then now the other guys are pushing back a little bit? And then, as part of that question, have yourselves, guys, be gone for – maybe become a little bit more rational with price, where at the end of the day, you want to get just the instrument in their hands so that you see the consumables ramp?

Christopher Bernard

Yes. I’ll answer the first half, Jonathan, first. As you look at the economy, certainly it’s playing a role in the commitment fees. So we’re talking about a five-year commitment, whether it’s a lease, whether it’s a lease-rental. Doctors are wondering where the paychecks are going to come from the three months, whether or not they’re going to pay a lease payment for five years. So that is certainly a piece of it. It’s certainly the reason for me that now to go talk to distributor partners to find a way to ease that commitment or the risks involved as they proceeded with that commitment.

Number two, if you look at as far as programs, we never want to make capital the barrier to the razorblades. And certainly, we are open to any and all ideas when it comes to placing those instruments in there. Also understanding that capitals, although it generates quite a bit of revenue for us here on the medical side. So we’re sent to the barrier piece. Our SAP on the unit has held very, very strong over the last two years. Certainly, we’ve seen a couple of down (inaudible) a couple of quarters on sold units based on what I believe is empty waiting rooms in some of these offices. But we’ll continue to look for what the doctors are looking for. And that is reduce the risk upfront, get the units in there, and we certainly know that’s once they’re in there, they’re absolutely useable.

Jonathan Block – SunTrust Robinson Humphrey

Okay. Great. And the last one, Clint or Al. Cash flow looked really solid. So it’s a tough question in this market, but any thoughts in terms of buying back stock at these levels.

Clint Severson

Well, we haven’t given a lot of thought to buying back stock because we haven’t been at these levels for very long, so. But we do have a Board meeting coming up tomorrow, along with our shareholders’ meeting. And that’ll probably be in discussion for the Board meeting.

Jonathan Block – SunTrust Robinson Humphrey

Okay. And I’m sorry, one last one. I’ll just slip it in. I think your old timeline for heartworm was around early calendar year ’09. You said it bounced back once. But does that still apply or maybe we’ll be back at that?

Clint Severson

Well, we’re kind of at the mercy of the USDA. So it’s really hard to predict. But I’d certainly like to have it done by the end of the calendar year, or certainly by the end of our fiscal year. And we’re pushing hard, yes, to get these guys to respond. And so far they’re responding to us. And we’re ready to go with the clinical trials. Yes. We’re just waiting for the approval of the protocol.

Jonathan Block – SunTrust Robinson Humphrey

Okay, great. Thanks, guys.

Clint Severson

Thank you.

Operator

Your next question comes from Scott Gleason with Stephens Inc.

Scott Gleason – Stephens Inc

Hey, Clint. Thanks for taking my call, and congratulations on a strong quarter.

Clint Severson

Thank you.

Scott Gleason – Stephens Inc

First, when you look at the systems side, I think, IDEXX on their call the other day said they placed 200 units in the US. So looks like you guys are outselling them kind of two-to-one in the market as far as new placements. Could you make any comments on what percent of the systems you’re placing now are competitive converts versus new customers being converted to client care testing.

Clint Severson

Well, Marty, you want to cover that?

Martin Mulroy

Yes. We took about 60 to (inaudible) out of the US market last quarter. So we’re still swapping out some commercial lab business as well as converting business from other instruments. It’s a blend.

Scott Gleason – Stephens Inc

And then, Clint, IDEXX has some pretty bullish commentary regarding the fourth quarter here. Or their fourth quarter, I’m sorry, you guys’ third quarter. Are you guys certain to see them more on the marketplace still on? Or can you make some commentary surrounding that?

Clint Severson

IDEXX, we see IDEXX everyday, every minute of every day. That’s always been the case as long as I’ve been here. So no, do we see more of them than we did before? No. They’ve always been a lot of visibility, a lot of coverage.

Scott Gleason – Stephens Inc

Okay. Can you guys maybe outline in a little more detail what the read on rental per rent could look like on the medical side, and just kind of talk through that in a little more detail?

Clint Severson

Okay. So I’ll give you my concept of it, and Chris and his team are still formulating it. But when we go out to sell a Piccolo machine, we go to a position and we show him how he can make more money. And of course, in the down economy, everybody wants to make more money. We can show him how he can be more efficient. So that’s very important in a down economy, to be more efficient in your practice. And we’ll have happier customers because they won’t have to call back, where they can whine, all those other kinds of things.

So we make this presentation, and sometimes do a short demo. And the customer will ask how much, and we’ll tell him $15,000 for a machine, and about $10 for a disc. And because the customer has no experience collecting from third party or from a private payer, they don’t know for use what they’re going to get for reimbursement. Nobody knows for sure until they start running it. So some customers believe that that’s too much of a risk. Risking $15,000, not knowing for sure what you’re going to get, and just the sales guy telling you that you’re going to make more money. Sometimes it’s not enough.

Now, because our salespeople generally have lots of leads and we generally don’t have much flexibility on the price, we just kind of move on to the next guy. So what we want to do here now is we want to take advantage of this fellow who’s concerned about his short term risk, to try to mitigate that some way because we know that once a Piccolo is purchased, they run lots of consumables. So we know that you’re getting paid and that there’s clinical utility, and that it’s working because if it wasn’t, they wouldn’t be ordering all that stuff. And so, that’s the general outline of what we’re trying to accomplish.

So Chris and his team are going to put together programs to try to mitigate the early risks so the customer has an opportunity to see exactly what he’s going to get as reimbursement, see exactly how it fits with his practice, and can experience the benefit for making a commitment for – our lease would be about three to five or cash of $15,000. So that’s the purpose of it, and that’s what we’ll be working on.

So Chris, you want to comment on that?

Christopher Bernard

Yes. I think Clint covered most of it there. I think that the other piece of this is working with distribution. Certainly, here at the end of the year, with the tax benefits for bringing on capital at the firm and in their existing lease programs, those are all good programs to work through the accounts that are not as concerned about the risks upfront. For the account that Clint just mentioned, we absolutely need to come up with a 90 to 120-day program that allows them to test the waters, if you will, on the reimbursement fees and help mitigate that risk.

Scott Gleason – Stephens Inc

So it’ll be more of a trial program with a deferred purchase, is that kind of right where you think about that?

Christopher Bernard

I think, at any level, there’s going to be some commitment and some accountability on the account of the office. So we need to look at some programs where we’re not just shipping Piccolos out for people to test drive in 90 to 120 days. So we’re probably looking out, what is the upfront commitment going to be, or what does it need to be in order to get those units installed, which is a positive to that obviously. And in conjunction, work with our distributor partners to make sure that it matches with their current programs that they have out there, mostly in the leasing arena.

Scott Gleason – Stephens Inc

Okay. And then, can you guys care to provide some commentary on the US Military medi wide. That came out a little bit softer this quarter and what to expect going forward?

Clint Severson

Yes, of course. The timing of the military sales are hard to predict. So what we did was – is put a person in charge of the military full time. So in the past, we had Vladimir who managed the military, the pack rim, South America. He is spread pretty thin. So we put Randy in charge of the military business and all the government business. So we’ll have a better understanding of what to expect. But the timing of the military sales is something that – we ship them when the order comes in, so.

Scott Gleason – Stephens Inc

So Clint, it’s more of a timing issue than any kind of–?

Clint Severson

Yes.

Scott Gleason – Stephens Inc

This issue is going or–?

Clint Severson

It’s more of a timing issue. Yes.

Scott Gleason – Stephens Inc

Okay. And then, this last question, yes. Clint, I know you talked in the past about the lower cost of the new vendor parts you guys are rolling in on the assistance side from your new Far East vendors. Can you maybe make some commentary on what we could expect from a margin standpoint on the system side going forward and maybe the timing of those benefits rolling in?

Clint Severson

Yes. So we can talk about the cost of the parts. When you talk about cost or the margin, it really depends on the number of instruments that you build and sell on a particular quarter. But I can tell you that the new machine, historically, has been in the low 40s, low 40s gross margin, whereas our classic machine that we built for seven, eight years, within the mid 50s, low to mid 50s. So our goal is, over the next few quarters here, is to get the new platform from the low 40s to the low or to mid 50s.

Scott Gleason – Stephens Inc

Okay. Great. Thanks a lot, Clint.

Clint Severson

Thank you.

Operator

Your next question comes from Bill Gibson with Nollenberger.

Bill Gibson – Nollenberger

Hi. Most of mine have been answered, but a couple of quick ones. What’s our sales cap on the vet side right now?

Clint Severson

Marty, how many salespeople do we have?

Martin Mulroy

Today we have 50 sales reps and seven field sales managers.

Bill Gibson – Nollenberger

So really it’s your year-end target already.

Martin Mulroy

Yes.

Bill Gibson – Nollenberger

Okay. And on the medical side, on the bill and magnesium, have they – new calibrated tests been submitted?

Christopher Bernard

Okay. We’re not going to submit the new calibration until phosphorous and CK have settled.

Bill Gibson – Nollenberger

Oh okay.

Christopher Bernard

We don’t want to get in a situation where we throw too much at them at one time.

Bill Gibson – Nollenberger

Got it, appreciate it. Thank you.

Clint Severson

Thank you.

Operator

Your next question comes from David Clair with Piper Jaffray.

David Clair – Piper Jaffray

Hey, guys. How are you doing? Can you hear me?

Clint Severson

Yes, we can, David.

David Clair – Piper Jaffray

Hey, just a lot of my questions have been asked as well, but where are you on the field side on the medical business? And what can we look for as far as targets? I think you mentioned that’s kind of a focal point.

Clint Severson

Is it 14 or 13 people?

Christopher Bernard

We have 15 territories, roughly that’s 14 field.

Clint Severson

Okay. So 15 territories, 14 field, and then, Chris, as you mentioned, you hired a business development guy to take a look at some of these occupational health and screening type markets. And so we will be adding salespeople as we – yes, as we figure out how to mitigate some of the risks upfront. Yes, so we can – our first goal is to increase the productivity of the people that we have out there. That’s the number one objective.

And because we believe the capacity should be anywhere from 12, 18 Piccolos for rent per quarter. And I think now that we’ve got the machine fixed so we don’t have all the problems that we had in the past, that this will allow us to increase that productivity. Once we have that productivity increased, Chris can hire as many people as he wants to hire as long as we see the ramp that we’re looking for.

David Clair – Piper Jaffray

Okay. And then, in your commentary you said, was it two Piccolos at LabCorp.

Clint Severson

Yes. Two at LabCorp; and that right now is in evaluation.

Martin Mulroy

Yes. One in the East Coast, one on the West Coast in two of their field labs where they’ve had them now for a little over three weeks, those will run another couple of weeks, both sites.

David Clair – Piper Jaffray

And obviously, that’s a pretty big account. Do you think that this could turn into something pretty good for you guys? Or what kind of expectations do you have there?

Martin Mulroy

We really hope so, it turns into something big. If you look at LabCorp and or (inaudible), if you look at the application as a big role, certainly, when we see a lot of business in the urgent care suburban walk-in clinics, certainly, they have business in that arena as well as well as they manage some very large oncology, radiology type offices as well. So really point of care at their patient service centers I believe is what the draw for the Piccolo is right now.

David Clair – Piper Jaffray

Yes. Okay. And maybe just a quick question on auction rate securities, any kind of update there?

Al Santa Ines

One of my auction rate securities have been declared by my bank, they redeem at the end of – no later than the end of November? So I’m out.

David Clair – Piper Jaffray

End of November?

Clint Severson

End of November, they’re all liquid.

David Clair – Piper Jaffray

Okay. All right, guys. Thanks a lot.

Clint Severson

Great. Thank you.

Operator

Your next question comes from Neal Goldman with Goldman Capital Management.

Neal Goldman – Goldman Capital Management

Hi, guys. How much inventory of the high cost parts do you still have and how long will it take you to move it?

Clint Severson

Well, we have some higher cost parts that are in the process of being modified so they work as good as the new stuff, so. But most of that will go into repairs and refurbished machines, and that kind of thing. So most of the parts that are going into our new machines are all new parts.

David Clair – Piper Jaffray

Okay. So that’s what’s going to hold back the margin improvement in the short run to where you expect it to be.

Clint Severson

Yes. It’s two things. Okay. One, it’s the volume, of course. And as the number of Piccolo volume picks up and the number of VS2s pick up, we’ll be spreading that fixed overhead cost over more units, then drive the cost per unit down. And then, of course, the parts are much less from the new vendors than they were from the old vendors.

David Clair – Piper Jaffray

Okay. One last thing, it’s just for comment, given that these auction rates are coming due by the end of November, I think it would be smart to do a major buyback at this point given where the stock is these days.

Clint Severson

Yes. Like I said, we have a Board meeting after our shareholder meeting tomorrow. So that will be a topic for discussion.

David Clair – Piper Jaffray

Okay. Thanks, guys.

Christopher Bernard

Thanks.

Clint Severson

Thank you.

Operator

(Operator instructions) Your next question comes from Lenn Vieux [ph] from State Partners.

Lenn Vieux – State Partners

Hi, Clint. How are you? Did you say that you also had a Piccolo at the Kaiser facility?

Clint Severson

Yes. Chris mentioned he – they sold two Piccolos to Kaiser and Cleveland.

Lenn Vieux – State Partners

Okay. Now, is this the LabCorp experiment and the Kaiser experiment, is this something new for the company?

Christopher Bernard

Well, the LabCorp evaluation is really a three-step process. Certainly, they want to see the clinical utility of the Piccolo versus what they normally see in their whole laboratory. That’s step one. Step two then becomes the application part. So as they talk about the patient service center to this point of care for them as well as some of the offices that they manage as a corporation.

The Kaiser purchases of the Piccolo are, in fact, up and running. Those were purchases – and there’s one of them that’s a backup for ED. The other one is being used for Kaiser’s version of a suburban walk-in urgent care.

Lenn Vieux – State Partners

Okay. Thank you.

Clint Severson

Thank you.

Operator

Your next question comes from Dave Tuckley [ph] with SIG.

Dave Tuckley – SIG

Hey, guys. This is actually Sean in for Dave today. I have a question on the – overall ASPs on the discs have been going up, but I noticed that the actual ASPs on the medical side have been coming down. Do you have any explanation for that?

Clint Severson

Okay. So the medical discs are lower cost than the vet discs. But the medical machines have a higher cost than the vet machines. So the vet tend to negotiate the pricing of the machine, and the medical doctors tend to negotiate the price of the consumables. Also, we are much earlier in the medical market than we are in the vet market. So when you’re early in the game, you tend to have to leave money on the table for the consumables because the customer is not used to this. He’s not really sure what benefits they’re going to be. And so they watch the price of the consumable really close.

And then, over time, as you end up with a position in the marketplace, you have the ability then to raise the price. So a little history back when we first started selling the VetScan, the average price on the disc in the vet market was about $9.40. And now, the average selling price in the US vet market is around $14. So we expect the same thing will happen on the medical side. So that’s something that we should expect when you hear this product.

Lenn Vieux – State Partners

Okay. And in the third quarter, what makes us so strong for instrument sales?

Clint Severson

Well, as you know, the third quarter for us is the December quarter. And if somebody buys capital equipment before the 31st of December, in most cases, they can depreciate it all or expense it for the calendar year. So depending on the tax bracket you’re in, if you operate in California and you’re at the maximum. It’s almost 50%. So the government pays for half of your capital equipment. That’s why it’s a strong Q3.

Lenn Vieux – State Partners

Okay. All right. Thanks, guys.

Clint Severson

Thank you.

Operator

Your next question comes from Tilton Gardner with Mutual Securities.

Tilton Gardner – Mutual Securities

Well, Clint, you and your team did an admirable job considering the environment there.

Clint Severson

Thank you, Tilton.

Tilton Gardner – Mutual Securities

So are the partners that you got out there still selling their proportion or are they slacking off versus your own guys?

Clint Severson

Well I think on the veterinary side of the business, our direct business is growing faster than our distributor business. That’s true. And I think as Marty expands his headcount, where a couple of years ago he was 20-something, then 30-something last year, 40-something now, 50-something, we’ll see more of our sales move from distribution where we are very light in the US. We have very light distribution coverage. We’re picking that up on a direct basis now.

And on the medical side of the business, it hasn’t really changed that much. Most of our business today on the medical side is through distribution. As we identify ways of mitigating the short term risks, we need to identify how to distribute it and what role they’re going to play in this. And so Chris is still figuring that one out.

Tilton Gardner – Mutual Securities

Okay. And I just wondered since IDEXX kind of broadened their lines, let’s say, have they de-emphasized or are they still trying to compete with you harder, or are they laying off on the blood testing side?

Clint Severson

No, no. They compete very hard.

Tilton Gardner – Mutual Securities

Still competing hard, ha?

Clint Severson

Absolutely.

Tilton Gardner – Mutual Securities

Okay. Thanks a lot.

Clint Severson

Thank you.

Operator

Your next question comes from Albert Olmund [ph], private investor.

Albert Olmund

Hi, Clint.

Clint Severson

Hi, Albert.

Albert Olmund

Is it true that the medical market is several times larger than the vet market?

Clint Severson

Our estimate on the total market for blood chemistry testing is about $4.9 billion. And our estimate is the veterinary market is about $500 million, and the medical market is about $4.4 billion.

Albert Olmund

Okay. Well then, would you anticipate long term that your medical sales would be several times larger than vet sales?

Clint Severson

Eventually, the sales here will be mostly medical sales. Yes.

Albert Olmund

Well that being the case, then I don’t believe IDEXX competes in the medical side. Would it be fair to say that they will become less and less of a significant factor insofar as competition to your total business.

Clint Severson

Our competition on the medical side of the business is the Centralized Laboratory. That’s correct.

Albert Olmund

Very good. Thank you.

Clint Severson

Thank you.

Operator

(Operator instructions) One moment please. At this time, there are no further questions. Mr. Severson, do you have any closing remarks?

Clint Severson

Yes. I want to thank everybody for tuning in. And remind everybody that the Abaxis product helps our customers be more efficient and save them money. So that is the message that our salespeople are taking to this vast customer base. And we look forward to the next conference call in January of ’09. So thank you for tuning in.

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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Source: Abaxis, Inc. F2Q09 (Qtr End 09/30/08) Earnings Call Transcript

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