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Executives

Carol Ruth – IR

Joe Capper – President and CEO

Ron Rubin – SVP and CFO

Scott Verner – SVP, Sales and Marketing

Analysts

Derek Leckow – Barrington Research

Avio Gabion [ph] – JP Morgan

Larry Solow – CJS Securities

Beth Lilly – Gabelli and Company

Derek Leckow – Barrington Research

Home Diagnostics, Inc. (HDIX) Q3 2009 Earnings Call Transcript November 5, 2009 8:30 AM ET

Operator

Greetings and welcome to the Home Diagnostics, Inc. third quarter 2009 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) It is now my pleasure to introduce your host, Ms. Carol Ruth, Investor Relations for Home Diagnostics, Inc. Thank you, Ms. Ruth. You may begin.

Carol Ruth

Thank you, operator. On the call with us today is Joe Capper, President and Chief Executive Officer; Ron Rubin, Chief Financial Officer; and Scott Verner, Senior Vice President of Sales and Marketing. Before starting the call, let me remind you that statements made in today’s conference call include forward-looking statements and are subject to risks and uncertainties.

Such statements are only predictions and reflect the company’s expectations and assumptions as of the date of this conference call based on currently available operating financial and competitive information. The actual events or results may differ materially from those projected in such forward-looking statements, due to a number of factors including risks and uncertainties identified in the company’s most recent annual report on Form 10-K and other filings with the Securities and Exchange Commission may differ materially from those projected.

Now, let me turn the call over to Mr. Capper, Chief Executive Officer.

Joe Capper

Thank you, Carol, and good morning, everyone. Welcome to our third quarter earnings call. I am joined by Ron Rubin, our Chief Financial Officer and Scott Verner, our Senior Vice President of Sales and Marketing. I will begin the call by providing an overview of my thoughts on the third quarter followed by Ron to provide you an update on our financial performance, and then Scott who will detail key sales and marketing initiatives.

First, I will begin by thanking the employees of Home Diagnostics for their efforts during the quarter and for their steadfast commitment to our company’s success. We are pleased to report solid results for the third quarter of 2009.

Total revenue for the quarter was $34.5 million, and EPS was $0.17 a share.

Sequential revenue growth for the quarter was 5%. Revenue for the quarter was down 2.8% versus the third quarter of 2008 and 2.4% year-to-date versus prior year-to-date.

Upon closer examination, however, these operating results are encouraging for several reasons. First, let’s examine how we perform the GAAP for competition. As we have recorded on prior calls, the competitive environment in the blood glucose market has never been more challenging. I am pleased to report we are up to the challenging in trending in the right direction. The four largest manufactures in the industry who comprise 85% to 90% market share have reported that their average year-to-date revenue is off by a fractionally 8%. Comparatively, our sales performance is considerably better than the clients posted by our competition. Secondly, we have analyzed market share information by payer segment which shows that we continue to grow, especially in cash pay and managed care market, which would explain our strong performance relative to the competitors.

Additionally, when we analyzed our out sales by channel and more importantly, the sales from our customers we are confident that our strategy is on target and delivering positive results. Let me explain. We can’t really report revenue in four segments

Distribution, which was down 16.9%; retail which was up 8.3%; mail service which was up 14.4% and international which was up 19.8%. Three out of our four segments were up for the quarter over the same period last year. The shortfall in the distribution segment is attributable to the three large national wholesalers, change in the buying behavior and managing down inventory. Specifically, these three customers have taken an average of 100 days of inventory out of their system. Not surprisingly for a company of our size, this has had a noticeable impact on our sales. However, to accurately assess our current and expected performance, it is important to examine end-user demand as measured by outsales data, despite an almost 17% drop in distribution revenues we posted a 2% increase in outsales for the quarter. Again, in spite of the drop in sales we’ve experienced into the large wholesalers, their outsales of our product have increased. Even more impressive was our outsales performance on the four largest national retail chains, which were up 20%. We are gaining ground on the competition growing to demand for our products by staying focused on the five strategic objectives I outlined on previous calls.

These objectives are

Number one, to grow domestically by 4% on expanding the quality value segment of the market, to find price-sensitive shoppers who are not willing to sacrifice on quality or service. Number two, employee integrated approach to accelerating the expansion of our international business. Number three, gain access to segments of the diabetic testing market where we are not effectively competing today. Number four, explore opportunities to commercialize additional products adjacent to diabetic testing business, and number five institutionalize a culture of cost reduction and control.

I would like to share some highlights relative to the progress we have made during the quarter around the first two objectives.

The operating results I just spoke about clearly demonstrate that our strategy to expand the quality value customer segment is working. Remembering the first objective is quality, and that we are committed to manufacturing the most accurate products possible, we recently funded an independent study to determine how the TRUEresult system compared to other leading brands in the market. The study was conducted by the International Diabetes Center; the results are in. The accuracy and precision of the TRUEresult meter is comparable to the LifeScan, Ultra, Bayer Contour and Abbott`s FreeStyle meters. Think about this for a moment. This is a reputable third party validation that patients who are living with diabetes can now have one of the best blood glucose monitoring systems on the market at a price far less than it would pay for a fancy name. To quote the last sentence from the study "This bottom line advantage is a combination of value and performance that sets these store brand systems apart from their competitors."

During the quarter, we continued with the successful rollout of the TRUE2go Colors in retail, our private label initiative with Liberty Medical and TRUEbalance our fourth no-code system for targeted mail service and DME customers.

As mentioned on previous calls, we have dedicated additional resources to expand into international markets, which we believe, are particularly receptive for our quality value methods. In the United Kingdom, where TRUEone has been a strong performer, we added additional sales personnel to capitalize on the recent success we have had in gaining preferred formulary listing on four primary care trusts.

We are also diligently working to gain reimbursement coverage in Europe for the TRUEresult and TRUE2go which recently received CE mark approval. In Germany, we had an excellent launch of the TRUEbalance, where we are far exceeding our initial forecast. We recently won the private label business for Wal-Mart, Mexico, commonly known as Rely-On [ph] and anticipate a Q1, 2010 rollout.

And late last night, we signed a Letter of Intent to purchase our distribution partner in Australia. While this is not a material acquisition, it is logical and consistent with our strategy, especially given our current position and the opportunity for growth in the Australian market.

Regarding the GDH-PQQ enzyme, we continue to make progress in our efforts to mitigate any potential risks associated with the use of the enzyme in the manufacturing of our TRUEtest strips

As a reminder, we have been working with the FDA on appropriate actions necessary to further educate the market. Concurrently, we have being working to develop a backward compatible replacement enzyme for the test strip. Preliminary results for the replacement enzyme have show excellent results.

In closing, I would like congratulate the company on receiving the Export Excellence Award as part of the 2009 Florida government’s Business Diversification Awards program. The award recognizes Home Diagnostic’s exports, increase in export sales, expansion of the TRUEtest platform, and overall contribution to Florida’s economic diversification and job creation.

At this point, I will turn the call over to Ron.

Ron Rubin

Thanks, Joe. Good morning, everyone. Total revenue for the third quarter of 2009 was $34.5 million, a decrease of 3% compared to revenue of $35.6 million in the third quarter of 2008.

Revenue in the retail channel was $8.6 million, up 8.3% compared to $8 million in the third quarter of 2008, which included a large stocking order related the initial launch of TRUEresult and TRUE2go at Walgreens.

In the third quarter of this year, we launched TRUEtest 25-counts at Walgreens and CVS. Excluding these channel fill orders in both periods, retail channel sales were up 19% in the quarter. This growth was driven by the continued roll-out of our TRUEresult and TRUE2go systems with our major program partners, as well as strong demand for our TRUEtrack and other systems.

Wal-Mart continues to show a significant growth in both the Sidekick and TRUEtrack brands. Given the increased contribution from Wal-Mart, we have decided to now include Wal-Mart TRUEtrack unit outsales, in our reported retail outsales trends. During the third quarter, unit outsales were up --test strip unit outsales were up 20%, and meter unit outsales were up over 88%. This marks a record quarter for both strip and meter unit outsales for Home Diagnostics, that positions us well for continued growth.

Revenue from our mail service channel was up 14.4 % to $6.1 million compared to third quarter 2008 revenue of $5.3 million. The main growth driver in the mail service channel continues to be our private label no-coding product at Liberty Medical. TRUEbalance, our newest no-coding meter also contributed to grow from the channel following the initial rollout last quarter.

Revenue from our distribution channel was $15.6 million, down 15.9% compared to %18.8 million in the third quarter of last year. The decrease was driven primarily by lower day supply versus the same period last year in several of our large wholesale customers, a result of higher inventory management and as we discussed last quarter, marked by purchasing trends of a large wholesaler.

Average wholesale inventory day supply at the end of the third quarter was approximately 75 days. This is up sequentially slightly, but down nearly a 100 days from the third quarter last year. While this decrease in inventory days has affected our reported distribution channel results, as Joe mentioned, the outsales trends with our major distribution customers showed improvement for the second consecutive quarter. In fact, the third quarter was a record for test strip unit outsales in the distribution channel.

Test strip unit outsales were up 2% compared to the third quarter last year, and were up 11% on a sequential basis versus the second quarter. This indicates the end market retail demand for our product is strong. Also contributing to the increase was the rollout of TRUEtest in the channel.

Moving to our international channel results, third quarter revenue was $4.2 million, up 19.8% from $3.5 million in third quarter last year. International growth was primarily driven by the successful launch of TRUEbalance in Germany and other European markets. Gross profit for the third quarter of 2009 was $17.9 million compared to $21.6 million in the third quarter of 2008. Our strip-to-meter ratio decreased to 7.2:1 versus 8.2:1 last year, reflecting our meter investments for the launch of TRUEresult and TRUE2go, and the rollout of TRUEbalance no-coding.

Our gross margin decreased to 51.8% compared to 60.8% in the year-ago period. As expected, gross margin was negatively impacted year-over-year by the continued investment and the rollout of our new co-products, a shift in channel mix, and lower average selling prices in the mail distribution channels.

Selling, general and administrative expenses were $11.6 million for the third quarter of 2009 as compared to $13.4 million in the third quarter of 2008 which included $400,000 of expenses associated with the TRUEtest product launch. The decrease in SG&A is primarily a result of lower sales and marketing expenses following last year’s launch of the TRUE2go and TRUEresult systems, as well as, cost reduction initiatives.

Research and Development expenses were $2.1 million for the third quarter of 2009 as compared to $2 million for the third quarter last year. Operating income for the third quarter of 2009 was $4.2 million compared to operating income of $6.2 million in the third quarter 2008.

And in terms of the third quarter 2009, it’s $2.9 million or $0.17 per share based on weighted average shares outstanding of $17.6 million. Net income for the third quarter last year was $4.5 million or $0.24 per share based on $18.8 million weighted average shares outstanding.

Our weighted average shares outstanding per diluted EPS in the quarter was $17.6 million, at September 30th 2009 we have 16.9 million shares outstanding and 3.6 million total stock options outstanding.

Moving on now to our balance sheet and operating metrics. At the end of September we had cash and cash equivalents of $22 million and no debt outstanding. Total equity at September 30, 2009 was $112.6 million.

Our cash increased $2.1 million in the quarter reflecting $4.2 million of positive cash flow from operations and $200,000 from stock options offset by $2.4 million of capital expenditures primarily related to the capacity expansion.

We remain on track with our TRUEtest capacity expansion and are scheduled to significantly expand our capacity by the second quarter of 2010. During the quarter, we took delivery of additional equipment and expect the remaining equipments to be received in the fourth quarter or early in 2010 following factory acceptance.

For the full year 2009, we now expect total capital expenditures to be $15 million to $16 million, including approximately $9 million related to the expansion. This is down slightly from our previous expectation for total capital expenditures in 2009 of $17 million to $19 million, as a result in the shift and the expected timing and delivery of the equipment related expansion and the final payment terms.

We are very pleased with our meter placements in the quarter, which totaled 430,000. This represents a record quarter for meters disbursed by Home Diagnostics. Meter placements are an important method to track the effectiveness of our sales and marketing efforts, as well as a leading indicator for our business.

Total strips were 3.1 million based on 50 comp-equivalent units. Our strip-to-meter ratio for the quarter decreased to 7.21 compared to 8.21 in the prior-year period. This reflects a 22% increase in meter distributions compared to the prior year and positions us well for future test strip sales.

Now turning to 2009 guidance. Based on the third quarter results and outlook for the fourth quarter, we are adjusting our expectations for the full year 2009. We now expect revenue to be in the range of a $126 million to $127 million, down from a range of $129 million to $131 million.

We expect earnings per share to be in the range of $0.30 to $0.32, down from a range of $0.36 to $0.38. The reduced guidance is primarily a result of challenging market conditions, specifically in the distribution channel. In addition to lower than expected inventory level in the channel, we are also experiencing some near-term weakness with some of our durable medical equipment distributors.

While these issues are negatively impacted during our short-term expectations for remainder of 2009, we believe we are well-positioned for growth in all our channels in 2010. In the retail and distribution channels, we have invested and building a patient base for our new products, and are now seeing results with record unit outsales and increased market share. We expect our distribution customers to end 2009 at historically low inventory levels, which positions us well for 2010.

Our investment in launching new products in the mail service channel will produce topline growth and contribute to earnings in 2010.

Finally, as Joe discussed, we have several opportunities outside the US, which will begin to contribute in 2010. We also plan to further leverage our SG&A to deliver positive earnings growth. We look forward to quantifying these opportunities in our next quarter’s call.

I will now turn the call over to Scott Verner for his comments.

Scott Verner

Thank you, Ron. On today’s call we will discuss our sales and marketing initiatives including continued rollout of TRUEtest product platform and an update on our progress in managed care.

During the quarter, we received positive feedback and promotional support for TRUEresult, TRUE2go and TRUEtest from our major co-branding partners. We are working closely with our partners to drive patient adoption of the new products to enhance shop placements, in-store displays, on-shop promotions, coupons and circular advertisements. In addition, we are providing our program partners and patients with even more options to best match their individual preferences.

During the quarter, we launched TRUE2go in colors with our major retail partners. Our product portfolio is directed at the latest industry trends including no-coding meters, multiple color options, and compact size. Following on the success of the 25-count TRUEtrack test strip offering that we launched late last year, we began providing a 25-count TRUEtrack test strip offering this quarter. The 25-count option is particularly strong in the cash market and it provides our patients with a lower cost alternative to the to the 50 and 100-count options. We have also continued the rolling launch of TRUEresult and TRUE2go into chains like Kmart, as well as regional pharmacies and chain grocers such as SuperValu, BI-LO, Ingles, Fiesta, Saves Mart and (inaudible).

Our strategy is working. The expanded product portfolio and aggressive promotional activity continues to drive sales results for our major retail partners. Out sales from our top four retail customers grew to 20% year-over-year. We believe that the quality and value delivered by our systems is the underlying differentiator of our product portfolio and key to its ongoing growth. One of our strategy is to highlight the accuracy and quality of our products.

During the quarter, we announced results of a company-sponsored clinical study led by the International Diabetes Center, a world renowned diabetes center, which concluded that TRUEresult yielded active results comparable to those obtained by the more expensive brand name products. Home Diagnostics is delivering on its commitment to provide affordable diabetes care products while maintaining the highest quality products. In October, we announced similar results from a study on TRUE2go, confirming not only the accuracy and precision of the system but also the simplicity and convenience it provides to patients with diabetes. Both clinical studies were designed to comprise with specific ISO standards which is a performance standard for self-testing blood glucose monitoring devices that includes the valuation for accuracy and is an FDA Recognized Consensus Standard.

We are leveraging the results of these studies to educate pharmacists, healthcare professionals and patients on the accuracy of our products along with the opportunity to say, we were then $400 per year on diabetes test and supply. We believe this clinical data will resonate with the medical community and patients alike increasing their comfort level and recommending and using our products.

During the quarter we were also pleased with the continued support of the TRUEtrack product platform by our top co-branding partners. Among our top four retail customers, Point-of-Sales data shows that TRUEtrack grew 12% year-over-year and TRUEtrack sales at Wal-Mart has increased five-fold year-over-year.

Wal-Mart is driving patient adoption of TRUEtrack with special low-back pricing along with continued promotion of Sidekick, which continues to perform well. As Joe mentioned, we also have a successful quarter for TRUEbalance, our newest no-code meter that utilizes test strips manufactured on the TRUEtrack production line. TRUEbalance allows us to provide competitively priced no-coding meters in the mail service and durable medical equipment markets.

One of our strategic objectives is to gain access to the high value insulin-dependant patient base through cost promotions to end users at the pharmacy counter. We are educating pharmacists on the quality and value provided by our co-branded products as well as co-coordinating promotional opportunities for patients when they purchase insulin or oral medications. We are also leveraging retail loyalty programs allowing us to target the diabetic patients more accurately.

Turning to managed care, we are focused on educating providers on a broad availability and economic value of our products, which is particularly important in the current environment of healthcare reform.

As a result we are gaining improved traction with Medicare advantage plans, many of which are searching for ways to reduce costs. They are finding the full-featured, wide distribution and competitive pricing offered by the TRUEtest platform and ideal match for the quality and value they want off from their members.

During the quarter we secured preferred status with Medicare advantage plan in Florida and ProCare, two Medicare advantage plans which offer great opportunities for growth. ProCare is a national PBM with 4.5 million lives with a heavy focus on commercial and Medicaid plan. With TRUEresult as one of two preferred systems, we have significant opportunities for market share gains with these new plans. We also continue to leverage our existing managed care relationships and the strong formulary coverage of TRUEtrack to gain additional coverage for TRUEtest.

Most recently, Indian health services selected TRUEresult and TRUE2go in order to provide its members with better diabetes monitoring solutions at lower costs. As a result, we are now on formulary with a dozen tribes [ph] and have the opportunity to expand this relationship across the United States.

We believe they will be receptive to our products, as tribes have been paying as much as 30% to 40% more for outdated meter systems.

With our TRUEresult system, they now have access to the highest quality no-coding technology systems at a much lower cost. We are capitalizing on our expanded managed care coverage through targeted poultry [ph] programs that utilize our internal sales team TRUEsales, DirectNow [ph] and pharmacy education programs.

Last quarter, we secured TRICARE as a preferred brand covering 9.2 million lives through the Department of Defense in order to provide our systems to military families. The adoption of our product is driven by proactively working with our national and regional retail partners as well as distribution partners on marketing campaigns promoting TRUEtest as a preferred co-pay for TRICARE members and their families.

Our foolproof program helped us achieve a 27.4% prescription growth over the prior year. Our prescription market share is up substantially to 4.4%, up from 3.8% market share in the second quarter. We have a sequential increase in managed care market share in the last nine quarters and have realized seven consecutive quarters of double-digit prescription growth. All of this is in addition to our ongoing strength in the cash market.

In summary, the company is well-positioned and possesses the product and strategy to further build market share. Our strategy is to offer comparable or better options and features as the competitors, but at a competitive price. We will also continue to focus on highlighting the quality and value and choice provided by our product portfolio. Our aim is to educate potential customers about saving money without sacrificing accurate results or personal style.

We will continue to meet the demands of the market place which can be seen with our recent introductions such as TRUE2go in colors, TRUEbalance and 25-count test strip offerings. We are working with our co-branding partners to drive adoption of our new no-coding meters and build a patient base for TRUEtest. We continue to leverage our unique position as the leading co-branding and private label blood glucose monitoring company to improve our managed care coverage.

Lastly, our hard work is yielding results with impressive market share gains, positive pull-through and outsales strengths.

And with that I will turn the call over to Joe for closing commentary.

Joe Capper

Thank you, Scott. In closing, we are pleased with the progress we have made this quarter towards building a best-in-class global franchise in the quality value BGM segment. We are extremely well-positioned moving forward from both a product and distribution standpoint. We set a record for meter placements in the quarter, grew our share in a highly competitive US market, demonstrate our products can effectively compete in the international market, validate the quality of our products to independent studies, and remain on track toward increasing our capacity threefold by the first half of next year.

We are in very good shape. I thank you for your interest in Home Diagnostics, and at this point I would like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Derek Leckow with Barrington Research. Please state your question.

Derek Leckow – Barrington Research

Thank you, good morning.

Joe Capper

Good morning.

Derek Leckow – Barrington Research

Joe, a question for you. You have some time now to kind of analyze the market share data and talk about the -- from your comments I recognized that you have got some more information there about how our private label is doing? Obviously, the market seems to be shrinking, and I wondered if based upon the 4.4% prescription share growth, if you could talk about some other elements of that market share, and talk of the, sort of, friendly opportunity for us over the next three to five years because it seems to me that you are picking up quite a bit of market share and you are growing the size of the overall private label side of the business. I just wondered if you could help me frame the overall opportunity going forward?

Joe Capper

Yes, kind of a broad question. Let me see if I can address it in two different ways. First of all, the market is -- I think, at a macro level the market has experienced a lot pressure this year. I don’t think it’s necessary shrinking and I wouldn’t look at it that way. All the information we see clearly is that there is more and more people being diagnosed with diabetes everyday and there is no replacement, no cost-effective replacement clearly for measuring a blood sugar a couple of times a day. We believe this year that the level -- the market in generally has been affected by various swings, the least of which is, but not the least which is the economic conditions that people are making choices. If we look at how we are doing within that market, yes, I believe you are right. Clearly, we see ourselves gaining ground relative to our competitors, and I think a couple of things are working in our favor.

One, it’s a pretty mature market from a technology standpoint, and as we stated in our comments today, we believe for quite some time, that the TRUEtest platform was as good as anybody else’s out there. And now we have third-party validation and that’s exactly what puts -- what’s happening. And so people are probably moving more towards in the mature marketplace like this moving more towards the value opportunity, and that’s really our sweet spot. So, yes, we do see ourselves by gaining ground just from a consumer demand standpoint.

We do look at various pieces of market share. Time and all together sometimes it’s challenging what we include, what do our competitors include. So, we are looking at, sort of, at a macro level we believe we are somewhere between 7% and 8% market share in the U.S. Then we break it down into, through pretty accurate pieces of information that we do get to look at sub-segments, Scott talked about the prescription data which is a pretty good measurement of what’s happened in the managed care markets from a payer standpoint, and we see ourselves gaining traction there. I think in Scott’s comments, he talked about from an accounting (inaudible) point 8% to 4.4%, that’s a monumental job.

I know when you are believing with small numbers the percentage always looks better from a growth standpoint, but that is a lot a share it can take. So, really kind of what I am looking at, in the standpoint health of the business, what are we seeing at the consumer level? Yes there is a lot of noise this year in distribution. These guys have adjusted inventory levels. We talked about that in the last few calls and we talked about again today.

We anticipate that sort of straightening itself out there in the next few months or quarters, and we will be starting to see a better reflection of what’s happened at the consumer level. So, again, health of the business, I think is very, very strong. Consumer demand is high. We are gaining market share. One of the great indicators, or leading indicators of the health of our business is how many people are taken our meter, right? We can’t sell test strips unless we have meters in patient’s hands. Last quarter, we put out more meters than ever had in any prior quarters. So, we think we are in pretty good shape.

One of the challenging aspect of this business is forecasting at the end-user level since we do sell through third-party distribution. But all the indicators that we are seeing from both a share and consumer demand standpoint tells us that things are trending in our direction.

Derek Leckow – Barrington Research

Yes, I think you are right, the third-party distribution has been what’s been causing sort of a variability here, and this is obviously a transition year. But I thought it was important to kind of look at your market share, because any other industry that has some maturity to at is typically running at about a 25% private-label penetration rate, and you only have 7% to 8%. Who are the other competitors in that category that you are seeing right now, and you’re also taking share from them?

Joe Capper

Yes, I don’t know that I would say, I will highlight any other competitor necessarily in that private label segment. There are people that are in there, but not nearly as well positioned as we are. I think my personal opinion on this, why it’s only 8% versus the typical 25%, 35%, 40% that you see in private label for consumer products in mature categories, I think it has more to do with other dynamics, and this is a medical device, specifically there is barriers such as the third-party payers, contractual and formulary limitations, where we can and cannot sell.

So, it's important for us, as Scott said, it continues to chip away and gain access in managed care. It is still a medical device; it is not a straight consumer product. So it’s more of a hybrid product. I believe the big opportunity for us to move from that 8, sort of, further in the market, 8% of the third market. We know that in the cash market where typically you would see behavior that is more consistent with other consumer products, we have about a third of the markets. So, big opportunity for us, but there is some other, sort of, variable in the industry that keep it from happening overnight.

Derek Leckow – Barrington Research

All right. That’s it for now. Thank you.

Operator

Our next question is coming from Tycho Peterson with J.P. Morgan.

Avio Gabion – JP Morgan

This is actually Avio Gabion [ph] for Tycho this morning. No question on sales and SG&A line. You did a good job managing it this quarter. How much of that is sustainable going forward, how much of that is just kind of the way discretionary spending on that could kick back up?

Joe Capper

I will say that we made conscious efforts to really get gain more leverage. Our SG&A has increased significantly over the last few years. We now feel we’ve got a base of SG&A now that we can leverage. So, I think it is -- some of the variable components as we move towards growing – that represent these opportunities internationally, those areas we will invest in, but I think we are pretty much -- clearly now we are at a sustainable level.

Ron Rubin

Yes, but clearly our operating expense structure here is leveragable. We do see as a percent of sales, we do anticipates in the futures as revenue grows, SG&A will come down as a percent of sales.

Avio Gabion – JP Morgan

Okay, great. And then just one quick question on the international sales, you did a good job talking about some of the trends in the European market this quarter, could you comment as well on what happened in Latin America, I know that, that was a bit of trouble spot earlier in the year, any additional color or comments there?

Joe Capper

Again, just to reiterate, we had a couple of markets where we have had some softness, one was in the Brazilian market and one was in Venezuela. We continue to monitor closely those markets, particularly Venezuela, because of some of the currency issues. So, we have -- the underlying business in Venezuela is performing. It’s just that we have limited ourselves to the distributors who will manage our accounts receivable exposure.

Brazil, the market has recovered somewhat, but it’s struggling a little bit. So, somewhere we are slowing down our shipments in that region just to manage our accounts receivable exposure.

Avio Gabion – JP Morgan

Thanks very much.

Operator

(Operator Instructions) Our next question is from Larry Solow with CJS Securities.

Larry Solow – CJS Securities

Good morning, guys. Just in relation to the whole market and some data there, your share was 4.4% this quarter three-eight last quarter, do you have what it was last year?

Ron Rubin

Yes, let me just clarify. What that number is how we are doing in sort of the prescription and managed care relatively. And it includes some big chunks of the market. It doesn’t include the cash, medi-medi markets. So, it’s a sub-segment of how we are performing in sort of the managed care market. So, we will probably show what that was (inaudible).

Joe Capper

About 3.5%. Yes, that third quarter historically really is about 3.5%.

Larry Solow – CJS Securities

Got you. And then the growth – just anyway to look at what the market itself is doing, I mean, obviously it sounds like that it’s not doing new as you guys are doing. But has it actually been tracked on a dollar basis, I am just looking at the strips data year-over-year or is it for a flat?

Joe Capper

We will get back to you on that. I don’t want to quote it from a strip data. When you look -- one of the easier ways to do it is look at what the large manufactures have reported on their earnings call, and they are reporting, on average, through the third quarter sales are down. Now, that’s a function of two things. One is, price pressure if they are having to compete with one another, and then to the extent if there is any contraction, it would show up in sort of volume. But it have to -- logic to tell me that they are probably experiencing some of the difficulty and challenges we are with their distribution partners.

Larry Solow – CJS Securities

Right (inaudible) distribution issues as well. And then just on the distribution side itself, which obviously is your largest segment, have you -- your outsales obviously are showing improving trends being up 2%. Is that a -- some of that indicative of starting to get TRUEresult in your new products out there or is that still kind of not really happening too much yet?

Joe Capper

Larry, clearly that is a factor, as Scott has been talking about this quarter and the prior quarters, we’ve been launching the new product with some of the regional chains, that go through distribution. That’s certainly is having an effect. But even the underlying business on the TRUEtrack product is performing nicely. And we talked about these initiatives, I think the economy is helping us somewhat. So we are seeing a – we are definitely seeing a rebound in the wholesalers.

Larry Solow – CJS Securities

And would you expect the trend on the -- clearly you are hopeful that the distributors are sort of at the -- probably at historical lows. I don’t know if (inaudible) going to lower inventories, but would you expect just on the outsourcing, the outsales part of the market that those trends will improve and you would get even better growth in 2010?

Joe Capper

Well yes that’s a magic question right. We don’t seen any trends in our business that would indicate otherwise. Clearly, it’s difficult to predict what’s going to happen in the marketplace. There can always be shift, some independent pharmacy to national chains. So as long as they (inaudible) much in the marketplace, we don’t see any slowdown in demand for our product either from our large customers or small customers, or we don’t hear from them any slowdown in demand for what we are bringing to the market from their customers. So, we feel pretty good about the trends.

Larry Solow – CJS Securities

Right, okay. I am just trying to breakdown the economy between the ridiculous growth at the retail level. Obviously, it’s just new product either you are getting in there, so maybe you didn’t know it was skewed a little bit, and from a smaller base, but showing great double-digit growth at the retail level. I know you’ve penetrated with your new product much more on that side, whereas on the distributor level, which obviously is the mass part of the market, sure it’s improved at all, but it’s still 2% -- is relatively flat. So, that’s what I am just trying to think, is there opportunities that, sort of, bridge that gap, if you will?

Joe Capper

Tough to tell. We -- again, I'd answer the question in the same way I did as that it’s tough to predict what's happening in the marketplace. Yes, we have had great double-digit growth in the retail segment of our business, but more importantly they have shown excellent growth in outsales of our products to end users.

Larry Solow – CJS Securities

Right.

Joe Capper

So feel pretty good about that. Do we think that there is some shift in the marketplace amongst independents and national chains? Clearly, and I think that’s probably driven by economic conditions, putting us -- you know how much shift there is, is challenging. So, we work very close with these folks. We can tell you that within the accounts we can be very well, information that they had shared with us. How we are doing with all of these large customers relative to the competitors? We are doing very, very well.

Larry Solow – CJS Securities

Okay. And then just on the growth margin, I know, obviously there are many reasons why your gross margins is depressed year-over-year, but why was a sequential fall that is related more to -- more draw down at the distributor level, because I know obviously your meter sales were at the highest ever, so that’s one reason why it would be down, but just talking about your strip-to-meter ratio was actually up sequentially, and so why is your growth margin, sort of, reversed back the other way this quarter, any particular reason for that?

Ron Rubin

I mean primarily, as what you said, it’s ratio related. It’s a heavier investment in meters, and also not having significant trust [ph] of purchases in the distribution channel, those will be the primary factors.

Larry Solow – CJS Securities

Okay. Bit just looking at on a sequential basis, because your strip-to-meter ratio was actually 7:2 this quarter versus 6:7 last quarter, albeit your gross margin -- and I imagined Liberty is probably improving, so I just thought it would at least not go down sequentially, but I -- is anything else in there that explains that?

Ron Rubin

I mean somewhere also because it’s heavier mix in the mail and then international channel is also and then we’ve got lower pricing in those channels has also had an impact sequential.

Larry Solow – CJS Securities

Okay. All right. Thanks.

Operator

Our next question is coming from Beth Lilly with Gabelli and Company.

Beth Lilly – Gabelli and Company

Good morning.

Joe Capper

Good morning.

Beth Lilly – Gabelli and Company

(inaudible) Do you think your gross margin (inaudible). What do you think gross margins can do (inaudible)?

Joe Capper

I don’t think we got much of that question. It sounded like it was looking for more clarity on gross margin performance as we moved forward? That’s what it sounded like.

Beth Lilly – Gabelli and Company

That’s exactly right, Joe. Sorry, Mike, I am on the cell phone.

Joe Capper

Okay, you wanted to talk a little bit on (inaudible) In fact, one of the reasons that margin was so compressed this quarter -- this year is because we have a distribution and the launch of (inaudible) Joe did talked about overtime. You know that will improve. Yes, we will give a little more color next quarter as you get those two. (inaudible) but I think just from a -- bigger picture, we would expect margins to improve from where we are today. But we did not expect to get back to the 60% levels that we have seen in prior years and a lot of that is just because of the some of the mix shift. We are doing a significant amount of business in the mail channel, and again, it is driving significant volumes. Will deliver bottom-line results, but it’s going to have an overall lower effect on the margins we have reported a couple of years ago.

Beth Lilly – Gabelli and Company

So, is it fair to say that, so for example, for the nine months your gross margins were around 51% as well as for the three months, for this quarter ended? Is it possible for the margins to go at maybe mid-50% over the next several years?

Joe Capper

We are not prepared at this point to quantify that. All we would say that we don’t think we will get back to the 50% level, but we do think that there will be improvements from where we are today.

Beth Lilly – Gabelli and Company

Okay. Will they go up next year?

Joe Capper

We will get some more detail on that exactly when we give our 2010 guidance next quarter.

Beth Lilly – Gabelli and Company

Okay. What about operating expenses? Are they going to go up and down below 40%, is that a sustainable level?

Joe Capper

For the foreseeable future.

Beth Lilly – Gabelli and Company

For the foreseeable future?

Joe Capper

Yes.

Beth Lilly – Gabelli and Company

Okay. Great, Okay. And then, just can you talk about capital spending needs next year, I mean, you have spent a lot of money over the last several years on facilities and expanding capacities, what are your capital needs going to be going forward?

Joe Capper

Yes, on a normalized basis we are not doing expansion. Our CapEx is sort of running in the $5 million to $7 million range. So, it should return to that. Now we may have a couple of a million dollars from the expansions in the next year to next year. Depending on the timing, the guidance I’ve given today assumes that we will have a couple of million dollars within the next year. So, again, we’ll give 2010 CapEx guidance, it will down substantially from where we have been the last couple of years.

Beth Lilly – Gabelli and Company

Okay. Okay. Great. Those are all my questions. Thanks.

Operator

Our next question is coming from Derek Leckow with Barrington Research.

Derek Leckow – Barrington Research

Yes. Hi, just still following up on my earlier questions on the size of the opportunity and the market growth and so forth. I have tried to model out the next five years here, and what I am coming up with is, if I assume a permanent shift in the distribution segment, and I used that 2% outsales number, sort of a going rate number, I am still coming up with close to double-digit growth over that period of time? And do you think that’s reasonable or do you think this distribution segment shrinks even further in the next three to five years?

Joe Capper

We are not prepared to talk about that today. We are sort of mixing up market opportunities as well as our guidance, and we are I can see – look around faces (inaudible) queasy about it. So, we will probably refrain from giving much more color on that, and really predicting market shifts is always challenging. So, our strategy really has been to try to position the company to best compete in all the categories that we service today. And, again, I think what we are seeing the best of -- kind of color I can give you on a go-forward basis is what’s happened today and what we are seeing.

Record meter placements is a wonderful leading indicator for our business, greater managed care market share certainly endorses the activity that has taken place to date and what were the strategies that we are executing in the field. We are wining pieces of business overseas. We think we have one of the best performing systems in the marketplace, and we think people will learn that overtime. And we are in excellent shape from a capacity standpoint.

So we feel great about where we are trying to figure out, and I know it’s frustrating because you find a lot of this trying to figure out who is going to buy, we think a lot of people are going to buy our products; trying to figure out they are going to buy it from a national wholesaler or a independent pharmacist versus a national chain is something that we’ll see in the future.

Derek Leckow – Barrington Research

Yes, I think just to kind of get at this at a different way, what I am looking at here is that obviously the retail channel and their outsales, those are obviously good leading indicators, and I should probably use those as sort of guidelines for the growth rates of those segments into next year and beyond. Wouldn’t you agree with that?

Joe Capper

That’s the best information we have today.

Derek Leckow – Barrington Research

Okay. And then we just have to kind of look at that distribution segment as something that’s obviously undergoing a marked shift. People are obviously losing the -- independents continue to lose share to the national chain. It’s natural we have to shift revenue from distribution into retail and that’s also true, right?

Joe Capper

That’s a possibility, but again, as a person running this business, I am very comfortable with our relationships and our position in those national chains if that shift happens.

Derek Leckow – Barrington Research

And are you thinking about the shift -- in terms of the days of inventory that they carry, are you feeling that we are get towards the bottom end of that opportunity for them? Are they have -- been obviously taking, improving cash flow by doing so, but do you think we are at the bottom of that or is it, they are still more to go in terms of the de-stocking over there?

Ron Rubin

As indicated the time to take levels down to 40 to 50 day ranges is (inaudible) below we hadn’t previously anticipated. So, it's hard for us to measure -- doing much less than that because they are certainly not independent. They got to keep those distribution centers stock. So it's hard for us to imagine that they will take the inventory levels, the level we are forecasting for them for the end of this year.

Derek Leckow – Barrington Research

Okay. Thank you.

Operator

There are no further questions at this time. I would like to turn the floor back over to management for any closing comments.

Joe Capper

Once again, thank you all for your attention and your participation on today’s call. We appreciate your continued interest in Home Diagnostics and look forward to updating you on future calls. Thank you, and have a great day.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time, and we thank you for your participation.

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Source: Home Diagnostics, Inc. Q3 2009 Earnings Call Transcript
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