Heska Corporation
Q3 2015 Earnings Call Transcript

Published: 11 Nov 2015

[Operator:]

Good day, and welcome to the Heska Corporation Third Quarter 2015 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Brett Maas of Hayden IR. Please go ahead.

[Brett Maas:]

Ladies and gentlemen, I'm Brett Mass of Hayden IR, Heska Corporation's Investor Relations Firm. Prior to discussing Heska Corporation's third quarter 2015 results, I'd 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 and involve known and unknown risks and uncertainties, which may cause actual results and performance to be materially different from that expressed or implied by those forward-looking statements. Factors that could cause or contribute to such differences are detailed in writing and 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 and specifically disclaims any obligation or intention to update any forward-looking statements to reflect events that occur after this time such statement was made. This morning Kevin Wilson, Heska's Chief Executive Officer and President will comment on Heska’s third quarter 2015 performance. And Mr. Napolitano, Heska's Chief Operating Officer and Chief Financial Officer will detail the Company’s financial performance. Following Mr. Napolitano, Mr. Wilson will discuss the announcement this morning about Heska's acquisitions of Cuattro Veterinary, LLC, then we will open up the call for your questions followed by closing comments. Now I will turn the call over to Kevin Wilson, Heska's Chief Executive Officer and President. Kevin?

[Kevin Wilson:]

Thanks Brett. Thanks everybody else for joining the call this morning. By nearly any measure Heska had a just a phenomenal third quarter, it was fantastic. Our revenues were up 29%, gross margins expanded three points during the period. Our expense discipline was superb. The operating income was up over 500% and net income was up 176% from $0.08 per diluted share last year to $0.20 this year. The team did a great job. I'm impressed with their work and I think you as shareholders will be pleased as well. In blood analyzers placements grew 66% over the prior year’s period. 83% of core analyzers placements in the quarter were to new customers. And we believe that Heska is now becoming a common and top choice for a growing number of high quality and high volume veterinarians throughout the United States. We continue to be encouraged with the direction, the momentum and the sustainability of these trends. New Heska analyzers that have been launched in recent quarter including the Element HT5 Hematology and the element POC blood gas platforms continue to gain share. We anticipate continuing the string of wins with our brand new Element I, T4, TSH and Cortisol platform that we announced at the end of last quarter. Element I is scheduled to launch this quarter with nearly 100 pre orders in hand with multi-year agreement for customers for the vast majority of these wins in each of these product categories, we continue to be encouraged with the layering and the scaling trends of the recurring revenues associated with these wins. In lateral flow rapid test, we continue to progress towards launching FIV//FeLV, Anaplasma, Lyme, CPV/CCV and Giardia as compliments to our currently available Solo Step and Mono Step heartworm lines. We continue to anticipate new sales from these test expansions in the second half of 2016. In Imaging, I want to congratulate the Heska imaging team again this quarter for super performance. They grew sales 87% and in the quarter they expanded gross margins over last year. I couldn’t be more pleased, they did a great job. And finally I want to call out, a special note of congratulations to Jason Napolitano who is named our Chief Operating Officer on October 1. Jason wants to continue to serve as our Chief Financial officer. Jason's long played a broader role than a typical Chief Financial Officer and I thought it was important to acknowledge his contribution with the additional title. And with that, I’ll now turn the call over to Jason for review of our financial results.

[Jason Napolitano:]

Thank you, Kevin. We had a very strong third quarter this year with profitability and revenue growth in excess of our internal forecasts. Total revenue for the quarter was $28 million, a 29% increase from $21.8 million in the prior year period. For the nine months ended September 30, 2015, we generated total revenue of $74.8 million, an increase of 14% as compared to $65.5 million in the prior year period. Revenue in our Core Companion Animal Health segment or CCA was $21 million for the third quarter of 2015, an increase of 28% compared to $16.4 million in the third quarter of 2014. A key factor in the increase was the strong revenue performance at our 54.6% owned subsidiary Heska Imaging US LLC or Heska Imaging US which generated $4.3 million in revenue as compared to $2.3 million in the third quarter of 2014. We also generated notable revenue increases in our canine heartworm preventive sales and our instrument consumables as compared to the third quarter of 2014. Revenue and our other vaccines pharmaceuticals and product segment or OVP was similarly positive. Quarterly revenue in this segment was $7.1 million as compared to $5.4 million in the prior year period, a 30% increase. A key factor in improvements was a new product launched by one of our customers in this segment. Gross margin that is gross profit divided by revenue was 41.4% in the third quarter of 2015, an improvement of over three percentage points as compared to 38.1% in the third quarter of 2014. A net shift to higher margin product areas in our CCA segment, an improved gross margin in Heska Imaging US where gross margin was 36.4% in the third quarter of 2015 as compared to 16.5% in the prior year period were factors in change. We continue to anticipate gross margin of around 35% for Heska Imaging US in future periods. We had $9.5 million in operating expenses in the third quarter of 2015, a 19% increase from the prior year period. The largest factor in the change is a charge of over $900,000 related to the resignation of Robert Grieve, our Executive Chair on October 1 2015. This charge relates to a certain accelerated stock vesting and post termination payments as contemplated for this type of scenario and Dr. Grieve previously negotiated employment agreement. I know that without discharge our general and administrative expenses would have declined for both the quarter and the nine month period when compared to the corresponding 2014 period. We'll retain access to Dr. Grieve's knowledge and judgment through a previously negotiated consulting agreement, which began effective upon Dr. Grieve's resignation. While there has been agreement that this was the right time for Dr. Grieve's employment with the company to transition to a consulting role, it doesn’t make it any easier from a personal perspective. Bob was a founder of Tesco way back in 1988, have been a Board member since 1990 and served as the company's Chief Executive Officer for over 14 years. He builds enduring relationships with many current and former Heska employees. Bob and I work together through some of the toughest financial times in Heska's history and I think it is fair to say without Bob's leadership and efforts, the company would not have survived to thrive in a manner we have done in this quarter. We thank Bob for all he has contributed to Heska over the years and wish him nothing but the best. We generated operating income of $2.1 million in the third quarter of 2015, up from $341,000 in the prior year period. For the nine months ended September 30, 2015, operating income was $5 million, up from $1.2 million in the prior year period. Depreciation and amortization was $3.2 million in the nine months ended September 30, 2015, up from $2.6 million in the prior year period. Stock-based compensation was $1.5 million for the nine months ended September 30, 2015 as compared to $1.1 million in the prior year period. Net income attributable to Heska Corporation was $1.4 million or $0.20 per diluted share in the third quarter of 2015 as compared to $513,000 or $0.08 per diluted share in the third quarter of 2014. For the nine months ended September 30, 2015, net income attributable to Heska Corporation was $3.2 million or $0.46 per diluted share as compared to $1.8 million or $0.28 per diluted share in the prior year period. I know the 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 recognize $722,000 in deferred tax expense or $0.10 per diluted share in the third quarter of 2015 as compared to $306,000 or $0.05 per diluted share in the third quarter of 2014. For the nine months ended September 30, 2015, deferred tax expense recognized was $1.5 million or $0.21 per diluted share as compared to $555,000 or $0.09 per diluted share in the prior year period. While we're extremely pleased with our results today, we can't say a single strong quarter will fundamentally change our long term outlook. We continue to face a highly competitive market in which we have to work hard to earn our share each day. We strive to generate the growth levels you see this quarter, every quarter and while we expect to him them more occasionally, we don't expect to do so consistently. We continue to believe low double-digit growth for our CCA segment is a reasonable intermediate term expectation for this segment. We expect our OVP segment will experience inflationary type growth over the intermediate term, but with some quarterly and even annual lumpiness as the large customer opportunities in that segment ebb and flow. We continue to believe we will be able to leverage our expenses so that our profits will grow at a more rapid pace than our revenue. As we wish to focus our efforts on long-term success rather than quarterly results, we will not be making any further forward-looking statements regarding our financial statements today. We had an extremely strong third quarter this year, which will set a high bar for us next year. We like what we're seeing in our different product lines and have been pleased with the initial adoption of our new hematology system and our new immunodiagnostic instrument. We expect a strong third quarter will contribute to a record setting 2015 for Heska. We continue -- we intend to continue to strive to generate even stronger quarters in the future. With that, I'll turn it back over to you Kevin.

[Kevin Wilson:]

Thanks Jason. As many of you may know, Heska entered the imaging business in the United States in February of 2013 with the acquisition of Cuattro Veterinary USA, which was subsequently renamed Heska Imaging U.S. Today we're expanding our imaging reach for the rest of the globe with the acquisition of Cuattro Veterinary LLC, which I'll refer to Cuattro International. International markets represent a significant portion of the opportunity in veterinary medicine. In fact Heska competitors are in a 40% to 50% or more of their sales and profits from these international markets that until this morning Heska was not targeting. With Heska's demonstrated success gaining share and profits domestically in 2015 and 2015, it's now time for us to compete for international sales in blood diagnostics and imaging. With this morning's acquisition we enter this competition with a strong and established platform and teams in Canada, Mexico, Continental Europe. The United Kingdom, Australia, The Middle East, Latin America and beyond. Over the coming year we intend to launch a full line of our Heska blood and imaging diagnostics products that by Heska's now optimized go-to-market modeling programs enter these international markets. Heska is acquiring Cuattro International for $6 million in stock subject to a minimum of 175,000 shares and a maximum of 200,000 shares and the assumption of approximately $2.1 million in debt. Cuattro International generated approximately $6 million in imaging revenue from non-domestic markets for the 12 months ended September 30 of 2015 and it was profitable during this period. One of the conditions to close is a positive shareholder vote to increase Heska's authorized shares so that Heska will have sufficient authorized shares to deliver at closing as well as to meet its obligations to current options holders. We currently anticipate that the Special Shareholder Meeting for this vote will occur in late December. Subject to the shareholder vote and other closing conditions this transaction is targeted to close January 1, 2016, and it is expected to be neutral to slightly accretive to Heska's earnings per share in 2016. With that I would like to open up the call for your questions.

[Operator:]

[Operator instructions] We'll go first to Nicholas Jansen with Raymond James.

[Nicholas Jansen:]

Hey guys, congrats on an excellent quarter. Just a couple questions first with regards to the relationship with Henry Schein, certainly by the numbers it's demonstrating nice success, but I wasn’t sure if you could provide any more kind of incremental commentary with regards to areas that you're seeing better success in others and then how we should be thinking about that relationship involving heading into 2016 thanks?

[Kevin Wilson:]

I think it's gone great. The teams are after a year working together, are getting to know each other and trust each other even more. So from a relationship standpoint, I think it's never been better. They've launched their access queue, which connects diagnostic devices to their practice management, their practice management software has a roughly 50% share in the United States. So that ability for their practice management to order test on Heska analyzers and then to receive the results from Heska analyzers is a true two-way communication. Is again super competitive and a nice added benefit to their software customers. So in terms of the relationship I think it's going fantastic. They do a great job.

[Nicholas Jansen:]

Great. And then on the plans to move international, it's obviously a big step for you guys thinking about moving into the diagnostic space overseas and it looks like you have a good partner in relationship as you progress over there, but maybe I just wanted to get your sense of how we should be thinking about the contribution of international over time? Is there a desire to pursue more distributor relationships overseas maybe adding some direct sales overseas, just maybe some broader perspectives on the international appetite now that you've announced this acquisition?

[Kevin Wilson:]

Yes, I think it's a little bit of both. Most of the international markets are better served through solid distributors because they have local knowledge, they have local relationships, they have local infrastructure, they're involved in the tax and they import export and all those types of things. So -- but one of the benefits of stepping into those markets with the Cuattro International in places is most of those Cuattro International relationships they've been operating for many, many years. So you have well known trusted local partners for the demonstrated success and advanced technologies and we think that, that's represents a very good pathway to expanding their product lines with some Heska Blood Diagnostic Solutions. And we also think that the models that we've kind of proven and optimized here in the United States with regards to reset rental and some of those models will be extremely attractive overseas as well. So I hope that answers your question. It's pretty exciting.

[Nicholas Jansen:]

No, absolutely, that helps. And then lastly regarding thinking about the gross margins which continue to surprise to the upside is relative to your original expectations, just wanted to kind of get your thoughts of as we think about the margin profile of Heska today relative to your two largest competitors. Is there any reason why we shouldn’t be able to think that Heska over time should be able to deliver similar type gross margins on an apples-to-apple basis or even below the line on an operating margin perspective? Do you think mid to high teens over a long period of time and not holding you to guidance, but just better sense of how you think about the margin profile of the business evolving now that you've established broader relationships domestically, thank you.

[Kevin Wilson:]

I think our margins have improved nicely in the last two years and we worked very hard on that. Our partners have kind of come alongside as sales have improved and they've really stepped up to help us as well. I think our business is very different from the model and from IDEXX's model and Abaxis model. So I don't really kind of target necessarily their levels. What we do is we look to see can we continue to improve and a lot of those things are little steps and I think that's what you see is you see nice improvement because of attention to detail and little steps. But we're not going to have a similar model to one of our competitors who makes their reagents in their own factory, but we also don't have that sitting on our balance sheet with the associated charges on the other side. So we have a different go-to-market. We rely on partners like Fuji and other folks to continue to optimize their business and as they get better and optimize their business, some of those benefits flow to us. So that's a long answer as saying we don't necessarily target specific gross margins of our competitors. We just target being better.

[Jason Napolitano:]

Just to add to that a little bit, Nick, it's Jason, I think over time, I think you've the trends right for sure. As Kevin mentioned, the models of some of the competitors are different. We have not gotten into manufacturing any of the metal and the hardware and things like that. So I would expect on the gross margin line we'll always be a little bit less than someone who is capturing all that margin themselves. On the other hand, we don't have the affiliated R&D that's generally spent by a third party. So there is sort of an offset on a different line item. So I don't know you could model it line item by line item, but I think the overall trend is sort of globally as you're describing I think make a lot of sense.

[Nicholas Jansen:]

Great, Kevin, Jason, great job and if Bob you are on the line listening, best of luck.

[Bob Grieve:]

Thanks Nick.

[Operator:]

And we'll take our next question from Ben Haynor with Feltl and Company.

[Ben Haynor:]

Good afternoon, gentlemen.

[Kevin Wilson:]

Hello Ben,

[Ben Haynor:]

Just on Cuattro a handful of relatively quick ones, are they direct in any other markets or are they dealing with distributors in all of them?

[Kevin Wilson:]

So they're direct in some markets, Canada for instance. I know the presumption is always North America is one they blog, but we have actually not been selling imaging devices outside of the United States for this last two years with the Heska Imaging team. So Canada is a direct market for imaging. In the past we've had other direct markets in Latin America such as Brazil and then we kind of make on the ground decisions and those change over time, but as you find good solid distributors while you're running a direct model oftentimes you will convert a direct model to a very good distributor relationship, We also do see some opportunities with our partner Henry Schein. They're a global organization and I think there are lots of opportunities to evaluate distributor models in other countries.

[Ben Haynor:]

And then are any of the international distributors out there, do they have exclusives with any of your would be competitors, or competitors?

[Kevin Wilson:]

Yes actually I believe all of our international distributor partners are exclusive with the Cuattro. So we don't share the lows, they’re focused on promoting the Cuattro products and they believe they are the best and so they are willing to sign up on an exclusive basis with them.

[Ben Haynor:]

Okay. And then could you give us a sense on how quickly the business is growing.

[Kevin Wilson:]

Don't know that we want – if we want to get into that detail at this time. I think we’re comfortable saying its neutral to slightly accretive in 2016 and we like the business but I don’t know that we’re ready to break out at this point.

[Ben Haynor:]

Okay. And then how quickly could you get your other instruments the full line out there into the international markets?

[Kevin Wilson:]

That’s a great question. So if you look at how we tend to want to go to market, we tend to do things in small groups first. We optimize those things and then we scale them and I think that’s been true with each of our programs here in the United States. So we'll follow a very similar model where we’ll do a soft launch in a country with a very good relationship with a long term partner. We’ll digest that, we’ll optimize that and then we’ll scale that with the other international markets. So that’s again a long answer saying, I would anticipate doing some of those in the second, third quarter of this year 2016 and based on that optimization period then scaling it to the latter half of the year and then into 2017.

[Ben Haynor:]

Okay. That’s helpful. And then lastly from me - our surveys have suggested that Q4 is shaping up to be a more robust year in terms of instrument installations then we see in the past couple of years, can you kind give us a sense of what you’re seeing out in the field so far in Q4?

[Kevin Wilson:]

I would echo some of the earlier company calls in the quarter. I think the tide is in a reason for everybody and I think the veterinarians are in a nice cycle and so we’re seeing very positive response. I'd like to think that some of those folks are interested in making transitions because of some of the savings they can realize and some of the benefits they can realize. So I actually think Heska is moving the needle a little bit on some of those numbers broadly because a lot of folks haven’t considered that that's a place where they can do better and I think the market is starting to embrace that idea that they should look at what they were doing for blood diagnostics. So yes, I would agree with that just in general.

[Jason Napolitano:]

I agree Ben, the tonality seems good, it seems like the economy is ticking up some strength from the limited data we have.

[Ben Haynor:]

Great. Well thank you very much gentlemen and congrats on the quarter.

[Operator:]

[Operator Instructions] We'll go next to Kara Anderson with B. Riley & Company.

[Kara Anderson:]

Hi good morning, thanks for taking my question. Could you remind me would this acquisition of Cuattro International satisfy the remaining 25.4% non-controlling interest?

[Jason Napolitano:]

No, they are separate entities. The Heska Imaging US was limited only to the United States market. So what this is – this is a 100% acquisition of essentially the international market of similar product.

[Kevin Wilson:]

Essentially the same business internationally and the ownership post close will be 100% ownership by Heska of the international business and it will continue to be 55% ownership by Heska in the U.S. and so those puts our exercise probably after 2016 or 2017 is our current expectation.

[Kara Anderson:]

Great, thank you.

[Operator:]

That concludes our question-and-answer session today. At this time I would like to turn the call over to Mr. Wilson for any additional or closing remarks.

[Kevin Wilson:]

Thanks everybody. We entered the fourth quarter a bit ahead of our internal schedule. In 2015, we worked hard to deliver great results while laying the foundations for the long-term health of our business and our systems. There is still a lot of work to do on all of these fronts and the competition isn't sitting still but overall I see great trends in the market, I see confident Heska teams, healthy margins, successful bundling programs and a robust sales geography and product pipeline for Heska. So we are encouraged for a strong finish to 2015 with our strong base in multiyear contracts in the United States, new international expansion opportunities, and exciting product launch, extensions on tap, we are excited to compete in the win in 2016 as well. So I look forward to updating you again after the close of the year. And until then, thanks for your interest in Heska and have a good day.

[Operator:]

That concludes today's call. We appreciate your participation.