IDEXX Laboratories, Inc.

Good morning and welcome to the IDEXX Laboratory Second Quarter 2019 Earnings Conference Call. As a reminder, today's conference is being recorded. Participating in the call this morning are Jay Mazelski, Interim President and 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 measures is provided in our earnings release, which may also be found by visiting the investor relations section of our website. In reviewing our second 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.

Good morning, everyone. HIDEX delivered continued strong financial performance in the second quarter. In terms of highlights, Q2 revenues of $620 million grew 7% on a reported basis or 9% organically. Results were driven by continued strong 11% organic gains in CAG diagnostic recurring revenues, net of a combined 0.5% growth headwind related to Brexit order timing and equivalent day impacts. The quality of our growth was excellent in the quarter, reflected in strong U.S. CAG diagnostic recurring revenue gains across our major modalities. and 39% growth in new and competitive catalyst placements in international markets, which supported solid global EBI gains and continued high growth in consumable revenues. Profit performance continued at a strong pace in Q2, supported by continued high CAG diagnostic recurring revenue growth and high profit flow through. EPS was $1.43 per share, an increase of 19% on a comparable constant currency basis, reflecting a better than projected 120 basis point improvement in constant currency operating margins. In addition to strong operating profit gains, Q2 EPS results also benefited from $0.04 per share and upside related to share-based compensation tax benefits. While our CAG-diagnostic recurring organic revenue growth remains strong and on track with our full-year 11% to 12% growth goals, Our overall Q2 organic growth of 9% was at the lower end of our projected growth range for the quarter, impacted by a few select factors. We fell short of our goals to build on very high prior year international chemistry upgrade levels, with the majority of our Q2 upgrade placement shortfall in China. We also saw increased pressure on China LPD revenues in Q2 driven by the African swine fever outbreak, as well as a relatively higher than projected impact from Brexit and equivalent day effects in the quarter. These factors were largely specific to the second quarter. We've refined our full-year revenue outlook to incorporate these effects while raising our full-year EPS guidance, reflecting continued benefits from high CAG diagnostic recurring revenue growth and disciplined P&L management. In terms of our full-year revenue outlook, we're maintaining our guidance for 11% to 12% organic growth and CAG diagnostic recurring revenues. We're refining our overall organic growth guidance to 9.5% to 10.5%, lowering our high-end growth outlook by 0.5%, incorporating our second quarter results. Our updated full-year revenue guidance is now $2,380,000,000 to $2,410,000,000, $10 million below our prior midpoint revenue range, reflecting $5 million in operational refinements and approximately $5 million of impacts related to updated FX estimates. We're raising our 2019 EPS guidance range by 5 cents per share at midpoint to $4.82 to $4.92, or 17% to 20% growth on a comparable constant currency basis. This outlook reflects 2 cents in EPS benefit at midpoint related to higher expectations for operating performance, driven by a raised outlook for 100 to 125 basis points in full-year constant currency operating margin improvement and lower projected interest expense. Our guidance builds in a $0.04 per share increase from updated projections for share-based compensation tax benefits, incorporating Q2 upsides, offset by a $0.01 negative impact related to updated FX assumptions. We'll review our updated 2019 outlook later in my comments. Let's begin with a review of our Q2 performance by segment and region. Q2 results reflect a continued strong performance in our companion animal group. Global CAG revenues were $547 million, up 10% organically, driven by 11% growth in CAG diagnostic recurring revenues, including strong global gains across our major modalities. As noted, our CAG diagnostic recurring revenue growth in the quarter was net of a 0.5% headwind from Brexit order timering and equivalent day effects, which were relatively greater than anticipated, impacted by the timing of European holidays. Year-to-date CAG diagnostic recurring revenues increased 11.4% in line with our four-year goals. Veterinary software services and diagnostic imaging systems revenues increased 9% overall and 7% organically in Q2, driven by double-digit organic gains in VSS revenues. We saw continued strong sales results across our practice management platforms and growth in recurring software services on our expanding PIMS and application install base. Our diagnostic imaging business also continues to achieve high levels of digital radiography instrument placements and growth in recurring services, although organic revenue gains in the quarter were moderated by comparisons to high prior-year instrument placement levels. Our water business revenues grew 10% organically in the second quarter to $35 million, with consistent mid-single-digit growth in the U.S., augmented by high growth in Asia and Latin America, aided by our expanded direct sales presence. Livestock, poultry, and dairy revenue in Q2 was $33 million, reflecting relatively flat organic growth. Strong organic growth in health herd screening revenues, aided by a favorable prior year comparison in the quarter, and solid gains in poultry and pregnancy testing were offset by greater than projected pressure on swine diagnostic testing revenues related to impacts from the African swine fever epidemic in China, as well as moderate declines in European disease eradication program revenues. By region, U.S. revenues are $389 million in the quarter, up 9% organically, driven by an 11% organic increase in CAG diagnostic recurring revenues. U.S. recurring revenue gains were supported by double-digit growth in U.S. reference labs and consumables and high single-digit gains in rapid assay sales. U.S. CAG recurring diagnostic growth continues to be primarily volume-driven, with net price gains continuing to trend in the 2% to 3% range across our major modalities. IDEXX growth continues to outpace broader market trends. In Q2, total visits per practice growth was 0.7% year-on-year, with clinical visits per practice growing at a greater amount, at 2.1%, and overall revenue per practice increasing 4.4%. Market growth results were slightly moderated from Q1 levels, which were refined following our latest dataset refresh. Note that these metrics are on a same-store basis and don't include growth benefits from incremental practice formation, which we estimated approximately 1% annually. International revenues in Q2 were $230 million, up 9% organically, driven by 11% organic gains in CAG-diagnostic recurring revenues. As noted last quarter, we saw benefits in Q1 related to advanced ordering ahead of the previous Brexit deadline. These effects reversed in the second quarter, which along with an unfavorable impact related to the timing of European holidays, reduced overall international CAG diagnostic recurring revenue gains by approximately 1.5% and consumable gains by over 3%. Adjusting for this dynamic, international consumable gains were nearly 20% in Q2, supported by our commercial executional focus in expanding our global catalyst install base. International CAG diagnostic revenue gains were moderated by consistent mid-single-digit revenue gains in our reference lab business. This is an area targeted for improvement in the second half of 2019, aided by relatively more favorable year-on-year comparisons and benefits from our expanding veterinary diagnostic consultant business model. In terms of segment performance, our Q2 results reflected strong global gains across CAG diagnostic testing modalities and continued progress in expanding our premium installed equipment base globally. Globally, EVI was up solidly in Q2 compared to very strong prior levels driven by growth and high-quality catalyst placements. In North America, we placed 319 catalysts at new and competitive accounts as well as 159 second catalysts at larger IDEX accounts. Second catalyst placements are supporting continued strong consumable growth and high customer retention rates aided by steadily expanding 360-degree program and other long-term contract commitments. These results compared a strong prior year new and competitive catalyst placement levels of 346 units and 95 second catalyst placements. Along with limited vet test upgrades, total North American catalyst placements were 486 in the quarter, up 8%, supporting a 15% year-on-year growth in our North America install base, including approximately 5% of growth benefit from upgrades completed in the second half of 2018 at Banfield. In international markets, we placed 761 catalysts at new and competitive counts, or 66% of total placements, up 213 units, or 39% compared to the prior year. Total international catalyst placements of 1,149 units were down 4% compared to very strong prior year levels, which had high levels of vet test upgrades in Asia-Pacific markets. As noted, while our new and competitive catalyst results were excellent, we did fall short of our goals in Q2 to build on our high priority levels of upgrades and expansion markets such as China, which contributed to a shortfall to our quarterly instrument revenue goals. Despite these dynamics, our international catalyst install base reached nearly 21,000 units in Q2, up 28% year-on-year and over 5% compared to ending Q1 levels. Overall, we placed 3,171 premium analyzers in Q2, down 2% year-on-year. Total catalyst placements were 1,635, down 1%, reflecting the tough compared to high prior year vet test upgrade levels. We achieved 602 SETA view placements in Q2, down 16%, compared to very strong prior year levels, which benefited from a high percentage of our early 360-degree program agreements, including 7u, compared to a more recent mixed shift, which has included relatively more catalysts as part of our 360 program commitments. We placed 934 premium hematology instruments globally in the quarter, up 7%, with a continued high attach rate with new and competitive catalyst placements. In addition to these strong premium instrument results, we placed a record 2,663 SNAP Pros in Q2, expanding our SNAP Pro install base to over 30,000. with over 27,000 installed in North America, helping to support increasing retention rates in our rapid assay business. CAG diagnostic instrument revenues in Q2 were $32 million, a decrease of 7% organically off a strong compare in 2018, which included mixed benefits from very strong placements of higher-priced set-of-view instruments. Benefits from a growing instrument-based test and software innovation and expanded direct commercial capability continue to drive strong recurring CAG diagnostic revenue gains across our major modalities. Instrument consumable revenues of $175 million grew 13% organically in Q2, net of a 1% growth headwind related to Brexit order timing and equivalent day impacts. Results reflect double-digit gains in the U.S. and normalized growth of nearly 20% in international markets. High volume-driven consumable gains were supported by continued expansion of SETA view and SQMA on a slide, with each contributing nearly 1% to year-on-year consumable revenue gains in the quarter. Reference laboratory and consulting services revenues of $214 million grew 10% organically into Q2. U.S. lab momentum continues to be very strong, reflected in low- to mid-teen volume-driven organic reference lab revenue gains and sustained high customer retention levels. Overall lab growth was moderated by consistent mid-single-digit organic lab growth in international markets. Rapid assay revenues of $69 million grew 9% organically in Q2, reflecting continued expansion of 40X Plus specialty and first-generation products, supported by planned promotional programs and high customer retention levels, aided by our expanded SnapPro install base. Rapid assay gains continue to be primarily volume-driven, augmented by moderate net price gains. Turning to the P&L, operating profit in Q2 was $164 million, of 13% as reported, or 14% on a constant currency basis, supported by operating margin gains across our CAG, water, and LPD segments. Operating margins were 26.5% of 120 basis points on a constant currency basis, or 140 basis points as reported, reflecting moderate gross margin gains and stronger than projected operating expense leverage. Gross profit was $358 million in Q2 of 8% as reported or 9% on a constant currency basis. Gross margins of 57.7% increased 30 basis points on a constant currency basis supported by product margin gains reflecting benefits from moderate net price increases and strong consumable and rapid assay growth. These gains in scale and productivity benefits in our U.S. lab business were offset by planned investments in lab capacity and systems, as well as incremental year-on-year costs associated with expanded software field service resources. Foreign exchange hedge gains, which are reflected in gross profit, were approximately $2.5 million in Q2. Operating expenses in Q2 were up 4% or 6% on a constant currency basis, resulting in 90 basis points of positive operating margin leverage. Constant currency operating expense increases were driven by growth in R&D spending and increased costs related to our expanded global commercial infrastructure, with some favorability related relative to our expectations for the quarter relative to the ramping of cost growth in these areas. Overall operating expense growth was moderated in Q2 by relatively limited constant currency growth in G&A costs, reflecting low year-on-year corporate function and benefit cost growth and LPD cost controls. EPS in Q2 was $1.43 per share, an increase of 16% as reported, and 19% on a comparable constant currency basis. Foreign exchange, net of hedge impacts in Q2 2018 and 19 decreased operating profit by $2 million and EPS by $0.01 per share. Our effective tax rate was 19.5% in Q2, including benefits of approximately 3% to our tax rate, or $0.05 per share related to share-based compensation activity, which is approximately $0.04 per share higher than projected. Free cash flow is $99 million for the first half of 2019. We continue to expect free cash flow of 60% to 65% of net income for 2019, reflecting a consistent four-year outlook for capital spending of $160 million to $175 million. This includes approximately $70 million of combined incremental capital spending related to our Westbrook, Maine, headquarter expansion and our German core lab relocation, or about 20% of net income. We allocated $20 million in capital to repurchase 86,000 shares in Q2. Year-to-date, we repurchased 353,000 shares for $74 million, or an average price of $210 per share. Our balance sheet remains strong. We ended Q2 with $956 million in debt, $111 million in cash, and $597 million in capacity under our revolving credit facility. Our leverage ratios as a multiple of adjusted EBITDA were 1.49 times gross and 1.31 times net of cash and investment balances. We're refining our 2019 four-year outlook for reduction in average shares outstanding from stock repurchases of approximately 1%, which reflects more recent stock price trends and assumes that we maintain net leverage ratios at current levels. We now project annual interest expense of approximately $34 million and improvement of $2 million more than offsetting these impacts. In terms of our update of P&L outlook for 2019, our full year reported revenue guidance is now $2,380,000,000 to $2,410,000,000, reflecting refined expectations for 9.5% to 10.5% overall organic growth and consistent 11% to 12% organic growth in CAG diagnostic recurring revenues. Our reported revenue outlook reflects a projected 1.5% to 2% full-year FX revenue growth headwind at the rates assumed in our press release. As noted, we're raising our 2019 full-year EPS guidance 5 cents per share at midpoint to $4.82 to $4.92, reflecting an outlook for 17% to 20% comparable constant currency EPS growth. Refinements to our revenue outlook are more than offset by increased expectations for full-year operating margin improvement now projected at 100 to 125 basis points, generating two cents of operational benefits, including net upsides from revised projections for four-year interest expense and share account reduction. Our EPS guidance assumes a 2019 effective tax rate of 19.5% to 20%, a 50 basis point improvement compared to earlier guidance, ending four cents of reported EPS upside. This tax rate includes an estimate of $12 to $14 million, or approximately 2.5% in projected full-year tax rate benefit from exercise of share-based compensation. At midpoint of our guidance estimates, this equates to about $0.15 per share in full-year benefit. We now estimate that foreign exchange rate changes will decrease reported EPS by $0.04 per share in one cent greater impact than our last outlook, ahead of approximately $11.5 million in projected hedge gains. For the third quarter outlook, we expect reported revenue growth of 9% to 10.5% and organic revenue gains of 10.5% to 12%, including 1% to 1.5% equivalent day growth benefits. We expect Q3 2019 operating margins to increase 50 to 100 basis points above prior year Q3 levels on a constant currency basis. And we expect our effective tax rate in Q3 to be approximately 21%, including projected benefits from share-based compensation exercise activity. That concludes the financial review. Our business momentum remains strong, and we're on track to deliver our 2019 financial performance aligned with our long-term goals. Let me now turn the call over to Jay for his comments.

Good morning, and thank you, Brian. IDEXX's second quarter results build on our strong start to 2019 and reflect the strength of our recurring revenue business model, keeping us on track towards excellent full-year results aligned with our long-term goals. Our performance was led by solid 11% organic growth in our CAG diagnostics recurring revenues, or 11.5% normalized for Q1 Brexit POIN and equivalent day impacts. This expanding, highly durable annuity contributed 77% of IDEXX's total revenues in Q2. Let me start with a few reflections on the quarter. We were especially pleased with the strength of our U.S. performance in Q2, where we drove 11% recurring CAG growth, reflecting strong gains across all CAG recurring diagnostic modalities. We saw continued momentum in our U.S. reference lab business, Whereas previously communicated, we continue to invest in operational enhancements, such as new courier routes, new day labs, and weekend service. These investments provide service level and results turnaround improvements, both of which support customer retention and new customer acquisition. In our North American vet lab business, catalyst placements were up 8%, including second catalysts placed at high testing volume accounts, which also support customer retention. and helped drive continued double-digit consumable gains. Of note, the rapid assay business grew at 9% organically, benefiting from superior clinical accuracy, effective promotional programs, and improving customer retention. The business was also aided by our expanding SnapPro installed base and increasing leverage of IDEXX multimodality testing capability. Reinforcing our long-held premise that test begets testing, we're seeing strong evidence of faster rapid assay 40X plus growth at IDEXX practices that also use our lab services and are adopting preventive care protocols. Globally, instrument placements were solid during the quarter, considering tough compares and overall quality, with notable strength in international competitive catalyst placements, which were up 39%. Our premium installed base continues to expand nicely, and we don't see a change in the competitive environment. These placement gains, along with ongoing increases in testing utilization, growth continued strong growth in international consumables. International consumable sales were up nearly 20%, normalized to the impact of Brexit order timing and equivalent days, aligned with our strategy to develop this significant and clinic opportunity in international markets. Continued solid momentum across our business is keeping us on track for 11% to 12% CAG diagnostics recurring organic revenue gains this year and comparable constant currency EPS gains at the high end of our long-term goals. Let me share some additional highlights related to progress on key fronts in our growth strategy. We continue to make solid progress advancing IDEXX preventive care. Our high same-store sales growth at the practice level in our U.S. labs business is being driven in part by the adoption of preventive care diagnostics, what we call IDEXX preventive care. To date through Q2, Over 3,100 practices have enrolled in the preventive care program since its inception, with 370 new practices enrolled in a quarter, a quarterly high for first-time enrollees. IDEXX preventive care practices are growing CAG diagnostics recurring revenue at approximately 14% on a trailing 12-month basis versus the 11% growth for IDEXX's U.S. customer base over the same period. Virtually our entire VDC population in the U.S. has now successfully partnered with customers in their territories to deliver IDEXX preventive care. In fact, the top 50% of our VDC population, as ranked by their engagement in preventive care, exceeded their first half territory revenue goals by approximately 200 basis points. It's a great example of how we create market growth. We always start with the customer and patient need to understand where appropriately applying IDEXX diagnostics, like fecal antigen and IDEXX SDMA, can uncover more underlying disease. In the case of preventive care, we bring the relevant tests together to create preventive care protocols that closely align with how customers consume diagnostics testing, along with compliance-driven pricing that support the practice of best medicine. We leverage big data to raise awareness and practice standards. showing the medical benefits of applying appropriate diagnostics testing for preventive care to all pets, not just older dogs and cats. Our field organization also plays an important role in customer success and market growth, representing a key reason we went to a high-frequency trusted advisor model. We're able to invest time and resources to help customers achieve their patient and business goals. In early Q3, we introduced our IDEX Anywhere Urinalysis Bundle, available exclusively to IDEX preventive care customers. This offering combines the convenience and pricing of preventive care diagnostics run at the reference lab with all the critical advantages of fresh urine run in-house on the city view. This innovation is enabled by our unique integration capabilities between the IDEX event lab station, practice management software, and the IDEX reference lab, providing to customers a seamless ordering and billing experience across modalities. We believe this multi-modality, customer-friendly solution could help further accelerate the our preventive care momentum, and help support SETI view placements and associated utilization. We continue to have exceptional performance with our SnapPro placements of over 2,300 placed in the second quarter in the U.S. alone, up 100% year over year. We continue to methodically transform our rapid assay customer base into a razor and blade business model as the SnapPro mobile instrument brings significant workflow and charge capture value to the veterinary practice. We see higher growth and rapid assay loyalty when customers adopt the SnapPro active and connected workflow. With the placements in Q2, we are now just a bit south of 65% of our Snap 40X plus revenue coming from these active and connected SnapPro customers. I'd also like to provide an update on the status of our international Salesforce expansion. Our international business performance is strong, as evidenced by the continued high growth and the economic value of instrument placements and international CAG recurring growth at 12.5% in Q2, adjusted for approximately a point-and-a-half combined headwind for Brexit order timing and equivalent day impacts. We've now completed the second full quarter within the expanded model, and the commercial teams are responding well. Having had responsibility for three such initiatives in the U.S., there's a time and distant element to building out an expansion as we onboard new sales professionals, develop their expertise in diagnostics and our product offering, and grow their customer relationships. We track key metrics on our progress, like tenure, which jumped nicely in Q2, since experience correlates well with effectiveness. We expect to see further business benefits of these efforts in the second half, consistent with our experience in the U.S., where field effectiveness increased every quarter with tenure and deeper customer relationships. Moving to the veterinary software portfolio, Q2 was another very strong quarter for global placements of Cornerstone, NEO, and Onomata Systems. In North America, practice management software placements grew 44% year-over-year for the quarter. NEO recently launched in Canada and Australia, complementing Cornerstone in both of those markets. Speaking of Cornerstone, we continue to see an unprecedented pace of Cornerstone upgrades to version 9.1, driven by customer excitement for the modernized user interface and improved easy use. We have upgraded close to 2,000 Cornerstone users in less than four months, a record, and testament to customer enthusiasm, and I'm pleased to share that we achieved a critical technical milestone in the development of Cornerstone Cloud, currently in field testing, which we will make available in the future and will bring the many benefits of the cloud to customers that value Cornerstone as the go-to high-end practice management system. Q2 is also a strong quarter for WebPACs, one of our nine cloud-based software-as-a-service offerings, which experienced a 34% year-over-year increase in enrollments, Other software offerings from IDEX are advancing nicely, including the development of an enterprise management and analytics platform for corporate customers. In summary, we feel very good about our business progress across a range of strategic fronts and believe we are well positioned to sustain strong recurring CAG diagnostics revenue growth and EPS gains aligned with our goals. We look forward to sharing more about the enduring growth potential we see for our business and our long-term strategy to capture this potential at the upcoming Investor Day later this month. Before I conclude, I wanted to extend our best wishes to John Ayers as he works through his rehabilitation process. The strong results we continue to deliver reflect the deep and talented team that John has developed at IDEXX, and I know he has great confidence in all IDEXXs to keep delivering against our purpose and potential. And with that, we'll open it up to Q&A. Cynthia?