IDEXX Laboratories Inc IDXX
Q1 2010 Earnings Call Transcript

Transcript Call Date 04/23/2010

Operator: Good morning, everyone, and welcome to the IDEXX Laboratories First Quarter 2010 Earnings Conference Call. Just a reminder, today’s conference is being recorded. Participating in the call this morning are Jon Ayers, Chief Executive Officer; Merilee Raines, Chief Financial Officer; and (Susan Ostrow), Director, Investor Relations.

IDEXX would like to preface the discussion today with a caution regarding forward-looking statements. Listeners are reminded that statements that members of IDEXX management may make on this call regarding management’s future expectations and plans and IDEXX’s future prospects constitute forward-looking statements for purposes of the Private Securities Litigation Reform Act of 1995. Such statements include but are not limited to statements regarding management’s expectations for financial results for future periods. Listeners are reminded that actual results could differ materially from management’s expectations. Factors that could cause or contribute to such differences are described in IDEXX’s annual report on Form 10-K for the year ended December 31, 2009 in the section captioned ‘Risk Factors,’ which are on file with the SEC and also available on IDEXX’s website, In addition, any forward-looking statements, represent IDEXX’s estimates only as of today and should not be relied upon as representing the Company’s estimates as of any subsequent date. The Company disclaims any obligation to update or revise any forward-looking statements in the future, even if its estimates or expectations change.

At this time, I would like to turn the conference over to Merilee Raines. Please go ahead.

Merilee Raines - Corporate VP, CFO and Treasurer: Good morning and thanks for joining our call today. First, a quick overview of our first quarter results. In our press release this morning, we reported revenues of $268.5 million, a year-to-year growth of 14% and diluted earnings per share of $0.55, a growth of 28%. Revenues came in roughly in line with our thinking at the time of our January call, while earnings per share were about $0.04 above our thinking at that time.

Revenue performance versus our expectation was the net result of a few factors. Somewhat lower sales of rapid assay kits and instrument consumables in the first two months of the quarter and unfavorable currency movements were largely offset by higher than anticipated distributor orders at the end of the quarter and higher sales of lab services.

As for the earnings favorability versus our prior thinking, currency produced about $0.01 of negative impact and distributor orders contributed about $0.02 of favorability. The remaining $0.03 of favorability was attributable to our business performance with operational efficiencies driving cost reductions that benefited our gross margins and control of operating expense spending more than offsetting the modestly lower revenues exclusive of quarter end distributor orders.

Now, on to further highlights on our first quarter performance. First quarter revenues grew organically 9%, after adjusting for a 4% favorable impact of currency and about a 0.5 contribution from acquisition. We anticipated the first quarter would show the highest revenue growth in our 2010 quarterly profile due to the easy comparison to the first quarter 2009 with its relatively weak capital sales.

To gain insight into the fundamental activity levels in our largest market, the U.S. vet services market, we have continued to analyze patient visit and practice revenue data that we derive from a subset of our customers who use our Practice Management software. The metrics we saw for the first quarter were largely consistent with what we saw in the fourth quarter of 2009. Patient visits were down about 1% year-to-year and practice revenues were up about a 1%.

This reinforces our thinking that a return to growth in this market will be gradual and gated by sustained improvement in factors that influence consumer spending, such as unemployment and consumer confidence. In addition, we believe from what we have experienced and heard that adverse weather in parts of the U.S. may have contributed to lower patient visits in the quarter, particularly in January and February.

Weather was a challenge in January and February in many parts of Europe as well. Asia Pacific continues to be an area of stronger economies and stronger performance for us with organic revenue growth of nearly 20% year-to-year for the first quarter across our portfolio of businesses.

Sales of instruments in our IDEXX VetLab suite at $17.5 million grew 15% in constant currency in the first quarter. Though, as noted upfront, first quarter capital sales last year were relatively weak, providing for an easy compare. We are pleased with this performance, particularly given the strong placements in the fourth quarter of 2009.

Placements in our chemistry offering, Catalyst and VetTest, were up over 20% year-to-year and we placed 484 Catalyst instruments in the quarter. Based on the very favorable feedback we are hearing from our current Catalyst customers and the momentum in our sales forces, both in the U.S. and international, we feel we are on track with our estimate of placing 2,400 Catalyst for 2010. Nearly 30% of the Catalyst placements in the first quarter were to new and competitive accounts, up from 25% in Q4.

With Catalyst as a centerpiece and the value of integrated information and workflow efficiency that can be obtained by purchasing other components of our instrument offering, that has helped to promote the sales of multiple instruments per transaction. As was the case last quarter, over 80% of the instruments we sold in North America in the first quarter were placed with others in our line. This compares to about 70% in the first quarter of last year.

Instrument consumable sales of $56.2 million grew organically 11%, or 4% when further normalized for changes in distributor inventory. This normalized growth is down a bit from about 4.5% we saw for full year 2009 and 6% in the fourth quarter of 2009, primarily due to a couple of factors.

First, in the fourth quarter last year, we increased the margin that distributors receive on Catalyst consumables to reflect their increased involvement in selling these slides, as we migrated from a drop-ship arrangement to the buy-sell arrangement we have with other products in our line. The increased margin to distributors now commensurate with our other products carried by distribution reduces the sales price we realize. Additionally, consumable sales were off to a slow start in the first two months of the quarter in the U.S. and Europe and we believe weather was the factor.

We expect that growth rates will tick up a point or two over the course of the ensuing quarters. We continue to see that growth in testing overall is approximately 15% higher for our Catalyst customers, who were previously VetTest owners compared to our population of VetTest owners.

Our rapid assay sales of $39.4 million grew organically year-over-year by 3%. When further normalized for changes in distributor inventory levels, revenues were down by almost 9% compared to a 1% normalized growth for full year 2009 and 2% for the fourth quarter.

If you recall, in the first quarter last year we conducted a couple of canine SNAP marketing programs, including a program done in conjunction with a pharmaceutical industry partner that shifted volume into the first quarter last year from the second quarter. This year, the extent of our programs was less, thereby creating a tough year-to-year compare.

When we further normalize for the impact of these programs, our first quarter year-over-year revenue decline was about 2%. A portion of this decline was in the feline segment where it has been generally observed that feline vet visits have fallen off more in the tough economy than canine visits. Additionally, on the canine side, we have seen some price erosion due to the increasingly competitive nature of the hardware market.

Further, as with instrument consumables, sales were particularly slow in January and February and we believe weather was a contributing factor to this occurrence. Having said all this, we observed more favorable trends in the later part of the quarter and expect we will see stronger performance in the second quarter.

Specific to our canine franchise 3Dx and 4Dx test represent approximately 75% of our overall canine SNAP unit testing volume in the quarter and 4Dx screening at our reference labs, though a small base demonstrated significant double-digit growth in the quarter.

So despite the increase in competition for heartworm-only testing, we are pleased that the market continues to understand the value associated with canine vector-borne disease screening with SNAP 3Dx and 4Dx, both in clinic as well as at our labs.

In the feline market, the SNAP Feline Triple test for feline leukemia virus, feline immunodeficiency virus and feline heartworm now accounts for about 70% of our worldwide testing volume when we look at the combined net sales of SNAP Feline Triple and the SNAP combination test for FIV and FeLV. Overall, we expect that normalized organic growth for rapid assay for the full year 2010 will be about flat to down about 1% from 2009.

U.S. distributor inventory levels for instrument consumables and rapid assays averaged 4.2 weeks at the end of the first quarter based on forward-looking demand. This is slightly above the level at the end of the fourth quarter, though within the range we consider customary.

Our laboratory and consulting services with revenues up $79.8 million had organic growth of 9% in the first quarter compared to 7% in the fourth quarter of last year. Approximately 70% of this revenue growth was the result of higher testing volume with the remainder due to price. Higher testing volume primarily from the acquisition of new customers continues to be driven by a number of factors, including our specialty test menu and advanced diagnostic protocol as well as our ability to leverage the full breadth of the IDEXX offering of integrated services, products and information management. Operationally, we continue to realize meaningful margin and service level improvements on a global basis that are driven by volume leverage, global purchasing scale and an array of lean processing initiatives.

Our Practice Information Management and Digital Radiography Systems with revenues of $18.8 million grew organically 22% in the first quarter, driven primarily by continued strong demand for digital radiography. Despite the still cautious outlook for the economy, veterinarians continue to migrate from older film-based systems to digital as the standard of care has evolved. We continue to be well positioned in the market due to the breadth and depth of our product portfolio. We entered the quarter with a solid order book and positive momentum and order volume throughout the quarter remained strong. Even as the overall economic environment remains challenging, we believe that favorable market dynamics will continue to support solid double-digit organic growth in this area moving forward.

Production Animal Services sales of $19.9 million represented 5% organic growth in the first quarter. This is consistent with the growth seen in the fourth quarter of 2009 and an improvement over the relatively flat performance for full year 2009 from 2008. Most of the growth in the first quarter occurred in Europe where the business won several tenders for testing related to a countrywide eradication program in Germany for a virus impacting beef and dairy production yield.

Our water segment had sales of $17.9 million for the quarter, which translated to 8% organic growth. This is up from 3% growth in the fourth quarter of 2009 and 2% growth for the full year 2009. We saw significant improvement in North America, our largest region, as well as faster growth in several smaller regions. For the year, we are projecting about 5% organic growth based on sustaining the growth in North America at the level we saw in the first quarter, but anticipating that growth in smaller geographies will be somewhat more erratic.

Turning to the rest of the P&L, the gross margin at 53% was about 50 basis points above our thinking in January, reflecting better than anticipated gross margins in both our VetLab and labs businesses. Our initiatives to drive productivity gains in these, our two largest businesses, are proceeding very well.

Operating expenses at 35% of revenue were modestly better than our thinking, reflecting our continued focus on managing discretionary spending. As we indicated in January, operating expenses as a percentage of revenue are highest in the first quarter due to spending in supported commercial activities such as tradeshows and annual sales meetings. Our spending profile in 2010 is consistent with this pattern.

Finally, our net interest expense of $300,000 and effective tax rate of 31.4% were largely in line with our expectations. Share count was a bit lower than our projection in January as we augmented our repurchase program to take advantage of share prices we considered to be attractive.

Turning to the balance sheet and cash flow, we ended the quarter with $106 million of cash and $157 of debt for a net debt position of $51 million. Our inventory balance was $122 million and that was up about $12 million from year-end levels. This was largely due to timing of receipt of chemistry slide orders as we had noted in January and normal seasonal bills.

Day sales outstanding at 42 days remain in good shape and our free cash flow was $14 million or 43% of net income. As noted in the past, free cash flow tends to be lowest in the first quarter due to regularly occurring events, such as compensation payments, and increases in receivables and inventory related to the ramp of some of our more seasonal businesses.

As we look forward, we continue to project full year revenues of $1.1 billion to $1.115 billion, reflecting slightly higher organic growth, offset by a modest reduction in the forecasted benefits from currency. Our revenue guidance implies 7% to 8% reported revenue growth, which translates to organic growth of approximately 6% to 7%, the difference being due to currency and some modest acquisitions made in 2009.

Organic growth is 50 to 100 basis points higher than our outlook in January, and the components of this growth are also slightly different, with stronger growth coming from lab services and instruments, including digital radiography, offsetting somewhat lower growth in rapid assay revenues.

We continue to project full year gross margin to be approximately 51.5% to 52% for the year, 50 to 100 basis points above the 2009 full year rate. While we do see incremental opportunity for gross margin expansion in both our VetLab and labs businesses based on first quarter performance, this upside is expected to be offset by revenue mix dynamics as relatively lower gross margin lab services and instruments drive more of the revenue growth versus our expectations in January. We continue to project operating expenses of approximately 34% of revenues for the full year, and so, all of these results in full year operating margin expected at 17.5% to 18%.

We expect the tax rate to be approximately 31.5% to 32% for the full year, about 150 to 200 basis points above the full year 2009 range, due primarily to the expiration of the federal R&D credit at the end of 2009. As mentioned on the fourth quarter earnings call, an extension of this credit would reduce our full year rate by approximately 1 percentage point and increase earnings per share by $0.03 to $0.04.

We continue to estimate net interest expense of $2 million to $2.5 million. We will see an increase in quarterly interest expense beginning in the second quarter of about $350,000 as the interest rate swaps that we put in place last March go into effect. These swaps enabled us to lock into a fixed interest rate of about 2.5% on a portion of our revolver over the next two years.

The weighted average share count for the year is expected to be down about 2.5% from the full year 2009 weighted average. This count is slightly lower than our expectation in January, reflecting the full year benefit of higher than planned share repurchase activity in the first quarter.

All of this leads us to increase our full year earnings per share projection to $2.23 to $2.28 compared to our January guidance of $2.20 to $2.25. This change in guidance versus January incorporates projected $0.03 negative impact from currency, partially mitigated by a projected $0.02 full year benefit from lower share count. The remaining $0.04 increase reflects our feeling that there is some modest further upside from business performance beyond the $0.03 we saw in the first quarter.

For a little more detail on currency, the rates implicit in our guidance today are the euro at $1.35, the pound at $1.53 and the Canadian dollar at parity with the U.S. dollar. This compares to currency rate assumptions previously of $1.40 for the euro, $1.60 for the pound and $0.95 for the Canadian dollar. To remind you, every 1% strengthening of the U.S. dollar vis-a-vis our basket of currencies reduces revenues by slightly more than $4 million and operating profit by about $750,000 on an annualized basis.

As for the balance sheet, we project DSO to remain at approximately 40 days and inventories to increase $5 million or so in the next couple of quarters in support of new product launches and then end the year at $115 million to $120 million. Capital expenditures are targeted to be $45 million, down slightly from the $51 million in 2009. And we project free cash flow to be approximately 110% of net income.

Now on to John for further comments on the business.

Jonathan W. Ayers - Chairman, President and CEO: Thank you, Merilee for the comprehensive review. Overall, I was pleased with our revenue growth across our portfolio businesses in the quarter. Despite continued albeit moderating headwinds in the U.S. market for veterinary care, we achieved high single-digit organic growth. Even more impressive, we made excellent progress in our efforts to be more cost efficient, both at the gross margin line and below. In particular, we made excellent progress on margin improvement in our instrument and reference lab businesses, areas of focus for us.

Before I go further, I wanted to provide a brief update on our FTC matter that we mentioned in our last call and discussed in our 10-K. To remind everybody, in January we received a letter from the FTC stating that they were investigating our marketing and pricing practices in the U.S. companion animal market. Last week, we did in fact receive a subpoena from the FTC that we had anticipated and we intend to fully cooperate with the FTC in this process. We are at a very early stage in the process and we’ve been advised that these investigations can last a year or more. Therefore, we don’t expect to have any further comments for quite a while.

While this matter will obviously require the appropriate time and attention to be responsive to the FTC, we certainly won’t be losing focus on our strategy of continued innovation and global commercialization, and we remain confident both in our legal position and in the ability of our business to adapt successfully to any possible outcome to this matter.

Turning to the economy, Merilee mentioned our read on the U.S. market for pet healthcare. We utilized actual clinic revenue data we received from hundreds of independent practices from around the country. This is not a survey data, actual data. We find from this data that pet owner traffic or clinic visits continue to be down about 1% year-over-year in the first quarter, essentially no improvement on this growth metric from Q4 2009. We continue to believe that we will see only a very gradual improvement over the course of the year in the underlying demand as measured by pet owner visits to their local vet.

However, I remain firmly convinced in the longer term secular trends that are intact; that is towards greater pet ownership, a strong bond between the owner and their pet or pets and stronger pet owner demand for quality medical care. A number of demographic factors are driving this trend, including an ageing population in the U.S. and other developed countries, as well an increase empty nesters, dual income no children couples, singles and other types of households that value pet ownership as a form of companionship, comfort, health and wellbeing. These households typically have more discretionary income to develop the health of their pet.

At the same time, we are advancing the veterinarians’ ability to deliver a higher standard of medical care through advancements in diagnostics and information technology. We see a target-rich opportunity for continued innovation that will drive our growth for many, many years to come.

Investors know that one of our key strategy is to make it easy and convenient for the veterinarian to obtain the results of routine blood work during the typical 15 or 20 minute exam window and have the opportunity to review those results with the pet owner, what we call real-time care.

Catalyst Dx, our flagship chemistry analyzer, is at the center of this strategy. Catalyst allows a veterinarian to generate chemistry results within 8 minutes of a blood draw and with very little hands-on-time by the technician. Catalyst Dx continues to build tremendous customer excitement, loyalty and word of mouth with each passing month. Customer satisfaction with Catalyst has now reached world-class levels according to our customer survey and sales force feedback.

Our instrument placements were strong in Q1 2010, even more so when you consider that at this point we do not operate with any substantial backlog when the quarter begins. And these are replacements in customer sites that generate consumable volume right away.

Our real-time care strategy is also supported by our touchscreen-based Laboratory Information Management System that we call IDEXX VetLab Station or IVLS. In Q4 of 2009, we launched a larger 15-inch touchscreen that has received great reviews from our customers. IVLS also integrates with the Practice Management software systems of many different vendors with an intelligent two-way interface that we call SmartLink or InterLink.

SmartLink and InterLink, depending on the software used by the customer, eliminate the patient data entry step and ensure that the results are automatically available in the electronic medical record and the blood work fee is captured on the clients’ invoice. This easy and intuitive software integration is a key differentiator for all line of IDEXX VetLab equipment and is of great interest to current and prospective customers when we are placing new in-house lab systems.

IVLS is also able to be connected to IDEXX through the Internet in what we call IDEXX SmartService. We now have over 3,300 SmartService connected customers, up from 2,000 three months ago, and we will be continuing to connect existing and new customers at a pace of roughly 100 per week. SmartService allows us to easily troubleshoot instrument concerns of the customer and download new software.

SmartService also allows us to introduce this quarter what we call Real-Time Care Protocols, a program that incentivizes customers with rebates based on usage that is tracked by IVLS and sent to IDEXX via SmartService. These Real-Time Care Protocols provide incentives to expand the size of the diagnostic panel that the customers run on a patient, expanding the diagnostic database on that patient and supporting more informed medical decision making. Real-Time Care Protocols help justify the cost of new instrument purchases and expand utilization. Real-Time Care Protocols will be a core element of our strategy in the years to come.

Again, all these capabilities, VetLab instrument integration, SmartLink, InterLink, SmartService and Real-Time Care Protocols are offerings completely unique to the IDEXX business model, what you might call a complete diagnostic ecosystem.

But it gets even better. We’re very excited to announce that in just a couple of months, we will be launching yet another significant innovation in point-of-care testing with ProCyte Dx, a revolutionary new hematology system. I view this product introduction as being as significant to IDEXX as our launch of LaserCyte in 2002. LaserCyte was the first and still the only point-of-care hematology analyzer that offers a complete blood count with five-part white blood cell differential and an absolute reticulocyte count, the latter parameter important to characterizing certain red blood cell abnormalities, such as anemia.

ProCyte will pair well with Catalyst Dx in higher test volume segment of the veterinary market. Complementary and cross selling opportunities provided by ProCyte and Catalyst Combo are key to our strategy in that customers are looking for an in-house lab that has both hematology and chemistry and each alone would be an incomplete diagnostic solution.

The two diagnostic modalities working together in an integrated system is of more value to the veterinarian who routinely runs both chemistry and hematology results to determine the health status of the patient. In fact, our SmartService data indicates that about 50% runs in-house today on IDEXX systems integrated with IDEXX VetLab Station include both chemistry and hematology or the CBC. So, it is all about having the best combination of instrument technologies that then in turn are integrated into one easy-to-use system. That is the basis of customer preference for in-house lab selection.

It is also interesting to note that about 95% of chemistry panels sent to the reference lab include a CBC, a far higher percentage than today’s in-house testing behavior, which suggests that ProCyte users will increase their utilization of hematology once they add ProCyte to their Catalyst as it is just so easy and quick to add the CBC.

With the IDEXX VetLab including a Catalyst and a ProCyte, a customer can now easily run a comprehensive diagnostic profile, including a chem 21 and a CBC in only 8 minutes, enabling real-time results within as short as a 15-minute appointment or if the customer can run a pre-anesthetic profile on four patients, each including a chem 10 and a CBC in a total of only 18 minutes, transforming practice efficiency in the busy morning rush to prepare for surgeries.

So why is ProCyte such a special hematology analyzer? This instrument is a compact bench-top analyzer that with just 2 minutes runtime and virtually no tech hands-on-time can provide a complete blood cell count with 24 different parameters, including the red blood cell indices, reticulocytes, platelets and an advance five-part white blood cell differential with five different species.

The ProCyte utilizes the same gold standard hematology technology laser flow cytometry as LaserCyte. In addition, ProCyte Dx incorporates two additional technologies commonly used in reference laboratory hematology systems, optical florescence and laminar flow impedance. When combined, these three technologies offer unprecedented accuracy, precision and a 2-minute runtime providing veterinarians with the most advanced hematology results available in an in-house bench-top analyzer.

ProCyte Dx is also a completely different kind of instrument launched for IDEXX with a much faster expected ramp time. ProCyte Dx was coded out through a partnership with Sysmex, a Japanese corporation that has worldwide leadership in hematology and the human diagnostic market, including an even stronger position in smaller platform systems.

ProCyte is a veterinary customized version of one of their platforms currently sold in the human market with mostly the same hardware. Sysmex has five years of experience with the human version of this system with over 5,000 placements. The ProCyte instrument has been under co-development for three years, and in the last 18 months IDEXX has completed extensive field trials in veterinary clinical settings and universities with over 70,000 sample runs. That a lot of runs.

ProCyte has surpassed our own performance expectations in terms of speed, accuracy, reliability and overall customer experience in these veterinary field trials. With ProCyte Dx, our comprehensive hematology offering now covers all segments of the in-house hematology market. ProCyte meets the needs of our higher volume customers, LaserCyte provides the same complete menu of tests for mid and smaller size accounts, and VetAutoread provides a basic CBC for lower volume customers, especially in emerging markets. We will support all three platforms for many years to come and we have several significant advancements in performance of our LaserCyte system planned over the next 12 months.

As far as target market, I would guess that for the U.S. ProCyte will be the preferred choice in the new standard of care for the upper half of the customer base, which, of course, represents the majority of in-house testing volumes. ProCyte will also likely expand utilization of point-of-care testing for hematology and chemistry in this important customer segment. We will showcase ProCyte Dx at the all important American College of Veterinary Internal Medicine Meeting Forum in June with the presentation of four peer-reviewed papers outlining the remarkable performance of this analyzer in different university and clinical settings.

We will begin to take orders this quarter and commence shipments in early Q3 with a controlled launch. ProCyte will likely take the place of what would have been LaserCyte sales to the higher end segment and its revenues have been incorporated into our guidance.

I am anticipating ProCyte with a list price in the high 20s and a realized price in the neighborhood of 20K, after customary trading allowances will command a price premium over other hematology offerings in the market including LaserCyte. Similar to Catalyst Dx, a majority of ProCyte analyzers will be purchased by current IDEXX customers. Many of these customers will trade in their current LaserCyte, which we will then refurbish and sell on to developing markets at competitive prices. However, ProCyte will also be a unique offering to mid to higher end practices that do not have IDEXX equipment.

Our innovation of real-time care, real-time result from the routine blood work continues to unfold with what I have all – everything that I have discussed on today’s call. In addition, we have a few other smaller advancements that will continue to build on the real-time care offering that I hope to discuss later this year. So, in summary, we had a strong first quarter with solid momentum at our business despite a tepid economy and have announced an exciting new instrument launch.

So, at this point, Cynthia I’d like to open the call to the Q&A period.

Read our Earnings Call Transcript disclaimer.
Add a Comment
E-mail me new replies.