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Heska Corp. (NASDAQ:HSKA)

The Wall Street Analyst Forum

November 28, 2007 9:50 am ET

Executives

Bob Grieve - Co-founder, Chairman and CEO

Jason Napolitano - CFO

Gerry Scott- President Wall Street Analyst Forum

Presentation

Gerry Scott

Hey, good morning ladies and gentlemen. In our ongoing attempt to adhere to the published schedule, I would like to go ahead and introduce the next company in this morning's program.

We are pleased to have Heska Corporation back with us. They have presented with us a couple of times over the years. To give you some unsolicited feedback that I got from our portfolio manager at the conference, who I won’t identify, said, I wanted to go to this meeting of Heska Corporation and did some homework before I came to the conference. I went and saw the veterinary in my block and my building, and said, what do you know about this company, Heska Corporation. The veterinarian’s response was I only use their stuff. I guess he sounded like the Vice President of Marketing because he used their stuff exclusively. I won't use anything but I won't point him out. He is looking at me right now. Then he immediately proceeded to go out and buy a number of shares and stock, kind of the Peter Lynch way of, Peter Lynch coming home and asking his daughter, you know what kids are buying or using at school or what are their toys and then doing the research and then taking a position in the company. So, I just got a case study about Heska Corporation very similar to that.

Heska focuses on the Animal Care market. They sell their products to various veterinarians. The company trades under the symbol HSKA and has been publicly traded since 1997. As noticed, their stock chart has done well, or it would be, like this? Since they started presenting over the last couple of years and that sort of reflects on us, but more what they are doing as a company.

So, without any further introduction, I’ll introduce Bob Grieve, Co-Founder, Chairman and CEO who will introduce any other folks he has with the company today.

Bob Grieve

Thanks very much Gerry and thanks for joining us here today. Thanks for those of you on the webcast also, for taking the time to listen. I am joined today here, at the table by Jason Napolitano, our Chief Financial Officer and Jason will join me as appropriate in the question-and-answer session.

As Gerry, indicated we are focused on companion animal health care. We make products, we partner for the development of products and we sell those products to veterinarians.

I’d like to show this forward-looking statement slide and encourage you if you are considering an investment to take a good look at our public filings as noted here in these forward-looking statements.

There are four major things I’d like to emphasize in the presentation today. The first is that we operate in a very positive market environment. Secondly, we have competitive advantages in our products, customer support and third point would be, we believe our stock trades at a very compelling valuation today. Then finally, one slide towards the end, to explain the tax benefit position that we have, that we believe is non-depreciated asset of our business.

Next, I will turn to the slide showing this young family here, with their dog and cat and child. This really underscores the premise of our market and the promise of our market, and that is pets are viewed by many people, by most people, as parts of the family, as members of family. Something in excess of 60% of people actually celebrate their pets birthday on the day that pet was born, more than 90% of people in this recent surveys said they'd risk their life for their pet. And I could go on and on with these statistics and some really presume to break rituality and gender or laughter, but it’s just amazing over and over these statistics convince us how important and valuable this market is.

The demographics are great in this market. Baby boomers day is 45 to 64, it's the fastest growing population in our society, population with peak income and it’s also good for us, the group that has a peak pet ownership right now.

The pet population itself is also growing. There are more households than ever that own a dog or a cat and those pet owning households own more dogs and cats than ever before. So, human and pet demographics are great. Within the pet population, another interesting nuance is that the pet population is aging just as the baby boomer population as well. So with better nutrition, better healthcare, pets are living longer and there are also more opportunities for products and certain diagnostics.

Within the overall companion animal industry, some other interesting numbers are here on this slide. There are about 110 million households in the US alone, about 73 million dogs, about 90 million cats in the American households. And I would point out here that all these statistics I am talking about are in United States and this is about half of the global market. So, as you extrapolate or contemplate the overall global market, keep that in mind.

The total companion animal industry, which would include toys, food, bedding and veterinary care is about $55 billion in annual sales. Our target market is about $3.5 billion, so that’s x-manufacturer to the veterinarians about, $3.5 billion U.S.

Then in terms of customers, as I said, we sell to veterinarians. We don't sell in the retail channel but only the [ethical] channel, to veterinarians about 40,000 of them practicing in about 20,000 clinics.

On the next slide, we have pointed out that vet practice has been changing substantially in the recent past. We believe that income from annual vaccinations should decrease and in some cases we did see evidence that it is decreasing. People don't believe the pets need to be immunized annually any more than we are in some cases. So, they are pulling back from that practice. And in some cases, there have been some adverse events associated with vaccination. I'll comeback to that when we talk about one of our products.

The second bullet here on practice change is that there are fewer opportunities in the pharmaceutical market. Typically, historically, a veterinarian wouldn't charge and I am generalizing here, they wouldn't charge for her or his service, but they would market product. So, if the manufacturer sold the product for $20, they might on average, market up to $40, roughly double the price of the product and that's how they made their income. But that's changing. Many of the brand leading generics that a consumer identifies or mainly, the brand leading products or pharmaceuticals that consumers identify, are going generic. There is price pressure, there is over the counter channel threats, particularly in flea control. Some of the flea control products are finding their way into the retail channel and are believed will do some more in the future.

The third point here is internet-based channels where a pet owner can have a relationship with a neighborhood veterinarian but still order their products over the Internet and have them drop, shipped or delivered to their door and that, in many cases can circumvent the local veterinary relationships.

So, fewer opportunities there in their business so they are turning more to wellness and health information. And then they will be actually charging for services and being paid, rewarded financially to practicing medicine, rather than doing product markup and also doing vaccine clinics. So, all this is greatness for us in our strategy again, because we are focused on advanced diagnostics, in particular, specialty products to extent but to get wellness and health information, you need the diagnostic information.

The next slide shows the positioned within the general industry in the U.S. and animal health. You can see in this slide, we have got our emphasis here in the top right. We are very focused on advanced diagnostic products for companion animal health. And by contrast, you see this group over here in the lower left, many of these would be household names in the pharmaceutical industry; very large companies that would have divisions that are focused on animal health themselves.

Those divisions are typically characterizes global. As I said, bigger businesses often higher units, focused in some cases on pharmaceutical that have to have certain revenue and margin thresholds, not involved in diagnostics but more in pharmaceutical and vaccines. And also, not just focused on companion animal health but that would be a part of the business along with poultry, livestock, of course medicine and so forth, even fish in some cases. You see Pfizer, as an example, stands out her. It's about, it's over $2 billion in total revenue globally and it's about half companion animal health.

The next group of companies that we bring up here, we see just below us would be IDEXX Laboratories. That's the market leader in our advanced diagnostic category by far. We positioned them slightly below us on the companion animal health axis because they also do food safety testing, water testing and they are also involved in livestock diagnostics. Further down still, will be ABAXIS. It is another interesting comp. We will refer it to you towards the end of the presentation. ABAXIS is principally, a chemistry analyzer, also some hematology as well. But they are trying to move more and more into human health. So, again, we placed them a little further down on this Y-axis.

In terms of our own company; we consider ourselves fully integrated, beginning with product development. We do our own R&D. We have certainly done so for sometime but we also do a lot of product developments through partnerships, as channel partners with device manufactures and I’ll give you some examples of that in just a few minutes. We also have captive manufacturing in our subsidiary in Des Moines, Iowa. An important point on this bullet is that, this facility also does third party or contract manufacturing, not under the HESKA label. You will see this reported in our financial statements as OVP product revenue, other vaccines and pharmaceuticals. I will show what that revenue looks like in our financial slide in just a few minutes, but when you see OVP product revenue that’s associated with that facility.

We also have full marketing capability. Our direct sales force as shown here is 31 people in the field right now as employees selling HESKA products. We have 24 people in inside sales at corporate headquarters in Colorado. They do outbound selling and in-bound order taking and support field sales. They also work with 13 regional full line distributors that have about 277 sales reps that carry the full line HESKA products and call them veterinarians as well.

Let me give you some sense of our sales critical mass. Also very important to us, we have invested a lot in customer and technical support. We differentiate ourselves with quality products. It was indicated in the introduction but also our customer support, we've really taken a lot of care and time and investment in it. There are 25 dedicated people, veterinarians, technicians available to the customer, and we are 24/7 emergency technical support.

I've got four slides that I want to show you to give you examples of some of the products we sell, the channels that we use and so forth. In the first instance, you'll see here a cluster of three instruments in the order of left. These are our three diagnostic analyzers and notably, all three of these have been introduced in 2007. You can see the i-STAT Handheld Analyzer here, introduced in January. Our HemaTrue Veterinary Hematology Analyzer launched in July and then just very recently, the DRI-CHEM Veterinary Chemistry Analyzer that we have launched and developed in collaboration with Fuji Film.

The in-clinic diagnostic instruments are very good business opportunities. For the veterinarian, they provide fast, accurate reproducible results. They give them the quality that you would expect in a reference laboratory but you get it in real time while the client waits. So, it's a great convenience also for the client to get a result immediately, so they don't have to be called back or there is no follow-up. So, we install the analyzer, sell the analyzer and then we sell proprietary consumable [stream] through each of those analyzers for years in that installed base.

The next slide in product portfolio would be our Heartworm testing and prevention business. We sell Solo Step Tests for heartworm testing or diagnostics. These are the only ones that test for the detection of heartworm infection. We have a suite of products here that are available for both dogs and cats. We have also in the recent past, developed a product called Tri-Heart Plus. It's a heartworm preventive to be used once you're sure the animal isn't infected; a monthly heartworm preventive, you just give it as oral, palatable product.

We developed the product through FDA registration and continue to manufacture it but it’s actually distributed and marketed by Schering-Plough Animal Health. They have a sales force for a different profile and a lot of distributor reach, and that has worked very well for us. They sell the product; we took up the registration and continue to manufacture it.

Turning to the next slide, the third slide in these product examples would be our Allergy business. We've been doing allergy testing and treatment for sometime. We are able to identify exactly what causes allergies in dogs, cats and horses using proprietary technology that we developed at our company. We consider ourselves as the worldwide leader in veterinary allergy. After the diagnosis is made we also formulate therapy prescriptions or allergy shots if you will, provided specifically for that individual animal.

The final slide that would give examples of products is also one of our specialty products here in this case, Feline Vaccines. You will remember, I mentioned that there is a lot of concern over vaccination, particularly because there are some times side effects associated with vaccines and particularly, there has been a lot of concern about injection site tumors, injection site sarcomas in cats. So we've worked to develop a vaccine to protect cats against the most prevalent causes of upper respiratory disease. These are viral respiratory infections. These are safe effective alternatives. We avoid the needle stick and the side effect concern by making these as nose drops. So rather than do a needle stick into the cat, to accomplish the vaccination you just drop the vaccine in the nose.

Next I would like to turn to the slide on shareholder return-driven leadership. I will just make the point on governance and alignment with shareholders. We have got a very independent Board, a world class Board, I would consider. I am sure you would have heard the names of three of the people that chair each our standing committees. I am the only person who is not independent on that Board. I have introduced Jason and introduced earlier myself as Chairman, Chief Executive Officer, as Co-Founder. Jason has been CFO there for some years. He was actually the banker that took us to public, back in 1997. So, he has been associated with -- in historic for sometime and has been, as I said, CFO for few years since then.

We are both sort of aligned with a mission, but we are also very invested in the company. We have had quite a lot of equity between us. And in that case, we are certainly aligned with shareholders.

Next, I turn to slide two to just show you financial trends, again, in a lot more detail on our public filings and also encourage you to listen to archived results as well, whenever you can. This just shows you five trailing years and then the last 12 months and it shows you the revenue growth over that period of time. And you can see, that from 2002 to the last 12 months tallied up to the end of September this year, you will see steady revenue growth and particularly driven by our Core Companion Animal business, shown on this slide as CCA.

You will see that the OVP business that I mentioned earlier, contract and private label manufacturing out of our Des Moines facility is lumpy. It's flattish, not a lot of growth. It can be up some years and down in others, which is shown there in the different colored bar. And then on top, would be our R&D and other revenue over that same period of time. And this will be revenue that you would characterize as amortized revenue from license fees, royalties.

An example of that would be product that we develop for treatment of -- nutritional product for treatment of feline type 2 diabetes. Nestlé Purina actually manufactures that product and sells it and then we make a royalty. So that would be the type of revenue that we show up in that black bar.

And then in terms of the bottomline, you can see we've made steady progress. We’ve made progress, you can see here, back to the same period of times I showed you in that paragraph. In 2002 we lost $8.5 million net loss. 2005 was our first full year where we showed a profit. More profit last year and you can see through the last 12 months approximately, $5.3 million in net income.

So, there is a steady progress at the bottomline as well as revenue growth. And yet, we perceive ourselves as a company in transition that often the investment communities isn't aware of just how much progress we've made here, and this transition to operating success hasn't been fully appreciated in the market.

We believe we are trading at a great valuation. As I indicated in the introduction, our ticker is HSKA. The share price on November 26 closed $2.09 and this is the last 12 months, the range $1.46 to $3. And, I mentioned that there were some comps on that slide that I showed you earlier.

Abaxis would be one you might want to take a look at, if you would like to. IDEXX, as I indicated, is the market leader. And then another company you can look at would be VCA Antech with the ticker, WOOF.

I mentioned and promised that I would show one more slide towards the end on what we believe is an un-depreciated asset in the business and that's our net operating losses, our historical losses. As we built this fully integrated company, we had lot of front-end expense and loss. These NOLs can be used to offset income taxes going forward.

At the end of last year, in our 10-K, we reported NOLs of nearly $168 million in U.S., nearly $2 million in Switzerland. And again, these are attributable to historical losses. Now, as we turn toward a profitable trend, we see this as being great in terms of cash flow benefit in the future, offsetting taxes.

With that, I'd turn to the last slide. I am not going to go through these bullets, but perhaps its service. I'll remind you some of the things I have said and we will invite you to ask questions. Yes, sir.

Question-and-Answer Session

Unidentified Analyst

[Question Inaudible]

Bob Grieve

Gentlemen, for the web audience benefit, gentlemen, calculated calculus and said we make about $0.50 an animal for pets in the U.S.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

Right, very sorry. In any case, yes, we would consider both on acquisitions if they are appropriate. We certainly aren't going to do them outside of the strategic context. We are going to really focus on this companion animal space and stay focused for the foreseeable future in that area. But if there are opportunities to grow critical mass and drive more revenue through and more penetration, we would love to do that.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

I think in our universe, we'd be more reactive and proactive.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

Yes. Just let me take this gentleman, Yes, sir.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

Good.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

Thank you. Now, the commentary again, for the web audience was, gentlemen, inquired of a veterinarian that practiced or lived in his own building, and she strongly endorsed the Heska brand and Heska products. And which in turn, I guess, charged you to consider to buy some stock. Is that the first summary? For the audience, I appreciate that a lot. Again, we've taken our position from a competitive standpoint and to focus on the highest possible quality in the product and the highest possible customer technical support that we can give. This is how we compete and this takes a bit more of ramp, a bit more of time. But we think it's an eminently more defensible position competitively.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

The FDA, as I indicated the one slide on the pharmaceutical area. The FDA has jurisdiction on the disposable, single-use diagnostics and on vaccines. It's the United States Department of Agriculture. So there are two different bodies in the US. Yes, sir.

Unidentified Analyst

In your R&D program, what is the direction for your new product development?

Bob Grieve

Right, the question is on our R&D program, what's the direction for product development? Our primary focus is advanced diagnostics and specialty products solutions. And these specialty products were often, will seek specialty products that would compliment a diagnostic, for example. So that's generally the area and it gives me an opportunity also to emphasis one other thing.

We do a lot of internal R&D but as I showed, we do also product developments through partnerships. So, we're able to, in case of those In-Clinic analyzers that I showed in the first slide, we're able to go to people that manufacture devices or analyzers for human health. We're able to do a lot of modification and work with them to make them acceptable for veterinary use. And then, we serve as a channel partner.

So in many cases the chassis, if you will, of that analyzer has been developed for the human healthcare market. It can be modified with relatively less R&D expense and then, we work as a channel partner through our Heska brand.

Unidentified Analyst

Thank you.

Bob Grieve

Yes, sir, you had a question sir.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

Right.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

Right. The question would be, in addition to selling the individual veterinary practices, do we also sell to Shelters in multi-doctor hospitals? The answer is yes, we do. Although, it's certainly not a predominance of practice, there are many multi-doctor hospitals or referral centers, for example, the Animal Medical Center on the [East River] is huge. Angell Memorial in Boston is another large one.

And there are also corporate practices, as I mentioned, VCA Antech has several hundred hospitals that they have rolled up. We would do business with those corporate practices, but we also work with Shelters. We'll often, frankly, discount product to Shelters help them out a bit. Our Feline Vaccines, for example, have been very popular and Shelters for Kittens.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

In the Shelter business?

Unidentified Analyst

[Question Inaudible]

Bob Grieve

I think the trends would be that, there are few trends. I always say there are no trends. They are obvious to me other than status quo in the Shelter area. Within corporate hospitals you are seeing aggregation, buying groups, seeking purchasing power. But you still got, if you take all of the major corporate hospitals today, put them all together, it's still between 5% and 10% to the total hospitals.

It is growing but is still a fairly diminimus part of the business for the customer base. And then, I think other than that, you are seeing more of multi-doctor practices in high urban density areas with specialization with all those practices. You might see, for example a dozen veterinarian just to pull a number out of the years, some of them boarded in surgery, some boarded in medicine, specializing in Oncology, Dermatology. So, you're seeing multi-doctor practices and specialization, for there is an urban dense market that will allow it.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

Alright. The question was to just re-stabilize earlier it was clearly focused on the ethical channel, but there are other opportunities in food, for example. The answer is no. Are we specifically elected not to get into it, say, the nutritional space, because this is a space that's dominated by very, very substantial retail players, with a lot of muscles about shelves space distribution.

It's about a lot more in terms of critical math, outside of our core expertise. And I think we would do alliance, as I mentioned earlier, we would do alliances if we happen to discover something that would be of value. We'd seek an alliance with a partner as we do with the Nestle Purina for Feline Type II Diabetes. Now, they are the marketer and we benefit from the royalty.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

Right. Actually, the largest player in the ethical channel in food is the company called Hill's Pet Nutrition. This is a division of Colgate. Again, a very, very substantial enterprise, a very entrenched but quite noted.

Unidentified Analyst

[Question Inaudible]

Bob Grieve

Let me try and get Jason Napolitano to the mike here as CFO and he is going to -- he is superb with the numbers. Would you repeat the question?

Jason Napolitano

Thank you, Bob. The question was just a general overview of our capital structure corporate position. We have currently approximately $10 million in debt, approximately $2 million of that is related to term debt, primarily borrowed against the equipment and to some degree, our facility in Des Moines, Iowa.

We have an $8 million revolver. It's actually $12 million revolver under which we currently have approximately $8 million borrowed and then it's a classic receivables and inventory based revolver. We have about $5 million in cash to offsetting that. We are not currently burning cash. We had a question about the cash burn as part of this.

In terms of ownership, we have three very large owners; largest is State of Wisconsin Investment Board; they are about 19%. Number two is Zesiger. Number three is Charter Ventures which is the original venture capital firm that founded Heska. Charter Ventures is about 12%. And then we have, number four, is Ashford Capital, out of Delaware which is just north of five now. And then we have got probably, another 20 or so institutions that have got a hold of roughly 5% of the shares. Insiders currently hold about 3% of the shares, and I think that answers the --

Unidentified Analyst

Only 3%?

Jason Napolitano

Yeah, but that excludes options that's just current shareholding, that excludes our option position.

Unidentified Analyst

[Question Inaudible].

Jason Napolitano

We have about 51 million shares outstanding. And if you want to get to the option detail, we have got really good disclosure, actually broken into charges in every Q. Okay?

Moderator

Are there further questions along this line? Yes sir?

Unidentified Analyst

[Question Inaudible]

Jason Napolitano

The question was about the 2008 outlook. We have been very disciplined about not speaking to anything beyond the current year. Our current year’s guidance was $5.6 million on our last earnings call which would be a clear record year for us. So, we're very excited about it.

Unidentified Analyst

5.6, un-taxed?

Jason Napolitano

There is some small European tax that flows through there. There is an AMT tax that's included in that calculation. What's not included, you have obviously done a lot of homework, is if we were to put a large tax benefit on our balance sheet, Bob mentioned the NOL, in the United States that's not currently on our balance sheet. If we put it on our balance sheet, we'll have a huge, likely deferred tax benefit this year and then next year we would report as if we were paying tax.

Unidentified Analyst

[Question Inaudible]

Jason Napolitano

The question is, how long does the tax loss benefit go for? The current legislation is 20 years from when you have a loss. That last year I believe we had a loss was 2004. So, the last of our NOLs would expire in the year 2024, approximately. Okay, thank you.

Bob Grieve

Thank you very much. Again, all of you hearing and those on the web, we appreciate your attention.

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