Heska's (HSKA) CEO Kevin Wilson on Q2 2016 Results - Earnings Call Transcript

| About: Heska Corporation (HSKA)

Heska Corporation (NASDAQ:HSKA)

Q2 2016 Earnings Conference Call

August 03, 2016 11:00 AM ET

Executives

Brett Maas - Hayden IR

Kevin Wilson - President & CEO

Jason Napolitano - COO & CFO

Analysts

Jim Sidoti - Sidoti & Company

Andrew Cooper - Raymond James

Ben Haynor - Feltl & Company

Jennie Tsai - Gabelli & Company

Operator

Good day, everyone and welcome to the Heska Corporation Second Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Brett Maas. Please go ahead, sir.

Brett Maas

Thank you. I am Brett Maas of Hayden IR, Heska’s Investor Relations firm. Prior to discussing Heska Corporation's second quarter 2016 results, I would like to remind you that during the course of this call, we may make forward-looking statements regarding future events or future financial performance of the Company.

We need to caution you that any such forward-looking statements are based on our current beliefs and expectations that involve known and unknown risks and uncertainties, which may cause actual results and performance to be materially different from that expressed or implied by those forward-looking statements.

Factors that could cause 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 this time they are made, and Heska does not intend or specifically disclaims any obligation or intentions to update any forward-looking statements to reflect events that occur after the time such statements were made.

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

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

Kevin Wilson

Thanks Brett. Heska’s second quarter was fantastic and it was above internal and external benchmarks. In fact it was a record second quarter. Compared to 2015, revenue was up 25%, operating income was up 94%, and net income was up 111% to $2.5 million, or $0.35 per diluted share. Growth accelerated from the first quarter, expense discipline remained solidly in place, the overall market is robust, and our product portfolio continues to gain momentum.

Virtually every area of Heska performed well in the second quarter. Our vaccines and pharmaceuticals segment performed better than expected with 74% revenue increase over last year. They did a great job, and I’d like to congratulate our employees. Digital imaging continues to see nice growth in new sales upgrades and bundling demand. We are consistently winning new imaging customers, while positioning Heska’s blood diagnostics products into conversations with the largest premium hospitals.

This team work and the processes surrounding it, has strengthened our performance. With substantial new product releases happening throughout the second half, we see these good results accelerating.

And in blood analyzers and consumables, Heska continue to take market share with our unique Reset subscription model, and the industry news family of analyzers and test. Retention is great and the number of customers enrolled in our multiyear blood testing and consumables agreements continues to grow very nicely. The source of these customer additions continues to be from market share gains and the size and quality of our newest customers is excellent.

The Heska blood diagnostics team continues to provide dealers the best job in the industry by far and they have [indiscernible]. Heska has brought to market the newest all line of our key diagnostics in the industry like the exclusive to Heska Element i immunodiagnostics platform, which has now passed the 300 units shift mark, and continues to grow nicely. This unique to Heska analyzer delivers the industry’s only TSH test for real time hypothyroidism confirmation in the clinic, along with other key tests like T4, Cortisol and an expandable menu of additional immuno-diagnostics test.

Demand has outstripped production this year of the date, but we are catching up and we have our enough stock to fill current demand and back orders in the third quarter. We strongly believe we have the best family of technology, test, and programs available anywhere in the market period. Assuming results validate this belief and our unique subscription model’s multi-year visibility and long-term customer loyalty to Heska, underpins our confidence. From this solid foundation, we have a great deal of market share gains, price share opportunities, geographical expansions and product line extensions left to accomplish as we earn what we believe is our rightful share of the market.

Turning to the operational side, Heska continues to deliver. In a period in which gross profit rose 23%, operating expenses were managed fantastically, coming in 4.9% as a percent of sales better than last year’s period. With this continued level of operational discipline and the strength of a growing recurring style subscription model in the period, operating income nearly doubled, net income more than doubled, and the balance sheet is in great shape. The operation team did a great job.

Industry wide, we continue to see strengthened stability. This seems to be supported by our industry peers as most folks are rising in the veterinary care space generally and the veterinary diagnostics space specifically. The overall veterinary market is robust. Our partners are strong. Our analyzer consumables and subscriptions continue to track well. We are gaining market share. Profits are up nicely and our development projects are on track.

Moving to some of our business development activities, I am pleased to note that the acquisition of the international veterinary imaging business was completed in the second quarter. We are hard at work, preparing to leverage this international platform for efficiencies, international revenues in imaging that are new to Heska, and international expansion of Heska’s blood diagnostics and upcoming expanded menu of single use diagnostics test.

Our announced expansion of our single use lateral flow test continues to progress. Last month, USCA regulators conducted reviews of the manufacturing facilities for these test expansions and the reviews were successfully completed without meaningful comment. The team is responsible for this product expansion and regulatory approval process continues to do great work, and we continue to be positive about the potential large growth for Heska in these products over the next 12 to 24 months and beyond.

Each of these initiatives wear nicely on top of Heska’s continued momentum and strong position. There is a great amount of Greenfield for Heska in new products and new geographies. And we’re building an ability to compete for and winning these opportunities. Of course competition is fierce in responses and we never lose sight of these things. And while our results over these past three years have been a pleasure to share each quarter, rest assured we aren’t even close to satisfied and aren’t even remotely done earning our rightful share of customer trust and business.

Now with that, I’ll turn the call over to Jason Napolitano, our Chief Operating Officer and Financial Officer. And he’ll detail the question’s financial results. At the conclusion of Jason’s remarks, we’ll open up the call to questions. Jason?

Jason Napolitano

Thank you, Kevin. Heska’s revenue for the quarter was $30 million, an increase of 25% as compared to $23.9 million in the prior year period. Heska’s revenue for the six months ended June 30, 2016 was $57.1 million, an increase of 22% as compared to $46.8 million in the first six months of 2016. Revenue for our Core Companion Animal Health segment or CCA was $24.5 million in the three months ended June 30, 2016, an increase of 18% as compared to $20.8 million in the second quarter of 2015.

Increased revenue from our heartworm preventive products, digital radiography products and our instrument consumables contributed to the change. We continue to believe revenue growth with some volatility but averaging in the low double-digits is a reasonable target for this segment over the next several years. Our vaccines pharmaceuticals and products segment or OVP generated $5.5 million in revenue in the second quarter of 2016, a 74% increase as compared to $3.2 million in the prior year period.

Increased revenue under our agreement with Eli Lily’s Elanco unit was a key factor in improvement. As we’ve said in the past, we expect inflationary type growth in this segment over time, although, we expect some lumpiness in quarterly and annual results. Gross margins, which is gross profit divided by total revenue, was 42.3% in the second quarter of 2016, down slightly from 43.1% in the prior year period.

Product mix in our OVP segment, along with lower gross margin in our chemistry consumables, somewhat offset by higher gross margins on our domestic imaging products, were factors in the decline. Heska Imaging US generated $4.7 million in revenue for the quarter with the gross margin of 45.7% as compared to $4.4 million with the gross margin of 37.5% in the prior year period. We continue to believe 35% is a reasonable gross margin target for Heska imaging U.S.

For the six months ended June 30, 2016 Heska Imaging US generated $10.8 million in revenue, a 25% increase from $8.6 million in the prior year period, while increasing gross margin from 37.6% to 42.3%. Total operating expenses for the second quarter of 2016 were $9.1 million, an increase of 8% as compared to $8.5 million in the prior year period. Expenses related to our acquisition of Cuattro Veterinary, LLC, which we’ve renamed Heska Imaging International, LLC, as well as higher commissions were factors in the change. We were pleased to close this acquisition on May 31, 2016, and the business posted strong June results with revenue of little more than $500,000.

Operating income for the second quarter of 2016 was $3.6 million, roughly double to prior year period level of $1.8 million. For the six months ended June 30, 2016 operating income was $5.5 million nearly double the prior year period level of $2.9 million. Depreciation and amortization was $2.2 million for the six months ended June 30, 2016, as compared to $2.1 million in the prior year period. Stock based compensation was $1.1 million in the six months ended June 30, 2016 as compared to $879,000 in the prior year period.

As we noted in our earnings release, in this quarter we have chosen to early adapt a new accounting standard related to employee stock compensation, which we otherwise would have been required to adapt for our coming fiscal year. This standard is intended to simplify accounting in this area. Whether the new features of this accounting standard is that excess tax benefits or tax benefits, which fall short of original estimates are to flow through our income statement rather than primarily through additional paid in capital under the prior statement.

We expect this approach will obviously tend to increase volatility in reporting entity’s financial statements. All benefits from this approach for the six months of 2016 were recognized in the quarter ended June 30, 2016 and hold $0.5 million or $0.07 per diluted share. Earthy approach required by this new accounting standard, there has been no adjustment to Heska’s 2015 financial statements.

In addition, I know that the deferred income tax expense line item on our financial statements primarily relates to taxes we would have paid if we did not have a large domestic net operating loss position, and is therefore essentially non cash accounting entry.

We generated $2.5 million in net income attributable to Heska Corporation or $0.35 per diluted share in the second quarter of 2016, which is more than double the $1.2 million or $0.17 per diluted share generated in the prior year period. For the six months ended June 30, 2016 this line item was $3.7 million or $0.51 per diluted share as compared to $1.8 million or $0.26 per diluted share in the prior year period.

On previous calls, we have discussed potential regulatory investments we are considering substantially expand a regular flow of cash to menu. I think it is fair to say this process is going more slowly than we’d initially anticipated. As we are getting later in the year, we have the best chance of what the investment should be in 2016. And we expect it to incur additional research and development costs of approximately $500,000 to $750,000 for the balance of the year in this area, with $100,000 to $200,000 of this occurring in the third quarter of 2016. We expect the balance of the investment in this area to occur in 2017.

We current expect at least one new product to be approved in this area in 2017 as a result of this investment. Although we expect our Company will continue to trend away from specific financial guidance in the future, we expect to discuss our outlook for 2016 on both this call and our third quarter earnings call. We believe Heska’s 2016 revenue should exceed $122 million, up from $120 million in revenue we expected to exceed on our last earnings call.

We expect 2016 operating income of at least $12.5 million as a reasonable expectation, including the impact of the research and development expenses affiliated with the regulatory investment previously discussed. I know that on our last earnings call we said we anticipate $12 million in 2016 operating income excluding these restructure and development expenses. So our outlook for both revenue and operating income is substantially sunnier than on our last call, based on the strong performance we saw this quarter and our preparation for the finish of the year.

In summary, we have once again posted a very strong quarter with gains across the board, traction in our subscription programs, operating leverage acceleration, market share gains and continued strength in our product launches. We intend to continue to work to grow our business domestically and internationally to deliver many more quarters like this one.

With that, Kevin and I would like to open the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we’ll take our first question from Jim Sidoti with Sidoti and Company. Please go ahead.

Jim Sidoti

Any update on the acquisition of the remaining share of the Cuattro domestic business?

Kevin Wilson

I think we’re on track for that. The trigger for that really is full year 2016 performance, and I think we’re on track for that. 2016 is a good year, and it looks like that minority put will be exercised in early 2017.

Jim Sidoti

And then with regard to the revenue gains in the quarter, would you characterize that as largely due to increased sales to an increasing customer base or new customers?

Kevin Wilson

I would characterize that mostly new customers I mean the install base continues to do a good job just in terms of their ongoing volume. I think customer visits are up in terms of pen owners going to the hospitals and that obviously drives testing. Testing is one of the main things that happens when customer visits are up. So I think it's probably combination of both. But I do think market share gains are driving a lot of that as well.

Jason Napolitano

Jim on the previous question I agree with Kevin. We’re expecting it's likely the minority put will occur. To me the big question is will they have enough performance to get to the higher of those puts, which is $30 million of revenue and $3 million of operating income for that business. And I think right now my guess would be they don’t quite make it there, but I would say they’ve a legitimate shot to do that. I would not be surprised if in early 2017 these families hit that number when we’re getting at higher level put.

Jim Sidoti

And remind me what the differences that they get to that higher level?

Kevin Wilson

Well, in both cases they get 25% in the cash and the balance sheet. The higher level put is $17 million and the lower level put is capped at $13.6 million.

Jim Sidoti

And is that in cash or in stock?

Kevin Wilson

Assuming our stock is at a reasonable level, reasonable compared to do they strike, we could deliver up to -- I think it's 55% of the stock.

Jim Sidoti

And is that your preference, or would you prefer to deliver in cash?

Kevin Wilson

Someone has to consider, Jim. Obviously we’re not a big fan of a lot of dilutions, but we don’t want to stretch our balance sheet to the point it could limit our opportunity. So that’s someone frankly than it defer. We see exactly what the number is and where our stock is.

Jim Sidoti

And then the last question I had is, as you think you have enough on your plate now between the pending acquisition and the remaining Cuattro business and the launch of the new products? Or do you still have room for -- to consider another acquisition?

Jason Napolitano

I don’t -- we still have room.

Jim Sidoti

Okay…

Jason Napolitano

But we’re not -- that’s not our growth plan, let's go out and roll things up and consolidate. But when opportunities come across, we love at them and I think we have bandwidth and I think we’re healthy and we’re growing. So, yes it's obviously an avenue that we touch to.

Kevin Wilson

I think the big question Jim is you track and this is the opportunity. If we do right opportunity, we would make times to evaluate and pursue it.

Operator

We’ll go next to Andrew Andrew Cooper with Raymond James. Please go ahead.

Andrew Cooper

Just a few for me, and I know you talked about one rapid assay instead of a few in 2017. But just as we think about launch there. Wondering to get your color on what your thoughts would be in terms of selling it out through the distributors and how it’ll be included in bundles or the rental reset type model, if you have any color there.

Jason Napolitano

I think probably at both hands, there is also an opportunity for private label partnerships with folks as well. So we’re having conservations surrounding all those ideas. Bundling those with the subscription agreement, they felt lot of sense as well. And I think offering a broad portfolio and then adding on those lateral flow tests is a logical step. Our friends at Henry Schein do very well with our subscription model on blood diagnostic analyzers already. And so I think adding to the Reset model is logical as well.

So I think it's a both hand. And then it’ll also be geographically dependent. I mean there are areas outside of the United States with those tests are valuable and finding local partners makes an awful lot of sense. And again our distributor partner Henry Schein is global as well. So we’re pretty bullish about that.

Andrew Cooper

And then Ken and moving on to the imaging segment, typically it's heavily fourth quarter is a quarter. So I was wondering what the pipeline looks like there and how you’re feeling about that, and if you see the same seasonality in the international business as well?

Kevin Wilson

I think we do. It's maybe a little bit less fourth quarter driven. Some of this is just tax policy in different countries. So not quite as fourth quarter driven, but we do see that. And with regards to the second half, there are two main segments in imaging; there is small animal, companion animal; and the there is decline segment. And we’re excited we’ve got a couple of really major new decline products that are hitting the market. This quarter, in preparation for the fourth quarter, and we think they’ll have really nice traction going into the fourth quarter. And the decline market is very much a fourth quarter business just in terms of their seasonality. So, we like what the pipeline looks for imaging for the balance of the year.

Andrew Cooper

And then last one from me just thinking about the international opportunity in general. You have only a month really under your belt. But if you could give any incremental color relative to what you discussed last quarter around the contribution there for 2017, and what markets you might target first?

Jason Napolitano

I think we said in our last call, about $3.5 million of revenue for the 2016 post close, so that would be July 1st through December 31st. I don’t know. We have much of an update on that. I have to say I wasn’t thrilled with the Brexit vote, but I am also not saying that that showing up in the data we’re seeing here. Kevin, do you have a comment?

Kevin Wilson

Yes, I would agreement with that. I mean the first thing is to integrate the acquisition and leverage the relationships to expand the product we sell to the current partners we have. So, imaging, I think, will grow but the primary focus is capitalizing the organization over the next six to 12 months and growing it by offering new products to those partners that are in those countries. And we’ll roll out more information on that going into 2017. But I don’t think we want to put hard numbers to it just yet.

Operator

[Operator Instructions] We’ll go to Ben Haynor with Feltl and Company. Please go ahead.

Ben Haynor

Just a handful from me, I guess, you commented last call on trends you’ve seen recently versus past periods in terms of analyzers and sale per rep per month, I believe it was, can you maybe comment on how that’s tracking?

Kevin Wilson

It is up again this quarter. And again we included the management numbers our internal numbers that we like to share to let you know directionally where we’re headed. But it is up and we’re happy with that. But we’re also probably not going to be holding ourselves to reporting that number on a quarter-by-quarter basis just because it's really not all that productive, other than to confirm the directions. But it is up again this quarter.

Ben Haynor

And then you mentioned the sales, expanding the sales force a little bit when you find good people here and there. How was that, if you’ve added a few people or where you have on that front?

Kevin Wilson

We have. We have some really nice new hires come through our full training program in the last quarter, in the second quarter. And I would like to point out that there is going to be, I’ll tell you, roughly 30 folks selling if you add fix, so fixed growth. So that’s on the order of magnitude of what we’re looking at. And early indications are very good.

Ben Haynor

And then I know its early days and on Cuattro International. But any commentary you can give on the trends you’ve seen, maybe in July and then also on the plans for maybe go to rental reset program in certain countries internationally in the future?

Kevin Wilson

Our plan definitely is to take the Reset subscription program internationally. We think it's probably has even more cash than internationally. And the analogy I use is cell phone. Cell phone pricing worldwide is different to certain markets, prepaids are bigger, subscriptions are bigger in some places, buying phones and paying as go. So, there’re lot of different models that can work. And we think that a lot of those markets in Europe, Eastern Europe all the way through Western Europe, are right for not making big capital expenditures, which is perfect for a subscription model.

So, we absolutely do have plans to roll that out over time. But again, these things take time. I think our growth of the things that we’re pursuing on today is very, very good. So, we would rather do it maybe little bit more slowly, little more thoughtfully and to layer than on top of doubling earnings and that feels pretty good. So, we do have a little bit of time to do it properly. And so, I wouldn’t expect big announcements in the second half. We just want to test guys, and get everybody comfortable with it. And we’ll have high order to.

And consistent with what we’ve done in the past we’ll run high orders too, we get to information to think a little bit, continue to file it, and if it's working then we start to feel it and that’s probably the model that we’ll follow with international expansion as well.

Ben Haynor

And then one last from me, you mentioned substantial new product releases in the second half. I know you don’t give specific on what they might be. But should we expect any new non-imaging instruments to potentially come out in the second half?

Kevin Wilson

The product releases that we’re working on now that are starting to be released into the market are imaging products. There are two for the decline market typically that prepares us very well for that fourth quarter decline rush. And it's probably the strongest line that we had in at least three or four years. So we’re really excited about that. We are working on some software products in terms of tying all of our stuff to the other end of cloud. We have literally millions of imaging studies in our cloud with veterinarian today and tying in our blood diagnostics to some of those things into that infrastructure. We think we’ll gain lot traction as well. And I think you’ll see some of those early releases before the end of the year.

Operator

And we’ll take the question from Jennie Tsai with Gabelli. Please go ahead.

Jennie Tsai

I had a question on more can you tell us on your CCA segment. You talked about your digital imaging. But could you provide details on instrument consumable growth and then heartworm growth is that segment -- in the quarter?

Kevin Wilson

Heartworm no, in fact we’ve deemphasized heartworm for the last two or three years, in large part based on margin. And also it's just until we expand the full line of test, we don’t really want to spend an awful lot of sales and marketing on that particular product. So, I would think it's fair to say that heartworm has trended down for us for the last two to three years, and that’s a little bit by design. In terms of consumables and analyzers, I would call the period roughly 20% in terms of analyzer placements to-date through the year and consumables up roughly 20% as well, just to put some context around that.

Jason Napolitano

And when we’re talking about heartworm being deemphasized, Jennie, we’re talking about the diagnostic products. I think as we mentioned, the heartworm presented in the instrument consumables, both are key contributors to growth for the quarter, so just to draw that distinction.

Jennie Tsai

Okay, great. Thank you.

Jason Napolitano

The heartworm predominantly continues to go well.

Operator

And it appears we have no further questions. I’d like to hand the call back over to Kevin Wilson for closing remarks.

Kevin Wilson

Thank you. Heska had a great start to 2016. The people at Heska have made all the difference this year. They’ve delivered for customers, and they’ve delivered for their co-workers, and they’ve delivered for shareholders. While we have a healthy respect for our competition, we fear no one. They may still be much bigger, but we see that as an opportunity. We begin each day with the idea that more, actually much more, of the market rightfully belongs to Heska because of our passion, our hard work, our respect for our customers, our better solutions and our focus on delivering better value of veterinarians and pet owners. I’d like to take a minute to offer a heart full of thanks to each Heska employee and their families for their passion and for their sacrifice for these things.

The highlights of our year-to-date 2016 financial performance are nearly endless. Earnings have more than doubled, revenues are up 25%, blood testing and subscription revenues and placements have risen roughly 20% for the year through competitive share gains, customer retention and exclusive to Heska technology releases like Element i. At the same time, cost increases have been very well contained and operating leverage improvements continue. Our sales pipeline going into the second half is super. Our field sales force is expanding and our product introduction pipeline is in the best shape I’ve seen in.

We address a huge market relative to Heska’s current share, and we address it with the flattish base line starting price and fewest recent price increases amongst the major competition. We have before us geographical expansion that for intents and purposes is pure growth to Heska. We have expansion coming in the form of entering the large product streams entirely new to Heska, like the lateral flow testing space that is roughly the size of our total current revenues. And we think we can win meaningful share in these opportunities.

We have the possibility to fine tune our subscription mode, our pricing, packaging cost, analyzers and bundles to grow rapidly and regularly for year. We have strong relationships with leaders in distribution and we have an expanding direct sales team. In short, it's very early in the Heska growth opportunity story. We have many levers to pull for growth and its exciting time to be a Heska team member and shareholder.

As we wind down the call today, I’d like to thank each of you for taking the time out of your busy day to learn more about our results and our passion. We know that there’re literally millions of investment options to follow. And we’re humble that you’ve chosen to invest your time and your resources into what we’re doing at Heska. Thanks for that and with that have a great day.

Operator

Thank you. This does conclude today’s conference. You may now disconnect, and have a wonderful day.

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