Heska Corporation
Q4 2016 Earnings Call Transcript
Published:
- Operator:
- Good day, everyone and welcome to the Heska Corporation Fourth Quarter and Year End 2016 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Brett Maas, Hayden IR. Please go ahead sir.
- Brett Maas:
- Hello and welcome. I’m Brett Maas of Hayden IR, Heska’s Investor Relations firm. Prior to discussing Heska Corporation's fourth quarter 2016 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 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 are contribute to such differences are detailed in writing in the places including Heska’s Corporation's annual and quarterly filings with the SEC. Any forward-looking statements speak only as of this time they are made, and Heska does not intend and specifically disclaims any obligation or intention to update any forward-looking statements to reflect events that occur after the time such statements was made. We have with us this morning, Kevin Wilson, Heska's Chief Executive Officer and President; John McMahon, Heska's Chief Financial Officer; and Jason Napolitano, Heska’s Chief Operator Officer and Strategist. Mr. Wilson will begin with brief comments and the results we report today, followed by further comments by Mr. McMahon, then we'll open the call up 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?
- Kevin Wilson:
- Thanks, Brett, and good morning everybody. I’m super pleased to report the shareholders another record quarter at Heska. We exceeded our internal expectations and our external benchmarks. For the quarter - year-over-year, total revenue increased 33%, operating income grew 83% and net income was up 70% to $3.5 million or $0.46 per diluted share. Year-over-year growth accelerated nicely during the first three quarters of 2016 and again it has accelerated in this record fourth quarter. Expense discipline remains solidly in place, the overall veterinary market is strong and Heska is getting more market share, virtually every area of Heska performed well in the fourth quarter and the strength is reflected in our results and our financial position. Our Core Companion Animal teams continue to win. In the fourth quarter, Core Companion Animal sales grew 44% over last year, largely by taking market share and blood diagnostics and imaging diagnostics. We confidently achieved solid net subscriber gains and we had even higher gains in subscription months under contract in the quarter for blood diagnostics business. The source of these gains in net subscribers continues to be primarily from new subscribers converting from competitive offering. The source of gains in subscription months under contract continues to be from a combination of new subscribers and agreement extensions and additions from existing subscribers. Our transition to a full subscription based blood diagnostics business now has critical mass and continues to grow in value. The fourth quarter was particularly strong in imaging diagnostics. A combination of excellent product releases in the e-client space, companion animal rental conversions to purchase contracts and the team’s motivation to get every customer possible into a solution resulted in this record quarterly performance. On the heels of this result, we intend to finalize the anticipated acquisition of the 45.4% minority interest that we do not currently own in Heska Imaging U.S. and we expect this to be completed towards the end of Q2. Having assembled this excellent global imaging diagnostics property over the past four years, we now look forward to even more impactful bundles and new subscription offerings that combine blood and imaging diagnostics in North America and in Europe in the second half of 2017. Veterinary market indicators continue to point towards broad based growth in 2017, led by the diagnostics segment served by Heska. Specific to Heska, we are targeting growth from a mix of market share gains in existing markets, geographical and greenfield expansion to primarily European markets, product line extensions, test menu additions, higher sales force density, healthy pricing, new partnerships and increased utilization from our thousands of subscribers as their own businesses grow. Success in these initiatives will be meaningfully additive to Heska’s current revenue baseline. I’m very pleased with our progress in this highly competitive market. Today’s Heska is healthy, ready to jump on opportunities, and confident about which levers to pull for long term growth, strategic partnerships and value creation. We hope we work intelligently with respect to these levers, even as we remain acutely aware that our competitors are strong, large, and motivated to contest our rise at every opportunity. Now I'll turn the call over to John to detail the fourth quarter and the full year financial results. Following that, we'll open up the call to your questions, John?
- John McMahon:
- Thanks, Kevin. As Kevin mentioned, we had a record fourth quarter to cap off what was an outstanding year for Heska. We recorded fourth quarter revenue of $39.5 million, a 33% increase over $29.8 million in the fourth quarter of 2015 and full year revenue of $130.1 million, a 24% increase over $104.6 million a year ago. Revenue for the Core Companion Animal Health segment or CCA was $33.1 million in the fourth quarter, that was a 44% increase over $22.9 million in the fourth quarter last year and was $107.4 million for the full year, a 27% increase over $84.2 million in 2015. The revenue growth in our CCA segment was spread broadly throughout our product offerings from instrument subscriptions and consumables as well as our heartworm preventive products. Revenue from digital radiography solutions in the U.S. grew 62% quarter-over-quarter and 34% year-over-year. I will discuss the positive ramifications the digital radiography performance will have on our business going forward in a few moments. Other Vaccines and Pharmaceutical segment or OVP generated revenue of $6.4 million in the fourth quarter of 2016, down slightly from $6.8 million in the same quarter last year. However, on a year-over-year basis, the OVP segment grew revenue 11% to $22.7 million in 2016 from $20.3 million in 2015. Revenue under our agreement with Eli Lily’s Elanco unit continues to drive performance in that segment. Year-over-year consolidated gross margin comparisons for both the quarter and year indicate the stability of our margins in the 41% to 42% range with the small fluctuations resulting from product mix in our OVP segment. Our instrument and consumable margins remained consistent and healthy, and we continue to provide our customers with the most competitive value in the industry. Total operating expenses on a year-over-year basis grew 5% to $37.4 million from $35.7 million. This increase was most notable in sales and marketing where we occurred higher sales competition costs resulting from record revenue. G&A expenses were up 4% year-over-year primarily from intangible amortization we began to incur in 2016 as a result of the acquisition of our international imaging business. R&D expenses were up year-over-year primarily due to product development for digital radiography solutions. Fourth quarter operating income grew 83% on a year-over-year basis to $6.5 million compared to $3.6 million in the fourth quarter of 2015. Full year operating income grew to 93% year-over-year to $16.5 million from $8.5 million a year ago. Depreciation and amortization was $4.6 million in 2016 and $4.2 million in 2015. Stock-based compensation was $2.3 million in both 2016 and 2015. Our effective tax rate for the year was 26.3% and as we have noted in previous quarters, the adoption of a new accounting standard related to the tax achievement of employee stock compensation exercises has led to a decrease in our effective tax rate on a year-over-year basis. The benefit of tax expense for the year was roughly $840,000 or $0.11 per diluted share. As we also note each quarter, the deferred income tax expense line item on our financial statements primarily relates to taxes we would have paid in we did not have a large domestic net operating loss position and is therefore essentially a non-cash item. Net income attributable to Heska Corporation for the fourth quarter of 2016 was $3.6 million or $0.46 per diluted share, a 70% increase over the $2 million or $0.28 per diluted share we generated in the third quarter of 2015. For the full year, net income attributable to Heska Corporation rose more than 100% to $10.5 million or $1.43 per diluted share as compared to $5.2 million or $0.74 per diluted share in 2015. On previous calls, we have discussed regulatory investments to substantially expand our lateral flow test menu. The process with the USCA is ongoing and while we did not incur the levels of spending we anticipated in 2016, we do expect to incur additional R&D cost in this area of approximately $1 million in 2017 with additional investment occurring in 2018. We currently continue to expect at least one new product to be approved in this area in late 2017 as a result of this investment. As I mentioned previously, the sale of our digital radiography solutions by Heska Imaging U.S. was a key driver of our Q4 and full year 2016 record revenue performance. Full year revenue contribution of $26.3 million and operating income of $3.7 million has exceeded the performance criteria needed for the minority interest in Heska Imaging U.S. to exercise a put option to sell their remaining to Heska following the audit of the 2016 financial statements. We have received notification that the put will be exercised at that time and we are looking to deliver the put payment to purchase the minorities position on May 31. Based on the Heska Imaging U.S. financial performance in 2016, the put payment will be valued at $13.8 million if we deliver all cash or up to $14.6 million if we deliver the maximum contractually allowable ratio of stock and cash. We are very excited by the prospects of moving forward to fully gain the synergies and strategic objectives we hoped for when we first made the investment in 2013. Since our initial investment in imaging, Heska stock has delivered a roughly 10X return and we are quite pleased. We are eager to fully assemble and integrate this global imaging diagnostic capability into our Heska strategy. With the Q2 anticipated acquisition of the minority portion of Heska Imaging U.S., investors should pay close attention to a few items. We have consolidated 100% of the revenues of Heska Imaging U.S. since acquiring the 54.6% majority interest in 2013 and we will continue to do so going forward. Since 2013, we have attributed 45.4 set portion of Heska Imaging U.S. Inc to the minority interest. For 2016, this minority interest in Heska Imaging U.S. income was $1.7 million. Following the purchase of the minority interest midway through this year, no further minority interest income portion will remain which is anticipated to result in a positive impact to net income offset modestly by any shares that maybe issued to complete the transaction. While we think that the transaction will be neutral to slightly accretive to 2017 EPS, please note that revenues from Heska Imaging U.S. are not expected to rise in a similar fashion at 2017 but may impact the flat to down year-over-year due to first the high level of our performance with Heska Imaging U.S. during Q4 of 2016. And secondly, our intension to move some portion of future imaging capital sell into a subscription model similar to our blood diagnostic reset program. Similar to our experience when launching our blood diagnostic subscription, converting imaging capital sales to a subscription model will reduce upfront revenue and current period profits recognition early into converting. So in summary, we anticipate continued growth in our core business will positively impact 2017 revenues and income. Lateral flow of test regulatory R&D investments will have no effect on revenue, but will reduce income. In imaging, high year-over-year comparisons and a new emphasis on imaging subscription will dampen year-over-year recognized revenue and income growth. And the elimination of the allocation of the imaging income to the minority interest in Heska Imaging U.S. will be neutral to revenue while positively impacting income. 2016 was a memorable year that was substantially above expectations and long-term growth trend. We shattered company records throughout 2016 and we did so well never wavering from our number one priority, which is providing our customers outstanding products, service and support at the fairest prices in a sustainable manner. With this foundation now firmly in place, we are working hard to exceed customer expectations and our own high standards in 2017 and beyond. So, with that, Kevin, and I would like to open up the call for your questions. Operator?
- Operator:
- Thank you. [Operator Instructions] And we will hear first from Nicholas Jansen with Raymond James.
- Nicholas Jansen:
- Hi, guys. Congrats on a strong fourth quarter. Just wanted to first touch base with the core CCA revenue as we think about the go forward expectations. I appreciate the comments on the imaging side, but you have exceeded expectations nicely on the imaging, the consumables and the allergy business in 2016. Just wanted to get your broader thoughts on how we should think about that bucket growing in 2017 amidst the litany of opportunities that you kind of discussed in the prepared remarks?
- Kevin Wilson:
- Hi, Nick, it’s Kevin. Thanks for the question and thanks for joining us this morning. We generally don’t give guidance and to get specific on just kind of segment reporting in terms of growth was something that that I don’t think we are comfortable doing. Having said that, the core business in blood diagnostics is continuing nicely, it’s doing what it’s been doing for last couple of years. In terms of market share, we got the vast majority of our customers now in subscriptions and that conversion, I think, is largely complete and so we think there is just good consistent growth to be had in that business. But I always point out, I don’t want folks to get too far ahead of themselves. We have very large competitors who are right now working really hard to make sure that we don’t continue that grow. So it’s competition, it’s very competitive, but I don’t think anything has really changed in terms of how competitive we are in the market and how happy our subscribers are. They seem pretty happy and we think that will continue throughout 2017. So, sorry, I can’t give you specifics, but that kind of opens up the guidance – guidance can of worms and we are just not really going down that road.
- Nicholas Jansen:
- That’s helpful. And then we think about the product innovation that you guys are looking to invest behind, you made some investments in imaging in 2016, now that you have a kind of full ownership of it, just trying to get – or soon to have a full ownership of it, just trying to think about your R&D pipeline excluding the rapid assets, which I think we all kind of understand, but some of your competitors have launched some new things and just trying to – on the urinalysis side, just trying to get a better understanding of kind of how we should be thinking about your R&D efforts and your partnership efforts leading to new equipment launches in 2017 and beyond?
- Kevin Wilson:
- That’s a great question. We were up in R&D primarily attributable to imaging last year and those tend to be multi-year cycles. So a lot of that R&D is now kind of being burst into the market and things seem to be going quite well. A lot of that R&D started to be seen by the market in the fourth quarter, which certainly contributed to their outperformance. In the lateral flow side, we are targeting at least one test in the second half of this year and for us, we think that that opens the door for those other test to follow fairly quickly. And so I think expanding that and getting into more of the single use blood diagnostics is a logical expansion. And the way I look at R&D broadly is there are times like in the urine space where a company of our size needs to be fast follower and we have the privilege of being in an industry that’s growing, but also that’s – this candle, it’s led by a very good industry leader. They spent an awful lot of money in R&D and they spent an awful lot of money educating the market as to why new segments are beneficial. That’s really not heavy lifting that a company of our size or even a company that’s two or three times our size can really do effectively on a global basis. And so I applaud the industry leader for spending that R&D money and for educating the market as to new tests and new revenue streams for the industry. So we do intent to be a fast follower, but fast follower doesn’t mean a quarter or two, there is still a bit of a row to hoe, I think, on that. I think they are good job doing it, but I don’t anticipate we will be left out of a major diagnostic segment. We are a diagnostic company. I think we do a very good job in blood diagnostics and I think we do a very good job in imaging diagnostics and other fluids and materials are being diagnosed at point of care in veterinary hospitals, I think it’s part of our mission to be in that space. That said, there are third parties out there, who use to look out with the off balance sheet R&D for a company like Heska that are actively looking to address those markets and they see – they seeing new segments coming on and they have new technologies and they are looking for partners and we think that Heska is probably a very good place for them to become partner to veterinary hospitals. So I don’t know if I answer your question specifically, but I hope it’s helpful at least to see how we look at it.
- Nicholas Jansen:
- No, that was very helpful. And then, I guess, I will close with just your European strategy. You’ve been over there for about nine months now. Just wanted to kind of get your thoughts on where we are in terms of building relationships, establishing distributor partnership, any sort of cross-selling that’s happened yet between imaging business and your existing blood diagnostic franchise, any thoughts on kind of that geographic expansion as we think that 2017 and beyond?
- Kevin Wilson:
- I think you will see some small international revenues hitting late in the year and the way I describe this is, is it’s really important especially given our business model that we get it right. And what I mean by that is, I will use Germany as an example. In the domestic market, we will go to a customer and we would say, we want to place a point of care lab in your hospital and we promise lower pricing, we promise you faster performance and accuracy and precision, we promise you warranty coverage and 24-hour support. And so, if we take that model and we go to somebody in Germany and say, we would like to place this in your hospital for free and give you infrastructure and we would like to partner with you for a six-year subscription and when you partner with us for six years, you are going to get your tests extremely quickly, your equipment is going to work perfectly, if it doesn’t, we are going to swap it out and provide the warranty service immediately and we are going to protect your prices and run a very efficient operation during that six-year period. It’s far more beneficial for us to spend a little bit more time getting the infrastructure and the setup a 100% perfect before you go to that broad market and make those promise because they promise to use us for six years and we promise to execute wonderfully for them for six years, that’s a little different than a lot of international expansions where you would go find a local partner and you would sell 100 units for that local partner and recognize the revenue and hope that local partner did a good job sometime over the next year. We are not pursuing that type of model. So I think the revenue ramp will be a little bit slower because we are actually partnering with our own infrastructure with the end-user, they just happen to speak German in this example. So all of that is just a long answer to say, we are moving carefully, diligently, we are definitely moving forward with it, but we want to get it right before we publically scale it.
- Nicholas Jansen:
- Great for the color and congrats on a great 2016 and I will hop back in queue. Thanks, Kevin.
- Kevin Wilson:
- Thank you, Nick.
- Operator:
- And next we will hear from Ben Haynor with Feltl & Company.
- Ben Haynor:
- Good morning, gentlemen. Thanks for taking the questions.
- John McMahon:
- Hi, Ben.
- Kevin Wilson:
- Thanks, Ben.
- Ben Haynor:
- First off for me, just looking at your next largest competitors, it also looks like they reported about $34 million in North America vet revenue, which was pretty similar to what you reported for CCA. They of course have a full line of rapid tests, you guys have the imaging, but it would appear that after kind of backing those out, you might be overtaking them on the in-house equipment and consumable side of the market here in North America, does that seem accurate to you?
- Kevin Wilson:
- I don’t know that we’ve crossed streams. I think at some point, we would hope to cross streams, but, I think, I mean, you are looking at the same math we are, but I haven’t looked at their revenue and their segments closely enough.
- Jason Napolitano:
- Hi, Ben, it’s Jason to further [indiscernible]. I’d be surprised if we were larger than the particular segment right now, I do think you are getting the trend right. I think the gap is closing and we are making nice progress, but I have to say they are probably is bigger than we are right now.
- Ben Haynor:
- Okay, that makes sense. And then, you mentioned expansion to sales force as one of the objectives here this year. Do you – can you provide us any idea of what that might look like, is it a handful of people, is it 10 people, how do you think about that?
- Kevin Wilson:
- I think we are largely in place, some of that work actually started in late third quarter and the fourth quarter. So we’ve increased sales density in the imaging side and we’ve increased sales density in the blood diagnostic side. That being said, it’s one of the nice things about Heska in our current size. This order of magnitude, if you have roughly 40 field sales people and you add 4, it’s 10% growth, when you add 8, it’s 20% growth. So that’s kind of the order of magnitude that we are talking about, but we think that can be meaningful and we think there is a need. I don’t think we are forcing that density. There is actually a need to cover commercial activity and interest to increase that. So a lot of that training has been done in the fourth quarter and we are starting to get early, early production from the new folks. And I’ve bragged on our training program on past calls, we implemented and really ramped up a couple of years ago and I think they are really doing a good job getting new folks, who also have a lot of energy to be fully trained on how to kind of relay our message and how it’s different. So I’m super happy entering the year with the status of the sales team. It looks really good.
- Ben Haynor:
- Okay. Very nice. And then lastly for me. It sure sounds like the trends that you saw in Q4 outside of the imaging have kind of continued into Q1 the past two months, am I carrying you correctly there?
- Kevin Wilson:
- Yeah, I mean, I think the trends are largely in place. I mean the – if you listen to everybody in this segment, the calls, the global growth trend in veterinary seems to be intact and diagnostic seems to be growing a bit faster than that. You know me, I actually – I try to be conservative, I don’t want folks to crazy and model the fourth as if it’s the full 2017. Because we focus on a lot of things, but from kind of high level, we get shareholder trust and they pay us well to lead the company ethically and honestly and then on a very high-level, we are supposed to give more transactions with veterinarians and provide them more value. If we do those things and higher earnings should follow and then we should prepare for the next five years. Those are kind of the things that I look at. What I don’t look at on a daily basis and an operational basis is the effect of revenue recognition, P&L, effects of R&D that should be done because it’s healthy for the business and it will help us do more transactions now, years and exit healthier five years down the road. So I just – again, I want to caution people, we want to do the right thing for the business to do more transactions, to deliver higher earnings over five years and not one quarter. So just be careful about extrapolating the fourth quarter to the entire year.
- Ben Haynor:
- That makes sense. Okay. Great. Thanks for taking the questions and congrats on the quarter.
- John McMahon:
- Thank you.
- Kevin Wilson:
- Thank you, Ben.
- Operator:
- And next we will hear from Jim Sidoti with Sidoti & Company.
- Jim Sidoti:
- Good morning. Can you hear me?
- Kevin Wilson:
- Hi, Jim, how are you today?
- John McMahon:
- Hi, Jim.
- Jim Sidoti:
- I’m well, I’m well, thank you. Can you break-out – I’m sorry if you said it already, I need to give it – the contribution from Cuattro international in the quarter?
- Kevin Wilson:
- We gave you the year, Jim. It was $26.3 million in revenue and $3.7 million in operating income.
- John McMahon:
- I don’t think he is asking…
- Kevin Wilson:
- Jim, are you asking international or you…?
- Jim Sidoti:
- Just the international piece for the quarter because that was the new piece for this quarter.
- Kevin Wilson:
- Yeah, it was about $3.5 million, Jim, for the year.
- Jim Sidoti:
- Okay. For the year?
- Kevin Wilson:
- Yeah.
- Jim Sidoti:
- And you had it for six months, I’m not sure?
- Kevin Wilson:
- Yeah, six, seven months.
- Jim Sidoti:
- Okay. All right. And it seems like we were lucky last year that you gave us some top line in operating income guidance, I think, it sounds like we are not going to get that in 2017. Can you give us some idea of where you think the OVP revenue will be in 2017?
- Kevin Wilson:
- Yeah, I think, traditionally, we’ve said it’s an inflation grower and I think traditionally we’ve been beating that number. So, again, I don’t think we are going to break-out segment by segment, but I think they are going to have a good year on par with what they did in 2016.
- Jim Sidoti:
- Okay. So that it’s not in 2016 that you consider one-time that would not repeat?
- Kevin Wilson:
- No, no. I think that business, they are doing a great job there operationally they are running a tight shift and there were no kind of one-off non-repeatable type of things. They have nice long-term relationships with some nice big partners and the animal health side. I think that will continue.
- Jim Sidoti:
- Okay. And then how about the tax rate. I know you said you had some benefits this year from some of the new regulations, does that reverse next year?
- Kevin Wilson:
- Yeah, so – no – so, Jim, the benefit to the tax expense, it’s basically a change in accounting that’s a term in the timing of when we get to recognize the tax deduction for employee stock option exercises and the whole – the benefit is driven by the behavior of the employees and when they sell their stock options and how long they hold them for. So it’s really hard to predict. And one of the things that it introduced when they made this change was it introduced a lot of variability in the tax rate. So we really can’t predict whether it’s going to be the same, be a little higher, be a little less, so it’s really – that piece of it is like I said is driven by employee behavior more than anything else.
- Jim Sidoti:
- Okay. And it’s now – it’s mostly a non-cash expense anyway?
- Kevin Wilson:
- Yes, exactly.
- Jim Sidoti:
- All right. And then last two. Is it correct to assume that if the share price stays about where it’s been in the past couple of weeks that the increase in shares from the pending acquisition of the remaining pieces of Cuattro would that all impacts your account by less than 200,000 shares?
- Jason Napolitano:
- Yeah, I think – Sam, this is Jason, again. That’s obviously math. We are cast at 55% of the value that can be delivered in shares and John has already shared with you the economic details, so you can plug into a little calculator pretty easily just what the implications of our current prices for that.
- Jim Sidoti:
- Okay.
- Jason Napolitano:
- The numbers you are throwing about is consistent with what, I think, we are all thinking.
- Jim Sidoti:
- Okay. But so not big delusion there because of that?
- Kevin Wilson:
- In general, roughly you could look at it, I forget the exact numbers, but let’s just say 55% rolls up to about $8 million, you divide that by whatever share value you want to place on that at the time of delivery, which would be some time around end of may, and that would be the maximum amount of share dilution that the deal could incur. I think it’s –
- Jason Napolitano:
- Correct.
- Kevin Wilson:
- Yeah, pretty clear.
- Jason Napolitano:
- The numbers you are throwing with that are consistent. We try to watch every share that goes out the door, obviously, but at a certain point [indiscernible] you are saying that it’s not really material from a dilution perspective?
- Kevin Wilson:
- Right.
- Jason Napolitano:
- The benefit it’s having a stock price that’s going off a bit.
- Kevin Wilson:
- Right.
- Jim Sidoti:
- And then my last question, there was probably significant acquisitions made during the quarter, VCA acquired by the parent company of Banfield. I know that hasn’t closed yet, but any comments on what you think that means for Heska?
- Kevin Wilson:
- I think it’s – I mean, it’s still undetermined, I think, there is opportunity there. We know the folks at VCA well and we know the folks at Banfield well and we are all still competing for the same business. There is still 1,000 Banfields and 900 VCAs and you got the BluePearls and I’m sure they are going to be very busy with integration and optimization and rationalization and all those things, so I don’t really see huge shifts in anybody’s direction mostly because if I were on the other side of that involved in that transaction, I’m pretty you’d be focused on kind of the bigger items before getting down to the do we want to switch vendors or do we want to increase or decrease certain activities, but don’t think there is going to be a huge near-term shift. I think long-term, I think, they are going to do great and I think when they do great, the people who supply them do great and we will try to be competitive and get some of that business.
- Jim Sidoti:
- All right. Thank you.
- Kevin Wilson:
- Thanks.
- Jason Napolitano:
- Thanks, Jim.
- Operator:
- And next we will hear from Raymond Myers with Benchmark.
- Raymond Myers:
- Great. Thanks for taking the questions and congratulations on a strong finish to the year.
- Kevin Wilson:
- Thank you.
- Raymond Myers:
- Kevin, I wanted to drill into your comment about the imaging being strong in the fourth quarter and also that – that would be converting to a subscription model next year. So wanted to get some sense of how much imaging equipment revenue was there in the fourth quarter and how much impact might that have on the growth rates this year?
- Kevin Wilson:
- I think roughly – roughly it was about $11 million in U.S. imaging for the quarter and it was year-over-year really over the last couple of years strong in large part based on product releases primarily in e-client base, so they just did a really good job of getting ready for the fourth quarter. The R&D team and production team got product on the shelf in October, so there was enough time to actually realize some of the benefits in the fourth quarter. So the e-client space I don’t think will convert to a subscription model as quickly as the companion animal space. And again, we are not going to break-out how many we sell companion animal versus e-client, but I think the companion animal side is larger than the e-client side. And they are just a very logical fit that when you go into a veterinary hospital and you place infrastructure and you say, use our infrastructure, what we need from you is blood to put in our infrastructure for the next six years, it’s not a whole lot different than going in and saying, use our digital radiography or ultrasound infrastructure for the next six years at the same time. It’s a very, very logical fit to say, hey, it’s $699 a month to select chemistry infrastructure and it’s $699 a month to select radiography infrastructure for the same period. It’s very, very nice fit there. When you had a minority interest, you had issues related to revenue recognition and triggers and puts and calls and those types of things that kind of combining that type of model across all of our diagnostic offerings is a little bit less easy in terms of comp plans and things like that. So I think as we complete the acquisition of the minority interest then the ability to kind of put those capital sales, which have traditionally been $50,000, $55,000 sales into a subscription model that pays out six years, I think that ability increases. And so you are going to have the exact same situation that you had with our conversion to blood diagnostics that started three, four years ago, which is early on, instead of realizing a $50,000, you are going to realize an $800 monthly subscription and annual match that with the D&A on the expense side and that will become your profit. So it will effectively reduce your revenue. Over the long-term, we think it’s a much better model and we think we have the bandwidth and the healthy business around that to make that conversion. And we think we will be only company in the space that has made that conversion meaningfully in imaging. So long-term, I’m kind of back to my principles of kind of running the business. If I look at a five year health and I look at the ability to increase earnings and do more transactions, converting imaging in part to a subscription model definitely seems to the call. Not 100% of the customer will want to subscribe, several of them will want to make an investment and that’s a portion that we don’t know. We don’t know if 70% would want to do imaging on a subscription or if 10% would do imaging on a subscription and the other 90% might want to make a capital investment, put it on their balance sheet and use their cash and so that’s undermined. And we really won’t know that until we pilot the program over the next couple of quarters.
- Raymond Myers:
- Great. Thank you. Next, what proportion of consumables have converted to the Heska Reset model so far?
- Kevin Wilson:
- I think we called out 72% a quarter or two ago. I don’t have a discrete number for you that would be kind of disclosure level, it’s higher than 72%, we continue to grow and so we have more subscribers, more months under subscription and we are shipping more stuff under subscription, so I can confidently say it’s higher than it was when we called it out at 72%.
- Raymond Myers:
- Okay, great. And then a couple of times during this call, you mentioned your competitors, they are larger than you, they are working hard too, is there any difference in the competitive response recently or is this just a cautionary state about strong competitors in general.
- Kevin Wilson:
- Well, I live in the cautionary statement world. These are aggressive guys who – they grew big business before I certainly got on the field, so I have a healthy respect for them, but not too healthy, I did not want to compete with them. So I think some of that is cautionary. Some of that is actually – really I would take it as seriously as I take it, which is their big effective, aggressive folks who – they want all of what we want, we want all of what they want and we feel like over the last couple of years, we are doing well, but as we encroach more and more on their business, I suspect they will continue to push back. So it’s a little bit of both.
- Raymond Myers:
- Okay, great. And did anything unusual influenced gross margin in the fourth quarter or was it just that you had unusually high imaging capital equipment?
- Kevin Wilson:
- So the margin I would say was mostly based on higher margin per imaging but we also have some mix effect in our OVP segment. But as I mentioned, it’s all pretty minor term fluctuations between 41% and 42%.
- Raymond Myers:
- Yeah, pretty close.
- Kevin Wilson:
- Yeah.
- Raymond Myers:
- Okay. Thank you. I’ll leave it there.
- Kevin Wilson:
- Thank you.
- Operator:
- And next, we’ll hear from David Westenberg with CL King.
- David Westenberg:
- Hey, guys. Congrats on a great quarter.
- Kevin Wilson:
- Thanks, David. How are you?
- David Westenberg:
- I’m doing well and you guys are doing very well. Thank you so much for taking the question. So I just missed it, was it the imaging in 2016 business, was that $26 million, what’s it?
- Kevin Wilson:
- $26.3 million.
- David Westenberg:
- $26.3 million. Thank you so much. So what’s kind of continuation of couple of questions, what’s really clicking in that imaging business. You go to the typical vet show in every single human player in imaging there, still loves GE. So how is [indiscernible] really resonating with Vet being a little bit more of let’s say well known brand?
- Kevin Wilson:
- I think in the veterinary space it’s quite well known so from a broad consumer base, some of the multinational brands I think are well known names but I don’t know if that translates a specific veterinary market. So I think I have to give credit to our people. I think our people who do the R&D are very specific and they wake up focused on how to make it better for veterinary and how to convert it from human medicine to make it acceptable to veterinarian. And then I think our sales people, they wake up every day and they only sell and care about veterinarian. So I think focus and I think our people and that’s people who are developing the products specifically to veterinarians and people who are selling the products specifically to veterinarian.
- David Westenberg:
- Great, thanks. And then you’re likely three years maybe four years in the margin share gain. Can you talk about some of the differences and your customer acquisition from maybe a year or two ago kind of meaning are they familiar with Heska now, are they more familiar with the reset model? What’s different right now in terms of getting them over the hump as oppose to maybe a year or two years ago?
- Kevin Wilson:
- A big piece of a transition like we’ve gone from is credibility and one of the best ways to gain credibility is pure credibility. So when you see pictures of hundreds and thousands of happy smiling veterinarians who’ve made the switch and it’s worked well. I think that becomes a much more acceptable and credible solution for you to consider. So we definitely benefit by pure credibility that we didn’t have when we first started it. The other thing I would point out is every veterinarian is not aware of making a diagnostic decision until they become aware of it meaning that it’s episodic. It’s not something that once a year veterinary hospital sits down and decides what they want to do in the segment. So it is about your people, it’s about your sales calls, it’s about your partners. Folks at Henry Schein do a great job for us. Our people, they go knock on doors, they buy sandwiches, they educate people and so it’s episodic and you want to be in front of the clinic when they’re looking for an alternative because maybe your competitors stumble, maybe there was a price increase that they weren’t happy about, maybe there was a backorder and so it’s episodic. And so it’s not one of those things where you’re looking for okay, here is a two or three horse competition with one race and see what happens with the whole market. It doesn’t really work that way and so I think there is a play out for years mostly because 99% of our customers today or is surgery are seeing pet owners and not really focus on making a switch until they are. Maybe that answers your question.
- David Westenberg:
- Thank you. And then could you talk about your relationship with the distributors? Your exclusive [ph], it has a store, it has its own brand and so how is that relationship shaping out? Would you consider continuing to work with them? Would you work with them more and would you consider maybe working with some of the other distributors?
- Kevin Wilson:
- Yeah, I think we’ve always considered the possibility to work with those distributors and up until now we’ve always decided that Henry Shine is a great partner and they’re doing a great job. So I don’t know that a whole lot is changed. They’ve owned the skill business pretty much since we started with them. I think that was a month or two after we went exclusive with them a couple two or three years ago and periodically they’re going to launch new products in the business that they own. I think on a sales rep level, our team has done a fantastic job of getting to know their team and people who know and like each other, tend to do business with people who know and like each other and I think that dynamic takes a long time to acquire that and I think it’s lasting and stable once it’s in place. So I think from a scaled level which is all that really matters, the reps are working well together and the veterinarians are hearing a good positive message from both sales team. So I like it.
- David Westenberg:
- Alright. Great job and then look forward to seeing you next week.
- Kevin Wilson:
- Thank you.
- Operator:
- And we do have one other caller in queue. We will take our last question from Mark Massaro with Canaccord Genuity.
- Mark Massaro:
- Hey guys, congrats on a great year and thanks for letting me in the queue here. So one of the news items that the North American bet was related to the Henry Shine announcements to launch the Samsung chemistry analyzer. Just looking at the specs, it weighs about 4 pounds, it’s about 10 inches high, so it’s a light weight chemistry analyzer at the margins potentially could be disruptive since it’s new. So I guess could you speak to the impact you think this analyzer may have given the fact that there are some concerns about its test accuracy. So I just wanted to ask how you’re thinking about this launch perhaps impacting to the next couple of quarters.
- Kevin Wilson:
- I think they are doing their job and we’re doing our job and nothing is changed. Skill has had Arkray and Samsung and Roche and Abbott [ph], and a couple of others. I’m probably forgetting currently they are stable and so they’ve now added six or seven horse to their stable of horses. I don’t think anything structured is fundamentally changed in that regard. So it’s kind of the same answer I gave David. Really at a rep-to-rep level, I think we’ve proven that when the Henry Shine rep has a great relationship with a veterinary clinic and they make a recommendation who are diagnostic, and that recommendation at Heska, we do a great job for them which enhances the business that they have in that hospital and enhances it for six years, some cases more and I think the Henry Shine reps are very thoughtful about that. They want to bring that benefit to the customer and we think that hasn’t changed. So they might launch two another analyzers next year at the Skill business. I don’t know that’s changed. So on a rep-to-rep level, I think we are seeing the Henry Shine reps support the solution that continues to make them look really good in front of their doctors.
- Mark Massaro:
- Excellent and just one more, I know that in certain parts of Western Europe in particular a lot of the markets there are pretty well developed and so I guess at a high level, are there certain geographies where you think you can gain greater traction initially and if that is the case at what point do you think we might see investment from direct sales and marketing?
- Kevin Wilson:
- I think you’ll start to see that in the second half of the year and I think you’ll start to see green shoots of results towards the latter part of the year. Early in the call we talked about making sure that we get it right. We are a little bit different and that we make a promise to an end user, and the end user make the promise to us on a subscription basis. So making sure that you have perfect execution is very important if you’re going to a broad market. I think the areas that are most likely anywhere in the EU, you are looking for stable market, stable currency and we make six year agreements with people. You are looking for good contract law, it’s enforceable on both sides and clear expectation. And so I think any market think Germany, Benelux, France, UK, those types of markets I would say just more developed kind of Western European market. Markets that don’t necessarily check all of those boxes in terms of contract law or currency things like that, that’s where you look for value added resellers in that specific country, that specific region. So if you were to think Ukraine or some Eastern European countries, they might now check all of those boxes and looking for global partnerships which would be more of a traditional resell to them and then they sell it to the end user. A lot of moving parts and again we’re not in a massive hurry, we want to get it right more than we want to get it fit.
- Mark Massaro:
- Great. Thanks very much guys.
- Kevin Wilson:
- Thanks, Mark.
- John McMahon:
- Thanks, Mark.
- Operator:
- And at this time, I would like to go ahead and turn the call back over to Mr. Kevin Wilson for any additional or closing remarks.
- Kevin Wilson:
- Thank you for that and thanks everybody who joined the call. So I’m super pleased with the results. The fourth quarter was fantastic and all of 2016 was fantastic. We posted 14 quarters of what I consider to be uninterrupted excellent results and just very, very proud of the team. They worked very hard to deliver these results and I think they’ve done it in a way that’s helping sustainable. More hard to consolidate and extend those advances and the good news is from our starting point we see huge amounts of business that we can compete for and we intend to do so. So thanks to everybody for your interest in our work and we’ll look forward to updating you in couple of months. Have a good day.
- Operator:
- Thank you. That does today's call. We do thank you all for your participation. You may now disconnect.
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