Heska Corporation
Q2 2018 Earnings Call Transcript

Published: 13 Aug 2018

[Operator:]

Good day, everyone. Welcome to the Heska Corporation Second Quarter 2018 Earnings Conference. Today’s call is being recorded. At this time for opening remarks, I would like to turn things over to Jon Aagaard. Please go ahead, sir.

[Jon Aagaard:]

Sure. Thank you and good morning everyone. Welcome to Heska Corporation’s earnings call for the second quarter of 2018. I am Jon Aaggard, Director of Investor Relations for Heska. Prior to discussing Heska’s second quarter 2018 results, I would like to remind you that during the course of this call, we may make certain forward-looking statements regarding future events or future financial performance of the company. We need to caution you that any such forward-looking statements are based on our current beliefs and expectations and involve known and unknown risks and uncertainties, which may cause actual results and performance to be materially different from that expressed or implied by those forward-looking statements. Factors that could cause or contribute to such differences are detailed in writing in places, including this morning’s earnings release and Heska Corporation’s annual and quarterly filings with the SEC. Any forward-looking statements speak only as of the time they are made and Heska does not intend and specifically disclaims any obligation or intentions to update any forward-looking statements to reflect events that occur after the time such statement was made. We have with us this morning, Kevin Wilson, Heska’s Chief Executive Officer and President, Catherine Grassman, Heska’s Chief Accounting Officer, and Jason Napolitano, Heska’s Chief Operating Officer and Strategist. Mr. Wilson and Ms. Grassman will provide details surrounding the results reported and then we will open the call to questions before closing. At this time then, it is my pleasure to turn the call over to Kevin Wilson, Heska’s CEO and President. Kevin?

[Kevin Wilson:]

Thanks, Jon. Good morning, everyone. Today, we are pleased to report a solid second quarter of 2018 for Heska that is in line with the outlook that we gave on our Investor Day on May 15 in New York. Today’s reported results demonstrate good progress in our strategic efforts to grow our highest quality revenue faster than lower margin revenue stream. To that end, point-of-care laboratory consumable sales rose 16% in the period in line with our 15% to 20% full year outlook even as point-of-care laboratory overall gross margins expanded 240 basis points. Imaging moderated in the period as expected to bring the first half imaging sales growth to 11.5% in line with our 10% to 12% full year outlook. Second quarter revenues came in $300,000 below our outlook for $30 million as we focused resources away from lower margin, lower value-add revenue stream and towards higher quality of revenue and growth initiatives resulting in consolidated gross margin outperformance of 100 basis points and operating margin outperformance of 170 basis points compared to our outlook. Overall, our commercial performance was in line or slightly better than my expectation. Turning to the specifics of our commercial performance in the second quarter, on the corporate group practices initiatives, in mid-May, Heska was selected to partner with Pathway Vet Alliance, which provides state-of-the-art pet healthcare in the United States in over 150 full-service hospitals and is staffed by over 3,000 dedicated employees. When combined with Heska’s PetVet Care Centers agreement earlier, these large account wins have largely secured the corporately owned group hospital commitments needed to meet Heska’s market share goals from this class of customer for 2018. Entering the second half of the year, we are focused on installing and delighting these large multiyear customers even as we continue to track additional opportunities with other groups. In a competitive marketplace that continues to consolidate into group practice ownership, we continue to believe that Heska is strategically well-positioned to continue capturing market share from this class of customers. While it remains fiercely competitive in the non-corporately owned individual practices segment of the market, we believe Heska did well in the second quarter and is positioned to deliver share growth from all of 2018 as we enter the second half of the year. In short, my sense is that we are continuing to win competitive customer site over to Heska even as we are doing well, satisfying and retaining our Heska Reset base of customers. On the product front, in the second quarter, the new Element DC5X dry chemistry analyzer began shipping in quantity, the large volume domestic hospitals late in the period. The DC5X launch has gone well and these higher volume customers are responding favorably. Product development project and geographic expansion initiatives announced during our May 15 Investor Day continued on pace with my expectations in the second quarter. Our earlier announced North American field commercial team expansion from 85 to 105 customer focused professionals is on schedule. Additionally, we continue to advance our product development and launch plan for expanded cloud data technology, urine sedimentation in chemistry, element i plus immunodiagnostics, imaging, fecal imaging and other new product development initiatives. Alongside these products advancements, our limited geographic expansion into Australia and New Zealand for 2018 is progressing nicely for the second half and we are on pace for a broad international launch into major European Union and other markets early in 2019. As part of our international expansion strategy and in addition to our previously announced project on Investor Day, after many years of effort, we are today very excited to announce our plans to release in the coming few months, what we believe is the world’s most advanced rotor style chemistry solution for global animal health in veterinary market. Codenamed element r, Heska’s all-new rotor-based chemistry analyzer is an exceptional fit for many customers, especially in earlier stage international markets for ease-of-use, size, accuracy and superior inventory SKU management are highly valuable attributes. With best-in-class performance for test menu and accuracy, element r delivers up to 20 tests per rotor as compared to competitive offering that are limited to 14. Additionally, element r delivers load and go simplicity of operations, full bidirectional communication and extremely compact and light form factor, best-in-class runtimes, the latest touchscreen user interface and superior cost-of-use economics when compared to the competition. These and many other element r advantages are very real and very exciting and we look forward to launching this platform simultaneously with our international launches over the coming months. In summary, we are very busy and we believe that we are creating great value with our work. Today, we are excited to share with you some of our progress without tipping our hand too much to the competition. Concerning our outlook, veterinary market indicators in the first half continue to point towards broad-based industry growth led by strong veterinary hospital pet business, diagnostics utilization, industry earnings and pricing. The global animal and pet healthcare industry continues to see favorable, broad-based trends that are increasingly driving meaningful investment and strategic consolidation activity. As evidenced by the Mars acquisition of VCA Antech and their subsequent expansion into European and Scandinavian hospital markets, the recently closed acquisition of Abaxis by Zoetis, the announced spin-off of Henry Schein’s animal healthcare business into a new Vets First Corp under the dynamic new leadership of Vets First Choice team. The announced public offering plans for Elanco and other major and minor activity. As a leading provider and innovator in the space, Heska’s customer base, product portfolio, product pipeline, expertise and growth opportunities or company specific strengths, that point towards an important and rapidly scalable role for Heska in the evolving race to serve animals and pets of all types and nationalities throughout the globe. We generally see the increase in investments, strategic consolidation and reforming of strategies amongst large global animal health players as a positive trend that will continue. As we enter the second half of 2018 and prepare for a very exciting 2019, we are focused on enhancing our important role in animal and pet health and we remain convinced that the value creation opportunity ahead of Heska far outstrip our past successes. Now, I will turn the call over to Catherine to go through the details of the quarter. Following Catherine’s comments, we will open the call up to answer your questions. Catherine?

[Catherine Grassman:]

Thanks, Kevin and good morning, everyone. We are pleased to report a strong performance for the second quarter of 2018, which as Kevin mentioned was in line with our previously communicated outlook. Strong product sales in our Core Companion Animal or CCA segment offset by expected lower revenue in our Other Vaccines and Pharmaceuticals, or OVP segment, resulted in a consolidation net revenue decrease of 11% to $29.7 million as compared to the second quarter of 2017. CCA revenue was $26.6 million for the second quarter of 2018, a 2.1% increase over $26.1 million in the second quarter of 2017. Revenue from point-of-care laboratory products grew 8% in the second quarter of 2018 compared to the second quarter of 2017 driven by strong sales growth of consumables of 16%, offset by lower non-core infusion pump sales and capital lease revenue recognition and our Reset subscriptions program as detailed during our Investor Day on May 15. Revenue from our point-of-care imaging products declined 8.2% in the second quarter of 2018 compared to the second quarter of 2017, bringing year-to-date imaging growth to 11.5%, in line with our outlook for 12% – 10% to 12% for the full year. Revenue from OVP declined 58.7% to $3 million in the second quarter of 2018 as compared to the second quarter of 2017 as a result of lower production and shipments related to contract manufacturing agreement. Consolidated gross margin in the second quarter of 2018 was 44% as compared to 44.7% in the second quarter of 2017. As we previously mentioned, we expect consolidated gross margin to be around 45% for the full year, with quarterly fluctuation primarily resulting in our OVP segment due to volume and product mix. In the second quarter of 2018, gross margin in our CCA segment grew 190 basis points to 49.5% as compared to the second quarter of 2017, which was offset by OVP segment margin that was a negative 3.7%, due primarily to lower plant utilization from lower volumes of shipments to contract manufacturing customers in the period. We continue to expect OVP margin to be approximately 22% for the full year with higher margin shipments due to the fourth quarter. Second quarter 2018 operating expenses as a percent of sales increased to 560 basis points to 36.6% as compared to the second quarter of 2017, due primarily to increased stock compensation expense. Second quarter 2018 operating income declined 51.7% to $2.2 million as compared to the second quarter of 2017. Depreciation and amortization was $1.1 million for both the second quarter of 2018 and 2017. And stock based compensation was $1.3 million for the second quarter of 2018 compared to $0.7 million in the second quarter of 2017. The company’s effective income tax rate for the second quarter of 2018 was 10.2%, including a 19.2% – including 19.2% of tax rate benefit from stock based compensation activity compared to 32.9% for the second quarter of 2017. The company estimates the discrete tax benefits associated with this activity was $500,000 for the second quarter of 2018 or $0.05 of diluted earnings per share, which is a comparable impact of prior year period. Net income attributable to Heska Corporation for the quarter was $1.9 million or $0.24 per diluted share, a 43.1% decrease over $3.3 million or $0.44 per diluted share in the second quarter of 2017. At June 30, 2018, Heska had $13.7 million in cash compared to $9.7 million as of December 31, 2017. Cash flow from operations was $4.5 million for the first six months of 2018 compared to $4.9 million for the six months ended 2017. Looking forward for the full year 2018, Heska continues to anticipate point-of-care laboratory consumables growth of between 15% and 20%, point-of-care imaging growth of between 10% and 12%. And we continue to target 1.5 to 2.0 share point gains in point-of-care laboratory competitive account. Due to potentially lower revenues from OVP segment contract manufacturing customers, lower sales of PCA segment, non-core infusion pumps in single-use heartworm test, the higher ratio of operating versus capital lease treatment of our recent subscription agreement and extended installation schedules within our corporate group customer effort, our updated outlook is for approximately $31 million of consolidated revenues for the third quarter, down from the prior forecast of $34.6 million and approximately $135 million of consolidated revenues for the full year, down from the prior forecast of $139 million. Due to focus and strength in higher margin revenue line, the outlook for full year operating margins that was – is revised to be higher by 30 basis points to 35 basis points to be approximately 11.8% and operating income is expected to be unchanged at approximately $16 million. We continue to anticipate capital investment and major product line expansion, research and development, licensing agreement and geographic expansion. With that, Kevin, Jason and I would like to open the call for your questions.

[Operator:]

Thank you. [Operator Instructions] We will go first to Mark Massaro with Canaccord Genuity.

[Mark Massaro:]

Hey guys. Thanks for taking the questions. My first one is maybe on the 2018 full year guidance, it looks like the expectations for Q3, essentially accompanies the guide down for the full year, so I guess can you just speak to the dynamics in play for Q4, effectively Q4 is unchanged. And just wanted to get your sense for OVP recovering in the back half of the year and maybe related to that, your expectations around fulfilling the large customer orders from the new corporate account wins?

[Kevin Wilson:]

And Mark, it’s Kevin. Good morning.

[Mark Massaro:]

Good morning.

[Kevin Wilson:]

I will take it in reverse order, if that’s okay. So the corporate account when the installations have begun, but they take a little bit longer I think than even we anticipated. And so when they take a little bit longer, even if you are ten sure in a period, that’s consumable revenue that doesn’t hit in the period. Now the contract term, the multi-year nature of it is going to get you the economics over the life of the contract. But getting their teams and our teams together, schedule the lines, training the lines, those types of things have taken a little bit longer, weeks longer, not months or years longer. So I think that’s part of it. In terms of the revenue guide in the third quarter, we have had softness in areas like infusion pumps, single-use heartworm test. These are fairly commoditized, low value-add products that are legacy products here at Heska. Margins in the 20% and sometimes below gross margin range. And for those who have known me for a while, I am big into opportunity cost, especially in small, agile organizations. And I just don’t want to focus an awful lot of opportunity costs and trying to protect and grow 20% margin business. And so if we are not going to invest in it, we can’t forecast performance of some of those products. So I think that’s why we called out those kind of lower margin products, as softness specifically in the third quarter. In terms of OVP, I think we have said all year that we have contract manufacturing for annual contract, minimums and as we get their forecast for shipments on a rolling basis, then we can update. And so based on historicals, the purchasing managers on the other side of these contracts at the beginning of the year may forecast a cadence, that as they become binding forecast, that cadence might get pushed out, but it has to get pushed out, but still occur in calendar year 2018. And so I think that’s part of the reason some of that OVP is back end loaded to the fourth quarter.

[Jason Napolitano:]

Mark, it’s Jason Napolitano. The – to the extent that Q4 is based on contractual minimum, we are confident that those are enforceable if it came to it. And as we are getting into this part of the year, those forecasts are starting to turn into firm POs. So for the full year outlook for that OVP segment, it’s starting to firm up pretty nicely at this point.

[Mark Massaro:]

Great. And a question for Kevin, congrats on the announcements of the element r, for a while you have talked about the merits of dry slide chemistry and then I guess you sort of surprised us with the rotor style chemistry announcement, can you just give us a little background on why you think rotor style chemistry, clearly Abaxis has had a lot of success in the marketplace with ease of use, but why now on rotors and can you just speak to your thoughts on how this potentially could cannibalize your dry slide?

[Kevin Wilson:]

Yes. We don’t see cannibalization as a factor for a couple of reasons. And I think as most people know we are at roughly 10%, 11% market shareholder. So we think that 9 out of 10 veterinarians want dry chemistry or rotors. And historically, 25% of that customer base has selected rotors. Here an intellectually honest person, there is a valid argument when 25% of smart consumers pick something. And so I have taken the idea that you should learn from that. This isn’t a new initiative for me, I looked at my notes, we began this effort 3 years ago and it takes time. But we are pretty gazed to be able to announce it. So I agree with some of the points, I will take with Zoetis and Abaxis, specifically in international markets where these customers a lot of times are on their first analyzer, they are a little less secure in their ability to train their technicians and handling and preparing sample, so the ease of use of our rotor, the ability to stock these things with fewer skews and longer shelf life, the size of the analyzer. Those types of things resonate well for the first-time users and I think in North America, where these folks might be on their third, fourth and fifth chemistry analyzer, they are more secure in their ability to have veterinary technicians handle samples, compare sample and the accuracy and precision and flexibility dry chemistry resonates with 75% of the North American market. Also, the ability to take these smaller affordable units into animal health environment, production animal and those types of things, I agree with my very large competitors that, that’s an opportunity. And I think it’s one that we want to be able to address. So we see this as really addressing international markets, where I think rotors resonate very, very well and that’s a largely Greenfield market. And we think having a competitive offering that allows us to offer that is good for Heska. So there is a place for both.

[Mark Massaro:]

That’s great. And one last quick one if I can, you indicated Australia and New Zealand international expansion in the second half. Presumably, I would guess that’s through a distributor. Can you just clarify if that has started rolling out or if that’s to come? And then second half of that is I think earlier in the year you indicated that you are very pleased with your work with Henry Schein in the U.S. Should we think of Henry Schein as a logical partner for early next year in Europe?

[Kevin Wilson:]

Henry Schein is always a valid partner. They are in the most international markets. And they have reach in some markets but not all and so it’s country specific. Australia and New Zealand, we are following a model where we will have local partners, they have local knowledge, local customer bases and those types of things, but in a lot of these countries and I know I am prepared to announce exactly the structure, but in a lot of these countries we will have a direct presence as well. We are not farming out everything to a third-party just so that we can hand the evaluation that IDEXX and Zoetis have gone through internationally only to pull it back. So I think we are being thoughtful and trying to look out 5 years, not for where is the easy, less work win for the fourth quarter of 2018. So, I think you can expect a hybrid. I think you can expect that each country will have different dynamics. And in some cases, there will be very strong logical distribution and logistics partner. And in some cases, we will do it direct.

[Mark Massaro:]

Great. That’s it for me. Thank you.

[Kevin Wilson:]

Thanks Mark.

[Operator:]

We will hear next from David Westenberg with CL King.

[David Westenberg:]

Hey, thanks for taking the questions. So again on the element r, the interesting product announcement, so can you talk about who – if you have a certain partner that’s manufacturing that and if that would just put at risk any of your relationships with your current supplier in Fuji?

[Kevin Wilson:]

Again, I will take it in reverse order. We don’t think it puts at risk that relationship. I am in constant communication with my friends at Fuji whether it’s long flights to Tokyo or for them coming in the other direction. So, I don’t think they are surprised and we think we have communicated that well. And contractually, it doesn’t represent a risk. In terms of manufacturing, this is a global product for us rights throughout the globe, animal health and veterinary, it is an extrusive product for us. So it’s not a shared product with other manufacturer, right and those types of things. So we are not wanting to share our contract manufacturing obviously we are now opening up a manufacturing plant in San Mateo, California to compete. We think there are other places to manufacture these things with good cost competitiveness. So we have done that, but I think that answers your question.

[David Westenberg:]

Yes. No, that’s great. That’s very helpful. So just on the, I think you call it the PVD single use, can you remind us if there is any seasonality with those kind of products that would show up in the P&L?

[Kevin Wilson:]

It’s not a ton in terms of some of the products like heartworm. And the reason I will say heartworm doesn’t have a ton of seasonality anymore is we just don’t sell that much of it anymore. So, your question was premised on, does it show up in the P&L, pumps can really – but the allergy products tend to be fairly consistent, because they are long-term immunotherapy driven. You maybe get a little bit more testing revenue in some periods than others, but yes, so some of those products have seasonality and some of them don’t, but I think we have kind of anticipated it fairly well.

[David Westenberg:]

Got it. And then I am just going to ask one more, on the corporate account win, you announced two really big 100 plus corporate account wins. Now, I think that there is a lot more in the market that are say 50 to 60 is there different challenges in winning those smaller corporate groups over and namely, I am thinking about maybe is a smaller group going to be more likely to be sensitive to veterinary pain points whereas these large groups that you have shown the ability to win, maybe they are more P&L driven, because they are looking at an aggregate of 100 plus hospitals. So any color on win dynamics in that corporate setting is very helpful? Thank you.

[Kevin Wilson:]

Yes. I think that’s an intuitive question. Smaller groups have less dollar savings, because they buy fewer quantities. So when you get a critical mass and you can save substantial money per clinic and you have 100 clinics, the dollars are larger than if you have 10 clinics. But having said that, I think the real sensitivity is quality, people want to standardize on top performance, top quality and what’s been really encouraging to us is to get some of the largest and most well-respected corporate groups early and I think there is a little bit of a halo there, these folks own some of the largest specialty hospitals, very well respected, they run very, very good businesses. And so what we are finding is the folks that own 20, 25, 30 hospitals, we are walking into those conversations with a fair amount of credibility at this point, because of the halo effect of getting the 100 plus folks. So yes, it’s a little bit of both, but every conversation is different and everybody has different friction points, pain points and worries, but the one thing that’s universal is they want veterinarians to select the highest quality medicine and to be passionate about having selected the highest quality medicine. That far overrides the cost savings and it’s been really pleasing and rewarding to be able to go in and prove that we have the highest quality medicine and then be able to put together a financial package that makes sense.

[David Westenberg:]

Got it. Thank you very much. And I will jump back in queue.

[Kevin Wilson:]

Thanks, David.

[Operator:]

And from Benchmark, we will move to Bruce Jackson.

[Bruce Jackson:]

Hi, thanks for taking my question. What’s the guidance for the operating margins? It looks like you are counting on getting some leverage there in the back half of the year, I was wondering where specifically you are expecting to pickup some operating leverage?

[Kevin Wilson:]

I think we see OVP margins ticking up a little bit. I think we continue to see good growth in higher margin consumables and point-of-care laboratory and imaging, I think the second quarter was kind of a normalization quarter, but I think imaging looks healthy for the second half and those tend to be good margin products as well and in some cases improving margin product. So, it’s really just – not just one lever, just like the lower margin items that we are not getting is not just one bucket item.

[Bruce Jackson:]

Okay. And then speaking of OVP if we look at the revenue guidance for the rest of the year, it looks like you are expecting a fairly big uptick in the OVP business, I was just curious to know are you expecting that to be up, down or about the same over 2017?

[Catherine Grassman:]

Down full year over ‘17.

[Jason Napolitano:]

Down slightly, I think over full year ‘17.

[Bruce Jackson:]

Okay. And then last question, you didn’t mention anything about the new immunoassay product you are working on, do you have anything to add about that program?

[Kevin Wilson:]

Yes. When you put these releases together, you are always trying to be sensitive, because we have a long, long, long list of projects that we have going. Immunoassay is progressing nicely. We are focused on launching the element i plus with key assays, T4, Cortisol, things like that, that allow us to place them into more locations while we build out the rest of the menu and that project is progressing. If we haven’t already, just early in this month, it’s impending I think we will conclude the additional $3 million investment in our partner on that. So, it hasn’t happened already in August, it should happen this month. So, that’s progressing nicely and kind of goes in that broad bucket in my prepared comments that things we listed during Investor Day are on track with my expectations. And so I didn’t update each individual project.

[Bruce Jackson:]

Okay, that’s it for me. Thank you.

[Kevin Wilson:]

Yes, thank you.

[Operator:]

We will move on to Ben Haynor with Alliance Global Partners.

[Ben Haynor:]

Good morning everyone.

[Kevin Wilson:]

Good morning, Ben.

[Ben Haynor:]

Just a few quick ones here from me. The element r here, that’s pretty exciting and very interesting and I know you have mentioned a number of the aspects of the device. I was kind of wondering about what the initial launch menu might look like, what the throughput might look like and whether it will have kind of the Slate hub integration upon launch?

[Kevin Wilson:]

I think, yes, in the positive to kind of the underlying question to all of it. So run time, we think it’s at or better than the industry leader. Menu will be a full menu. So, we are not lacking and scrambling to launch any assay that we consider to be a full menu for comprehensive rotor, liver rotor, equine panels, those types of things, it will be a launch with a full complement of panels to compete day 1.

[Ben Haynor:]

And then Slate hub integration?

[Kevin Wilson:]

Yes, actually. So the two-way communication is already built in, so it supports – and so for HL7 that they want you to embed in that integration capability.

[Ben Haynor:]

Okay, perfect.

[Kevin Wilson:]

Sure. Also with practice management software in our Heska new software, so the ability to order captured has communicated the results, capture charges, all of those types of functions are already in the product.

[Ben Haynor:]

Okay, great. And then do you think the launch of that could help you with – well even more with some of these corporate accounts out there? For example, one of these firms that was acquired not too long ago that had a large installed base of competitive rotor instruments?

[Kevin Wilson:]

I don’t see it really as a corporate account focused product. I really do see it as an international Greenfield product. I see it as an expansion opportunity into animal health, herd production type of animals over a longer period of time, where it just – an open dry chemistry system is just not an appropriate dwelling factor, but I really do see this and I think I agree with Zoetis and Abaxis on this that for the international growth market, there is some pretty compelling reasons why consumers, veterinarians will pick rotors internationally. I think in the domestic market, the ground is fairly firm and fairly set. And roughly 20%, 25% of the customers have selected rotors, but they have had that opportunity over 15, 20 years and roughly 75% of the customers have selected dry chemistry. So, we still tend to emphasize the large corporate accounts, especially domestically. It will all be dry chemistry for us.

[Ben Haynor:]

Okay, that’s very helpful. And then lastly from me, it looks like one of your competitors kind of changed their plans or altered their plans a bit on fecal product launch, does that impact your desire to get out there into the market or the timing of the element f at all?

[Kevin Wilson:]

It doesn’t impact it, because we are pushing for it and we are as excited as we can be about it. So, what the competition is doing is really not all that relevant to how excited we are. What we just know they are tens of millions of fecal advance being done that aren’t being captured by anybody that could be served better and we think we have the right mousetrap. They have reiterated that they think they have the right mousetrap and that’s the beauty of market capitalism. We will both execute and see which one the market agrees with. I am hopeful that we are first to market, but even if we weren’t, I think our approach is different enough and they have drawn a line in the sand saying they don’t agree with our approach as being as good as their approach and we will see who succeeds or who blinks. That’s the fun part of competing.

[Ben Haynor:]

Makes sense. Well, that does it for me. Thanks for taking the questions.

[Kevin Wilson:]

Thanks, Ben.

[Operator:]

We will move next to Kara Anderson with B. Riley.

[Kara Anderson:]

Hi, good morning.

[Kevin Wilson:]

Hi, Kara.

[Kara Anderson:]

I was just wondering if you could provide more color on the low margin OVP business, whether this is new product that’s being pushed on to you through the segment and whether you have experienced this kind of margin before?

[Jason Napolitano:]

Yes. I think Kara, this is Jason Napolitano. The margins you are seeing are fairly typical for the OVP segment. There have been periods in our history. We have got maybe up to 30%, but particular in recent times for the book of business that we have, this is pretty much in line with expectations.

[Kara Anderson:]

Okay. And then on the imaging business, it was up I think 33% in Q1, down in Q2. I know Q4 is typically a nice, strong quarter seasonally, but to guess your full year guidance, it really doesn’t fly double-digit growth in the second half. I am just wondering if you can comment on why or remind me why again, this is such a I guess, lumpy business?

[Kevin Wilson:]

Well, the relative dollars are small. And so I mean I will just to give you a kind of a word picture. So the last shipping day of this quarter was Saturday and if you happen to have 3 units sitting on the dock on the Saturday for $180,000 on a business that’s that high that actually moves the needle a reasonable amount. And so there is just lumpiness just given the fact that your large transaction size is $50,000ish, $60,000ish per transaction and there is fewer transactions in that particular area during the year. So timing of that matters probably more than others. We like our forecast in that, it’s healthy. They are tracking good business. So, we don’t think it’s an unusual hockey stick. And as you pointed out, it has always been literally for decades, imaging has always been a fourth quarter stacked business and we don’t think that’s going to change this year or in any foreseeable year.

[Jason Napolitano:]

We think Kara historically, there has been some tax advantage to veterinarians to buying late in the year. This is such a large capital good expenditure that can get pickup the tax advantage and there is also major tradeshow they usually pull off in the fourth quarter.

[Kara Anderson:]

Thank you. That’s very helpful.

[Operator:]

And from Raymond James, we will hear from Andrew Cooper.

[Andrew Cooper:]

Hey, guys. A lot has been covered. Thanks for taking the questions. Just a couple for me. First, I think you have done a good job over the past really years of sizing the heartworm business, but can you talk about kind of what the size of the infusion business is and how much of a drag if this doesn’t rebound it could be in the back half relative to the guidance change?

[Kevin Wilson:]

We are checking. While we get you the context for the revenues for the year, we will probably be down about $1 million for infusion pumps year-over-year and I will get you the number here shortly on $1 million out of $4 million, $3 million, $2 million, we are pulling that number for you. So, it’s contextualized for you.

[Andrew Cooper:]

And is that one like heartworm, where you have kind of really totally deemphasized and it might kind of bleed lower over for the next two, three, four quarters or you think we are near a stabilization point?

[Kevin Wilson:]

I think we are near a stabilization point. And I will tell you why, we don’t promote the product. So in that regard, it is like heartworm, but what makes it different from heartworm is we have tens of thousands of these things floating around veterinary hospitals with the Heska brand on it. And when you won’t stick to something and unit #4 breaks you tend to go online and just hire a replacement for unit #4 and it tends to be the same brand model and consistency as your other 5 units. So that business operates a little bit differently than seasonal heartworm in that regard, but we don’t have teams promoting it, we used to run specials, we used to do buy one, get one free, we used to do inside sales promotion to drive that product, but again, it’s not the future. And we have just ridiculously cool future things that there is an opportunity cost to focus in on that product with the current margins that we have. If we can get the current margins up, then we will focus on it, but it’s still managed from John Dillinger, why do you rob banks and that’s where the money is. Right now, the money is not pumped, so we are really not focused on it that much. It’s roughly $4 million. So you have got $1 million down on a roughly $4 million revenue business.

[Andrew Cooper:]

Okay, that’s helpful. Thanks. And then my next one you talk about the element r being more of a global focus and I guess as we are thinking about the international presence and what the kind of toolkit might look like when you go to sell. I know in the 10-K, you talk about limited geographic rights at least for some products. Can you give us some color or is there anything in the existing portfolio that you won’t be able to sell internationally or where the economics materially change when you try to expand those contracts globally?

[Kevin Wilson:]

Yes, that’s a great question. For chemistry and hematology, which are what we consider to be core lab in the markets that we intend to address, we have rights and we have similar or better cost margins than what we are operating on in United States. So we think we are well established in terms of rights and margin in the market that we are trying to address. In the ancillary products, I won’t go through each one of them just in terms of which ones we tend to promote, which ones we have rights to promote and what the margins are if they are not as good as the United States, but the core lab is in place and that’s really where the competition happens, the ancillary products sell some of them and we won’t others market specific.

[Andrew Cooper:]

Okay, great. That’s helpful. Thanks, guys.

[Kevin Wilson:]

Appreciate it.

[Operator:]

[Operator Instructions] We will move next to Jim Sidoti with Sidoti & Company.

[Jim Sidoti:]

Good morning. Can you hear me?

[Kevin Wilson:]

We can hear you, Jim. How are you?

[Jim Sidoti:]

Good, good. I hate to keep the focus on the OVP business, because it isn’t really the growth story, but I just want to be clear, you cut your revenue guidance for the year by about $4 million. That was strictly due to the OVP business and the non-core pump business, is that correct?

[Kevin Wilson:]

It’s also due to ratio of operating lease, the capital lease treatment in our subscription agreement. I guess you recall capital lease treatment gives you upfront revenue recognition whereas an operating lease spreads it over the term of the contract evenly. That’s a pretty significant difference when you look at that change in some of the terms in those contracts.

[Jim Sidoti:]

Okay, alright. And then did you give guidance for full year OVP revenues?

[Kevin Wilson:]

I think we are keeping it right around $19 million. I think we have said $19.5 million previously. So, it’s right around $19 million to $19.5 million and gross margin is right about 22%.

[Jason Napolitano:]

I don’t believe the 15% downs you a little bit here.

[Jim Sidoti:]

Okay. Alright, great. So then the lower revenue guidance is more for the pumps and the way you account for the equipment?

[Catherine Grassman:]

It was all three. All three contributed to the $4 million decline.

[Jim Sidoti:]

Okay, alright. Good. Alright, glad to get that out of the way. With element r, when do you expect to be able to start to launch that?

[Kevin Wilson:]

We have got our first batch ordered and in production and so we expect to have inventory by the end of the year and some of it is just commercial launch, people on the street, regulatory shipping with just the other work that we have been doing on the international expansion. So, in the next several months, not a second half of next year type of thing, but it’s right at this point, whether it’s the December or January, but it’s in that timeframe.

[Jim Sidoti:]

Early 2019 is a pretty safe estimate though?

[Kevin Wilson:]

We think so, yes.

[Jim Sidoti:]

Okay. And you talked about all the changes in the industry over the past few months, the acquisition of Abaxis, the spin-out of some of the other companies, that businesses, which one or two of those things do you think most significantly impacts Heska and how do you think it will impact you?

[Kevin Wilson:]

I mean, it’s a great question. It could result in probably an hour-long conversation. I think in general, I will make a couple of comments. The trend is larger investment larger scale consolidation and I think that makes sense just in terms of servicing veterinarians who are servicing pet owners. So, there is bit more efficiency, more scale, it’s turning into a global market as opposed to a primarily North American market reaching out. And I think the global side of that market, including China and Asia has gotten to the size and gotten the attention of global investors. So, I think that trend will continue. In terms of which one affects us the most, I think we have done a pretty good job of not farming our success out. So, we think these are generally favorable trends, but a lot of it just depends on execution on the other side. If Henry Schein Animal Health spins out the Vets First Choice and Vets First Corp executes well, I think the whole industry benefits because their whole business model is to drive utilization into veterinary clinic and that benefits all diagnostics that would benefit IDEXX, that would benefit Zoetis and that would benefit Heska. And then the competition is on the margins, can it benefit us more than them. But I don’t think there are any earth-shattering, game-changing deals that I have seen other than to say the one trend is global scale with larger investments, faster ramp and I think that only benefits the whole industry. And we are a small part of an industry that’s thriving. I don’t know if I answered your question, like I said it’s a much longer conversation, but I am not overly concerned by anything I have seen and I am not overly excited by anything I have seen. I think it’s just a natural progression.

[Jim Sidoti:]

Okay, alright. Thank you.

[Operator:]

And we will hear from David Westenberg with CL King.

[David Westenberg:]

Hey, thanks for taking the follow-up. So, I think you answered it, but just for clarity purposes, the element r will be launched in the U.S., but it’s still going to be kind of a secondary to element DC. Am I correct there or?

[Kevin Wilson:]

No, I mean to be more explicit, we don’t see launching it in the near-term in the U.S. Our dry chemistry business is in line with 75% of the market. We think that’s the winning argument in a very mature U.S. market, we are tickled and thrilled with our dry chemistry solution, which we just launched a DC5X, we just signed up a large corporate account. So we like that strategy. And those consumables are growing 15% to 20%. There is really not a reason to create channel market product conflict or confusion. For us, the entire rest of the globe is Greenfield in incremental and additive. So, we can define our message in our first message in our first look in these markets. And what we have done is we have allowed ourselves to align with rotors, which we believe in those markets are compelling, Zoetis and Abaxis clearly agree with that and we are not entirely convinced that dry chemistry will obtain 75% of the emerging markets. In fact, I don’t think that’s going to be the case. And so I don’t know if it’s 50

[David Westenberg:]

Perfect. Thank you very much. Yes, I should have got that. I heard something during the call and I thought I understood something else. So thank you for clearing that up.

[Kevin Wilson:]

Fair enough, David. Thank you.

[Operator:]

And at this time, I would like to turn the conference back to management for any closing remarks. That’s great. Thank you. Thank you everybody for joining our call. Just to reiterate, I am pleased with our results. The team did a great job in the second quarter and I am hopeful that today’s information has been helpful to you as you evaluate our prospects and our progress and our performance. We look forward to updating you again in the next couple of months and until then thanks for your interest in Heska and have a great day.

[Operator:]

That will conclude today’s conference and again thank you all for joining.