IDEXX Laboratories, Inc.

Good morning, and welcome to the IDEXX Laboratory's fourth 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 fourth 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. Fourth quarter 2019 and full year 2019, comparable currency operating expense growth, operating profit growth, operating margin growth, and comparable constant currency EPS growth exclude the impact of the fourth quarter 2019 CEO transition charges. 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.

Thanks, and good morning, everyone. I'm pleased to take you through our fourth quarter and full-year 2019 results and to provide an update on our financial outlook for 2020. IDEX achieved continued strong financial performance in Q4, which supported delivery of full-year revenue and EPS gains aligned with our long-term financial goals. In terms of highlights, we achieved 10% organic revenue growth in the fourth quarter driven by 11% organic growth in CAG diagnostic recurring revenues and 10% organic growth in our LPD and water businesses. Solid fourth quarter gains supported full-year organic revenue growth of over 10% and nearly 12% organic growth in CAG diagnostics recurring revenues. Our full-year EPS was $4.89, an increase of 21% on a comparable constant currency basis supported by 120 basis points in comparable constant currency operating margin improvement. Note that our comparable growth rates and comparable operating margin improvement metrics now exclude impacts from Q4 CEO transition charges. These charges reduced operating profits by $13.4 million in Q4, aligned with expectations, and EPS by $0.14 per share after tax, approximately $0.04 better than initial projections reflecting updated tax provision estimates. Four-year EPS results included $0.22 per share in tax benefit from share-based compensation activity, $0.05 per share above our guidance estimates. We also saw an additional $0.04 below the line upside to our earlier guidance estimates related to final tax provision estimates and lower than projected interest expense. We're well positioned to build on these strong results in 2020. We're maintaining our outlook for 9% to 10.5% organic revenue growth, reflected in our increased guidance range of $2,620,000,000 to $2,655,000,000 in annual revenues, which include updated FX estimates. We're raising our EPS guidance range by $0.12 to $5.42 to $5.58 per share, reflecting 13% to 16% comparable constant currency EPS growth. Positive revisions to our preliminary guidance range reflect the flow-through of our 2019 performance with consistent operational improvement assumptions and favorable updates to projections for interest expense, share-based compensation tax benefits, and FX impacts. We'll walk you through the details of our 2020 guidance later in my comments. Let's begin with a review of our fourth quarter and full-year 2019 results by segment. Q4 results were supported by continued strong momentum in our companion animal group. Global CAG revenues were up 11% organically, driven by 11% organic gains in CAG diagnostics recurring revenues, net of a modest equivalent day's headwind overall. By region, U.S. CAG diagnostic recurring revenues increased 10.5% organically, net of a 0.5% equivalent day's impact. Consistent strong U.S. gains were supported by low to mid-teens organic growth in reference lab sales, double-digit gains in vet lab consumables, and solid gains in rapid assay revenues. U.S. CAG Diagnostics' recurring revenue growth remains primarily volume-driven, with net price gains trending in the 2% to 3% range. We also maintain high levels of customer retention across modalities. U.S. CAG Diagnostics' revenue growth continues to outpace broader market trends. Total visits per practice were relatively flat in the quarter on a same-store basis, with a 4.3% increase on overall same-store practice revenue. Total market clinical visit growth was 1.8% in Q4, following relatively strong Q3 results, with some moderation in visit gains earlier in the fourth quarter, offset by stronger gains in December. For the full year, clinical same-store visit growth increased 2.5% of the 7,500 practices in our dataset, up from 2.1% in 2018, reflecting continued solid market expansion in diagnostic services. International CAG diagnostic recurring revenues increased 12% organically in Q4, net of a modest overall equivalent days headwind. International results reflected mid-teens organic growth in consumable revenues supported by a 25% year-on-year expansion in our Catalyst install base outside of the US. Strong consumable gains of nearly 20% in Europe and continued strong gains in Canada and Latin America were moderated to a degree in Q4 by impacts related to the timing of shipments in Asia, which benefited Q3 2019 and prior year Q4 results, as well as equivalent day impacts. For the full year, international consumable revenues increased nearly 20% organically. International reference lab sales increased organically at consistent high single-digit rates in Q4, with solid gains across our major regions. For the full year, global CAG diagnostic recurring revenues increased nearly 12% organically, reflecting 11% gains in the U.S. and 13% growth in international markets, aligned with our long-term goals. By modality, global reference lab and consulting services revenues expanded 11% organically in the fourth quarter, supported by nearly 1%... equivalent day growth benefit, with an additional 2% of reported growth benefit related to the initial integration of Marshfield Labs. Four-year organic growth of 11% in lab revenues was driven by consistent strong growth in the U.S., supported by continued high same-store sales growth at IDEXX customers. Global VetLab consumable revenues grew 12% organically in Q4, net of a 1.5% equivalent day headwind. For the full year, Vet Lab consumable revenues increased 14% organically, driven by double-digit growth across U.S. and international markets, supported by increases in diagnostic test utilization and ongoing expansion of our premium instrument install base. We had another excellent quarter in terms of high-quality instrument placements in Q4, supporting double-digit year-on-year growth in our Economic Value Index, or EVI. Global premium placements increased 13% year-on-year in Q4, driven by 23% year-on-year growth in catalyst placements, supporting a 19% year-on-year growth in our global catalyst install base. Overall, we placed 2,517 catalysts in the quarter, with 456 at new and competitive accounts in North America, up 8% year-on-year, and 1,119 new and competitive placements in international markets, a 24% year-on-year increase. We also achieved 1,248 premium hematology placements up 7% and 713 CETAVUE placements down 4% compared to strong priority levels. Overall, our Set-A-View global install base is now over 8,900 instruments of 35% year-on-year. Rapid assay revenues grew 4% organically in Q4, reflecting solid gains across U.S. and international markets, net of a 1.5% equivalent day headwind. For the full year, rapid assay revenues grew nearly 8% organically, reflecting continued solid growth of 40X-plus specialty and first-generation products. Growth, high customer retention, and our rapid assay business continue to benefit from ongoing expansion of our Engage SnapPro install base, supported by an additional 10,000 placements in 2019, bringing our global install base to over 37,000. Veterinary software services and diagnostic imaging system revenues increased 9% organically in Q4, supported by double-digit gains in VSS and continued solid expansion of digital imaging services. Overall, global CAG revenues grew nearly 11% organically in 2018, and we're targeting continual double-digit organic gains in the CAG business in 2020. In terms of our other lines of business, water revenues grew 10% organically in Q4, including approximately 1% benefit from equivalent days, supported by solid gains across our major regions. For the full year, water revenues increased 9% organically with faster operating profit growth, resulted in 47% full-year 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 2020. Livestock, poultry, and dairy revenue in Q4 increased 10% organically. Strong Q4 growth results were supported by benefits from the sales of diagnostic testing programs for apricot and swine fever in China, which offset declines in core swine diagnostic testing, as well as solid growth in poultry testing and herd health screening. Q4 results also benefited from favorable year-on-year comparisons related to timing of government and distributor orders. For the full year 2019, our LPD revenue was up 6% organically with relatively higher operating profit growth benefiting from productivity improvement and cost controls. We're pleased with our progress in expanding our LPD revenues and profits in 2019 in a very dynamic global climate. In 2020, we're targeting flat to modest organic growth in our LPD business as benefits from growth in our pregnancy testing franchise and African swine fever testing programs are moderated by expected ongoing pressures on broader swine diagnostic testing in Asia and bovine government disease control programs in Europe, as well as tough compares related to strong 2019 herd health screening levels. Turning to the P&L, gross profit was up 10% on a reported basis in Q4, or 11% adjusted for foreign exchange impacts. Gross margins decreased slightly in a constant currency basis, reflecting increased investment in our reference-led business related to day lab capacity, route expansion, system investments, and acquisition integration, which offset benefits for moderate net price gains and continued strong consumable revenue growth. Foreign exchange hedge gains, which benefited gross profit, were $3.5 million in Q4. Operating profit in Q4 was flat as reported, including impacts from CEO transition charges. On a comparable constant currency basis, operating income increased 12%, reflected solid profit gains across our CAG, water, and LPD segments, supported by high revenue growth. As expected, comparable constant currency operating margin gains were relatively flat in Q4. Operating expense growth increased to 10% on a comparable constant currency basis driven by increases in global CAG commercial capability and R&D. As we'll discuss in our guidance update, investment impacts will carry into the first half of 2020. For the full year, operating profit increased 13% as reported or 16% on a comparable constant currency basis. This reflects an operating margin of 23% and an increase of 120 basis points on a comparable constant currency basis which excludes CEO transition charge impacts. Constant currency operating margin gains reflected a balanced 50 basis points of gross margin improvement and 70 basis points of operating expense leverage on strong volume growth. EPS in Q4 was $1.04 per share, including $0.05 per share in tax benefit related to share-based compensation activity. On a comparable constant currency basis, EPS increased 17%. For 2019, EPS was $4.89 of 21% on a comparable constant currency basis. For the full year, foreign exchange rate changes decreased EPS by 5 cents per share, net of FX hedge gains of nearly 11 million. Full year EPS results included 19 million or 22 cents per share in tax benefit related to share-based compensation activity, which provided 3.7% of benefit in our 2019 effective tax rate of 18%. We had interest expense of $30.6 million for the year, net of approximately $2 million of capitalized interest related to major facility projects. Free cash flow was $304 million for 2019, or 71% of net income. Capital spending came in at $155 million, including $58 million of combined investment, or approximately 14% of net income related to our Westbrook main headquarter expansion and German core lab relocation. with some favorability to earlier estimates related to timing of major project cash deployment. We allocated $304 million of capital towards the repurchase of 1,215,000 shares for the full year 2019 at an average price of $250 per share. This included repurchases of 532,000 shares in Q4 for $139 million. Our balance sheet is in an excellent position. We ended the year with $991 million in debt $90 million in cash and $560 million in capacity under our revolving credit facility. Our leverage ratios as a multiple of adjusted EBITDA were 1.45 times gross and 1.32 times net of cash at year-end. Our strong financial performance and disciplined capital allocation supported achievement of a 46% after-tax return on invested capital, excluding cash investments for 2019. We're well positioned to build on the strong performance in 2020 with a financial outlook aligned with our long-term goals. We're increasing our reported revenue guidance range to $2.620 million to $2.655 million, up $7.5 million at midpoint, including approximately $5 million of benefit from updated FX assumptions. We're maintaining consistent guidance for 9% to 10.5% organic revenue growth, supported by continued strong CAG diagnostics recurring revenue growth of 11% to 12%. Our guidance assumes 0.5% growth rate benefit from completed 2019 acquisitions, which is offset by a projected 0.5% FX growth headwind, resulted in projected revenue growth of 9% to 10.5%. We're raising our 2020 EPS outlook to $5.42 to $5.58 per share, an increase of 12 cents. This aligns with a comparable EPS growth of 13% to 16%, reflecting a consistent outlook for 50 to 100 basis points of comparable constant currency operating margin improvement. The $0.12 increase in the EPS outlook compared to our preliminary guidance includes approximately $0.05 in combined benefit from the flow through 2019 operating performance and favorable updates to assumptions for interest expense and projected reductions in average shares outstanding. We're now projecting approximately $35 million in net interest costs in 2020 and a 1% to 1.5% reduction in average shares outstanding, with both metrics aligned with an assumed maintenance of our net leverage at 1.5 times EBITDA. Our updated outlook also reflects $0.05 in projected tax benefit from share-based compensation activity. We're now projecting an effective tax rate in 2020 of 20% to 21%, including $7.5 to $9.5 million, or 1.5% in tax rate benefit from exercises of stock-based compensation in 2020, which equates to $0.09 to $0.11 per share. Finally, our guidance benefited by $0.02 from updated FX assumptions. Overall, we're now projecting an estimated $0.09 negative year-on-year impact from FX, net of $5 million of projected hedge gains in 2020. In terms of free cash flow, we're targeting deployment of $140 million to $155 million in capital spending, including approximately $35 million related to the completion of our Westbrook headquarters, German Core Lab projects, and the acquisition of real estate associated with the U.S. Core Lab. For 2020, this results in an outlook for free cash flow of 75% to 80% of net income, including approximately 7% impact from these discrete investments. In terms of our first quarter outlook in 2020, we expect Q1 reported revenue growth in the 9.5% to 11% range, reflected organic gains of 10% to 11.5%, including a projected 1% equivalent day tailwind related to the leap year. We expect our operating margins will be moderately below prior year levels, reflecting stepped up commercial and lab investments advanced in the second half of 2019 and as we continue to integrate our Marshall acquisition and onboard our Westbrook headquarters expansion. We expect operating margin gains in 2020 will be driven by second-half performance as we grow into our scaled investments, including our new headquarters and German core lab facility. That concludes the financial overview. Let me now turn the call over to Jay for his comments.

Good morning, and thank you, Brian. IDEX had a strong finish to 2019 with double-digit growth across our companion animal, livestock, and water diagnostic businesses. Core CAG diagnostics recurring revenue, which now represents over three-quarters of overall company revenues, grew 12% organically for the full year. Excellent execution across our businesses enabled us to deliver organic revenue of 10% plus and comparable constant currency EPS growth of 21%. aligned with our long-term financial goals. Return on invested capital at 46% for the year was exceptional. The progress we are advancing on key strategic fronts positions us well to build on this performance in 2020. Outstanding commercial execution is an essential pillar in our organic growth strategy, and we consistently see a high return in increasing these field-based capabilities that allow our sales professionals to spend more time with customers. Expansion in the number of our global customer-facing resources and investments in enabling commercial systems in areas like Salesforce and Service Cloud were two areas of focus in 2019. We completed the U.S. commercial expansion in Q4 and start the year with our expanded U.S. team in seat and trained. We now have 530 field-based professionals in the U.S. to support market development, more than double the number from five years ago. As we enter 2020, we anticipate some settling in during the first quarter of the expansion, as sales professionals, including those newly recruited, develop relationships in their new or reconfigured territories. Notably, we accomplished this expansion in Q4 while delivering 425 new and competitive catalyst placements in the U.S., a record number. We also continued to make progress with preventive care, with 360 new enrollees in a quarter, to reach over 3,800 enrollees in the program to date. Customers are embracing the IDEC preventive care turnkey solution and increasingly view it as a foundational pillar in their own practice strategies. We believe that our North American commercial resources are properly balanced at this point with the addressable market opportunity. And in 2020, we will focus on driving productivity in our expanded sales force, which becomes even more effective over time with tenure and with deeper customer relationships. Our commercial capability and performance in international markets also continues to advance as they build tenure and competencies with key commercial programs like IDEXX 360. The commercial team's priorities have been driven by the economic value index of an instrument placement that prioritizes high-value competitive chemistry placements, resulting in 24% growth in new and competitive catalyst placements in Q4 to a record of more than 1,100 units. Our catalyst installed base outside of North America grew 26% year over year, supporting nearly 20% organic revenue growth at IDEXX VETLAC consumables internationally in 2019. We expect to gain global leverage and further strengthen execution in 2020 with our enhanced field global commercial organization, as previously announced. Leading with innovation includes expanding our testing platforms is another key growth pillar. We are excited by the new innovations that we announced at VMX earlier this month. These were enthusiastically greeted by customers as clinically rigorous and value-added since veterinarians embrace new and expanded tools that enable them to raise the standard of care in workflow-efficient ways. This year, we are bringing bioacids to our Catalyst platform, with shipments expected this quarter. Catalyst bioacids, as a measure of liver function, brings reference lab test quality in clinic. This is a great example of how we constantly make our Catalyst platform more valuable to customers. Catalyst has a steady innovation heartbeat with eight politically important tests launched over the past eight years. The technology for life benefit of Catalyst is supporting continued global expansion of this best-in-class testing platform. Following another great year of instrument replacements and customer retention, as of the end of 2019, approximately 41,000 practices of Catalyst installed. even with a successful installed base expansion. We estimate there remain approximately 70,000 addressable placement opportunities for Catalyst alone around the world. Our innovation focus increasingly uses large clinical data sets with AI and machine learning to develop highly capable algorithms that assist clinicians with even the most challenging patients. This is the case with SocietyBDX, a groundbreaking platform with NeuroNetwork 5.0, leveraging 350 million images launching this quarter. We are adding advanced bacteria detection capabilities made possible by proprietary reagents leveraging patent-pending technology and no additional charge for our 8,900 customers. Seeing bacteria is clinically relevant and especially challenging because of their very small size, the difficulty of seeing bacteria in highly cluttered image, and because debris can be mistaken for bacteria due to similarity in appearance. Moreover, because our in-clinic analyzers are all connected by smart service, we will be able to quickly update our global installed base with no customer disruption. In Reference Lab, our broad and differentiated service portfolio, including fecal antigen DX, continues to support strong same-sort customer growth. Because the fecal antigen test does not rely on the visual confirmation of parasite eggs, it's able to uncover twice as many infections as O&P alone. identifying the presence of intestinal parasites earlier in the life cycle of the infection. We're also further expanding our reference lab offering with an exciting new service, digital cytology, announced at VMX for launch in North America in February. Cytology results often have at least a two-day turnaround time. With our new digital cytology service, we are transforming the speed at which customers receive results with expert interpretation to within two hours. Seven days a week, 365 days a year. We're able to do this by leveraging existing capability of an integrated IT workflow, the wide adoption of customer-facing applications like VetConnect Plus, a field service diagnostic workforce of about 150 field service reps to install and train customers, and a global network of more than 100 veterinary clinical pathologists. We continue to invest in further improving our lab service offering internationally. We're excited about adding our state-of-the-art core German reference laboratory in late spring of this year to our sophisticated global and regional hub and spoke laboratory network. Adoption and utilization of IDEXX SDMA continues to advance nicely in clinic and lab diagnostic modalities. Seventy-five percent of global Catalyst customers have ordered Catalyst SDMA and have now run it three and a half million times. In fact, in North America, that number is almost 80% adoption. IDEXX SDMA has also been included in almost 28 million chemistry panels at IDEXX reference labs. Customers are increasingly seeing SDMA, a direct measure of GFR impairment or kidney function, as a standard of care. In fact, the American Animal Hospital Association has updated their canine diagnostics wellness testing guidelines by life stage and testing guidelines now for the first time include SDMA. Our veterinary software offerings continue to enjoy robust customer adoption. Customers who use our software applications believe that they are an outstanding enabler to delivering excellent patient care and to running their practices in an efficient manner. Q4 was another strong quarter for new placements of Cornerstone, Neo, Onomana, and SmartFlow systems. In North America, we had record patient management software placements, including cloud-based and on-premise software, for 63% year-over-year growth in installs for the quarter. We introduced a much improved user experience update with Cornerstone software version 9.1 in March of last year, and we are pleased that well over half of our install base upgraded by the end of 2019. Work on Cornerstone Cloud continued to progress on schedule in Q4, with very positive customer feedback positioning us to scale for commercial launch later this year. IDEXX WebPacks enjoyed another strong quarter with 23% year-over-year increase in subscriptions and a customer-installed base of more than 4,500 subscribing practices. We recently released for the end of Q1 delivery a cloud-based software update. It provides new functionality powered by artificial intelligence automatically that corrects image orientation and sorts images by body part, potentially shortening read time by 25%. Overall, across these multiple integrated software offerings, we are providing the most comprehensive technology stack offering relied on by independent practices and corporate groups around the world. In addition to our progress in our core CAG business, we also had strong performance in our water and livestock diagnostic businesses in the fourth quarter, with both achieving 10% organic revenue growth. We continue to expand our high return water business globally to focus on commercial execution. Our livestock business has also shown tremendous resilience this year in the face of macro challenges and continued input from the African swine fever in Asia. Looking ahead, we are optimistic about the long-term potential of our business and our ability to sustain its high growth. One of our key strategic goals is to grow CAG diagnostics recurring revenue. which in 2020 were targeting at 11% to 12%. Major drivers include the strong global momentum in expanding our installed base of premium instruments, continued customer adoption of IDEXX's differentiators like integration and ongoing new platform features, and our expanded commercial capability aligned with building on this momentum. Over the next 25 years, we see tremendous opportunity for ongoing growth of CAG diagnostics recurring revenues with a global addressable companion animal diagnostics market of over $30 billion, with the majority of that existing outside of the United States. We remain focused on our commitment to providing exceptional service to our customers and improving the standard of care to enable the best clinical decision-making and healthy practice growth. Before we open the call to questions, I want to thank our employees and congratulate them for the accomplishments in 2019 in pursuit of our purpose to enhance the health and well-being of pets, people, and livestock. Okay, and with that, we'll take questions.