IDEXX Laboratories, Inc.

Good morning and welcome to the IDEXX Laboratory's first quarter 2019 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-looking statements 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 first quarter 2019 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 2018 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. IDEX delivered continued high revenue growth and excellent financial results in the first quarter. In terms of highlights, we achieved 10% organic revenue growth, driven by 12% organic gains in CAG diagnostics recurring revenues. As expected, FX impacts from the strengthened U.S. dollar reduced reported revenue growth by about 3%. Operating margins improved 210 basis points on a constant currency basis, better than projected, reflecting strong gross margin gains and operating expense leverage, which benefited from high CAG diagnostic recurring revenue growth as well as timing delays related to select IT and R&D project spending. EPS was $1.17 per share, up 16% on a reported basis or 27% on a comparable constant currency basis. Strong revenue growth and operating margin gains drove 21% constant currency operating profit growth. We also recognized about $0.02 per share in upside related to higher than projected tax benefits from stock compensation activity. In terms of our full-year guidance, 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 increasing our 2019 EPS guidance range by 10 cents to $4.76 to $4.88 per share. This incorporates an increase of about 7 cents from an updated outlook for 80 to 110 basis points in full-year constant currency operating margin improvement, 1 to 2 cents per share in benefit from updated interest and expense projections, and 1 to 2 cents in upside related to updated effective tax rate projections. Our operating margin outlook factors in additional investments we're advancing this year in reference lab capacity corporate customer support resources, and customer-facing software capability, while continuing to deliver strong operating margin improvement and comparable constant currency EPS gains aligned with our long-term financial goals. We'll review our updated 2019 outlook later in my comments. Let's begin with a review of our Q1 performance by segment and region. Q1 results were supported by continued strong performance in our companion animal group. Global CAG revenues were $509 million, up 10% organically, driven by 12% organic growth in CAG diagnostics recurring revenues. Veterinary software services and diagnostic imaging systems revenues increased 7% overall and 6% organically, with overall revenue gains constrained by comparisons to very strong prior year digital imaging system placement levels. Veterinary software services revenue grew at high single digit rates organically in Q1, reflecting very strong sales results across our practice management platforms, with the continued growth of our PIMS and application install base supporting expansion of recurring software service revenues. Our digital imaging business continued to achieve high levels of digital radiography system placements and high growth in recurring WebPAC subscription revenues linked to our expanding install base. Our water business revenues grew 8% organically in the first quarter to $30 million, reflecting continued solid growth in the U.S. and double-digit gains in international markets. Livestock, poultry, and dairy revenue in Q1 was $32 million, up 4% organically. Gains in herd health screening, poultry, and pregnancy product sales were offset by moderate declines in European disease eradication program revenues, continued market demand impacts on our dairy testing business, and continued pressure on swine diagnostic testing revenues related to impacts from the African swine fever epidemic in China. By region, U.S. revenues were $358 million in the quarter, up 9% organically, driven by 11% growth in CAG diagnostic recurring revenues, net of an approximate 1% equivalent day headwind. Strong U.S. gains reflected continued double-digit growth in reference lab and consumables and solid mid-single-digit growth in rapid assay sales. CAG-diagnostic recurring revenue gains were primarily volume-driven, with U.S. net price gains continuing to trend in the 2 to 3 percent range. In terms of our broader U.S. market trends, this quarter we've significantly revamped and expanded our reporting from our data set from approximately 7,500 practices, representing five different practice information management systems. We've also refined our weighting framework based on practice size and region, prepared in collaboration with animaletics. We're now providing same-store growth in clinical visits per practice, augmenting our quarterly reporting on total same-store visit and revenue growth for companion animal veterinary visits of all types. In Q1, we saw improvement in total visits per practice growth to 1.3% year-on-year, with clinical visits per practice growing at a greater amount of 2.2%, and overall revenue per practice growth of 5%. Please note that these metrics are on a same-store basis and do not include growth benefits from incremental practice formation, which we estimate at approximately 1% annually. The Q1 2019 earnings snapshot on our website shows quarterly data on clinical visit growth for 2018 and Q1 2019, as well as some additional information we've added that describes our measurement methodologies and refinements we've made to our historical data to reflect the additional insight we've gained from our data analysis efforts. International revenues in Q1 were $218 million, up 11% organically. International results were driven by strong 14% organic gains in CAG diagnostic recurring revenues, including continued 20% plus organic growth in consumable revenues, as we benefit from 30% year-on-year growth in our catalyst install base outside of the U.S. We saw modest benefits from advance ordering in the U.K. ahead of the Brexit deadline, which added approximately 2% to international consumable growth in Q1. International reference lab growth was in the mid-single-digit range as we continued to advance commercial efforts targeted on accelerating growth in this line of business while sustaining strong momentum in expanding our catalyst install base in international markets. In terms of segment performance, Q1 results were supported by continued progress in driving catalyst placements at new and competitive accounts. The quality of our instrument placements was strong in Q1. We achieved 307 placements at new and competitive accounts in North America, up 7 percent, with a high attach rate of premium hematology instruments, which drove a solid increase in EVI, our measure of multi-year economic value of instrument placements. We also placed 122 second catalysts at IDEX accounts in North America, compared to 59 in Q1 2018, supporting growth in customer utilization at larger accounts. Internationally, we've placed 633 catalysts at new and competitive accounts of 20%. By region, competitive and new catalyst placements represented 69% of total placements in North America and 62% internationally. Strong catalyst placement results and continued high retention is reflected in 24% year-on-year growth in our global catalyst install base. Overall, we placed 2,775 premium analyzers in Q1, down 2% compared to very strong prior year levels. Q1 results were led by 1,463 catalyst placements globally, up 4% overall, supported by 443 placements in North America, a 20% year-on-year increase, and 1,020 placements in international markets, down 1% compared to record prior year results prior year results, which included high levels of VET test upgrades in emerging markets. As noted, we saw a high attach rate of premium hematology instruments with chemistry placements in Q1, which supported 823 premium hematology instruments globally, up 9%. Set of view placements were 489 in Q1, down 26% versus very strong prior year levels, impacted by our exceptional set of view placement performance in Q4, as well as our commercial focus in Q1 on capturing high EVI new and competitive catalyst placement opportunities. In addition to strong premium placement results, we drove continued momentum with SnapPro with 1,999 placements in the quarter. CAG diagnostic instrument revenues in Q1 were $29 million, a 3% decrease organically off a tough compare in 2018, which included mixed benefits from very strong placements of higher-priced SETA view instruments. Benefits from an expanding instrument-based test innovation and enhanced commercial capability continue to drive strong CAG-diagnostic recurring revenue gains across our major modalities. Instrument consumable revenues of $167 million grew 15% organically in Q1. Results reflected double-digit gains in the U.S. and continued 20%-plus growth in international markets. High volume-driven consumable gains continue to be supported by expansion of SETAview pay-per-run and estimated slide revenues, which contributed approximately 3 percent combined to year-on-year consumable revenue gains in the quarter. Reference lab and consulting services with revenues of $203 million grew 11 percent organically in the first quarter. U.S. lab momentum remains strong, reflected in solid double-digit volume-driven organic revenue gains supported by expansion of our preventative care programs. As noted, international reference lab growth was in the mid-single-digit range, supported by solid gains in Europe. Rapid asset revenues of $54 million grew 6% organically in Q1, reflecting solid gains across U.S. and international markets. Rapid asset gains were primarily volume-driven, supported by growth in 40X plus and first-generation products. Turning to the P&L, operating profit in Q1 was $133 million, up 18% as reported, or 21% on a constant currency basis. reflecting profit gains across our CAG, water, and LPD segments. Operating margins were 23.1% of 210 basis points on a constant currency basis, supported by solid gross margin gains and operating expense leverage. Gross profit was $332 million in Q1, of 9% as reported or 12% on a constant currency basis. Gross margins increased 110 basis points on a constant currency basis, supported by continued moderate CAG diagnostic net price gains, volume leverage and productivity gains in our U.S. reference lab business, NICS benefits from high consumable growth, as well as solid gross margin improvement in our water and LPD businesses. Foreign exchange hedge gains, which are reflected in gross profit, were $1.4 million in Q1. Operating expenses in Q1 were up 4 percent or 7 percent on a constant currency basis, resulting in 100 basis points of positive operating margin leverage. Operating expense increases were driven by growth in CAG sales and marketing and R&D spending, with overall spending increases mitigated by modest constant currency growth in G&A costs, including benefits from later phasing of certain IT-related projects. EPS in Q1 was $1.17 per share, an increase of 16 percent as reported, and 27 percent on a comparable constant currency basis. Foreign exchange net of hedge impacts in Q1 2018 and 2019 decreased operating profit by $4 million and EPS by $0.03 per share. Our effective tax rate was 17.7% in Q1, including benefits of 4.4% to our tax rate, or $0.06 per share, related to share-based compensation activity, which was approximately $0.02 per share higher than projected. Free cash flow was minus $4 million for Q1 reflecting normal quarterly seasonality and increased capital spending related to major projects. We continue to maintain our four-year outlook for free cash flow of approximately 60 to 65 percent of net income for 2019 and 160 to 170 million in capital spending, which includes approximately 20 percent of free cash flow impact driven by 70 million of combined incremental capital spending related to our Westbrook main headquarter expansion and our German core lab relocation. We allocated $54 million in capital to repurchases of 267,000 shares in Q1. We ended Q1 with $1,052,000,000 in debt, including $100 million of new 10-year notes issued in the quarter. Our liquidity remains strong with $117 million in cash and $502 million in capacity under our revolving credit facility. Our leverage ratios as a multiple of adjusted EBITDA were 1.69 times gross and and 1.5 times net of cash and investment balances. We're maintaining our 2019 full-year outlook for reduction in average shares outstanding from stock repurchases of 1 to 1.5 percent, which assumes net leverage at 1.5 times EBITDA. We're now projecting annual interest expense, net interest expense of $36 million, incorporating a more favorable full-year interest rate outlook. Turning to our 2019 guidance, we're reinforcing our full-year revenue outlook while raising our EPS range by $0.10 per share. Our full-year reported revenue guidance remains $2,385,000,000 to $2,425,000,000, reflecting consistent expectations for 9.5% to 11% overall organic growth and 11% to 12% organic growth in CAG diagnostic recurring revenues. Our reported revenue outlook reflects a consistent projected 1.5 percent full-year FX revenue growth headwind at the rates assumed at our press release. We're raising our 2019 full-year EPS guidance 10 cents per share to 476 to 488, or 16 to 19 percent growth on a comparable constant currency basis. This incorporates a 30 basis point increase in our outlook for constant currency operating margin improvement, now estimated at 80 to 110 basis points for the full year. resulting in approximately 7 cents per share in improvement in our EPS guidance range. We've also refined our outlook for net interest expense and stock compensation tax benefits, which combine to add approximately 3 percent to our full-year EPS range. We've updated our outlook for our 2019 effective tax rate to 20 percent to 20.5 percent, including an updated estimate of 8.5 million to 10.5 million or approximately 2% in full-year projected tax rate benefit from exercise of share-based compensation. We estimate that foreign exchange rate gains will decrease reported EPS by $0.03 per share, net of approximately $11 million in projected hedge gains. For the second quarter, we expect reported revenue growth of 7% to 8.5%, and organic revenue gains of 9% to 10.5%. supported by consistent 11 to 12 percent CAG diagnostic recurring revenue gains. We expect Q2 operating margins to be approximately 50 basis points higher than prior year levels on a constant currency basis. This outlook incorporates a re-phasing of planned first half investments, impacts of higher international commercial staffing levels, and incremental investments in select areas, including increases to our U.S. day lab capacity. We expect our effective tax rate in Q2 to be approximately 21.5%, 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. Thank you, Brian.

Now a little commentary. We had a strong start in 2019 in the first quarter with organic revenue growth of 10% and comparable constant currency EPS gains of 27%. supported by better-than-expected margin gains. Globally, we delivered a solid 12% organic growth in our CAG diagnostic recurring revenues at the higher end of our full-year growth rate goal, with strong gains across the U.S. and international regions. This expanding, highly durable annuity contributed 77% of IDEX's total revenues in Q1. Instrument placements globally, considering both quality and quantity together, were solid, with strength in the US, Europe, and Latin America offset by year-over-year declines in Asia Pacific, primarily related to tough comparisons. Our premium install base continues to expand at high rates, and we do not see any change in the competitive environment. In Q1, our US field organization was in its second quarter of the latest territory expansion And so we saw strong momentum in placements of catalysts to new and competitive accounts, up 7%, as our field organization inspires customers to trade up to IDEX's advanced technology offering. We also had an exceptional quarter with SnapPro placements of almost 2,000, driven by the U.S., up 68% year over year. We are methodically transforming our rapid assay customer base into a razor and blade business model, as a SNAP Pro mobile instrument brings significant workflow and charge capture value to the veterinary practice. And we're seeing higher growth and rapid assay loyalty when customers adopt SNAP Pro workflow. With placements in Q1, we're now well over 60% of our SNAP 40X coming from active and connected SNAP Pro customers. Despite tough comparisons to high prior year Cetaview placements, New and competitive catalysts and snap-prone gains supported solid growth in the U.S. economic value index in the quarter. They really did a great job. Europe also saw strong, solid Q1 growth in catalyst placements and instrument placement value, which is impressive given they are in their first quarter of the field sales expansions. The European expansions are on their way to completion at 92% occupancy. However, 40% of field reps are in their first year, and as a result, sales productivity in Europe will be building through 2019 as field experience and time and territory advances. This is the same dynamic we saw in the US when we undertook a similar major expansion in 2015. The US companion animal market is on very solid footing, as is the pet owner in general, based on macro and the trends we see. We are excited to be presenting this quarter a much expanded and improved market growth reporting, as shown on the second page of our earnings snapshot, with an upgrade to our methodology and an expansion in the number of practices, 7,500 in total, coming from a variety of both IDECs and third-party practice management systems. Additionally, weighted to reflect the market in terms of geography and practice size and type with the support of Animalytics, and we're grateful for their partnership. We are giving back to the industry by publishing these important metrics on a quarterly basis as part of our earnings. This is an industry with otherwise limited to no market data of this kind. Of course, the data also helps investors understand IDEX a little bit better. From this data, we're seeing 2.2% clinical visit growth from existing practices in Q1. To get to total market visit growth, we need to add the impact of net new practice formation, which we estimate to be about 1%. Pet care in the U.S. is a very healthy market, with existing veterinary practices making investments in technology and infrastructure and new practices being opened. Our growth of the companion group diagnostics recurring revenue to the U.S. was 11% in Q1, net of about 1% equivalent day headwind. We are and have been growing faster our diagnostic volume than patient visit growth for several reasons. First, we're seeing strong same-store sales in diagnostic volume growth beyond clinical visit growth, driven by our unique innovations and our focus on driving health ongoing increases in the utilization of diagnostics in pet care. Across our modalities, we estimate this adds about 4% of incremental volume to clinical visit growth. To this, you add another 2% growth in the number of new practices that are utilizing IDEX as their primary diagnostic partner, whether it be in-house, reference lab, or both. Call this customer share gain, if you will. In fact, we topped 20,000 practices, sending at least one sample to IDEXX Reference Labs in Q1, a record for this metric in Q1. We also continue to realize 2% to 3% net price realization in companion animal diagnostic recurring revenue. So added all up, 9% volume growth from a variety of sources and 2% to 3% new price realization gets us to low teens DX recurring revenue in the U.S., aligned with the high end of our long-term U.S. growth potential of 9 to 13 percent. Same-store sales at the practice level is being driven in part by the adoption of IDEXX's fecal offering and by preventative care diagnostics, what we call the Preventative Care Challenge, or PCC. To date, through Q1, nearly 2,800 practices have enrolled in the PCC program since its inception, with over 300 new practices enrolled in the quarter. These 2,800 practices are growing IDEXX diagnostics at just under 15% on a trailing 12-month basis. Preventative care is a great example of how we are creating new market growth with our innovations incorporated into reference lab PCC profiles. all of which include at a minimum IDEXX SDMA with the chemistry, the IDEXX CBC, fecal antigen, and IDEXX's 40X offering. Together they make an IDEXX PCC panel a well-justified annual pet owner investment in their pet and the pet's health by uncovering underlying disease as part of a wellness visit. Just think it this way, running a PCC panel on a pet as part of an annual physical exam is like a human getting a physical with blood work every seven years. The only difference is that the blood work is even more important in pet care as the pet can't speak for themselves and we got these dogs running around dog parks sniffing around and drinking from the puddles. It's just a different situation and we're finding there's a lot of value. When a veterinary practice partners with IDACS with our proprietary PCC panels, their overall practice revenue growth accelerates generally without the addition of any staff. Clearly, 2019 is the year where preventative care diagnostics, driven by the expanded capabilities of IDEX's unique offering, is moving into the mainstream of veterinary medicine to the benefit of the veterinary practice, pets, owners, and IDEXs alike. And yet, we believe IDEX is only serving 10% of the total addressable market for preventative care. We also see nice same-store sales growth in the VetLab consumables business from the adoption of new menu, including Catalyst SDMA, Cetiview, and now Catalyst Progesterone. Customer retention rates in the U.S. remain stable in Q1 at world-class levels of 98% to 99%. In an environment where competitors use their only weapon, price, to compete, it is nice to see our customers do not equate price with value. and evidenced the value of our innovations through their loyalty. New product launches in the quarter included Catalyst progesterone, which is off to a strong start both U.S. and internationally. France led the launch, helping to expand the availability of poodles. We completed the update of all set of you in the field with the newest algorithm, NeuroNetwork 4.0, benefit of our Internet of Things strategy with our instruments. In the veterinary software portfolio, we released Cornerstone 9.1 to great excitement and rave reviews. This new release brings a transformed user experience that is more intuitive and reduces clicks, and we're seeing a more rapid take-up of this new release as a result. We had strong placements of new Cornerstone, Neo, Animana, and SmartFlow systems in the quarter. In addition, this month we formally announced the prospective availability of a cloud version of Cornerstone for our customers who value the deep and unique functionality of Cornerstone as the go-to high-end practice management software, but also want the benefits of a cloud, such as full mobile access. We're seeing strong adoption in our IDEXX web packs, our cloud-based software-as-a-service offering, with its new reference image library and the ability to work with both IDEXX digital imaging systems as well as those from third parties. Total Webpack subscriptions have seen a 40% growth year over year. Other software offerings from IDEXX are advancing nicely, including Petly plans for wellness plans, Enterprise to support our corporate customers, and of course, IDEXX VetConnect Plus, which continues to make steady advancement in both functionality and utilization. It is indeed a comprehensive and impressive IDEX software technology stack. We're serving a growth market and supporting further market growth through our advanced diagnostics and software technologies. Given our success, we have in the works augmented investments planned in the North American market, including reference lab capacity expansion, corporate account support resources, and further investments in our customer-facing software strategies. Of note, we have no plans for further expansion of our field-based footprint in the U.S. or internationally in 2019 in diagnostics, other than completing the occupancy plans in Europe and a small expansion to serve corporate accounts. With these investments, we're focusing on the remainder of 2019 on driving field sales productivity, which comes from time and territory, advancing our CRM, and advancing programs such as EVI and IDEXX 360. In summary, we see very solid trends in our markets globally in 2019 and remain on track to advance our strategy of investments to further our innovation agenda, such as our outlook for about $150 million in cash R&D, while delivering on our 2019 revenue goals and an augmented outlook of 16% to 19% comparable constant currency EPS gains for the year. And Kevin, with that, I'll open the call to questions.