IDEXX Laboratories, Inc.

Good morning and welcome to the IDEXX Laboratory's second quarter 2020 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 McCann, Chief Financial Officer, and John Ravis, Senior Director, Investor Relations. IDEXX would like to preface the discussion today with a caution regarding four 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 gaps. A reconciliation of these non-gap financial measures to the most directly comparable gap 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 2020 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 2019, 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 if 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 McKinnon.

Good morning, everyone. IDEX delivered excellent financial results in the second quarter. We benefited from a V-shaped recovery in our CAG business and flow-through profit benefits from favorable product mix and disciplined cost controls. In terms of highlights, revenue increased 3% as reported and 4% organically, supported by 7% growth in CAG diagnostic recurring revenues. Following a period of significant pressure on CAG diagnostic testing volumes in late March through mid-April, we saw a sharp recovery in market demand for diagnostics globally in the second quarter, including very high growth levels in June, supported by pent-up demand for wellness and non-wellness testing. Better-than-expected CAG diagnostic recurring revenue growth and benefits from proactive cost controls drove a 410 basis point improvement in constant currency operating margins in the quarter. This enabled delivery of $1.72 in early earnings per share, an increase of 23% on a comparable constant currency basis. For the first half of 2020, we delivered EPS of $3.01, up 18% on a comparable constant currency basis, despite headwinds related to the COVID pandemic. As we'll discuss, solid pet healthcare market growth trends have continued in July, pointing to a foundation for continued solid revenue growth for our core CAG business. We're also well-positioned in terms of our financial management approach, aligned with our goal to deliver operating profit gains at or above the rate of revenue growth in the second half of 2020. While we're very encouraged by recent market trends and our ability to manage through the COVID pandemic effectively, we recognize that potential future effects related to the pandemic may be dynamic and challenging to project. As such, we will not be providing specific financial guidance for 2020 at this time. Let's begin with a review of our second quarter revenue results and recent market trends. Second quarter organic revenue growth of 4% was driven by 7% organic gains in CAG diagnostic recurring revenues in both U.S. and international markets. Our overall revenue growth also benefited by 1% from our OptiHuman PCR test initiative. These gains offset impacts related to the pandemic, which reduced new IDEXX VetLab and digital instrument placements and pressured noncompliance water testing. We also saw impacts from the reversal of March stocking orders and our water and LPD businesses, which reduced Q2 revenues by 4.5 million, or less than 1%. As noted, our overall performance was driven by growth in CAG diagnostic recurring revenues, which strengthened considerably through Q2. By month, CAG diagnostic recurring revenues declined approximately 16% in April, increased 8% in May, and grew an impressive 30% in June, supported by strong gains across our major modalities. Consistent solid revenue trends were seen across our major regions, reflecting the global strength and resilience of the veterinary healthcare market. CAG-diagnostic recurring revenue gains were aided by a rebound in clinical visits, as demonstrated in our same-store U.S. weekly tracking data published in our earnings snapshot available on our website. Following an 18% contraction in clinical visits in April, same-store clinical visits rebounded to plus 2% in May and plus 7% in June, resulting in a 3% overall decline for the quarter. Early quarter pressure on testing was greater in wellness visits, which were down 5% for the quarter overall, but rebounded strongly in May and June. Non-wellness visits, which we estimate drive about 75% of U.S. diagnostics revenue, were down only 1% on the same-store basis in Q2. Clinical visit activity outpaced overall vet practice visit activity in the second quarter, as business mix at veterinary clinics has shifted towards more service-based offerings. These dynamics supported a solid 2.5% increase in overall veterinary clinic revenues in Q2, despite a 5% decline in overall visits to clinics in the quarter. We're very encouraged by the broad market recovery. These solid trends have continued in July, reflected in gains of 6%, and U.S. same-store clinical visits through the first three weeks ended July 17th, with solid growth now reflected across major U.S. regions. Please note that there is some latency in the reporting of the most recent weekly data, with these metrics continuing to improve as additional visit data is added over time. We believe the health and resilience of the global pet health care market is a positive factor that can support continued solid growth in CAG diagnostic recurring revenues in the second half of 2020. These improved market trends supported a strong recovery in IDEX revenues in the quarter. By modality, IDEX global reference lab revenues increased 7% in Q2, reflecting 6% organic gains and approximately 2% growth benefit from acquisitions, offset by a 1% FX headwind. Results reflected high single-digit gains in the U.S. and modest overall organic growth in international markets, as strong gains in key regions like Germany, Japan, and Australia were offset by lockdown-related impacts in the U.K. and Canada. IDEXX VETLAG consumable revenues increased an impressive 13% on an organic basis despite early quarter pandemic-related impacts, reflecting low to mid-teen growth in both U.S. and international markets. Gains were supported by solid increases in testing utilization, sustained high customer retention levels, and continued expansion of our global premium install base. As expected, CAG instrument placements were constrained in Q2, impacted by restrictions on sales access to veterinary clinics and deferrals of new purchase decisions. This contributed to a $19 million or 40% year-on-year decline in reported CAG instrument revenue in the quarter. The quality of CAG instrument placements remained high, reflected in 165 catalyst placements at new and competitive accounts in North America and 536 new and competitive placements in international markets. We also benefited from 231 second catalyst placements driven by momentum with North American customers. These new placements and sustained high customer retention levels supported a 16% year-on-year growth in our global catalyst install base. We also achieved 545 premium hematology placements and 275 SETAVU placements, bringing our global SETAVU install base to over 9,500 instruments of 25% year-on-year. As Jay will discuss, our field sales force is focused on rebuilding the new instrument pipeline globally as we gradually gain increased access to vet clinics. Rapid assay revenues decreased 5% organically in Q2, primarily reflecting early quarter pandemic-related volume pressure. as well as year-on-year dynamics related to promotional timing and activity. Consistent with our overall trends, rapid assay revenues showed a strong rebound from nearly 40% year-on-year revenue declines in April to nearly 30% year-on-year gains in June, supported by pent-up demand for wellness testing. Overall, CAG-diagnostic recurring revenue growth remains primarily volume-driven, with consistent net price gains of 2% to 3%. In other areas of our CAG business, our veterinary software and diagnostic imaging revenues declined 3% organically overall. Double-digit gains in recurring service revenues were offset by declines in new veterinary software and diagnostic imaging system placements, reflecting pandemic-related constraints on new sales activity. Turning to our other business segments, following a 16% organic gain in our water business in Q1, we saw a 16% organic revenue decline in Q2. Second quarter results were impacted by the reversal of 2 million of accelerated stocking orders, reducing organic growth by 7%. The vast majority of our water testing volumes are compliance-related or mandated by government regulations, and these volumes have sustained as an essential service, albeit with some disruption in early Q2 related to business lockdown effects as well as beach and pool closures. Approximately 20% of our water revenues are from non-compliance testing related to areas like special projects, construction, and real estate transactions. We saw a greater than expected decline in this area related to reduced overall business activity and prioritization of lab spending. While we saw improvement in water revenue trends as we worked through the quarter, we anticipate that non-compliance testing demand will be uneven in the near to moderate term, as public and private testing labs and public utilities adapt to pandemic-related macro impacts. Livestock, poultry, and dairy revenue increased 2% overall in Q2, net of an estimated 2.5 million, or 8% headwind, related to the reversal of accelerated stocking orders. LPD results continue to benefit from demand for diagnostic testing programs for African swine fever and improvement in core swine testing volumes in China, supported by large producer efforts to rebuild swine herds. We're also seeing continued solid growth for poultry testing globally. Overall LPD gains were moderated in Q2 as expected by lower herd health screening levels compared to strong prior results impacted by the rebuilding of bovine herd populations in key Asia-Pacific markets, which is reducing export supply. Finally, as noted, IDAC's overall growth in Q2 benefited by approximately 1% from revenues associated with our OPID COVID-19 PCR test. This includes benefits from our initial test supply program with the state of Maine. We're extending these support efforts through the implementation of a lab-based testing capability in partnership with the Maine CDC that will provide capacity for up to 350,000 human COVID tests over the next several months. We're continuing to focus on supporting COVID PTR testing globally, leveraging the capabilities of our OptiHuman and LPD businesses. We note that human PCR testing is a very dynamic area with shorter-term project commitments and growing competition from alternative suppliers that make demand difficult to project. In addition to these efforts, we recently completed work to adapt our OptiPCR test for use on wastewater samples, which will be offered to IDEXX water customers through our water commercial organization. We're very pleased to be leveraging the capability of IDEXX to contribute to the management of the COVID-19 pandemic globally. Turning to the P&L, profit results were very strong in Q2, benefiting from solid revenue gains, favorable product mix, and proactive steps to manage costs in the context of the pandemic. These actions supported a 380 basis point improvement in reported operating margins, or gains of 410 basis points in a constant currency basis, driving an increase in operating profits of 18% as reported and 20% on a constant currency basis. EPS was $1.72 per share, including benefits of $4.9 million or $0.06 per share related to share-based compensation activity. On a comparable constant currency basis, EPS increased 23%. Gross profit increased 6% as reported or 8% on a constant currency basis in Q2. Gross margins increased 210 basis points on a constant currency basis supported by net mixed benefits from strong consumable sales and lower instrument revenues. benefits from moderate net price gains, and solid productivity improvement in our lab operations supported by tight cost controls. In the second half of 2020, we'll see relative increases in our reference lab costs reflecting the onboarding of our new German core laboratory and as we add lab staffing to ensure high customer service levels globally in a growing market. Operating expenses in Q2 decreased 4% as reported and 2% on a constant currency basis. As noted on our last call, we advanced a targeted $25 million of quarterly operating expense reductions compared to our original spending plans to mitigate potential impacts from the pandemic. Benefits from these initiatives, as well as approximately $5 million in lower than expected health and dental costs, were realized in the quarter. These efficiencies, in combination with stronger than expected revenue growth, enabled 200 basis points of positive operating expense leverage. Given the strong recovery in our business, we've discontinued temporary salary and benefit reductions, which yielded an estimated $13 million in savings in the second quarter. In the second half of 2020, we intend to advance targeted hiring and prioritize investments in support of our long-term growth strategy, including augmentation of our international commercial capability while delivering solid operating profit gains at or above the rate of revenue growth. In terms of cash flow, we generated $236 million in positive cash flow year-to-date. On a trailing 12-month basis, our net income to free cash flow conversion rate was 80%, or 93% adjusted for our investments in our Westbrook headquarters expansion and German lab relocation, which are now largely complete. Our balance sheet is in a very strong position, enhanced by steps in Q2 to add to our liquidity and flexibility. We ended the quarter with leverage ratios of 1.4 times gross and 1.26 times net of cash, with $105 million in cash and $877 million in capacity available on our expanded $1 billion revolving credit facility. We did not allocate capital to share repurchases in the quarter, and I intend to continue prioritizing funding of our growth strategy and business operations this year. Overall, we're very pleased with the strong momentum and high level of operational execution demonstrated in our business in Q2. IDEX has a great business model with tremendous long-term potential. We're very pleased to have managed through the first half of 2020 effectively, despite the pandemic impacts, and look forward to building on that progress. I'll now turn the call over to Jay for his comments.

Thank you, Brian, and good morning. Welcome to our Q2 earnings call. Today, we're pleased to report excellent Q2 results, supported by a sharp global recovery in the pet healthcare market. As Brian noted, in Q2, we delivered 4% overall organic growth and a 7% increase in CAG diagnostics recurring revenues, despite significant early quarter headwinds related to stay-at-home policies. We managed well the initial impacts from the COVID-19 pandemic, and we've seen a strong and sustained recovery in our core companion animal health business that is highly encouraging. and reinforces our optimism and the long-term growth potential of our business. Proactive cost discipline allowed us to deliver strong profit gains while ensuring ongoing investment in our innovation programs, a high level of continued service for our customers, and investments in the health and safety of our employees. This strong level of performance reflects IDEX's extraordinary resilience and gives us confidence in our ability to sustain solid growth and financial results as we manage through the ongoing dynamics associated with the pandemic. Let me start with a brief update on our supply chain performance, market trends, observations on how our customers are adapting, and the success of our commercial organization in engaging customers to support the recovery of the market. IDEXX has supplied veterinary practices in an uninterrupted fashion with point-of-care diagnostic products and services, like reference lab testing, and we have high confidence that we can continue to do so in the future. Our manufacturing operations, which are largely based in the U.S., have excellent visibility to secondary suppliers for key components and products that we do not directly manufacture. Our reference lab performance has also been especially noteworthy in light of disrupted and challenging logistics and more complex workplace procedures to keep lab employees safe. Our network lab capability enables us to seamlessly toggle to an alternative lab without service disruption in the event of a COVID-19 infection. These capabilities are possible through significant investments that have been made over a long period of time in lab density, common lab information management systems, and courier route and logistics capability. Not having to worry about service or product availability, our customers have been able to focus on their mission of caring for patients and have been highly resilient through the pandemic. They have now expanded the breadth of services provided from the early COVID-19 focus on sick and emergency patient services. As Brian noted, despite an overall 5% decline in same-practice visit levels in Q2, vet clinics were able to increase same-practice revenues by 2.5%, supported by an increased emphasis of medical services enabled by diagnostics testing. Customers have adapted to new ways of delivering service, such as an increased use of telehealth and curbside check-in where the pet owner remains in a car during the appointment. Staff from veterinary clinics have indicated that this has increased their comfort level with recommending more comprehensive and clinically relevant diagnostics with support from pet owners. Veterinarians also say that they are increasingly focused on delivering core medical services to their patients as a result of the substitution of product sales to e-retailers, which have accelerated. To treat, veterinarians have to first diagnose, and IDEXX's proprietary diagnostics are a key tool in advancing the standard of care. Supported by these trends, we've seen solid improvement in both wellness and non-wellness visits, with additional acceleration of wellness visits more recently, reflecting in part pent-up demand. The proportion of clinical visits, including at least one diagnostic, has increased since March in both wellness and non-wellness visits. In addition, we're seeing greater dollars of diagnostic revenue per clinical visit. Overall, the average diagnostic revenue per clinical visit in 2020 that included at least one diagnostic has been trending above previous year's levels as well, approximately 5% higher for the first half of 2020 versus the first half of 2019. In fact, diagnostics revenue per clinical visit overall and per non-wellness visit has been higher than in 2019, every month this year. We're also seeing evidence of increased interest in pet ownership through the pandemic. including among current pet owners, another indication of the strengthening of the pet-human bond. These improvement trends are global and have sustained in early Q3, as evidenced by continued solid U.S. clinical growth trends, albeit at moderated levels from the extraordinary growth rates seen in June. We are monitoring the evolution of the pandemic and associated management of infection rate growth across regions, which may impact future demand. We remain encouraged by the solid global recovery in demand in our core CAG business, supported by an ever-growing pet owner bond. Our commercial execution also continues to be noteworthy. We're very pleased with the effectiveness of our global commercial team during a period with a very challenging market backdrop. Field occupancy remains in the high 90s, and customers appreciate that the cadence and level of our field visits, whether they are physical or virtual in nature, are at very high levels. Our global teams also show tremendous agility in supporting our customers during this period, including designing and implementing a new remote instrument install and training process, which enabled us to successfully onboard new customers in a safe and effective way when requested. Some of these new processes enabled us to place over 1,800 premium instruments globally in a quarter, including over 1,000 catalyst placements, with over 700 in new and competitive accounts. Our field service representatives continue to be welcomed by veterinary practices, and we've seen an increase in in-person visits by our customer account managers, up to 40% in June versus the 25% we saw in April for the U.S. While pandemic-related factors have constrained CAG instrument placements, as well as new software system implementations and pressure new digital imaging system sales, we expect the pace of capital placements to gradually improve over the balance of the year, Our field teams have used this time to build pipelines, and the rate at which this improvement occurs will be related to ongoing improved VDC access to veterinary practices and to higher practice owner confidence that will inevitably come with an economic recovery. As Brian noted, moving forward, we will be augmenting our commercial presence internationally. Our approach will be to add resources selectively on a rolling basis in targeted markets, leveraging the capabilities of our new global commercial model which we look forward to discussing more at our upcoming investor day. We're encouraged by the resilience of the companion animal market and believe there is a significant long-term opportunity to increase standards of care globally, supported by our direct commercial capability. As we support customers, we are working to continue to advance programs that support a higher level of care, such as preventive care. We saw continued adoption of the IDEXX preventive care program with over 100 new enrollees in a quarter, supported by the strong recovery and market demand for veterinary services and robust wellness visits traffic, bringing our total enrolled practice level to 4,300. As expected, our Q2 additions were reduced from prior quarters, as this is a program that requires broad practice access to onboard and train a large number of staff. Customers continue to embrace the IDEXX preventive care approach and consider it a foundational element of their care offering as they look to uncover more with IDEX proprietary diagnostics. Growing enrollment and engagement in the IDEX Preventive Care Program is a key focus for our commercial team in the second half of the year and our Recover Together initiative. As we support continued market recovery, we also continue to advance our new product initiatives introduced at VMX in January. Though capital placements have experienced some near-term headwinds in the second quarter as a result of restricted practice access, digital cytology is experiencing strong customer interest. With our sophisticated information management systems and clinical pathology experts around the globe, we were able to provide results very often and well under the two-hour commitment, allowing veterinarians to provide close-to-real-time cytology professional services. Our technology for life philosophy, as represented by the introduction of bile acids in our IDEXX PhantLab instrumentation suite, has also been received with strong enthusiasm. Bioassets reflects the eighth parameter introduced in Catalyst over the last eight years. We are pleased with the breadth of global adoption to date, as about 1,000 customers across 35 countries have now utilized Bioassets on Catalyst with reference-led quality performance. As noted on the last call, our SiteAview Advanced Bacteria Detection Kit started to ship in April, and over 750 customers have now utilized the kit. Detecting bacteria in urine is a key driver of clinical value. And we are confident that this enhanced capability will drive an even greater appreciation for and testing with the SETI view platform. In addition to keeping innovations on track, as Brian discussed, we brought new COVID-19 tests to market for both animals and people by leveraging core technical and manufacturing capability. We also continue to advance our operating capability. We're excited, very excited, to have completed the move into our new European core lab located in Kornwestheim, Germany, that now houses over 500 employees. With state-of-the-art capabilities and automation, our Kornwestheim facility will enable us to further optimize our lab network in Europe, expand service levels, and bring improved efficiency while supporting our continued growth for years to come. Kornwestheim is now the largest lab in our global network. and the dedication and perseverance of our team made it possible to bring this lab online in the middle of a pandemic. Moving to our VSS business. Although we faced some headwinds related to new software and diagnostic imaging system placements, as access to veterinary practices was impacted by COVID-19, we had excellent double-digit growth in our recurring service revenues, supported by the expansion of our customer subscription base for cloud solutions like Webpack, SmartFlow, and Neo to highlight a few applications. We also saw hundreds of customers take advantage of integrated software solutions like secure remote access and telehealth that help practices manage their business in this environment. We continue to strengthen our leadership in global execution and software and are excited to announce the addition of Michael Schreck as Corporate Vice President and General Manager, IDEXX Veterinary Software and Services, reporting to me. Michael has over 20 years of experience in industry-leading software and technology. He has global responsibility for our customer-facing software business and will work closely with our global CAG commercial team to advance software solutions to support more efficient workflows and practice management, improve patient care, and value-added services that drive the overall health of veterinary practices. The health and safety of our workforce and their families and our communities continue to be a top priority for us. though we have begun to bring back a small number of employees engaged in product development where there are benefits to on-site access. The majority of IDEX employees continue to work remotely, and travel remains highly restricted. We are providing a spending allowance for many of our remote workers to help them maintain a health and safety work environment outside of our facilities. I'm especially appreciative of our employees around the world whose role required them to work on-site during these last several months in order to provide essential services to our customers Health and safety procedures continue to advance for our on-site employees, and in addition to physical distancing and PPE, now also include daily temperature checks in many locations. Given improved market and business trends, we're happy to share that we've discontinued temporary reductions in employee salary and benefits. In light of the recovery in market demand, we are adding resources to critical areas like manufacturing and lab operations to ensure we can support market demand and customer service levels moving forward. Our teams continue to stay highly engaged and productive. Our 2020 Mid-Year Employee Engagement Survey showed an all-time high employee engagement level for the organization during a period in which a global pandemic has created significant business and personal challenges for our employees. Overall, we're very encouraged by the strong recovery in our business. The resilience of our industry and IDEXX's business in particular is extraordinary. We're positioning ourselves to support sustained market growth while delivering solid financial performance as we continue to advance our long-term strategy. In this context, I would be remiss if I didn't take the opportunity to thank both our employees and customers. Our customers continue to provide medical services against the backdrop of economic uncertainties and new, challenging workplace and employee safety requirements. As many of us, including me, are pet owners, we couldn't be more appreciative. And a huge thank you to my IDEX colleagues around the world for their tremendous efforts in continuing to support these customers and our business. I'm very proud of what we accomplished this past quarter. In closing, we're looking forward to our first ever virtual Investor Day on Thursday, August 13th. We will share updates on our long-term opportunity, strategic priorities, and financial goals. You can now register for the event on the investor relations section of our website. Participating in the event will be members of my senior management team, including Brian McKean, CFO, Tina Hunt, General Manager for Point-of-Care Diagnostics and Worldwide Operations, Mike Lane, General Manager of Reference Labs and Information Technology, and Jim Parlochek, the Chief Commercial Officer. And that concludes my opening remarks. We now have time for some questions.