IDEXX Laboratories Inc's CEO Discusses Q4 2013 Results - Earnings Call Transcript

| About: IDEXX Laboratories, (IDXX)
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IDEXX Laboratories Inc (NASDAQ:IDXX) Q4 2013 IDEXX Laboratories Inc Earnings Conference Call February 3, 2014 10:30 PM ET


Jon Ayers – CEO

Brian McKeon – EVP & CFO


Ryan Daniels – William Blair & Company

Erin Wilson – BofA Merrill Lynch

David Clair – Piper Jaffray & Co.

Ross Taylor – CL King & Associates

Jon Block – Stifel Nicolaus

Nicholas Jansen - Raymond James & Associates

Ben Haynor – Feltl and Company

Mark Masaru – Canaccord Genuity


Good morning, everyone, and welcome to the IDEXX Laboratories Fourth Quarter 2013 Earnings Conference Call. As a reminder, today's conference is being recorded. Participating in the call this morning are Jon Ayers, Chief Executive Officer, Brian McKeon, 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 management may make on this call regarding IDEXX's future expectations, plans, and prospects constitute forward-looking statements for purposes of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by the use of words such as expects, may, anticipates, intends, would, will, plans, believes, estimates, should, and similar words and expressions.

Such statements include but are not limited to, statements regarding management's expectations for financial results for future periods. Investors should be aware that any forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the Company's filings with the Securities and Exchange Commission.

Please refer to these filings for a more detailed discussion of forward-looking statements, and the risks and uncertainties of such statements. All forward-looking statements are made as of today, and as except as required by law, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Also 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 can be found on our website,

Finally, we plan to end today's call by 9:30 a.m. Eastern. In order 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, please feel free to get back into the queue and if time permits we'll be more than happy to take your additional questions.

I would now like to turn the conference over to Jon Ayers. Please go ahead.

Jon Ayers

Okay, thank you, Bonnie. I'm very pleased to have our new Executive Vice President and Chief Financial Officer, Brian McKeon on the call. We also have Ed Garber, our Director of Investor Relations. I'm going to turn the call over to Brian to take you through our financial performance and our guidance, and then I'll come back with some color commentary.

Brian McKeon

Thanks Jon, good morning, everyone, and thanks for joining us today on our call. I'm thrilled to be joining the IDEXX management team, and very pleased to take you through the solid progress achieved by the Company in Q4 in 2013.

In terms of financial highlights, the Company achieved 10.6% organic revenue growth in the fourth quarter, supported by strong revenue growth in all our Companion Animal Group product areas, including accelerated growth in instrument placements. Normalized organic growth for CAG Q4 recurring diagnostic revenue, or organic revenue that's associated with instrument consumables and service, rapid assay test kits, and lab services, adjusted for acquisitions, foreign-exchange, and distributor inventory changes, increased 11% year-over-year. This reflects a gain of 10% in North America, 13% in Europe, and 19% in Asia-Pacific.

Overall, the Company achieved nearly $1.4 billion where the full year, with CAG recurring diagnostic revenues reaching nearly $1 billion 2013. This expands a powerful flywheel for our business that drives cash flow and value creation.

Strong revenue growth supported delivery of fully diluted EPS of $0.82 in Q4, and $3.48 for 2013 at the high-end of our full-year guidance range. EPS growth for the full-year 2013 was 12%, adjusting for currency, which had a $0.10 negative impact, and the impact of onetime factors. Overall, the Company finished the year with strong momentum, and we're well positioned to deliver our goals for improved growth and strong profit and cash flow performance in 2014.

Today, we're reinforcing our goals for improved organic growth in 2014. We're also reaffirming our 2014 revenue and EPS outlook, offsetting some headwinds from changes in currency rates, with an improved outlook for business performance.

As we provide guidance today, we'd like to highlight a change in our approach. Given that the recurring revenue from diagnostic products and services within our Companion Animal segment is the key driver of our economic model, and the steps we've taken to integrate our go-to-market approach across modalities to support veterinary care and customer development, we'll provide an outlook for overall growth in this revenue category.

Our goal is to partner with customers to grow diagnostic recurring revenue, regardless of modality. So while we'll continue to provide historical detail on revenue growth within VetLab consumables, rapid assay, and reference labs, we'll provide more directional information on the outlook for growth in these sub categories going forward. We think this approach better aligns with how we're leveraging the strengths of our business, as illustrated by the IDEXX diagnostic advantage and our revolving approach to market development.

Before we review performance outlook, let's start with observations on the economic environment in our segment. For a number of years now, we've shared what we see in the US veterinary market based on data from approximately 700 of our Cornerstone customers. As we've expanded connectivity with veterinary practices, we now have data from over 4,000 practices in the US, including non-cornerstone customers that we can include in our analysis.

Looking back, we can see that there's been a strong correlation between the two data sets over the last four years. Overall, practice level data shows continued moderate growth. Based on the broader data set, compared to prior year, patient visits for Q4 were up 1.9%, and practice revenues grew 5.2%.

For the full year, patient visits were up 2.1% versus 2012, and practice revenues were up 5.5%. For reference, the data for the full-year from the 700 customers of our previous reporting shows patient visits up 1.3%, and practice revenue up 4.8%.

While practice growth appears steady, the growth guidance we'll share today continues to reflect a cautious outlook on the economy, given uncertainty both domestically and abroad. In this context, IDEXX delivered total fourth quarter revenues of $354 million, reflecting organic revenue growth of 10.6% versus Q4 2012, supported by strong growth across all CAG revenue areas. Overall Companion Animal growth was 12% for the quarter.

CAG diagnostic recurring revenue grew 11% normalized Q4, and nearly 10% for the full-year. As noted, this revenue category showed solid gains across all major regions in Q4.

The VetLab instruments revenue of $28 million grew 15% organically in the quarter. This turnaround in growth from the double-digit declines we saw in the previous three quarters was in part due to an easing compare against the prior-year period, when the Catalyst Dx reagent program was first offered in North America.

Adjusting for this, worldwide instrument revenues grew 8%, fueled by an increase in placements of our highest value instruments, Catalyst Dx and ProCyte Dx, which both grew in the double digits in the quarter. We're very pleased with these results and the underlying increase in the effectiveness of our global commercial organization, which Jon will discuss further.

Worldwide chemistry unit placements in Q4 declined 14% year-over-year, mostly due to lower year-over-year VetTest placements in Europe and Asia. Regions that saw very strong VetTest placements in Q4 2012.

Importantly, worldwide Catalyst Dx placements grew 10% for the quarter. And the quality of replacements was very high, with almost 50% going to customers new to IDEXX, our highest quarterly unit performance for this metric on record.

For the full-year, we placed 2,400 Catalyst units worldwide. For the year, total chemistry unit placements declined 4%, impacted by VetTest lapping. Very close to last quarter's guidance of a decline in the low single digits.

Our worldwide hematology placements in Q4 increased 12% year-over-year, driven by record ProCyte Dx placements, including strong growth in all major regions. Similar to Catalyst Dx, we had our highest quality number of placements to customers new to IDEXX. Though with 40%, a little bit below the 45% we saw in Q3, as placements of trade up units were also quite strong. For the full-year, hematology placements to declined 3%, consistent with guidance.

Going forward, we'll be providing guidance for total Catalyst placements instead of total chemistry replacements. Catalyst drives most of our chemistry consumable revenues, and will be the focus of our growth plan. While we'll certainly continue to place VetTest instruments, they'll mostly be installed at smaller clinics in developing countries and have less of an impact on overall consumable growth.

For 2014, we expect Catalyst placement growth to be the range of 10% to 15%. This includes the impact of Catalyst One, which we plan to start shipping to customers in North America in the fourth quarter.

As noted in our recent press release, we'll begin taking orders for the Catalyst One instrument in Q1 of this year. We'll ship a Catalyst Dx to those customers who purchased Catalyst One to use until a Catalyst One is available. While we'll recognize the benefits from higher consumable sales when new loan instruments are in place, we won't recognize capital revenue in Catalyst One until the Catalyst One swap occurs, which we anticipate to happen throughout 2015.

This will result in an estimated $5 million to $10 million in deferred instrument revenue in 2014. This anticipated revenue deferral was included in the revenue guidance we provided in our October conference call. As we'll explain later, what this means, is that our growth outlook for 2014 is stronger than it appears, reflecting the positive momentum we're driving on the chemistry front.

We're also very pleased with the momentum we're seeing in hematology, where we have a clear technology advantage. For total hematology instrument placements, we also expect 2014 growth to be in the range of 10% to 15%.

The progress we've made in developing our instrument base continues to support strong growth in revenues for the instrument consumables portion of diagnostic recurring revenues. Instrument consumable revenues of $82 million in Q4 grew organically 13% versus the prior-year period, or 14% when normalized for changes in US distributor inventory levels. This brings our normalized consumable growth for the full-year to 14% at the high end of the guidance provided last quarter.

Growth continues to be driven by a number of factors, including the quality of replacements, our increasing installed base, increased testing as current IDEXX customers upgrade their in-house labs with Catalyst and ProCyte, and enhanced loyalty from our base of Catalyst customers who now account for about 85% of our US chemistry consumable revenue, exclusive of corporate accounts.

In 2013, our full-year growth rate also benefited by about 2% from higher-price due to our go-direct strategy in Scandinavia, and changes in our sales channels in the US. So net, the underlying instrument consumable growth rate was about 12% this year. For 2014, we're expecting continued strong instruments consumable gains in a similar range, supported by our accelerated instrument placement plan.

We're also seeing solid momentum in our rapid assay modality. Our fourth quarter rapid assay revenues of $36 million grew 9% organically versus the prior-year period, or 10% further when further normalized for changes in distributor inventory levels. For the year, rapid assay revenues grew 5%, both organically and normalized, which was at the high-end of our expectations for 4% to 5% growth.

Our expectation for 2014 is to sustain the solid momentum, and to add growth from sales of our new SNAP Pro instrument, expected to begin shipping in March. US distributor inventories for instrument consumables and rapid assays averaged 4.3 weeks at the end of the fourth quarter, based on forward-looking demand, which is within their normal and customary range.

Our Reference Laboratory and consulting services modality with revenues of $107 million grew 11% organically in the fourth quarter, including an estimated 1% of benefit from lapping the impacts of Hurricane Sandy.

We saw higher lab volume growth across each of our major geographies. In North America, we continued to benefit from the new diagnostic sales force model, and increasing customer utilization of VetConnect PLUS, which improves customer retention. Jon will be adding some additional color on this later in the call.

For the full-year, Reference Laboratory and consulting services grew 9% organically, which was at the high-end of our guidance. Our expectation for 2014, is to see organic growth rates in a similar range for labs and consulting services, as we continue to leverage our differentiated offering and the IDEXX diagnostic advantage.

Our practice management and digital imaging systems business, with revenues of $27 million in Q4, grew organically by 16% in the quarter to yield full-year growth of 6%, consistent with our full-year expectations. The fourth quarter organic growth was fueled by strong digital imaging system orders and placements, the continued to ramp in Pet Health Network Pro, which achieved over 1,100 customer sign-ups by the end of the year, and higher sales of Cornerstone systems.

All these areas benefited from improved sales capacity effectiveness, coupled with products and services that are well positioned in the market. We're entering 2014 with a healthy backlog and good commercial momentum, and we're projecting 15% plus organic growth next year for practice management and digital information imaging systems.

Our Livestock, Poultry, and Dairy business revenue grew 4% organically in Q4 to $32 million. In addition, our acquisition of Madasa on August 20th, a distributor located in Brazil, contributed just over $2 million of revenue in the quarter.

Quarterly results also benefited from stronger volumes of bovine products in Europe and Asia, and higher dairy sales in China. The total year decline in organic growth of 1% was in line with our guidance.

For 2014, we're planning for mid- single-digit organic revenue declines in LPD, as we continue to work through the anticipated reduction in BSE and other bovine testing related to the success of eradication programs in Europe. To remind investors, aspects of the Livestock, Poultry, and Dairy business have always been subject to factors that we have little control over, such as disease outbreaks, availability of government funding, and the timing of government-sponsored eradication efforts.

These aspects can make our growth rates in this business relatively more volatile than other areas we report. While we're projecting that these factors will pressure revenue in 2014, it could help us in future years.

The water business grew revenue grew 3% organically to $22 million for the quarter, primarily due to continued gains in our core Colilert testing business, particularly in the European region. For the full-year 2013, the water business grew 4% organically, in line with our last guidance of mid single digit organic growth. We expect growth for water in 2014 to again be in the mid- single-digit range, driven by continued market penetration from our products.

Overall, strong revenue growth across our business supported solid profit and cash flow performance. Gross profit in Q4 increased nearly 12% year-over-year, supported by a 40 basis point year-over-year improvement in gross margin to 53%.

Gross margin gains were primarily due to price realization, productivity improvements in our reference labs from targeted initiatives, and volume leverage, partially offset by unfavorable revenue mix, including higher relative sales of lower margin VetLab instruments. Gross margin for the full-year of 55% was in line with our guidance.

Operating expenses were 36% of revenue for the quarter and 35.5% for the year, slightly higher than our full-year guidance of 35%, in part due to higher compensation related expense, including commissions and bonuses reflecting strong business performance. As expected, we saw year-over-year increases in operating expenses in support of our strategy to accelerate growth. These included investments related to the ramp-up of our IDEXX diagnostic advantage initiative, global expansion including impacts from recent acquisitions, and increases in R&D and technology spending.

Our effective tax rate at 27.9% was favorable to our expectations, primarily due to profit mix in certain foreign jurisdictions. Free cash flow was $56 million, or 129% of net income in Q4. We repurchased 814,000 shares during the quarter, in line with our thinking when we provided guidance last quarter.

As we look forward to 2014, we project revenues to be approximately $1.48 billion to $1.5 billion, a year-over-year increase of 7.5% to 8.5% in reported growth, and 7% to 8% in organic growth. This organic growth outlook is consistent with our 2014 guidance provided in our last earnings call.

Our absolute revenue range is same as our earlier outlook, reflecting a higher revenue base given the strong revenue results in Q4 of 2013, offset by less favorable current impacts at current exchange rates. Regarding foreign exchange, the change from our outlook primarily reflects the significant weakening of the Canadian and Australian dollar and Yen from our last forecast.

As noted, our guidance includes the impact of an expected $5 million to $10 million of deferred revenue associated with the Catalyst One introductory offer. Adjusting for the impact of this revenue deferral, we're effectively planning to increase growth from 6.7% in 2013 to about 7.5% to 8.5% in 2014.

A key driver of our growth plan is an expectation for 9% to 11% normalized growth in CAG diagnostic recurring revenues. As highlighted earlier, this comprises our combined growth expectations for instrument consumables, reference lab services, and our rapid assay test kits. This growth outlook will be supported by continued strong gains across all major regions.

Benefits from our focus on the customer and innovation would support a growth trajectory next year. Key drivers on this front include: a step-up in instrument placements we're expecting from our Catalyst One launch, which will support strong continued consumables growth, targeted 15% plus growth in our practice management and digital imaging business, supported by a fully staffed sales organization and great momentum in our Pet Health Network Pro service offering, and the placements of SNAP Pro instruments.

We also expect to see continued benefits from global expansion, building on the double-digit organic growth we achieved in international CAG revenues in 2013. In terms of our entry rate heading into 2014, we expect Q1 organic growth to be in line with our targeted full-year growth range.

We expect gross margin to improve by about 50 basis points to around 55.5% in 2014, as our VetLab business benefits from a favorable mix of high-margin instrument consumable revenue and reduced products and service costs. We also expect to benefit from targeted initiatives in our reference lab business to improve productivity, as well as supply cost savings and volume leverage.

Finally, we expect both businesses to benefit from price realization. These impacts are partially muted by a 15 basis point headwind from 2013 currency hedge gains that are not projected to recur in 2014.

Operating expenses as a percent of sales are expected to remain at around 35.5%, with a quarterly profile that's highest as a percentage of revenue in the first quarter due to commercial activities such as trade shows and sales meetings. These impacts in the effective new hires added in 2013 supporting global commercial expansion, should yield operating expenses in the range of 37% of revenues in Q1.

We intend to sustain investment in support of our accelerated growth agenda. Adjusting for the trend set in 2013 and the unfavorable impact of currency exchange in 2014, operating expenses as a percent of revenue for the full-year expected to increase modestly. This increase is primarily due to the expansion of our international commercial efforts, including the incremental impact of infrastructure costs associated with our acquisition in Brazil, and to a lesser degree, continued expansion of our North America commercial organization.

Operating margin is expected to be nearly 20%, an increase of approximately 60 basis points from 2013, both on a reported basis and after including adjustments for trend set and the impact of foreign exchange. We expect the tax rate to be approximately 31.5%, and have not assumed the R&D tax credit will continue into 2014. As a reminder, in 2013, we recorded a favorable impact of both 2012 and 2013 R&D tax credits, so the increase in the tax rate is due to not having those benefits in 2014.

Net interest expense is expected to be about $9.3 million, with an increase from 2013 due to both higher average debt balances and a higher interest rate resulting for the impact of a long-term debt we issued last November. Weighted average share count is projected to be down about 4% from full-year 2013 levels.

All of this leads to our full-year earnings-per-share guidance of $3.76 to $3.86, the same as the guidance provided on our October call. Compared to our October guidance, EPS was negatively impacted by $0.04 from unfavorable currency, so we're effectively lifting EPS by $0.04 to reflect our solid Q4 performance, and our confidence in the strength of the business. Earnings-per-share growth for 2014 when normalized for the trend set provision we recorded in 2013, the R&D tax credits recognized in 2013, and the impact of foreign exchange, is projected to be 11% to 14%.

Free cash flow is projected at 95% to 100% of net income for 2014. The capital expenditure is at $80 million, up from $78 million in 2013, are related to equipment purchases for our manufacturing and lab operations, and information technology infrastructure, offset partially by reduced spending due to completion of our corporate headquarters building. Please note that we're no longer classifying instruments used as part of our reagent rental programs as capital expenditures for cash flow presentation, and have excluded that from our 2013 reported number.

That concludes the financial overview, let me now turn the call over to Jon for his comments on our business performance and our areas of focus heading into 2014.

Jon Ayers

Okay, thanks, Brian, nice work.

We had a strong quarter of growth in virtually every aspect of our business. Our strategy of game changing innovation and veterinary diagnostics, combined with strong customer centric commercial organizations in North America and around the world is proving to deliver value and growth to our customers, and thus to IDEXX.

Our double-digit organic revenue growth of 10.6% was driven by the 12.1% organic growth of our CAG segment into this quarter. As Brian mentioned, a key growth metric for IDEXX is the growth of our recurring revenue in diagnostic products and services, which was 11.3% in Q4 on a global basis, up from 10.6% in Q3, and 8% in the first half of the year.

In North America, our sales transformation in CAG diagnostics started to mature as it completed its second quarter of deployment. We continue to achieve an over 60% increase in the number of in-person customer visits versus the prior-year, supported by a 98% territory occupancy rate.

Beginning in 2014, we have changed the field sales professional's goals and compensation plans in North America to emphasize growth of IDEXX recurring diagnostic revenue in their territory, regardless of modality. In addition, their plans will incorporate instrument placements. Now, sales professionals are aligned to retain account loyalty at IDEXX agnostic modalities, and grow the accounts usage of diagnostic in their practice, thus our field sales of professionals North America are directly aligned with the Company's goal of growing recurring revenue diagnostics.

We also saw very strong results in Europe and our Asia-Pacific countries, notably Australia and Japan. These international markets are benefiting from the investments we've been making in sales leadership, marketing, and sales.

For example, in the Nordic countries where we went direct in 2013, we achieved 75% growth in Q4, and almost 60% for the full year of 2013. And even though some of this growth was one-time margin captures as a result of going direct instead of through distribution, we also had strong volume growth. Our global sales organizations delivered a strong quarter of placements in our in-house instruments and with customers.

Even as Catalyst placements were up 10% year-over-year, we had by far best quarter for ProCyte placements and hematology in general. ProCyte placements exceeded our previous highest quarterly unit placement achieved in Q4 2012 by over 25%. In North America, we saw an amazing turnaround in ProCyte placements, now that the sales organization is settled into their new roles. With unit placements in Q4 that were 83% over the average of the first three quarters of 2014.

These results did not come at the expense of our LaserCyte hematology instrument, as its placements in North America were up 35% on the same basis. This speaks not only to the early productivity benefits of our sales structure, but also to the extraordinary unique clinical value of hematology offering.

As Brian noted, we also has strong performance in our customer information management and digital imaging systems product lines. Capital placements were strong, now that we have experienced team of sales specialists. In addition, we benefited from moving beyond the focus and distractions, successfully managing the diagnostic sales transformation that5 occupied our sales leadership in North America early in the year.

In addition to capital, about 40% of our revenue in information management and digital imaging is recurring revenue. Including Pet Health Network Pro subscriptions, software maintenance and consumed supplies. This recurring revenue is separate and apart from our diagnostic recurring revenues. We saw strong year-over-year growth in this recurring revenue of 25% in 2013.

Turning to our strategy of advanced diagnostic insight and value through information technology, VetConnect PLUS total activations stand at just over 11,600, including those in the UK as a result from our launch in November, and Canada in July. When IDEXX customer is activated, they are able to VetConnect PLUS.

However, the more important question is the actual customer utilization. We find that customers who are power users of VetConnect PLUS find a greatly enhanced value from our diagnostic offering, and thus, are 75% less likely to switch away from IDEXX. And this is true for both reference labs and the in-house instrument diagnostic modality.

Currently, our loyalty across these three diagnostic modalities ranges between 95% and over 98%, numbers which have strengthened by roughly 1% plus or minus over the past year. And of course, these loyalty metrics comprise the mix of customers that range from the spectrum from power users, to active users of VetConnect PLUS, to those who have yet to engage. So when we look at the VetConnect PLUS utilization from July of 2013, when we started measuring the usage by practice, to January, 6 months later, we have seen the growth in the number of VetConnect PLUS power user practices by over 85% to over 1,200.

The total number of accounts actively using VetConnect PLUS reached 5,500. An active user in this case is an account that uses VetConnect PLUS more than once or twice during a month. Our goal is to continue to transform our diagnostic customer base into power users, and thus, helping to improve veterinary medicine and grow the revenues of the practice, and correspondingly customer loyalty IDEXX. Our new sales structure will further support customer adoption of VetConnect PLUS and its many benefits.

Finally, I want to comment on new products. We're very excited but the Catalyst One announcement. Catalyst One has a 25% to 30% lower price point than Catalyst Dx, and all the same extended functionality, but for the second sample drawer only needed by the highest line practices.

Then decoration of T4 for thyroid testing as part of a sample run in our in-house lab, make for an even more complete offering for preventative care and senior pet testing, as more than 50% of the chemistry panels that go to the reference lab incorporate a T4 test. With the new price point, Catalyst One now fits practices that today run as few as one sample a day. We believe that covers the vast majority of the market that does not already enjoy the benefits of Catalyst technology.

We, nevertheless, continue to invest in R&D. In 2014, our cash investment in R&D will surpass $100 million when both expensed R&D and software investment that's capitalized is counted. While some of this R&D is devoted to finishing the development of SNAP Pro and Catalyst One, much of it is going to innovations that have yet to be announced or launched. We expect to have other important new product launches during the course of 2014, and are also working on products for commercialization in 2015 and beyond.

To sum up 2013, we successfully concluded a year of major transformation in our commercial organization. We're now beginning to see the impact of our new approach in organic revenue growth. We are on track with a strategy aligned with practice growth that supports IDEXX growth, with continued game-changing innovations and diagnostic and information technology for the veterinarian that provides for advanced yet affordable health care for our family pets.

So with those opening comments, Cynthia, I'll turn the call over to questions.

Question-and-Answer Session


[Operator Instructions] Ryan Daniels, William Blair.

Ryan Daniels – William Blair & Company

Yes. Good morning, guys. Thanks for taking my question. Let me start with a quick one regarding the commentary you made on the data sets you now have available on the market. I know in the past you have referenced the 700. I know in some places, you probably got another 1100 through Pet Health Network Pro but I’m the 4,000 number – number one, how did you get to that? Where are you going to get in the data from? And number two – if we look forward, how much do you said expanded data set either internally or to help your clients with benchmarking or analytics to grow their practices?

Jon Ayers

Yes, Ryan. Thank you very much. We are over 4000 and we get that data from practices of variety of ways and of course it's going to help us support practice growth. And I think we're just really in the early days of that. And so I don't know if that was all elements of that question but we are excited about it.

Ryan Daniels – William Blair & Company

Anything in particular you’re going to be using to leverage to help internal sales or drive placements? Or how much do you use that expanded data set going forward?

Jon Ayers

Well, I think we’re really only scratching the surface of using it. It’s just a capability that is really come online over the course of the second half of 2013.So, I’d say we're at the top of the first inning on that.

Ryan Daniels – William Blair & Company

Okay and then one quick financial, you discussed this a little bit, Brian, in your prepared comments. But the sales and marketing cost I think ramped up quite a bit sequentially. I know some of that’s probably compensation for the expanded Salesforce in North America. But can you give us a year on kind of run rate going forward how you view that if there is anything unique in this quarter given the strong placement growth. Do you mind to bump that up? Just any color for the outlook?

Brian McKeon

Sure. A highlight with what was unique and that we did have some higher commissions and bonus accruals consistent with the very strong performance. We have had a ramp-up in investments through the year and sales and marketing not just in support of North America’s sales transformation but also in support of the strong growth we’re driving in international. And what we're trying signal is you should see our OpEx as a percentage of sales in a similar range next year and kind of a similar kind of a quarterly profile where we have higher level in Q1 and some of that’s driven by the 15% increase in the feet on the Street in North America and ramping up for that and year-over-year compares. So, it’s all consistent with the strategy. I think net net we’re doing a good job of balancing those investments with improving the top line trajectory to keep the profit and cash flow performance coming.

Ryan Daniels – William Blair & Company

Okay. Perfect. That’s helpful. Thanks, Brian.


Thank you. Next one in line is Erin Wilson. Your line is open.

Erin Wilson – BofA Merrill Lynch

Great thanks for taking my questions. You mentioned Sandy but did harsher weather conditions later this year have any sort of meaningful offsetting impact to overall utilization trends in the quarter? And how should we think about the general utilization incorporated into your 2014 guidance as far as fundamental veterinary demand goes? And has anything materially changed from what you envisioned in the third quarter on the third quarter call?

John Ayers

I –you know there's always going to be different – whether things I guess people experience the weather in early 2014 too, I think as Sandy stood out a little it. We’re – as Brian mentioned in his opening comments, we have a cautious outlook for the global economy. We think that’s a prudent and appropriate. It’s really not any different than the assumptions we built into the guidance in October.

Erin Wilson – BofA Merrill Lynch

Okay. Great. And can you speak to the overall trends in – the competitive dynamics in the Reference Laboratory space both on the domestic front and the can you think the dynamics internationally with your German lab initiative? And you mentioned are you alluded to some incremental cost there? If you could comment on that.

John Ayers

Yes. We really believe that we have a great overall diagnostic offering including the reference lab mortality. We think we’re really transforming a diagnostics. We think it's a different kind of offering. We have now a newly aligned sales force in North America with over 140 territories, 90% occupancy rate. And their job is to grow diagnostic usage regardless of modality. We’re really touching it quite differently in that regard. But of course, we’re going to compete the customers to reference that modality as part of their as we have in the past. And we think it’s a – we know when customers adopt us that they want to continue using us. So we really know it's a superior offering. And I – so I just kind of leave it at that. We’re really rolling that new approach out globally. Every country is little different but we believe that pets around the world are same in regard of providing diagnostic insight regardless of modality.

Brian McKeon

In terms of the – I'm not quite sure we pick up on the cost reference. I think for reference lab, we’re continuing – we intend to continue to drive improvements in our returns in that business as we have and that is one of the drivers of the gross margin improvement that we’re highlighting for next year.

Jon Ayers

I do want to follow-up on the European [INDISCERNIBLE] is providing a great – a next morning service level that really was non available to customers. I think that is helping us achieve good volume growth in the Nordics for example we achieved in 2014. In Nordic, I think we've got over 30% growth in diagnostic revenues in 2014. Of course none of that will – that’s all ready lapping – or all ready lapped the go direct strategy in those markets.

Erin Wilson – BofA Merrill Lynch

Great, thanks.


Thank you. Next we’ll go to the line of David Clair with Piper Jaffray. Your line is open.

David Clair – Piper Jaffray & Co.

Hi good morning everybody. Sorry for some of the background noise. I’m actually in the airport.

But Jon, you mentioned in the prepared comment, expectations for ongoing sales force expansion, what should we expect here in terms of geographies you plan to add to and any kind of percent increase in headcount that you think of us would be great.

Jon Ayers

Thank you, David for the question. You know We did have a roughly 15% increase in our field representation starting in July. So, of course we will have – you know we won't lap that until July of 2014 so that’s part of the increase in investment in the first part of the year.

We plan to continue to grow our commercial revenues consistent with our revenue growth across the board. It will be a variety of different ways that we make investment because we know our customers veterinarians around the world the sales support that we give them. In fact one of their number one complains prior to the current model was that they didn’t see our sales threat frequently and often did not have enough opportunity to share with them all the new innovations that we’re bringing to the market. And so, we think that is a good ROI investment in those commercial resources.

David Clair – Piper Jaffray & Co.

Okay and then do think you’d see any impact for foreseeing epidemic diarrhea virus on LPD business at all?

Jon Ayers

I have to tell you there are a lot of pieces to the LPD business. So, don’t think there’s going to be any material impact there you know like enforcing this – only one of three or four different major categories of that business. And that’s a variety of products across the global economy. So, I think any particular effect will be indiscernible.

David Clair – Piper Jaffray & Co.

Okay, the. Sorry if I missed this in the prepared comments, but what should we be looking for in terms of tax rate for 2014?

Brian McKeon

We had said 31.5%.

David Clair – Piper Jaffray & Co.


Jon Ayers

And you know you know are appropriately so believe assuming no benefit from the R&D tax credit because that is not in the tax code as of the – now in 2014.

David Clair – Piper Jaffray & Co.

Great, thank you.


Thank you. (Operator Instructions). And we’ll go to line of Ross Taylor with CL King. Your line is open.

Ross Taylor – CL King & Associates

My first question relates to the sales force. If I understood your comments correctly it sound like you do think you’re seeing your good benefit from the change in your sales force in terms of instrument placements and you’re winning new instrument customers. But I wonder if you could elaborate on what you might be seeing on the reference lab side. Do you expect to see a similar benefit there? Is there kind of lag or delay to do some of the contracts that maybe in place, you know, locking up some of that business?

Jon Ayers

We – you know we –I guess one thing is – our approach is to inspire the customers. And we believe the customers are inspired with Mr. Using our reference lab modality. Our sales force goal is to grow all the diagnostic categories. And we don't distinguish between –we don’t tell a customer how they should run their diagnostics. We have a full complete offering and we get the flexibility to run you’re in-house or reference lab, whatever works for him. We have world-class modalities across-the-board and we’re going to compete very aggressively for the customers business in all those modalities.

I think we are very pleased with the – over 11% recurring revenue growth that we achieved in Q4,which is you know an acceleration over the early parts of the year. I think any – the impact that the sales organization has is typically over four quarter because cumulative the growth you know in a particular quarter is reflective of the sales force activities of growing customers – adding new modalities and retaining customers over the prior four quarters. So, you know that's the nature of the flywheel recurring revenue aspect of our business.

Ross Taylor – CL King & Associates

Okay. And switching over to Catalyst one. The $5 million to $10 million in deferred revenue, I – it seem to essentially catch-up for that in 2015. Is that correct?

Brian McKeon

That’s right – when we place the - ultimately placed the Cat one, we’ll see a benefit from that.

Ross Taylor – CL King & Associates

Okay. And how long do you think it takes replace Catalyst Dxs that you loaned out this year how – many quarters does it take to replace that with the Catalyst One?

Jon Ayers

Yes. It will occur over the course of a year later from when they replaced roughly. So, in 2015 we would expect they would all be customers would have their Catalyst One by – within a year of their having signed up for Catalyst technology in receiving the Catalyst Dxs as the interim instrument.

Ross Taylor – CL King & Associates

Okay. And my final question is on – you know I wondered with VetConnect PLUS. What you have to do to get a customer to change to be heavy power user VetConnect PLUS? You know how much of that effort to that take and what kind of benefit do you think you ultimately see getting them to switch or change their behavior a little?

Jon Ayers

Yes. It’s – first of all, there really are no barriers other than just a focus on seeing it, seeing their own patients with the historical results and so it’s one of the things our reps do when they call on customers is take them through it. Again, there – it doesn't cost anything. It’s instantaneous. It has all the historical data and as customer see the greatly enhanced insight and appreciate that they can share that insight easily with the pet owner both in paper and through electronically – inside of medical record, through pet the – all sorts of ways to share that as having greater value for the money that the pet owners.

Since when they – any one of the benefit will get them hooked. So, it’s just the behavior change. In the veterinary world, it takes time. We’re very pleased by the rate of growth that we have seen in the century. In my experience, it's a very fast rate of growth but we’ll be continuing to work on that over the course of 2014 and beyond.

But the benefits are – mostly for – it’s a big platform but the ones that I mentioned are the increased loyalty that the customers have to the IDEXX diagnostic offering as a result of seeing this value, which I originally thought this is just as one sample in the context of the whole history.

And I will tell you of course we’re bringing the rapid assay business into the VetConnect ecosystem as a result of digitizing the SNAP test results with SNAP Pro. I think the first benefit customer see with SNAP Pro is just really greatly eases their work flow but the secondary benefit is it adds it to t VetConnect PLUS comprehensive diagnostic record.

So we’ll be adding more capability to VetConnect PLUS over time, at the same time we’re increasing utilization. And that additional capability in and of itself will increase utilization of VetConnect PLUS.

Ross Taylor – CL King & Associates

Okay. That’s helpful. Thanks very much.


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

Jon Block – Stifel Nicolaus

Thanks and morning guys. Jon, maybe the first one I'm Catalyst One. Excuse me. And I know it is real early but maybe you can give us an update on how the traction has been? And is it coming from the VetTest users were Catalyst One arguably just a better fit that Dx? Or are you seeing it more so from the competitive and clinic offerings? And then a second part of that question is your salesforce compensated differently in 2014 for competitive win with Catalyst One versus VetTest upgrade? Thanks.

Jon Ayers

Yes. Well, thank you for those questions. Of course, it’s very early. We’ve only been a couple of weeks. You are at the North American veterinary conference where he showed Catalyst One. I will tell you that the customer response was very positive. And it came really from all sectors that don't already have Catalyst technology. And they like the form factor. They like the simplicity. They like the price point. And they like the fact that T Force [ph] is now integrated into the sample run and the panel. These are all pretty significant advantages. And so, we’re seeing a similar response from VetTest customers and anybody who has competitive clinic because the competitive clinic simply doesn’t have many – most of the differentiators that Catalyst technology has.

I will also mentioned that it is absolutely clear that our hematology offering ProCyte and LaserCyte are highly differentiated and you saw the nice snapback in results in Q4 as our North American sales organization matured and learned how to integrate that.

So, it’s not just – we’re not just offering – a chemistry in-house lab is incomplete without hematology. Really need both to have a full patient insight. And so, we’re really competing across both chemistry and hematology as an integrated offering. 1And so the response has been very good.

With regard to your question on competitive placement, the consequence of compensating or rather compensate them with regarding placements, instrument placements – that’s a portion of their compensation. But the major portion of their compensation is the growth in diagnostic revenues in their territory.

So, as you know we’ve said in the past that when you upgrade a VetTest customer to Catalyst technology and – you get a 25% uplift in utilization of the in-house lab so that’s good. But when you upgrade a competitive – analyze you get 25% plus you get 100% you weren’t getting in the first place. You get 100 – you get as five times. And so, that obviously has an impact not only in IDEXX but it’s nicely aligned in terms of helping the rep grow their net diagnostic territory. So, for that reason alone competitive placements will be attractive for the sales professionals.

Jon Block – Stifel Nicolaus.

Okay great. That was very helpful. And then just have to burn a question here. According to the cornerstone data, it looks the market may be decelerated a little bit at least the level of growth from Q3 to 4Q. It actually makes your number out that’s more impressive. But maybe just had a high level of – you can speak to why this slide overall market decel? Arguably that was often easy Sandy comp and just what you see the overall market for Q4 moving into Q1. Thanks.

Jon Ayers

Yes. We are very pleased that we have more than what I call sample set but really a broad cross-section of the industry now we can quote with the over 4000 practices that include not only cornerstone customers but non cornerstone customers – there all IDEXX customers in one way shape or form or another.

But I would say I'm not sure we saw anything meaningful deceleration. I think with the number five, over 5% practice revenue growth for the year. 5.5% is a pretty solid growth for the growth and veterinary healthcare.

I will comment as one kind of a technicality is what we’re measuring is we’re measuring same-store sales growth. We aren’t counting the formation of new practices, right? That wouldn’t be – that would be additional growth in the industry netted by any practices that go out of business and generally that's a very low number. So if anything that number maybe a little bit conservative. You’re trying to extrapolate into industry growth.

Brian McKeon

Our conclusion was more similarity and difference than the trends. Steady growth.

Jon Block – Stifel Nicolaus

Okay, perfect. I’ll follow-up with you guys off-line for the rest. Thank you.

Jon Ayers

Okay. Thanks, Jon. Appreciate it.


Thank you. (Operator Instructions) And we will go to the line of Nicholas Jansen with Raymond James and Associates. Your line is open.

Nicholas Jansen – Raymond James and Associates

Hey, guys. Most of my questions have been answered. But maybe just thinking about the international success you’d seen I think you commented on the recurring revenue growth – 13% in Europe, 90% in Europe in the fourth quarter. Now, what specific strategies are kind of driving from that result? And then how do you think Catalyst One positions you to maybe accelerate that given that I would assume that more international practices might be smaller in size which might make Catalyst One more appropriate for them? Thanks.

Jon Ayers

Yes. Let me take those two questions in reverse order.

Really the Catalyst One is going to be a phenomenal instrument for our international customers because in general, practices outside the US are smaller than they are inside the US. Of course, there’s a wide range of practices in the US. There are smaller practices in the US. We think Catalyst One can be very attractive there.

But it's going to be an instrument that’s going to have tremendous run rate for us internationally. And what’s interesting is even with that, our international operations have done very, very well with existing product lines of hematology and chemistry.

And just one example I think I’d give you is Japan and the placements of ProCyte and Catalyst. And I think it’s because our Japan team has really come up to speed on the in-house offering combined.

When you combine Catalyst and ProCyte instruments, which are the major instruments we place in Japan, they were up almost threefold placements in customers in Q4. We’re up almost threefold when compared to the average of the bind in the first three quarters so they average per quarter. Big jump, threefold, a jump in the fourth quarter.

And so – and you know we've got significant opportunities in Japan. Japan is a very attractive market for us. They’re a real-time care market. They love instrumentation. I think they do appreciate the highly differentiated ProCyte and Catalyst offering. And yet when we introduce Catalyst One in Japan you know that will help us continue that momentum for many years to come.

So I think we’ve just done a good job. We have very strong country management in both countries around the world. We added Brazil, for example, very strong country manager in Brazil now which is open – Madasa acquisition. We’re strong in Europe with good results. We’re strong in Australia that really – in fact international is a faster growth opportunity then domestic even as domestic as a good growth.

Nicholas Jansen – Raymond James and Associates

Okay. Then maybe just my second follow-up would be in terms of – I think we’ve all kind of come to the conclusion that the switch and distributor and WI last year really didn't have any impact on your business.

So I guess the question with your expanded sales force and some of the investments that you’re making there, why won’t you perhaps maybe go to nonexclusive with the others as well as you kind of think about the way you’re kind of positioning yourself to the long-term? Thanks.

Jon Ayers

Yes. I think we’ve always been pleased with our strategy of combining the effort of our direct sales force with our distribution to help practice growth. We believe the biggest opportunity is to grow the category. We are the market leaders. We understand how to grow veterinary medicine through diagnostics. We are very strong in our partnership with distribution. The new territory alignment has been well received by our distribution partners. We think we will have greater productivity from our distribution partners working in partnership with us to inspire customers to grow their practices through IDEXX diagnostic technology and so we believe that growth strategy and that partnership together to support the practice is the right way to go in North America.

Nicholas Jansen – Raymond James and Associates

Thanks guys, nice quarter.

Jon Ayers

Thank you.


Thank you. Next, we’ll go to the line of Ben Haynor with Feltl and Company. Your line is open.

Ben Haynor – Feltl and Company

Good morning, gentlemen. Thanks for taking the question. Just one quick housekeeping one and I apologize if I missed it. But what is the guidance applied for share count in 2014?

Brian McKeon

We said we expect to be down about 4% versus this year’s average.

Ben Haynor – Feltl and Company

Great that's all I had. Thank you very much.


We’ll go to the line of Mark Masaru with Canaccord Genuity. Your line is open.

Mark Masaru – Canaccord Genuity

Hi. Good morning. Thanks for taking my question. You guided to strong Catalyst placements for 2014. So, could you provide some additional color on how Catalyst One could help you accelerate or maintain growth especially as we look at the US market? And perhaps some color on the percentage of Catalyst customers that might migrate down to Catalyst One would be helpful.

Jon Ayers

Yes. Okay. Thank you for the question.

We really don't see Catalyst one being targeted to Catalyst customers because somebody who is already – started to use Catalyst Dx is enjoying all the differentiators, whether it’s expanded menu or the integration with the cloud -based VetConnect PLUS or the fast real-time workflow, there’s just the – or the very easy whole blood. All those benefits – they’re all ready enjoying those benefits.

Catalyst one and Catalyst Dx are really targeted for customers who have not yet moved to Catalyst technology. We – the numbers that Brian gave you for placements in 2014 would be of course revenue and those that would be associated with deferred revenue on Catalyst One introductory offer but it’s a combined Catalyst Dx unit placement and there of course be a mix of the two.

We do believe that Catalyst One is going to be a very attractive for customers to upgrade whether they've got or bed test or they've got competitive equipment because of its enhanced capability at a lower price point and an attractive form factor.

So, as I have said you can easily justify a Catalyst One based on one sample a day. And that really takes you really deep into the marketplace in North America. So we’re very excited.

And I do want to say that our guidance for some 7% to 8% organic revenue growth incorporates and anticipates that we‘ll have $5 million to $10 million of deferred revenue that won’t be counted in our revenue because of Catalyst one introductory offerings which we're doing today even in the first quarter and where they get the Catalyst Dx until they have their Catalyst One yet they’re of course are purchasing our consumables from the get go. And so you know if you were to look at that deferred revenue and adjust for that deferred revenue that would take us to a higher organic growth of 7.5% to 8.5%.

I’ll also comment that our 7% to 8% growth is also of course the higher base that we’re going into this year than we anticipated in the October revenue guidance because of our strong performance in Q4. So we’re – the absolute revenue growth currency adjusted – the absolute revenue guidance for 2014 currently adjusted is actually higher because of the base and then we’re – we've got the currency which everybody has which is a headwind for us in 2014. But the fundamental currency adjustment performance we believe will be that some 7% to 8% off of that higher base. So we’re excited about the prospects for growth in 2014.

Mark Masaru – Canaccord Genuity

Great. Thanks. And just as a follow-up. In the context of the cornerstone data, obvious – very slight deceleration but are you observing any notable push back on pricing that consumers might be giving to the veterinarian?

Jon Ayers

You know we really aren't. In fact, what we find – and it's a good question. I appreciate that you asked that question. What we found is that when veterinaries can actually communicate the value of the medical care, including showing the diagnostic results that the pricing is in context to value.

When there is pricing pushback is because the customers don't appreciate the value because the vet isn’t able – isn’t yet – and by the way, veterinarians are trained in practice and veterinary medicine and taking care of the pets but really I think it is more of a recent phenomena about the bond they have between the practice and the pet owner and the importance to actually communicate – the rather sophisticated medical care that they can provide, including the benefits of preventative care.

So we find – in our customers – when they are effective that we see double-digit growth in the practice. We just don't see the pushbacks in that area because it’ s just – the level of care that is actually provided much below what customers – a broad segment of customers will demand, will allocate in terms of share wallet when they appreciate the benefits that it has to their beloved pet family members. And it’s because of that very, very strong bond that many – if not most pet owners have – with their pet family members.

So I don't really think the pushback is – I think that’s something the veterinarians have a lot of control over and of course our strategy is just to help provide them the tools in the training to be able to accomplish that.

Mark Masaru – Canaccord Genuity

Great, thank you.


And with that Mr. Ayers, I’d like to turn it over to for closing comments.

Jon Ayers

Well, I want to thank everybody for joining the call. I also want to really – a big congratulations to our employees at IDEXX, 5500 plus employees. I think we really had a major transformation that we accomplished in 2013. I think it positions us to achieve our purpose; to enhance the health and well-being of pets and thus people through supporting veterinary care.

It’s – companies – when they go through this, there’s always risks but I think we've gotten through the rest period. We’re now seeing the benefits in Q4 and we’ve positioned the Company very strongly to advance our strategy of innovating through diagnostics information technology and with a major piece of work by our employees.

So I really want to thank everybody in the Company that was involved in this transformation and congratulate them on what I think was a very transformational year for IDEXX, as we’re concluding 2013 and we look on to 2014 with optimism, with regard to our strategy and caution with regard to the economy. And I think those are both prudent, given where we are.

So, with all that we’ll conclude the call and thank you all very much.


Thank you. And ladies and gentlemen that does conclude your conference call for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.

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