IDEXX Laboratories, Inc.

Good morning, and welcome to the IDEXX Laboratory's fourth quarter 2018 earnings conference call. As a reminder, today's conference is being recorded. Participating in the call this morning are John Ayers, Chief Executive Officer, Brian McKeon, Chief Financial Officer, and John Ravis, Senior Director, Investor Relations. IDEXX would like to preface the discussion today with a caution regarding forward-looking statements. Listeners are reminded that our discussion during the call will include forward that are subject to risks and uncertainties that could cause actual results to differ materially from those discussed today. Additional information regarding these risks and uncertainties is available under the forward-looking statements notice in our press release issued this morning, as well as in our periodic filings with the Securities and Exchange Commission, which can be obtained from the SEC or by visiting the investor relations section of our website, IDEX.com. During this call, we will be discussing certain financial measures not prepared in accordance with generally accepted accounting principles or GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure is provided in our earnings release, which may also be found by visiting the investor relations section of our website. In reviewing our fourth quarter 2018 results, please note all references to growth, organic growth, constant currency growth, and comparable constant currency growth refer to growth compared to the equivalent period in 2017 unless otherwise noted. To allow broad participation in the Q&A, we ask that each participant limit his or her questions to one with one follow-up as necessary. We appreciate you may have additional questions, so please feel free to get back into the queue, and if time permits, we'll take your additional questions. I would now like to turn the call over to Brian McKeon.

Thank you, and good morning, everyone. I'm pleased to take you through our fourth quarter and four-year 2018 results and provide an update on our financial outlook for 2019. IDEXX achieved continued strong financial performance in Q4. This concluded another year where we again delivered revenue and EPS gains above our long-term financial goals. In terms of highlights, we achieved 10% organic revenue growth in the fourth quarter, on track with our expectations, driven by consistent 13% organic growth in CAG diagnostics recurring revenues. We achieved full-year organic revenue growth of 11.6%, aligned with our long-term financial goals of 10% plus annual gains, supported by 13% organic growth in CAG diagnostics recurring revenues in both U.S. and international markets. Our full year EPS was $4.26, an increase of 36% on a comparable constant currency basis. This performance reflected strong top line growth, a 130 basis point improvement in operating margins on a constant currency basis, and benefits from U.S. tax reform. We're well positioned to build on these results in 2019. We're maintaining our outlook for 9.5% to 11% organic revenue growth reflected in our consistent guidance range of $2,385,000,000 to $2,425,000,000 in annual revenues. We're raising our EPS guidance to $4.66 to $4.78, our growth of 15% to 18% off our 2018 results on a comparable constant currency basis, aligned with our long-term goals. This is an increase of $0.04 per share at midpoint reflecting flow-through of $0.06 per share of 2018 profit upsides supported by operating margin gains at the high end of our goals and upsides from approximately 50 basis points of favorability in our effective tax rate, which we expect will sustain in 2019. These gains are partially offset by a $0.02 per share reduction in our estimate for share-based compensation tax benefits related to changes in our stock price, which is excluded in our comparable constant currency EPS growth calculation. Our guidance reflects consistent expectations for year-on-year foreign exchange impacts. We'll walk you through the details of our 2019 guidance later in my comments. Let's begin with the review of our fourth quarter and four-year 2018 results by segment and region. Q4 results were driven by ongoing momentum in our companion animal group. Global CAG revenues were $479 million, up 12% organically, reflecting continued strong gains in recurring CAG diagnostics revenues. Global CAG diagnostics recurring revenues increased 13% organically, including $4.5 million, or 1.3%, in growth benefit from the new revenue accounting standard, primarily related to our modified retrospective restatement. By region, U.S. CAG diagnostic recurring revenues increased 13.3% organically, driven by mid-teen growth in consumables and reference lab sales, and continued solid growth in rapid assay revenues. U.S. CAG diagnostics recurring revenue growth was primarily volume-driven, with overall net price gains of approximately 2%. U.S. recurring CAG diagnostics customer retention metrics sustained at high levels, reinforcing the durability of a recurring revenue base. IDEXX's U.S. recurring CAG growth performance continues to outpace U.S. veterinary practice market growth reflected in our data set from approximately 5,000 clinics. In Q4, patient visits were up 0.3% and clinic revenues increased 4% per practice compared to the prior year period, a relatively lower level of overall practice level and growth compared to recent trends. This same store growth data is for veterinary visits of all types, and appears to be impacted by moderated growth in non-clinical visits, as we've seen growth for clinical visits trending closer to 2%. These solid clinical visit trends are aligned with our continued strong business results. We're refining our data tracking and analysis of clinical versus non-clinical visit trends and look forward to sharing more of this front on future conference calls. International CAG diagnostic recurring revenues increased 12.5% organically in Q4 2020, driven by 20% plus organic growth and international consumable revenues. Mid-single-digit reference lab growth improved relative to our third-quarter results, with overall gains constrained by continued softer performance in select markets, impacted in part by a commercial focus in 2018 on driving very strong in-clinic revenue gains. Veterinary software services and diagnostic imaging systems revenues increased 9% globally in Q4, reflecting 8% organic gains and benefits from our recent acquisition of SmartFlow. These results were supported by solid growth in recurring software services associated with our practice management platforms and continued strength in our diagnostic imaging business, which posted a 20% increase in digital imaging system unit placements for the full year 2018. For the full year, overall CAG revenues increased 13% organically, driven by 13% gains in CAG diagnostic revenues, strong premium instrument placements, and solid growth in our veterinary software and digital imaging business. Full-year CAG diagnostics recurring revenue growth included 1.3% in non-recurring growth rate benefit from the new revenue accounting standard changes. Adjusting for this effect, our 2019 goals target continued low-teen organic growth in our CAG business, building on our strong business momentum. Our water business revenues grew 8% organically in the fourth quarter to $30 million, driven by strong gains in international markets, which were offset to a degree by the timing of year-end U.S. shipments, which moderated overall Q4 growth. For the full year, water revenues reached $125 million, up 9% organically, with faster operating profit growth, reflecting 45% operating margins. We're very pleased with our continued momentum in the water business and are targeting continued high single-digit organic growth in this highly profitable business in 2019. Livestock, poultry, and dairy revenue in Q4 was $34 million, down 5% organically, as expected, reflecting comparisons to high 2017 year-end government program and distributor ordering. Quarterly growth was also pressured by end-market impacts related to African swine fever outbreaks in China, which is our largest market for swine diagnostic testing, and the continued impact of low milk prices in key markets, which has constrained demand for dairy testing and growth in bovine pregnancy test sales. For the full year 2018, our LPD revenue was $131 million, up 1% organically. As our LPD revenues are 90% international, macroeconomic pressures in markets like China can have a relatively larger impact on the LPD business segment than the company as a whole. Given these factors, our 2019 outlook factors in expectations for relatively flat organic growth in our LPD business. For the full year 2018, total U.S. revenues reached $1,358,000,000, up 13% organically, and international revenues increased 10% organically to $855,000,000, or approximately 39% of IDEX's total revenues. Full-year revenue gains were driven by 13% growth in CAG diagnostic recurring revenues in both U.S. and international markets, solidly within our long-term target growth ranges. Our strong Q4 and full-year results reflect continued benefits from global expansion of our premium instrument base. Globally, we placed 3,957 premium analyzers in Q4, an increase of 8% compared to high 2017 Q4 levels, bringing full-year 2018 premium placements to 13,047, up 14%. We placed 2,042 catalysts in total in Q4 globally, a 10% year-on-year increase, 1,170 premium hematology instruments, up 13%, and 745 set of views, in line with very strong prior year levels. Our focus on high economic value placements drove a 15% global increase in global catalyst placements at new and competitive accounts in Q4 and solid EBI gains in both North America and international. In North America, we placed 421 catalyst placements at newer competitive accounts or 76% of total North America catalyst placements. International catalyst placements at newer competitive accounts increased 29% year-on-year in Q4 to 710 instruments contributing 48% of total international catalyst placements. For the full year, our new and competitive catalyst placements totaled 3,626 globally, an impressive 20% year-over-year increase. In addition to strong premium instrument results, we've placed 2,345 Snap Pros in Q4, supported by over 2,000 placements in North America, bringing our worldwide install base to over 25,000. CAG diagnostic instrument revenues in Q4 were $37 million, a 3% increase organically off a strong compare in 2017, with gains moderated in the quarter by instrument program mixed impacts. Q4 instrument revenues included $10.5 million in revenues attributed to the accounting standard, primarily related to expansion of the IDEXX 360 customer program. Our strong Q4 instrument placement results capped a year of substantial progress in expanding our premium instrument base. We finished the year with 37,000 catalysts, up 24%, nearly 29,000 premium hematology analyzers, up 11%, and nearly 6,600 set of views, up 69%, reflecting a record 2,719 set of view placements in 2018. Combined, our premium instrument base increased 21% globally in 2018. Our expanding instrument base and benefits from new test innovation and our strength in commercial capability continues to drive strong recurring CAG diagnostic revenue gains. Instrument consumable revenues of $157 million grew 19% organically in Q4. Results reflect continued 20% plus gains in international markets and sustained mid-teen growth in the U.S. High volume-driven consumable gains were supported by expansion of SETAview paper run and SDMA slide revenues, which again contributed about 4% combined to year-on-year consumable revenue gains in the quarter. Reference laboratory and consulting services with revenues of $178 million grew 11% organically in the fourth quarter. U.S. lab momentum remains strong, reflected in mid-teen volume-driven organic revenue gains. Global lab revenue growth was moderated by mid-single-digit gains in international markets, which, while up from Q3, were impacted by continued soft growth trends in select markets. We're forecasting continued moderate lab growth in our international reference lab business in the near term as we enhance our commercial focus to build on the very strong progress we've driven in developing our IDEX vet lab business in international markets. Rapid assay revenues of $48 million grew 5% organically in Q4, reflecting solid gains across U.S. and international markets. Rapid asset gains were primarily volume-driven, supported by continued growth of 40x plus specialty and first-generation products. Turning to the P&L, gross profit was $300 million in Q4, up 10% on a reported basis. Adjusting for foreign exchange impacts, gross margins increased about 70 basis points, supported by continued solid net price gains and strong growth in consumable revenues. Foreign exchange hedge gains, which benefit gross profits, were $1 million in Q4. Operating profit in Q4 was $115 million, up 18% as reported, or 20% on a constant currency. Operating profit results benefited from strong revenue gains and operating expense leverage, supporting a 170 basis point improvement in constant currency operating margins in the quarter. Operating expenses in Q4 were up 6% as reported or 7% on a constant currency basis, driven by growth investments in sales and market and supporting G&A resources in our CAG business, with overall OPEX growth mitigated by discipline, cost control, and LPD. For the full year, operating profit was $491 million. This reflects an operating margin of 22.2% for the full year, an increase of 130 basis points on a constant currency basis. This outstanding result reflects approximately 30 basis points of constant currency gross margin gains or about 50 basis points of improvement adjusted for impacts related to cost reclassifications in our lab business. Our strong full-year operating margin results also reflect significant operating expense leverage benefiting from our accelerated revenue growth while we expanded our sales and marketing capability globally and increased investment in products and software R&D which reached $118 million in 2018, or nearly $130 million on a cash basis. EPS in Q4 was $0.98 per share, including $0.01 per share in tax benefit related to share-based compensation activity, and $0.02 in negative impact related to year-over-year FX changes. On a comparable constant currency basis, EPS increased 40%, including net benefits from U.S. tax reform. For 2018, EPS was $4.26, including $21 million, or $0.24 per share, in tax benefit related to share-based compensation activity. For the full year foreign exchange, rate changes increased EPS by $0.01 per share, net of FX hedge loss impacts of $1 million. Adjusting for these factors and prior year discrete tax impacts, 2018 EPS growth was 36% on a comparable constant currency basis. Our effective tax rate for 2018 was 17.6%, including approximately 5% of rate benefit related to share-based compensation activity. This tax rate was approximately 3 cents per share favorable to our earlier guidance estimates, including about 2 cents of additional benefit related to share-based compensation activity. Free cash flow was $284 million for 2018, or about 75% of net income. Our free cash flow was net of $116 million of capital investment, including $42 million of combined investment related to our Westbrook, Maine headquarters expansion and German Core Lab relocation. We also supported $60 million in instrument program investments for the year, an increase of $44 million year-on-year associated with our very successful IDEXX 360 program in the U.S., in support of strong premium and replacement growth internationally. We allocated $369 million in capital towards share repurchases for the full year 2018, including repurchases of 489,000 shares in Q4 for $103 million. Our balance sheet is in an excellent position. We ended the year with $1.6 billion in debt, $124 million in cash, and $450 million in capacity under our revolving credit facility. Our leverage ratios as a multiple of adjusted EBITDA were 1.67 times gross and 1.46 times net of cash. Our strong performance and disciplined capital allocation supported achievement of a 49% after-tax return on invested capital, excluding cash and investments for 2018. We're well positioned to build on this strong performance in 2019 with a financial outlook aligned with our long-term goals. We're maintaining consistent 2019 guidance for 9.5% to 11% organic revenue growth and revenue of $2,385,000,000 to $2,425,000,000. This outlook equates to reported revenue growth of 8% to 9.5% net of a consistent projected 1.5% FX growth headwind at the rates assumed in our press release. We finalized the components of our revenue guidance as part of our year-end planning and refined our CAG diagnostic recurring revenue organic growth outlook to 11% to 12%, building on our exceptional 13.2% organic growth in 2018, which included 1.3% of non-recurring growth rate benefit related to the implementation of the new revenue standard. We're raising our 2019 EPS outlook to $4.66 to $4.78, an increase of $0.04 per share at the midpoint, reflecting approximately $0.06 per share in flow-through of 2018 profit upsides, offset by a 2% per share reduction in estimated tax benefits from share-based compensation activity. This outlook factors in an estimated $0.03 negative year-on-year impact from FX, net of $10 million in projected hedge gains, consistent with our preliminary guidance estimates. As a sensitivity, a 1% change in the dollar from rates assumed in our press release would impact 2019 revenues by approximately $8 million and operating profit by approximately $2 million net of hedge positions currently in place. We've refined elements of our P&L outlook as we finalize our 2019 plans while maintaining a consistent comparable EPS growth outlook of 15% to 18%. We're now targeting 50 to 80 basis points of constant currency operating margin improvement a slight reduction to the high end of our targeted improvement range, with targeted year-on-year gains driven primarily by gross margin improvement. This refinement is offset by favorable updates to our projections for interest expense and year-on-year share count reduction. We're now projecting $37 million to $38 million in net interest costs in 2019 and a 1% to 1.5% reduction in average shares outstanding with both metrics aligned with an assumed maintenance of our net leverage rate levels at approximately 1.5 times EBITDA. Our outlook for effective tax rate in 2019 remains at 20% to 21%, as sustained 2018 upsides are offset by updated estimates for tax rate benefits of stock-based compensation, reflecting more recent share price levels. We now project $6.5 million to $8.5 million or approximately 2% in tax benefit from exercise of stock-based compensation in 2019, approximately $0.02 per share below prior estimates, and $0.15 per share below high 2018 levels. In terms of free cash flow, we expect to continue to invest in high-return instrument growth programs globally and to deploy $160 million to $175 million in capital spending, including approximately $70 million related to completion of our Westbrook Headquarter and German Core Lab projects. For 2019, this results in an outlook for free cash flow of 60% to 65% of net income, where approximately 80% of net income normalized for these two major projects. In terms of our first quarter outlook in 2019, we expect Q1 reported revenue growth in the 6% to 7.5% range, reflecting organic gains of 9% to 10.5%, net of a projected 1% equivalent day's headwinds. Q1 operating margins are expected to be at the lower end of our full-year improvement goals of 50 to 80 basis points as we continue to advance implementation of our international commercial resource expansion. We expect our effective tax rate in Q1 to be 18.5% to 19%, including projected benefits from share-based compensation exercise activity. That concludes the financial overview. Let me turn the call over to John for his comments. Okay.

Brian, thank you. A little color commentary, and then we'll open up to questions. We finished 2018 with strong revenue growth and impressive bottom line results, even as we're making significant incremental investments in business to support our customers, and that will generate sustained growth for years to come. Companion Animal Diagnostic recurring revenue, which constitutes 75% of IDEX's overall revenues in 2018, grew organically 13% for the quarter and the full year, consistent with our expectations. diagnostic recurring revenue, which represents almost two-thirds of the total global, generated organic growth of 13.3%, while international generated 12.5%. International growth was supported by 20% plus instrument consumable organic revenue growth. Clearly, pet owners have an increasing appreciation of the importance of health care for their pets. Our growth trends as 2018 wraps up are also a testament to the value our customers see in IDEX's unique diagnostic offering and the importance the IDEX technologies play in health care. The market for medical and technician talent is really competitive right now, as you can see from this morning's job report. In fact, it's been reported that there is one veterinarian available for every five veterinarian job openings. And so practice owners need to attract and retain valued staff by providing them essential tools and a partner to support their job well and take the best care of patients. Thus, the importance of IDEX is far more advanced innovations. And so our customer retention metrics, which are the foundation of growth in a recurring revenue model, continue at exceptionally high levels in Q4, if not inching up ever so slightly. Our organic growth remains primarily volume-driven, augmented by continued modest price realization, the latter reflecting the benefits of how our offerings advance with the benefit of almost 130 million of cash R&D and diagnostics and software in 2018, and a projected almost 150 million in cash R&D in the same, in 2019. This technology-for-life approach includes the behind-the-scenes software upgrades that happen regularly for our point-of-care instruments, like the recently announced Neural Network 4.0 for SEDview Advancing Menu and the progesterone test for our Catalyst platform, our seventh new test in seven years on the Catalyst platform, as well as regular advances in VetConnect Plus, our cloud-based diagnostic software. For 2018, placements of catalysts to new and competitive counts were up 20%. New and competitive catalyst placements over the course of the year are an important contributor to the 19% organic relative and IDEXX VetLab instrument consumables Q4. We're pleased with the instrument placement results that Q4 contributed to the year that Brian has enumerated, as well as the completion of the rollout of Catalyst-1 analyzers at over 1,000 Banfield hospitals. We're entering 2019 having completed important commercial expansions around the world. The U.S. expansion with the greater customer coverage from a deeper field-based professional organization was in place for the start of Q4. There's always some settling in during the first quarter of an expansion as our professionals, including newly recruited professionals, develop relationships with their customers in their new or reconfigured territories. Especially in this light, the North American growth metrics, also against a strong compare, were very strong. As we enter 2019, we're beyond this initial settling in period in our US market, our largest, with an experienced world-class team of professionals and frontline leadership. This team is focused on growing diagnostic and software category, advancing customers' adoptions of new protocols such as preventative care diagnostics, fecal antigen testing, your analysis unit instead of you, and growing the overall number of customers that benefit from IDEX's unique technologies. Our U.S. field footprint isn't in place with our U.S. field footprint in place a quarter ago. Our 2019 U.S. focus is on the productivity that comes from rapid development and time and territory. Our commercial investments in the U.S. in 2019 will focus on high ROI opportunities beyond the field footprint. Our international teams expansion plans were timed generally about a quarter later than the US. At this point, we're largely complete in hiring expanded commercial resources to advance instrument placements and companion animal group diagnostic recurring revenue growth in accordance with our plans. Our international teams are building competencies with our key commercial strategies. For example, the economic value index of an instrument placement to prioritize high value chemistry placements which is one of the reasons why we saw a 29% growth in new income competitive catalyst placements in Q4 internationally to a record over 700 units, which was up 100 units from Q3 of 2018, which itself was a quarterly record. Another strategic competency being adopted by international is leveraging the IDEXX 360 program to accelerate instrument placements and drive recurring revenue growth. This type of program selling is generally new to our IDEX teams outside of North America, and I'm pleased with the team's progress here as the year wrapped up. Our international teams are poised to have a great 2019, spreading the benefits of IDEX's innovations such as IDEX SDMA, including on catalyst placements, and our best-in-class hematology offerings as the expansions complete their settling period in the first quarter of 2019. These international commercial expansions, along with a unique diagnostic and software technology offering, gives us confidence in our revenue growth targets, primarily driven by volume testing gains with secondary support from modest price realization and net new customer additions. While current economic times bring a steady din of broader macro noise, IDEX's growth remains solid, reflecting the durable, recurring nature of our revenues, the benefit of our differentiation enabled by our industry-leading investments in innovation, and supported by the growing bond between pets and their owners. In sum, we are sustaining solid growth momentum as we enter 2019, which gives us confidence for the 11 to 12% projected organic growth of CAG diagnostic recurring revenues in 2019, similar to the 2018 growth trends on an adjusted basis. Before I open the call to questions, I want to express my deep gratitude to our employees for their accomplishments in 2018 in the pursuit of our purpose to enhance the health and well-being of pets, people, and livestock, and also my gratitude to the continued confidence our customers have in IDEX as a value-added technology partner. So with those comments, Cynthia, we'll open the call to questions.