Heska Corporation
Q4 2020 Earnings Call Transcript

Published: 23 Feb 2021

[Operator:]

Good day, and welcome to the Heska Corporation Fourth Quarter and Full Year 2020 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jon Aagaard, Director, Investor Relations. Please go ahead, sir.

[Jon Aagaard:]

Thank you, and good morning, everyone. Welcome to Heska Corporation's earnings call for the fourth quarter and full year of 2020. I am Jon Aagaard, Head of Investor Relations at Heska. With us this morning, we have Kevin Wilson, Heska's Chief Executive Officer and President; and Catherine Grassman, Heska's Chief Financial Officer. Mr. Wilson and Ms. Grassman will provide details surrounding the results reported as well as the company's 2021 outlook, and then we will open the call to questions.

[Kevin Wilson:]

Hey, thanks, Jon, and good morning, everybody. I was telling Jon this morning I'm thrilled that people are listening to me instead of Chairman Powell. So hopefully, we have some good information for you today. Before I begin, I'd like to encourage callers to review this morning's release data in our written comments. I think you'll find them helpful. And as you do -- as you'll see, we're pleased to report an exceptional fourth quarter and full year. Heska delivered record revenue and universal strength across all key metrics. Fourth quarter sales rose 90.5%. Full year sales rose 16.9%. Subscriptions for the year grew 25% from good gains in market share and retention. I encourage callers to look at the subscriptions' details in this morning's release. In the fourth quarter, North American POC Lab Consumables grew nicely at 15.5%, a continuation of the 15.2% we captured in the third quarter, bringing the year-to-date performance to 11.2%, which is above our full year guide of 8% to 10%. And we again captured solid International segment performance with exceptional results from our Spanish, Australian and German teams in particular. In summary, throughout 2020, all of our Heska teams executed well to deliver results in which it is hard to find a bad metric. While Catherine will cover the specifics of the quarter in greater detail, I wanted to highlight a few things in advance of our Q&A time today. Starting with our people. Heska teams have worked well throughout a difficult year from a remote and hybrid posture. Morale is good, in large part because winning in a healthy way is motivating. We've raised our game in all areas. While it's been more difficult to visit customers and possible customers in person and to do installs of new equipment in 2020, we do see that dynamic shifting to a more normal situation towards the end of the second quarter of 2021, just in time for our Element AIM ramp-up to begin.

[Catherine Grassman:]

Thanks, Kevin, and good morning, everyone. As Kevin noted, we are pleased to report exceptional financial performance for the fourth quarter and full year of 2020 in which we met or exceeded our 2020 outlook in all metrics previously communicated. At the conclusion of our discussion around our performance, I will take you through an overview of our financial outlook for 2021. Now to the results. Underpinned by expanding global demand in the companion animal health care market, Heska delivered excellent performance. During 2020 and in the midst of a global pandemic, Heska closed on a single most transformational transaction in our company's history, the acquisition of scil animal care, which contributed to our consolidated net revenue growth of 60.9%. Continued strong performance in legacy Heska businesses and products also contributed to our growth for the quarter and for the year. We report our results geographically in 2 segments

[Operator:]

. The first question comes from David Westenberg of Guggenheim Securities.

[David Westenberg:]

Congrats on a great year. So I just want to start with -- you gave out new data, like instrument revenue in Q4 was definitely great. And then it looks like there's an acceleration in terms of new accounts and subscription wins, but you've also given commentary that says market share is tough when you can't go in to see the clinic. So can you help us reconcile why those numbers that are going so far up, suggesting acceleration of market share, but your commentary is kind of a little more muted there?

[Kevin Wilson:]

Yes. I think you want to be as realistic as you can, nobody has a crystal ball. And you have to assume that you have really, really strong competitors. I think everybody understands that about our space. So I think maybe -- but for some of the challenges getting into clinics, maybe would have done better. We do see that opening up a little bit. We do see that as a tailwind may be for imaging, which is more difficult just by the nature of just the size and the installation process. But yes, I do think it's a realistic number given that you don't know what the future holds and you have really strong competition.

[David Westenberg:]

Yes, maybe take a step back. I mean it looks like -- I mean, maybe even just from a kind of a retrospective view, the subscription growth was great, and again, new account growth was great. But you also kind of said it's hard to get into accounts. So maybe if you can conceptualize where were you like signing the subscription but not necessarily installing the instrument because again, the numbers look really great in terms of that. But I know that there's a pandemic going on. So I'm just trying to conceptualize that difference. I don't know if that makes sense?

[Kevin Wilson:]

Yes. No, no. I mean, installations have continued. It's just harder. It's harder to schedule. It's harder to travel, but installations, I think, have continued for everybody in the industry. You just spend more time trying to figure out whether you can get in there on Tuesday, or if it's going to be 2 Tuesdays or 3 Tuesdays from now. But that has opened up a little bit since kind of the March-April time frame when people were a little bit frozen in place. So it's not like what you would see just in the general market. Restaurants aren't as busy. But they're still open, and some are doing better than others. And so I think we've still been able to progress. It's just been -- it's been a little bit more difficult than it otherwise would have been.

[David Westenberg:]

Got it. You had a lot of new equipment coming out in the near term. Can you talk about your willingness to maybe win a fraction of the diagnostic pie rather than the entire diagnostic pie? I mean, I know your business is built on the subscription concepts, but there's a lot of new products. Is something where winning a small fraction could be something just really interesting as you're rolling out digital cytology, fecal analysis, urine analysis, all these kind of new products?

[Kevin Wilson:]

Yes. There's no question. We're trying to serve customers' diagnostic needs. And if they currently get those diagnostic needs at a reference lab, we still want to serve that need if we have the technology to do so. So digital cytology for us is not a defensive play where it might be a defensive play for folks who are in the reference side business. For us, it's the ability to offer our customers more services. And so we like that trend. We think technology is bringing things more to the point of care. We think that Progesterone is the current example. It's inefficient to take a slide, a sample, and drop in an envelope and have somebody drive a car to pick it up, drive the car to the airport, drop it into a box, put it on an airplane, fly to Los Angeles or New York and drive it from the airport to a central lab and then have it looked at. We think that's -- it's not green. It's not efficient, and we think technology can make the experience better for the pet, the pet owner and the veterinarians. So I think that's a perfect example of getting a small piece of the very large pie. If there's $500 million a year in free cash flow happening at the central reference lab, we would be thrilled to get a smaller piece but to get some of that. And so I think entering those types of businesses for us is it's definitely on the menu, and we're beginning that process. Similarly, the Element AIM, if you look at the lab business, you have blood and plasma. Testing, which we've been in now for quite a long time, but you also have urine and fecal. And then you have pathology-type services, specialty-type services. And Heska is largely just been in the blood and plasma side of the business for the last decade or two. And we're now moving into the other half of what you would call laboratory testing with urine and fecal and blood slides and scenarios and things like that, and then also adding the third leg of that store, which is professional services. So I think that's in line also with getting a small piece of a much bigger pie. We just haven't been at that table. And in 2021, we're at that table in a big way. And we think we can do better than 0. We've shown our ability to gain market share in a really competitive space in point of care blood and plasma, and I think we can do the same thing in the other segments.

[Operator:]

Next question comes from Andrew Cooper of Raymond James.

[Andrew Cooper:]

Maybe starting with just a little bit sort of higher-level one. But Kevin, you said you're not going to comment in regards to some metrics on driving utilization, which is something if we think back, longer term, we haven't heard Heska talk about a lot. So maybe just -- can you give us some context of sort of what you're doing? How that's been received? And certainly, we've seen competitors do a lot of that. So it's interesting to see Heska sort of make that shift. Any color there would be really helpful.

[Kevin Wilson:]

Yes. We think that's a game-changing milestone, first. Look, we don't invest lots of effort and money trying to drive utilization in an installed base that's 500 or 1,000 or even 2,000. You just don't get the leverage, but when you get over a couple of thousand, and we're well over that number now in North America, and then you have several thousand outside of North America, driving utilization in that installed base can move the needle. And so we've got a much bigger competitor who's just been a wonderful example of that. They're extraordinary at it. And that's just a lever I haven't really been willing to pull until the end of 2020. But by way of example, I said last week, we had a web seminar, I just say -- called it a webinar. And I want to say we maxed it out, and I don't remember if that was 500 or 1,000 participants, but we haven't traditionally done those things at Heska. So we do think we can drive utilization in our installed base. The installed base itself is growing. So it's kind of that multiplier effect. So yes, that is something that we're actively pursuing in the second half of 2020, and it's going well.

[Andrew Cooper:]

Okay. Great. And then maybe on the International business. The growth, I think, especially in the consumables is a good number, but could you help us unpack a little bit? Obviously, there's lapping when the deal came in. So what's the sort of underlying same-store consumables growth that you're sort of looking for whether you want to adjust out for the -- some rationalizations or not? Just anything to help us get a flavor for how do you think that market is growing and what your sort of share gains might look like there through '21?

[Kevin Wilson:]

I don't think, today, we're prepared to dive a whole lot deeper on that. We've only owned the business since April of 2020. So we have 1 more quarter before we lap it. And I do think we'll be able to share a little bit more data. But 3 quarters, which is really 2 quarters if you factor in some of the delays with COVID after April 1 is really just not enough of a time line to give you the level of data that we're confident in. So I think we're going to pause on that. We try to be transparent. We think it's good. We think it's positive. It's part of our consolidated outlook. But we need another quarter or two before we dive into more detail.

[Operator:]

Next question comes from Steven Mah of Piper Sandler.

[Steven Mah:]

Congrats on the quarter.

[Kevin Wilson:]

Thank you.

[Steven Mah:]

Yes. I want to dig in on the International subscriptions. Can you give us a sense or some color on the number of scil customers that you've converted and are part of that 335 international subscriptions? And give us some color on if that conversion rate is what you've been expecting. I've been trying to get a sense for how the subscription model conversion is going and maybe when that will be completed and when we should expect gross margins to improve?

[Kevin Wilson:]

Yes. So 2020's international subscriptions, we ended 2020 at about 335. And we ended 2013 in the North America efforts. If you go all the way back to 2013, we ended 2013 at about 370. And in 2014, in North America, we ended at 730. And so we've put a forecast together this year that we'll start at 335, so a little bit less than we started in 2013 in North America. But we'll take that to 835 internationally in kind of our first year, which is obviously better than the 730. So put another way, we do see a faster adoption rate with the International customer base. And International for us isn't just scil. So part of that 330 has been work before we really got busy with scil. So CVM companies in Spain. We've since put those 2 businesses together with scil business and the CVM business. So they've been active in subscriptions during the second half, and they've done well. And then Australia has done well also. So that 330, I view, is largely a baseline number. That's kind of our starting number, that 335. And I view that as very similar to the 370 that we started in North America in 2017. But I do think it's going to be a faster adoption rate. So we're calling out 835 for this year, which is faster than what we did in North America.

[Steven Mah:]

And maybe just sneak one last one in. On the Point of Care Lab consumables increase of 15.5%, is there any element of a backlog catch up or do you think that's more durable going forward?

[Kevin Wilson:]

We don't have a backlog in there. And Q3 was 15.2%, I recall. So we don't see any of that really as a snapback. I think that's a -- it's just a strong market. And I think we did well within a strong market.

[Steven Mah:]

Okay. Got it. Okay, so it's not like a backlog hangover from Q3 that maybe didn't get good pushed into Q3 but tripled into Q4. Do you think it's more durable then?

[Kevin Wilson:]

We do. Yes. I think the whole second half was 1 big nice period.

[Operator:]

Next question comes from Chris Schott of JPMorgan.

[Chris Schott:]

The first one for me was, I was just looking at the guidance for '21 on -- for North America contract subscription value growth. And I think it's about 7% over 2020. I'm trying to kind of bridge a little bit, given the new product cycle you're seeing, it does seem like it's a bit of a slowdown in forecasting guidance and just some color there. And maybe in a similar vein, just the growth you're expecting in new subscriptions versus contract value in '21. Can you just talk a little bit about the dynamics that we're seeing there of the 7% subscription -- or 9% subscription growth versus 7% contract growth expectation? And I have a follow-up after that.

[Kevin Wilson:]

Yes. No, it's a great question. So what I would point out is contract subscription value is the minimum that the customer signs up for. And we're quite confident in utilization, especially some of these new products that if we ask for a lower contract subscription value, but we get a longer term, we would make that trade because we're confident in utilization. And we don't really want to cause any angst in adoption by asking for higher monthly dollar commitments. We'd rather keep that friction as low as possible, and obtain longer-term contracts that people are comfortable with. And we believe that they'll -- their utilization, the value of the utility of the products that we're selling will exceed that anyway. So that's a big piece of our thinking in that gap between minimum contract subscription value maybe not growing exactly in line with the number of subscriptions. But you'll also see some really nice growth in months under subscription as well. So anyway, we think it all works out.

[Chris Schott:]

Great. So no trend in there, just the contract value size. That makes sense. And then my second question, I think you addressed a little bit of this in the remarks, though. You've had EBITDA margins in the low to mid-teens over the past few quarters. Just help us bridge a little bit from those recent trends versus the 8% target that you're expecting for this year.

[Kevin Wilson:]

So I'll take a first stab at it that if we're doing better than that, we have so many things to grow, so many things to invest in that we will probably accelerate investment in some of those product rollouts. And then maybe I'll let Catherine, if there's any other color that she wants to add.

[Catherine Grassman:]

Yes. No, I think that it's a good point in addition to -- we have experienced that in this year, especially, we have some reduced costs inhibit our legacy business is just a result of immobility among the group, which we've built back into to encourage and enhance sales in '21. So that's obviously going to pull that down a bit as well as expand it a bit in Europe as well. So there are some additional costs going in there that are bringing that margin down on a comparative basis.

[Operator:]

The next question comes from Ben Haynor of Alliance Global Partners.

[Benjamin Haynor:]

So first for me, just kind of following up on one of the earlier questions on International Point of Care Lab consumable growth of 35%-plus. Just thinking about having the full Q1 this year versus not having anything last year plus the COVID impact in Q2. I mean it seems like the way to read that to me is that to emphasize the plus a little bit more just with the snapback from COVID plus like full q1, is that fair? I know you said you don't want to get into it too much, but just any thinking on that, that would be helpful.

[Catherine Grassman:]

Super nicely...

[Kevin Wilson:]

Super broadly. You got it, Catherine? Go ahead.

[Catherine Grassman:]

Yes. I mean, Ben, I think you're right on point. I certainly see that there is potential for upside on that percentage. In Q1 and Q2, evaluation is spot on. But just keeping in mind that one of our strategies, right, that we're in process and throughout '21, working on in fact transition of the existing base onto our Reset program. That typically, you're getting utilization plus new customer growth, and we're going to be very focused on transitioning our customer base. I mean obviously looking and still being aggressive in the new customer acquisition space internationally, but really protecting that base is a key priority for us.

[Benjamin Haynor:]

Great. And then just also, I get -- following up on an earlier one. I understand the desire to remove friction on the installed that's impacting kind of the minimum ESG. But my recollection is over time as the existing accounts add, new equipment re-up for various reasons, that should go up at the existing accounts. And it's always hard to kind of figure out which metrics to emphasize because you can always give $1 away for $0.90, and you get 1 side of the equation to move up for efficacy or try and maximize revenue, there's some trade-offs there. But I guess when you look at it and understanding that friction removal makes sense in your case, should we be looking at it as months under subscription, is the main thing to be looking at? Or subscriptions total? I mean, what's going to give us the best evidence that you guys are kind of executing to plan, if that makes sense?

[Kevin Wilson:]

No, it's a great question. So here's kind of how I roughly look at it. Active subscriptions leads me to look to retention and market share gains. So when those go up, that's roughly the bucket that I look at. Months under subscription leads me to say, are we achieving our main goal? If the premise in our market is veterinarians, health care, veterinarians, in particular, are going to do wonderfully over the next couple of decades, and they're going to do more point of care testing, more diagnostics testing. So 20%, 30% of their revenues as they continue to grow, then our mission is to be as close to the veterinarian for decades. That's our mission, right? And so months under subscription gives me a little snapshot there to say, are we meeting that mission of having the long-term proximity being closest to the veterinarian? And so that's how I look at that metric, and that's a key success metric. And then minimum CSV for me is more about just a check to make sure that we're not giving a $1 away for $0.90. That you're maintaining some discipline there, that you're achieving that long-term relationship with the customer, you're getting more customers, the first 2 metrics. And you're doing it in a way that the customer is confident to commit to spending a certain amount of their spend with Heska. So that's kind of how I look at those 3 just in terms of the dashboard. I don't know if that helps.

[Benjamin Haynor:]

No, that was very helpful and exactly what I was looking for.

[Operator:]

. The next question comes from Jim Sidoti of Sidoti & Company.

[James Sidoti:]

Can you hear me?

[Kevin Wilson:]

Jim, we can.

[James Sidoti:]

Two questions from me. Are you going to update anything about the rollout for urine and fecal? So should I assume that the time lines that you put out previously are still okay?

[Kevin Wilson:]

They are.

[James Sidoti:]

Okay. And then the second one, I know this is the first time in my career that we're facing an inflationary environment and rising interest rates. Have you factored that at all into your guidance? And if so, how do you think it would impact the top in the top line and the margins?

[Kevin Wilson:]

So we haven't factored that into our guidance. We feel like we're reasonably well protected in our subscriptions. Our subscriptions have a CPI, get-out-of-jail-free card. So if for some reason, we woke up and know Jimmy Carter, 15% interest rates, our pricing would adjust by contract. And so we feel like we're protected there. We don't see that happening, by the way, but we have to look around the corner and bake that into our contracts, and our customers view that as reasonable. They too would then be inflationary with their pricing. So I think we're protected there. We don't see that macro event. We're not huge capital driven. We don't have large debt payments that are subject to variable interest rates and those types of things. And I think largely inflation driven by gigantic balloons of cash being sprinkled on consumers, largely is probably a good thing for pricing in things like pet health care because it sits right between kind of consumer, consumer cyclical, but it's also a health care requirement. So I think we're probably positioned fairly well for that environment.

[James Sidoti:]

Okay. And I think I heard Catherine say that she expects net interest expense for 2021 to be around $1 million. Is that correct?

[Catherine Grassman:]

That's correct.

[James Sidoti:]

Sorry, I didn't hear you.

[Catherine Grassman:]

I'm sorry, I was just confirming. Yes, Jim was correct.

[Operator:]

Our last question comes from Andrew Cooper of Raymond James.

[Andrew Cooper:]

I just figured I could jump in for a follow-up since nobody else asked this. But just on the AIM, I know the rollout is on track. But any color you can give on sort of the backlog continuing to build, how you're feeling about some of the goals you talked about in November in terms of rolling out to the existing installed base. And just the level of excitement you're hearing from customers. Any updates there?

[Kevin Wilson:]

Yes, we just can't go fast enough. So we continue to build backlog. We're -- every quarter goes by, we're confident that demand is more than there to get to where we want to be. So really, it's an execution question. It's just getting a wonderfully working product out to as many customers as fast as possible. So needless to say, our sales team is chomping at the bit and so a lot of our customers. I don't want to get into specifics because I don't want to update our backlog in public but it's good.

[Operator:]

It appears there are no further questions at this time. I'd like to turn the call back to Kevin Wilson for any additional or closing remarks.

[Kevin Wilson:]

Well, thanks, operator, and thanks to everybody who joined the call. Obviously, Heska, we did great last year, and we continue to expect that we'll accelerate momentum in 2021. We think we'll execute well in the second half of our 5-year strategic plan. And I look forward to updating you guys next quarter. Until then, thanks for your interest and your support in our work. And be safe, count your blessings and take care of your pet through the vet. So we appreciate you, and have a good day out there. Okay. Thanks. Bye.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.