Heska Corp (HSKA) 2015 Q4 法說會逐字稿

Good day, and welcome to the Heska Corporation Fourth Quarter and Year-End 2015 Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Brett Maas. Please go ahead, sir.

Hello, and welcome to Heska Corporation's earnings call for the fourth quarter 2015 financial results. I am Brett Mass of Hayden IR, Heska's Investor Relations Firm.

Prior to discussing Heska Corporation's fourth quarter 2015 results, I'd like to remind you that, during the course of this call, we may make certain forward-looking statements regarding future events or future financial performance of the Company. We need to caution you that any such forward-looking statements are based on our current beliefs and expectations, and involve known and unknown risks and uncertainties which may cause actual results and performance to be materially different from that expressed or implied by those forward-looking statements. Factors that could cause or contribute to such differences are detailed in writing in places, including Heska Corporation's annual and quarterly filings with the SEC. Any forward-looking statements speak only as of the time that 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 statement was made.

We have with us this morning Kevin Wilson, Heska's Chief Executive Officer and President, and Jason Napolitano, Heska's Chief Operating Officer and Chief Financial Officer. Mr. Wilson will begin with a summary of the results we reported today. Following further comments by Mr. Napolitano and Mr. Wilson, we'll open up the call for your questions, and conclude with Mr. Wilson's closing comments.

Now, I will turn the call over to Kevin Wilson, Heska's Chief Executive Officer and President. Floor is yours.

Thanks, Brett. Today marks the third anniversary of my joining at Heska, and I just wanted to open the call this morning for a few moments and just take a second to thank everybody at Heska for welcoming me. I've been energized, inspired and challenged by them every day to succeed, and I look forward to many more years of success with them.

Now, on to the earnings. Heska had a great fourth quarter and a fabulous 2015 by nearly every measure. For the fourth quarter, revenue was up 22%, gross profit was up 22%, operating income was up 103%, and net income rose a wonderful 144%.

For all of 2015, consolidated revenue rose 16% to a record of $104.6 million. Gross margin increased 2.5 percentage points, gross profit increased 24%, operating income increased 194%, net income doubled to $5.2 million, and stockholders' equity grew over $10 million. These were record results for Heska, and I think it's fair to say that the men and women of Heska beat expectations on the top-line and on the bottom-line, and that they delivered for customers and shareholders in 2015. Because of them, our core business has never been healthier, and the future has never been brighter for Heska.

As I prepared for today's call, I went back to look at last year's transcript for context. On last year's call, I noted that Heska had gotten the mix of annual financial performance and long-term priorities just about right in 2014, then I noted that our model was working, our model was proving to be nicely scalable, and I was more encouraged about Heska's future going into 2015 than at any other time. As we enter 2016, our model is working, our model is proving to be nicely scalable, and again, I'm more encouraged about Heska's future than any other time.

With that nice thought in mind, I'll turn the call over to Jason for more detailed review of our financial results. Jason?

Thank you, Kevin. We had a particularly strong fourth quarter this year, which caps off a record year for Heska. For the first time ever, Heska's annual revenue exceeded $100 million, and the Company achieved the highest levels of profit in its history.

Total revenue in the fourth quarter of 2015 was $29.8 million, a 22% increase from $24.3 million in the prior year period. For the full year, total revenue was $104.6 million, up 16% from $89.8 million in 2015.

Heska has two operating segments - Core Companion Animal Health, or CCA, and Other Vaccines, Pharmaceuticals, and Products, or OVP. The results of our 54.6% owned subsidiary, Heska Imaging US, LLC, or Heska Imaging, is included in our CCA segment.

In 2015, blood testing and other non-imaging instruments and supplies represented 37% of our consolidated revenue, 30% from consumables and 7% from hardware revenue. Both Heska Imaging and our OVP segment represented 19% of our consolidated revenue.

Other revenue, which consisted primarily of our heartworm and allergy-related products, represented 25% of our consolidated revenue. In the fourth quarter of 2015, our CCA segment had revenue of $22.9 million, up 9% from $21.1 million in the prior year period. These results included $6.7 million from Heska Imaging in the fourth quarter of 2015, an increase of 11% as compared to $6 million in the prior year period.

In addition to the improved performance of Heska Imaging, key factors in the improvement were greater revenue from our heartworm preventive, our hematology instruments, and our chemistry instruments, somewhat offset by lower international revenue and domestic revenue from our heartworm diagnostic tests.

OVP revenue in the fourth quarter of 2015 was $6.8 million, up 114% from $3.2 million in the prior year period. Greater revenue from our contract with Elanco, a unit of Eli Lilly & Company, as well as a new product from one of our customers, were key factors in the improvement.

CCA 2015 revenue was $84.2 million, an increase of 16% as compared to $72.4 million in 2014. This includes $19.6 million in 2015 revenue from Heska Imaging, up 44% as compared to $13.6 million in 2014. In addition to the significantly improved results from Heska Imaging, increased revenue from our instrument consumables, our chemistry instruments, our hematology instruments, and our allergy drops, somewhat offset by lower international revenue and lower domestic revenue from our heartworm diagnostic tests, were key factors in the change.

[2000] OVP revenue was $20.3 million, an increase of 16% as compared to $17.5 million in the prior year period. Increased revenue from a new product for one of our customers was a key factor in the improvement.

Gross profit in the fourth quarter of 2015 was $12.2 million, up 22% as compared to $10 million in the prior year period. This includes $2.7 million in gross profit from Heska Imaging in the fourth quarter of 2015, which represents an increase of 29% from $2.1 million in the prior year period.

Gross margin, that is gross profit divided by total revenue, was 41.1% in the fourth quarter of 2015, down slightly from 41.3% in the prior year period. Lower gross margin on some of our instrument consumables, somewhat offset by improved gross margin at Heska Imaging, was a factor in the change.

2015 gross profit was $44.2 million, a 24% increase as compared to $35.7 million in 2014. This includes $7.5 million in 2015 gross profit from Heska Imaging, which represents an increase of over 100% from $3.6 million in 2014.

Gross margin was 42.3% in 2015, up 2.5 percentage points from 39.8% in 2014. Higher gross margin in our OVP segment due to product mix, as well as higher gross margin for Heska Imaging, were key factors in the improvement. We continue to believe a gross margin of 35% represents a reasonable target for Heska Imaging, going forward.

Our operating expenses were $8.7 million in the fourth quarter of 2015, an increase of 5% from $8.3 million in the prior year period. A key factor in the change was increased commissions, which contributed to an increase in our sales and marketing expenses. For the full year 2015, our operating expenses were $35.7 million, an increase of 9% as compared to $32.8 million in the prior year period. Increased commissions and distributor incentives, which contributed to an increase in our sales and marketing expenses, were key factors in the change.

2015 depreciation and amortization was $4.2 million, up from 2014 depreciation and amortization of $3.7 million. Increased depreciation and amortization from rental units was a key factor in the change.

2015 stock-based compensation was $2.3 million, and 2015 excess tax benefit from stock-based compensation was $1.5 million. This compares to stock-based compensation of $1.7 million and excess tax benefit from stock-based compensation of $228,000 in 2014.

Operating income was $3.6 million in the fourth quarter of 2015, an increase of 103% as compared to $1.8 million in the prior year period. 2015 operating income was $8.6 million, an increase of 194% from 2014 operating income of $2.9 million. These results include 2015 operating income of $799,000 from Heska Imaging as compared to a 2014 operating loss of $2.1 million from Heska Imaging.

The changes in interest and other expense were largely due to currency effects for both the quarterly and annual periods. On the bottom line, net income attributable to Heska Corporation was $2 million in the fourth quarter of 2015, an increase of 144% as compared to $829,000 in the prior year period. This translates to $0.28 in diluted earnings per share attributable to Heska Corporation compared to $0.12 per share in the fourth quarter of 2014.

2015 net income attributable to Heska Corporation was $5.2 million, more than double our 2014 result of $2.6 million. This translates to $0.74 in diluted earnings per share attributable to Heska Corporation compared to $0.41 per share in 2014.

As discussed extensively in our public filings, the owners of the 45.4% of Heska Imaging which we do not own, which I will refer to as the imaging minority, have certain put rights to sell us the remaining equity of Heska Imaging. Our 2015 results have greatly clarified the put structure.

Excluding for more discussion put rights in Change-in-Control scenario, there are now two put rights available to the imaging minority, which each may be exercised following the audit of our 2006 financial statements, and each may be exercised following the audit of our 2017 financial statement. After that, these puts rights expire.

Obviously, the earliest that any of these put rights could be exercised is in 2017 following the audit of our 2016 financial results. If either put is exercised, the imaging minority will be entitled to the value of 25% of Heska Imaging's cash in addition to the values I will discuss in a moment.

The first put level is available if Heska Imaging generates at least $20 million in revenue. This put is struck at nine times operating income subject to a maximum payout of $13.6 million. The second put is available if Heska Imaging generates at least $30 million in revenue and $3 million in operating income. This put has a fixed payout of approximately $17 million. We may deliver up to 55% of the payout value on both of these puts and stock, with the stock valued at essentially 10% discount to market.

Our latest estimate for Heska Imaging in 2016 shows over $20 million in revenue and over $2 million in operating income. So, we expect the imaging minority to be in a position to exercise its first level put, but not its second level put, following the audit of our 2016 financial statements.

Our latest estimate for Heska Imaging in 2017 shows results just at the $30 million of revenue and $3 million in operating income levels. So, we expect there is a good chance that the imaging minority will be able to exercise its second level put following the audit of our 2017 financial statements.

Last November, we announced the acquisition of Cuattro Veterinary LLC, which sells the same digital radiography products in the veterinary market internationally which Heska Imaging does domestically. I will refer to Cuattro Veterinary LLC as Cuattro International for the purposes of this discussion.

We filed a proxy statement for a special meeting to obtain the shares necessary to close this transaction, which the SEC has chosen to review. As a result of our dialogue with the SEC, we have decided to have an audit done for the financial results of Cuattro International in 2015, and are planning to have the vote for our stockholders to approve the increase in our authorized shares previously contemplated to occur at a special stockholder meeting to be held at our Annual Meeting of stockholders this coming May 13.

The 2015 unaudited financial results we have obtained for Cuattro International show revenue of $5.3 million and operating income of $578,000. Assuming we have a positive vote and obtain the required share increase, we anticipate the closing of the acquisition of Cuattro International on May 31.

In summary, we posted yet another outstanding quarter in the fourth quarter of 2015. We have commercial success across many of our different product lines. We were also able to increase gross margin significantly, and successfully leveraged our operating expenses. We can't promise that every quarter will be a strong as this one, but we can say that we will continue to work diligently so that every quarter has the potential to show such strength. We look forward to adding more exciting opportunities to our business in the coming years. With that, I'll turn it back over to you, Kevin.

Thanks, Jason. I'd like to conclude our prepared remarks by providing you with our expectations for results and for reinvestment in Heska during 2016.

On a veterinary market-wide basis, I continue to see a healthy market for veterinary care overall, and I agree with most of the industry that this trend is well established after a very strong fourth quarter [and] to 2015. Specific to Heska, with our momentum and good prospects coming out of a great 2015, continued growth in Heska's current core business looks promising.

When I joined Heska in 2013, it was to help build the enterprise exponentially more valuable than the one we had begun with. Since that time, we've seen the market value of Heska rise sixfold. We try to be good stewards and allocators of our resources, and I think we've largely gotten that right. We've pursued healthy profits in growing shareholder value through a careful balance of consistent and strong quarterly earnings on the one hand, and investment in future growth engines for long-term value creation on the other hand.

At times, a tension may exist between these two priorities. When confronted with a choice, we tend to favor a larger upfront investment in long-term value creators over marginally higher immediate term reported earnings.

I see the possibility of making this limited time tradeoff in 2016 to accelerate some promising growth projects that are fast ripening.

One such project is our single-use blood test space. As many of you many know, at the end of 2014, the largest player in the single-used testing space moved to a direct-only sales model and moved away from distribution. This created a great deal of demand from our distribution partners for a full family of single-used lateral flow blood tests to replace tens of millions of dollars on lost distributor sales in this segment.

In 2015, Heska competitors have benefited unchallenged by Heska from this new demand. In 2017, Heska will compete to fill this demand. There's a big opportunity for Heska to expand beyond our single approved SOLO STEP brand of heartworm test to a full family of lateral flow tests.

Several months ago, we announced that we are aggressively expanding our test menu to do just that. As we navigate this expansion, we may accelerate our regulatory investments in this segment to bring to market several tests in 2017 and 2018 that should meaningfully increase our long-term results and our value.

Depending on the size and the timing of our efforts to finalize USDA registration for these new products, we may invest up to $2 million in 2016 towards these regulatory investment efforts. Given this variable, it's probably worth spending a few minutes talking about the outlook for our business over the next couple years. Jason?

Thank you, Kevin. The trend in recent times at Heska has been away from specific financial guidance. While we expect this trend to continue, there may be specific times when we feel a more detailed financial outlook would be beneficial to stockholders. We believe this is one of those times.

We estimate our 2016 revenue will be a bit shy of $120 million, including approximately $3.5 million from Cuattro International, which we assume will close at the end of May.

We currently have purchase orders and forecasts in our OVP business that includes some of our lower gross margin products. Due to this product mix combination, in 2016 we expect consolidated gross margins as compared to 2015 to be pressured and down by about one percentage point. Longer-term, we would expect our recent trend towards higher gross margin to continue as we continue to grow our install base of instruments using our higher margin consumable products.

Absent a potential regulatory investment to expand our lateral flow test menu, we expect approximately $11 million in 2016 operating income. To state the obvious, if we spend an additional $2 million on a regulatory investment an $11 million estimate for 2016 operating income would become a $9 million estimate. Assuming we do not make a regulatory investment, we estimate our 2017 revenue would be approximately $135 million, and our 2017 operating income will be more than $15 million.

Any new product launches in 2017 resulting from the regulatory investment would represent incremental revenue and operating income opportunities in 2017. While we are optimistic the success we are experiencing will continue, we don't expect it will be linear by month or by quarter. For instance, large contract manufacturing orders in OVP that we ship during the first quarter -- that we plan to ship during the first quarter may slip into the second quarter of 2016. This does not affect our revenue outlook for the year, but it does affect our year-over-year first quarter results comparisons.

We currently expect revenues to be approximately flat in the first quarter of 2016 as compared to the first quarter of 2015, and investors should expect to see a very slight operating loss for the first quarter of 2016. Longer-term, we continue to believe that our OVP segment will generate inflationary-type growth, albeit with a certain quarter-over-quarter lumpiness. We continue to believe that our CCA segment will grow revenue in the low-double-digits, our gross margin will trend upward, our operating expenses will grow more slowly than our revenues, and we will continue to investigate attractive acquisition opportunities.

At this time, I would like to turn the call over to the operator for Q&A.

Thank you. (Operator instructions.) Nicholas Jansen.

Hey, guys, nice finish to 2015. A couple questions here.

First, on the USDA registration, that $2 million potential investment for 2016, how you guys think about the 2017 and 2018 revenue opportunity if you are to grow your portfolio of rapid assays from one to something that's much bigger than that? What do you think about the overall market, where you'll be differentiated, and kind of the returns off of that investment?

Hey, Nick, it's Kevin. Thanks for the question.

Given our size, its substantial. I think one of our competitors reported 140% increase in that segment last quarter. So, it's a very nice space that Heska should be competing in, similar dynamics to what we're competing in with the chemistry, hematology, blood gas, analyzer business, and we think we can pick up a meaningful amount of that business.

So, we don't know if it's a $40 million opportunity or an $80 million opportunity, but it's on the order of those types of numbers. So, when you start looking at our baseline, there's pretty substantial growth there, and we think it's worth controlling our future and making those investments.

And maybe just a follow-up for that Jason. In terms of that $2 million spend, would that basically just go away in 2017? So, if you think about that $15 million or so EBIT number provided in 2017, you don't have to subtract another two off of that like you did for 2016, correct?

That's correct, Nick. There might be some smaller opportunities we look at in 2017, but not on the order of $2 million. So, you would see our R&D line literally more than double versus the numbers we just reported, and then I expect it to come down significantly in 2017, more like the baseline you've been seeing.

Okay, that's helpful. And then, secondly, thinking about the instrument success that you've had over 2015, obviously you've had creative ways to drive great adoption there. But, just wanted to kind of get your thoughts on the consumable pull-through, how we should be thinking about the acceleration of consumable growth as those instruments are leveraged?

Yes, Nick. The first step is placements continue to rise, and because we have more of a kind of a software-as-a-service-style contract with our customers, those placements tend to be pretty darn sticky.

So, our net subscriber base is really how we refer to it internally, continues to grow very nicely. Our usage within that net subscriber base similarly continues to grow very nicely. So, we don't call out specific growth numbers on that, but the trends are very good, and they continue to actually improve.

And I would just add to that, Nick, I'm not sure if you were implying this, but if you were, we found that a vet tends to test as they're going to test, and it's actually quite challenging to change the way they're practicing medicine. So, to the extent we see average usage numbers changing, that's usually more of a function of getting to a larger, or let's say a smaller vet on average than the ones we had in the pool previously, rather than going out there and changing the way those veterinarians are using the instruments.

Okay. And then, on the 1Q color regarding the potential slip of orders at OVP and kind of flat revenue, I just wanted to kind of make sure I understand that a little bit better. So, are you talking about OVP revenue being flat year-over-year or down significantly, which would bring down the total consolidated? Because I'm just trying to get a better sense of the bridge on the CCA segment year-over-year in the first quarter.

Sure. I expect OVP is going to be down, Nick. We're seeing in some of the products we're getting POs on on the CCA side a similar phenomenon. So, I expect CCA to be up, but only up slightly.

But, in both cases, we see forecasts in POs after the first quarter that's going to make up for that, and then some. So, this is one of the timing issues that we tried to refer to on the prepared remarks, where sometimes you get a little bit of a shift, and you've got a quarter that's not too exciting. But, as long as you've got the orders and the forecast for the rest of the year, it's not too troublesome.

Okay. And then, my last question would just be from a cash flow perspective. Thinking about the working capital drain you guys have had over the last two years as you placed instruments versus selling instruments, when should we expecting kind of an acceleration in free cash flow? And on that point, is the use of that cash flow all gobbled up with the put rights that are outstanding? Thanks.

Yes. You will see when we file the K, cash provided by operating activities was $2 million this year. I expect that number is going to grow throughout the future as we move forward. And your intuition is right. We're probably not going to look at doing too much else with that cash until we've got clarity on some of these put rights.

I'll stop there. Thanks, guys.

Thanks.

Thank you. (Operator instructions.) Ben Haynor.

Good morning, gentlemen. Thanks for taking the questions.

Hey, Ben.

Hey, Ben.

Hey, if you do decide to do the $2 million investment in the lateral flow test, when would that start? I mean, is that something that could start two weeks from now, or is that more likely to happen this summer, or later in the year?

Yes, I think right now we're anticipating some time during the second quarter.

Okay. And then, can you give any color on how the Element i is doing and whether that's helped you get other instruments into some of these large and mega-size practices that you've talked about in the past?

Yes, you bet. It's one of those funny things. On a call, you have to rewind your brain and stop December of the following year when you're living January and February of this year.

The short answer to your question is the Element i has kind of blown the doors off what we expected it to do. It's having a great launch. But really, those analyzers started shipping in January in earnest, and I think it's beat every expectation we've had from uniform production line. So, it's going quite well.

Yes, we've been very pleased with the initial uptake of that product, Ben.

Great. And then, has it helped you get other equipment into practices?

It has, but you're stealing my thunder for May. But yes, it's a very attractive product, and it's something that's very unique. Nobody else has it. So yes, it's getting us in the door where we wouldn't otherwise get an invite.

Okay, great. And then, on Cuattro International, you may have discussed this in the past, but is the gross margin there pretty similar to what you see with the Heska Imaging?

It's going to be a bit lower, Ben, because you're going for distribution, where most of the Heska Imaging business is a direct business. So, I think we said expectation is 35% for Heska Imaging, I'd say may be 10 points lower, maybe a little bit lower than that, for the international business.

Okay. I think that's all I had, gentlemen. Thanks for the time.

Thank you. (Operator instructions.) [John Breisler].

Hi, thanks for taking my questions. Just wanted to clarify that the only new product -- there were no new products revenues recognized in Q4 but just the Element i is the new product for 2016. Is that correct?

That's correct. So, it was announced but did not begin shipping until Q1. We may have shipped one or two.

We shipped some.

One or two in Q4.

You shipped one or two in Q4?

We really didn't start commercially available shipments in earnest until January.

Can you kind of frame or quantify what, quote-unquote, (inaudible)? Like, that would be helpful. I'm just trying to get a feel for what this product could hopefully be for you guys.

Yes, we really stay away from specific analyzer numbers. It's not 10s, it's hundreds, and it's not thousands. So, sorry to play Pin the Tail on the Donkey, but it's variable, but has exceeded our sales forecast.

Great, I appreciate it. That's all I have.

Hey, thank you.

Thank you.

Thanks.

Thank you. (Operator instructions.) Jennie Tsai.

Hi, guys, how are you today?

Great. How are you doing, Jennie?

Good. Thanks for the questions. I just have -- I guess I'll just ask one on Element I, too, because is that on a subscription model also?

It is.

Okay, just wanted to clarify that. And then, secondly, Kevin, any thoughts on the sales and marketing organization, any additions or changes for 2016?

That's a great question. We're slowly expanding it, and by that I mean we don't really believe in big scale-ups. You hire talented people one at a time. I will note that I think it is getting easier for us to recruit talent in the industry. When some competitors pay lower commissions and lower bonuses, it tends to put the higher quality reps perhaps in play for recruitment, and so we're actively recruiting experienced reps throughout the country.

But, there's not a plan to say let's double the sales force. We're having a great deal of success with our friends over at Henry Schein. I think we've got a very, very good model and a very good training program. So, now it's just a matter of, in kind of a healthy, organic way, expanding that territory-by-territory.

Great. That makes sense. Thanks so much.

You're welcome. Thank you.

Thank you. (Operator instructions.) And it does appear we have no further questions at this time. I will now hand it back over to you speakers for any additional or closing remarks.

Thank you. Heska had a great 2015, and I couldn't be more proud of the people and the work that we did. They delivered a great financial performance, and they laid a solid head start for 2016.

Our core business is growing nicely. We're super-encouraged by the trends in that business and the overall market. We have exciting new developments in the works to drive even faster growth over the next several years.

So, I'd like to thank shareholders for trusting us with their investment. We're honored, and we take it very seriously. And I look forward to updating you again in May on our progress. Thanks, and have a good day. Bye.

And that does conclude today's program. We'd like to thank you for your participation. Have a wonderful day, and you may disconnect at any time.