IDEXX LABORATORIES INC quarterly report, Q2 FY2015

IDEXX Laboratories, Inc. — Q2 2015 Form 10-Q Summary

Business context and reporting period

Unaudited results cover the three and six months ended June 30, 2015, compared with the corresponding 2014 periods. IDEXX operates through Companion Animal Group (CAG), Water, Livestock, Poultry and Dairy (LPD), and Other segments. Effective January 1, 2015, the company completed its transition to an all-direct U.S. sales strategy for rapid assay kits and instrument consumables. Prior-period segment information was retrospectively reclassified for certain livestock testing services.

Financial performance and key metrics

Metric	Q2 2015	Q2 2014	Change
Total revenue	$413.3 million	$390.1 million	6.0%
Gross profit	$232.8 million	$218.5 million	6.5%
Gross margin	56.3%	56.0%	Up 30 bps
Operating income	$88.3 million	$83.2 million	6.1%
Operating margin	21.4%	21.3%	Up 10 bps
Net income attributable to IDEXX	$56.9 million	$57.2 million	Down 0.5%
Diluted EPS	$0.60	$0.55	9.1%
Interest expense	$7.3 million	$3.0 million	Up $4.3 million

For the six months ended June 30, 2015, revenue was $795.8 million versus $750.3 million, gross profit was $448.3 million versus $420.6 million, operating income was $161.1 million versus $153.3 million, and net income attributable to IDEXX was $103.5 million versus $103.8 million. Diluted EPS increased to $1.09 from $1.00. Six-month gross margin was 56.3% versus 56.1%, and operating margin was 20.2% versus 20.4%.

Revenue and segment developments

Q2 organic revenue growth was 12.0%, excluding currency and acquisitions; reported revenue growth was reduced by a 6.5% currency impact and increased by 0.5% from acquisitions.
CAG revenue increased 9.2% to $351.6 million, with 14.4% organic growth. Recurring diagnostic revenue, VetLab consumables, reference laboratory services, and Catalyst One instrument placements were key contributors.
Water revenue increased 2.3% to $25.1 million, with 8.4% organic growth. Gross margin increased to 71.9% from 65.8%, partly due to royalty expirations and lower product costs.
LPD revenue decreased 14.1% to $32.1 million and operating income decreased 45.1% to $5.9 million, primarily due to lower Asia-Pacific livestock testing volumes and reduced operating efficiencies.
Other revenue declined 25.6% to $4.6 million, mainly from lower pharmaceutical and OPTI Medical analyzer sales.
U.S. revenue increased 12.8%, while international reported revenue declined 3.4%; international organic growth was 11.1% after excluding currency and acquisitions.

Cash flow, liquidity, debt and capital allocation

Six-month operating cash flow was $65.5 million, down from $115.3 million. Higher accounts receivable and inventory uses reflected the all-direct U.S. model, new products, instrument demand, and slower collections.
Investing cash outflow was $227.6 million, including $190.4 million of marketable-security purchases and $46.9 million of capital expenditures. Management estimated approximately $100 million of total 2015 capital expenditures.
Financing cash flow was $3.3 million, including approximately $250.1 million of long-term debt issuance and $220.1 million of share repurchases.
Cash and cash equivalents were $163.2 million at June 30, 2015, compared with $322.5 million at December 31, 2014. Marketable securities were $180.9 million, resulting in total cash, cash equivalents and marketable securities of $344.0 million.
The company had $498.0 million outstanding under its $700 million revolving credit facility and approximately $201.0 million of remaining borrowing availability, before a $1.0 million letter-of-credit reduction.
Long-term debt was $598.9 million at June 30, 2015 versus $350.0 million at year-end 2014. The company issued $150 million of senior notes in February 2015 and approximately $100 million of euro-denominated notes in June 2015.
The company repurchased 3.1 million shares for $220.1 million during the first six months and authorized an additional 8 million shares for repurchase in June 2015. A two-for-one stock split was distributed June 15, 2015.
Management stated that cash, short-duration marketable securities, operating cash flow and committed borrowing capacity should fund operations, capital requirements and anticipated growth needs for at least the next twelve months.

Material changes versus the prior comparable period

Revenue and operating income increased, but net income was essentially flat because higher operating income was offset by substantially higher interest expense.
The strong U.S. revenue performance benefited from distributor-margin capture following the direct-sales transition. The transition also increased working-capital requirements and contributed to higher sales, marketing, general and administrative costs, accounts receivable and inventory.
Foreign-exchange movements reduced Q2 revenue by approximately $25.6 million and six-month revenue by approximately $46.9 million. Net currency effects reduced six-month operating income by approximately $12.0 million after hedging gains.
Operating cash flow declined by $49.8 million, while investing cash use increased by $206.2 million, primarily because of marketable-security purchases and higher capital investment.
Debt increased materially, while cash declined because of marketable-security purchases, share repurchases and capital expenditures.
The company adopted marketable-securities accounting policies during the period; the securities were high investment grade and no other-than-temporary impairment was identified.

Guidance, outlook, risks and unusual items

At the company’s then-current currency assumptions, management expected full-year 2015 currency changes to reduce revenue by approximately $86.0 million, operating profit by $17.9 million and diluted EPS by $0.13, net of anticipated hedging gains of $20.8 million of operating profit and $0.16 of EPS.
Management planned a broader Latin American Catalyst One launch in the third quarter of 2015 and a North American launch of cloud-based practice-management and digital-radiography software during the third quarter.
Approximately $3 million of Catalyst One-related deferred instrument revenue remained unrecognized at June 30, 2015 under an introductory customer program.
Key risks include continued U.S. dollar strengthening, competition and technological advances, the loss of former U.S. distributors and their promotion of competing products, economic weakness affecting veterinary and testing demand, working-capital requirements, market-value fluctuations in the investment portfolio, and execution of the all-direct sales model.
Legal proceedings were described as arising in the ordinary course of business; management did not expect currently pending matters to have a material effect, although outcomes cannot be predicted with certainty.
The company was in compliance with its debt covenants, including a maximum consolidated leverage ratio of 3.5-to-1, at June 30, 2015.
Disclosure controls and procedures were assessed as effective, and no material changes to internal control over financial reporting were reported.

Important facts for investors to verify

Whether recurring CAG growth and the all-direct U.S. model remain strong after the effects of distributor-margin capture and inventory normalization.
The sustainability of operating margins as sales, marketing, support costs, freight and working-capital needs increase.
Accounts-receivable collection trends, inventory turns and the cash-conversion impact of the direct-sales strategy.
Debt levels, interest expense, leverage-covenant headroom and remaining revolving-credit availability.
Actual foreign-exchange results versus the company’s stated 2015 currency assumptions and hedge effectiveness.
LPD volume recovery, competitive pressure on U.S. rapid-assay products, and performance of Catalyst One and planned cloud-based products.
The composition, liquidity and market-value sensitivity of the $180.9 million marketable-securities portfolio.
The timing and accounting treatment of deferred Catalyst One revenue and other customer loyalty-program arrangements.