Heska Corp (HSKA) 2017 Q4 法說會逐字稿

Good day, and welcome to the Heska Corporation Fourth Quarter and Year-end 2017 Earnings Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Brett Maas of Hayden, Investor Relations. Please go ahead, sir.

Thank you. Prior to discussing Heska Corporation's fourth quarter and full year 2017 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 in places including Heska Corporation's annual and quarterly filings with the SEC. Any forward-looking statements speak only as of the time they are made, and Heska does not intend 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 Strategist; and Catherine Grassman, Heska's Vice President, Chief Accounting Officer and Controller. (Operator Instructions)

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

Thanks Brett. And good morning, everybody. Today, we're pleased to report fourth quarter and full year results for 2017. Our release this morning contains information and details around a one-time non-cash charge of $5.9 million or $0.77 per diluted share related to enactment of the 2017 Tax Cuts and Jobs Act. Adjusted and on a non-GAAP basis to exclude these impacts, Heska delivered record fourth quarter net income of 39.8% over the prior year to $4.8 million, which is $0.63 per diluted share. For the year, we produced a 50.8% increase to $15.9 million in net income, which is $2.07 per diluted share.

Consolidated gross margins rose 5.4% in the fourth quarter to 46%, and 3.6% to 45% for the full year, which helped to deliver a 3.2% rise in operating margin for the fourth quarter to 19.7%, with full year operating margins rising to 14.1%. Cash flow from operations rose 77.8% over the prior year to $10.4 million. Our balance sheet is in excellent condition, and our liquidity position is healthy and supportive of our growth plans.

On an operational and profit basis, Heska exceeded my goals for 2017. Missing my goal was a $7.7 million shortfall in imaging sales compared to the very strong prior year, which resulted in the majority of the consolidated revenue underperformance for the year. Going forward, however, for 2018, we see imaging revenues returning to 10% growth and early results for January and February are confirming this rebound.

The core of our growth and profitability is, and continues to be, our point-of-care laboratory consumables and subscriptions under our unique Heska Reset subscriptions model. In the fourth quarter and for the full year, Heska won market share, realized increasing test volume and price and finished the year with the largest installed base of users in our history. Given that this is our highest margin product line, its continued strong growth in excess of 15% throughout 2017 and into 2018 is encouraging.

For 2018, our job at Heska is clear: first, continue to win in our baseline domestic plan that emphasizes Heska Reset diagnostic subscriptions; second, continue the growth in Heska Imaging that we have seen in January and February; and third, work to deliver on our next big product and geographic expansion opportunities to drive major steps up in growth. I'm optimistic that we can do these things well. As we do our work, I hope long-term shareholders may invest and benefit alongside us, our customers and our industry partners.

Now I'd like to take a moment to welcome Catherine Grassman, our Chief Accounting Officer to the call. I, the Board of Directors of Heska, and the entire accounting and finance teams of Heska have been impressed by Catherine's intelligence and excellent work for some time now, and we couldn't be happier for Catherine and for investors that she has taken on an expanded role. In addition to Catherine's excellent work, she's a genuinely wonderful person, and I'm sure everyone will be better off for knowing her and for working with her.

Now with that, I'll turn the call over to Catherine to go through the details of the quarter and the year. Following Catherine's comments, I'll provide additional insight into our plans and upcoming Investor Day scheduled for May 15 in New York City. Then we'll open the call to your questions.

Catherine, you're up.

Thanks, Kevin. For the fourth quarter, we recorded revenue of $36 million, an 8.9% decrease over $39.5 million in the fourth quarter of 2016. And full year revenue of $129.3 million, a 0.6% decrease over $130.1 million in 2016. Revenue for the Core Companion Animal Health segment, or CCA, was $29.7 million in the fourth quarter, a 10.2% decrease over $33.1 million in the fourth quarter of 2016. CCA revenue was $105.2 million for the full year, a 2.1% decrease over $107.4 million in 2016, largely due to $7.7 million less in imaging revenues. As a reminder, CCA revenue is comprised of: first, our care -- our core point-of-care laboratory products, which include subscription agreements comprised of several components, including lab consumables and equipment; second, our point-of-care imaging products; and third, our single use pharmaceuticals, vaccines and diagnostic tests for companion animal use.

Our Other Vaccines and Pharmaceutical segment, or OVP, generated revenue of $6.3 million in the fourth quarter of 2017, down slightly from $6.4 million in the same quarter last year. However, on a year-over-year basis, the OVP segment revenue increased 6.5% to $24.2 million in 2017, from $22.7 million in 2016.

Our gross margin improved in Q4 to 46% as compared to 40.6% in the fourth quarter of 2016. Full year 2017 gross margin increased to 45% from 41.4% in 2016. Improvement in gross margins for both periods largely resulted from favorable pricing across point-of-care lab and imaging products, favorable product mix in our OVP segment and full year 2017 revenue and cost of revenue offsetting adjustments as reported in our Form 8-K.

Total operating expenses on a year-over-year basis grew 7.2% to $40 million from $37.4 million. The increase was most notable in G&A expenses, which were up 12.9% year-over-year due to increases in compensation and consulting fees.

Fourth quarter operating income grew 8.9% on a year-over-year basis to $7.1 million, compared to $6.5 million in the fourth quarter of 2016. Full year operating income grew 10.2% to $18.2 million, compared to $16.5 million in 2016.

Depreciation and amortization was $4.8 million in 2017 as compared to $4.6 million in 2016. Stock-based compensation was $2.7 million in 2017 as compared to $2.3 million in 2016.

Our effective tax rate for the quarter was 115.1% and 48.5% for the full year. As a result of the enactment of the 2017 Tax Cuts and Jobs Act, we revalued our deferred tax assets, primarily consisting of our net operating loss carryforwards, in light of the reduction to the federal tax rate. This resulted in a nonrecurring, non-cash accounting charge of approximately $5.9 million. Excluding the impact of this one-time charge on a non-GAAP basis, our effective tax rate was 31.6% for the quarter and 16.4% for the full year.

Including the -- including impacts from the 2017 Tax Cuts and Jobs Act, net loss attributable to Heska Corporation for the fourth quarter of 2017 was $1.1 million or a loss of $0.14 per diluted share. For full year, net income attributable to Heska was $10 million or $1.30 per diluted share. Excluding the previously mentioned nonrecurring, non-cash accounting charge attributable to U.S. tax reform, adjusted net income attributable to Heska for the fourth quarter was $4.8 million or $0.63 per diluted share as compared to $3.5 million or $0.46 per diluted share in the fourth quarter of 2016. On a full year basis, excluding the impact of U.S. tax reform, net income attributable to Heska was $15.9 million or $2.07 per diluted share as compared to $10.5 million or $1.43 per diluted share in 2016.

Kevin, back to you.

Thanks, Catherine. Before we go to questions, I'd like to spend a few moments updating you on our outlook for 2018. In our Core Companion Animal segment, the outlook for our point-of-care laboratory and imaging products in 2018 is encouraging. Our teams and customers remain confident in the unrivaled accuracy, speed, breadth and value combination of Heska technology under the Heska Reset model. We believe Heska Reset subscriptions will win market share for Heska and currently serve domestic markets and in potential international markets.

In lab consumables, the major growth and high-margin profit driver for Heska, we anticipate consumables growth to continue to be between 15% and 20% with stable-to-improving gross margins. Contributing to lab consumables growth in 2018 and beyond is our expectation that Heska will win between 350 and 475 new veterinary hospital subscribers from competitor accounts.

To support organic, domestic customer share gains and any future product line extensions, Heska intends to expand the North American based point-of-care diagnostic sales and utilization teams from 85 dedicated professionals to 106, a roughly 25% increase beginning in June and paced evenly through December. This expansion in sales professionals will also prepare Heska for upcoming growth initiatives, which include new product launches into the North American market in the first half and possibly also in the second half.

As indicated on our last call, we have begun a new product release cycle in point-of-care laboratory equipment and consumables. To kick things off for 2018, late last year, we launched the new Element COAG analyzer and test platform. This is a new and additive product line for Heska point-of-care laboratory, and we've been pleased that this launch has gone well and customers and the sales teams have responded enthusiastically.

Close on the heels of last year's Q4 launch of the Element COAG platform, in early February at the 2018 VMX Conference in Orlando, veterinarians were excited to learn of the prerelease debut of Henry Schein Animal Health's new Axis-Q lens software solution. Axis-Q lens consolidates trends, reports and shares in-clinic laboratory and reference laboratory results from a broad array of providers chosen by the veterinarian for display and analysis on computers, smartphones and tablets. Because of Henry Schein's leadership in practice information management solutions, the majority of veterinarians will now have the choice and the flexibility to consolidate and trend results from Heska in-clinic laboratory with their reference laboratory provider's results. This has been a major request from veterinarians for several years and Henry Schein and Axis-Q lens are delivering strongly.

Continuing with the momentum, on March 4 at the 2018 Western Veterinary Conference in Las Vegas, Heska will release the first major new addition to the Heska dry chemistry product line since 2012, the Element DC5. The all-new Element DC5 delivers the highest throughput of any fully featured point-of-care veterinary dry chemistry solution by combining a new and higher level of automated workflow, unique simultaneous staging of 5 patient samples, onboard bidirectional data sharing with Axis-Q and other practice management software solutions, a streamlined touch interface, a modern and compact form factor and superior accurate dry chemistry performance from FUJIFILM, the inventor of dry chemistry technologies. The ultra-premium Element DC5 will be preferred by the highest volume multi-doctor specialty hospitals that do the most point-of-care testing. Element DC5 is targeted to begin to ship to customers during the second quarter of this year.

In imaging diagnostics, last year's mid-November debut of the all-new Slate Hub went well and the additional accessories for Slate Hub are expected to be generally available in the second quarter of this year. For Heska Imaging in 2018, we are pleased to begin the year on a solid go forward footing. While imaging revenues for 2017 were $7.7 million less for the full year than in the prior year, which accounts for the majority of our consolidated revenue shortfall, we expect imaging to return to 10% growth in 2018. In contrast to early 2017, Heska Imaging enters 2018 integrated, with a robust pipeline, benefiting from newly launched products, capturing a new extended maintenance revenue stream and experiencing a good head start from a solid performance in January and February.

Moving on to our Other Vaccines and Pharmaceuticals, or our OVP segment, Heska's team delivered an above trend line result in 2017 with revenue growth of 6.5% to $24.1 million and gross margins that increased by 6.9% to 31.4%. Each of these achievements exceeded expectations and historical ranges, which we have viewed for some time as 3% multi-year revenue growth trends at 18% to 20% gross margins. In-line with these multiyear trends and adjusting for 2017 outperformance, absent new initiatives in 2018, we expect OVP to achieve approximately $21 million in revenues at roughly 19% gross margins.

Overall, veterinary market indicators continue to point towards broad-based growth with industry estimates of 5% veterinary hospital growth and 7% hospital diagnostics growth appearing to be intact as 2018 begins. Our baseline target for 2018 is for approximately 7% consolidated revenues growth from the areas discussed previously on this call, namely a mix of market share gains in existing markets, increased sales team density, tests and analyzer additions, healthy pricing and increased utilization from the largest installed base in our history.

Due to positive margin mix led by higher-margin, faster-growing laboratory consumables and a return to growth in Imaging products, our baseline target for 2018 assumes gross margin expansion of 30 to 50 basis points along with positive inventory conversion trends. It is important to note that our baseline target for 2018 excludes the effects of growth initiatives, which we currently identify as being geographic expansion and major product line extensions and investments that may result in substantial impacts to our estimated baseline target in 2018 and the actual future performance. Key growth initiatives are scheduled to be more fully shared during our Investor Day, scheduled for May 15 in New York City. Key growth initiatives may include: research and development investments for projects slated for launch in 2019 and 2020; major new product line extensions into addressable markets in excess of $100 million in size, the first of which is expected to occur during the second half of 2018.

As a reminder, Heska has been pursuing urine sedimentation, urine chemistry, fecal testing, analyzer-based single and multiplex measurement of unregulated substances and infectious disease detection as well as other product line extensions. Growth initiatives may also include geographic expansion investments and initiatives outside the United States, which are anticipated to be meaningful and a significant opportunity and challenge for 2018 and 2019.

We will host an Investor and Analyst Day in New York City on May 15 to update our baseline target for 2018 and to provide more details on our growth initiatives and their potential impacts for 2018 through 2022.

At this point, we'd like to take the opportunity to open the call up for your questions. Operator?

(Operator Instructions) And our first question, we'll hear from Mark Massaro with Canaccord Genuity.

I guess the first one on the guidance for 2018, I just want to confirm, Kevin, that the 7% growth is -- which you're calling a baseline target, does not assume contribution from new products or geographic expansion or new sales hires, is that correct?

That's correct. The new sales hires will be in that plan, we called that out for June through December but the baseline, the way I look at it, is blocking and tackling and running our current playbook domestically. So geographic expansion is outside of that, major analyzer additions are outside of that -- and I would look at the sales force expansion as two things. Part of that is part of realizing our roughly 2% market share gain and then part of that is an anticipation of growth initiatives. So we would, kind of, have to do both of those things.

Got it. So it's reasonable to think that with the benefit of some new product launches that double-digit growth for 2018 is something that you think you might be able to achieve? Of course, I know that that's not in your baseline but just for investors to get a sense of where the numbers may fall at the end of the year? Double-digit growth is something you probably could achieve if you perform on your new product launches.

Mark, I don't want to scramble the egg, I'd purposely unscramble the egg by saying, look the baseline business is doing well. Consumables are good, profitability is good, gross margins are good, we're executing well, the macro market in the U.S. is good. There are going to be some headwinds in OVP year-over-year, they are still doing fine, but that's -- when it's up 6.5%, it's got to normalize to a long-term trend of 3%. So you'll have up years and you'll have down years. So what I'm trying to say is to make it easy on folks, if you kind of put the puts and takes into the mix, you come up with a 7% baseline. And then on top of that, if we successfully launch a new product or do a geographical expansion, then yes, I think growth is in excess of 7%. The question then becomes for folks like you to answer at what time do we do that and how much does that affect the calendar year? Fortunately or unfortunately, I'm not entirely calendar-year driven, so if we get it right and it costs us 2 months, I'm -- of delay to get it right, I'm not that stressed about whether or not growth comes in at 7% or 9% in 2018. I'm more focused on what does a 3-year plan look like and getting that right. So I'm not squirming on you a little bit, but I'm trying to be a little more precise to say baseline is 7%, if we get these step-up events earlier, 2018 could be higher than that. If we get them later, they have less impact in the calendar year.

Okay. That makes perfect sense. On the OVP segment, obviously you had a good year with 6.5% growth for '17. The 2018 guidance, if I'm doing the math right, is for minus 13%. My understanding is that OVP typically would hover between maybe a 7% to 8% grower and a 3% grower. So can you just provide some context for why OVP you're expecting a decline of double digits?

No. We look at that -- the term we've used, I think, for years, even years before I even got here, so maybe decades, has been inflationary grower. I moved away from that term because I'm not aware there has been a lot of inflation in the last couple of years, I didn't know that it was all that precise. But I think inflationary grower has often been interpreted as about 3% growth. And so I think that's really been a trend line and it's lumpy. It's a contract manufacturing business largely, so it is reliable and you know generally what you're going to get for the year. You don't really know what you're going to get for each quarter, so it's lumpy because it's based on purchasing managers at the contract manufacturing side taking inventory that meets their needs, and we simply produce and deliver on their schedule, not ours. So, no, I would look at that as a 3% long-term grower, and so if it outperforms to 6.5%, it's got to normalize with a down year, and I think that's all we're seeing. And then next year could be up again. A lot of it is just based on again trends of the people who buy the products out of that facility. So I think they're doing a good job. They're doing their job, which is producing really quality stuff at a USDA facility for folks like Elanco, Bayer, Merck, and they're doing a good job, but they don't control the end-user market and pull through and the timing of their inventory shipments as much as our other businesses.

Great. And last one for me on the Element DC5x, congratulations on that soon-to-be roll out. You indicated in the press release that this is a 5-patient sample, high throughput analyzer. Can you just maybe speak to where you see this fitting in, in a industry that has plenty of competition? So can you just speak to the value it has relative to some of the other -- your existing platform as well as the competitive platforms in the market?

I think categorically, it is absolutely the gold standard in space. If you look at high-volume users, which are the most coveted users for everybody, so call it 3 main competitors of which we're one, we all covet the largest high-volume users. And the largest high-volume users will do lots of testing for things like presurgical testing. And so their morning, if you go sit in a veterinary hospital, that's a specialty hospital, multi-doctor, their morning is very, very busy, and they're trying to do presurgical panels before anesthesia. And they might have patients lined up in each room ready for surgery and the faster they can run those things through, the faster they can their surgeries done, the faster that they can discharge those patients and get the next set through. It's a big deal, and I do think it will attract specialty hospitals both corporately owned specialty hospitals and individually owned specialty hospitals. And I think history has shown that when you get the top end users in the market, and they're very, very happy with your accuracy and speed, that, that kind of gives you a credibility halo to get that next group of customers that might not be quite as large. So we think it's a big deal. We think it definitely puts Heska at the top of the heap. It's dry chemistry technology from the inventor of dry chemistry technology, it's accurate, it's precise, it's faster than anything out there and I think large-volume users are going to love it. So we're excited about it. I think, it's a big deal.

And next, we'll hear from Raymond Myers with Benchmark.

Let me first pick up on that Element DC5x, it sounds really exciting, congratulations for getting that out. I want to ask you about the revenue recognition for that, is that primarily that customers will run more chemistries and therefore you get more throughput? Or is there any placement revenue that you make at the time of placement?

So it's both. When we do a subscription, there are multiple components to a subscription. And there are a number of options to doing that. So if you place a more expensive piece of equipment, you'll have higher costs on that equipment in that placement. Now depending on the total value of the long-term contract, you'll get an equipment portion of revenue booked the month that you place that. Some of these specialty hospitals, on the other hand, we might place them at no minimum usage, knowing that these are very, very large users and placing a $1,500 a month minimum usage or a $3,000 a month minimum usage isn't what's going to drive the usage. If we were to do that, it would actually fall under operating lease accounting, where you would get no upfront revenue for the equipment, all of which is to say, in my mind, it doesn't matter a whole lot how we recognize the equipment portion of our placements. What I focus on is market share gains, the number of veterinarians who themselves are growing diagnostic 7%, 8%, that have agreed to put all of their dog and cat blood through our infrastructure. And if I can get the largest users to put the most amount of dog and cat blood through our infrastructure for 6 years, I'm far less concerned about the upfront revenue recognition. So I would just caution folks that sometimes we focus on the what happened this month. The whole point of moving to a subscriptions model was to not focus on the upfront equipment sale portion but to capture and grow and benefit with the veterinarian as they put dog and cat blood through our infrastructure for 6, 7, 8, 10 years. That's really the goal. Does that answer your question, Ray?

Yes, well said. Let's move on to your guidance that you'll be increasing the sales force substantially in the second half of this year, sounds exciting as well. Can you talk about what -- how you would deploy this additional sales force? What type of growth opportunities you see stemming from that? And what expense do we expect in the second half? Because I do believe your guidance was excluding the extra expense of some of these growth initiatives, so help us understand how that flows through.

Yes it is, and I'm going to kick the can down the road a little bit to Investor and Analyst Day because there are a lot of moving parts in that question. So you have the flow in of the expense, you have the productivity of the new sales reps, layer on that the market share gains and then layer on that any new product launches. And I think what we're saying by the expansion is first of all, we can use more density because we're growing and second of all, we need more happy, smiling, trained, enthusiastic faces in front of veterinarians because 9 out of 10 veterinarians still haven't converted from a competitor to Heska yet. So we need more people to go to talk to 9 out of 10 who still have something else that should hear our value proposition. And I think the third thing that we might be saying with that is if we layer on a major new product launch, it's a new segment, a new product area for us, then we probably need more happy, smiling, enthusiastic faces to go tell 10 out of 10 veterinarians that don't have Heska in that product area why they should. We'll be a little more specific on the Investor Day about the financial impacts and how to model that but pretty difficult to do I think on a call without a PowerPoint slide or 2.

We'll look forward to that. Can you give us any guidance around profitability? I understand you're making these investments that will be tremendously helpful over the next year or 2. How should we think about the impact on profitability for 2018?

Yes. And I think probably the same answer, I will be a little bit more specific, all those moving parts I just listed, if you invest in sales force and something runs through the P&L, it hits the P&L. If you do a research and development investment just prior to launch, that might run through the P&L. And so I encourage investors to look at this business on a long-term trajectory and say 2 things. If the highest margin consumables are growing nicely and healthy, it's our job to deploy that growth and that gross margin and that profitability in other areas that are going to then drive high-growth consumable margins over a multiyear period. And it's less our job, I think, to worry about 90-day impacts of a particular spend that could swing things for us, I do think we can do a better job on a go-forward basis of communicating and anticipating some of those investments and matching them up with those swings, and so we intend to get out a little bit ahead of those things again on May 15 on our Investor Day. And I think, you'll have a little bit more to kind of fill out your model.

Great. And the last question is for Catherine. What is the 2018 tax rate that you're assuming?

Candidly, lower than the statutory and blended state rates, hovering around 20%.

And next, we'll move on to David Westenberg with CL King.

I know you're trying to avoid that scrambling and unscrambling, but I'm looking at the 2-year stock growth rate, and you ran at 11%, now you're going off an easy comps, so that 7% growth rate that you're calling out as the base case, now would there be upside to that given the fact that we are kind of in a 2017 easy comp here?

Yes. I don't know that I want to go there. I think, we were careful, and we tried to be reasonably precise in calling out 7%. And I think, we want to stay there, I'll leave it to investors and analysts to assume or presume whether we're going to be successful with a growth initiative in 2018. I think if we are, it could be better. I think if we're delayed, it could be 7%. And I know there's variability in there, but that's part of the reason we like to play the game, there's a little tension there, and we'll try and make it much better, and -- but we want to set the expectation at 7%, so that's what we've done.

Got it. I apologize. I know that was one you are trying to avoid. I'm going to go to on to some of the new products here. Can you talk about whether you're going to rely a little bit more on third-party? Or with this, you might take some of this in-house? Can you talk about what the rationale would be either to take it in-house or rely on the third-party? And what the both -- the impact would be both on the P&L and from a revenue impact?

Yes, David. I can tell you what I've done in the past, and how I think most of this is done in actuality, whether it's Heska or our competitors. For most of these analyzer-based technologies, with a couple of exceptions, we rely on third-party partners who manufacture hardware and technology, and we do it with them to [veterinarize] it. I do think that some of these products we've been working on are maybe a little bit more tailor fit and customized to our needs, so we are spending a little bit more time. We think getting them right as opposed to just adapting things that are available on the human side, and I would point to kind of the urine sedimentation and chemistry space as an example. We do think we can do some interesting things there. But we're not going to announce that we've purchased a plant in Shenzhen, China, and we're now manufacturing things directly. And I don't think that's inconsistent. I think Apple uses contract manufacturing as well, so we won't be spending tens of millions of dollars on fabrication and things like that. Did that answer the question? I think that was the question.

Actually, going a little bit more -- I'm looking more about the impact on R&D on the P&L as you're going to do these new products, whether, I don't know, for instance, you're talking about a urine sediment analyzer, I'm guessing that's going to be something that you would have a third party OEM and manufacture to you and then maybe your R&D would just come in at the very end as you're [veterinarizing] it. I'm just trying to get a handle on what the P&L might look like as you're launching these new products. Keeping in mind, I know a lot of this is coming in the Analyst Day, if you want to get vague, that's perfectly fine with me. I'm just trying to understand what these new products are going to be in terms of impact on P&L.

I think you've got it, in terms of concept. Again, the reason we called out, kind of, a base case 2018 target and then we've got the growth initiative off to the side is there's nice symmetry there. And I think investors would then be able to say, okay there's an investment here that may or may not run through the P&L but here's exactly the size of the market. Here's the opportunity, here's the margin, here's the step-up event. And I think having that symmetry just off to the side where you can evaluate that as a project base as opposed to having it embedded in your 2018 base target is helpful to investors. And so we tend to want to focus on May 15 on some of the growth initiatives as stand-alone evaluation as opposed to, again back to scrambling the egg, we're trying to avoid scrambling the egg.

And you touched on, in prior calls, about winning more consolidated practices. Now you have a new really high throughput instrument, you called out that this is going to be for large vet practices. Now, would this have maybe some upside opportunity to win maybe some consolidated practices that also have to be maybe consolidated in the same region? Just give us, maybe, a way to think about some of the upside with this new product and new kinds of customers that maybe traditionally you haven't been able to get in the past.

Yes. So I would start with and not pridefully, but I would say we have been able to get them in the past. The way we got the PetVet Care Centers' contract was their 2 largest specialty facilities with millions of dollars in revenue had already converted to Heska from our competitors prior to being acquired by PetVet Care Centers. And when PetVet Care Centers acquired those very, very large hospitals and again top 5% type of hospitals in the country in terms of volume and size, and they looked at the performance of diagnostics and they're smart folks, they know that diagnostics may represent 20% of the business that they just acquired, their question was why is diagnostics so much better in these 2 very large hospitals than the rest of our portfolio. And so they picked up the phone and said, "Why is your diagnostics so much better than the rest of our portfolio." And the answer was, "Yes, we moved to Heska, we think it's great, equipment is great." I think the Element DC5 just enhances that ability, whether it's a corporately owned contract we're trying to win or whether it's a standalone very large hospital that someday becomes corporately owned or stays standalone, I think you'd have to put us in the leadership position if throughput and ease-of-use and speed and dry chemistry, accuracy is your punch list of things that you're looking for, I think, we have to be the leader in that evaluation, and so I think it's a big deal.

Next, we'll move on to Kara Anderson with B. Riley FBR.

So with the new equine products released in the quarter that were believed to have caused delays in sales in the third quarter, can you provide more color on what you believe is the key reason for the imaging's underperformance in Q4? And was it really further delays in your investment? And second to that question is for imaging to be up 10% for the full year, does that require an acceleration from what you're seeing in January and February?

So I'll take it in reverse order. It does not require an acceleration from what we're seeing in January and February. So there is a nice start to the year that I think just confirms what we're thinking for the full year. In terms of the fourth quarter launch, the Slate Hub products and those accessories launched, I think on November 14, and then when you back into Thanksgiving and then you back into Christmas, you back into New Year's, you don't really have an awful lot of selling days, let alone an awful lot of shipping days. And so I think, the team did a really good job. They also, from a profitability standpoint -- we don't look at it on a product line or unit base profitability but they generated an awful lot of contribution margin for the fourth quarter. The prior year's fourth quarter was just really good and -- but the fourth quarter for 2017, I think, was profitable and the folks did a very good job. So all of which is to say, I think, imaging is integrated. We had to focus on integrating that business from June 1 through December. And I think it's largely integrated, and I think gross margins for the fourth quarter were good. I think, the product launch went very well. I think, the accessories will start to layer on, which are kind of additive revenues. We've never had those accessories that are new with Slate Hub, so it's a little bit of tailwind there. They've got the service revenue. I mean, there are just a number of reasons why we're pretty optimistic that it's back on the solid footing and back to a 10% grower.

Great. And then second and last one for me, and I'm sorry if I missed it, but did you talk about the reformulated heartworm test that was slated for 1Q?

We didn't, and I think it's actually slated for the first half. So I'm going to get a little squishy on you on that one, but I don't think it's not a 1Q. I'm still optimistic that it's a first half. We will push very hard. I think, heartworm season is coming up into full swing, and we'd like to be on market. I will point out though that -- I want to put that into context because that's a nice additive, but it's not really core to really our growth plans going forward. That heartworm franchise was maybe a $10 million franchise in 2012, and it's shrunk now to just under $2 million. So if you look at that and you just straight line that, maybe it's going backwards $2 million a year for the last couple of years. So it's been a headwind. But it's already under $2 million, so even if we did nothing, it would be pretty difficult to lose more than $2 million because it's already under $2 million. So there's not a lot of downside in that. And so I do think, on a go-forward basis, when that new reformulation comes to market at much better gross margins, which means much better end-user pricing, I think the differentiation between multiplexing tests that do 4 tests as opposed to a heartworm test, which I think is still a very popular segment, I think that slightly under $2 million franchise probably goes back to growth. But again, we're still in USDA regulatory, and we're still in acquiring samples to get that. That continues to be the delay. I'm still optimistic that we might get that in the first half.

And our next question, we'll hear from Jim Sidoti with Sidoti & Company.

I understand you're a little bit hesitant to getting into too much detail ahead of your Investor Day, but just on a high-level basis, I think what you're saying is we should assume that operating margins will decline or will not increase in 2018 the way they did in 2017 because of some of these increased investments in sales and marketing, is that right?

I think that's fair. I think that's fair. And we haven't been precise on that, but we'll be more precise on it on the Investor Day. But even then, it's -- spreadsheets are very precise, they might not be very accurate. So there's still a human factor here. You still have to recruit people in June and July and August and September, then you have to roll things out and so you can't control all those human factors. And I pointed out in the past, we are still of a size where those human factors can move things on a 30- to 90-day basis. They aren't really trends, they are just a function of the fact that we're still of a size that you can do better on a 30- or 90-day and you get a positive swing or you can have that human factor that delays things or costs things a little bit higher in terms of expense for a 30- or 90-day period and you have a negative swing. And so I just caution folks to not extrapolate that forward. The strategy in the long-term benefits of a 3-year rollout are far more important than trying to nail whether or not it's X basis points or Y basis points in terms of operating margin.

And I assume over the 3-year plan that operating margins will improve?

I think so, I -- know past performance is no guarantee of future performance disclaimer, but I recall when we started our work in early 2014, we were under 10%, maybe 8% operating margins. I think, we finished this year at 14%. So we've picked up about 200 to 250 basis points in most years that I've been here. I don't think there's anything miraculous that would cause that to stop on a long-term basis but I would just caution folks that a quarter doesn't make a trend. So we've taken it from 8% to 14%, we had a high watermark of 19% and change in the fourth quarter. So every year, we have a high watermark in the fourth quarter that's higher than last year's high watermark and then we drift towards that. And I think, I've said publicly for a couple of years that I do see our long-term operating margins drifting up towards where our bigger competitors are, and I still that -- I still see that to be the case.

Okay. And then last question. I just want to confirm, Catherine said, did you say the GAAP tax rate in '18 will be around 20%?

Yes.

We'll move on to Ben Haynor with Aegis Capital.

Just a couple of quick ones for me. On the growing from 85 to 106 sales and -- sales/utilization people, how does that -- is that all -- first off, is that all domestically? And then how does it shake out, is it adding a dozen new territories and a dozen new utilization people to man those territories as well as a dozen new salespeople? Or how do you think about that? Or how should we think about that?

Yes. So we have blood diagnostic laboratory point-of-care folks, we have imaging folks, we have some that have been piloting a dual role where they carry the entire point-of-care diagnostics offerings, and then we're divided into regional manager territories and each of those territories is expanding and actually has been expanding for some time. I think, we're just a little quieter about it. We went ahead and called this one out because there's a step-up. I think just in anticipation of maybe some new products that are going to require more happy, smiley faces telling veterinarians about why they should switch to Heska. So I would just think it's more -- we're not revolutionizing the sales force, we're just increasing the density. And we saw open territories literally where it's just plain too much geography for a human being to cover all the clinics in the territory. So for us finding points of expansion without pinching high performers is, I think, easier than it is for folks who have higher density already.

Okay. That's helpful. And you called out, you expect like 350 to 475 new customer wins, which sounds pretty similar to kind of what you've been running at the past couple few years after you take out the corporate accounts. Do you -- in that 350 to 475, do you assume that there are some corporate accounts in there that maybe the new DC5 helps you win? Or doesn't that really factor into that number?

No, we do assume that there are corporate wins in that number. And I do think the DC5 will help us with some specific corporate accounts that we've been working to convince, but it's competitive. The other guys might decide to put 5 analyzers on the counter and say they have a DC5 too, I don't know. It's competitive, so -- but I think we're just confirming maybe with a number as opposed to a percentage to try and give some context. People here, 1.5% to 2% they may not be aware of just how many hospitals that is, so I just try to put a number on it. That's really the only change in my script.

And next, we'll move on to Andrew Cooper with Raymond James.

A lot has already been asked, so I'll keep it kind of brief here. But higher level, if we think back to when international imaging was kind of brought in and what the approach was to geographic expansion, it feels like now it's pushed out further than I think you'd initially expected and is more of the outside growth initiative, but could you just give some color on kind of what's been different on that relative to initial thoughts? And kind of how you're looking to approach it? Anything there would be helpful, please.

That's a good question. International is a hugely important growth initiative for us. And so I go back in preparation for calls and I read the transcripts and I look at the last couple, and this is a continuation of the work that we've been doing for 1.5 years now. But I think, we're solving for a 20-year problem in terms of logistics, in terms of infrastructure, in terms of reach. We would like to establish a structure that is competitive with the largest competitors, much more than we'd like to have a tiny beachhead somewhere that just improves this year's results. So we've been focused, I think, a little bit more longer term with maybe a little bit bigger of an appetite. We have that progress, we've spent a lot of time on this particular issue. Recently, we have entered into a letter of intent that codifies some of that progress for an expansion. And so it does look like it's pushed out, but we do think there will be some success here in 2018. We're not at the point now that we want to call it out here in February 28, but we do think we're getting close to being able to launch in a bigger way.

And that will conclude today's question-and-answer session. At this time, I would like to turn the call back over to management for any additional or closing remarks.

Thank you, operator. And thanks to all the investors and analysts who called in. I'll just leave you with a couple of my thoughts. There is -- the value-creating work that we've done in 2017 has positioned us, I think, very well for the next several years. And 2017 was uncharacteristically quiet on major step-up events, but our pipeline of major opportunities has never been this large, broad, healthy or ripe. Our first act from 2013 to 2017, that period rewarded us primarily for improving our base business, and I think we've achieved that. I think our second act from 2018 to 2022 holds more value-creating opportunity and reward than our first act. And in that new period, we're going to focus on broadening our product and expanding geographically. I'm fully aware of the strength and the size of our competitors and the difficulty of the goals that we have, but I am placing my confidence in Heska to win in this next act from 2018 to 2022. And I'm super encouraged that we have well-informed industry partners and we have long-term investors who join me in my optimism that we can accomplish these things. So I look forward to updating everybody on May 15 during our Investor Day on our progress and with more details on this optimism and our plans. And we'll see you soon. Thanks. Bye-bye.

And that will conclude today's call. We thank you for your participation.