Heska Corporation
Q1 2016 Earnings Call Transcript

Published: 3 May 2016

[Operator:]

Good day, and welcome to the Heska Corporation First Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jeff Stanlis with Hayden IR. Please go ahead, sir.

[Jeff Stanlis:]

Thank you. Hello, and welcome to Heska Corporation's earnings call for the first quarter of 2016. I am Jeff Stanlis of Hayden IR, Heska's Investor Relations Firm. Prior to discussing Heska Corporation's first quarter 2016 financial results, I'd like to remind you that during the course of this call, we may make 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 intentions to update any forward-looking statements to reflect events that occur after the time such statements were made. With that said, we have with this morning with us Kevin Wilson, Heska's Chief Executive Officer and President; and Jason Napolitano, Heska's Chief Operating Officer and Chief Financial Officer. Mr. Wilson will begin with the summary of results we reported today. Following further comments by Mr. Napolitano and Mr. Wilson, we'll open up the call for your questions followed by Mr. Wilson's closing comments. Now, I would like to turn the call over to Kevin Wilson, Heska's Chief Executive Officer and President.

[Kevin Wilson:]

Thanks Jeff. Heska had a great first quarter. In fact, it was a record quarter. Compared to 2015, revenue was up 19%; operating income was up 93%; and net income was up 98% to $1.2 million, or $0.17 per diluted share. Virtually every area of Heska performed well in the first quarter. Our Vaccines and Pharmaceutical segment entered the year facing temporary headwinds but performed better-than-expected and they did a great job. Digital imaging continued to see super demand from large hospitals for stand-alone imaging solutions and for bundles of imaging and blood diagnostics, which propelled them to a 44.5% gain. In allergy, Heska Allercept continued to impress with great results in a space that’s been lifted by substantial attention from industry giants, who have increased awareness amongst veterinarians and families with pets that suffer from skin allergies. And in blood analyzers and consumables, Heska was up 25.8%. Encouragingly, the great majority of new analyzer customers in the first quarter were new to Heska in the segment. In chemistry devices for instance, our internal reports indicate the new customers were 71% of placements in the period, and that over 70% of them were medium, large, or very large customers. All of which is to say that the number of customers enrolled in our multi-year blood testing and consumables agreements continues to grow nicely. The source of these customers appears to be from market share gains; and the size and quality of our newest customers is excellent. The blood diagnostics team is doing a fantastic job. We continued to see positive signs specific to Heska and also industry-wide. The overall veterinary market is robust. Our partners are strong. Our analyzer consumables continue to track well. We are gaining market share. Profits are up nicely, and our development projects are on track. Now I'll turn the call over to Jason Napolitano, our Chief Operating and Financial Officer, to detail the quarter's financial results. At the conclusion of Jason's remarks, I'll return for few comments and then we'll open up the call to questions. Jason?

[Jason Napolitano:]

Thank you, Kevin. We’re once again very pleased to report strong quarterly results. Total revenue for the first quarter of 2016 was $27.1 million, a 19% increase as compared to $22.9 million in the prior-year period. Revenue in our Core Companion Animal Health segment, or CCA, was $23.4 million for the first quarter of 2016, an increase of 20% compared to $19.6 million in the prior-year period. Key factors in the improvement were strong revenue performance from imaging products, blood analyzer consumables and our hematology instruments. Blood analyzer consumables and instruments generated $11.4 million in revenue, an increase of 25.8% as compared to $9 million in the first quarter of 2015. Our 54.6% owned subsidiary, Heska Imaging US, LLC, which I will refer to as Heska Imaging, generated $6.1 million in revenue, an increase of 44.5% as compared to $4.2 million in the first quarter of 2015. Revenue in our Other Vaccines, Pharmaceuticals and Products segments, or OVP, was $3.7 million, as compared to $3.3 million in the prior-year period, a 12% increase. Revenue from Reproductive Product, a new product by one of our customers, somewhat offset by lower sales of cattle vaccines for international distribution were key factors in the improvement. Gross margin, that is gross profit divided by revenue, was 42.1% in the first quarter of 2016, a slight decline compared to 44% in the first quarter of 2015. A key factor in the decline was lower gross margin in our OVP segment due to product mix. We incurred $9.5 million in operating expenses in the first quarter of 2016, a 5% increase from $9.1 million in the prior-year period, which represents a nice decline in terms of percentage of revenue. Greater sales and marketing expenses related to the success we enjoyed in our imaging products, increased development spending related to our imaging products and greater legal expenses were factors in the increase in each of the operating expense line items. Depreciation and amortization was $1.1 million in the first quarter of 2016, compared to $1 million in the first quarter of 2015. Stock-based compensation was $527,000 in the first quarter of 2016, as compared to $398,000 in the prior-year period. We generated operating income of $2 million in the first quarter of 2016, nearly doubled the $1 million result we achieved in the prior-year period. We also generated $133,000 in other income in the first quarter of 2016, primarily related to a third-party purchase of demutualized insurance company stock to which we were entitled. This compares to an expense of $137,000 in the first quarter of 2015, primarily related to currency losses. Net income attributable to Heska Corporation was $1.2 million, or $0.17 per diluted share, in the first quarter of 2016, as compared to $598,000 or $0.09 per diluted share in the first quarter of 2015. A note that net income results include deferred tax expense, which is a non-cash accounting charge, primarily related to the usage of our large domestic net operating loss position. We recognized $582,000 in deferred tax expense or $0.08 per diluted share in the first quarter of 2016, as compared to $257,000 or $0.04 per diluted share in the prior-year period. These quarterly results are substantially stronger than we had anticipated. Along with positive general timing variations, several factors contributed to the stronger than anticipated results. First, Heska Imaging had a stronger-than-expected second half of the quarter performance, for an increase in revenue of $1.9 million over the prior year. We believe this is indicating of the future performance in imaging and expect a strong year from Heska Imaging with revenue over $25 million and operating income of roughly $3 million. Second, in analogy, we had been concerned about the result of new allergy drug treatments hitting the market to compete with our immunotherapy. Despite the new competition, we were still able to grow our allergy business in the first quarter of 2016. Third, we benefited from continued strength in our relationship with Henry Schein. We received an order in the first quarter of 2016, which exceeded our expectation by roughly $1 million. Fourth, in our OVP segment, we were able to ship approximately $400,000 in revenue prior to quarter-end that we previously expected to ship early in the second quarter. As a matter of policy, we generally ship product as soon as possible. We also experienced a strong close to the quarter with some of our other costs. We continue to be excited by what these early year results could mean for our future. Last month, we mailed definitive proxy statement to our stockholders proposing the authorized share increase required to close our acquisition of Cuattro Veterinary, LLC, which I will refer to as Cuattro International. We have been pleased with the response we have seen so far with over 99% of the proxy vote we have received to-date in favor of this share increase. Under Delaware law, the positive vote of an absolute majority of shares outstanding is required to pass the share increase. I encourage any of our stockholders who have not yet indicated their voting preferences on our proxy matters to do so. We anticipate the share increase required to close our acquisition of Cuattro International will pass and we expect this acquisition to be effective at the end of this month. On our last earnings call, we discussed the potential regulatory investment we were considering, which could substantially expand our lateral flow test menu. We continue to investigate and negotiate with third-parties on this matter. Although no final decision has been made, we believe it is likely we will pursue this regulatory investment and we will spend approximately $2 million on it in 2016, primarily later in the year. Although we expect our company will continue to trend away from specific financial guidance, given the complication this potential regulatory investment introduces, we are going to comment more specifically on our financial outlook for 2016 now. We estimate our 2016 revenue will be over $120 million, including approximately $3.5 million from Cuattro International, after this acquisition closes at the end of May. We still expect gross margin to be lower than in 2015 due to product mix in our OVP segment, perhaps on the order of 0.5 percentage point to a percentage point. Absent the prior mentioned potential regulatory investment to expand our lateral flow test menu, we anticipate generating around $12 million in 2016 operating income, $1 million improvement as compared to the metric we shared with you on our last call. In summary, we are proud of our first quarter 2016 successes and look to build on them for the rest of the year and beyond. With that, I'll turn it back over to you Kevin.

[Kevin Wilson:]

Thanks, Jason. While we are always working hard on many fronts and in all segments of our business, I wanted to take a few moments this morning to focus on two initiatives from our blood analyzer business that have been particularly important achievement. The first is our successful transition to a multi-year subscription style model call Heska Reset. And the second is our full product refresh. We began the Heska Reset trial model in 2013 and widely launched it in 2014. Under the Heska Reset program, we largely forgo the traditional upfront payment for analyzer at the point of shipment, in part, because we believe it's an antiquated barrier to doing more beneficial business with our customers. Now rather replace the analyzer for free, warrantee the analyzer for free, offer superior pricing on tests and pre-arrange price protections for the Heska Reset term. In exchange for this, customers enrolled for five or more years to get the best technology, super flexibility and test selection, substantially lower test pricing, lower monthly minimums, automated billing, and the Heska Reset program’s lowest pricing on test in excess of the monthly commitment. This lower barrier, lower friction fair model is increasingly what distributor partners and veterinarians sprinter. Approximately 70% of Heska’s roughly 2,250 regularly active blood analyzer customers have enrolled in our multi-year programs for over $60 million in minimum testing over five or more years. The benefits to having reached its critical adoption mass are numerous, including significant long-term momentum and visibility for Heska and our partners, unrivaled value for veterinarians, installed base stability from which to grow and extend enrolments, and lower transactional costs and barriers to doing business with Heska. It's hard for established companies to fully embrace the benefits of a long-term subscription-style model and to make the transition away from recognizing large revenue and profits at the point of each capital equipment shipment. I'm extremely proud of Heska for making this shift so quickly and so successfully, and I believe they having done so, will prove to be a long lasting island of strength that is somewhat unique to Heska in the market. To attract Heska Reset enrolments and to expand and extend our current subscribers’ packages, we've also totally refreshed the Heska blood diagnostics analyzer line. Today, our product offering is a newest line up in the industry and we believe that we have the best family of technology, tests and programs available anywhere in the market. In the past two years, we've added the new Element POC blood gas and electrolyte platform, launched the new Element HT5, five-part laser, and impedance hematology platform and fully refreshed are Element DC dry chemistry offering. At the end of 2015, we announced the release of our new Element i immunodiagnostics platform, which is the industry's only point of care T4, TSH, and Cortisol solution. Our commercial release in the first quarter of 2016 has gone extremely well, and we’ve delighted customers with Heska’s exclusive capability in this area. With over 300 analyzers sold and 200 delivered, we're working hard to meet all the demand for this one-of-the-kind platform. With each new product addition, whether a new blood analyzer platform, a digital imaging solution or totally new Heska segment offering, our model is to revisit our existing Heska Reset customers with opportunities to extend and to add to their ongoing Heska relationship. In most cases, customers that upgrade or add new analyzers also renew and extend their current Heska Reset subscription term for another 60 months or more at the same time. This supports our goal of lifetime engagement with each customer through Heska Reset. If we do our jobs well, we can spend less money and time on customer acquisition and frictional transaction costs, and more time and resources on delighting customers with new offers, new products, and an ever expanding relationship with Heska. We will continue to work hard to do our jobs well, and we are gratified for your interest in our progress as we do so. Now we'd like to invite you and/or line for your questions.

[Operator:]

[Operator Instructions] And we’ll go first to the side of Nick Jansen. Please go ahead.

[Nicholas Jansen:]

Hey guys. Great quarter. Just a little bit more detail on the strength. It looks pretty broad-based and you kind of raised your ‘16 guidance, it appears by the level of success in 1Q. But just wanted to get your thoughts on some of the sustainability of these trends, some of the ordering patterns that might have surprised you in the quarter? Are those a pull-forward from 2Q to 1Q, and how we should be thinking about the near-term set-up and context of what was a very strong quarter?

[Jason Napolitano:]

Yes, Nick. Thanks for the comments. I think mostly it's indicative of just the strength of the product line. The Des Moines revenue was a pull-through, a pull-forward for sure where we about $400,000 we thought should ship Q2 that ended up shipping - we managed to get it out by the end of Q1. May be some of the Henry Schein was a little bit of a timing question. It's always hard to say because they are ordering pretty frequently. But mostly I think the business is just going better than we had anticipated last time we talked.

[Nicholas Jansen:]

And then on imaging, the 44.5% year-over-year growth, usually it steps down more significantly sequentially because 4Q is usually a strong capital sales quarter and 1Q less so. What are you seeing there? What's driving that level of success? Is it the bundled offering, is it the advanced solutions on the cloud-based technology, any thoughts there? Certainly over $25 million of revenue you guys are guiding to for ‘16, certainly suggests continued momentum. Just wanted to get your broader thoughts there?

[Kevin Wilson:]

Well, I love your answer. It was great momentum and bundling. The teams are doing great job. There is just more visibility. It's part of what you want when you have a very focused imaging team that works with a very focused blood diagnostics team and the story fits. So when any patient, whether it's a pet or a human goes into see the doctor, pretty commonly say, well, let's take an x-ray and get some blood work. And it makes an awful lot of sense to really fine-tune the sales organizations to do the same, and that seems to be working. So I think it's a number of things. I think we gained share. I think new product launches at the end of the year just creates a lot of good visibility, so just across the board. And I would just say it's probably just good old-fashion hard work. There is just a lot of sales calls and a lot of hard work and they had a great quarter.

[Nicholas Jansen:]

That's helpful. And I think before you had a thought that the imaging business might exercise their option after the end of this year. Clearly it looks like they might be performing better than what you had originally anticipated. Is it still the expectation that the option will be exercised in the first quarter of next year, or should we think about that changing now given the improved business momentum?

[Jason Napolitano:]

I suspect it will be exercised at the end of this year. Yes.

[Kevin Wilson:]

I mean, anything, Nick, from my chair, I think strength like this and the improved outlook, I think it’s - if anything more likely than I thought it was the last time we spoke.

[Nicholas Jansen:]

Okay, that's helpful. And then on the $2 million R&D investment tied to the product registrations for the lateral flow rapid assays. Just wanted to kind of get your thoughts on the conversations that you're having right now with your partners. Will that $2 million be spent for the entire year, or is some of that could be leaked into 1Q? How do we think about the launch timing there and your ability to tackle this $200 million type market opportunity?

[Kevin Wilson:]

Yes. I think as we said in the prepared remarks, Nick, we continue to negotiate with some providers on this. It's definitely possible that you see some of that $2 million leak into 2017 assuming we are going to move forward in all of this the sooner the better, but sometimes just the required timing, certain things are gating items. You’ve got a certain path you’ve got to follow. Sometimes that will cause delays. So as we said, that spend should be more in the second half of the year, and I wouldn't be surprised if some of it did leak into 2017.

[Jason Napolitano:]

Yes, and just a clarification, to the providers that we're working with, it’s for regulatory approval. So there are massive amounts of documentation that have to be moved around. And so organizing that and then getting regulators to do inspections and those types of things, sometimes those things are beyond the control of the team and that really dictates the calendar in terms of the spend. If everybody could raise their hands, say we can get the paperwork and the regulator there to do what they need to do tomorrow, we would spend it tomorrow. But in some respects, that calendar is really not entirely within our control.

[Nicholas Jansen:]

Got it. And then last one for me. I appreciate the color regarding full-year ‘16 expectations. I acknowledge that you don't want to update ‘17 stuff every time you report on ‘16 because you did give some color on ‘17 last quarter. But just in terms of your thoughts on the business today where you stand, there is nothing that you see that would kind of be any sort of gating factors to the momentum heading into ‘17 relative to those prior expectations? Thanks.

[Jason Napolitano:]

For sure. I think on a macro basis, I think I pointed out that the entire community is healthy. The hospital providers are healthy. The reference lab folks are healthy. Veterinarian visits are up. Most surveys show that veterinarians are healthy and growing and pet ownership is moving in the right direction. So I think part of it is the rising tides lifting all boats and that's a great thing. We don't really see anything indicate that trend is going to reverse. And then of course the momentum specific to Heska is, I think, very much in place as well, so we like what's happening.

[Kevin Wilson:]

I think from my chair, Nick, if anything, I think the outlook for 2017 is even shinier than it was the last time we spoke.

[Nicholas Jansen:]

I would agree. Thanks guys. Nice job.

[Operator:]

[Operator Instructions] We’ll go next to the side of Brett [ph] Haynor. Please go ahead. Your line is open.

[Ben Haynor:]

They meant Ben. But congrats on the quarter guys and thanks for taking the questions.

[Kevin Wilson:]

Thanks Ben.

[Ben Haynor:]

Good deal. So, I guess, first for me, with the momentum that you seem to have, what needs to happen before you start thinking about adding new sales people? And then any color that you can provide on sales person productivity trends that you’ve seen over, call it, the last year or so?

[Kevin Wilson:]

Yes. So momentum is good and that means more customers needing more visits, and so we are aware of that. In large part, we work very closely with Henry Schein, in that regard. We will be adding sales people and we are in the process of doing that. If you recall, we really started this whole refresh, I guess, in probably second half of 2013. To just give you some very rough numbers, these are off the top of my head. But in 2013, I think the average sale per rep was under two analyzers per month, and I think that trend continued in 2014 as well. In 2015, I think it rose above two for the first time. And in 2016, I recall that we were about three for the first time ever. So the productivity per rep is certainly happening. And once you have something that's healthy, then you scale it. And so for us to scale back in 2013 I think was the wrong strategy. So we've got a lot of things right, got the narrative right, fully retrain the entire sales force and aligned it with the marketing. The addition of the Henry Schein folks I think make the trip more effective as well. So we are in the process of adding - but we'll add slowly. And I think I said in the past too that we won't do mass hiring. We’ll add strategically. We’ll hire one quality person at a time to show geography that clearly needs additional tension. And so that's really more of our strategy. Some of our larger competitors may have the luxury of adding 50 people or something kind of big and impressive, but that's really not the path that we are on. We are going to be more one, two at a time and make sure that they are successful. I hope that answers the question.

[Ben Haynor:]

That’s very helpful. And then on the - can you talk a little bit about consumable volumes and then the 70% or above of your count base that have signed up for the Reset program versus the 30% who haven't? Are they pretty comparable, or the Reset accounts meaningfully higher or lower, and also do they tend to be larger practices than the 30%?

[Kevin Wilson:]

And again this is just general color, but the mix is not materially different between large, medium and small, whether they are Reset or the direct. What I would point out is when we started in 2013, we effectively had 0% on an enrolled subscription. And so what you're seeing is you're seeing a decade worth of installed base having moved over to a subscription model in the last two, 2.5 years. So that 70% - the 30% that remains, a vast majority of those are legacy customers that were in place prior to the launch of subscription agreement. Many of those are very, very happy just continuing doing exactly what they’ve being doing or they have other reasons to not make that enrollment. What's also encouraging is as we move forward - for instance, in the last period, we were roughly 70% new customers. So as we go out into the market in our current base remains healthy on a subscription models. We go out and we add 70% new customers to that base and then we expect to see that percentage tick-up necessarily because virtually all of our ongoing sales and our entire focus is really on the subscription model, not the older sell the box and get the consumables overtime model.

[Ben Haynor:]

Got it. That makes sense. And then, lastly for me. I noticed one of your larger competitors reported a very strong international quarter. I know you guys have mentioned attacking that market in the past and you’ve got the Cuattro International acquisition hopefully closing before the end of the month. What does seeing performance like that make you think of the opportunities that you might have internationally?

[Kevin Wilson:]

It gets us excited. We like to compete, and in the areas that we compete geographically I think we are showing that we compete very well and we think that as we expand that geography and we complete the acquisition of the international imaging business and we move similar business model to primarily Western European countries, Scandinavia, places like that, we think we'll have some more success competing. And we applaud them. They appear to be doing a great job, and they certainly validate it. There is very nice market over there and we are excited to go compete with them and do our best to take some share.

[Ben Haynor:]

Great. That's all I have. Thank you very much gentlemen.

[Kevin Wilson:]

Thanks a bunch.

[Jason Napolitano:]

Thanks Ben.

[Operator:]

[Operator Instructions] And we’ll take our next question from the side of David Westenberg. Please go ahead.

[David Westenberg:]

Guys, thanks for taking my question and congrats on a very good quarter.

[Kevin Wilson:]

Thanks David.

[David Westenberg:]

So one of your competitors reported just growth of about 4%. The other one had consumable growth in North America, they said, I think in the high-single digits. Historically these numbers - in a historical perspective, it seems kind of low, particularly when you're talking about what you saw in visits from say, DCA [ph]. I know you don't breakout consumables but perhaps can you put maybe what you saw in this really strong blood growth in kind of perspective in how you were able to really - it seems like beyond the competitors, your growth there?

[Kevin Wilson:]

Can you put that in perspective?

[Jason Napolitano:]

Yes. It’s about what we would expect. We don't break it out and we won't in large measure because we think ultimately what we are focused on and what we are measured on is the actual earnings release and how we are doing financially. That said, we think that as we gain market share, and we believe that we are, that it makes sense to see consumable pull-through. We think we have pretty good visibility when customers are signed up for over $60 million in consumables over the next five years. That gives us a nice platform, a nice baseline. And in terms of just monthly and quarterly lumpiness, I really can't speak to that. I have no idea if they were timing issues with the competitors, but I can't really speak to their results. We didn't see anything out of the ordinary or abnormal aside from what we called out. There is always timing issues with stocking with Henry Schein and we assume that they align their warehouse stocking needs with what the customer are ordering from them and they have hundreds of reps and clinics every day saying here is what we need and we think they are pretty good at that. So no, we didn't really see anything out of the ordinary.

[David Westenberg:]

Got it. Thanks. And then I believe Henry Schein actually had their sales meeting for the year recently. Can you talk about maybe they probably set goals for Heska. Can you talk about where they were compared to last year, and if you were pretty pleased with Henry Schein’s new goals for the year?

[Kevin Wilson:]

Yes, I don’t know. I was at that sales meeting and it's great. I mean, they are an impressive organization. They do a great job. Their North American vet leadership has been fantastic to work with. In terms of hard numbers, it's not a quota by another name. I think they are just focused on getting their customers what they want. And I think if Heska does a good job and continues to grow I think for demonstrating that customers want the Heska Reset program, they like the subscription agreement, they like not having barriers to entry to doing business with us. They like not paying $10,000 for the privilege of using consumables for years, and the Henry Schein folks, they advocate for their customers, and they advocate the best solution for their customers. And so I think in general it’s just really more about optimizing that training, servicing their needs, being responsive, and let them do their job and that's what's happening. So I think that's more the flavor as opposed to let's sit down and have hard core negotiations about what everybody must do. It's a nice relationship where they are performing very well, because they want to, and we are performing very well because we want them to. So I hope that answers the question.

[David Westenberg:]

Great. And then, of the 2,250 customers that you quoted, that's having at least one of your chemistry, hematology or hand-holder analyzers. Is that correct?

[Kevin Wilson:]

That’s correct. I would say the vast, vast majority of those have a family of our analyzers.

[David Westenberg:]

Okay. All right. That’s very, very helpful. And then just continuation of the last questions. You’ve now had the Reset for two years and you’ve had the chance to review the sort of what you see in year one and then year two. Do you have any visibility about how the utilization rate changes in year two as opposed to the first year under the Reset program?

[Kevin Wilson:]

The year-over-year stuff really hasn't shown variation. They have minimum needs and they have testing needs in their clinic. If we do a good job, we increase their point of care testing because we are faster and we are cost competitive with the reference lab. So we do see cases where people grow their in-clinic. But yes, just in terms of being on a subscription, I don't know that it's fundamentally changing their behavior in terms of monthly test usage.

[David Westenberg:]

Great. Thanks for taking my questions. Appreciate it.

[Kevin Wilson:]

Okay. Thank you.

[Operator:]

And we’ll next to the side of Kara Anderson. Please go ahead.

[Kara Anderson:]

Hi, good morning. Thanks for taking my questions. Just a follow-up on the previous question about the international opportunity. How soon do you think you might be able to scale your business internationally and products beyond the offerings from Cuattro Vet?

[Kevin Wilson:]

I think it's definitely going to be a process. I'll give you more of a philosophy answer. We tend to pilot things. We make them healthy. We optimize them, we iterate and then the scale. And so what I would anticipate is I would anticipate a very targeted approach in a very friendly market with a very strong partner. We’ll optimize that for a number of quarters and then we'll start to scale it in markets to demonstrate the same characteristics, all of which is to say I doubt very much it’s in our culture to just drop it in and try and do a mega deal with somebody and hope for the best. So I would expect that to scale over time, which is why we don't have massive baked in growth based on those types of things until they are proven.

[Kara Anderson:]

Okay, great. And then on the Element i, was there any portion of the better-than-expected demand behind the quarter’s revenue outperformance?

[Kevin Wilson:]

Not really because I want to say nearly 100% of those were done under a Reset agreements, meaning customers signed up for five years because they want to do T4, TSH and Cortisol testing and we shipped them an analyzer, and they committed using a certain amount of tests over a period of time. So I wouldn't say our new product offerings tend to give us immediate quarter spikes which is one of the things I like about the model. It's also one of the things that makes it very difficult for companies transition to. So no, just in terms of the quarter be [ph], I don't think the Element i really meaningful impact in terms of the quarter revenue.

[Kara Anderson:]

Okay. And then lastly, can you talk about the competitive options out there for the Element i?

[Kevin Wilson:]

In terms of TSH, I don't believe there are point of care competitors, and so if you're looking for confirmation on hypothyroidism, which is a very common disease, T4 will give you a basic indicator, but TSH is generally acknowledged to be required to conform what's going on. So I think right now the reference lab would be the only option.

[Kara Anderson:]

Okay, great. Thank you.

[Kevin Wilson:]

You’re welcome. Thanks.

[Operator:]

[Operator Instructions] We’ll go next to line of the Jenny Tsai [ph]. Please go ahead.

[Unidentified Analyst:]

Hi, your OVP - good morning, guys.

[Kevin Wilson:]

Good morning, Jenny [ph].

[Unidentified Analyst:]

Your OVP segment did better-than-expected. Can you provide any details on the new business that you mentioned in the press release?

[Jason Napolitano:]

The OVP new business?

[Unidentified Analyst:]

Yes.

[Jason Napolitano:]

That’s a customer that has in the past year launched some new products. I don't think they don't want us to go anywhere beyond that, but it was - we’ve had a nice year with them.

[Unidentified Analyst:]

Okay, great. And so what are you are expecting for the year in terms of sales growth for OVP? I know in the past you talked about growing in line with inflation. Just kind of your thoughts now?

[Jason Napolitano:]

Yes, I think, this year is probably flattish for OVP. We had a very strong year last year with $20 million. I think it was a record year going back to when Heska acquired that operation back in ‘96. So I'd say outlook for this year I would say is probably flattish.

[Unidentified Analyst:]

Okay. Also your gross margin, I know you talked about product mix affecting margins. Just kind of stepping back, when do you expect the volume discounts kicking in that you might see your gross margins improving over time?

[Kevin Wilson:]

Jenny [ph], the product mix is going to continue to be important. As imaging grows, it's going to move the needle. If OVP does have out-size performance in any one period, it’s going to move the needle probably in the other direction. I wouldn't expect meaningful ticks up or down based on volume discounts. We think we've done a good job pricing some of those things in for the long-term and we've got long-term visibility but I don't see any major shifts in that that are going to move the gross margin percentages meaningfully.

[Jason Napolitano:]

I agree with, Kevin. I think it was a very long-term as we continue to grow hopefully, you might get some negotiating power. But in the short-term, your mix is going to be a much more important factor in terms of what you see each quarter and even each year.

[Unidentified Analyst:]

Great. Thanks. Also I just want to clarify the $10 million of operating income that you guided for 2016. That does include the $2 million of incremental R&D spend, right?

[Jason Napolitano:]

I think we said $12 million which excluded it, so it gets - so yes, I think you’ve got it right.

[Unidentified Analyst:]

Okay, great. Thank you. And congrats on an excellent quarter.

[Kevin Wilson:]

Thanks a bunch.

[Jason Napolitano:]

Thanks.

[Operator:]

At this time we have no further questions. I'd like to turn it back over to management for any closing remarks.

[Kevin Wilson:]

Well, thanks everybody. Thanks for attending the call. Heska just had a fantastic quarter. We are excited to get back with you to report second quarter results as well, and have a good day. Thanks. Bye-bye.

[Operator:]

We'd like to thank everybody for their participation on today's conference call. Please feel free to disconnect your lines at any time.