IDEXX Laboratories, Inc.

Good morning and welcome to the IDEXX Laboratory's third quarter 2019 earnings conference call. As a reminder, today's conference is being recorded. Participating in the call this morning are Jay Mazelski, 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 third 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 in 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, and thanks for joining us on our third quarter earnings call. Today I'll take you through our quarterly results and our updated outlook for the full year 2019. I'll also provide an overview of our preliminary guidance for 2020. Jay will follow with his comments. IDEXX delivered continued strong revenue and profit gains in Q3. In terms of highlights, revenues of $605 million grew 11% as reported and 12% organically, including over 1% of growth rate benefit from equivalent days. CAG diagnostic recurring revenues increased 14% organically, including nearly 2% of equivalent day growth rate benefit, reflecting double-digit gains across U.S. and international markets. EPS of $1.24 per share increased 21% on a comparable constant currency basis, benefiting from better than expected organic revenue growth, which supported a 130 basis point improvement in constant currency operating margins. Excellent operating results are keeping us on track towards strong full-year financial performance. In terms of our 2019 revenue outlook, we're refining our full-year guidance to $2,395,000,000, to $2,405,000,000, a $5 million increase at midpoint incorporating our strong Q3 performance. This reflects an updated full-year organic growth outlook of 10% to 10.5% overall and 11.5% to 12% for CAG diagnostic recurring revenues, both at the higher end of our previous guidance range. We're adjusting our 2019 EPS guidance to $4.72 to $4.78 or 15% to 16% growth on a comparable constant currency basis. This is $0.12 per share lower than our prior guidance midpoint, incorporating $0.18 per share in projected Q4 charges related to our recently announced CEO transition. Adjusting for this impact, our outlook is $0.06 per share higher at midpoint, incorporating benefits from our strong third quarter operating performance and lower projections for full year net interest costs. In terms of our preliminary 2020 outlook, we're projecting revenue of $2.610 million to $2.650 million, reflecting organic revenue growth of 9% to 10.5%, supported by sustained high growth in CAG diagnostic recurring revenues. Our 2020 EPS outlook is $5.30 to $5.46 per share, or comparable constant currency EPS growth of 17% to 20%. As we'll discuss, our 2020 EPS outlook incorporates 11 cents per share in projected headwinds from year-over-year FX impacts and expectations for approximately 12 cents per share in reduced tax benefits from share-based compensation activity. Let's begin with a review of our Q3 revenue growth performance by segment. Excellent third quarter revenue growth results were driven by continued strong momentum in our companion animal group. Global CAG revenues increased 13% organically, reflecting 14% organic gains in CAG diagnostic recurring revenues, including nearly 2% in growth benefit from equivalent days in the quarter. By region, U.S. CAG diagnostic recurring revenues increased 13% organically, including nearly 2% in growth rate benefit from equivalent days, reflecting continued strong gains in consumables and reference labs. U.S. CAG recurring diagnostic growth remains primarily volume-driven, with net price gains continuing to trend in the 2% to 3% range. We also maintain consistent, exceptionally high levels of customer retention across modalities. IDEXX U.S. CAG diagnostic recurring revenue growth continues to outpace broader market trends, which improved in the quarter. In Q3, total visits per practice growth was 1.4% year-on-year, with clinical visits per practice growing at 2.7%, and overall revenue per practice increasing 5.3%, reflecting continued solid growth trends in the U.S. companion animal health care market. International CAG diagnostic recurring revenue increased 16% organically in Q3, including approximately 1.5% of equivalent day growth benefit. International consumable revenue gains normalized for approximately 2.5% of benefits from equivalent days sustained at approximately 20%, and international organic revenue reference lab growth improved to high single-digit rates. Globally, reference lab and consulting service revenues grew 12% organically in Q3, supported by consistent low-to-mid-teen volume-driven gains in the U.S. Robust U.S. lab growth continues to be driven by strong same-store sales growth at IDEX customers, augmented by net customer acquisition benefits and moderate net price gains. As Jay will discuss, in October we closed on the acquisition of Marshfield Laboratories, a national service provider based in Wisconsin, adding to our U.S. market capabilities. Global consumable revenues increased 18% organically in Q3, including nearly 3% of equivalent day growth benefits. These results reflected strong growth across U.S. and international markets, driven by increases in diagnostic test utilization and expansion of our installed instrument base. We had an outstanding quarter in terms of high-quality instrument placements, supporting double-digit year-on-year growth in our Economic Value Index, or EVI. Overall, premium instrument placements increased 14% year-on-year, driven by 18% year-on-year growth in catalyst placements, which supported an 18% year-on-year increase in our global catalyst install base. Globally, we placed 1,898 catalysts in the quarter, with 360 at new and competitive accounts in North America, and 910 new and competitive placements in international markets. We also achieved 965 premium hematology placements globally of 18 percent and 589 CETAVU placements in line with strong priority levels. Please note that we've expanded the data shared in our quarterly earnings snapshot available on our investor relations website to include premium instrument placements by category and region, as well as quarterly tracking of our global premium install base. Rapid Assay revenues grew 10% organically in Q3, including nearly 3% of equivalent day growth benefits, reflecting continued expansion of 40X+, specialty, SNAP feline, and first-generation products. Growth and high customer retention in our Rapid Assay business continues to benefit from expansion of our engaged SNAP Pro install base, supported by an additional 2,683 SNAP Pro placements globally in Q3 and bringing our global installed base to over 34,000. Veterinary software services and diagnostic imaging systems revenues increased 6% organically in Q3, driven by continued strong gains in VSS recurring service revenues. Overall segment revenue gains were constrained in Q3 by comparisons to very strong prior year digital system placement levels. In terms of our other business segment performance in the quarter, water business revenues grew 7% organically, supported by continued solid growth across U.S. and international markets. Livestock, poultry, and dairy revenue increased nearly 10% organically. Third quarter results were driven by strong year-on-year gains in Asia Pacific markets, which benefited from a favorable prior year comparison. The prolonged outbreak of African swine fever continues to negatively impact the swine population in China, However, demand for new diagnostic testing programs and increased diagnostic testing for alternative poultry food sources offset lower recurring swine testing volume levels in Q3. Health third screening levels, while down from strong priority levels, were also relatively higher than expected in the quarter. Turning to the P&L, operating profit in Q3 increased 19%. as reported, and on a constant currency basis, driven by solid profit gains across our CAG, water, and LPD segments. Operating margins increased 130 basis points on a constant currency basis, reflected solid gross margin gains, and operating expense leverage on high revenue growth. Gross profit increased 13% as reported, or 14% on a constant currency basis in Q3. Gross margins increased 60 basis points on a constant currency basis supported by mixed benefits from strong consumable revenue growth, lab productivity gains, and moderate net price increases. Foreign exchange hedge gains, which are reflected in gross profit, were approximately $3 million in Q3 and approximately $7 million year-to-date. Operating expenses in Q3 increased 9% as reported and 10% on a constant currency basis, resulting in 70 basis points of constant currency operating margin leverage. Operating expense increases were driven by growth in R&D spending and increased costs related to our expanded global CAG commercial capability. EPS in Q3 was $1.24 per share, including benefits of $4 million or $0.05 per share related to share-based compensation activity, which was approximately $0.03 per share higher than projected. On a comparable constant currency basis, EPS increased 21%. Foreign exchange net of favorable year-on-year hedge impacts had an immaterial impact on operating profit and EPS in the quarter. Year-to-date free cash flow through the third quarter was $195 million. We continue to expect free cash flow of 60% to 65% of net income for 2019. This reflects a consistent outlook for four-year capital spending of $160 million to $175 million, including approximately $70 million of combined incremental spending related to our Westbrook main headquarter expansion and in our German core lab relocation. Our strong cash flow generation supported the allocation of $91 million in capital towards the repurchase of 330,000 shares in the quarter. We've maintained a strong balance sheet with leverage ratios as a multiple of adjusted EBITDA of 1.39 times gross and 1.24 times net of cash at the end of the quarter. We continue to maintain a 2019 full-year outlook for reduction in average shares outstanding from stock repurchases of approximately 1%, which assumes that we maintain net leverage at similar multiples of EBITDA. We now project annual net interest expense of $31.5 million, an improvement of $2.5 million compared to our previous guidance. In terms of our updated P&L outlook for 2019, as noted, we're refining our full-year reported revenue guidance to $2,395,000,000 to $2,405,000,000, reflecting an organic growth outlook of 10 to 10.5 percent, and CAG recurring diagnostic organic revenue growth of 11.5 to 12 percent, both at the higher end of our prior guidance range. At midpoint, this reflects a $5 million reported revenue increase, factoring in our strong third quarter performance. In this updated outlook, modest projected benefits from our recently completed U.S. lab acquisition are offset by refined projections for FX impacts. For the full year, we now expect a 2% headwind from FX on revenue growth. In terms of EPS, we're lowering our 2019 full-year guidance by $0.12 per share at midpoint to $4.72 to $4.78 per share, incorporating $0.18 of impact related to the CEO transition. This results in comparable constant currency growth of 15% to 16% for 2019, including approximately 4% of growth impact related to projected Q4 transition charges. Costs related to the separation agreement will lower full-year 2019 operating profit by an estimated $13.4 million and year-on-year operating margin improvement by approximately 55 basis points. Incorporating this impact, our updated outlook is for 55 to 70 basis points in full-year constant currency operating margin improvement, or 110 to 125 basis points of improvement, excluding the Q4 transition charge impact, which is consistent with the higher end of our prior guidance range. Our full-year operating margin outlook includes expectations for higher levels of year-on-year operating expense growth in Q4, including effects from the advancement of an additional expansion of our U.S. commercial field resources, which Jay will discuss in his comments. Strong full-year operating margin performance, excluding transition charge impacts, and benefits from lower projected interest costs yield approximately $0.06 per share in full-year operational EPS benefit compared to previous guidance. Our updated EPS guidance assumes a 2019 effective tax rate of approximately 20%, including approximately 1% of impact related to CEO transition costs. This tax rate also includes an updated estimate of $15 million, approximately 3%, in full-year projected tax rate benefit from exercise of share-based compensation, netting approximately $0.02 of upside compared to previous guidance. At the midpoint of our guidance estimates, this equates to about 17% per share in full-year share-based compensation tax benefit. Operational and share-based compensation tax benefit upsides are mitigated by $0.02 per share of negative impact related to the strengthening of the U.S. dollar since our last conference call. Our 2019 EPS guidance now assumes $0.06 in negative full-year impact-related FX charges net of hedge impacts. And for the full year 2019, we're projecting hedge gains of $11.5 million. As we look ahead to 2020, we're targeting continued strong revenue and profit growth consistent with our long-term goals. Our preliminary revenue outlook is $2,610,000,000 to $2,650,000,000, reflecting expectations for 9% to 10.5% organic revenue gains, supported by sustained high growth in CAG diagnostic recurring revenues. Our guidance reflects expectations for overall reported revenue growth of 9% to 10.5%, with an estimated 0.5% foreign exchange headwind, related to the recent strengthening of the US dollar offset by year-on-year benefits from completed 2019 acquisitions. Our preliminary 2020 EPS guidance of $5.30 to $5.46 per share incorporates expectations for operating margin improvement of 100 to 150 basis points on a constant currency basis, including approximately 50 basis points of year-on-year improvement related to lapping the Q4 2019 charges related to the CEO transition. At rates assumed in our press release, we estimate that FX will decrease reported operating margins by approximately 30 basis points and EPS by approximately 11 cents per share, net of established hedge positions, which we estimate will result in 6 million of net pre-tax gains in 2020. Our projected 2020 effective tax rate is 21% to 22%. This outlook assumes $3 to $5 million, or approximately 5 cents per share, in share-based compensation tax benefits and assuming our current share price. Note that our projections for share-based compensation tax benefits incorporates timing of future option expirations. As IDEX transitioned from 7-year to 10-year option lives in 2013, this has the effect of lowering the level of options scheduled to expire in 2020, contributing to a 12-cent reduced projected tax benefit in 2020 compared to 2019. For 2020, we're projecting a 1% reduction in shares outstanding related to share repurchases at assumed consistent net leverage ratios and net interest expense next year of $36 million. Adjusting for changes in currency and share-based compensation tax benefits, this 2020 EPS outlook equates to a projected 17% to 20% comparable constant currency growth rate. We look forward to providing an update and more detailed review of our 2020 guidance in our year-end conference call. That concludes our financial review. I'll now turn the discussion over to Jay.

Good morning, and thank you, Brian. IDEXX's third quarter results reflected solid growth across our companion animal, livestock, and water diagnostic businesses, an outstanding achievement by our IDEXX team globally. High growth in CAG diagnostic revenues continues to lead our performance with attractive flow-through benefits to profit, keeping us on track to deliver strong full-year operating results. Excellent commercial execution is a key theme in our continued growth momentum, and enhancing capability in this area consistently delivers a high return on investment. In our U.S. CAG business, we benefit from the increased IDEX engagement with customers in an underdeveloped diagnostics market with solid growth momentum, as evidenced by the 2.7% growth in same-store clinical visits seen in the quarter. Our U.S. commercial team remains highly productive, delivering 13% CAG diagnostics for current organic revenue growth in the U.S., including approximately 2% benefit from equivalent business days. Execution was excellent across the board, resulting in both impressive revenue gains from all modalities and sustained high customer retention rates. Increased customer engagement is helping to drive sustained low-to-mid-teens organic growth in reference labs, led by same-store testing expansion and double-digit organic gains in consumable revenues supported by our expanding premium instrument installed base. Instrument placements were excellent in a quarter, led by 14% year-on-year growth in U.S. new and competitive catalyst placements. This supported a 10% year-on-year expansion of our U.S. catalyst installed base and double-digit growth in U.S. EVI. SnapPro placements were also robust in Q3, with over 2,200 placed in the U.S., up 77% year-over-year. SnapPro brings significant workflow, electronic medical record, and charge capture benefits that complement our differentiated rapid assay point-of-care diagnostics. Importantly, customers who are connected through SnapPro are highly engaged and stay with us longer. Our U.S. commercial team continues to make excellent progress in advancing our preventive care initiative. In Q3, we enrolled 330 new practices, bringing our total enrollees since program launch to nearly 3,500. Almost two-thirds of our VDCs had at least one new customer enrollee in a quarter. As discussed at Investor Day, a key commercial goal is to inspire customers to increase the use of medically relevant blood work in clinical visits. When we consider blood work as a representative proxy for diagnostics utilization, It was included in only about 8% of clinical wellness visits in 2018. The increased rate of diagnostics testing with blood work and practices post-enrollment in our preventive care program is notable. Specifically, if we take our 2017 preventive care enrollees who have now been in the program for over a year, the average annual increase in the percentage of wellness visits that include blood work is approximately 1% per year since 2016. This compares to approximately 20 to 30 basis points of annual increase for non-enrollees. These convincing early success indicators reinforce the 1 to 2 percent contribution to annual CAG diagnostics recurring revenue growth potential we see from this initiative. Our strong growth in the U.S. demonstrates that diagnostics as a category continues to grow in importance and relevance to the veterinary profession. Our customers are in turn asking our category experts to spend more time partnering with them. The combination of increasing customer engagement and key growth initiatives like IDEX Preventive Care, strong operating results and commercial momentum, and a healthy product pipeline gives us confidence to once again expand our commercial presence in the U.S. We are already underway with an 8% expansion in our U.S. field-based professionals, which we expect to be largely in place by the beginning of Q1 2020. As with our past field expansions, these are thoughtfully planned and supported by detailed regional analytical modeling that considers a number of factors, including territory size and specific geographic differences such as traffic patterns and population growth. The most important factor is the market opportunity, as calculated by our ability to grow our installed base, expand diagnostic testing, and expand category share across in-clinic and reference lab modalities. While we've said this before, it bears repeating. The data continues to prove out that the more time we spend with customers, the more they grow with IDEX. This expansion will bring us to an estimated 530 field-based professionals in the U.S., up from 490 at the end of 2018. We're very excited by the opportunity this expansion affords us heading into 2020. The category of diagnostics is increasing in importance on a global basis as well. And as a result, we're seeing the benefits from our recently completed CAG commercial expansion in international markets. We saw 16% international CAG diagnostics recurring revenue organic growth in Q3, including approximately a point and a half equivalent business days growth benefit. These gains were again led by international consumables growth of approximately 20% organically, normalized for equivalent business days, and supported by continued expansion of our catalyst installed base. which increased 26% year-over-year. Our international reference lab showed improvement year-over-year, high single-digit growth, benefiting from the completed commercial expansion, strong commercial execution, as well as focus on customer service and IDEXX 360 programs that are increasingly multimodal in character. The IDEXX 360 program is gaining traction with our international customers, supporting excellent instrument placements and double-digit growth in EVI, benefiting from a 28% year-on-year increase in placements to new and competitive accounts internationally. In addition to excellent commercial execution, the ongoing adoption and expansion of IDEX differentiators, born of our industry-leading investments in innovation, is a second key theme supporting our strong growth performance. Our strong reference lab growth in markets like the U.S., for example, continues to be supported by high growth in parasitology, driven by growing adoption of our proprietary fecal antigen test. In the U.S., approximately 60% of parasitology panels run at our reference lab included fecal DX antigen in the third quarter, up from approximately 50% in Q3 2018. Our performance-leading 4DX Plus franchise also continues to expand. In the U.S., in addition to sustained solid growth in clinic, we're seeing high levels of incremental growth in 4DX Plus testing in our reference labs, following engagement with our preventive care programs. As we've highlighted in the past, only approximately 36% of dogs in the U.S. receive a vector-borne disease test of some kind, while only approximately 15% of dogs in the U.S. receive a full vector-borne multi-analyte test. This expansion of 40X plus usage is a very encouraging sign, with additional long-term benefits for vector-borne disease testing. We also continue to make excellent progress advancing SDMA as an essential element of the chemistry panel, which our reference lab customers have benefited from since 2015 and launched to our Catalyst installed base in early 2018. We now have over 70% of Catalyst customers globally who have purchased Catalyst SDMA, while almost 60% have used it. This has translated into a total of 2.9 million runs since its introduction on the slide. We're also very excited about the new SDMA-based chronic kidney disease staging guidelines that were issued in September by the International Renal Interest Society. This is an expert panel of internationally renowned nephrologists who established evidence-based clinical practice guidelines for the evaluation and management of chronic kidney disease. The full incorporation of SDMA into CKD staging guidelines reflects the widespread recognition that SDMA is an accurate measure of kidney function the impairment of which may be due to kidney disease or other disease processes. These updated SDMA-based staging guidelines are the next step in improving not only early diagnosis of kidney, but also tailoring treatment to individual patients. IDEX-SDMA has transformed the landscape of how veterinarians manage patients with impaired kidney function. Finally, we continue to extend our capability and advantages in veterinary software, by advancing our software on multiple fronts simultaneously. Our goal is to provide a truly comprehensive technology offering that both independent practices and corporate groups around the world rely on to run their businesses. Q3 was again a strong quarter for global placements of new Cornerstone, NEO, Hanamana, and SmartFlow systems. Inclusion of software systems in the IDEXX 360 program is accelerating commercial efforts in North America. In the U.S., practice management software placements grew 35% year-over-year. Sticking with the U.S., we've seen an unprecedented pace of Cornerstone upgrades, the version 9.1, with more than 2,700 practices upgraded year-to-date across North America, driven by customer demand for the all-new user interface and streamlined clinician experience. We achieved yet another critical development milestone for Cornerstone Cloud in Q3 – which is now successfully running in a live environment for more than a quarter. Initial customer feedback is extremely positive, and we look forward to eventually making the many benefits of the cloud available to the thousands of customers that value Quarterstone as the standard-bearer in practice management software. Q3 was another strong quarter for growth for WebHacks, with a 29% year-over-year increase in subscriptions. Our enterprise management and analytics platform for corporate groups continues to make big strides, providing a command and control center for corporate groups C-suite. And Beconic Plus, the most widely used app in veterinary medicine, had another strong quarter, growing out new functionality for sharing diagnostic results with pet parents and growing to more than 29,000 engaged practices globally. In addition to our strides in growing our business organically, we're also pleased to highlight our recent acquisition of Marshfield Labs and the addition of their employees. Marshfield is a highly professional, well-run laboratory that has a national customer base with a relatively stronger presence in the mid- and upper Midwest regions. We look forward to quickly bringing our unique innovations, like SDMA, PicoEnogen, and Vecanet Plus, to name just a few, to Marshfield customers, many of whom we work with today. In summary, we feel very good about our business progress across a range of strategic fronts and believe we are well positioned to build on this momentum in 2020 and deliver on our long-term financial goals. Before I conclude, and on behalf of all my IDEX colleagues around the world, I'd like to extend our thanks to John Ayers and our best wishes for John's continued rehabilitation. John's love and affection as a pet parrot to cats translated into his deeply held beliefs on the unique role that pets and their care play in our lives. As a result, he always reminded us of what's possible and what IDEX can contribute through our unique diagnostics and software that expand the health and well-being of the pets we love. It's in John's vision that IDEX, as an organization, will remain committed to helping strengthen the role and relevance of the veterinarian as the key to improving the lives of pets and animals and the people who love them. On a personal note, I'm looking forward to continuing to work with John, both on the board of directors and as a trusted advisor. And with that, we'll open it up to Q&A.