Heska Corporation
Q4 2017 Earnings Call Transcript
Published:
- Operator:
- Good day and welcome to the Heska Corporation Fourth Quarter and Year End 2017 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Brett Maas of Hayden Investor Relation. Please go ahead, sir.
- Brett Maas:
- Thank you. Prior to discussing Heska Corporation's fourth quarter and full year 2017 results, I like to remind you that during the course of the 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 that 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 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, or specifically disclaims, any obligation or intention 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; and Jason Napolitano, Heska's Chief Operating Officer and Strategist; and Catherine Grassman Heska’s Vice President, Chief Accounting Officer and Controller. Following managements comments we will open the call to your questions, followed by Mr. Wilson's closing comments. Now, I'll turn the call over to Kevin Wilson, Heska's Chief Executive Officer and President. Kevin, floor is yours?
- Kevin Wilson:
- Thanks, Brett, and good morning everybody. Today, we are pleased to report fourth quarter and full year results for 2017. Our release this morning contains information and details around the one-time non-cash charge of $5.9 million or $0.77 per diluted share related to enactment of the 2017 Tax Cuts and Job Act. Adjusted and on a non-GAAP basis to exclude these impacts, Heska delivered record fourth quarter net income of 39.8% over the prior year to $4.8 million which is $0.63 per diluted share. For the year, we’ve produced a 50.8% increase to $15.9 million in net income which is $2.07 per diluted share. Consolidated growth margins rose 5.4% in the fourth quarter to 46% and 3.6% to 45% for the full year, which helped to deliver a 3.2% rise in operating margin for the fourth quarter and 19.7% with full year operating margins rising to 14.1%. Cash flow from operations rose 77.8% over the prior year to $10.4 million a balance sheet is in excellent condition and our liquidity position is healthy and supportive of our growth plan. On an operational and profit basis, Heska exceeded my goals for 2017 missing my goal with a $7.7 million shortfall in imaging sales compared to the very strong prior year which resulted in a majority of the consolidated revenue underperformance for the year. Going forward however, for 2018 we see imaging revenues returning to 10% growth and early results for January and February are confirming this rebound. The core of our growth in profitability is and continues to be our point of care laboratory consumables and subscriptions under our unique Heska reset subscriptions models. In the fourth quarter and for the full year, Heska won market share, realized increasing test volume and price and finished the year with a largest installed base of users in our history. Given that this is our highest margin product line, its continued strong growth in excess of 15% throughout 2017 and into 2018 is encouraging. For 2018, our job at Heska is clear first continue to win in our baseline domestic plan that emphasizes Heska reset diagnostics subscriptions. Second, continue to growth in Heska Imaging that we have seen in January and February; and third, work to deliver on our next big product and geographic expansion opportunities to drive major steps up in growth. I’m optimistic that we can do these things well. As we do our work, I hope long-term shareholders may invest and benefit alongside us our customers and our industry partners. Now, I’d like to take a moment to welcome Catherine Grassman, our Chief Accounting Officer to the call. I, the board of directors of Heska, the entire accounting and financings of Heska have been impressed by Catherine’s intelligence and excellent work for some time now, and we couldn’t be happier for Catherine and for investors that she has taken on and expand the role. In addition, Catherine’s excellent work she is a genuinely wonderful person and I’m sure everyone will be better off for knowing her and for working with her. Now with that, I'll turn the call over to Catherine to go through the details of the quarter and the year. Following Catherine’s comments, I'll provide additional insight into our plan and upcoming Investor Day schedule for May 15th in New York City then we’ll open the call to your questions. Catherine, you are up.
- Catherine Grassman:
- Thanks Kevin. For the fourth quarter, we reported revenue of $36 million an 8.9% decrease over $39.5 million in the fourth quarter of 2016 and full year revenue of $129.3 million a 0.6% decrease over $130.1 million in 2016. Revenue for the Core Companion Animal Health segment or CCA was $29.7 million in the fourth quarter, a 10.2% decrease over $33.1 million in the fourth quarter of 2016. CCA revenue was $105.2 million for the full year, a 2.1% decrease over $107.4 million in 2016 largely due to $7.7 million less than imaging revenues. As a reminder, CCA revenue is comprised of first, our core point of care laboratory product which includes subscription agreement comprised of several components including lab consumables and equipment; second, our point of care imaging product; and third, our single-use pharmaceuticals, vaccines and diagnostic tests for Companion Animal use. Our Other Vaccines and Pharmaceuticals segment or OVP generated revenue of $6.3 million in the fourth quarter of 2017 down slightly from $6.4 million in the same quarter last year; however, on the year-over-year basis, the OVP segment revenue increased 6.5% to $24.2 million in 2017 from $22.7 million in 2016. Our gross margin improved in Q4 to 46% as compared to 40.6% in the fourth quarter of 2016. Full year 2017 gross margin increased to 45% from 41.4% in 2016. Improvement in gross margin for both periods largely resulted from favorable pricing across point of care lab and imaging products, favorable product mix in our OVP segment and full year 2017 revenue and cost of revenue offsetting adjustments as reported in our form 8-K. Total operating expenses on a year-over-year basis grew 7.2% to $40 million from $37.4 million. The increase was most notable and G&A expenses which were up 12.9% year-over-year due to increases in compensation and consultancy fees. Fourth quarter operating income grew 8.9% on a year-over-year basis to $7.1 million compared to $6.5 million in the fourth quarter of 2016. Full year operating income grew 10.2% to $18.2 million compared to $16.5 million in 2016. Depreciation and amortization was $4.8 million in 2017 as compared to $4.6 million in 2016. Stock-based compensation was $2.7 million in 2017 as compared to $2.3 million in 2016. Our effective tax rate for the quarter was 115.1% and 48.5% for the full year. As a result of the enactment of the 2017 Tax Cuts and Jobs act, we revalued our deferred tax assets, primarily consisting of our net operating loss carry forward in light of the reduction to the federal tax rate. This resulted in a non-recurring non-cash accounting charge of approximately $5.9 million. Excluding the impact of this one-time charge on a non-GAAP basis, our effective tax rate was 31.6% for the quarter and 16.4% for the full year. Including the impacts from the 2017 Tax Cuts and Jobs act, net loss attributable to Heska Corporation for the fourth quarter of 2017 was $1.1 million or a loss of $0.14 per diluted share. For full year, net income attributable to Heska was $10 million or a $1.30 per diluted share. Excluding the previously mentioned non-recurring non-cash accounting charge attributable to U.S. tax reform, adjusted net income attributable to Heska for the fourth quarter was $4.8 million or $0.63 per diluted share as compared to $3.5 million or $0.46 per diluted share in the fourth quarter of 2016. On a full year basis, excluding the impact of U.S tax reform, net income attributable to Heska was $15.9million or $2.07 per diluted share as compared to $10.5 million or $1.43 per diluted share in 2016. Kevin, back to you.
- Kevin Wilson:
- Thanks Catherine. Before we go to questions, I'd like to spend a few moments updating you on our outlook for 2018. In our Core Companion Animal segment, the outlook for our point of care laboratory and imaging products in 2018 is encouraging. Our teams and customers remain confident in the unrivaled accuracy, speed, breadth and value combination of Heska technology under the Heska reset model. We believe Heska reset subscriptions will win market share for Heska in currently serve domestic markets and in potential international markets. In lab consumables, the major growth and high margin profit driver for Heska, we anticipate consumables growth to continue to be between 15% and 205 with stable to improving gross margins, contributing to lab consumables growth in 2018 and beyond is our expectation that Heska will win between 350 and 475 new veterinary hospitals subscribers from competitor accounts. To support organic, domestic customer share gains in any future product line extensions, Heska intends to expand the North American based point of care diagnostic sales in utilization teams from 85 dedicated professionals to a 106, a roughly 25% increase beginning in June and pace evenly through December. This expansion in sales professionals will also prepare Heska for upcoming growth initiatives, which includes new product launches into the North American market in the first half and possibly also in the second half. As indicated on our last call, we have begun a new product release cycle in point of care laboratory equipment and consumables. To kick things off for 2018, late last year we launched the new Element COAG analyzer and test platform. This is a new and additive product line for Heska point of care laboratory and we've been pleased with this launch has gone well and customers and the sales teams have responded enthusiastically. Close on the heels of last year's Q4 launch of the Element COAG platform, in early February at the 2018 BMX Conference in Orlando, veterinarians were excited to learn of the pre-release debut of Henry Schein Animal Health' new Axis-Q LENS software solution. Axis-Q LENS consolidates, trends, reports and shares in-clinic laboratory and reference laboratory results, from a broad array of providers chosen by the veterinarian, for display and analysis on computers, smartphones, and tablets. Because of Henry Schein's leadership in practice information management software solutions, the majority of veterinarians will now have the choice and flexibility to consolidate and trend results from Heska in-clinic laboratory with their choice of reference laboratory providers' results. This has been a major request from veterinarians for several years and Henry Shine and Axis-Q LENS are delivering strongly. Continuing with the momentum, on March 4th at the 2018, Western Veterinary Conference in Las Vegas, Heska will release the first new addition to the Heska dry chemistry product line 2012, the Element DC5. The all new Element DC5 delivers the highest throughput of any fully featured point of care, veterinary dry chemistry solution by combining a new and higher level or automotive workflow, unique, simultaneous staging of five patient samples, on-board bi-directional data sharing with Axis-Q and other practice management software solutions, a streamlined touch interface, a modern and compact form factor and superior accurate dry chemistry performance from Fujifilm, the inventor of dry chemistry technologies. The ultra premium Element DC5 will be preferred by the highest volume, multi-doctor specialty hospitals that do the most point of care testing. Element DC5 is targeted to begin to shift the customers during the second quarter of this year. In Imaging Diagnostics, last year’s mid November debut of the all new Slate Hub went well and the additional accessories for Slate Hub are expected to be generally available in the second quarter of this year. For Heska Imaging in 2018, we are pleased to begin the year on a solid go forward footing while Imaging revenues for 2017 were 7.7 million less for the full year than in the prior year which accounts for the majority of our consolidated revenue shortfall. We expect imaging to return to 10% growth in 2018. In contrast to early 2017, Heska Imaging enters to 2018 integrated with a robust pipeline, benefitting from newly launched products, capturing a new extended maintenance revenue stream and experiencing a good headstart from a solid performance in January and February. Moving on to our other vaccines and pharmaceuticals for our OVP segment, Heska’s team delivered an above line result in 2017 with revenue growth of 6.5% to $24.1 million and gross margins that increased by 6.9% to 31.4%. Each of these achievements exceeded expectations than historical ranges which we have viewed for sometime as 3% multi-year revenue growth trends at 18% to 20% growth margins. In line with these multi-year trends and adjusting for 2017 outperformance, absent new initiative in 2018 we expect OVP to achieve approximately 21 million in revenues at roughly 19% gross margins. Overall veterinary market indicators continue to point towards broad based growth with industry estimates of 5%, veterinary hospital growth and 7% hospital diagnostics growth appearing to be intact s 2018 begins. Our baseline target for 2018 is for approximately 7% consolidated revenues growth from the areas discussed previously on this call namely a mix of market share gains in existing markets, increased sales in density, test and analyzer addition, healthy pricing and increased utilization from the largest install base in our history. Due to positive margin mix led by higher margin, faster growing laboratory consumables and a return to growth and imaging product, our baseline target for 2018 assumes gross margin expansion of 30 to 50 basis points along with positive inventory conversion trends. It is important to note that our baseline target for 2018 excludes the effects of growth initiative, which we currently identified being geographic expansion and major product line extensions and investments that may result in substantial impact to our estimated baseline target in 2018 and the actual future performance. Key growth initiatives are scheduled to be more bullish here during our Investor Day scheduled for May 15 in New York City. Key growth initiatives may include research and development investment for projects related for launch in 2019 and 2020. Major new product line extensions into addressable markets in excess of $100 million in size, the first of which is expected to occur during the second half of 2018. As a reminder, Heska has been pursuing the urine sedimentation, urine chemistry, fecal testing, analyzer base single and multiplex measurement of unregulated substances and infectious disease detection as well as other product line extension. Growth initiatives may also include geographic expansion investments and initiatives outside the United States, which are anticipated to be meaningful and a significant opportunity and challenge for 2018 and 2019. We will host an Investor and Analyst Day in New York City on May 15 to update our baseline target for 2018 and to provide more details on our growth initiatives and their potential impacts for 2018 through 2022. At this point, we’d like to take the opportunity to open the call up for your questions. Operator?
- Operator:
- Thank you. [Operator Instructions] And our first question will heard from Mark Massaro with Canaccord Genuity.
- Mark Massaro:
- I guess the first one on the guidance for 2018. I just want to confirm Kevin that the 7% growth which you’re calling a baseline target does not assume contribution from new products or geographic expansion or new sales hires, is that correct?
- Kevin Wilson:
- That’s correct. The new sales hires will be in that plan and we’ll call that out for June through December, but the baseline the way I look at it is locking and tackling and running our current playbook domestically. So geographic expansion is outside of that, major analyzer additions are outside of that, and I would look at the sales force expansion as two things part of that is part of realizing are roughly 2% market share gain. And then part of that is, is an anticipation of growth initiatives. So, we were kind of have to do both of those things.
- Mark Massaro:
- So, it's reasonable to think the benefit of some new product launches that double-digit growth for 2018 is something that you think you might be able to achieve. Of course, I know that that's not in your baseline, but just for investors to get a sense of where the numbers may fall at the end of the year, double digit growth is something you probably could achieve, if you perform on your new product launches.
- Kevin Wilson:
- Yes, Mark I don't want to scramble the egg and I purposely unscramble the egg, by saying, look the baseline business is doing well. Consumables are good, profitability is good, gross margins are good. We're executing well. The macro market in the U.S. is good. There’re going to be some headwinds in OVP year-over-year. They're still doing fine, but that's -- when it's up 6.5% is got to normalize to a long-term trend of 3%, you'll have up years and you'll have down years. So what I'm trying to say is, is to make it easy on folks, if you kind of put the puts and takes into the mix you come up with a 7% baseline. And then on top of that, if we successfully launch a new product or do a geographical expansion, then yes, I think growth is an access of 7%. The question then becomes for folks like you to answer, that what time do, we do that, and how much does that affect the calendar year. Fortunately or unfortunately, I am not entirely calendar year driven, so if we get it right and it costs us two months of delay to get it right, I'm not that stressed about whether or not and growth comes in at 7% or 9% on 2018 and more, more focused on what is the three year plan look like and getting that right. So I'm not squirming on you a little bit, but I'm trying to be a little more precise to say baseline is 7%, if we get these step up events earlier, 2018 could be higher than that, if we get them later, they have less impact on the calendar year.
- Mark Massaro:
- Okay, that makes perfect sense. On the OVP segment, obviously you had a good year with 6.5% growth for 2017. The 2018 guidance, if I'm doing the math right is for a minus 13%. My understanding is that OVP typically would hover between maybe a 7% to 8% grower and a 3% grower. So can you just provide some context for why OVP you're expecting a decline of double digit?
- Kevin Wilson:
- Now, we look at that, the term we've used I think for years, even years before I even not here. So maybe decade has been inflationary grower. I moved away from that term because I'm not aware there’s been a lot of inflation in the last couple of years, but I didn't know that it was all that precise. But I think inflationary growers often been interpreted is about 3% growth. And so I think that's really been a trend line and it's lumpy. If the contract manufacturing business largely, so it is reliable and you know, generally what you're going to get for the year, you don't really know what you're going to get for each quarter, so it's lumpy because it's based on purchasing managers, at the contract manufacturing side, taking inventory to meet their needs and we simply produce and deliver on their schedule, not ours. So, no, I would look at that as a 3% long-term grower and so if it outperforms the 6.5% it's got to normalize with the down year, and I think that’s all we’re seeing. And then next year could be up again, a lot of it is just based on again trends of the people who buy the products out of that facility. So I think they’re doing a good job, they’re doing their job which is producing really quality stuff at USDA facility for folks like Elanco, Bear Merck and they’re doing a good job, but they don’t control the end user market and pull through and the timing of their inventory shipments as much as our other businesses.
- Mark Massaro:
- And last one from me on the Element DC5x congratulations on that, soon to be roll out. You indicated in the press release that this is a five patient sample, high throughput analyzer. Can you just maybe speak to where you see this fitting in an industry that has plenty of competition? So can you just speak to the value it has relative to some of the other, your existing platform as well as the competitive platforms in the market?
- Kevin Wilson:
- I am categorically is absolutely the gold standard in space. If you look at high volume users, which is the most coveted users for everybody, so it's call it three main competitors of which we’re one, we all covered the largest high volume users. And the largest high volume users will do lots of testing for things like pre-surgical testing. And so their morning if you go sit in a veterinary hospital that’s a specialty hospital, multi-doctor their morning is very, very busy and they’re trying to do pre-surgical panels before anesthesia. And they might have patient lined up in meeting each room ready for surgery and the faster they can run those things more the faster they can get their surgeries done and then faster than they can discharge those patients and get the next set through. It’s a big deal and I do think it will attract specialty hospitals both corporately owned specialty hospitals and individually owned specialty hospitals and having shown that when you get the top end users of the market, they are very, very happy with your accuracy and speed that, that kind of gives you a credibility halo to get that next group of customers that might be quite as large. So we think it’s a big deal, we think it definitely puts Heska at the top of the heat. Its dry chemistry technology from the inventor of dry chemistry technology, accurate it's precise, its faster than anything out there and I think large volume users are going to love it. So we’re excited about it, I think it’s a big deal.
- Operator:
- And next we’ll hear from Raymond Myers from Benchmark.
- Raymond Myers:
- Let me first pick up on that Element DC5x, it sounds really exciting gradually just for getting that out. I want to ask you about the revenue recognition for that. Is that primarily that customers will run more chemistries and therefore you get more throughput? Or is there any placement revenue that you make at the time of placement?
- Kevin Wilson:
- So, it's both, when we do a subscription there are multiple components for the subscription and there are number of options to doing that. So if you place a more expensive piece of equipment, you’ll have higher cost on that equipment and that placement. Now depending on the total value of the long-term contract, you’ll get an equipment portion of revenue booked a month that you place that. Some of the specialty hospitals on the other hand, we might place them at no minimum usage knowing that these are very, very large users and placing a $1500 a month minimum usage or $3000 a month minimum usage is what's really going to drive the usage. If we were to do that, it would actually fall under operating least accounting where you will get no upfront revenue for the equipment. All of which is to say in my mind doesn’t matter a whole lot, how we recognize the equipment portion of our placement. When I focus on market share gain, a number of veterinarian through themselves are growing diagnostic 7%, 8% that have agreed to put all of their dogs and cats let through our infrastructure and if I get the largest users to put the most amount of dogs and cats let through our infrastructure for six years and far or less concerned about the upfront revenue recognition. So I just cautioned focus that sometimes we can focus on what happened this month. The whole point of moving to a subscriptions model was to not focus on the upfront equipment sale portion, but the capture and grow and benefit with the veterinarian as they put dogs and cats let through our infrastructure for 6, 7, 8, 10 years that’s really the goal.
- David Westenberg:
- Let’s move on to your guidance that you’ll be increasing the sales force substantially in the second half of this year. It sounds exciting as well. Can you talk about what -- how you would deploy this additional sales force? What type of growth opportunities you see stemming from that? And what expense to be expected in the second half because I do believe your guidance was excluding the extra expense of some of these growth initiatives. So help understand how that flows through?
- Kevin Wilson:
- Yes, it is and I’m going to kick the can down the road a little bit to Investor and Analyst Day because there are a lot of moving parts in that question. So you have the flowing of the expense, you have the productivity of the new sales rep, layer on that the market share gain, and then layer on that any new product launches. And I think what we’re seeing by the expansion is, first of all we can use more density because we’re growing. And second of all we need more happy smiling trained enthusiastic faces in front of veterinarian because 9 of the 10 veterinarians still haven't converted from a competitor to Heska yet. So we need more people to go to talk to 9 out of 10 who still have something else that should hear our value proposition. And I think the third thing that we might be saying what that is, if we layer on a major new product launches the new segment, a new product area for us then we probably need more happy smiling enthusiastic faces to go tell 10 out of 10 veterinarians that don’t have Heska in that product area why they should. We’ll be a little more specific on the Investor Day about the financial impact and how to model that, but pretty difficult to do I think on a call with our PowerPoint slide or two.
- David Westenberg:
- We look forward to that, thanks. Can you give us any guidance around profitability? I understand that you’re making these investments that will be tremendously helpful over the next year or two. How should we think about the impact on profitability for 2018?
- John McMahon:
- Yes, and I think probably the same answer it will be a little more specific, all those moving parts I just listed, if you invest in sales force and something runs through the P&L, it hit the P&L. If you do a research and development investment just prior to launch, that might run through the P&L. That’s why I encourage investors to look at this business on a long-term trajectory and say two things. If the highest margin consumables are growing nicely and healthy, it's our job to deploy that growth and that gross margin and that profitability in other areas that are going to been drive high growth consumable margins over a multiyear period. And it's less our job, I think, to worry about a 90 day impacts of a particular spend, that could swing things for us. I do think we can do a better job on a go forward basis of communicating and anticipating some of those investments and matching them up with those swings. And so, we intend to get out a little bit ahead of those things again on May 15th on our Investor Day. And I think you'll have a little bit more to kind of fill out your model.
- Raymond Myers:
- Great, thanks Kevin. And last question is for Kathryn. What is the 2018 tax rate that you're assuming?
- Catherine Grassman:
- Candidly lower than the statutory and the state rates hovering around 20%.
- Operator:
- And next to move on to David Westenberg with C.L. King.
- David Westenberg:
- Hey, thanks for taking the question. I know you're trying to avoid the scrambling and unscrambling, but you know, I'm looking at the two year stock growth rate and you know, you ran at 11%, now you're going off an easy comp. So that's 7% growth rate that you're calling out as the base case. Now, would there be upside to that given the fact that we are kind of in a 2017 easy comp here?
- Kevin Wilson:
- Yes, I don't know that I want to go there. I think we were careful and we try to be reasonably precise in calling out 7% and I think we want to stay there. I'll leave it to investors and analysts to assume or presume whether we're going to be successful with a growth initiative in 2018. I think if we are, it could be, it could be better. I think if we're delayed it could be 7% and I know there's variability in there, but that's part of the reason we liked to play the game, as we’ll attention there and we'll try and make it much better and but we want to set the expectation at 7%. So that's what we've done.
- David Westenberg:
- Got it. I apologize. I know that was when you're trying to avoid. So anyway, I'm going to go on to some of the new product here. Can you talk about whether you're going to rely a little bit more on third-party or with this? You might take some of this in house. Can you talk about what the rationale would be, either take it in house or rely on the third party and what the impact would be both on the P&L from a revenue impact?
- Kevin Wilson:
- I mean, I can tell you what I've done in the past and how I think most of this is done in actuality, whether it's Heska or our competitors. For most of these analyzer based technologies with a couple of exceptions. We rely on third party partners who manufacture hardware and technology, and we do it with them to veterinarize it. I do think that some of these products we've been working on or maybe a little bit more tailor fit and customized to our needs, so we are spending a little bit more time. We think getting them right as opposed to just adapting things that are available on the human side, and I'd point to kind of urine sedimentation and chemistry space as an example we do think we can do some interesting things there. But we’re not going to announce that we purchase the plant in Shenzhen, China and we’re not manufacturing things directly. And I don’t think that’s inconsistent. I think Apple uses contract manufacturing as well. So, we won’t be spending 10s of millions of dollars on fabrication and things like that. Does that answer the question? I think that was the question.
- David Westenberg:
- You’re actually giving a little bit more, like I’m looking more about the impact on R&D on the P&L as you’re going to do these new products whether I don’t know for instance you’re talking about a year in sediment analyzer and I’m guessing that’s going to be something that you would have a third party OEM and manufacture to you and then maybe your R&D will just come in at the very end as your veternizing it. I’m just trying to get a handle on what the P&L might look like as you’re launching these new products, and keeping in mind I know a lot of this is coming in the Analyst Day if you want to get vague, that’s purposely fine with me. I’m just trying to understand what these new products are going to be in terms of impact on P&L?
- Kevin Wilson:
- I think you’ve got it in terms of concept. Again the reason, we called out kind of a base case for our 2018 target and then we got the growth initiative to offer the size is, there is nice symmetry there and I think investors would then be able to say, okay there is an investment here that may or may not run through P&L, but here is exactly the size of the market, here is the opportunity, here is the margin, here is the step up event. And I think having that symmetry just off to the side where you can evaluate that as a project base as opposed to having it embedded in your 2018 base target is helpful to investors. So, we tend to want to focus on May 15th on some of the growth initiative as standalone evaluation as opposed to again back to scrambling the egg where we’re trying to avoid scrambling the egg.
- David Westenberg:
- And you touched on in prior calls about winning more consolidated practices, now you have a new really high throughput instrument. You called out that this is going to be for a large web practices. Now, would this have maybe some upside opportunity to win maybe some consolidated practices that also have maybe consolidated in the same region? Just give us maybe a way to think about some of the upside with this new product and new kind of customers that maybe traditional you haven’t been able to get in the past?
- Kevin Wilson:
- So, I would start with and not pridefully, but I would say we have been able to get them in the past. The way we got the PetVet Care Centers contract was, they're two largest specialty facilities with millions of dollars in revenue had already converted to Heska from our competitors, prior to being acquired by PetVet Care Centers. And when PetVet Care Centers acquire those very, very large hospitals and again top 5% type of hospitals in the country in terms of volume and size. And they looked at the performance of diagnostics and they're smart folks I know that diagnostics may represent 20% of the business that they just acquired. There question was why is diagnostic so much better in these two very large hospitals than the rest of our portfolio, and so the picked up the phone and said, why your diagnostic so much better than rest of our portfolio and the answer is, yes, we move to Heska we think it’s great, equipment is great. I think the Element DC5 just enhances that ability whether it’s a corporately owned contract we’re trying to win or whether it’s a standalone very large hospital that some day we can’t corporately owned or stayed standalone I think you’d have to put us on the leadership position it’s throughput and ease of use, it’s speed and dry chemistry accuracy is your punch list of things that you’re looking for. I think we have to be the leader in that evaluation so I think it's big deal.
- Operator:
- And next we move on to Kara Anderson with B. Riley FBR.
- Kara Anderson:
- So with the new equine products released in the quarter that were believed to have caused delays in sales in the third quarter. Can you provide more color on what you believe is the key reason for the imaging under performance in Q4? And was it really further delayed in your investment? And second to that question is, for imaging to be up 10% for the full year does that require acceleration from what you’re seeing in January and February?
- Kevin Wilson:
- So I'll take in reverse order, it does not require an acceleration from what we’re seeing in January and February. So there is a nice start to the year that I think just confirms what we’re thinking for the full year. In terms of the fourth quarter launch, the Slate Hub product and those accessories launch I think on November 14th and then when you back in the Thanksgiving and then when you back in the Christmas, you back in the New Year, you don’t really have an awful lot of selling days led alone and off to shipping days. And so I think the team did a really good job. They also from a profitability standpoint, we don’t look at it on a product line or unit based profitability, but they generated and off a lot of contribution margin for the fourth quarter. The prior year’s fourth quarter was just really good and the fourth quarter for 2017, I think was profitable and the folks did a very good job. So all of which is to say I think the imaging is integrated. We had to focus on integrating that business from June 1st through December, and I think is largely integrated and I think gross margins for the fourth quarter were good, the product launch went very well. I think the accessory will start to layer on which are kind of additive revenues. We never had those accessories that are new with Slate Hub. There is a little bit of tailwind there. They got the service revenue and there just a number of reasons why we’re pretty optimistic that it backed on the solid footing and back doing 10% grower.
- Kara Anderson:
- And then second and last one from me and I’m sorry if I missed it. Did you talk about the reformulated heartworm test that was slated for 1Q?
- Kevin Wilson:
- We didn’t and I think it’s actually slated for the first half, so I’m going to get a little squishy on that, but I don’t think it’s not a 1Q. So optimistic it is the first half. We will push very hard I think heartworm season is coming out into full swing and we’d like to be on market. I will point out those that I don’t want to put that into context so that’s a nice additive but it’s not really poor to really our growth plans going forward. That heartworm franchise was maybe a $10 million franchise 2012 and it shrunk now to just under $2 million. So if you look at that and gives a straight line that maybe it's going backwards $2 million a year for the last couple of years, it's just been a headwind. But it's already under $2 million. So even if we did nothing, it would be pretty difficult to lose more than $2 million because it's already under $2 million, so there's not a lot of downside in that. And so, I do think on a go forward basis, when that new reformulation comes to market, at much better gross margin, which means much better end user pricing. I think the differentiation between multiplexing tests to do four tests as opposed to a heartworm test, which I think is still a very popular segment. I think that slightly under $2 million franchise probably goes back to growth. But again, we're still in USDA regulatory, we're still in acquiring samples to get that. That's, that continues to be the delay. I'm still optimistic that we might get that in the first half.
- Operator:
- And our next question we'll hear from him Jim Sidoti and Sidoti & Company.
- Jim Sidoti:
- So, I understand you are a little bit hesitant to giving too much detail ahead of your Investor Day, but just on a high level basis. I think what you're saying is we should assume that operating margin will decline or will not increase in 2018, the way they it did in 2017 because there's some of these increased investments in sales and marketing. Is that right?
- Kevin Wilson:
- I think that's fair. I think that's fair. And we haven't been living in precise on that. But it will be more precise on it on investor day, but even then it's, spreadsheets are very precise, they might not be very accurate. So there's still a human factor here. You still have to recruit people in June and July and August, September, and then you have to roll things out and you can't control all those human factors. And I pointed out in the past, we are still of a size where those human factors can move things on a 30 to 90 day basis, that aren't really trends, they are just a function of the fact that we're still of a size that you can do better on a 30 or 90 day and you get a positive swing or you can have that human factor that delays things or costing a little bit higher in terms of expense for 30 or 90 day period and you have a negative swing. And so, I just caution folks to not extrapolate that forward. Strategy in the long term benefits of a three year roll out are far more important than trying to nail whether or not it's, X basis points or Y basis points in terms of operating margin.
- Jim Sidoti:
- And I assume over the three year plan, net operating margins will improve.
- Kevin Wilson:
- Yes, I think so. I, no past performance is no guarantee of future performance disclaimer, but I recall when we started our work in early 2014, we were under 10%, maybe 8% operating margin. I think we've finished this year at 14%, so we've picked up about 200 to 250 basis points in most years that I've been here. I don't think there's anything miraculous that would cause that to stop on a long term basis, but I would just caution folks that a quarter doesn't make a, doesn't make a trend. So we've taken it from 8% to 14%, we had a high watermark of 19% and change in the fourth quarter, so every year we have a high watermark in the fourth quarter that's higher than last year's high watermark and then we drift towards that and I think I've said publicly for a couple of years that I do see our long-term operating margins drifting up towards where our bigger competitors are and I still see that to be the case.
- Jim Sidoti:
- Okay. And then the last question I just want to confirm from Catherine said. Did you say the GAAP tax rate maintained will be around 20%?
- Kevin Wilson:
- Yes.
- Operator:
- We’ll move on to Ben Haynor with Aegis Capital.
- Ben Haynor:
- Just a couple of quick ones from me on the growing from 85 to 106 sales in sales flash utilization people -- how does that, is that all first off is that all domestically and then how does it check out is it adding a dozen now territories and a dozen new utilization people at land loss territories was both a dozen new sales people. Or how do you think about that or how should we think about that?
- Kevin Wilson:
- Yes, so we have blood diagnostic laboratory folks, we have imaging folks, we have some that have been piloting a dual role where they carry the entire point of care diagnostics offering and then we’ve divided in the regional manager territories and each of those territories is expanding. And actually has been expanding for sometime I think we’re just a little quieter about it. We wouldn’t have called this out because there is a step up. I think just been anticipation of maybe some new products that are going to require more happy smiley faces telling veterinarians about why patients switch to ask us. So I would just think its more, we’re not revolutionizing the sales force, we’re just increasing the density and we sort of open territories literally where it's just playing too much geography for a human being that cover all the clinics in the territory. So for us finding points of expansion without pinching high performers is I think easier than it is for folks to have higher density already.
- Ben Haynor:
- Okay, that’s helpful. And then you called out you expect 350 to 475 new customer wins, which sounds pretty similar to kind of what you’ve been running at in the past couple of few years after you had taken out the corporate accounts. Do you -- in that 350 to 475, do you assume that there are some corporate accounts in there that maybe the new DC5 helps you win or doesn’t that really factor into that number.
- Kevin Wilson:
- No we do assume that there are corporate wins in that number, and I do think the DC5 will help us with the specific corporate accounts that we’ve been working to convince. But it's competitive. You know the other guys might decide to put 5 analyzers on the calendar so they have a DC52. I don’t know. Its competitive, but I think we were just confirming maybe with a number as opposed to a percentage to try and get some contacts, you know people here 1.5 to 2%, they may not be worth just how many hospitals that is. So I just try to put a number on it, that’s really the only change in my script.
- Operator:
- And next we move on to Andrew Cooper with Raymond James.
- Andrew Cooper:
- Hey guys thanks for taking the question. a lot have been already answered, so I’ll keep it kind of brief her but higher level and we think back to when international imaging was kind of broadening and what the approach was to do graphic expansion. It feels like now is pushed out further then I think you would initially expected is more of the outside growth initiatives. But you see just give us some color on kind of what's been different on that relative to initial thoughts and kind of you’re looking to approach it project and anything there will be helpful please?
- Kevin Wilson:
- You’re welcome. That’s a good question. International is the hugely important growth initiative for us, and if I go back in preparation for the call and I read the transcript and I look at the last couple and this is a continuation of the work we’ve been doing for year and half now. But I think we’re solved in for 20 year problem in terms of logistics in terms of infrastructure in terms of liege, we would like to establish a structure that is competitive with the largest competitors much more than we’d like to have the tiny beachhead somewhere that just improve this year results. So we’ve been focused on I think a little bit more longer term with maybe a little bit bigger of an appetite. We have that progressed. We spend a lot of time on this particular issue. Recently, we had entered into a letter of intent that quantifies some of that progress for an expansion. And so, it does look like it pushed out, but we do think there will be some success here in 2018. We’re not at this point now where we want to call it out year end in February 28th, but we do think we’re getting close to being able to launch in a bigger way.
- Operator:
- And that will conclude today’s question-and-answer session. At this time, I'd like to turn the call back over to management for any additional or closing remarks.
- Kevin Wilson:
- Thank you operator and thanks to all the investors and analysts who called in. Just leave you with a couple of my thoughts. The value creating work that we’ve done in 2017 has positioned us I think very well for the next several years and 2017 was uncharacteristically quiet on major step of events, but our pipeline of major opportunities has never been this large, broad, healthy alright. Our first act from 2013 to 2017 that period rewarded us primarily from improving our base business and I think we have achieved that. I think our second act from 2018 to 2022 holds more value creating opportunity and reward than our first act and in that new period we’re going to focus on broadening our product and expanding geographically. I’m fully aware of the strength and the size of our competitors and the difficulty of the goals that we have, but I’m placing my confidence in Heska to win in this next act from 2018 to 2022, and I’m super encouraged that we have well informed the industry partners and the long-term investors who joined me in my optimism that we can accomplish these things. So I look forward to updating everybody on May 15th during our Investor Day on our progress and with more details on this optimism and our plans and we’ll see you soon. Thanks. Bye bye.
- Operator:
- And that will conclude today's call. We thank you for your participation.
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