ABAXIS (ABAX) Clinton H. Severson on Q4 2016 Results - Earnings Call Transcript

| About: ABAXIS, Inc. (ABAX)

ABAXIS, Inc. (NASDAQ:ABAX)

Q4 2016 Earnings Call

April 28, 2016 4:15 pm ET

Executives

Joe Dorame - Managing Partner, Lytham Partners LLC

Clinton H. Severson - Chairman & Chief Executive Officer

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

Donald Wood - President & Chief Operating Officer

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

Rick Betts - Director, Medical Sales & Marketing, Medical Diagnostics

Analysts

James P. Sidoti - Sidoti & Co. LLC

Erin Wilson - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Ethan T. Roth - Stifel, Nicolaus & Co., Inc.

Nicholas M. Jansen - Raymond James & Associates, Inc.

Mark Massaro - Canaccord Genuity, Inc.

David Westenberg - C.L. King & Associates, Inc.

Ben C. Haynor - Feltl & Co.

Operator

Good day, and welcome to the Abaxis Fourth Quarter and Fiscal 2016 Financial Results Conference Call. All participants will be in a listen-only mode. After today's presentation there will be an opportunity to ask questions. Please note that this event is being recorded.

I would now like to turn the conference over to Joe Dorame with Lytham Partners. Please go ahead, sir.

Joe Dorame - Managing Partner, Lytham Partners LLC

Thank you. Good afternoon and thank you for joining us today to review the financial results of Abaxis for the fourth quarter and fiscal year 2016, which ended March 31, 2016. Again, my name is Joe Dorame. I'm with Lytham Partners, and we are the Investor Relations consulting firm for Abaxis.

With us today representing the company are Mr. Clint Severson, Chairman and Chief Executive Officer; Mr. Ross Taylor, Chief Financial Officer; Mr. Don Wood, President and Chief Operating Officer; Dr. Craig Tockman, Vice President of Animal Health Sales and Marketing, North America; and Mr. Rick Betts, Director of Medical Sales and Marketing, North America.

At the conclusion of today's prepared remarks we will open the call for a question-and-answer session. If anyone participating on today's call does not have a full text copy of the press release, you can retrieve it from the company's website at abaxis.com or numerous financial websites.

Before we begin with prepared remarks we submit for the record the following statement. This conference call may include statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including but not limited to statements related to the company's cash position, financial resources, and potential for future growth; market acceptance of new or planned product offerings; future recurring revenues and results of operations. Abaxis claims the protection of the Safe Harbor for forward-looking statements contained in the Reform Act. These forward-looking statements are often characterized by the terms may, believes, projects, expects or anticipates, or words of similar import that do not reflect historical facts.

Specific forward-looking statements contained in this conference call may be affected by risks and uncertainties, including, but not limited to, those related to transitioning medical sales to Abbott; losses or system failures with respect to the company's manufacturing facilities and operations; fluctuations in quarterly operating results; the market acceptance of the company's products and the continuing development of its products; required FDA clearance and other government approvals; manufacturing and distributing its products on a commercial scale free of defects; the protection of the company's intellectual property or claims of infringement of intellectual property asserted by third parties; risks related to the condition of the United States economy; and other risks detailed under Risk Factors in the annual report on Form 10-K and other documents filed by Abaxis from time to time with the United States Securities and Exchange Commission.

Forward-looking statements speak only as of the date the statements were made. Abaxis does not undertake, and specifically disclaims, any obligation to update any forward-looking statements.

With that having been said, I'd like to turn the call over to Mr. Clint Severson, Chairman and Chief Executive Officer of Abaxis. Clint?

Clinton H. Severson - Chairman & Chief Executive Officer

Great. Thank you, Joe, and good afternoon, everybody. After a few comments, I will turn the call over to Ross Taylor, our CFO, who will review the numbers for Q4 and FY 2016. Then Don Wood, our President and COO, will cover both the vet and medical markets. After that, we'll take questions. Both Craig Tockman and Rick Betts will be available for the Q&A session.

We had a great Q4 with sales and earnings up double digits year-over-year. For the year, sales and earnings were at record levels, with total sales up in the high-single digits, but adjusted for currency, finished just under 10%. Earnings were up double digits as well.

For Q4, year-over-year medical sales were up double digits. Vet sales, adjusted for currency, were up double digits. Total consumable sales were up double digits. North American sales were up double digits. Gross margins were up double digits, and expenses as a percent of sales were down.

In addition to that, we bought back stock and raised the dividend 9%. So with those highlights, Ross, you're on.

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

Thanks, Clint. I will review the highlights from our financial results and other important fundamentals for the quarter, and also for the fiscal year. As I've mentioned in previous calls, Abaxis completed the sale of its AVRL reference lab business to VCA in March of 2015, and we've reclassified AVRL as a discontinued operation at that time. Accordingly, when discussing the financial results today and comparisons against prior quarters, my figures exclude any contribution from AVRL, with the exception of one item I will discuss at the end of my remarks.

So moving on to the details of the quarter, total revenues in Q4 increased 10% to $57.0 million, compared to $52.0 million last year. Changes in foreign currencies reduced our total revenue growth in the quarter by less than 0.5%. For the entire fiscal year ending in March 2016, our revenues increased 8% to $218.9 million from $202.6 million last year. Foreign currencies reduced revenue growth for the year by about 1.3 percentage points.

Importantly, total consumable revenues in Q4 increased 14% to $43.1 million from $37.8 million last year. For all of fiscal year 2016, consumable revenues were $165.0 million compared to $144.4 million last year, an increase of 14%.

In Q4, instrument sales decreased 5% to $11.1 million from $11.7 million last year. For the full year, instrument revenues were $43.0 million compared to $48.6 million last year, a decrease of 12%. Global veterinary revenues were $46.6 million in Q4, a 9% increase from $42.6 million last year. This increase was driven by a 14% increase in veterinary consumables, partially offset by a 7% decline in instrument revenues. For the full year, global veterinary revenues increased 8%, driven by 14% growth in consumables.

Global medical revenues were $9.5 million in Q4 compared to $8.7 million last year, an increase of 10%. This increase was driven by a 13% increase in medical rotor revenue and a 6% increase in Piccolo instrument revenue. For the full year, medical revenues increased 7%, driven by a 14% increase in consumables.

Focusing within our consumable product lines, Abaxis sold a total of 2.48 million rotor units on a global basis in Q4 compared to 2.27 million units in Q4 last year, for an increase of 9%. Total rotor revenues increased 8% to $31.5 million from $29.3 million last year. Total rotor revenues grew at a slower pace than units, primarily due to a change in the sales mix of medical versus vet rotors and a small impact from foreign currencies.

Global sales of vet rotors were 1.55 million units in Q4 of this year compared to 1.46 million last year. This represents an increase of 6%. Looking at the various geographies, our sales of veterinary rotors in North America increased at a high-single-digit pace in the quarter, while our veterinary rotors unit sales outside of the U.S. declined approximately 1%. Europe was the source of weakness for our international vet rotors, as it was in the December quarter.

Global veterinary rotor revenues in Q4 were $24.7 million compared to $23.3 million last year, an increase of 6%. ASPs for vet rotors were (8:27) flat in both the North America and on a global basis. During Q4, global sales of medical rotors were approximately 930,000 units compared to about 815,000 units last year, which represents an increase of 14%.

Global medical rotor revenues were at $6.8 million compared to $6 million last year, an increase of 13%. Revenues grew at a slower rate than units, mostly as a result of mix and a small impact from foreign currencies.

For all of fiscal year 2016, global rotor units increased 12% to 9.5 million units from 8.5 million units last year. For the year, veterinary rotors units grew 9% while medical rotor units grew 16%. In Q4, revenues from other veterinary consumables which we define to include hematology reagent, i-STAT cartridges, coagulation cartridges, and rapid assay has increased 37% to $11.6 million compared to $8.5 million last year. The majority of the year-over-year increase in other veterinary consumables were the result of growth in our rapid assay product line which has had strong year-over-year growth since the March 2015 quarter. I should also note though that our hematology reagents also had very strong growth in the quarter.

Switching over to the instrument product category, Abaxis sold a total of 1,594 instruments in Q4 compared to 1,536 instruments in Q4 last year. Looking at the individual instrument product lines, Abaxis sold 320 Piccolos in Q4 compared to 283 in Q4 last year. Within our veterinary business, during Q4, Abaxis sold 680 VetScan chemistry instruments compared to 481 VetScans last year.

Hematology instrument sales were 391 units in Q4 compared to 471 in Q4 last year. In addition, Abaxis sold a total of 203 i-STAT and coagulation instruments in aggregate in Q4 compared to 301 last year.

Looking at our revenues by major geographic region, our total revenues in North America in Q4 increased 11% to $46.4 million from $41.8 million last year. Our international revenues in Q4 were $10.5 million compared to $10.3 million last year, an increase of 3%.

Now I'll move on to review gross profits, expenses, and income. In Q4, our gross profits increased 14% to $32.3 million from $28.4 million last year. Our gross profit margin was 56.7% in Q4 compared to 54.6% in Q4 last year, an increase of 210 basis points. The increase in our gross profit margin was driven by improvement in our rotor margins as well as product mix. Instruments were 20% of revenues in Q4 this year compared to 23% last year. For the full year, our gross profit margin was 56.3%, an increase of 250 basis points from last year.

During Q4, total operating expenses were $20.0 million compared to $21.2 million last year, a decrease of 6%. Operating income was $12.3 million in Q4 compared to $7.2 million last year, an increase of 72%. The operating profit margin in the quarter was 21.6%, consistent with the levels of the prior three quarters.

Our income tax rate was 33.0% in Q4 compared to 41.6% last year. Our tax rate for the full year was 34.1%. Based on our current views we anticipate our income tax rate for the fiscal year ending March 2017 should be in a range of 36.5% to 37.0%. Reported EPS from continuing operations were $0.36 in Q4 compared to $0.17 last year. For all of fiscal year 2016, reported EPS from continuing operations were $1.36 compared to $0.91 in fiscal 2015.

Just a few additional data points before I complete my remarks. Our blended rotor average selling price was $12.69 in the March 2016 quarter compared to $12.87 in the March quarter last year and $12.34 in the December 2015 quarter. Our cost of goods for each rotor unit was $3.47 in the March 2016 quarter, down from $3.73 in the March quarter last year and equal to the $3.47 level in the December 2015 quarter.

Also I should note that we took advantage of the low stock price and attractive valuation compared to historical ranges and we repurchased $13 million in common stock during the quarter. Specifically, we repurchased 325,000 shares at an average price of $40 during the quarter. We still have $24 million remaining under our existing share repurchase authorization. We finished the quarter with $152 million in cash and equivalents, down $3 million from $155 million at the end of December.

Finally, you'll notice within our Q4 income statements that we reported a gain from discontinued operations of $559,000 after taxes. This gain relates to the AVRL business which we sold to VCA in March 2015. During Q4, on the one year anniversary of the closing of the sale of our AVRL business we fulfilled certain conditions specified in the sale agreement with VCA that resulted in this gain. We do not anticipate recognizing any material items related to AVRL going forward.

This concludes my remarks, and I'll now turn the call over to Don.

Donald Wood - President & Chief Operating Officer

Thank you, Ross. Before getting into specifics about the performance of North American Animal Health and domestic medical, I want to review some highlights and key points from the results of our quarter and fiscal year. Overall we had a very strong quarter. Worldwide revenues increased 10% in Q4 and 8% on the fiscal year. Our North American Animal Health business had an overall excellent performance with double-digit revenue growth in Q4 compared to last year, and domestic medical business also grew double digits year-over-year in Q4.

Our international business was a little soft with 3% revenue growth but overall growth of 12% for the year. The year was bolstered in December quarter by 200 of our Piccolo units sold to a distributor in China. Europe was flat in Q4, while Asia Pacific and Latin America both grew double digits. Changes in foreign currency exchange rates reduced our international growth by 1.8% in Q4 and 8.5% during the year. The overall impact on total revenue was 0.3% in Q4 and 1.3% reduction for the fiscal year.

Importantly, worldwide growth in Q4 and the fiscal year were driven by revenues from consumables. Our worldwide consumable revenue grew 14% year-over-year in both Q4 and the year. Our consumables have higher margins and contributed to roughly 80% of our worldwide revenues. While Q4 worldwide instrument sales declined 5%, our worldwide VetScan instrument sales in Q4 increased by 32%. Our vet instrument sales to new customers in North America continue to be strong, and we increased our installed base and gained market share in the North American vet market during both fourth quarter and the year.

In addition, we're pleased with Abbott's performance in the U.S. medical market. Our installed base of Piccolos in North America continues to grow, and the North American Piccolo rotor units grew year-over-year at a double-digit pace for our ninth consecutive quarter.

Looking at margins, I am particularly excited about the 210 basis points improvement in our gross profit margin in Q4, and our 252-basis-point improvement for all of fiscal year 2016. Our Q4 rotor manufacturing costs declined 7% from last year's level, driving a 166-basis-point improvement in our rotor gross profit margin in Q4. Our environment at Abaxis is continuous process improvement in quality, costs and capacity, and we've got a history of continually reducing our rotor manufacturing costs.

We anticipate that there's still room to improve our cost per rotor over the next several years. Our operating profit margin was 20% or higher in each of the four quarters of fiscal year 2016, and it was 21.5% for the entire year. The improvements in revenue and margin resulted in operating income growth of 72% in Q4 and 35% for the fiscal year.

Our year-over-year earnings per share growth was 112% in Q4 and 49% for the fiscal year. Our results in Q4 are a testament to the strength of our partnership with Abbott and the efforts of our North American Animal Health sales and marketing team and the contributions of the North American veterinary distribution partners. We are pleased with our partnership with Abbott as it continues to grow and improve as they now work to penetrate the U.S. hospital and physicians' office, urgent care, and multiple other market segments.

In addition, our North American veterinary distribution partners are now settling in into focused and carefully coordinated routines with Abaxis. We and our partners are benefiting from our ongoing training activities, and our reps are building trust-based relationships and increasing our exposure and presence in the market. All of us are excited about our results and what will come in future quarters.

Turning to the details of North American Animal Health, we posted a total revenue of Q4 fiscal year 2016 of $37.4 million which was up 10.6% year-on-year or $3.57 million and 16% quarter-on-quarter or $5.14 million. We placed a total of 1,001 instruments in the quarter comparing against 1,105 last year and 1,003 last quarter. We placed 511 VetScans in Q4 which is up 13% year-on-year and up 27% quarter-on-quarter.

We also placed 297 hematology analyzers which was down 27% year-on-year and down 9% on the quarter. Of note, 42% and 53% of these analyzers, respectively, were placed in new customer accounts. We also placed a total of 193 VSpros and i-STAT instruments for customers in North America. Consumables on both of these lines continue to grow. With all of these placements, we grew our market share in Q4 and throughout the year. Overall, our customer attrition remains low.

North American rotors revenues increased at a 9% pace, while hematology reagent revenues increased 31%. Rapid test sales were up 90% year-on-year and 18% quarter-on-quarter. We are continuing both our sales booking programs along with the distribution initiatives in this quarter based on the success our programs are having in this product market.

For the fiscal year, North American Animal Health total revenue was $141.7 million, up 11%, offset by lower instrument sales. Rotor revenue, our most important metric, was up 10.7% and hematology reagent revenues, up 19.3%. Rapid revenues were up a very strong 81.3% year-on-year. While we have record placements in fiscal year 2015 with the distribution change, fiscal year 2016 was still our second best year on record for analyzer placements with a total of 3,727 instruments. Of these, 1,585 were VetScans, down 29% on the year, but with 875 in new customer accounts. We also placed 1,173 hematology instruments, down 10% year-on-year, but 61% of those were in new accounts.

Moving forward, our vet products offering have several new products ready for formal launch in the coming months that will add to our momentum. The VetScan Vue rapid test reader received excellent reviews at both the North American and Western conferences held last quarter, and we will launch this product in May helping us to grow our rapid test sales. The Vue will automatically time the test for the customer and will read and report the results for the veterinarian. The data can be transmitted back to the phone or a computer by means of an app. It can also be transmitted to the Practice Management Software. The functionality of this device is far and above anything our competition offers.

We are on schedule with the phased release of our total connectivity solution which will be our FUSE product line which will be released in September. This was previewed at NAVC in January, and again at Western Conference. Users were enthusiastic about the easy graphical user interface, the easy compatibility to the vet practice management system and the new bidirectional capacity it has, which allows our customers to take and execute orders across our instrument suite and to display, print and archive results.

Over the next few months, we will be phasing in both these connectivity solutions starting with our interim VetSync connection device, which we'll formally launch in May. This will allow easy connections between our chemistry and hematology instruments so that our customers can easily obtain and print these combined patient reports until the full FUSE launch in September.

We have a new program with the American Animal Hospital Association, which formally launched April 1. This strategic initiative leverages our Abaxis Professional Services group and helps our customers perform optimal medical diagnostic protocols. Our association with AAHA bolsters the credibility of our work and concepts, and we have already seen an overall increase in installed customer satisfaction as well as consumable utilization improvements at customer sites.

In Q1 fiscal year 2017, North American Animal Health also began the full rollout of our new national account in Banfield Hospitals. We have completed the beta sites and expect to install all hospitals by the end of September. We have an outstanding team working on the installs and training, and everything is working on our mutual plans and it's totally on time. Abaxis is now proud to be a primary supplier to the two largest veterinary hospital systems in the country, and we expect more new business from this market segment as corporate practices see the value of our cost savings, our workflow efficiencies and accurate instrumentation. We continue to improve our execution in the marketplace as we strive to continuously improve our sales training and our customer training, as well as work more closely with our distributor partners.

Through this vast network of both inside and outside distributor sales representatives, combined with our Abaxis regional sales managers and our professional services group, we have the ability to touch the customer with greater reach and frequency than our competition. Each component of our North American Animal Health sales and marketing engine is focused on growing our business by engaging and supporting the more than 1,000 professionals that represent our product in the market. Together, we will onboard new customers, increase utilization to our analyzers, grow our rapid test revenues and increase consumable growth with our existing customer base.

Now moving to North American Medical, for the quarter, Domestic Medical Division finished with revenues of $6.8 million, up 9% from Q4 last year, but down 2% from Q3's finish of $7 million. Shipments in Q4 included 756,000 rotors and 222 Piccolos product analyzers, which compares to 662,000 rotors and 222 Piccolos from the prior year. Rotor units shipped increased a healthy 14%, while instrument units were flat with last year.

For the year, the North American Medical Division finished with revenues of $25.3 million, eclipsing the $25 million mark for the first time in our division's history. Compared to last year, the Ebola-assisted finish of $24.9 million, revenues were up 1% year-on-year. We sold a record $2.9 million medical rotors in North America during our fiscal year, and we shipped a cumulative total of 724 Piccolos. Our partnership with Abbott continues to flourish as they work to penetrate both the U.S. hospital and physician's office market. Well over 100 of the Piccolo placements in fiscal year 2016 were with hospital customers where rotor utilizations are the highest.

In addition, at the hospitals in the U.S. continues to expand our footprint to include urgent care centers and free-standing emergency rooms. The Piccolo becomes increasingly important to efficient care deliveries. These sites see patients after hours and weekends when the hospital lab is closed and need accurate blood chemistry diagnostics on-site. The Piccolo is a logical choice for their mini-lab solution. Together with Abbott, we have a continued focus on this important segment for future growth.

The urgent care market continues to be the dominant Piccolo segment for placements growth in fiscal year 2017 and now represents over 20% of the Piccolo users base in the United States. The Piccolo was rapidly becoming the standard of care at urgent care market, and we look for this to continue as the population demands greater convenience for healthcare. Additionally, the pediatric market is evolving, and Abbott is focused on growing placements in this sector where there is both high utility and strong clinical need.

The Piccolo was certainly used for jaundice monitoring in infants, but also used throughout the pediatric care cycle. It's used for checking lipids and internal organ functions of childhood obesity and the side effects of acne prescriptions in young adults. The utility of the Piccolo continues to expand for patients and doctors alike.

And with that, I'll turn it back to you, Clint.

Clinton H. Severson - Chairman & Chief Executive Officer

Great. Thank you, Don. So next year, a key focus will be on R&D and the expansion of our international sales and marketing effort. Our high-sensitivity immunoassay project is moving to the next level. With feasibility completed, we'll be moving into the development phase. This will entail developing specialty tests that we can add to the disk and run with chemistries. We will start with vet and follow with medical tests. We'll also be developing expanded capabilities on our Piccolo and VetScan instruments that will allow us to potentially reduce our instrument costs to below $2,000, a key goal in the two-by-two program.

R&D expenses this year will increase by about $5 million, and we should launch our first tests in about 18 months. Once we have the first high-sensitivity immunoassay test completed, the additional ones will be less expensive to develop and will have a shorter time to market. Success with this project will allow us to compete in a market about double the size we are now competing in and will allow us to provide products in a medical segment with higher reimbursement rates.

As I've stated in the past, we have underinvested in our international business in the past. So this year, we'll be expanding our market coverage by adding folks in the markets where we compete. In the past, we have worked remotely through distribution. We expect this to add about $3 million to our sales and marketing expenses this year with returns starting in late Q3 or Q4. Success with these two initiatives will give us the runway for double-digit sales, earnings, and dividend growth for years into the future.

Goals for next year include double-digit sales growth with an increase in operating earnings despite the scale up in R&D and international sales and marketing expenses. We want to complete all the installations of the hematology machines in our Banfield accounts and keep our Phase II connectivity project on schedule with the launch date for Q2. Completing the launch of the VUE Rapid Test Reader in Q1 is a goal and, of course, hitting the development goals for our high-sensitivity immunoassay project will be key.

Okay. With all of that, we are now ready for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. And our first question comes from Jim Sidoti of Sidoti and Company. Please go ahead.

James P. Sidoti - Sidoti & Co. LLC

Good afternoon. Can you hear me?

Clinton H. Severson - Chairman & Chief Executive Officer

We can.

James P. Sidoti - Sidoti & Co. LLC

Great. Can you just give us an update on where you are with the orders for Banfield?

Clinton H. Severson - Chairman & Chief Executive Officer

Craig, you want to cover that one?

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

Yeah. (30:31).

James P. Sidoti - Sidoti & Co. LLC

Right. Have you started to ship?

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

Yes. So we have all the – there's about 50 sites installed to date, and there's a defined rollout schedule which will have everything installed and operating by end of December, close to 1,000 sites.

Clinton H. Severson - Chairman & Chief Executive Officer

It's right on schedule.

James P. Sidoti - Sidoti & Co. LLC

Okay. So you should be shipping about over 900 units in fiscal 2017?

Clinton H. Severson - Chairman & Chief Executive Officer

That's correct.

James P. Sidoti - Sidoti & Co. LLC

Right. And then, Clint, did you say that you expect to grow operating income even with the $3 million of extra sales and marketing expense?

Clinton H. Severson - Chairman & Chief Executive Officer

That's the goal.

James P. Sidoti - Sidoti & Co. LLC

Okay. Right. And then on the Piccolo – I'm sorry, there were a whole lot of numbers you put out. How many Piccolo units did you sell in the quarter?

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

222.

Clinton H. Severson - Chairman & Chief Executive Officer

Yeah. We shipped that out...

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

222 Piccolos.

Clinton H. Severson - Chairman & Chief Executive Officer

That's domestic. You might be asking global, Jim, which is 320.

James P. Sidoti - Sidoti & Co. LLC

Okay. And how does that compare to a year ago?

Clinton H. Severson - Chairman & Chief Executive Officer

283.

James P. Sidoti - Sidoti & Co. LLC

All right. Great. And then the Rapid Test reader, when did you say that will launch?

Clinton H. Severson - Chairman & Chief Executive Officer

Likely next month.

James P. Sidoti - Sidoti & Co. LLC

Okay. So you should start to see a contribution of that in probably your second fiscal – second quarter in the fiscal year.

Clinton H. Severson - Chairman & Chief Executive Officer

Yeah, Q2 or Q3. That's good.

James P. Sidoti - Sidoti & Co. LLC

Okay. All right. Thank you.

Clinton H. Severson - Chairman & Chief Executive Officer

Thank you.

Operator

And our next question comes from Erin Wilson of Credit Suisse.

Erin Wilson - Credit Suisse Securities (USA) LLC (Broker)

Great. Thanks for taking my questions. On the veterinary consumables trend, is that in line with your internal expectations both, I guess worldwide and North America, if you could comment on that? And is that what we should expect the run rate to be going forward?

Clinton H. Severson - Chairman & Chief Executive Officer

Yeah. Erin, Our expectations are usually higher than what we do. But in this case we're pleased with our consumable growth rate. And yeah, we expect to build on it. So we expect that to grow next fiscal year as well, yeah.

Erin Wilson - Credit Suisse Securities (USA) LLC (Broker)

Okay. And just can you speak to your distribution relationships or how are they progressing? Do you still have visibility from an inventory standpoint into the channel and how, I guess, generally are the relationships different than they were last year?

Clinton H. Severson - Chairman & Chief Executive Officer

Yeah. Craig, you want to handle that one?

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

Inventory is right where it should be. Everybody has what their expectations are. And like anything else, relationships take time to develop. We've been working together now four or five quarters depending on the distributor plus those that we've been working with for a long time. And those relationships are growing and getting stronger. We expect bigger things. The longer you work together, the better flow you get and the better you are able to identify our targets together and close them up. So we have that early excitement with all the change, and we've settled into a very good routine. And there's a lot of initiatives both from our side and our partner side to continue to grow that business and will remain our focus together.

Erin Wilson - Credit Suisse Securities (USA) LLC (Broker)

Okay. Great. Thank you.

Clinton H. Severson - Chairman & Chief Executive Officer

Thank you.

Operator

And our next question comes from Jon Block of Stifel. Please go ahead.

Ethan T. Roth - Stifel, Nicolaus & Co., Inc.

Hi. Thanks. This is Ethan Roth on for Jon Block. Just a couple of financial questions to start for Ross here. The first – in 2016, you delivered pretty substantial leverage particularly in gross margin but also in operating expenses. As we look to 2017, should we expect to see further improvement in margins? I guess, we should, based on Clint's comments but at a slightly lower rate than 2016. And would you expect the formula to be the same with most of the margin improvement coming from gross margin versus OpEx leverage? Thanks.

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

I think, first, Ethan, looking at the gross profit margin, I really would expect the pace of improvement there to moderate quite a bit in fiscal year 2016. I think mix is going to have some impact I think in fiscal 2017, and also, we leased a new facility here in Union City. They're also going to have an impact on the gross margin. So, I would expect a much more moderate level of gross margin improvement in fiscal 2017 compared to what we've seen previously. I think, with the operating expenses, I would take the numbers that Clint gave out to heart. And I think if you factor in some of those changes, I think, that's probably the best advice I can give you on the SG&A and R&D side.

Ethan T. Roth - Stifel, Nicolaus & Co., Inc.

Okay. That's helpful. And so I mean, on the buyback, you're active this quarter for the first time in a while. You mentioned in your prepared remarks, some of that seem to be opportunistic given where the stock was. But has anything changed with the company's capital allocation strategy given the amount of cash on the balance sheet?

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

Yeah. So, we increased our dividend as with the headline on the press release by 9%. And we are – we're careful about how we do our buyback program, but we have – how much, Ross, in the buyback program?

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

We have $24 million left.

Clinton H. Severson - Chairman & Chief Executive Officer

$24 million left. And if I ask for another $24 million, I think the board would probably approve it. So, yeah.

Ethan T. Roth - Stifel, Nicolaus & Co., Inc.

Okay. And then, maybe a final one for me. Clint, you mentioned building out the infrastructure international. But just looking at the North American vet business, can you just give us an update on how many direct North American vet reps you have in the field today, and do you believe that's properly sized to support your business and distributors in 2017? Thanks.

Clinton H. Severson - Chairman & Chief Executive Officer

Yeah. Craig?

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

We have – we have over 70 folks in the field. And we're going to add a few more over the next few quarters. And, yes, we feel very good about our field presence.

Clinton H. Severson - Chairman & Chief Executive Officer

Great. Next question.

Operator

And our next question comes from Nick Jansen of Raymond James. Please go ahead.

Nicholas M. Jansen - Raymond James & Associates, Inc.

Hey, guys. So, just one clarification first regarding the expense increases on the OpEx line. Is that year-over-year on top of normal growth, or is that the total dollar value that we should be thinking about from an uptake perspective?

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

It's an increase on top of what we spent. We're going to increase R&D by about $5 million and sales and marketing from Europe about $3 million. That's about $8 million.

Nicholas M. Jansen - Raymond James & Associates, Inc.

Okay. Just wanted to make sure that was the right metric. And then looking at the VetScan placements in the quarter, certainly, nice bounce back off a more modest level that you saw over the last couple quarters. Was there anything that changed in terms of your selling strategy? Have you taken a little bit more lead generation focus on with your own reps as you digest perhaps a little bit slower uptake from some of the distributors you signed on? How do we think about that number because it certainly was an acceleration from the recent trend?

Clinton H. Severson - Chairman & Chief Executive Officer

I think I'm not going to say too terribly much about how we're doing things. But yeah, I think like I said, we've got a growing opportunity with our distributor partners, and we have those relationships continuing to develop and we continue to look for opportunities together. And as Don mentioned in his comments, we have some very good leverage with these national accounts contracts we've been talking about over the last four or five quarters. And so it's really just a matter of continuing to work hard and work smart.

Nicholas M. Jansen - Raymond James & Associates, Inc.

Okay. My last question on rapid assays, do you have a run rate revenue where you're at today, so we can kind of get a sense of the market share you've captured over the last four or five quarters since launch of some of your new tests? And then kind of conversely with that, how do you position the VetScan VUE with distributors. Any sort of unique program that we should be thinking about from an adoption perspective right out of the gate? Thank you.

Clinton H. Severson - Chairman & Chief Executive Officer

I'll give you a revenue number, Nick, and some others can respond to the rest of your question. And I'm really not going to give you much of a revenue number, but we're kind of in the high teens in terms of revenues for the rapid assays.

Nicholas M. Jansen - Raymond James & Associates, Inc.

That's for the quarter?

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

I'm sorry. That's for the fiscal year.

Clinton H. Severson - Chairman & Chief Executive Officer

And as far as use of the Vet VUE, everything we do is designed to some more VetScans. And so that's a piece of use of VUE but frankly, it's such a fabulous oral instrument. We're going to want everybody who buys our rapid test to use the Vet VUE. So obviously, our goal is to leverage that instrument to entice people to buy and use more of our rapid test in addition to buying VetScans and hematology analyzers alongside it as they get excited about our rapids program. So, we're going to leverage the entire product line together.

Nicholas M. Jansen - Raymond James & Associates, Inc.

That's it for me. Thanks.

Clinton H. Severson - Chairman & Chief Executive Officer

Great. Thank you.

Operator

And our next question comes from Mark Massaro of Canaccord Genuity. Please go ahead.

Mark Massaro - Canaccord Genuity, Inc.

Hey, guys. Thanks for taking the questions. The first question is, can you comment if you've made any tweaks with your work with distributors and are there cases now where you have distributors behaving a little bit differently than maybe a quarter ago as they work with some of your direct reps?

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

We try and tweak our relationships all the time, Mark. No. I think all of our distributors are working very hard. Some are more effective than others and that's normal and some have a better focus than others, but everybody is working extremely well together.

Clinton H. Severson - Chairman & Chief Executive Officer

Yeah, I'll just make a comment as well. Okay. So we've been with this system of working through these large distributors for one year and one quarter. And so the relationship is still pretty new. One year and one quarter is not that long. And every quarter it gets better. Every quarter, people get more comfortable working with each other. Every quarter, our people get more skilled at managing other people because we kind of went from our guys doing their own thing by themselves out there to now having an average of about 20 distributor reps in each one of their territories.

So, that's a big change, and it takes a while for people to get proficient at that. But I think every quarter, it gets better. And when you look at the comparisons for our FY 2016 versus FY 2015 and you look at the fact that even though we had a big Ebola in 2015, we added stocking orders to these big distributors, we still beat the number by quite a bit.

And then when you look at the earnings, you look at the kind of leverage we get with using distribution, you look at our sales and marketing costs have gone down, and we get more efficient here as more volume comes in because our distributors help us sell more. And it's just kind of adding two and two, putting it together. You can see the results. So yeah, we're pleased.

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

The answer, too, Mark, is that I'm sure most of you know there was a major distribution change in another product line this past quarter which actually could have slowed things down for us because of a lack of focus, and we still grew the business very nicely. So like Clint said, we're working every day to get that relationship better and better.

Mark Massaro - Canaccord Genuity, Inc.

Yeah. Great. Yeah. Well, congratulations on the animal instrument number. I mean, it appears that it's up – increased 35% sequentially. Maybe more specifically, are you asking some of your distributor partners to sell as opposed to just generate leads?

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

No. We're responsible for closing our sales. We work with our distributors to identify the opportunities, help us open the door, help us ask for the sale, and that hasn't changed. Our distributor partner – our relationships are exactly as they've been.

Mark Massaro - Canaccord Genuity, Inc.

Okay. Great. And maybe a question for Don; really strong gross margin performance in the quarter. How should we look at gross margin opportunity as we look out to the end of fiscal year 2017? Is there a particular target that you have in mind?

Donald Wood - President & Chief Operating Officer

There is, but it's not something we make public. But what I said in my notes is that we expect our costs to go down every year. If you look back over the years, our costs have come down X amount per year on average, and that's a pretty good story going forward. Some of our best cost reductions – the Two by Two program is now in its seventh full active year, and the larger contributors are yet to come. We have multi-cavity tools that are actually – the steel's cut and we have validations that will be done latter part of this year, and all of that will then commence, contributing when it goes live, probably March or April next year.

But there are many, many smaller things that contribute to a rotor cost, small $0.01, $0.02, $0.03 reductions that add up to a whole bunch of cents at the end of the year. So each year, we have – almost like planes landing, we have cost reduction programs that are landing out on the production floor that contribute to the bottom line. So you'll see this, Mark, for probably a couple more years. And then after that, once the lines are all automated and all four lines are in, you'll see volume being the main contributor once we get that all rolling. But it will take years before we get there.

Mark Massaro - Canaccord Genuity, Inc.

Great. And if I can just sneak one last one and I'll hop off. The vet disc growth, I believe, increased 14% year-over-year. Last quarter, I think it was 6%. You did call out seasonality, but I would love to ask about how you think you can do on a pro forma basis. And just comment on any puts and takes on the consumable piece on animal health.

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

Well, I – so Ross is going to confirm those numbers, but we look at our business from two directions. One is getting new customers and not losing any. And the second piece is helping our customers utilize our equipment and our tests better and more frequently. So a lot of what we are implementing this year is circled around that aspect of the business as well. We've been very focused on gaining new customers. We'll continue to do that, but we also are now working with our distributor partners to help us grow the business in those places we've already sold. So, it's not a single objective and it's not a single focus.

Mark Massaro - Canaccord Genuity, Inc.

Got it. Thank you.

Clinton H. Severson - Chairman & Chief Executive Officer

Okay. Thank you.

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

If I can just clarify, some of those numbers you gave out on the rotor growth, Mark. You may be confusing some of the consumables versus the rotor units. For the quarter, rotor units on a global basis for Vet were up 6%. That was for the quarter. For the year, rotor units were up a little bit more than 9% just for Vet...

Donald Wood - President & Chief Operating Officer

Worldwide.

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

Worldwide.

Clinton H. Severson - Chairman & Chief Executive Officer

Okay. Next question.

Operator

Our next question is coming from David Westenberg of C.L. King. Please go ahead.

David Westenberg - C.L. King & Associates, Inc.

Hey, guys. Thank you and congratulations on the good quarter.

Clinton H. Severson - Chairman & Chief Executive Officer

Thank you.

David Westenberg - C.L. King & Associates, Inc.

So can you talk about the buying groups and how they're impacting the business? Can you talk about the challenges of working with buying groups, but retaining your ASPs?

Clinton H. Severson - Chairman & Chief Executive Officer

Okay. Craig?

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

Our buying groups – it's hard for me to comment on maintaining the ASPs because then I'd be really kind of divulging how we're working with these folks. But each buying group tends to have a primary distributor they prefer to work with. And each buying group has certain commitments that they make to try and grow the business for their own benefit. So all this is just constantly working with those groups to gain access to their members. And some groups are very good at helping us do that, and other groups we have to work with stronger. So it's really – it's a matter of access, and then holding the groups accountable to the growth that they want to see.

David Westenberg - C.L. King & Associates, Inc.

Great. Thanks. And the weakness in Europe, was that part of the management and country rearrangement, or was that just general weakness in the overall market in Europe?

Clinton H. Severson - Chairman & Chief Executive Officer

Yeah. So part of that was currency. I think currency for the quarter affected it by about, what, 4%, Ross?

Ross Taylor - Chief Financial Officer, Vice President-Finance & Secretary

I think it was more like 2%.

Clinton H. Severson - Chairman & Chief Executive Officer

Like 2% for the quarter. And, yeah, again, I think one of the challenges we've had in Europe is market coverage. So we've had good distributors over there, but they've been pretty much operating on their own. And so, our initiative now for this next fiscal year is to put people on the ground to work with distribution in Europe like we do here in the U.S. And so we've actually hired our first one for Italy, and we're in the process of interviewing one for France. And we just promoted one of our internal people in Germany that is from Spain and speaks fluent Spanish, and she's on the ground there as well. So, we're moving pretty fast, okay? And then in addition to that, we need people in Asia that are based in the country as well.

So, yeah. So we expect our international business, once these people are in place and have about three to six months to get up to speed, we will pick up big time. There's lots of opportunity outside the U.S., and because in the past, our focus has been mostly U.S. We just haven't been able to invest like we should have. But now we have the resources and the management bandwidth to do it. So, that's the goal for next year.

David Westenberg - C.L. King & Associates, Inc.

Great. Thanks. That's helpful. And then you've had your best placement numbers over the last six quarters in terms of the history of the company, just very good quarters, a lot of them. Can you talk about if there's an – you can't obviously have these great quarters forever. I mean there's just a limited market. You're gaining market share, it appears like. Can you talk about maybe some of what the distributors can provide in terms of defense and sort of keeping out once you sort of gained this market share.

Clinton H. Severson - Chairman & Chief Executive Officer

Yeah. So I'll make a comment then I'll let Craig comment as well. So here's the deal, so we have round the 30% market share. This is on the vet side. And so that's 70% to go. How do you go from 30% market share to 100% market share? That would be the question. And so, yes, so the first thing that has to happen is you have to have the best product, which we have then you have to have distribution, wide distribution, which we now have.

And then you need sales people that know every single veterinary clinic in their territory. They've identified in list of priority which ones they think they can close a deal with better product in the next 12 months, and then they have to meet with their 20 distributor reps and come up with a strategy on how to get the demo and how to present the data including the numbers, costs, and benefits and efficiencies.

And then working hand to hand with that distributor rep, you focus on those top accounts. And of course, that's what our people have been trained to do now, and that's what they're doing. And so we think there's lots of runway to add new accounts.

Now, you add the high-sensitivity immunoassays now to the disc, okay, and they'll be able to do complete thyroid panels along with their chemistries, some of the hormones and some of the other things that they normally send out to their reference lab. They'll be able to do those in-house as we had those projects. And then on top of that, you add the new software offering we have where they can trend things and the can hook up to cloud and all those benefits. It makes it even more advantageous to have our stuff. And then, of course, as we add the VUE and the rapid test, guess what, the instrument actually reads the test. So you don't have this interpretation problem that you have with other tests. It automatically logs it in to the software system wirelessly. These are all huge advantages.

And as long as these advantages are being presented to the customer over and over again through this massive distribution that we have, that makes it easier to close the sale. So, that's how we see it. Craig, I'll let you add to that.

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

All I heard is I got to get 100% market share. I can't add another thing to that.

David Westenberg - C.L. King & Associates, Inc.

All right, guys. Congrats again on the quarter.

Clinton H. Severson - Chairman & Chief Executive Officer

Thank you.

Operator

And our next question comes from Ben Haynor of Feltl & Company. Please go ahead.

Ben C. Haynor - Feltl & Co.

Good afternoon, gentlemen. Thanks for taking my questions. It looks like you had a pretty nice quarter in VetScans sold. Is there anything in particular that you could attribute that to coming from what's traditionally a seasonally strong quarter to what's typically a seasonally weaker quarter?

Clinton H. Severson - Chairman & Chief Executive Officer

Yes, I'll comment and I'll let Craig comment. I think the difference is we're just getting more efficient at working with these very large distributors and these almost 1,000 reps out there. And like I mentioned before, our sales people have about 20 distributor reps in their territories that they work with.

And so, we're just getting better at identifying the potential accounts, getting the access through the distributor rep, putting together the strategy, representing the advantages of throwing out the existing steps ahead and adding the Abaxis equipment that's more efficient. Just getting that message, I think once you get the message in a demo, closing the sales, not that tough. So, we're just getting better. That's all.

Craig Tockman - Vice President, Sales and Marketing, North American Animal Health

Yeah. And I think a lot of these folks have never been really – they've never been asked to look for these opportunities. That's not how our competitor's model was with these folks. We've taken time to get folks on the right page about looking for opportunities and opening those doors for us instead of just keeping us out. So that's been a big piece of it. And we're forming our partnerships all over the industry. Lots of folks like what we do and like how we do it. And we're working with a lot of great people to open those doors. So, it's really just the continuation of what we've been trying to build on for six quarters. And I think our results are starting to bear fruit and we will continue to grow

Ben C. Haynor - Feltl & Co.

Okay. Great. And then, lastly for me on kind of the development pipeline and adding immunoassays to the disc. how is that coming along and when would you anticipate being able to offer that?

Clinton H. Severson - Chairman & Chief Executive Officer

Okay. So, we have the feasibility as completed. Now, we're moving to the development phase. And we expect the first test in about 18 months. This will also entail modification to our VetScan and our Piccolo instrument which I indicated before is a benefit because potentially we can reduce the costs below $2,000 with these changes that we're making.

And then of course test will follow, the ones that follow would be less complex to develop because you have a model. Once you have your first model, it's just a matter of changing antibodies, raw materials and that kind of thing. So, that's the goal and it's a huge – if we are successful with this, it potentially – can potentially double the available market that we compete in. Plus in addition to that, once you have the specialty test on the disc, for those patients where they need a specialty test today, they send all thing out to the lab. And if we get the specialty test on the disc, they don't have to send it out to the lab anymore for those patients. So, this is a major R&D effort here that if successful will have a huge impact on the company.

David Westenberg - C.L. King & Associates, Inc.

Okay. Great. Very helpful. Thank you very much, gentlemen.

Clinton H. Severson - Chairman & Chief Executive Officer

Thank you.

Operator

Our next question comes from Roger Goodspeed (58:36), a private investor. Please go ahead.

Unknown Speaker

Hello, Clint. Congratulations to you and your entire team on a terrific quarter.

Clinton H. Severson - Chairman & Chief Executive Officer

Thank you, Roger.

Unknown Speaker

I just had one question for you and I apologize if I didn't hear it earlier, I had to jump on and off. But as you know, I'm always interested in updates with respect to the possible rollout further in the retail pharmacy market on the medical side. And I'm curious as to if there's anything further you can share with us as to progress there, particularly as it relates to the turmoil that another highly visible private company with a very large, at least in history, a very large valuation is having, which had a relationship or has a relationship with Walgreens.

I'm hopeful that the universe of companies that have a technology that can deal with the point of sale medical market in a retail pharmacy context has now been pared down every further so that Abaxis is the only one. But whatever you can share on that whole situation would be helpful.

Clinton H. Severson - Chairman & Chief Executive Officer

Yeah. So I'll comment and then I'll let Rick talk as well. Yeah. So we're still fully engaged with these folks, and we have pilots going on not only in the U.S. here, but in Canada and in Latin America as well, also in Europe. So, in Italy, we've got a number of retail stores, drugstores handling routine blood testing for re-upping medications and those kinds of things.

And so, yeah, so it's still ongoing. It's a real market. I think what has been demonstrated is the demand for this kind of a service where you can 24 hours a day go up and get your LIPITOR re-upped or your blood pressure medicine or whatever you're taking. You can go into the drugstore, and they can do the blood test, make sure that the meds are still working like they're supposed to be working.

And if they are, you get re-upped, and it's much more efficient. And so we think it's going to happen in the end. But these are big commitments and it takes time for people to get ready to pull the trigger on this stuff. So Rick, I'll let you add more color to that.

Rick Betts - Director, Medical Sales & Marketing, Medical Diagnostics

Yeah. Thanks, Clint. You're right, there's a lot of change going on in the retail pharmacy market. The big players have all publicly said that they'd like to be the key points or the key leaders in primary care in the United States. Where they are now in delivering on that promise, there's a pretty good step in between. So, they're currently delivering screening technologies. So those screening people rather than doing true diagnostics. And there's a lot of components that need to come to play for that. There's the hospital systems, the insurance providers, all those people together and you'll have the retail conglomerates themselves, they all need to come together in delivery of this primary care platform.

The Piccolo has not changed and it is the device for delivery of diagnostic grade chemistry tests in this environment and it does it inside of 12 minutes which is what is required in the retail environment. There is – the model has been proven for delivering diagnostics in a retail setting. It's just not – it hasn't come to maturation yet between the clinic and the pharmacy. So, it's – the Piccolo remains a mainstay and the choice of all those providers moving forward. So, it hasn't changed and we remain ready for when they are ready to implement primary care.

Unknown Speaker

Okay. Thank you. So the difficulties that one company has haven't necessarily led to all the trend in enquires to a greater extent or more momentum than you would otherwise expect.

Rick Betts - Director, Medical Sales & Marketing, Medical Diagnostics

Well, we don't know what these people are thinking. They haven't shared everything with us yet. Maybe they it has, maybe not. We don't know for sure.

Unknown Speaker

Okay. Thank you very much.

Clinton H. Severson - Chairman & Chief Executive Officer

Yeah. Thank you.

Operator

And, ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Clint Severson for any closing remarks.

Clinton H. Severson - Chairman & Chief Executive Officer

Okay. Thank you very much for tuning in. And I want to congratulate all the employees of Abaxis who did such a fantastic job in our FY 2016 with unbelievable earnings growth, sales growth on top of very, very difficult comparisons. And yeah, we look forward now to topping this performance in our next fiscal year, which is always a challenge when we have record years. But the team is up for it, and yeah. So we're looking forward to our next call which will be in July to update everybody on our Q1.

So thank you very much again for tuning in.

Operator

And, ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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