IDEXX Laboratories, Inc. — Q2 2018 Form 10-Q Summary
Business context and reporting period
IDEXX develops diagnostic products, services and information-management solutions for companion-animal veterinary, livestock, poultry, dairy and water-testing markets, with a smaller human point-of-care diagnostics business. The filing covers the three and six months ended June 30, 2018; financial statements are unaudited and prepared under U.S. GAAP.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Change |
|---|---|---|---|
| Revenue | $580.8 million | $508.9 million | 14.1% |
| Gross profit | $332.4 million | $292.7 million | 13.6% |
| Gross margin | 57.2% | 57.5% | Down 30 bps |
| Operating income | $145.6 million | $122.6 million | 18.8% |
| Operating margin | 25.1% | 24.1% | Up 100 bps |
| Net income attributable to IDEXX | $108.7 million | $85.4 million | 27.4% |
| Diluted EPS | $1.23 | $0.95 | 29.5% |
| Metric | Six months 2018 | Six months 2017 | Change |
|---|---|---|---|
| Revenue | $1.118 billion | $971.0 million | 15.2% |
| Gross profit | $635.5 million | $550.9 million | 15.4% |
| Gross margin | 56.8% | 56.7% | Up 10 bps |
| Operating income | $258.6 million | $214.8 million | 20.4% |
| Operating margin | 23.1% | 22.1% | Up 100 bps |
| Net income attributable to IDEXX | $198.1 million | $154.4 million | 28.3% |
| Diluted EPS | $2.23 | $1.72 | 29.7% |
Q2 revenue growth was driven primarily by the Companion Animal Group (CAG), which represented $507.5 million of revenue and grew 15.4% reported and 13.4% organically. Water revenue increased 11.0% to $32.7 million, LPD increased 4.3% to $35.0 million, and Other revenue declined 6.7% to $5.6 million. CAG recurring revenue increased 15.1% to $437.7 million, including growth in consumables and reference laboratory services.
For the first half, operating cash flow was $153.7 million versus $141.5 million in the prior-year period. Investing activities provided $232.7 million, mainly because the company liquidated marketable securities; financing activities used $395.7 million, including $218.0 million of revolving-credit repayment and $189.9 million of open-market share repurchases. Cash and cash equivalents ended at $174.6 million, compared with $187.7 million at December 31, 2017.
At June 30, 2018, the company had $437.0 million outstanding under its revolving credit facility and $603.1 million of long-term debt. Remaining borrowing availability under the $850 million facility was $412.0 million, after consideration of a $1.0 million letter of credit. Gross debt was $1.043 billion, net debt was $868.9 million, and management reported gross debt to Adjusted EBITDA of 1.84x and net debt to Adjusted EBITDA of 1.53x, versus a 3.5x covenant limit. The company was in compliance with its financial covenant.
Material changes versus the prior comparable period
- Revenue growth reflected higher testing volumes, expansion of the CAG instrument installed base, increased reference-laboratory activity, price increases and favorable foreign exchange.
- Operating margin improved despite higher sales and marketing, general and administrative, and research and development spending, primarily due to operating leverage and revenue growth.
- Q2 gross margin declined modestly because of higher information-technology costs, increased reference-laboratory capacity investments, employee benefits and unfavorable instrument mix. First-half gross margin increased modestly.
- The effective tax rate declined to 20.9% in Q2 and 18.0% for the first half, compared with 25.5% and 22.5%, respectively, primarily because of the lower U.S. statutory tax rate under the 2017 Tax Act.
- The company adopted the new revenue standard on January 1, 2018 using the modified retrospective method. It increased reported Q2 revenue by approximately $14.9 million and first-half revenue by approximately $27.2 million, with corresponding effects on profit. The standard primarily accelerated recognition for instruments placed under customer incentive and volume-commitment programs.
- The new IDEXX 360 volume-commitment program increased upfront instrument placements and shifted activity away from instrument-rebate and reagent-rental programs. Management stated that the change affects timing rather than the overall economics of customer contracts.
- Marketable securities were liquidated following the 2017 Tax Act, resulting in an approximately $0.3 million loss and enabling repayment of revolving debt. The company does not expect material interest income for the remainder of 2018.
- Share repurchases totaled approximately $200.7 million, including employee share withholding, during the first half, versus $172.4 million in the prior-year period.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide a comprehensive full-year revenue or earnings guidance range. Management expects current cash, operating cash flow and available borrowing capacity to fund operations, capital expenditures and anticipated growth for the next twelve months and foreseeable future.
Management cited continued demand for diagnostic technologies, increased reference-laboratory testing, growth in consumables and expansion of the installed instrument base. The filing estimates that, under its currency assumptions, foreign exchange would increase 2018 revenue by approximately $9 million, operating profit by approximately $1 million and diluted EPS by approximately $0.01. A 1% strengthening of the U.S. dollar was projected to reduce revenue by approximately $4 million and operating income by approximately $2 million for the remainder of 2018.
Key risks include foreign-currency volatility; dependence on sole- and single-source suppliers; supply-chain interruptions, tariffs and regulatory changes; data-privacy and cybersecurity compliance, including GDPR; competition and product demand; execution of customer incentive programs; litigation and intellectual-property claims; and estimates of rebates, future customer purchases and contract assets. The company reported no material litigation accruals, no material acquisitions in the first half of 2018 and no off-balance-sheet arrangements other than letters of credit and third-party guarantees.
The company expects adoption of the new leasing standard to increase reported assets and liabilities for operating leases. It does not expect the standard to have a material overall impact on financial statements, although certain reagent-rental placements may require earlier instrument revenue and cost recognition.
Most important facts for an investor to verify
- Reconcile reported growth with organic growth and isolate the effect of the new revenue standard, foreign exchange and customer-program timing.
- Assess the sustainability of CAG recurring revenue growth, particularly consumables, reference laboratories and instrument placements.
- Monitor gross-margin pressure from information technology, laboratory-capacity investments, employee costs and instrument mix.
- Review liquidity after substantial share repurchases and debt repayment, including the $437.0 million revolving-credit balance and covenant compliance.
- Evaluate the realizability and timing of customer acquisition costs, contract assets and deferred revenue arising from multi-year customer programs.
- Track foreign-exchange sensitivity, hedging results and the effect of a stronger U.S. dollar on 2018 results.
- Review supplier concentration, cybersecurity and privacy exposure, including GDPR compliance and reliance on third-party cloud providers.