HDI Reports – A Message to the Major Players

HDI Reports – A Message to the Major Players

This morning Home Diagnostics (NASDAQ:HDIX) reported first quarter results that showed total revenues decreased by 2.1%. Given the double digit losses experienced by the major branded players in the blood glucose monitoring space, HDI’s results are impressive. Long known for their co-branded value price strategy it appears the difficult economy is helping HDI while hurting the major branded systems.

Looking at the results more closely two items stand out and should send a message to all the branded players; retail channel sales grew 25.2% and mail service channel sales increased 21.8%.  As Diabetic Investor predicted with the tough economy and continued pricing pressure retailers would ramp up marketing of their co-branded systems which are supplied by HDI. Besides providing a higher margin for retailers these co-branded systems generate additional store traffic as consumers return the store to refill their supply of test strips. Additionally these co-branded systems carry a lower price point which allows the retailer to offer their customers a more economical choice to help manage their diabetes. Given that the co-branded systems are viewed as technologically equal to the branded offerings the retailer can use a just as good cost less sales strategy. A strategy that plays very well in the current economy where consumers are watching every dollar they spend.

The increase in the mail service channel is directly attributable to HDI deal with Liberty Medical, the largest player in the mail service channel. This deal is somewhat of a double edge sword for HDI as they must sacrifice margin to secure this business. On the flip side they don’t have to worry much about when it comes to marketing or distribution expenses as Liberty actively promotes their co-branded systems and all systems are shipped to a central location for distribution.  With their recent acquisition of Access, Liberty has extended their dominance in the mail order channel and should provide HDI with even greater sales in the future as Liberty converts the Access customers to the Liberty branded system, something that Liberty is very good at.

It’s also worth noting that sales to distributors decreased by 19% which isn’t a completely a reflection on HDI. As Diabetic Investor reported earlier this year with Cardinal’s decision to stop carrying Abbott (NYSE:ABT) systems sent a clear message that BGM companies are no longer in control of their own destiny. To help control their costs distributors are moving towards a one price fits all strategy while at the same time carrying less product inventory. Like the retailers, distributors see they have the upper hand when negotiating with BGM companies who are desperate to maintain market share. As Abbott learned the hard way either you play ball on price or you’re gone.

In an ominous sign for the major branded players HDI is beginning to make inroads into the managed care area. Granted their share of this market is miniscule when compared to the majors any inroads made here hurt the majors who can ill-afford to lose share.

Some may be concerned with the fact that during the quarter gross margin decreased to 47.1% compared to 58.1% in the prior year period. According to a press release issued by the company “As the Company previously guided, gross margin was negatively impacted by the continued investment in the roll out of the new no-code products in the retail and mail service channels. Gross margin was also impacted by lower pricing in the mail service and distribution channels.”

The fact of the matter is lower margins are here to stay which is another reason all the players in BGM, branded and value players both are taking steps to control their costs. This news is even more evidence that the BGM has fully transformed into a commodity market where price is the main driver. It’s interesting to note that during the Q&A session of this morning call the company did acknowledge that even lower price systems from offshore manufacturers are showing up with increasing frequency.

The real question for HDI and their partners is can they hold onto their new customers when the economy improves or will consumers switch back to branded systems. Diabetic Investor isn’t all that worried as by the time economy improves there will be fewer branded players to deal. The fact is the BGM market will soon look like the soft drink market where you have two dominate brands that will control 80% or more of the market with the remaining share divided between the remaining players.

There was a time when Dr. Pepper and Seven Up were able to compete with Coke and Pepsi as independent companies. However, due to market conditions the two companies in effort to remain competitive combined forces. This is not unlike what will happen with BGM where the Big Four will soon become the Big Two who play the role of Coke and Pepsi. Should Bayer regain their interest in acquiring Abbott’s diabetes device unit they would become Dr.Pepper/Seven Up. This leaves HDI and AgaMatrix to fight over the growing value/co-branded segment of the market.

There was a time when Diabetic Investor felt AgaMatrix could make a serious run at HDI and appeared to making progress as they too  had a deal with Liberty. And like HDI, AgaMatrix was able to offer high quality systems at a lower price point. However, HDI has fought hard to regain the upper hand in this market segment while AgaMatrix has struggled to penetrate HDI’s installed customer base. Retailers have been reluctant to convert their co-branded products from HDI to AgaMatrix. The fact of the matter is for smaller companies like HDI and AgaMatrix getting others to distribute and sell your products is the key as they both lack the resources to take on the majors. The two companies can co –exist but at present HDI is gaining while AgaMatrix is struggling.

When it’s all said and done today’s results from HDI are just more evidence that the BGM has fully transformed into as commodity market. For the branded players the situation is actually simple; remain relevant using their size and resources strategically. Let’s face facts here Coke and Pepsi even in tough times are doing quite nicely thank you very much. Dr.Pepper/ Seven Up can do alright as long as they realize their limitations and can remain relevant by stressing their not Coke and Pepsi. Finally for HDI and AgaMatrix they too can remain relevant by accepting the fact that lower margins are here to stay and controlling costs is critical to long term survival. Based on what we heard today, HDI understands what needs to done and has developed a well thought out strategy. This is solid first step now it’s time to see if they can execute.