愛德士 (IDXX) 2006 Q2 法說會逐字稿

Good day, everyone, and welcome to the IDEXX Laboratories second quarter 2006 earnings conference call. Just a reminder, today's conference is being recorded. Participating in the call this morning call are John Ayers, Chief Executive Officer; Merilee Raines, Chief Financial Officer; and Ed Garber, 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's 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 and the timing of new product introductions.

Listeners are reminded that the actual results could differ materially from management's expectations. Factors that could cause or contribute to such differences are described in IDEXX's quarterly report on Form 10-Q for the quarter ended March 31st, 2006 and annual report on Form 10-K for the year ended December 31st, 2005, which are on file with the SEC and also available on IDEXX's website, idexx.com. 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 the estimates or expectations change.

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

Thanks, Evelyn. Well, welcome and thank you for joining us today. I'll start with a discussion of our second quarter financial results and outlook for the second half, and John Ayers will follow with some comments on our business. We will then welcome your questions.

As our earnings release from earlier this morning indicates, we had a very strong second quarter and first half results. Our second quarter revenues of $191.4 million and diluted earnings per share of $0.78 mark year-to-year growth on a reported basis of 19% and 32%, respectively.

Earnings per share in the second quarter of 2006 contained $0.04 of favorability, primarily related to the attainment of certain international tax incentives that were discrete in nature. Earnings per share growth adjusted for acquisition integration costs in 2005, the aforementioned tax item in 2006 and the impact of share based compensation in 2006 grew 37% year-to-year.

Performance for the second quarter exceeded our internal expectations. Also, I would note that our expectations regarding what the second quarter would contribute to the year's revenues and earnings have been somewhat higher than the Street consensus. Therefore, from an internal perspective, we would not view all of the upside to the Street numbers as the basis for determining our upwardly revised guidance.

Based on second quarter performance and our outlook, we are increasing our guidance for the full year 2006 to revenues of $730 to $734 million, up from $704 to $712 million, and earnings per share of $2.64 to $2.70, up from $2.44 to $2.52. These new ranges would produce reported growth of 14 to 15% for revenues and 15 to 17% for earnings per share.

Earnings per share growth adjusted for 2005 and 2006 discrete items and projected 2006 equity compensation expense would be 21 to 23%. This increase in our guidance reflects the strong first half performance and continued topline year-to-year growth in the second half consistent with the first half. We expect second half gross margins as a percentage of revenue to be about on par with first half margins, and operating expenses to increase slightly as a percentage of revenues. I will discuss these points further as we walk down the P&L.

Let me first remind you that our earnings press release contains a table showing product line revenues and revenue growth rates adjusted for currency and acquisitions completed in the last 12 months, and a table reconciling reported gross profit, operating income, and earnings per share for 2005 and 2006 to the corresponding measures adjusted for certain discrete items in both years, and for share based compensation expense in 2006. These tables, which we have recently incorporated in our earnings press release, are intended to be helpful to you in understanding year-to-year growth rates, adjusting for these specific items.

Now let me give you some details on the P&L. As mentioned, revenues of $191.4 million grew 19% year-to-year on a reported basis. Currency was neutral in the second quarter and acquisitions contributed 2%. So organic growth -- that is, growth adjusted for these two factors were 17%.

Our Companion Animal Group with revenues of $156.9 million had the same reported and organic growth rates as the total company, 19% and 17% respectively. Looking at the Companion Animal Group product and service categories, instruments, consumables, and related services and accessories grew 15% on a constant currency basis. Instrument revenues of $12.6 million grew 20% on a constant currency basis.

Our IDEXX VetStat Electrolyte Analyzer, launched in the third quarter of last year, was a key contributor to placement growth overall. And as expected, we saw a pickup in instrument unit placements after a relatively softer first quarter.

For the first half, total unit placements grew by 15% over the first half of 2005. Though the size of the proprietary consumable revenue stream varied by instrument, we are seeing increasing evidence that placements of each component of our IDEXX VetLab suite contribute to placements of other instruments in the suite and to increase retention of instruments already owned by our customers. Instrument consumable sales of $43.2 million in the second quarter of 2006 had a currency adjusted growth of 13%, or 12% after adjusting further for year-to-year changes and distributor inventory.

Growth for the first half, adjusted for currency and distributor inventory changes, was 11%. While this growth is strong and reflective of our sustained focus on instrument placements and enhanced functionality, we are at this time sticking with our longer term growth rate guidance of 7 to 9% for instrument consumables as we monitor net new placements of instruments and the ramp in utilization of consumables from new placements.

Point-of-care rapid assay products, with revenues of $32.6 million, grew 19% on a constant currency basis. Relative changes in distributor inventories year-to-year had a 5% favorable impact on rapid assay products growth, so the adjusted growth for rapid assays was 14% in the second quarter and 15% for the first half.

As mentioned during our first quarter call, this very strong performance was attributable to greater sales force effectiveness in converting customers from heartworm-only testing to SNAP 3Dx, our three-way parasite disease screen for dogs and strong price realization in our canine line as a result of some adjustments to our promotional program.

Though we expect the growth rate for the canine line will decline somewhat in ensuing quarters as we run up against tougher compares, we feel confident at this time to raise the longer term growth rate projection for rapid assays to 7 to 9% from 6 to 8%. This is a good time to note that we ended the quarter with just under three weeks of inventory at our US distributors based on forward-looking demand. This is just slightly below the three to four-week range where we have been operating for quite some time now.

Laboratory and consulting services second quarter revenues of $47.8 million grew by 15%, adjusted for both currency and acquisitions. Organic growth for the first half was also in the mid teens. This growth is the manifestation of efforts on multiple fronts, including, to mention a few, successful integrations of newly acquired labs, continued focus on quality and service enhancements and expansion of the geographic coverage in the countries we serve around the world. Based on the performance of this business over the last few quarters and on our outlook, we are revising upward our longer term growth projections for laboratories and consulting services to 12 to 14% from our previous thinking of 10 to 12%.

Our computer systems and digital radiography product line posted revenues of $10.8 million, an increase of 50% year-to-year, or 30% when adjusted for currency and the third quarter 2005 acquisition of our direct digital imaging product line. We launched our Companion Animal direct digital imaging system in the latter part of the second quarter as we had expected, and recorded our first sales of this system in the quarter.

Water sales of $15.1 million for the quarter rebounded some from the first quarter, an expectation we indicated in the first quarter call, and grew 5% adjusted for currency. As we stated last quarter, we project the longer term growth in water to be in the low to mid single digits.

The Food Diagnostics segment sales were $19.4 million, a year-to-year organic growth of 29% for the quarter and 25% for the first half. Our production animal product line continues to exhibit very strong performance with year-to-year organic growth of 34% for the first half.

Our BSE and scrapie test kit is gaining increasing market acceptance with its enhancements to ease of use and inefficiency, and we now project BSE revenues for 2006 to be $10 to $12 million, up from our previous thinking of $8 to $10 million. Several other production animal products also demonstrated strong growth. Our new revenue projection for full year 2006 of $730 to $734 million represents year-to-year reported growth of 14 to 15% with completed acquisitions projected to add 1 to 2% to growth and currency projected to be essentially neutral.

Looking at the rest of the P&L, gross margin at 52% of revenues was essentially in line with our thinking. We expect second half margins to be roughly on par with to slightly above first half margins of 51.5% of revenues. There will be some variability by quarter as a result of seasonal revenue mix.

We continue to expect improvements in gross margin beyond 2006 with the fundamental drivers being improving margins on instrument consumables in accordance with pricing under supply contracts, efficiencies in our manufacturing processes, lower cost to provide after sales service for our IDEXX VetLab instruments, and improving margins in our lab services due to volume leverage and efficiency.

Operating expenses, including R&D and SG&A, were 32% of revenues. Though right about in line with our expectations in dollar terms, these expenses were a couple of points below the projected 34 to 34.5% of revenue due to the strong revenue performance. For the first half of 2006, these expenses grew by 19% year-to-year and we are continuing to make investments, primarily in R&D and sales and marketing that will drive long-term growth. We expect operating expenses will increase somewhat in the second half, and expect full year expenses to be 34 to 35% of revenues.

The operating margins for the quarter of $37 million or 19% of revenues was stronger than our internal projections, the result of higher revenues and relative to revenue, lower operating expense growth. We expect operating margins to decline 100 basis points or so as a percentage of revenue in the second half of the year from the first half, commensurate with our investments in R&D and sales and marketing and to be 17 to 17.5% of revenues for the full year.

Just a word on taxes and interest income. The favorability we achieved in taxes in the second quarter has caused us to revise down our rate projection for the year to 32 to 33% from 33 to 34%. Net interest income for the year should be approximately $2 million. Earnings per share for the first half of 2006 of $1.33 grew by 21% on a reported basis and 26% when adjusted for the impacts of discrete items we have discussed in both 2005 and 2006, and the impact of share based compensation in 2006.

The revised earnings per share guidance that we have given today of $2.64 to $2.70 would produce a year-to-year reported growth of 15 to 17% or 21 to 23% when adjusted for the anticipated impact of FAS 123R for 2006 and the discrete items of acquisition integration costs and dividend repatriation totaling $0.08 in 2005, and favorability associated with tax incentives of $0.04 in 2006. As mentioned upfront, this 20% plus growth reflects a very strong performance in the first half and continued strong performance in the second half, tempered somewhat by a step up investments in key areas.

As we look out over the longer term, we still look for EPS growth in the mid-teens. We serve attractive markets with favorable trends, and we believe there are opportunities for continued investments to enhance our position in these markets and to drive sustained, double-digit, topline growth.

Moving now to the balance sheet and cash flow, we ended the quarter with cash and investments of $77 million. Cash provided by operations was $48 million, and we used $8 million to purchase equipment, and $11 million to purchase our headquarters facility and surrounding land in Maine. The cash consumed for the facility purchase reflects the purchase price of $19 million, net of the assumption of $8 million of debt.

As we stated last quarter, under FAS 123R, a portion of the tax benefit from option exercises is now shown in financing activities in the cash flow statement. This amount was $1 million in the second quarter, so free cash flow, as we have historically calculated it, was a $30 million, or 117%, of net income for the second quarter. Year-to-date, free cash flow is $24 million, or 56% of net income. And we project free cash flow for the year to be about 70% of net income.

As we have previously stated, this is lower than recent history due to our projected higher capital expenditures, most notably the purchase of our main facility. I should note that we also used $8 million in the quarter for the purchases of some intangibles and businesses. The most significant expenditure was for the purchase of intellectual property and distribution rights from an Australia-based diagnostics company, primarily related to our rapid assay product line.

For the balance of the year, we project DSO at approximately 40 days and inventories at $85 to $90 million. We project full year capital expenditures to be $60 to $65 million. And now, to John.

Okay. Thank you, Merilee. Obviously, a strong quarter. As we indicated in our Q1 call, we're pleased with the fundamentals of our business. In Q2, we had the strength in the topline of the Companion Animal Group, while our production animals services business had unusual -- unusually strong and broad-based growth. Finally, we didn't have any weak areas in the portfolio.

As a result of strong top line growth, our bottom-line results were even stronger, as Merilee has discussed. We were able to achieve these bottomline results, even as we expanded our investments in the business to support our longer term financial targets of 10% plus topline growth and mid-teens earnings per share growth. While the business is very strong in Q2, I'd like to suggest our performance for the first half of the year, considering the first two quarters together, as being more indicative of where we see the business at this point.

As indicated in the press release we had 15% topline growth in the first half, or 16% adjusted for currency. That 16% was composed of 14% organic growth and 2 from tuck-in acquisitions. Reported earnings per share growth for the first half was 21%, and after the non-GAAP adjustments mentioned in the press release, including share based compensation, tax items and last year's acquisition integration costs, EPS growth for the first half of the year was 26%.

I'd mentioned a couple of IDEXX Q2 items before we turn it over to Q&A. First, we were very pleased to announce last week that our main manufacturing R&D and headquarters facility received ISO 9001, 2000 certification in July. Those are the milestones in our multi year focus on quality and with that higher customer satisfaction and lower costs. ISO 9001 designation is appreciated particularly by our international customers, including those in our water and production animal services products.

A large number of IDEXX employees worked hard for this result and I want to take this opportunity to thank and congratulate them. Our efforts and focus on continuous improvement in quality and operational excellence are by no means finished and as I indicated in our earnings announcement, we have much work to do to see the full benefits in the P&L of our efforts. In the new product area, we launched, as expected, our direct digital radiography systems for the small animal market to rave reviews. There's no question regarding the extraordinary image quality of our 14-by-17 inch DR plate.

We look forward to an exciting future in this business as we help transform the industry over the next several years from film to digital radiography. Third, we commenced the limited launch of our next generation canine rapid assay tests, the SNAP 4Dx. We expect full lunch of this product in September as we begin the new program season. Customer feedback has been extremely positive. In particular, the veterinary practitioner is gaining a much better appreciation of the dangers of co-infection by a multiple tick-borne diseases. And 4DX now screens for additional infectious agent that's present in the canine population.

Forward in the pharmaceutical business, we've now determined that we will not move forward and seek FDA approval on our current new animal drug application for Tilmycosin. And as a result we're probably several years away from a new product in this area. However, we continue to be excited about our use of our proprietary fatty-acid salt technology to deliver actives, including antibiotics, and a single-dose formulation.

We remain committed to our pharmaceutical business, in part, because the existing portfolio of products on the market are doing well, growing and essentially covering the businesses' costs. And, in part, because the long-term outlook for our technologies, including fatty acid salt.

I mentioned the potential for impairment of the pharmaceuticals goodwill in my last call. To update investors, we tested for impairment with our new outlook and determined that there is none based on the long-term opportunity we see in IDEXX Pharmaceuticals.

Finally, our production animal services business deserves special mention due to its 34% year-over-year organic growth in the first half of 2006. And that would be adjusted for currency. Our HerdChek BSE-Scrapie product is being well received in Europe. However, we see strength across the core lines. The broad strength in this business is akin to the old maxim, luck is where preparedness meets opportunity.

We have the right products and the right people in the right global markets to take care of customer needs. To sum up, this has been a very good time for IDEXX markets around the world. In companion animal health, the practicing veterinarian is more and more appreciating the importance the diagnostics as a key element of good medicine. Diagnostic work also creates attractive, high-margin revenue for the veterinarians at a time when revenues and margins from other services such as vaccinations are stagnant.

However, IDEXX has much work ahead of us to fulfill our key strategies and to see the full potential of our unique and extraordinary business model. And our employees remain dedicated to that task.

So, Evelyn, at this point, I'd like to open it up for investor Q&A.

Thanks, Mr. Ayers. [OPERATOR INSTRUCTIONS] We'll first go to Rick Wise, Bear Stearns.

Yes, hi. Good morning. This is Danielle [Intalsi] for Rick Wise. Just a question on first, you talked about strength in market, strong market fundamental. I was wondering if you could give more color on where that strength is coming from, i.e., is it emerging markets, internationally or anything like that?

Yes, Danielle. Thanks for that question. It's all over. It's in North America. It's in Europe. It's in the developed economies of Asia. We even have a joint venture in China, really more focused on the production animal service line of business. So I couldn't call out any one particular region as fundamentally different than the others.

Okay. Great. And another follow-up question on your R&D. I was wondering if you could provide a product pipeline update, maybe going out for the rest of '06.

On R&D, we have got really a lot of different products. And it's a steady stream. Usually, not any one of them are big and material individually. I did mention the SNAP 4Dx. We're on track for that full launch in September. But the rest of the products are really just very small ones which really add to the fundamentals of the product line.

Okay. Great. And then finally, if I could, one housekeeping question. Your shares are trending lower. I was wondering if you could give any guidance for share count?

Okay. Danielle, I think you can -- in terms of looking for the total year, you can probably assume that the weighted average share count is going to be about where it was in the second quarter. When we look at total count for the year, we'll decline a little bit in the next couple of quarters. But total year should be about on par.

Okay, great. Thanks so much.

[OPERATOR INSTRUCTIONS] We'll next move to Ryan Daniels, William Blair.

Yes, good morning, guys and congratulations on a great quarter.

Thank you, Ryan.

Thank you, Ryan.

A quick question. It seems like over the last four or five quarters, you guys have pretty consistently looked at one of your business lines within the companion animal group and taken up the long-term guidance this quarter, both the lab and rapid assay. So I guess a little bit of a follow on to the last question is, is there anything in particular that you would pinpoint really driving the strength across all of your products in the CAG business?

Well, Ryan, it's really -- it's a phenomenon that I think the whole industry in the profession is seeing. The most -- the vast majority of our products are diagnostic-related and provide medical or in some cases business information to the veterinarian. And I think that's just a good growth area to be in. And we're supporting that growth and trying to take advantage of it as best as we can by having the right technologies and introducing new diagnostic technologies.

No single one is a blockbuster in our business, but sum total of it. The further introduction of new technologies along with the veterinarians' appreciation for the important that diagnostics can play in the medical practice. It's just a good place to be right now. And so we see that in the companion animal business.

Okay. That's helpful. And then do you have any thoughts on kind of if we look longer term, since you've made all these upward revisions with the total top-line growth that the organization may look like? I assume it might be a little more favorable than what you've alluded to in the past.

Well, the future is uncertain. We think it's a strong fundamentals. We've given our revenue guidance for the second half of the year, which I think is in a 14% to 15% range. Our longer-term targets are 10% plus.

Okay.

And we're pretty confident with that number. And that's the best we can see at this point in time.

Okay. Fair enough. And then, John, it seems like in your prepared comments, you alluded to the fact that instrument placements are begetting more instrument placements. Is that a change from in the past, i.e., or are your products getting better and are you becoming a more of a provider of choice, which is driving volume or anything different or is that just more akin to macro trends that you're using -- that people are using more and more diagnostics and as a leader you're just seeing more of that volume?

Well, it is part of a long-term strategy that we've had that every quarter, we add another element to it. And that is that our instruments work together well as a suite, as a system. And we integrate them and -- in a way that provides the best and most timely kind of information with added analytical capabilities, laboratory information management system to the suite that's more powerful. And we're continuing to upgrade that.

Our instrument quality is improving and the breadth of the menu are improving. And just what we're seeing is that as we add more value to the suite, which could be an instrument, a software update, a new menu item or quality improvement, the suite itself becomes more valuable. Any one addition adds value to the whole suite. And that is core to our instrumentation strategy.

Sure. Okay. Then two more quick ones and I'll hop off. Can you talk a little bit about the roll off -- rollout of 4Dx, would you anticipate that will follow the trajectory to 3Dx in the switchovers you saw there from your traditional product or might this be a slower rollout?

It is -- 4D will not replace 3Dx. 4Dx will be provided in addition of 3Dx. Nothing in the veterinary profession happens very fast. It takes a while for adoption of new technologies. But I will say that in areas of the country where the bug that is new 4Dx versus 3Dx is of concern to the veterinary profession, it's being received a very, very positively.

Now that's regional, there are certain regions, Northeast, upper Midwest where that is of concern. And the other factor is people are realizing, look, you may have two different infections going on and when you have two different infections going on that's of greater concern than one. It's not a good thing, and it requires more attention. And when you test for it and you find it, then you decide that maybe you want to do more screening to make sure that you're finding it.

Okay. Great. And then last question, when you mentioned your luck being prepared when you see the opportunities, is that hinting at something finally picking up a little bit in China? I know that's a huge market, and you guys have been waiting for some momentum there. Has something turn the corner there were you're starting to work in the production segment a little more?

Great question. And the answer is, not yet. I mean, China is -- we still think China is ahead of us, we did move to 95% ownership of our joint venture in China in the second quarter, it was sort of a long standing strategy, so we're very, very well positioned in China, both with on the ground presence and first mover advantage in broad product line. But China is still a very small piece to the puzzle. Today, we think it's something -- there is lot of -- there's something like 6 billion chickens and 40 million pigs in China. So there is a lot of opportunity we think ahead of us in China.

Sure. Big market. Okay. Thanks, guys.

And we'll take our final question from Lee Brown with Merrill Lynch.

Hey, congratulations John, Merilee, Ed and rest of the team. What an impressive quarter here. The stock's reacting very nicely. I'm sorry if I missed some of these things - I've been hopping around reporting, but did you give unit growth for instrument placements?

We did for the first half of the year. And for the first half, the total unit placements grew by 15%.

Okay. Great. And then in terms of consumable growth, did you provide that number as well? And again I apologize if you provided this.

Yes. The growth for the first half of the year for consumables, adjusted for currency and distributor inventory changes was 11%. It was 12% fully adjusted for the second quarter, and 11% for the first half.

Okay. And did inventory adjustment have a meaningful impact in the quarter?

They really did not have much of an impact on the consumables piece.

Okay. And then moving on to your rapid assay products, which had a nice quarter relative to our estimates, but what's driving that?

Well, I think we had a -- we did a particularly good job in the first half of 2006. With a combination of converting customers to 4D -- to 3Dx and in some cases 4Dx with the limited launch, but it was really 3Dx. And at the same time doing so without the need for promotional -- same promotional discounts. And so it was an impressive performance, which translated into pretty strong revenue growth.

The bottom line there is you're not needing to provide discounts to get the market growing. Is that -- that's a bottom line?

Yes. Not to the same degree that we had previously.

Okay. And then just moving to the P&L. The SG&A numbers pretty impressive there in terms of cost controls. Did you talk about that being a normalized sort of run rate going forward, or what do you expect for full year in terms of that line item?

Lee, I think that -- it really wasn't so much an issue of cost control. We have ramped up our spending in both R&D and SG&A. It's just that the revenue growth was so impressive this quarter that as a percentage of revenue these expenses came in lower than what we projected in dollar terms. We're right about on -- actually with our thinking.

We do expect that those investments, we're going continue to make investments in those areas and we see them going up in the second half of the year and for the total year being about 34% to 35% of revenues.

Sure. I'm fully on board with them. I mean I think you were only about $400,000 off on a 48.7 million number relative to my estimate, but to your point it was about 170 bps below expectation because of the strong revenue growth and given your stronger sales outlook, we can expect greater P&L leverage coming through the SG&A. Is that appropriate?

That's not how we see it in our projections.

Okay. We can talk offline on that. I will try to get better feel for where I should use those P&L lines items. And just one last question. Thank you so much for your time. An update on Banfield and how that's working out for you guys?

Well, Banfield is a great customer for us. We continue to fill out their large number of hospitals with our instrumentation. We still need to complete that and we'll probably take the rest of the year to do so. And we're also working closely with them with regard to protocols, which will help drive the utilization of those instruments and thus our consumables.

Okay, guys. You beat me by $0.11. My hat's off to you. Congratulations, thank you for your time.

Thank you, Lee.

And that is all the questions we have today. Mr. Ayers, I'd like to turn the conference back to you for any additional or closing remarks.

No, I think that's it. I just want to, again, take this opportunity to thank all our employees for their hard work and it's nice to see it in the results. And we have -- we still have much ahead of us. So we'll update investors at the next conference call in the third quarter. Thank you again for joining us.

And that does conclude today's teleconference. I'd also like thank everyone for their participation. You may now disconnect.