Home Diagnostics, Inc. Q2 2008 Earnings Call Transcript

Sep.21.08 | About: Home Diagnostics, (HDIX)

Home Diagnostics, Inc. (HDIX) Q2 2008 Earnings Call Transcript August 7, 2008 8:30 AM ET

Executives

Carol Ruth – IR, The Ruth Group

Ron Rubin – SVP, CFO and Secretary

Scott Verner – SVP of Sales and Marketing

Dick Damron – President and CEO

Analysts

Tao Levy – Deutsche Bank

Derek Leckow – Barrington Research

Tycho Peterson – JP Morgan

Operator

Greetings, and welcome to the Home Diagnostics, Incorporated second quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms. Carol Ruth, Investor Relations. Thank you, Ms. Ruth, you may begin.

Carol Ruth

Thank you, operator. On the call with us today is Dick Damron, 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.

Now let me turn the call over to Ron Rubin. Ron.

Ron Rubin

Thank you, Carol. Good morning everyone and welcome to our second quarter 2008 conference call. I'll begin today's call by discussing our quarterly financial results. I'll then pass the call onto Scott Verner, our Senior Vice President of Sales and Marketing who will discuss recent sales and marketing initiatives, and then Dick will discuss our key strategic initiatives for 2008, and provide an update on the new product launch. We will then open the call for questions and answers.

We are very pleased with our second quarter results, which included record quarterly revenue of $33.4 million, an increase of 18.9% compared to revenue of $28.1 million in the second quarter of 2007. Strong distribution and mail service channel sales were the primary growth drivers in the quarter.

Revenue from our distribution channel was $17.9 million, an increase of 32.6% compared to $13.5 million for the second quarter of 2007. The year-over-year growth in distribution was driven by strong trade show pre-booking orders as several of our major customers replenished their inventory from the low levels we saw at the end of the first quarter as well as a shift in order timing compared to the second quarter of 2007. As we previously have discussed, the second quarter of 2007 reflected lower distribution sales as a result of the acceleration of orders into the first quarter of 2007 ahead of the April 1st price increase last year. For competitive reasons we did not institute a price increase in the distribution channel in 2008.

Out sales in the distribution channel slowed slightly to mid-single digits driven in part by decreased sales of certain durable medical equipment suppliers and certain of our national distribution customers. We have taken steps aimed at increasing demand for our products, which Scott will discuss. These initiatives are starting to show results as we enter the trade show season.

Based on preliminary trade show results, our sales are likely to exceed last year at all three of our national wholesale customers.

Revenue from our retail channel was $6.1 million down slightly compared to second quarter of 2007. Second quarter 2008 retail channel sales included a $700,000 return reserve provision in anticipation of the launch of the TRUEtest product platform following FDA clearance. The return provision was made in anticipation of the Sidekick product being replaced on the shelves at certain of our co-brand retail partners with the new TRUE2go blood glucose meter. These units will be placed back in the inventory for sale to other domestic and international customers. As Scott will discuss Sidekick will still be available for other retail partners including Wal-Mart that remains a key component of our international strategy.

Excluding this return adjustment in the quarter, retail channel sales were up 9.3% compared to the second quarter of 2007. This growth was the result of promotional activity from our large co-brand partners and continued progress with Rite Aid, which we launched in the first quarter.

Out sales trends at our major retail partners remained very strong in the quarter. Revenue from our mail service channel is up 22.3% at $5.3 million compared to second quarter 2007 revenue of $4.3 million, driven by our targeted sales outreach and strategic initiatives focused on mail service growth.

As we stated last quarter, we have implanted programs to certain customers to drive greater share at Home Diagnostics’ products through patient conversions and new patient additions. This is the result of an increase in meter distributions intended to drive future test strip sales. While we are pleased to report that this strategy is beginning to produce results.

During the second quarter we benefitted from increase test strip sales with customers who have implemented these programs. We continue to invest in these relationships with several of our existing customers, which we expect will continue to drive increased sales in the channel.

Moving to our international channel results, second quarter revenue was $4.1 million, a 2.3% increase from $4.0 million in the prior year. Overall, we are pleased with our international growth with the exception of the German market, which continues to be a challenge following several organizational changes at our German distributor. We have taken steps to address this market, which Dick will discuss later in the call.

Excluding Germany, our international sales increased 17.5%, which was driven by continued expansion in Latin America and strong traction in Australia.

Gross profit for the second quarter of 2008 was $19.9 million compared to $16.1 million in the second quarter of 2007. As a percentage of sales, gross margin increased 220 basis points to 59.6% compared to 57.4% in the year ago period. The increased gross profit margin was attributable primarily to an increase in our strip-to-meter ratio to 7.3:1 in the second quarter compared to 5.7:1 in the prior year period.

This increase was driven by higher test strip sales in the distribution channel and more targeted meter investments.

We also continued to realize cost savings from changes implemented late in the second quarter last year to our test strip manufacturing process. As you may recall last year we invested in modifying our test strip manufacturing equipment enabling us to produce more strips per sheet of material with greater efficiency and lower cost.

Selling, general and administrative expenses were $13.7 million for the second quarter of 2008 as compared to $11.6 million in the second quarter last year. The year-over-year increase in SG&A primarily reflects higher expenses for sales and marketing to support initiatives to drive future growth as well as additional personnel to support the TRUEtest product launch and other initiatives. During the second quarter, we spent approximately $300,000 in expenses associated with the TRUEtest product launch.

Research and development expenses were $2.4 million for the second quarter of 2008 as compared to $2.3 million in the second quarter last year. Our R&D expense in the quarter included costs related to new product development and preparing the new manufacturing equipment for commercialization of the TRUEtest product platform.

Operating income for the second quarter of 2008 was $3.8 million, up from $2.3 million in the second quarter last year. Our operating margins for the second quarter of 2008 increased to 11.2% from operating margin of 8.2% in the second quarter of last year.

Net income for the second quarter of 2008 was $2.7 million or $0.14 per share based on weighted average shares outstanding of 18.9 million. Net income for second quarter last year was $1.8 million or $0.09 per share based on 19.8 million weighted average shares outstanding.

Our 18.9 million of weighted average shares outstanding for diluted EPS for the quarter includes 1.1 million of dilution per stock options. As of June 30, we had 17.8 million shares outstanding and approximately 3.3 million total stock options outstanding.

We continued to repurchase shares of our common stock under our buyback program. During the second quarter, we purchased approximately 283,000 shares of our common stock for an aggregate cost of $2.2 million. We have approximately $3.2 million remaining under our aggregate $10 million board-approved share repurchase program.

Moving on now to our balance sheet and operating metrics, at the end of June we had cash and cash equivalents of $34.4 million and no debt outstanding. We have $10 million available under our revolving credit facility. Total equity at June 30, 2008 was $109.3 million.

Our business continues to produce significant cash with over $3.6 million of free cash flow generated in the second quarter.

Our capital expenditures for the second quarter were $1.6 million. We now expect CapEx for the full year 2008 to be in the range of $7 to $8 million.

For the second quarter of 2008 total meters distributed were 355,000. Total strips were 2.6 million based on 50 count equivalent units. And our strip-to-meter ratio, as I stated earlier, was 7.3:1. We will be filing our 10-Q in the next few days, which will provide greater detail on our financial performance for the quarter.

Now turning to guidance. For the full-year 2008 we are reaffirming our previously stated annual guidance of revenue to be in the range of $124 million to $127 million and earnings per diluted share to be in the range of $0.50 to $0.52 based on 19 million diluted shares outstanding. As a reminder our earnings per share guidance does not include the $0.03 contribution to earnings from the tax reserve adjustment we recognized in the first quarter following the IRS settlement we discussed on last quarter’s call.

Our guidance assumes a second-half launch of the TRUEtest product platform at our largest retail customers and includes launch-related marketing expenses. We currently estimate loss related marketing expenses to be approximately $2 million, which is down from the $3 million estimate we discussed on last quarter conference call. This decrease primarily reflects a reallocation of marketing expense dollars to introductory pricing discounts and incentives that we believe will make an important contribution to building a solid base of users on the new systems.

This reallocation combined with our ramp up towards full manufacturing efficiency should have a temporary negative impact on our gross margins. Therefore, we now expect gross margins for the full year to be approximately 59% to 60% as compared to the 60% to 61% communicated on last quarter’s call.

Our reduced expectations for the full year gross margins will be offset by the decrease in sales and marketing expense for the year. We therefore remain confident in our full year 2008 EPS guidance of $0.50 to $0.52.

Consistent with prior years, we expect the majority of our revenue and earnings to be generated in the second half of 2008. This is due to several factors, including the new product launch, customer ordering patterns, and the ramp-up of new customer accounts.

I will now turn the call over to Scott Verner our Senior Vice President of Sales and Marketing.

Scott Verner

Thank you, Ron. Good morning everyone. As we enter the second half of the year we are concentrating our sales and marketing efforts on two key areas. First, we are continuing to focus on drug in pull through of TRUEtrack system and leveraging existing opportunities for the products across all our channels. Secondly, we are working with our customers to prepare for the upcoming launch of TRUEresult and TRUE2go, which we expect to be available in the market later this year pending FDA clearance.

First I would like to discuss our TRUEtrack initiatives. TRUEtrack continues to be a driver of new account wins and is helping us achieve increased product penetration and market share growth. During the quarter we secured enhanced product placement on the retail shop with a large co-brand partner moving from the bottom shelf to the top left shelf in prime position ahead of the branded products. This move to the top shelf coincides with the launch of new TRUEtrack packaging, which enhances the product’s reputation of quality and value. This same retailer also changed the way test strips were merchandized making it easier for patients to compare our value proposition versus the branded products.

During the quarter, I attended the annual meeting for the National Association of Chain Drug Stores or NACDS in San Diego. We had meaningful discussions with many of our co-branding partners devoted to finalizing the TRUEtrack promotions and programs for the second half of 2008 and the first half of 2009.

I am pleased to provide an update on our sales and marketing strategy. A prime example of our focus on improving pull through is in the distribution channel where our internal telesales organization continues to excel having achieved a 40% increase over its full year 2007 revenue total. We are beginning to see improvements in TRUEtrack pull through in midsize and regional chains that purchase through our large distributor partners.

Our telesales team is equipped with the same marketing programs as our field sales force aimed at acquiring new customers and stimulating sales growth among our current customers. One example of this is our two ways to save [ph] program, a targeted in-store display promotion for both meters and strips.

Our managed care team continues to effectively use newly implemented analytical tools and targeting capability. During the quarter we added 3 new formularies totaling 200,000 lives with formulary positions of tier 1. We are also very excited about 3 additional agreements we reached in July with large regional managed care providers in California. They are CalPERS, which is the California Public Employees Retirement System, CalOptima, and (inaudible) totaling almost 700,000 covered lives. These agreements represent excellent opportunities for us and our co-brand partners. In fact one of these formularies created a new exclusive tier for Home Diagnostics and on another we replaced a leading branded provider as one of two on tier one. The CalPERS opportunity is a result of collaboration with our retail partners in the managed care arena. Underscoring the strong relationships we have formed with these customers they are committed to educating pharmacists about the benefits and value of TRUEtrack in driving pull through will CalPERS members.

A key metric in evaluating our managed care growth is the IMS data. According to IMS, Home Diagnostics achieved a 20% increase in the number of prescriptions during the second quarter versus Q2 2007. During the quarter we also saw our market share increase to 3.6% up from 3.0% in the second quarter of 2007 and 3.4% in the first quarter of 2008. We attribute this growth to our integrated sales strategy and strong execution of our sales team.

Our mail service channel continues to grow. We achieved 22% growth in the quarter driven by our targeted sales strategy and our ability to strengthen our relationships with customers. We are using the competitive bidding environment to drive new relationships and we are very pleased to have signed contracts with two of the largest competitive bidding winners in the country. With these new account wins and increased growth within the existing accounts we are well positioned in the mail service channel.

Now turning to the launch of our new products, TRUEresult and TRUE2go. We have received very positive feedback from our co-branding partners in our meetings leading up to the launch. They are very excited about the no coding technology, which will allow them to enter the premium segment of the market with co-branded products at value prices. Our planning for the launch kit’s ad placement, pharmacy awareness programs, and telesales strategy that will comprise the bulk of our promotional campaign for the launch is nearly completion. We are well positioned to execute on our promotional programs once the products receive FDA clearance.

As our product line expands we are managing both the life cycle of our products and the specific needs of our customers. To this point we have been working with our customers to add new products and rationalizing the placements of our existing products. For example, for certain customers we will be replacing Sidekick with TRUE2go. TRUE2go shares the same strip platform as TRUEresult and will be promoted jointly.

Sidekick however, still has very strong customer base and will be sold by other partners. Additionally, Sidekick is expanding domestically with Wal-Mart moving from 1600 stores to over 2400 stores. Sidekick also continues to grow internationally particularly in Latin America.

Overall, I am very pleased with the progress we have made in the quarter, more importantly we are well positioned for continued growth adding new customers, expanding our managed care footprint and improving pull through. Our focus on improving sales of TRUEtrack and its many benefits to our customers, managed care providers, and patients continues to unfold contributing to our success.

We continue to prepare for the launch of TRUEresult and TRUE2go, which represents a new opportunity to enter the premium segment of the market. I am confident that our sales and marketing team will continue to excel in the second half of the year and into 2009 as we continue to achieve our goals and improve our overall market position.

I will now turn the call over to Dick Damron.

Dick Damron

Thank you, Scott, and good morning everyone. On today’s call I will provide additional insight into the drivers of our performance in the second quarter. I will also provide an update on competitive bidding, briefly review areas where we see the strongest opportunities for growth and discuss our progress for our new product introduction.

We are pleased with our second quarter financial performance. We continue to successfully execute on our growth strategy in each of our business channels in the quarter. One of the key drivers of our second quarter results was the mail service channel where sales increased more than 22% in new patient conversions and gaining a greater share of new patient starts. We are also continuously working to introduce our value proposition to new mail service partners resulting in successful signing of new contracts strengthening the foundation for future mail service growth. Overall, our strategic efforts and investments in the channel are beginning to pay dividends driving test strip sales with existing and new customers.

On a related note, I would now like to give you an update on the CMS competitive bidding initiative. In late June and early July of this year, the House of Representatives and Senate voted to pass a Medicare bill that included a provision to delay national competitive bidding. In mid-July the House and Senate voted to override the President’s veto of the bill, which has now been officially passed into law. As a result, competitive bidding will be delayed at a minimum of 18 to 24 months and in its place there will be a 9.5% reduction in reimbursement for mail service throughout the country beginning on January 1, 2009. This is a significant change given that previously the expectation was for an average price reduction of 40% (inaudible).

We continue to believe that Home Diagnostics is well positioned in this reimbursement environment and that any reduction in reimbursement benefits us in the long-term due to our competitive price structure. We have an advantage as a leading provider of value priced, quality blood glucose monitoring products and just in time manufacturing capabilities.

As I have already mentioned, we think our value proposition is extremely attractive to mail service providers especially in lieu of lower reimbursement and we are working to capitalize on these opportunities.

Even though competitive bidding has been delayed the process benefitted Home Diagnostics in two ways. First it has strengthened our relationships with our existing customer base. Second, it brought new opportunities to Home Diagnostics as potential customers evaluate their product portfolio. This resulted in two new contracts with large mail service providers, which we expect to contribute to future revenue growth.

In the retail channel, we continue to see positive out sale trends. The introduction of our co-brand product to Rite Aid has contributed to the results in this channel. The sales and marketing strategy that we have invested in has begun to drive performance and we expect this momentum to continue.

For the first six months of 2008, distribution channel sales are at 5% over the same period last year. While we are up 32.6% for the quarter as we mentioned on our last call the growth in our distribution channel during the quarter is mostly due to order timing. As Ron stated the out sales growth has slowed to mid-single digits. We have had discussions with senior management of our distribution partners and have launched sales and marketing programs designed to increase pull through from the independent pharmacies that buy through distributors.

The international market continues to represent a significant opportunity for our TRUEtrack, TRUEread, and Sidekick products. In Latin America the recent introduction of TRUEread and Sidekick have been successful and have led to increased sales in the quarter. In the United Kingdom we continue to gain momentum through our program that provides our TRUEtrack meter to nurses nationwide to support adoption of the product. We plan to launch Sidekick, which will be known as TrueOne in the UK by the end of this year.

In Australia, our partner Diabetes Australia in New South Wales, is effectively driving mid-teens growth and we remain excited about this market opportunity as our partnership continues to mature.

In Canada, we continued to be delayed in securing Ontario provincial reimbursement for the Shoppers Drug Mart private brand, private label TRUEtrack system. We expect that reimbursement approval will accelerate our sales in Canada.

As Ron mentioned our distribution partner in Germany has undergone several management changes. I recently traveled to Germany to meet with the new management team and I am encouraged by the opportunities that this management change represents.

Now, I would like to briefly comment on few important growth drivers for the remainder of 2008 and beyond. Our management team has been focused on individual channel strategies to drive our overall market share. We measure our success by increased product pull through with existing customers, acquisition of new customers, increased formulary coverage and market share gains. We have achieved success in all of these areas during the first half of the year. The results of the recent IMS data illustrate the market share gains these programs have delivered.

On the new product front, we are in the final stages of the FDA clearance process for TRUEresult and TRUE2go. Once we receive FDA clearance we expect to make TRUEresult and TRUE2go available during the second half of 2008. We are prepared to ship the products very rapidly following FDA clearance. We are extremely excited to launch our TRUEresult and TRUE2go meter systems and believe they will be well received in the market place. I would like to thank all of our employees for their hard work and commitment and I will now turn the floor over to your questions. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from the line of Tao Levy with Deutsche Bank. Please proceed with your question.

Tao Levy – Deutsche Bank

Good morning guys.

Dick Damron

Good morning.

Tao Levy – Deutsche Bank

Just a couple of question on my end. One, Dick could you just give us any insight as to what is going on at the FDA, because they asked you for a follow up questions and you have answered them and you kind of feel that we are still on track for an approval, I guess, over the next few months?

Dick Damron

We have had correspondence with the FDA on the application for both of the two products Tao. We sent that in the first quarter of this year. I think as we have talked previously, we have had two rounds of discussions, conference calls, with the FDA. Right now the FDA has a new requirement and we just have to be the first application that they have received and we have been asked to address this requirement. They are looking for educational materials that we can deliver to healthcare professionals particularly in multi-patient user settings that use the enzyme that we are using on the test strip as far as the TRUE2go and TRUEresult products. So, they have given us their comments on these educational materials. We are in full agreement with their comments on the materials. We have already turned those materials around and given them back to the FDA. So, we would expect to hear from them very soon.

Tao Levy – Deutsche Bank

Really the question then is not really on the product it is just on the educational material that needs to get signed off on and that is it?

Dick Damron

At this point from the calls we have had with them it appears to be the educational materials Tao.

Tao Levy – Deutsche Bank

Okay great. And you made a comment, and I don’t know if I caught it correctly. On the distributor side you were saying that the sales to distributors in the quarter was pretty good but the out sales, were those good that you hearing back from the distributors. It that how that works or?

Ron Rubin

Yes, Tao it is Ron. As we have discussed, we track the out sales, which is basically the sales that distributors are selling through to their pharmacy customers and we noticed that the decline in the quarter down the mid-single digits which is the lowest level we have seen in a while. Historically we have had good growth in the channel. Part of the issue is two of our large national distributors have had some slowing of out sales growth that is partially due to the loss of customers. In many cases, we picked those up with another national wholesaler or regional wholesaler. So, we are seeing nice gains in other customers, but collectively in a couple of large distribution partners the growth has slowed, and we’ve – Scott and Dick have been discussion at high levels, senior levels, with the distribution partners to come up with programs and promotions to address the pull through at the independent pharmacy. Scott discussed some of these on the call. Some of these initiatives include the telesales, better targeting with our partners to identify either new customers or existing customers who can do better.

We talked about this, two ways to save program, which promotes both free meters and also savings on the test strips. So, these programs take a little while to roll out but we are focused on it. We are working closely with our partners to improve the situation. We look to reporting on it going forward.

Tao Levy – Deutsche Bank

Do you feel, I mean historically, you know, the third quarter on the distributor level tends to be the strongest quarter, is that still your expectation just given the possibility that maybe the inventory levels are going up here and maybe they are not going to order as much and depending on I guess, the timing of the approval of your new product. I don’t know if you will be selling it first to distributors or first to retail or everyone will get it.

Ron Rubin

Tao, first of all on the new products it is going to go mainly to the co-brand chain retailers. As far as the expectations for the third quarter, yes, the third quarter as you recall, as all three of the major wholesalers have trade shows where they bring in there independent pharmacy customers. They offer discounted pricing and (inaudible) and payment terms on the product purchases. And so historically our third quarter has always been the largest quarter in that channel, will continue to be. The way the process works with most of our wholesalers is beginning in June for the most part they will offer a free trade show buying opportunities. So that is the first opportunity independent pharmacies have to purchase at these discounts. So, we see a little bit of lift in June, which we started to see and then the trade shows take place in July.

So, there are orders that take place at the actual trade shows and then they wrap up after the shows with a post trade show buying period. But all this really culminates at the end of the third quarter in September. So, we would expect increased demand to meet the demand from the trade show buy but also the wholesalers typically will stock up on inventory during the trade show period to meet demand in the fourth quarter as well because as you know they operate on a thin margin and are very focused on trying to pick up some additional profit. And that is consistent profit margin, and that is consistent with what we see in the past and we expect that to continue.

But be mindful that we have considered the out sale trends in developing our estimates and our guidance for the balance of the year.

Tao Levy – Deutsche Bank

Okay. I know that is kind of what is going on. And then my last question, do you feel like with competitive bidding you know, at the end they are not really not taking place, that you might have gotten some incremental benefit in mail order in the second quarter that might not be recurring or do you feel like giving your interactions and relationships with some of the new customers that you have brought in and deeper penetration there that it is going to be with or without competitive bidding taking place now going forward? You are now in a much better position today then you were, you know, six months ago on the retail – I am sorry, on the mail order side?

Scott Verner

Tao it is Scott. Definitively, the competitive bidding process that our customers went through force them to evaluate who their best partners would be as the dynamics changed in the market place with these government changes. So, they are folks that we have targeted for a long time that were using other companies that opened their doors up to us and were very interested in our value proposition. A big part of this isn’t just price but it is the overall value that Home Diagnostics can bring like having a sustainable supply chain and our 25-year history of having strong distribution and you need to very solid partners that can also help you promote, educate, and motivate folks if you have the change in the business. So, it resulted in picking up two new customers in this quarter and it is helping us increase our share within existing customers. So, while it was a lot of work on our end not knowing how this was going to play out because the government was deciding. From a business standpoint it was a great doorway for us to walk through and partner with people at a whole new level in a compressed time frame.

Tao Levy – Deutsche Bank

Okay. Thanks a lot guys.

Dick Damron

Hi Tao, let me just say just one another thing on the competitive bidding. I think that there is one other subtlety with respect to how assuming competitive bidding comes back into play, how they are going to be able to position their product portfolios. They have some limitations in there on the product mix that have to be more reflective of what I think the US product mix is that will somewhat mitigate the ability of the Asian producers to come in and dominate that mix for competitive bidding. You know, we know from talking to the key competitive bidding bidders in this first round it was – with a high component of the Asian produced products.

Going forward to the next round it is going to be more difficult for them to buy that bid with Asian produced product. So, our value proposition to all the other branded companies in the United States takes on a very attractive – is a very attractive position for the bidders there.

Tao Levy – Deutsche Bank

But why is that on the Asian side, why can’t they increase?

Dick Damron

There is a limitation on their – when they go back to competitive bidding there is a certain limitation on the mix of products that they can use for their product portfolio that they are proposing to CMS.

Tao Levy – Deutsche Bank

Is it the type of product or where it is manufactured?

Dick Damron

It is based on the market share. The market share that product represents in the US market.

Tao Levy – Deutsche Bank

Okay, got you. Okay, great, thanks a lot.

Dick Damron

In other words if you have a product that have zero market share in the US –

Tao Levy – Deutsche Bank

You can’t have it (inaudible).

Dick Damron

You can’t bid that to 100%.

Tao Levy – Deutsche Bank

Got you. Then thanks a lot.

Operator

Thank you. Our next question comes from the line of Derek Leckow with Barrington Research. Please proceed with your question.

Derek Leckow – Barrington Research

Thank you. Good morning. Congratulations on a great quarter.

Dick Damron

Good morning Derek.

Derek Leckow – Barrington Research

I had a question on the managed care comments you made in your prepared remarks, I think it was Scott, can you tell us you know where you are now relative to your expectations and those of tier one that you mentioned and maybe talk about that relative to where you think you can be by the end of the year and of course commenting in light of the new product being launched?

Scott Verner

You know Derek there is couple of things that play there. I would not want to estimate where I think we would be by the end of the year. I mean we are fully deployed and integrated managed care sales force and we put in all new analytical tools in targeting but to decide when certain of these agreements that we have in the queue are in our pipeline that will be culminated with an executed agreement is a little hard to determine.

There are a couple of factors that play here. One is some of the existing agreements that they have with other manufacturers come up under expiration and review. In some cases we work with these people on a weekly and monthly basis and then they realize that we’ve got increased distribution, our market share has gone up and they pay attention to that. And then the last piece, certainly TRUEtest in the long-term fits into this because entering the premium segment and then the no coding feature set is really going to turn some other managed care organizations towards that product. But the great things is that so far this year everything we have been adding has been TRUEtrack and not related to TRUEtest. So, it is just – it is a culmination of areas but I think the fact that we are targeting much better, we are focusing our time with customers where we believe we can win and lastly the fact that our co-branding partners are helping us enter into these agreements providing us with letters of support showing that we have great distribution and then they are willing help in the conversion process to pull through people after we gain it.

Dick Damron

Derek, just one follow-up comment there. I agree with Scott. It will be difficult to tell where we are going to be at the end of the year and certainly with these opportunities in California that we mentioned on the call and Scott elaborated somewhat in feedback from the folks on their side, we have exceeded their expectation on the conversions that we would get to this stage of the process. So, we are encouraged that we are going to start to really build some momentum there.

Derek Leckow – Barrington Research

That is an important indicator isn’t it?

Dick Damron

It is.

Derek Leckow – Barrington Research

The conversion rate tells you that, I mean, you can use that information as you market to others or how does that play out?

Dick Damron

Well, I think at some point we are likely to do that Derek. I am not sure I can say at 45 days that is a trend. I would rather be exceeding their expectation than falling short. But (inaudible) continue to monitor this and certainly if we continue to see this on through the balance of this year, I think it will play out not just with the managed care folks, remember this is pull through as well through our retail co-branders, now get the benefit us well.

Derek Leckow – Barrington Research

Okay great. Then just a couple of more questions, on inventory can you give us the inventory balance at the end of the quarter?

Scott Verner

Yes, we are at about $15 million of inventory at the end of the quarter that is already (inaudible) of the new meters for the new system and the materials and so forth. We also have seen a stock up coming in the summer months of our materials is consistent with what we have done in the past around the hurricane season, and the inventory is up a little bit to about $15 million.

Derek Leckow – Barrington Research

Okay. Are you are stocking the new strips as well or just the meters at this point?

Scott Verner

No we have got meters under production and we also began producing the strips as well.

Derek Leckow – Barrington Research

All right. And then just finally if I look at my model here, just maybe some comments on the guidance, you had a pretty wide diversion of estimates for the third quarter because of the fact that we have these launch expenses that we are trying to capture. Would you expect that to be down year-over-year in Q3 and perhaps just some color comment on Q4, I guess at that point?

Dick Damron

Derek it is very difficult to predict because the launch is going such an impact and the timing as to when that hits not only our top line but also from (inaudible). So, we really stopped just sticking to the full year estimates.

Derek Leckow – Barrington Research

All right. So, just to have it straight, the amount of money –

Dick Damron

As far as the launch market spend?

Derek Leckow – Barrington Research

Yes.

Dick Damron

It is probably fair to guess the estimate that will be spent pretty evenly over the third and fourth quarters.

Derek Leckow – Barrington Research

So split that between that two. Okay. And as you look – look at my model here a couple of years out, you are developing or building a lot of cash and I wondered if you wanted to comment on perhaps other product categories that might apply to your relationships with the retailers, you know the store brand market or the co-branding strategies that you guys have. Is there other categories you are looking at perhaps acquisitions that you could make, and any comments on that?

Dick Damron

Derek this is Dick again. We just had a very detailed review from our R&D group. They have been collaborating with the marketing department over the course of this summer on new product opportunities. Still staying within the diabetes category. I don’t think and (inaudible) in the past I don’t see it is going outside diabetes in the near future at all. Acquisitions certainly would be a possibility. We have got several people that we are working with to help identify distribution partners in Europe in particular. So, I think distribution, acquisition of a distribution partner in Europe is a possibility very similar to the situation we had in the UK. As you know, we bought our distributor there in 2005. We would consider doing that elsewhere in Europe but we are starting to fine-tune first product development internal. We are starting to fine-tune those plans as we go into our budget planning process for 2009 and beyond and you know we may have more to say on that in the next quarter’s call.

Derek Leckow – Barrington Research

Okay great. Let me stop there. Congratulations and good luck.

Dick Damron

Thank you.

Ron Rubin

Thanks Derek.

Operator

(Operator instructions) Our next question comes from the line of Tycho Peterson with JP Morgan. Please proceed with your question.

Tycho Peterson – JP Morgan

Hi good morning. Thanks for taking the call.

Dick Damron

Morning.

Ron Rubin

Good morning.

Tycho Peterson – JP Morgan

Just to be clear on the, I guess, the revised spending expectations with regard to the launch. Can you give us a sense as to what you know the key steps here are, maybe Scott, you know in the next couple of months, I mean is it still (inaudible) pharmacist kits or other initiatives that you are going to be focused ahead of the launch?

Scott Verner

Yes, there are several components to the launch you know involving gaining distribution, educating the pharmacist, the launch strips as you identified are very robust and a good investment for us and then of course we put together several programs and promotions so there is quick uptake and pull through on that product at the retail shop and also to encourage, you know, trial and to have a better shop position and carve outs for the new product. So all that is part of the pre-plan and then as we get closer to launch that is when we incur those spends, but there is very aggressive promotions that have been designed around this product to make sure that there is a lot of excitement both at the store level and at the management level within the organizations to support it.

Tycho Peterson – JP Morgan

And can you – maybe Ron can you give us a sense of how we should think about margins on the new products, generally?

Ron Rubin

Tycho, we have not given specific product gross profit margins but we talked, the pricing on these TRUEtest platform is going to be priced above where we are in the TRUEtrack but still at a discount to the branded players. Cost – you know, this year the cost is going to be a little higher just because of the ramp up in production not only in the full year in scaling up the manufacturing. So, this year the gross margin on the products can be not reflected over the long-term but going forward I think it is going to based on the retail launch and the pricing structure, we would expect as we get out to ’09 that this product will be a driver of margin improvements, but to give specific margin on the product we are not going to do that.

Tycho Peterson – JP Morgan

Yes, I know that. That is fine.

Dick Damron

Dick this is – Tycho this is Dick. Just as a reminder also the first launch of product because of the negative margin on meters and our drive to get meters in the hands of users, initially the margin is heavily impacted by that.

Tycho Peterson – JP Morgan

Okay, Ron I guess you know in your prepared comments you talked about, you know, part of the reason for not pushing through a price increase this year was pricing trends in distribution. Can you just comment on what you are seeing in terms of competitive pricing on the distribution side?

Ron Rubin

Yes, what we have talked about in the past is particularly in the independent pharmacies that are geared towards selling a product for the Medicaid and Medicare market. You know that is where we have seen – some of the branded players bring to market a product offering designed specifically for the Medicaid and Medicare patient. That is where they have somewhat closed the gap to where our pricing traditionally has been. So, one of the steps we did was with the TRUEread product to help address that but it continues to be an issue. One of the reasons – that is one of the main reasons we did not institute a price increase in the channel to ward off some of that competition.

Tycho Peterson – JP Morgan

Okay and then are you seeing competition from any newer unexpected areas. I mean you talked in the past about some of these emerging Asian manufacturers, it doesn’t seem like they have gained much ground, but can you just comment on the competitive landscape?

Dick Damron

You know some of it is coming from the branded players. There are a couple of branded companies as you look at it are continuing to lose share and they are getting price aggressive in some areas. So, they have kind of dipped into our strength a little bit and as Ron said that is why we did not take a price increase so we can keep our advantage in the independent pharmacy.

Ron Rubin

And Tycho this is what we have talked about in the past. The Asian suppliers, they are not – we don’t see them as a competitive threat with the chain retailers or with the really the – for the most part with the independents. We see the Asian competitors as more in the mail service DME side of the business where the patients are less attuned to what the current branded products are in the retail pharmacy and it is more a pricing issue. So, you know the variations in price continue to be there and continued to be aggressive with pricing in those channels.

Tycho Peterson – JP Morgan

Okay, and then just finally how are looking at kind of software patient management, I mean I know you have got track record and you know some other tools to help patients monitor their levels, can you just talk about, I mean is there a competitive differentiating factor here, just the selling point with customers?

Scott Verner

Yes, it is Scott. Well, it is important in certain area to have software available. It really represents about a 1% usage in the market place. So, we do offer, you know, software with our products to help patients and HCPs that want to have it. I think it is important to go forward that we continue to look at and partner with other companies that are developing new software strategies including Microsoft that is working and launching their HealthVault initiative. We have been very close with them on that and we believe because it is Microsoft that they are going to be a good partner for Home Diagnostics as we go forward and develop with them under their architecture.

Tycho Peterson – JP Morgan

Okay, thank you very much.

Dick Damron

Thanks.

Operator

Thank you, ladies and gentlemen. There are no further questions at this time. I would like to turn floor back to management for closing comments.

Dick Damron

Well, thank you very much for participating and listening in to the quarterly call, and we look forward to our next quarterly call, which should be in the month of November. Thank you very much.

Operator

Ladies and gentlemen, this concludes today’s teleconference and you may disconnect your lines at this time. Thank you for your participation.

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