IDEXX Laboratories Inc

NASDAQ:IDXX

Earnings Call Transcript 2019-Q2

[Operator]

Good morning, and welcome to the IDEXX Laboratories Second Quarter 2019 Earnings Conference Call. As a reminder, today’s conference is being recorded. Participating in the call this morning are Jay Mazelsky, Interim President and Chief Executive Officer; Brian McKeon, Chief Financial Officer; and John Ravis, Senior Director, Investor Relations.

IDEXX would like to preface the discussion today with a caution regarding forward-looking statements. Listeners are reminded that our discussion during the call will include forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those discussed today. Additional information regarding these risks and uncertainties is available under the forward-looking statements noticed 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, idexx.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 measure is provided in our earnings release, which may also be found by visiting the Investor Relations section of our website. In reviewing our second quarter 2019 results, please note all references to growth, organic growth, constant currency growth and comparable constant currency growth refer to growth compared to the equivalent period in 2018 unless otherwise noted.

To allow broad participation in the Q&A, we ask that each participant limit his or her questions to one with one follow-up as necessary. We appreciate you may have additional questions, so please feel free to get back into the queue and if time permits, we’ll take your additional questions.

I would now like to turn the call over to Brian McKeon.

[Brian McKeon, Chief Financial Officer]

Good morning, everyone. IDEXX delivered continued strong financial performance in the second quarter. In terms of highlights, Q2 revenues of $620 million grew 7% on a reported basis or 9% organically. Results were driven by continued strong 11% organic gains in CAG Diagnostic recurring revenues, net of a combined 0.5% growth headwind related to Brexit order timing and equivalent day impacts. The quality of our growth was excellent in the quarter, reflected in strong U.S. CAG Diagnostic recurring revenue gains across our major modalities. And 39% growth in new and competitive Catalysts placements in international markets, which supported solid global EVI gains and continue to high growth and consumable revenues.

Profit performance continued at a strong pace in Q2 supported by continued high CAG Diagnostic recurring revenue growth and high profit flow through. EPS was $1.43 per share, an increase of 19% on a comparable constant currency basis, reflecting a better than projected 120 basis point improvement in constant currency operating margins. In addition to strong operating profit gains, Q2 EPS results also benefited from $0.04 per share, an upside related to share-based compensation tax benefits.

While, our CAG Diagnostic recurring organic revenue growth remains strong and on track with our full year 11% to 12% growth goals, our overall Q2 organic growth of 9% was at the lower end of our projected growth range for the quarter, impacted by a few select factors. We fell short of our goals to build on very high prior year international chemistry upgrade levels with the majority of our Q2 upgrade placement shortfall in China. We also saw increased pressure on China LPD revenues in Q2, driven by the African swine fever outbreak, as well as a relatively higher than projected impact from Brexit and equivalent day affects in the quarter.

These factors were largely specific to the second quarter. We’ve refined our full your revenue outlook to incorporate these effects, while raising our full year EPS guidance, reflecting continued benefits from high CAG Diagnostic recurring revenue growth and discipline P&L management.

In terms of our full year revenue outlook, we’re maintaining our guidance for 11% to 12% organic growth in CAG Diagnostic recurring revenues. We’re refining our overall organic growth guidance to 9.5% to 10.5%, lowering our high-end growth outlook by 0.5%, incorporating our second quarter results. Our updated full year revenue guidance is now $2,380 million to $2,410 million, $10 million below our prior midpoint revenue range reflecting, $5 million in operational refinements and approximately $5 million of impacts related to updated FX estimates.

We’re raising our 2019 EPS guidance range by $0.5 per share at midpoint to $4.82 to $4.92, or 17% to 20% growth on a comparable constant currency basis. This outlook reflects $0.02 in EPS benefit at midpoint related to higher expectations for operating performance driven by a raised outlook for 100 to 125 basis points in full year constant currency operating margin improvement and lower projected interest expense. Our guidance builds in $0.04 per share increase from updated projections for share-based compensation tax benefits, incorporating Q2 upsides, offset by $0.01 negative impacts related to updated FX assumptions.

We’ll review our updated 2019 outlook later in my comments. Let’s begin with a review of our Q2 performance by segment and region. Q2 results reflected a continued strong performance in our Companion Animal Group. Global CAG revenues were $547 million, up 10% organically driven by 11% growth in CAG Diagnostic recurring revenues, including strong global gains across our major modalities. As noted, our CAG Diagnostic recurring revenue growth in the quarter was net of 0.5% headwind from Brexit order timing and equivalent day effects, which were relatively greater than anticipated impacted by the timing of European holidays.

Year-to-date CAG Diagnostic recurring revenues increased 11.4% in line with our full year goals. Veterinary software, services and diagnostic imaging systems revenues increased 9% overall and 7% organically in Q2, driven by double-digit organic gains in VSS revenues. We saw continued strong sales results across our practice management platforms and growth in recurring software services on our expanding PIMS and application installed base.

Our diagnostic imaging business also continues to achieve high levels of digital radiography instrument placements and growth in recurring services, although our organic revenue gains in the quarter were moderated by comparisons to high prior year instrument placement levels.

Our Water business revenues grew 10% organically in the second quarter to $35 million with consistent mid-single digit growth in the U.S., augmented by high growth in Asia and Latin America, aided by our expanded direct sales presence.

Livestock, Poultry and Dairy revenue in Q2 was $33 million, reflecting relatively flat organic growth. Strong organic growth and health herd screening revenues aided by a favorable prior year comparison in the quarter and solid gains in poultry and pregnancy testing were offset by greater than projected pressure on swine diagnostic testing revenues related to impacts from African swine fever – the African swine fever epidemic in China, as well as moderate declines in European disease eradication program revenues.

By region, U.S. revenues are $389 million in the quarter, up 9% organically, driven by an 11% organic increase in CAG Diagnostic recurring revenues. U.S. recurring revenue gains were supported by double-digit growth in U.S. Reference Labs and consumables and high-single digit gains in rapid assay sales. U.S. CAG recurring diagnostic growth continues to be primarily volume driven with net price gains continuing to trend in the 2% to 3% range across our major modalities.

IDEXX growth continues to outpace broader market trends. In Q2, total visits per practice growth was 0.7% year-on-year, with clinical visits per practice growing at a greater amount at 2.1%, and overall revenue per practice increasing 4.4%. Market growth results were slightly moderated from Q1 levels, which were refined following our latest dataset refresh. Note that these metrics are on the same-store basis and don’t include growth benefits from incremental practice formation which we estimated approximately 1% annually. International revenues in Q2 were $230 million, up 9% organically, driven by 11% organic gains and CAG Diagnostic recurring revenues.

As noted last quarter, we saw benefits in Q1 related to advanced ordering ahead of the previous Brexit deadline. These effects reversed in the second quarter, which along with an unfavorable impact related to the timing of European holidays, reduce overall international CAG Diagnostic recurring revenue gains by approximately 1.5% and consumable gains by [indiscernible]

Adjusting for this dynamic, international consumer gains were nearly 20% in Q2, supported by our commercial executional focus and expanding our global Catalyst installed base. International CAG Diagnostic revenue gains were moderated by consistent mid-single digit revenue gains in our Reference Lab business. This is an area targeted for improvement in the second half of 2019, aided by relatively more favorable year-on-year comparisons and benefits from our expanding veterinary diagnostic consultant business model.

In terms of segment performance, our Q2 results reflected strong global gains across CAG Diagnostic testing modalities and continued progress and expanding our premium installed equipment based globally. Globally EVI was up solidly in Q2 compared to very strong prior year levels, driven by growth in high quality Catalyst placements. In North America, we placed 319 Catalysts at new and competitive accounts, as well as 159 second Catalysts at larger IDEXX accounts.

Second Catalyst placements are supporting continued strong consumable growth and high customer retention rates, aided by steadily expanding 360 degree program and other long-term contract commitments. These results compare to strong prior year, new and competitive Catalysts placement levels of 346 units and 95 second Catalysts placements. Along with limited VetTest upgrades, total North American Catalyst placements were 486 in the quarter, up 8% supporting a 15% year-on-year growth in our North American installed base, including approximately 5% of growth benefit from upgrades completed in the second half of 2018 at Banfield.

In international markets, we placed 761 Catalyst at new and competitive accounts, or 66% of total placements, up 213 units or 39% compared to the prior year. Total international Catalysts placements of 1,149 units were down 4% compared to a very strong prior year levels, which had high levels of VetTest upgrades in Asia-Pacific markets.

As noted, while our new and competitive Catalyst results were excellent, we did fall short of our goals in Q2 to build on our high priority levels of upgrades in expansion markets such as China, which contributed to a shortfall to our quarterly instrument revenue goals. Despite these dynamics, our international Catalyst installed base reached nearly 21,000 units in Q2, up 28% year-on-year and over 5% compared to ending Q1 levels.

Overall, we placed 3,171 premium analyzers in Q2, down 2% year-on-year. Total Catalyst placements were 1,635, down 1% reflecting the tough compared to high prior year VetTest upgrade levels. We achieved 602 SediVue placements in Q2, down 16% compared to very strong prior year levels, which benefited from a high percentage of our early 360 degree program agreements, including seven new compared to a more recent mix shift, which has included relatively more Catalyst as part of our 360 program commitments.

We placed 934 premium hematology instruments globally in the quarter, up 7% with a continued high attach rate with new and competitive Catalysts placements. In addition to these strong premium instrument results, we placed a record 2,663 SNAP Pros in Q2, expanding our SNAP Pro installed base to over 30,000, with over 27,000 installed in North America, helping to support increasing retention rates in our rapid assay business.

CAG Diagnostic instrument revenues in Q2 were $32 million, a decrease of 7% organically off a strong compare in 2018, which included mixed benefits from very strong placements of higher priced SediVue instruments.

Benefits from a growing instrument base, test and software innovation and expanded direct commercial capability continue to drive strong recurring CAG Diagnostic revenue gains across our major modalities. Instrument consumable revenues of $175 million, grew 13% organically in Q2, net of 1% growth headwind related to Brexit order timing and equivalent day impacts.

Results reflect double-digit gains in the U.S. and normalized growth nearly 20% in international markets. High volume-driven consumable gains were supported by continued expansion of SediVue and SDMA in a slide with each contributing nearly 1% to year-on-year consumable revenue gains in the quarter.

Reference Laboratory and consulting services revenues of $214 million, grew 10% organically into Q2. U.S. lab momentum continues to be very strong reflected in low- to mid-teen volume driven organic Reference Lab revenue gains and sustained high customer retention levels. Overall lab growth was moderated by consistent mid-single digit organic lab growth in international markets.

Rapid assay revenues of $69 million, grew 9% organically in Q2, reflecting continued expansion of 4Dx Plus specialty and first generation products supported by planned promotional programs and high customer retention levels, aided by our expanded SNAP Pro installed base. Rapid assay gains continued to be primarily volume driven, augmented by moderate net price gains.

Turning to the P&L, operating profit in Q2 was $164 million, up 13% as reported or 14% on a constant currency basis, supported by operating margin gains across our CAG order and LPD segments. Operating margins were 26.5%, up 120 basis points on a constant currency basis or 140 basis points as reported reflecting moderate gross margin gains and stronger than projected operating expense leverage.

Gross profit was $358 million in Q2, up 8% as reported or 9% on a constant currency basis. Gross margin was $57.7%, increased 30 basis points on a constant currency basis, supported by product margin gains, reflecting benefits from moderate net price increases and strong consumable and rapid assayed growth. These gains and scale and productivity benefits in our U.S. lab business were offset by plan investments in lab capacity and systems, as well as incremental year-on-year costs associated with expanded software field service resources Foreign exchange hedge gains, which are reflected in gross profit, were approximately $2.5 million in Q2.

Operating expenses in Q2 were up 4% or 6% on a constant currency basis resulting in 90 basis points of positive operating margin leverage. Constant currency operating expense increases were driven by growth in R&D spending and increased costs related to our expanded global commercial infrastructure with some favorability related – relative to our expectations for the quarter relative to the ramping of cost growth in these areas.

Overall operating expense growth was moderated in Q2 by relatively limited constant currency growth in G&A costs reflecting low year-on-year corporate function and benefit costs growth and LPD cost controls. EPS in Q2 was a $1.43 per share, an increase of 16% as reported and 19% on a comparable constant currency basis. Foreign exchange, net of hedge impacts in Q2 2018 and 2019 decreased operating profit by [indiscernible] million and EPS by $0.01 per share. Our effective tax rate was 19.5% in Q2, including benefits of approximately 3% to our tax rate or $0.05 per share related to share-based compensation activity, which is approximately $0.04 per share, higher than projected.

Free cash flow was $99 million for the first half of 2019. We continue to expect free cash flow at 60% to 65% of net income for 2019, reflecting a consistent full year outlook for capital spending of $160 million to $175 million. This includes approximately $70 million of combined incremental capital spending related to our Westbrook Maine headquarters expansion in our German core lab relocation or about 20% of net income. We allocated $20 million in capital to repurchase 86,000 shares and Q2.

Year-to-date, we repurchased 353,000 shares or $74 million or an average price of $210 per share. Our balance sheet remains strong. We ended Q2 to with $956 million in debt, $111 million in cash, and $597 million in capacity under our revolving credit facility. Our leverage ratios as a multiple of adjusted EBITDA were 1.49 times gross, and 1.31 times net of cash and investment balances.

We’re refining our 2019 full year outlook for a reduction in average shares outstanding from stock repurchases of approximately 1%, which reflects more recent stock price trends and assumes that we maintain net leverage ratios at current levels. We now project annual interest expense of approximately $34 million, an improvement of $2 million more than offsetting these impacts.

In terms of our updated P&L outlook for 2019, our full year reported revenue guidance is now $2,380 million to $2,410 million, reflecting refined expectations for 9.5% to 10.5% overall organic growth and consistent 11% to 12% organic growth in CAG Diagnostics recurring revenues. Our reported revenue outlook reflects a projected 1.5% to 2% full year FX revenue growth headwind at the rates assumed in our press release.

As noted, we’re raising our 2019 full year EPS guidance $0.05 per share at mid point to $4.82 to $4.92 reflecting an outlook for 17% to 20% comparable constant currency EPS growth. Refinements to our revenue outlook or more than offset by increased expectations for full year operating margin improvement, now projected at 100 basis points to 125 basis points, generating $0.02 of operational benefits including net upsize from revised projections for full year interest expense in share account reduction.

Our EPS guidance assumes at 2019 effective tax rate of 19.5% to 20%, a 50 basis point improvement compared to earlier guidance lending $0.04 of reported EPS upside. This tax rate includes an estimate of $12 million to $14 million or approximately 2.5% and projected a full year tax rate benefit from exercise of share-based compensation. At midpoint of our guidance estimates – this equates to about $0.15 per share in full year benefit. We now estimate the foreign exchange rate changes will decrease EPS, reported EPS by $0.04 per share, $0.01 greater than – a $0.01 greater impact in our last outlook head of approximately $11.5 million in projected hedge gains.

For the third quarter outlook, we expect reported revenue growth of 9% to 10.5% and organic revenue gains of 10.5% to 12% including 1% to 1.5% equivalent day growth benefit. We expect Q3 2019 operating margins to increase 50 basis points to 100 basis points above prior year Q3 levels on a constant currency basis, and we expect our effective tax rate in Q3 to be approximately 21% including projected benefits from share-based compensation exercise activity.

That concludes the financial review, our business momentum remains strong and we’re on track to deliver our 2019 financial performance aligned with our long term goals.

Let me now turn the call over to Jay for his comments.

[Jay Mazelsky, Interim President and Chief Executive Officer]

Good morning and thank you, Brian. IDEXX second quarter results build on our strong start to 2019, and reflect the strength of our recurring revenue business model, keeping us on track towards excellent full year results aligned with our long term goals. Our performance was led by solid 11% organic growth in our CAG Diagnostics recurring revenues, or 11.5% normalized for Q1 Brexit pooling and equivalent day impacts. This expanding highly durable annuity contributed 77% of IDEXXs total revenues in Q2.

Let me start with a few reflections on the quarter. We were especially pleased with the strength of our U.S. performance in Q2, where we drove 11% recurring CAG growth, reflecting strong gains across all CAG recurring diagnostic modalities. We saw continued momentum in our U.S. reference lab business, whereas previously communicated, we continued to invest in operational enhancements such as new courier routes, new day labs, and weekend service. These investments provide service level and results, turnaround improvements, both of which support customer retention and new customer acquisition.

In our North American VetLab business, Catalysts placements were up 8% including second Catalysts placed at high testing volume accounts, which also support customer retention and help drive continued double-digit consumable gains. Of note, the rapid assay business grew at 9% organically benefiting from superior clinical accuracy, effective promotional programs and improving customer retention. The business was also aided by our expanding SNAP Pro installed base, an increasing leverage of IDEXX multimodality testing capability.

Reinforcing our long held premise the test that indicates testing; we’re seeing strong evidence of faster rapid assay 4Dx Plus growth, and IDEXX practices that also use our lab services and are adopting Preventive Care protocols. Globally instrument placements were solid during the quarter, considering tough compares at overall quality, with notable strength in international competitive Catalysts placements, which were up 39%. Our premium installed base continues to expand nicely, and we don’t see a change in the competitive environment. These placement gains along with ongoing increases in testing utilization drove continued strong growth in international consumables.

International consumable sales were up nearly 20% normalized for the impact of Brexit order timing and equivalent days aligned with our strategy to develop this significant in-clinic opportunity in international markets. Continued solid momentum across our business is keeping us on track for 11% to 12% CAG Diagnostics recurring organic revenue gains this year, and comparable constant currency EPS gains at the high end of our long-term goals.

Let me share some additional highlights related to progress on key fronts in our growth strategy. We continue to make solid progress advancing IDEXX Preventive Care. Our high same-store sales growth at the practice level in our U.S. Labs business is being driven in part by the adoption of Preventive Care diagnostics, what we call IDEXX Preventive Care. To date through Q2, over 3,100 practices have enrolled in the Preventive Care program since its inception. With 370 new practices enrolled in the quarter, a quarterly high for first time enrollees. IDEXX Preventive Care practices are growing CAG Diagnostics recurring revenue at approximately 14% on a trailing 12-month basis versus 11% growth for IDEXX U.S. customer base over the same period

Virtually our entire VDC population in the U.S is now successfully partnered with customers in their territories to deliver IDEXX Preventive Care. In fact, the top 50% of our VDC population as ranked by their engagement in Preventive Care exceeded their first half territory revenue goals by approximately 200 basis points. It’s a great example of how we create market growth. We always start with the customer and patient need to understand where appropriately applying IDEXX Diagnostics, like fecal antigen and IDEXX SDMA can uncover four underlying disease.

In the case of preventative care, we bring the relevant test together to create Preventive Care protocols. That closely aligned with how customers consume diagnostics testing along with compliance driven pricing that support the practice of best medicine. We leverage big data to raise awareness in practice centers, showing the medical benefits of applying appropriate diagnostics testing for Preventive Care to all pets, not just the older dogs and cats. Our field organization also plays an important role in customer success and market growth. Representing a key reason, we went to a high frequency trusted advisor model. We’re able to invest time and resources to help customers achieve their patient and business goals.

In early Q3, we introduced our IDEXX anywhere urine analysis bundle, available exclusively to IDEXX Preventive Care customers. This offering combines the convenience and pricing of Preventive Care diagnostics run at the reference lab, with all the clinical advantages of fresh year running in-house on the city view. This innovation is enabled by our unique integration capabilities between the IDEXX VetLab station, practice management software, and the IDEXX reference lab providing to customers, a seamless ordering and billing experience across modalities. We believe this multimodality customer friendly solution could help further accelerate our Preventive Care momentum. It helps support said of you placements and associated utilization.

We continue to have exceptional performance with our SNAP Pro placements of over 2,300 placed in the second quarter in the U.S. alone, up 100% year-over-year. We continue to methodically transform our rapid assay customer base into a razor and blade business model. As the SNAP Pro mobile instrument brings significant workflow and charge capture value to the veterinary practice. We see higher growth and rapid assay loyalty with customers adopt this SNAP Pro active and connected workflow. With the placements in Q2, we are now just a bit south of 65% of our SNAP 4Dx plus revenue, coming from these active and connected SNAP Pro customers.

I’d also like to provide an update on the status of our international sales force expansion. Our international business performance is strong. As evidenced by the continued high growth and economic value of instrument placements and International CAG recurring growth at 12.5% in Q2, adjusted for approximately 1.5% combined headwind for Brexit order timing and equivalent day impacts.

We’ve now completed the second full quarter within the expanded model and the commercial teams are responding well. Having had responsibility for three such initiatives in the U.S., there’s a time and distant element to building out the expansion. As we onboard new sales professionals develop their expertise in diagnostics and our product offering and grow their customer relationships. We track key metrics on our progress like tenure, which jump nicely in Q2. Since experience correlates well with effectiveness. We expect to see further business benefits of these efforts in the second half consistent with our experience in U. S. Where we feel effectiveness increased every quarter with tenure and deeper customer relationships

Moving to the veterinary software portfolio, Q2 was another very strong quarter for global placements, Cornerstone, Neo and Animana systems. In North America, practice management software placements grew 44% year-over-year for the quarter. Neo recently launched in Canada in Australia, complimenting Cornerstone in both of those markets.

Speaking at Cornerstone, we continue to see an unprecedented pace of Cornerstone upgrades to version 9.1 driven by customer excitement for the modernized user interface and disease. We have upgraded close to 2,000 Cornerstone users in less than four months. A record and testament to customer enthusiasm and a place to share that we achieved a critical technical milestone in the development of Cornerstone cloud, currently in field testing, which we’ll make available in the future and will bring the many benefits of the cloud to customers that value Cornerstone, as the go to high end practice management system.

Q2 was also a strong quarter for Web PACS, one of our nine cloud-based softwares and service offerings, which experienced that 34% year-over-year increase in enrollments. Other software offerings from IDEXX are advancing nicely, including the development of an enterprise management and analytics platform for corporate customers.

In summary, we feel very good about our business progress across the range of strategic fronts, and believe we are well positioned to sustain strong recurring CAG Diagnostics revenue growth and EPS gains aligned with our goals. We look forward to sharing more about the enduring growth potential we see for our business in our long-term strategy to capture this potential at the upcoming Investor day later this month.

Before I conclude, I wanted to extend our best wishes to Jon Ayers, as he works through his rehabilitation process. The strong results, we continued to deliver reflected deep and talented team that Jon has developed at IDEXX. And I know he has great confidence in IDEXX to keep delivering against our purpose in potential.

And with that, we’ll open it up to Q&A.

[Operator]

Thank you. [Operator Instructions] And we will go to line of Michael Ryskin with Bank of America. Your line is open.

[Michael Ryskin, Bank of America]

Hey, guys, thanks for taking the call. I want to start on the Reference Lab. The overall numbers, I mean, that was one area that came in a little bit lighter relative to expectations. And you talked a little bit about the U.S. performance and how well that held in, but international it seems like continues to lag just a little bit. I wonder if there’s anything going on there. I mean, we’ve talked in the past about the EVI and the focus on the point of care offering, but I want to see if the dynamic changed at all. And I wonder if there was any impact of the heat wave in Europe like we’ve seen in the past or anything like that?

[Brian McKeon, Chief Financial Officer]

Yes, Mike. Why don’t I just kind of clarify the numbers? But the Reference Labs trends in Q2 were very consistent with what we saw in Q1. I think here we have some normalization going on, but the U.S. was – the Q1 was 14%. It was like 13% normalized in Q2, and we had mid-single, very consistent mid-single digit gains in international. So we didn’t have a change in trend and Jay can talk more about this, but as you know, we’ve been sort of signaling target improvement as we work through the year on the international labs and we will have some more favorable comparison, but Jay can expand on that.

[Jay Mazelsky, Interim President and Chief Executive Officer]

Yes, just some additional context heading. Our overall business performance internationally was quite strong. We saw the 12.5% normalized CAG recurring growth performance. And as Brian indicated in his remarks, really strong competitive and placements associated economic value with the international consumables growth at nearly 20% normalized. So overall, very good performance. As I indicated, we’re still in the process of building out the VDC expansion and I think time is as our VDC has continued to build relationships with their customers in the market and we know with time comes additional effectiveness.

Keep in mind that we start with very strong country organizations. A lot of our sales professionals and country managers in international have been with the company, and know diagnostics for a decade or two decades. So that’s the base where we are building off of. In additional, they are representing phenomenal product line across the broad-based diagnostics offering. So we’re feeling good and about where we are and expect to continue to build off that capability in the second half.

[Brian McKeon, Chief Financial Officer]

And just to reinforce something Mike on performance versus expectations, we felt very good about the recurring CAG growth in the quarter. If you’d normalize the effects we highlighted, it was 11.5%. That’s where we are year-to-date, that’s right in range with what we are trying to achieve, fee for the full year. So relative to what we were targeting, this was an area that was right on line with what we’re hoping to achieve.

[Michael Ryskin, Bank of America]

All right. That’s helpful. And a quick follow-up if I could. I’ve gotten a flurry of your questions, since you brought up the comments on China. That was a little bit surprising. Could you just walk us through what happened there? What do you saw in the quarter? What your expectations are for the rest of the year?

[Brian McKeon, Chief Financial Officer]

Yes, we had a couple of effects that were related to China. Let me break them down and maybe LPD is the easier one to start with. But we’ve been working through the Africans swine fever impact. As you know China is not a big part of our overall company revenues. It’s 2.6% last year, roughly evenly split between LPD and CAG and – but within the LPD business, the swine testing business in China is a meaningful part of our LPD revenues, and we saw an acceleration in decline on the African swine fever from the Q1 levels. It’s a business it’s a little tougher to predict.

We can – we sell into larger laboratories and so it’s a little less visibility than some of other assets of our business, but that was a couple of $1 million below what we were expecting to achieve in the quarter, and we feel like we’ve got that reason to calibrate it. We’ve got some other initiatives we are advancing to mitigate that and we’ve got some promising trends in other parts of the business, health herd screening that we feel good about. So I think the – net-net we think we’ve got that factored in but that was a surprise in Q2.

On the instrument placements, we had excellent competitive instrument placements in China. The challenge that we had was, we had very strong prior year VetTest upgrades as well and I think in retrospect, we probably had overly aggressive goals going into this year to both to make progress on the competitive – new competitive front and to build on the strong upgrades. So it’s always been a competitive market, wouldn’t necessarily relate to softness in the market per se, I think, with some more as I mentioned, retrospect that we probably had aggressive goals here. But I think that’s another point of context. So China is smaller for us overall, but I think in the quarter, had some impacts, but we feel we’ve got that calibrated in the updated outlook.

[Michael Ryskin, Bank of America]

That’s really helpful. Thanks.

[Operator]

Thank you. Our next question will come from the line of Ryan Daniels with William Blair. Your line is open.

[Ryan Daniels, William Blair]

Hey, guys. Thanks for taking the questions. And I’ll also start by wishing Jon the best in his rehabilitation. Jay, maybe one for you, you talked about the record enrollment of, I think 370 practices in the IDEXX Preventive Care program. Can you speak a little bit towards what’s driving that? It seems a little bit unique, I think, we typically see kind of a rapid growth in early adopters and then slowly in the vet space. So what’s driving such strong momentum there for your business?

[Jay Mazelsky, Interim President and Chief Executive Officer]

Sure. Thank you, Ryan, for the question. We think it really starts with a fact that there is a very sizable market opportunity and I’m going to refer my comments specifically to North America in the U.S. We think that the U.S. Preventive Care market, addressable market is about $3 billion, we saw about $1 billion and that have served in – and we have about a third of that. So we’re still in the – in our early stages of being able to develop this marketplace.

And then you look at just sort of benchmark and provide some background context on the opportunity, a fairly small percentage of Companion Animals are getting tested today. We have cited statistics and data in the past that about 15% of dogs come in to a practice for clinical visits undergo a chemistry test, only 15%. On the vector-borne disease side, a little over third. So 36% canines in any given year get some sort of vector-borne disease screened. This could be something as basic as heartworm, only 15% are getting the full vector-borne disease screened before the act. So that stats with a very sizable opportunity.

And then from a programmatic standpoint, the IDEXX Preventive Care program, I think really hits a sweet spot in the marketplace we have a care protocols designed specifically for Preventive Care or wellness screening, it’s priced to really drive compliance with the client. We are able to provide tools and training for the practices and repeat follow-ups. So from the standpoint of operationalize, they’re implementing a concept that our customers are quite interested in to begin with, but have struggled in the past to be able to get good traction with this, we think we have really hit the sweet spot and our field is trained and excited by it and consequently driving growth with it.

[Ryan Daniels, William Blair]

Okay, super helpful color. And then just as a follow-up on a different topic, the operating margin performance continues to display upward pressure despite investments you’re making. Can you maybe highlight what some of the key deltas are between prior expectations versus kind of the expectations you had going into the year? What are really the major upside drivers there? Thanks.

[Brian McKeon, Chief Financial Officer]

Yes, I think a couple of factors. I think we always benefit from good execution on growing the CAG recurring diagnostic revenue. So I think there the incremental flow through from that growth is high gross margin for us and I think that always if we’re executing well, which we have been, supports good P&L profile. We’ve had, as I mentioned in my comments, somewhat slower than anticipated ramp in some of the growth we’re projecting for R&D and sales and marketing, nothing to be concerned about, it’s more just in a world where there is a lot of competition for talent, where we don’t have all the position filled with the way that we had originally projected and we’re confident we can get on that track, but we had some upside related to that.

And we have had good G&A management. We’ve been disciplined in the corporate functions, we had better than expected benefit cost, which is something that we have – our HR team does a tremendous job of managing that area. And I think we’re seeing good results as a company from that. That’s been favorable. And so those are some of the drivers, I think it’s broadly Ryan, more just reflective of the health of our business model, when we’re growing, the recurring CAG revenues as well that has good favorability for us.

[Ryan Daniels, William Blair]

Okay. Thanks for the color.

[Operator]

Thank you. Our next question will come from the line of Erin Wright with Credit Suisse. Your line is open.

[Erin Wright, Credit Suisse]

Great. Thanks. And I do wish Jon all the best in his recovery as well. We’re all thinking about him here. And thanks for taking my questions as well. I guess a follow-up to the last question there kind of on the profit experience that obviously, was pretty strong and were there any some timing dynamics, where you’re seeing that some of the costs were potentially pushed out to the outer quarters or how should we be contemplating that quarterly cadence in terms of the profit dynamic for the balance of the year?

[Brian McKeon, Chief Financial Officer]

Somewhat, you know, more modest, I would say, in terms of pushing out timing. I think it’s more of the ramp of the cost, Erin, so we’re a little favorable in Q2 and we’re anticipating we’ll be back on track in the back half of the year and that’s reflected. We shared a 50 to 100 basis points constant currency improvement in Q3 so that reflects that we’re seeing the cost growth particularly in R&D and in the international sales and marketing, getting ramping as we work through the year.

So it – we had – that I would say is the bigger driver was and we have some specific benefits just in terms of things that we’ve been managing effectively in the quarter, but we feel comfortable with effectively we’re – we’ve an outlook for the second half that’s more 50 to 100 basis points which is in line with our longer-term trends and goals.

[Erin Wright, Credit Suisse]

Okay, great. Thanks. And then on the Preventive Care side, what could add instead of your urine analysis to the program add for you? Is this significant in terms of financial contributions or placement trends or how much of your existing kind of Preventative Care users are actually already incorporating urine analysis in their program? I’m just curious what could this could add? Thanks.

[Jay Mazelsky, Interim President and Chief Executive Officer]

Yes. So we – thank you, Erin, for the question. We think over time that it will help support our Preventive Care momentum. Over – there’s a majority of customers who already use urine as part of the testing panel for Preventive Care, and one of their requests from customers as they wanted to pressure because it’s more clinically relevant. So being able to provide at a multimodality screen for customers was extremely well received in the marketplace, we’re enthusiastic about it and we think it also, by the way, help with SediVue placements over time.

[Erin Wright, Credit Suisse]

Thank you.

[Operator]

Thank you. Our next question comes from the line of Jon Block with Stifel. Your line is open.

[Jon Block, Stifel]

Great, thanks, guys. Good morning. Maybe two questions on some similar themes that were already touched upon, but just to go to Preventative Care, I think, Jay, you might’ve mentioned roughly a 300 basis point premium growth rate from those called PCC adopters versus the non-adopters. And maybe if you can elaborate on that a little bit. Do you think we see that delta widen further over time? And maybe if you were to isolate the practices that did adopt PCC, where were they previously? In other words, were they 7% or 8% and jumped to 14% or 15%? Any more granularity would be helpful. Thanks.

[Jay Mazelsky, Interim President and Chief Executive Officer]

Yes. So, just in terms of that, that 300 basis point orbit, we think that those customers are using more diagnostics that they have got from largely testing geriatric patients that testing adults and senior patients and incorporating diagnostics in their panels. I think what the data shows is that they had perhaps assumed that if a dog or cat was well and was an adult, that they didn’t do diagnostic testing, they didn’t need to do it. And what the data is showing is that they’re very significant, we’re able to uncover very significant number of abnormalities that require follow-up in doing testing. So we think that it’s just a classic case of being able to demonstrate that the clinical benefit of doing testing more broadly across the population patients.

In terms of how that plays out differentially, in terms of growth over time, we’ll say, we expect to continue to see benefits, but that’s a function of…

[Brian McKeon, Chief Financial Officer]

And Jon, we’ll share more of that at Investor Day, that’s obviously part of the long-term strategy and we’ll share how we’re thinking about that.

[Jon Block, Stifel]

Okay, great. And then sort of a quick follow-up, two small ones. First on new products, you got that Analyst Day coming up, right. As you just mentioned, I hope you’ve got a lot of to discuss. But is the belief that new product introductions are more, call it an industry conference event rather than a Wall Street event and the other small one would just be on the $5 million in organic revs coming down, it certainly seemed like it did not occur in CAG recurring. So if we were to isolate it, Brian, is this sort of 50-50 between, call it LPD and the instrument side? Thanks, guys.

[Brian McKeon, Chief Financial Officer]

Two questions, just on the first one, Analyst Day is we intend to have discussions in new products when we’re ready to bring them to market. So I think we’re – you should anticipate, we’ll have those discussions close to when we’re ready to bring products to market and we’re not going to be trying to time it around investor events if you will. No offense, but I think we want to have this lined up as best we can in terms of executing with their business.

And in terms of the dynamics versus – deltas versus our expectation in the quarter, Jon. It was – that was pretty much it. It was three things; it was – the international upgrades where we – we had great competitive placements, but we were probably a little aggressive on trying to do that and build on the upgrades. It was LPD, China, specifically African swine fever effects. And to a degree we’ve underestimated the days impacts in Europe somewhat. We didn’t flag that 0.5% impact heading into the quarter and we knew there were some impact, but that turned out to be just where the days fell a little bit more significant than we anticipated.

But some total that was about $5 million, $6 million delta to where we thought we’d come in and we’re basically just flowing that through. We think it’s a largely second quarter. We’ve calibrated effectively and feel very good about the year. And as you pointed out, the recurring CAG right on track and healthy year-to-date trends right in line with what we hope to achieve for the full year.

[Jon Block, Stifel]

Perfect. Thanks for your time, guys.

[Operator]

Thank you. [Operator Instructions] We will go to the line of Mark Massaro with Canaccord Genuity. Your line is open.

[Mark Massaro, Canaccord Genuity]

Hey, guys, thank you. And I also want to send my best regards to Jon in his recovery. I guess my first question is just on the, how you guys are thinking about – I know you’re not ready to guide for 2020, but you’ve posted some really strong growth in premium instruments as you’ve talked about in recent quarters. And you’re going up against difficult compare, as we think about our models for next year. Recognizing that instruments are only 6% of your revenue, how do you think about growth rates in instruments going forward given difficult comparison?

[Brian McKeon, Chief Financial Officer]

We intend to continue to build on our rate of placements. I think that the more important metrics to kind of focus on, are broader than just placement growth we’re obviously, as we’re growing our placements, expanding our installed base that supported by improving retention. So we pointed out in this quarter, the 15% year-on-year growth in the North American Catalyst installed base, about 5 points to that is the Banfield expansion and 28% international. So we’re -- now this is a business where we’re adding more instruments and doing a better job retaining our customers that installed base continues to grow, it’s the flywheel effect.

And that forms the foundation for additional drivers of growth, right? In terms of expanding the adoption of our innovations on this platform – on our platforms, adding new innovations as we have done in recent years as well, and that’s all supported by the in-house commercial capabilities that we have the VDC model. And that outflows into the strong double-digit recurring CAG growth delivering and we intend to deliver in the future. So it’s one metric, as you point out, we’re building on bigger numbers we want to keep going on that, but there is a broader model here in terms of driving increased utilization and innovation on these platforms that grow and capability over time that support the double-digit growth.

[Jay Mazelsky, Interim President and Chief Executive Officer]

Yes, just to add some color to Brian’s remarks. A key element of our strategy, Mark, is to be able to continue to drive menu expansion which in turn supports the CAG Diagnostics revenue growth. So if you take look at Catalyst for example, we have a technology for life type of philosophy, seven new assays as part of the menu in seven years, latest being Progesterone, it’s a great example of bringing Real-Time Care measurement to the clinic. As you know the pregnancy, the contamination of it, there is tight window on the veterinarian wants to be able to advise the breeder in terms of the optimal time, it -- if you are able to do that in a real-time basis with Catalyst in the clinic that drives serial testing.

In the case of SediVue, another great example, with SediVue the neuro network 4.0 which we released earlier in the year based on 175 million images, more geared towards the 4.0 release of liver function, bilirubin and ammonium biurate. So we’ve got excellent customer feedback on that, and we continue to drive do manual expansion more testing utilization. So that’s a key element for our strategy.

[Mark Massaro, Canaccord Genuity]

Excellent. And I also wanted just ask about the end market. Trends look strong to us. You reported clinical visits grew 2.1% this quarter. Do you expect clinical visits to hover in that call it 2% growth rate? And then I also wanted to ask about how you’re thinking about competitive dynamics for the next year given Zoetis expecting to complete their integration of Abaxis on their SAP?

[Brian McKeon, Chief Financial Officer]

Yes. So from a market performance standpoint, top line practice revenue growth was 4.4%. That the clinical piece that you indicated was 2.1%, we think the relevant piece, at least, for our business because that’s where the diagnostic testing occurs as part of those visits. And we’re in pretty much in line with what we have seen in the past is a little bit of variability quarter-to-quarter. But we think it was a strong quarter, it supports the CAG Diagnostics recurring growth profile that we achieved in the quarter and that we have indicated from an outlook standpoint, we expect going forward.

And I also think that when you take a look at some of our market development activities like Preventive Care, that will continue to drive the market. Part of what we do is we create markets, we manufacture our own growth. In terms of the your second question on competitive dynamics, we haven’t up to now seen a change, more broadly speaking in the competitive landscape, we’re always looking and anticipating that, but our focus is really on our customers and servicing our customers with solutions that address both the clinical and business needs.

[Mark Massaro, Canaccord Genuity]

Thank you.

[Operator]

Thank you. Our next question comes from the line of David Westerberg with Guggenheim Securities. Your line is open.

[David Westerberg, Guggenheim Securities]

Thank you for taking the question and best to Jon as well. So can you give us an update qualitatively or quantitatively on SDMA slide? Is it running above, below or at expectation in terms of contributing to growth, and how do you see this as a kind of a multiyear growth driver?

[Jay Mazelsky, Interim President and Chief Executive Officer]

Yes, thank you, David for the question. We are very pleased with the progress we’ve made on Catalyst SDMA and in fact, close to 60% of customers in the second quarter actually used SDMA on Catalyst, that’s a global number since its introduction are close to 70% of customers have actually purchased SDMA for Catalyst. Another benchmark connected with that is, we’ve now run over 2 million SDMA tests on Catalyst since its introduction. Now that’s on top of 22 million tests plus, 22 million plus test that we run the global reference lab since introducing that test on the reference lab.

So we think from a customer perspective, customers have really accepted SDMA as an essential element of the chemistry panel. They see significant clinical value, not just for sick patient visits, but also well visit testing. One study I will share more of this at Investor Day is looking at well patient testing when we move from just a basic Preventive Care straight. So chemistry, CBC, the one that includes SDMA, we see a 40% increase in profiles that indicate the need for further action. So we’re really clinically powerful. I think our customers appreciate that and we are seeing the type of uptick in the metrics I shared with you that support it.

[David Westerberg, Guggenheim Securities]

Got it. All right. Thank you. And then – just maybe to around consolidators and corporate clients, can you just talk about changes and demand around software, middleware or Web links Smart Flow? Are these good conversation starters? Are these revenue drivers? Are they maybe cross-selling opportunities? Can you just walk us through the more the software part element of the corporate customer base?

[Jay Mazelsky, Interim President and Chief Executive Officer]

Sure. I’d be glad to do. So just as a background, keep in mind that the whole notion of corporate and consolidation, it’s not a new dynamic in the marketplace. IDEXX has had quite a successful track record in partnering and growing with corporate accounts over time. But when you talk to the corporate account CEOs, they generally identify commonly, three top issues. One is staff engagement and retention, the second one that you pointed out is really this notion of enterprise scale in IT and software, the third, they want to continue to drive or improve profitable growth in their corporate practices.

And we address all three as a company. First with diagnostics, because diagnostics is connected to the Information Management piece, and they I think recognize our diagnostic as a profit center, it drives the care envelope, it’s an important part of their practices that is in subject of some of the same headwinds that they may see in product sales whether it’s food or therapies. And there’s a lot of evidence that when we provide these types of solutions to them, their staff will desire to practice best medicine remain more highly engaged.

From an Information Management standpoint, now getting specifically, to the core of your question, our customers, are corporate customers place a very high premium on integration in helping them out with workflow and workflow optimization. And the type of solutions that support that are Cornerstone or PIMS solutions, Smart Flow, Netconnect+, enterprise management and analytics packages that we come up with. The Smart Flow is a great example, where they have a really resonating with an application that works with our PIMS and other third-party PIMS that provides embedded connectivity that helps them with workflow, optimization and communication in the staff. It automatically captures, charges, if they desire to go paperless or paperless light, it has electronic forms. So these are the type of things that they are looking for, and highly responsive to.

[David Westerberg, Guggenheim Securities]

Great. Thank you.

[Operator]

Next we’ll go to the line of Andrew Cooper with Raymond James. Your line is open.

[Andrew Cooper, Raymond James]

Thanks for the question. Lots already been asked. So I will keep it quick. Just as we think about kind of IDEXX 360, and more conversations about leveraging the multimodality approach. How has that evolved relative to kind of layering in your end, like you mentioned and some of the numbers competitively? Has there been any change there and how do you continue to drive that as a really competitive advantage for IDEXX relative to what others in the space can’t replicate?

[Jay Mazelsky, Interim President and Chief Executive Officer]

Yes, so, we obviously, have differentiation because we have multimodality solutions and have the ability, like we’ve have just shown with the IDEXX anywhere urine analysis bundle to be able to provide, the best clinically from a solution standpoint, wherever it makes sense to be tested. So I think it’s largely supportive of helping the practice the way they want to.

[Brian McCann]

And Andrew, I’d point we’ve seen steadily increasing rates of growth in cross CAG agreements with our customers. And that’s been a trend that’s been ongoing, but really has accelerated with concepts like 360 and the advancements that we continue to make and just bringing together broader capability to our Information Management innovation and so, to your point it’s an area that’s a building momentum and you see that in the strong growth in EVI and in as well as increasing retention rates across modalities. So it’s definitely been core to IDEXX strategy for a long time and we’re executing very well against programs like 360, just help to reinforce that.

[Andrew Cooper, Raymond James]

Great. And then just one more quick one, I think following up on a question I think Jon asked, but when we think about Preventive Care and the uptake in growth relative to the base, can you help us think about the ramp of how fast from an account says, all right we want to layer it in with the pricing you suggested et cetera, et cetera to seeing that outcome. What the sort of the ramp looks like? And how if there’s any kind of color we should be thinking about or you think about the tail to that as we get out further from the first year to the second year? I know it’s still early but any color there would be great.

[Jay Mazelsky, Interim President and Chief Executive Officer]

I mean just keep in mind from a background standpoint that it takes time. It’s a change management event in the practice. It’s not just the veterinarians but the veterinarian tax receptionist, all practice has to change focus from into a new testing category or approach. So it takes time. We’ll share some insights at Investor Day in terms of what that looks like but there’s no one rule that fits all.

[Brian McKeon, Chief Financial Officer]

We’ve made very good progress and it’s supporting a high reference lab growth and we’re seeing benefits across the business. So it’s something that I will that will build over time and like many other things that we have in our business, there’s a very long runway for development, which bodes well for sustaining high growth for the long run.

[Jay Mazelsky, Interim President and Chief Executive Officer]

We have time for one more question.

[Operator]

That will be a follow-up from the line of Michael Ryskin with Bank of America. Your line is open.

[Michael Ryskin, Bank of America]

Hi, thanks for squeezing me for the follow-up. I just want to confirm something from the prepared remarks, I thought I heard you say that the third quarter organic guide was 10.5% to 12% for the total company. I recognize you’ve got the extra selling day and that should be a sizeable at 100 to 250 bps tailwind but that still, just trying to look at the comps from prior years. You still have a much tougher comp 3Q versus 4Q. So I was wondering if there was anything other than going on in pacing between third quarter and fourth quarter as you go through the year? And have also how you think about some of the you call it out the guide for the second quarter, all U.S. instrument placements may have been too aggressive, so just want to get a sense of how, the aggressive guidance in 2Q factor into third quarter and beyond?

[Brian McKeon, Chief Financial Officer]

Just on the third quarter, we talked about to restate, 9.5% to 10.5% overall organic and 10.5% to 12% recurring with the day-to-day and a half. I think that the day benefit is a little bit higher on the recurring fees, Mike, so it’s largely reflective of the year to-date trend adjusting for the days and we feel very good about our momentum and our ability to deliver that. So it’s not anything specific to Q3 timing other than the day change.

[Michael Ryskin, Bank of America]

Okay, got you. I think I heard you wrong on the overall number then.

[Brian McKeon, Chief Financial Officer]

And I would say on the instrument – look, we’re -- as you know we’ve got -- we’re always trying to build off of a high base and we are executing very well on driving EVI gains and expanding our Catalyst installed base and we think we’ve got our full-year impact of my back half outlook properly calibrated.

[Michael Ryskin, Bank of America]

Thanks.

[Jay Mazelsky, Interim President and Chief Executive Officer]

Okay, thank you, all, with that we’ll conclude the call. I want to thank our employees for the very strong progress and performance in Q2 and the advancement of our purpose, which is enhancing the health and well-being of pets, people of livestock around the world. I’m also – and also I’m grateful for the confidence that our investors have in IDEXX and our business model. We look forward to being able to share our work with investors and seeing all of you in person or through a Reg FD Presentation at our Investor Day in a couple of weeks. So thank you very much for calling in. Cynthia, that’s it.

[Operator]

Ladies and gentlemen, that does conclude your conference call for today. Thank you for your participation and for using AT&T, the Executive Teleconference Service. You may now disconnect.