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(Exact name of registrant as specified in its charter)
iDelaware
i01-0393723
(State
or other jurisdiction of incorporation
or organization)
(IRSEmployer Identification No.)
iOne
IDEXX Drive
iWestbrook
iMaine
i04092
(Address
of principal executive offices)
(ZIP Code)
i207-i556-0300
(Registrant’s telephone number, including area code)
Title
of each class
Trading Symbol(s)
Name of each exchange on which registered
iCommon Stock, $0.10 par value per share
iIDXX
iNASDAQ
Global Select Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYesýNo ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). iYesý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
iLarge
accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. The number of shares outstanding of the registrant’s Common Stock, $0.10 par value per share, was i85,782,572
on October 28, 2019.
GLOSSARY OF TERMS AND SELECTED ABBREVIATIONS
In order to aid the reader, we have included certain terms and abbreviations used throughout this Quarterly Report on Form 10-Q below:
Term/ Abbreviation
Definition
AOCI
Accumulated
other comprehensive income or loss
ASU 2016-02
ASU 2016-02, Leases (Topic 842); also referred to as the “New Leasing Standard”
CAG
Companion Animal Group, a reporting segment that provides veterinarians diagnostic products and services and information management solutions that enhance the health and well-being of pets
Credit Facility
Our $850 million five-year unsecured revolving credit facility under an amended and restated credit agreement that was executed in December 2015, also referred to as line of credit
FASB
U.S.
Financial Accounting Standards Board
LPD
Livestock, Poultry and Dairy, a reporting segment that provides diagnostic products and services for livestock and poultry health and to ensure the quality and safety of milk and improve dairy efficiency
OPTI Medical
OPTI Medical Systems, Inc., a wholly-owned subsidiary of IDEXX Laboratories Inc., located in Roswell, Georgia. This business manufactures and supplies blood gas analyzers and consumables worldwide for the human point-of-care medical diagnostics market. The Roswell facility also manufactures electrolytes slides (instrument consumables) to run Catalyst One®, Catalyst Dx®,
and blood gas analyzers and consumables for the veterinary market; also referred to as OPTI.
Organic revenue growth
A non-GAAP financial measure and represents the percentage change in revenue, as compared to the same period for the prior year, net of the effect of changes in foreign currency exchange rates, certain business acquisitions and divestitures. Organic revenue growth should be considered in addition to, and not as a replacement for or as a superior measure to, revenues reported in accordance with U.S. GAAP, and may not be comparable to similarly titled measures reported by other companies.
R&D
Research and Development
Reported
revenue growth
Represents the percentage change in revenue reported in accordance with U.S. GAAP, as compared to the same period in the prior year
SaaS
Software-as-a-service
SEC
U.S. Securities and Exchange Commission
Senior Note Agreements
Note purchase agreements for the private placement of senior notes having an aggregate principal amount of approximately $700 million, referred to as senior notes or long-term debt
U.S. GAAP
Accounting
principles generally accepted in the United States of America
Water
Water, a reporting segment that provides water microbiology testing products
Accounts
receivable, net of reserves of $3,831 in 2019 and $4,702 in 2018
i268,319
i248,855
Inventories
i204,893
i173,303
Other
current assets
i126,174
i108,220
Total
current assets
i703,382
i654,172
Long-Term
Assets:
Property and equipment, net
i496,584
i437,270
Operating
lease right-of-use assets (Notes 2 and 8)
i78,977
i—
Goodwill
i212,171
i214,489
Intangible
assets, net
i35,662
i41,825
Other
long-term assets
i224,705
i189,593
Total
long-term assets
i1,048,099
i883,177
TOTAL
ASSETS
$
i1,751,481
$
i1,537,349
LIABILITIES
AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
Accounts payable
$
i75,515
$
i69,534
Accrued
liabilities
i278,626
i260,683
Line
of credit
i229,500
i398,937
Current
portion of deferred revenue
i42,986
i41,290
Total
current liabilities
i626,627
i770,444
Long-Term
Liabilities:
Deferred income tax liabilities
i33,734
i29,267
Long-term
debt
i696,634
i601,348
Long-term
deferred revenue, net of current portion
i48,345
i60,697
Long-term
operating lease liabilities (Notes 2 and 8)
i66,341
i—
Other
long-term liabilities
i77,078
i84,826
Total
long-term liabilities
i922,132
i776,138
Total
liabilities
i1,548,759
i1,546,582
Commitments
and Contingencies (Note 16)
i
i
Stockholders’
Equity (Deficit):
Common stock, $0.10 par value: Authorized: 120,000 shares; Issued: 105,594 shares in 2019 and 105,087 shares in 2018; Outstanding: 85,888 shares in 2019 and 86,100 shares in 2018
i10,559
i10,509
Additional
paid-in capital
i1,189,554
i1,138,216
Deferred
stock units: Outstanding: 143 units in 2019 and 162 units in 2018
i4,416
i4,524
Retained
earnings
i1,505,152
i1,167,928
Accumulated
other comprehensive loss
(i45,565
)
(i41,791
)
Treasury
stock, at cost: 19,707 shares in 2019 and 18,988 shares in 2018
(i2,461,698
)
(i2,288,899
)
Total
IDEXX Laboratories, Inc. stockholders’ equity (deficit)
i202,418
(i9,513
)
Noncontrolling
interest
i304
i280
Total
stockholders’ equity (deficit)
i202,722
(i9,233
)
TOTAL
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
$
i1,751,481
$
i1,537,349
The
accompanying notes are an integral part of these condensed consolidated financial statements.
Unrealized
gain on net investment hedge, net of tax expense of $947 and $1,105 in 2019 and $175 and $888 in 2018
i3,007
i555
i3,507
i2,818
Unrealized
(loss) gain on investments, net of tax (benefit) expense of $(21) and $93 in 2019 and $12 and $61 in 2018
(i67
)
i37
i295
i187
Unrealized
gain (loss) on derivative instruments:
Unrealized gain, net of tax expense of $1,973 and $2,335 in 2019 and $62 and $1,846 in 2018
i8,473
i1,728
i10,451
i7,514
Reclassification
adjustment for (gain) loss included in net income, net of tax (expense) benefit of $(688) and $(1,295) in 2019 and $(153) and $476 in 2018
(i2,483
)
(i103
)
(i5,796
)
i1,936
Unrealized
gain on derivative instruments
i5,990
i1,625
i4,655
i9,450
Other
comprehensive (loss) gain, net of tax
(i4,982
)
i372
(i3,774
)
(i5,717
)
Comprehensive
income
i103,856
i93,586
i333,474
i285,653
Less:
Comprehensive income (loss) attributable to noncontrolling interest
i1
(i37
)
i24
(i23
)
Comprehensive
income attributable to IDEXX Laboratories, Inc.
$
i103,855
$
i93,623
$
i333,450
$
i285,676
The
accompanying notes are an integral part of these condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
1. iBASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The accompanying unaudited condensed consolidated financial statements of IDEXX Laboratories, Inc. and its subsidiaries have been prepared in accordance with U.S. GAAP
for interim financial information and with the requirements of Regulation S-X, Rule 10-01 for financial statements required to be filed as a part of this Quarterly Report on Form 10-Q. Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to “IDEXX,” the “Company,” “we,”“our,” or “us” refer to IDEXX Laboratories, Inc. and its subsidiaries.
The accompanying
unaudited condensed consolidated financial statements include the accounts of IDEXX Laboratories, Inc. and our wholly-owned and majority-owned subsidiaries. We do not have any variable interest entities for which we are the primary beneficiary. All intercompany transactions and balances have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements reflect, in the opinion of our management, all adjustments necessary for a fair statement of our financial position and results of operations. All such adjustments are of a recurring nature. The consolidated balance sheet data at December 31, 2018, was derived from audited financial statements, but does
not include all disclosures required by U.S. GAAP. The results of operations for the three and nine months ended September 30, 2019, are not necessarily indicative of the results to be expected for the full year or any future period. These unaudited condensed consolidated financial statements should be read in conjunction with this Quarterly Report on Form 10-Q for the quarter ended September 30, 2019, and our Annual Report on Form 10-K for the year ended December 31, 2018, (the “2018 Annual Report”) filed with the SEC.
We
have included certain terms and abbreviations used throughout this Quarterly Report on Form 10-Q in the "Glossary of Terms and Selected Abbreviations."
NOTE 2. iACCOUNTING POLICIES
Significant
Accounting Policies
The significant accounting policies used in preparation of these unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2019, are consistent with those discussed in Note 2 to the consolidated financial statements in our 2018 Annual Report, except as noted below.
i
New
Accounting Pronouncements Adopted
We adopted ASU 2016-02, Leases (Topic 842) (the "New Leasing Standard"), as of January 1, 2019, using the optional transition method that allows for a cumulative-effect adjustment in the period of adoption and did not restate prior periods. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward the historical lease classification. The adoption of the New Leasing Standard resulted in the recording of operating lease liabilities of $i86.7
million and right-of-use assets of $i83.7 million. Prior to our adoption of the New Leasing Standard, rent prepayments of approximately $i1.0
million were recorded within other current assets and the impact of recognizing rent expense on a straight-line basis of approximately $i4.0 million was recorded within other current and long-term liabilities. Upon adoption of the New Leasing Standard, these rent prepayments and straight-line rent impacts are now recorded within operating lease right-of-use assets and represent the net difference between operating lease
liabilities and right-of-use assets.
The New Leasing Standard requires us to classify certain reagent rental programs as sales-type leases and thus accelerate instrument revenue and cost recognition at the time of instrument placement. We did not change the historical lease classification for placements prior to January 1, 2019, therefore this change will apply to certain new placements beginning on January 1, 2019. Under prior U.S. GAAP, instruments placed under our reagent rental programs were classified as operating leases and instrument revenue and cost was recognized over the term of the program. The New Leasing Standard did not have a material impact on our consolidated earnings and had no impact on cash flows for the three and nine
months ended September 30, 2019.
/
9
i
Adoption of the New Leasing
Standard impacted our condensed consolidated balance sheet as follows:
We
adopted ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220) Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, on January 1, 2019. We elected not to reclassify the $i1.7 million of stranded tax effects from the Tax Cuts and Jobs Act enacted on December
22, 2017, from accumulated other comprehensive income to retained earnings in the period of adoption.
In August 2018, the SEC issued Final Rule Release No. 33-10532, “Disclosure Update and Simplification,” which makes a number of changes meant to simplify interim disclosures. The new rule requires a presentation of changes in stockholders’ equity and noncontrolling interest in the form of a reconciliation, either as a separate financial statement or in the notes to the financial statements, for the current and comparative year-to-date interim periods. The additional elements of this release did not have a material impact on our overall condensed consolidated financial statements. We adopted the new disclosure requirements in our Form 10-Q during the first quarter of 2019.
New
Accounting Pronouncements Not Yet Adopted
For a discussion of other accounting standards that have been issued by the FASB prior to January 1, 2019, but are not yet effective, refer to Note 2. Summary of Significant Accounting Policies - New Accounting Pronouncements Not Yet Adopted in our 2018 Annual Report.
NOTE 3. iREVENUE
RECOGNITION
Our revenue is recognized when, or as, performance obligations under the terms of a contract are satisfied, which occurs when control of the promised products or services is transferred to a customer. We exclude sales, use, value-added, and other taxes we collect on behalf of third parties from revenue. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or services to a customer. To accurately present the consideration received in exchange for promised products or services, we apply the five-step model outlined below:
1.
Identification
of a contract or agreement with a customer
2.
Identification of our performance obligations in the contract or agreement
3.
Determination of the transaction price
4.
Allocation
of the transaction price to the performance obligations
5.
Recognition of revenue when, or as, we satisfy a performance obligation
We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. The timing of revenue recognition, billings, and cash collections results in accounts receivable, contract assets and lease receivables
as a result of revenue recognized in advance of
10
billings (included within other assets), and contract liabilities or deferred revenue as a result of receiving consideration in advance of revenue recognition within our unaudited condensed consolidated balance sheet. Our general payment terms range from i30
to i60 days, with exceptions in certain geographies. Below is a listing of our major categories of revenue for our products and services:
Diagnostic Products and Accessories. Diagnostic products and accessories revenues, including IDEXX VetLab® consumables and accessories, rapid assay, LPD, Water, and OPTI testing products, are predominantly
recognized and invoiced at the time of shipment, which is when the customer obtains control of the product based on legal title transfer and we have the right to payment. Shipping costs reimbursed by the customer are included in revenue and cost of sales. As a practical expedient, we do not account for shipping activities as a separate performance obligation.
Reference Laboratory Diagnostic and Consulting Services. Reference laboratory revenues are recognized and invoiced when the laboratory diagnostic service is performed.
Instruments, Software and Systems. CAG Diagnostics capital instruments, veterinary software and diagnostic imaging systems revenues are recognized and invoiced when the customer
obtains control of the products based on legal title transfer and we have the right to payment, which generally occurs at the time of installation and customer acceptance. Our instruments, software, and systems are often included in one of our significant customer programs, as further described below. For veterinary software systems that include multiple performance obligations, such as perpetual software licenses and computer hardware, we allocate revenue to each performance obligation based on estimates of the price that we would charge the customer for each promised product or service if it were sold on a standalone basis.
Lease Revenue. Revenues from instrument rental agreements and reagent rental programs are recognized either as operating leases on a ratable basis over the term of the agreement or as sales-type leases at
the time of installation and customer acceptance. Customers typically pay for the right to use instruments under rental agreements in equal monthly amounts over the term of the rental agreement. Our reagent rental programs provide our customers the right to use our instruments upon entering into agreements to purchase specified amounts of consumables, which are considered embedded leases. For some agreements, the customers are provided with the right to purchase the instrument at the end of the lease term. Lease revenues from these agreements are presented in product revenue on our unaudited condensed consolidated income statement. Lease revenue was approximately $i5.3
million and $i14.5 million for the three and nine months ended September 30, 2019, respectively, as compared to $i3.0
million and $i9.0 million for the three and nine months ended September 30, 2018, respectively, including both operating leases and sales-type leases under ASC 842, Leases, during 2019, and ASC 840, Leases, prior to 2019. See below for revenue recognition under our reagent rental programs.
Extended
Warranties and Post-Contract Support. CAG Diagnostics capital instruments and diagnostic imaging systemsextended warranties typically provide customers with continued coverage for a period of one to five years beyond the first-year standard warranty. Customers can either pay in full for the extended warranty at the time of instrument or system purchase or can be billed on a quarterly basis over the term of the contract. We recognize revenue associated with extended warranties over time on a ratable basis using a time elapsed measure of performance over the contract
term, which approximates the expected timing in which applicable services are performed.
Veterinary software post-contract support provides customers with access to technical support when and as needed through access to call centers and online customer assistance. Post-contract support contracts typically have a term of i12
months and customers are billed for post-contract support in equal quarterly amounts over the term. We recognize revenue for post-contract support services over time on a ratable basis using a time elapsed measure of performance over the contract term, which approximates the expected timing in which applicable services are performed.
On December 31, 2018, our deferred revenue related to extended warranties and post-contract support was $i40.7
million, of which approximately $i2.8 million and $i18.5
million were recognized during the three and nine months ended September 30, 2019, respectively. Furthermore, as a result of new agreements, our deferred revenue related to extended warranties and post-contract support was $i37.8 million
at September 30, 2019. We do not disclose information about remaining performance obligations that are part of contracts with an original expected duration of one year or less and do not adjust for the effect of the financing components when the period between customer payment and revenue recognition is one year or less. Deferred revenue related to extended warranties and post-contract support with an original duration of more than one year was $i24.3
million at September 30, 2019, of which approximately i9%, i35%, i28%,
i18%, and i10%
are expected to be recognized during the remainder of 2019, the full years 2020, 2021, 2022, and thereafter, respectively. Additionally, we have determined these agreements do not include a significant financing component.
11
SaaS Subscriptions.We offer a variety of veterinary software and diagnostic imaging SaaS subscriptions including IDEXX Neo®, Animana®, Pet Health Network® Pro, Petly®
Plans, Web PACS, rVetLink®, and Smart Flow™. We recognize revenue for our SaaS subscriptions over time on a ratable basis over the contract term, beginning on the date our service is made available to the customer. Our subscription contracts vary in term from monthly to itwo years.
Customers typically pay for our subscription contracts in equal monthly amounts over the term of the agreement. Deferred revenue related to our SaaS subscriptions is not material.
Contracts with Multiple Performance Obligations. We enter into contracts where customers purchase a combination of IDEXX products and services. Determining whether products and services are considered distinct performance obligations that should be accounted for separately requires significant judgment. We determine the transaction price for a contract
based on the consideration we expect to receive in exchange for the transferred goods or services. To the extent the transaction price includes variable consideration, such as volume rebates or expected price adjustments, we apply judgment in constraining the estimated variable consideration due to factors that may cause reversal of revenue recognized. We evaluate constraints based on our historical and projected experience with similar customer contracts.
We allocate revenue to each performance obligation in proportion to the relative standalone selling prices and recognize revenue when transfer of the related goods or services has occurred for each obligation. We utilize the observable standalone selling price when available, which represents the price charged for the performance obligation
when sold separately. When standalone selling prices for our products or services are not directly observable, we determine the standalone selling prices using relevant information available and apply suitable estimation methods including, but not limited to, the cost plus a margin approach. We recognize revenue as each performance obligation is satisfied, either at a point in time or over time, as described in the revenue categories above. We do not disclose information about remaining performance obligations that are part of contracts with an original expected duration of one year or less.
The following customer programs represent our most significant customer contracts which contain multiple performance
obligations:
Customer Commitment Programs. We offer customer incentives upon entering into multi-year agreements to purchase annual minimum amounts of products and services.
Up-Front Customer Loyalty Programs. Our up-front loyalty programs provide customers with incentives in the form of cash payments or IDEXX Points upon entering into multi-year agreements to purchase annual minimum amounts of future products or services. If a customer breaches its agreement, they are required to refund all or a portion of the up-front cash or IDEXX Points, or make other repayments, remedial actions, or both. Up-front incentives to customers in the form of cash or IDEXX Points are not made in exchange for distinct goods or services
and are capitalized as customer acquisition costs within other current and long-term assets, which are subsequently recognized as a reduction to revenue over the term of the customer agreement. If these up-front incentives are subsequently utilized to purchase instruments, we allocate total consideration, including future committed purchases less up-front incentives and estimates of expected price adjustments, based on relative standalone selling prices to identified performance obligations and recognize instrument revenue and cost at the time of installation and customer acceptance. We have determined these agreements do not include a significant financing component. Differences between estimated and actual customer purchases may impact the amount and timing of revenue recognition.
On December 31, 2018,
our capitalized customer acquisition costs were $i124.4 million, of which approximately $i8.5
million and $i26.2 million were recognized as a reduction of revenue during the three and nine months ended September 30, 2019, respectively. Furthermore, as a result of new up-front customer loyalty payments, net of subsequent recognition, our capitalized customer acquisition costs were $i131.0
million at September 30, 2019. We monitor customer purchases over the term of their agreement to assess the realizability of our capitalized customer acquisition costs and review estimates of variable consideration. Impairments, revenue adjustments that relate to performance obligations satisfied in prior periods, and contract modifications during the three and nine months ended September 30, 2019, were not material.
Volume Commitment Programs. Our volume commitment programs, such as our IDEXX 360 program,
provide customers with a free or discounted instrument or system upon entering into multi-year agreements to purchase annual minimum amounts of products and services. We allocate total consideration, including future committed purchases and expected price adjustments, based on relative standalone selling prices to identified performance obligations and recognize instrument revenue and cost at the time of installation and customer acceptance in advance of billing the customer, which is also when the customer
12
obtains control of the instrument based on legal title transfer. Our right to future consideration related to instrument revenue is recorded as a contract
asset within other current and long-term assets. The contract asset is transferred to accounts receivable when customers are billed for future products and services over the term of the contract. We have determined these agreements do not include a significant financing component. Differences between estimated and actual customer purchases may impact the amount and timing of revenue recognition.
On December 31, 2018, our volume commitment contract assets were $i40.9
million, of which approximately $i2.0 million and $i7.0
million were reclassified to accounts receivable when customers were billed for related products and services during the three and nine months ended September 30, 2019, respectively. Furthermore, as a result of new placements under volume commitment programs, net of subsequent amounts reclassified to accounts receivable, our contract assets were $i70.5
million at September 30, 2019. We monitor customer purchases over the term of their agreement to assess the realizability of our contract assets and review estimates of variable consideration. Impairments, revenue adjustments that relate to performance obligations satisfied in prior periods, and contract modifications during the three and nine months ended September 30, 2019, were not material.
For our up-front customer loyalty and volume
commitment programs, we estimate future revenues related to multi-year agreements to be approximately $i1.6 billion, of which approximately i7%,
i25%, i21%,
i19%, and i28%
are expected to be recognized during the remainder of 2019, the full years 2020, 2021, 2022, and thereafter, respectively. These future revenues relate to performance obligations not yet satisfied, for which customers have committed to purchase goods and services, net of the expected revenue reductions from customer acquisition costs and expected price adjustments, and as a result, are lower than stated contractual commitments by our customers.
Instrument Rebate Programs. Our instrument rebate programs, previously referred to as IDEXX Instrument Marketing Programs, require an instrument purchase and provide customers the opportunity to earn future rebates based on the volume of products and services they purchase over the term of the program. We account for the customer’s right to earn rebates on future purchases as a separate performance obligation and
determine the standalone selling price based on an estimate of rebates the customer will earn over the term of the program. Total consideration allocated to identified performance obligations is limited to goods and services that the customer is presently obligated to purchase and does not include estimates of future purchases that are optional. We allocate total consideration to identified performance obligations, including the customer’s right to earn rebates on future purchases, which is deferred and recognized upon the purchase of future products and services, offsetting future rebates as they are earned.
On December 31, 2018, our deferred revenue related to instrument rebate programs was $i57.4
million, of which approximately $i4.4 million and $i13.9
million were recognized when customers purchased eligible products and services and earned rebates during the three and nine months ended September 30, 2019, respectively. Furthermore, as a result of new instrument purchases under rebate programs, net of subsequent recognition, our deferred revenue was $i50.1 million
at September 30, 2019, of which approximately i9%, i31%,
i25%, i17%,
and i18% are expected to be recognized during the remainder of 2019, the full years 2020, 2021, 2022, and thereafter, respectively.
Reagent Rental Programs.
Our reagent rental programs provide our customers the right to use our instruments upon entering into multi-year agreements to purchase annual minimum amounts of consumables. These types of agreements include an embedded lease for the right to use our instrument and we determine the amount of lease revenue allocated to the instrument based on relative standalone selling prices. We evaluate the terms of these embedded leases to determine classification as either a sales-type lease or an operating lease, as defined within the New Leasing Standard. We elected the package of practical expedients permitted under the transition guidance within the New Leasing Standard, which among other things, allowed us to carryforward our historical lease classification and therefore all reagent rental program placements prior to January 1, 2019 will continue to be classified as operating leases. We have not elected the practical expedient
within the New Leasing Standard to combine lease and non-lease components.
Sales-type Reagent Rental Programs. Our reagent rental programs that effectively transfer control of instruments to our customers are classified as sales-type leases and we recognize instrument revenue and cost in advance of billing the customer, at the time of installation and customer acceptance. Our right to future consideration related to instrument revenue is recorded as a lease receivable within other current and long-term assets, and is transferred to accounts receivable when customers are billed for future products and services over the term of the contract. As a result of new placements under reagent rental programs, our lease receivable assets were $i4.5
million at September 30, 2019. The impacts of discounting and unearned income
13
at September 30, 2019, were not material. Profit and loss recognized at the commencement date and interest income during the three and nine months ended September 30, 2019, were not material. We monitor customer purchases over the term of their agreement to assess the realizability of our lease receivable assets.
Impairments during the three and nine months ended September 30, 2019, were not material.
Operating-type Reagent Rental Programs. Our reagent rental programs that do not effectively transfer control of instruments to our customers are classified as operating leases and we recognize instrument revenue and costs ratably over the term of the agreement. The cost of the instrument is capitalized within property and equipment. During the three and nine months ended September 30, 2019, we transferred instruments of $i5.5
million and $i10.5 million, respectively, as compared to $i6.6
million and $i14.7 million for the three and nine months ended September 30, 2018, respectively, from inventory to property and equipment.
We estimate future revenue to be recognized
related to our reagent rental programs of approximately $i30.9 million, of which approximately i11%,
i37%, i27%,
i16%, and i9%
are expected to be recognized during the remainder of 2019, the full years 2020, 2021, 2022, and thereafter, respectively. These future revenues relate to performance obligations not yet satisfied for which customers have committed to future purchases, net of any expected price adjustments, and as a result, may be lower than stated contractual commitments by our customers.
Other Customer Incentive Programs. Certain agreements with customers include discounts or rebates on the sale of products and services applied retrospectively, such as volume rebates achieved by purchasing a specified purchase threshold of goods and services. We account for these discounts as variable consideration and estimate the likelihood of a customer meeting the threshold in order to determine the transaction price using the most predictive approach. We typically use the most-likely-amount
method for incentives that are offered to individual customers and the expected-value method for programs that are offered to a broad group of customers. Revenue adjustments that relate to performance obligations satisfied in prior periods during the three and nine months ended September 30, 2019, were not material. Refund obligations related to customer incentive programs are recorded in accrued liabilities for the actual issuance of incentives, incentives earned but not yet issued and estimates of incentives to be earned in the future.
Program Combinations. At times, we combine elements of our significant customer programs within a single customer contract.
We separate each significant program element and include the contract assets, customer acquisition costs, deferred revenues and estimated future revenues within the most relevant program disclosures above. Each customer contract is presented as a net contract asset or net contract liability on our unaudited condensed consolidated balance sheet.
Future market conditions and changes in product offerings may cause us to change marketing strategies to increase or decrease customer incentive offerings, possibly resulting in
incremental reductions of revenue in future periods as compared to reductions in the current or prior periods. Additionally, certain customer programs require us to estimate, based on historical experience, and apply judgment to predict the amounts of future customer purchases, customer rebates and other incentive payments, and price adjustments related to multi-year agreements. Differences between estimated and actual customer purchases may impact the amount and timing of revenue recognition.
IDEXX Points. IDEXX Points may be applied to trade receivables due to us, converted to cash, or applied against the purchase price of IDEXX products and services. We consider IDEXX Points equivalent to cash. IDEXX Points that have not yet been used by customers are included in accrued liabilities until utilized or expired. Breakage is not material because customers
can apply IDEXX Points to trade receivables at any time.
Accounts Receivable. We recognize revenue when it is probable that we will collect substantially all of the consideration to which we will be entitled, based on the customer’s intent and ability to pay the promised consideration. We apply judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer. We maintain allowances for doubtful accounts for potentially uncollectible receivables. We base our estimates on a detailed analysis of specific customer situations and a percentage of our accounts receivable by aging category. Additional allowances may be required if either
the financial condition of our customers were to deteriorate, or a strengthening U.S. dollar impacts the ability of foreign customers to make payments to us on their U.S. dollar-denominated purchases. Account balances are charged off against the allowance when we believe it is probable the receivable will not be recovered. We do not have any off-balance sheet credit exposure related to our customers. We have no significant customers that accounted for greater than 10% of our consolidated revenues and we have no concentration of credit risk as of September 30, 2019.
14
Disaggregated
Revenues. We present disaggregated revenue for our CAG segment based on major product and service categories. Our Water segment is comprised of a single major product category. Although our LPD segment does not meet the quantitative thresholds to be reported as a separate segment, we believe it is important to disaggregate these revenues as a major product and service category within our Other reportable segment given its distinct markets, and therefore we have elected to report LPD as a reportable segment.
i
The following table presents disaggregated
revenue by major product and service categories:
Costs
to Obtain a Contract. We capitalize sales commissions and the related fringe benefits earned by our sales force when considered incremental and recoverable costs of obtaining a contract. Our contracts include performance obligations related to various goods and services, some of which are satisfied at a point in time and others over time. Commission costs related to performance obligations satisfied at a point in time are expensed at the time of sale, which is when revenue is recognized. Commission costs related to long-term service contracts and performance obligations satisfied over time,
including extended warranties and SaaS subscriptions, are deferred and recognized on a systematic basis that is consistent with the transfer of the goods or services to which the asset relates. We apply judgment in estimating the amortization period, which ranges from i3 to i7
years, by taking into consideration our customer contract terms, history of renewals, expected length of customer relationship, as well as the useful life of the underlying technology and products. Amortization expense is included in sales and marketing expenses in the accompanying unaudited condensed consolidated statements of income. Deferred commission costs are periodically reviewed for impairment.
On December 31, 2018, our deferred commission costs, included within other assets, were $i13.9
million, of which approximately $i1.1 million and $i3.4 million of commission expense were recognized during
the three and nine months ended September 30, 2019, respectively. Furthermore, as a result of commissions related to new extended warranties and SaaS subscriptions, net of subsequent recognition, our deferred commission costs were $i15.2 million at September 30, 2019. Impairments of deferred commission costs during
the three and nine months ended September 30, 2019, were not material.
15
NOTE 4. iACQUISITIONS
We believe that our acquisitions of businesses and other assets enhance our existing businesses by either expanding our geographic range and customer base or expanding our existing product lines.
During the third quarter of 2018, we acquired substantially all of the assets of a software company for $i25.0
million, including a holdback payment of $i1.0 million, to offset possible pre-acquisition indemnity claims, and a contingent payment of $i1.5
million. The holdback payment, less settlement of any indemnity claims, will be paid on the second anniversary of the acquisition date, while the contingent payment will be paid within i36 months if certain commercial goals are achieved. This acquisition expands the IDEXX suite of veterinary software offerings and further underscores our commitment to investing in software innovations that advance the veterinary profession.
This acquisition was accounted for as a business combination. The fair value of the assets acquired consist of $i20.3 million of goodwill, representing synergies with our current software product offerings, $i2.6
million in technology intangible assets, $i2.4 million in customer relationship intangible assets, and $i0.3
million of net tangible liabilities. The goodwill is expected to be deductible for income tax purposes. Pro forma information has not been presented for this acquisition because such information is not material to our financial statements. The results of operations have been included in our CAG segment since the acquisition date. The acquisition expenses incurred were not material.
NOTE 5. iSHARE-BASED
COMPENSATION
The fair value of options, restricted stock units, deferred stock units, and employee stock purchase rights awarded during the three and nine months ended September 30, 2019, totaled $i3.8 million
and $i40.1 million, respectively, as compared to $i0.7
million and $i33.5 million for the three and nine months ended September 30, 2018, respectively. The total unrecognized compensation expense, net of estimated forfeitures, for unvested share-based compensation awards outstanding at September 30,
2019, was $i63.2 million, which will be recognized over a weighted average period of approximately i1.9
years. During the three and nine months ended September 30, 2019, we recognized expenses of $i9.4 million and $i22.6
million, respectively, as compared to $i6.5 million and $i18.9 million
for the three and nine months ended September 30, 2018, respectively, related to share-based compensation.
i
We determine the assumptions used in the valuation of option awards as of the date of grant. Differences in the expected stock price volatility, expected term or risk-free interest rate may necessitate distinct valuation assumptions at each grant date. As such, we may use different assumptions for options
granted throughout the year. Option awards are granted with an exercise price equal to the closing market price of our common stock at the date of grant. We have never paid any cash dividends on our common stock, and we have no intention to pay such a dividend at this time; therefore, we assume that no dividends will be paid over the expected terms of option awards.
i
The weighted averages of the valuation assumptions used to determine the fair value of each option award on
the date of grant and the weighted average estimated fair values were as follows:
Inventories are stated at the lower of cost (first-in,
first-out) or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. iThe components of inventories were as follows:
During the third quarter of 2018, we decided to discontinue the development of our in–house SNAP Fecal product and focus resources and capital on supporting fecal antigen testing within our reference laboratories, which resulted in a $i2.6
million impairment of construction in progress production equipment related to SNAP Fecal. This impairment charge was recorded as general and administrative expense in our CAG reporting segment.
NOTE 8. iLEASES
The
majority of our facilities are occupied under operating lease arrangements with various expiration dates through 2067, some of which include options to extend the life of the lease, and some of which include options to terminate the lease within 1 year. In certain instances, we are responsible for the real estate taxes and operating expenses related to these facilities. Additionally, we enter into operating leases for certain vehicles and office equipment in the normal course of business. We determine the expected term of any executed agreements using the non-cancelable lease term plus any renewal options by which the failure to renew imposes a penalty in such amount that renewal is reasonably assured. The derived expected term is then used in the determination of a financing or operating lease and in the calculation of straight-line rent expense. Rent escalations are considered in the calculation of minimum lease payments in our capital lease tests and in determining
straight-line rent expense for operating leases. Minimum lease payments include the fixed lease component of the agreement, as well as fixed rate increases that are initially measured at the lease commencement date. Variable lease payments based on an index, payments associated with non-lease components and short-term rentals (leases with terms less than 12 months) are expensed as incurred. Consideration is allocated to the lease and non-lease components based on the estimated standalone prices.
We determine if an arrangement is a lease at its inception. Operating leases are included in operating lease right-of-use assets, accrued liabilities, and long-term operating lease liabilities in our consolidated balance sheets. Our financing leases are not material to our financial statements.
Right-of-use
assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease liabilities and right-of-use assets are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an explicit rate, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Rent expense for lease payments is recognized on a straight-line basis over the lease term. The operating lease right-of-use assets also includes any rent prepayments, lease incentives upon receipt and straight-line rent expense impacts, which represent the difference between our operating lease liabilities and right-of-use
assets.
17
i
Maturities of operating lease liabilities were as follows:
(in thousands, except lease term and discount
rate)
Current
operating lease liabilities, included in accrued liabilities
$
i14,802
Long-term operating lease liabilities
$
i66,341
Weighted
average remaining lease term - operating leases
i10.7 years
Weighted average discount rate - operating leases
i3.3
%
/
Rent
expense charged to operations under operating leases was approximately $i5.3 million and $i15.6 million during the three
and nine months ended September 30, 2019, respectively. Variable rent and short-term lease expenses were not material.
i
Supplemental cash flow information for leases was as follows:
Cash paid for amounts included in the measurement of operating leases liabilities
$
i14,878
Right-of-use
assets obtained in exchange for operating lease obligations, net of early lease terminations
$
i7,870
/
At
December 31, 2018, under ASC 840, Leases, the minimum annual rental payments under our lease agreements were as follows: $i19.4 million in 2019; $i17.1
million in 2020; $i14.5 million in 2021; $i10.8
million in 2022; $i8.5 million in 2023; and $i36.5
million thereafter.
On December 19, 2014, we entered into a Multicurrency Note Purchase and Private Shelf Agreement among ourselves, Metropolitan Life Insurance Company ("MetLife"), and each of the accredited institutional purchasers named therein (the "Existing Agreement"). Pursuant to the terms of the Existing Agreement, we had the ability to request that MetLife purchase, over
the three-year period beginning on December 19, 2014, up to $i50 million of additional senior promissory notes of ours at a fixed interest rate and with a maturity date not to exceed ififteen
years (the "Shelf Notes").
On March 14, 2019, we amended the Existing Agreement to (i) increase the Shelf Notes facility size from $i50 million to $i150
million, (ii) extend the Shelf Notes facility issuance period from December 19, 2017 to December 20, 2021 and (iii) make various implementing and administrative changes in order to facilitate a $i100 million Shelf Notes issuance on March 14, 2019. We also submitted to MetLife a request to purchase
$i100 million of our Shelf Notes at a i4.19%
per annum rate, due March 14, 2029, (the "Series C Notes"). We used the proceeds received from the Series C Notes for general corporate purposes, including a partial repayment of borrowings under our Credit Facility.
19
NOTE 12. iREPURCHASES
OF COMMON STOCK
We primarily acquire shares by repurchases in the open market. However, we also acquire shares that are surrendered by employees in payment for the minimum required statutory withholding taxes due on the vesting of restricted stock units and the settlement of deferred stock units, otherwise referred to herein as employee surrenders. We issue shares of treasury stock upon the vesting of certain restricted stock units and upon the exercise of certain stock options. The number of shares of treasury stock issued during the three and nine months ended September 30, 2019 and 2018,
was not material.
i
The following is a summary of our open market common stock repurchases, reported on a trade date basis, and shares acquired through employee surrender:
Shares
acquired through employee surrender for statutory tax withholding
i1
i1
i38
i50
Total
shares repurchased
i331
i303
i721
i1,334
Cost
of shares repurchased in the open market
$
i91,051
$
i73,247
$
i165,198
$
i265,209
Cost
of shares for employee surrenders
i277
i390
i7,849
i9,110
Total
cost of shares
$
i91,328
$
i73,637
$
i173,047
$
i274,319
Average
cost per share - open market repurchases
$
i275.50
$
i242.78
$
i241.56
$
i206.59
Average
cost per share - employee surrenders
$
i286.65
$
i253.34
$
i209.20
$
i181.68
Average
cost per share - total
$
i275.53
$
i242.83
$
i239.87
$
i205.65
/
NOTE
13. iINCOME TAXES
Our effective income tax rate was i18.0%
for the three months ended September 30, 2019, as compared to i14.5% for the three months ended September 30, 2018, and i18.5%
for the nine months ended September 30, 2019, as compared to i16.9% for the nine months ended September 30, 2018. The increase in our effective tax rate for the three months ended September
30, 2019, as compared to the same period in the prior year, was primarily driven by lower tax benefits from share-based compensation. The increase in our effective tax rate for the nine months ended September 30, 2019, as compared to the same period in the prior year, was primarily driven by lower tax benefits from share-based compensation, partially offset by a nonrecurring item recorded in the three months ended March 31, 2018, that resulted from the 2017 Tax Cut and Jobs Act.
The effective tax rate for the three and nine months ended September 30, 2019, differed from the U.S. statutory tax rate of 21% primarily due to tax benefits from share-based compensation.
20
NOTE
14. iACCUMULATED OTHER COMPREHENSIVE INCOME
i
The
changes in AOCI, net of tax, consisted of the following:
Basic earnings per share is computed
by dividing net income attributable to our stockholders by the weighted average number of shares of common stock and vested deferred stock units outstanding during the year. The computation of diluted earnings per share is similar to the computation of basic earnings per share, except that the denominator is increased for the assumed exercise of dilutive options and assumed issuance of unvested restricted stock units and unvested deferred stock units using the treasury stock method unless the effect is anti-dilutive. The treasury stock method assumes that proceeds, including cash received from the exercise of employee stock options and the total unrecognized compensation expense for unvested share-based compensation awards, would be used to purchase our common stock at the average market price during the period. Vested deferred stock units outstanding are included in shares outstanding for basic and diluted earnings per share because the associated shares of our common
stock are issuable for no cash consideration, the number of shares of our common stock to be issued is fixed and issuance is not contingent. See Note 5 to the consolidated financial statements in our 2018 Annual Report for additional information regarding deferred stock units.
i
The following is a reconciliation of weighted average shares outstanding for basic and diluted earnings per share:
Shares
outstanding for diluted earnings per share:
Shares outstanding for basic earnings per share
i86,198
i86,756
i86,206
i87,029
Dilutive
effect of share-based payment awards
i1,469
i1,697
i1,427
i1,658
i87,667
i88,453
i87,633
i88,687
/
Certain
options to acquire shares have been excluded from the calculation of shares outstanding for diluted earnings per share because they were anti-dilutive. iThe following table presents information concerning those anti-dilutive options:
Weighted
average number of shares underlying anti-dilutive options
i29
i15
i247
i274
NOTE
16. iCOMMITMENTS, CONTINGENCIES AND GUARANTEES
Commitments
See "Note 8. Leases", for more information regarding our lease commitments.
Contingencies
and Guarantees
We are subject to claims that may arise in the ordinary course of business, including with respect to actual and threatened litigation and other matters. We accrue for loss contingencies when it is probable that future expenditures will be made, and such expenditures can be reasonably estimated. However, the results of legal actions cannot be predicted with certainty, and therefore our actual losses with respect to these contingencies could exceed our accruals. At September 30, 2019, our accruals with respect to actual and threatened litigation were not material.
From time to time, we have received notices alleging that our products infringe third-party proprietary rights, although
we are not aware of any pending litigation with respect to such claims. Patent litigation frequently is complex and expensive, and the outcome of patent litigation can be difficult to predict. There can be no assurance that we will prevail in any infringement proceedings that may be commenced against us. If we lose any such litigation, we may be stopped from selling certain products and/or we may be required to pay damages as a result of the litigation.
22
We have had no significant changes to our contingencies and guarantees discussed in Note 15 to the consolidated financial statements in our 2018 Annual Report.
NOTE
17. iSEGMENT REPORTING
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker (“CODM”), or decision-making group, in deciding how to allocate resources and in assessing performance. Our CODM is our Chief Executive Officer. Our reportable segments include diagnostic and information
technology-based products and services for the veterinary market, which we refer to as the Companion Animal Group (“CAG”), water quality products (“Water”) and diagnostic products and services for livestock and poultry health and to ensure the quality and safety of milk and improve dairy efficiency, which we refer to as Livestock, Poultry and Dairy (“LPD”). Our Other operating segment combines and presents products for the human point-of-care medical diagnostics market with our out-licensing arrangements. Assets are not allocated to segments for internal reporting purposes.
Certain costs are not allocated to our operating segments and are instead reported under the caption “Unallocated Amounts.” These costs include costs that do not align with one of our existing operating segments or are cost prohibitive to allocate, which primarily consist of our
R&D function, regional and country expenses, certain foreign currency revaluation and settlement gains and losses on monetary balances in currencies other than our subsidiaries’ functional currency and unusual items. Corporate support function costs (such as information technology, facilities, human resources, finance and legal), health benefits and incentive compensation are charged to our business segments at pre-determined budgeted amounts or rates. Differences from these pre-determined budgeted amounts or rates are also captured within Unallocated Amounts.
i
The
following is a summary of segment performance:
(in thousands)
For the Three Months Ended September 30,
CAG
Water
LPD
Other
Unallocated
Amounts
Consolidated Total
2019
Revenue
$
i533,130
$
i34,906
$
i31,370
$
i5,897
$
—
$
i605,303
Income
(loss) from operations
$
i124,490
$
i17,045
$
i4,994
$
i1,379
$
(i8,106
)
$
i139,802
Interest
expense, net
(i7,004
)
Income
before provision for income taxes
i132,798
Provision
for income taxes
i23,960
Net
income
i108,838
Less:
Net income attributable to noncontrolling interest
i1
Net
income attributable to IDEXX Laboratories, Inc. stockholders
$
i108,837
2018
Revenue
$
i478,097
$
i33,108
$
i29,420
$
i4,823
$
—
$
i545,448
Income
(loss) from operations
$
i102,241
$
i15,874
$
i4,007
$
i443
$
(i5,215
)
$
i117,350
Interest
expense, net
(i8,311
)
Income
before provision for income taxes
i109,039
Provision
for income taxes
i15,825
Net
income
i93,214
Less:
Net loss attributable to noncontrolling interest
(i37
)
Net
income attributable to IDEXX Laboratories, Inc. stockholders
$
i93,251
/
23
(in
thousands)
For the Nine Months Ended September 30,
CAG
Water
LPD
Other
Unallocated
Amounts
Consolidated Total
2019
Revenue
$
i1,589,397
$
i99,980
$
i95,980
$
i16,105
$
—
$
i1,801,462
Income
(loss) from operations
$
i384,095
$
i47,394
$
i17,637
$
i3,657
$
(i15,568
)
$
i437,215
Interest
expense, net
(i23,503
)
Income
before provision for income taxes
i413,712
Provision
for income taxes
i76,464
Net
income
i337,248
Less:
Net income attributable to noncontrolling interest
i24
Net
income attributable to IDEXX Laboratories, Inc. stockholders
$
i337,224
2018
Revenue
$
i1,456,417
$
i94,909
$
i96,658
$
i15,872
$
—
$
i1,663,856
Income
(loss) from operations
$
i332,435
$
i43,458
$
i13,439
$
i2,071
$
(i15,415
)
$
i375,988
Interest
expense, net
(i25,291
)
Income
before provision for income taxes
i350,697
Provision
for income taxes
i59,327
Net
income
i291,370
Less:
Net loss attributable to noncontrolling interest
(i23
)
Net
income attributable to IDEXX Laboratories, Inc. stockholders
$
i291,393
See
“Note 3. Revenue Recognition” for a summary of disaggregated revenue by reportable segment and by major product and service category for the three and nine months ended September 30, 2019 and 2018.
NOTE 18. iFAIR
VALUE MEASUREMENTS
i
U.S. GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. U.S. GAAP requires an entity to maximize the use of observable inputs, where available, and minimize the use of unobservable inputs when measuring fair value.
We have
certain financial assets and liabilities that are measured at fair value on a recurring basis, certain nonfinancial assets and liabilities that may be measured at fair value on a non-recurring basis and certain financial assets and liabilities that are not measured at fair value in our unaudited condensed consolidated balance sheets but for which we disclose the fair value. The fair value disclosures of these assets and liabilities are based on a three-level hierarchy, which is defined as follows:
Level 1
Quoted prices in active markets for identical assets or liabilities
that the entity can access at the measurement date.
Level 2
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Assets
and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. We did not have any transfers between Level 1 and Level 2 or transfers in or out of Level 3 of the fair value hierarchy during the three and nine months ended September 30, 2019.
24
Our cross currency swap contracts
are measured at fair value on a recurring basis in our accompanying unaudited condensed consolidated balance sheets. We measure the fair value of our cross currency swap contracts classified as derivative instruments using prevailing market conditions as of the close of business on each balance sheet date. The product of this calculation is then adjusted for counterparty risk.
Our foreign currency exchange contracts are measured at fair value on a recurring basis in our accompanying unaudited condensed consolidated balance sheets. We measure the fair value of our foreign currency exchange contracts classified
as derivative instruments using an income approach, based on prevailing market forward rates less the contract rate multiplied by the notional amount. The product of this calculation is then adjusted for counterparty risk.
The amounts outstanding under our unsecured revolving credit facility (“Credit Facility” or “line of credit”) and senior notes (“long-term debt”) are measured at carrying value in our unaudited condensed consolidated balance sheets though we disclose the fair value of these financial instruments. We determine the fair value of the amount outstanding under our Credit Facility and long-term debt using an income approach, utilizing a discounted cash flow analysis based on current market interest rates for debt issues with similar remaining years to maturity,
adjusted for applicable credit risk. Our Credit Facility and long-term debt are valued using Level 2 inputs. The estimated fair value of our Credit Facility approximates its carrying value. The estimated fair value and carrying value of our long-term debt were $i751.9 million and $i697.2
million, respectively, as of September 30, 2019, and $i607.3 million and $i601.8
million, respectively, as of December 31, 2018.
i
The following tables set forth our assets and liabilities that were measured at fair value on a recurring basis by level within the fair value hierarchy:
Money
market funds with an original maturity of less than ninety days are included within cash and cash equivalents. The remaining balance of cash and cash equivalents as of September 30, 2019 and December 31, 2018, consisted of demand deposits.
(2)
Equity mutual funds relate to a deferred compensation plan that was assumed as part of a previous business combination. This amount is included within other long-term assets. See footnote (4) below for a discussion of the related deferred compensation liability.
(3)
Cross
currency swaps and foreign currency exchange contracts are included within other current assets, other long-term assets, accrued liabilities, or other long-term liabilities depending on the gain (loss) position and anticipated settlement date.
(4)
A deferred compensation plan assumed as part of a previous business combination is included within accrued liabilities and other long-term liabilities. The fair value of our deferred compensation plan is indexed to the performance of the underlying equity mutual funds discussed in footnote (2) above.
The
estimated fair value of certain financial instruments, including cash and cash equivalents, accounts receivable and accounts payable, approximate carrying value due to their short maturity.
NOTE 19. iHEDGING INSTRUMENTS
Disclosure
within this note is presented to provide transparency about how and why we use derivative and non-derivative instruments (collectively “hedging instruments”), how the instruments and related hedged items are accounted for, and how the instruments and related hedged items affect our financial position, results of operations and cash flows.
i
We are exposed to certain risks related to our ongoing business operations. The primary risk that we currently manage by using hedging instruments is foreign currency exchange risk.
We may also enter into interest rate swaps to minimize the impact of interest rate fluctuations associated with borrowings under our variable-rate Credit Facility.
Our subsidiaries enter into foreign currency exchange contracts to manage the exchange risk associated with their forecasted intercompany inventory purchases and sales for the next year. From time to time, we may also enter into other foreign currency exchange contracts, cross currency swaps or foreign-denominated debt issuances to minimize the impact of foreign currency fluctuations associated with specific balance sheet exposures, including net
investments in certain foreign subsidiaries.
The primary purpose of our foreign currency hedging activities is to protect against the volatility associated with foreign currency transactions, including transactions denominated in the euro, British pound, Japanese yen, Canadian dollar, and Australian dollar. We also utilize natural hedges to mitigate our transaction and commitment exposures. Our corporate policy prescribes the range of allowable hedging activity. We enter into foreign currency exchange contracts with well-capitalized multinational financial institutions, and we do not hold or engage in transactions involving derivative instruments for purposes other than risk management. Our accounting
policies for these contracts are based on the designation of such instruments as hedging transactions.
We recognize all hedging instruments on the balance sheet at fair value at the balance sheet date. Instruments that do not qualify for hedge accounting treatment must be recorded at fair value through earnings. To qualify for hedge accounting treatment, cash flow and net investment hedges must be highly effective in offsetting changes to expected future cash flows or fair value on hedged transactions. If the instrument qualifies for hedge accounting, changes in the fair value of the hedging instrument from the effective portion of the hedge are deferred in AOCI, net of tax, and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.
We immediately record in earnings the extent to which a hedging instrument is not effective in achieving offsetting changes in fair value. We de-designate hedging instruments from hedge accounting when the likelihood of the hedged transaction occurring becomes less than probable. For de-designated
26
instruments, the gain or loss from the time of de-designation through maturity of the instrument is recognized in earnings. Any gain or loss in AOCI at the time of de-designation is reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. See “Note 14. Accumulated Other Comprehensive Income” for further
information regarding the effect of hedging instruments on our unaudited condensed consolidated statements of income for the three and nine months ended September 30, 2019 and 2018.
We enter into master netting arrangements with the counterparties to our derivative transactions which permit certain outstanding receivables and payables to be offset in the event of default. Our derivative contracts do not require either party to post cash collateral. We elect to present our derivative assets and liabilities in the unaudited condensed consolidated balance
sheets on a gross basis. All cash flows related to our foreign currency exchange contracts are classified as operating cash flows, which is consistent with the cash flow treatment of the underlying items being hedged.
Cash Flow Hedges
We have designated our foreign currency exchange contracts as cash flow hedges as these derivative instruments mitigate the exposure to variability in the cash flows of forecasted transactions attributable to foreign currency exchange. Unless noted otherwise, we have also designated our derivative instruments as qualifying for hedge accounting treatment.
We
did not de-designate any instruments from hedge accounting treatment during either the three and nine months ended September 30, 2019 or 2018. At September 30, 2019, the estimated amount of net gains, net of tax, which are expected to be reclassified out of AOCI and into earnings within the next 12 months, is $i5.9
million if exchange rates do not fluctuate from the levels at September 30, 2019.
We hedge approximately i85% of the estimated exposure from intercompany product purchases and sales denominated
in the euro, British pound, Canadian dollar, Japanese yen, Australian dollar, and, in prior years, the Swiss franc. We have additional unhedged foreign currency exposures related to foreign services and emerging markets where it is not practical to hedge. We primarily utilize foreign currency exchange contracts with durations of less than i24 months. Quarterly, we enter into contracts
to hedge incremental portions of anticipated foreign currency transactions for the current and following year. As a result, our risk with respect to foreign currency exchange rate fluctuations and the notional value of foreign currency exchange contracts may vary throughout the year. The U.S. dollar is the currency purchased or sold in all of our foreign currency exchange contracts. The notional amount of foreign currency exchange contracts to hedge forecasted intercompany inventory purchases and sales totaled $i176.0
million and $i190.9 million at September 30, 2019 and December 31, 2018, respectively.
i
The
following tables present the effect of cash flow hedge accounting on our unaudited condensed consolidated statements of income and comprehensive income, and provide information regarding the location and amounts of pretax gains or losses of derivatives:
Amount of gain (loss) reclassified from accumulated other comprehensive income into income
$
i7,091
$
(i2,412
)
/
27
Net
Investment Hedges
In June 2015, we issued and sold through a private placement an aggregate principal amount of €i88.9 million in euro-denominated i1.785%
Series C Senior Notes due June 18, 2025. We have designated these euro-denominated notes as a hedge of our euro net investment in certain foreign subsidiaries to reduce the volatility in stockholders’ equity caused by changes in foreign currency exchange rates in the euro relative to the U.S. dollar. As a result of this designation, gains and losses from the change in translated U.S. dollar value of these euro-denominated notes are recorded in AOCI rather than to earnings. We recorded gains of $i3.0
million and $i3.5 million, net of tax, within AOCI as a result of this net investment hedge for the three and nine months ended September 30, 2019, respectively.
The related cumulative unrealized gain recorded at September 30, 2019, will not be reclassified in earnings until the complete or substantially complete liquidation of the net investment in the hedged foreign operations or a portion of the hedge no longer qualifies for hedge accounting treatment. See Note 12 to the consolidated financial statements included in our 2018 Annual Report for further information regarding the issuance of these euro-denominated notes.
During May 2018, January 2019, and March 2019, we entered into cross currency swap contracts as a hedge of our net investment in foreign operations to offset foreign currency translation gains
and losses on the net investment. The cross currency swaps have a maturity date of June 30, 2023. At maturity of the cross currency swap contracts, we will deliver the notional amount of €i80.0 million and will receive approximately $i93.5
million from the counterparties. The change in fair value of the cross currency swap contracts are recorded in AOCI and will be reclassified to earnings when the foreign subsidiaries are sold or substantially liquidated. During the three and nine months ended September 30, 2019, we recorded gains of $i3.1
million and $i4.0 million, net of tax, within AOCI as a result of these net investment hedges, respectively. We will receive quarterly interest payments from the counterparties based on a fixed interest rate until maturity of the cross currency swaps. This interest
rate component is excluded from the assessment of hedge effectiveness and, thus is recognized as a reduction to interest expense over the life of the hedge instrument. We recognized approximately $i0.6 million and $i1.7
million related to the excluded component as a reduction of interest expense for the three and nine months ended September 30, 2019, respectively.
i
Fair Values of Hedging Instruments
Designated as Hedges in Consolidated Balance Sheets
The fair values of hedging instruments and their respective classification on our unaudited condensed consolidated balance sheets and amounts subject to offset under master netting arrangements consisted of the following derivative instruments, unless otherwise noted:
Total
derivative instruments presented as cash flow hedges on the balance sheet
i148
i603
Non-derivative
foreign currency denominated debt designated as net investment hedge on the balance sheet(1)
Long-term debt
i97,165
i101,777
Total
hedging instruments presented on the balance sheet
i97,313
i102,380
Gross
amounts subject to master netting arrangements not offset on the balance sheet
i148
i603
Net
amount
$
i97,165
$
i101,777
(1) Amounts
represent reported carrying amounts of our foreign currency denominated debt. See "Note 18. Fair Value Measurements" for information regarding the fair value of our long-term debt.
29
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This Quarterly Report on Form 10-Q contains statements which, to the extent they are not statements of historical fact, constitute “forward-looking statements.” Such
forward-looking statements about our business and expectations within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), include statements relating to future revenue growth rates; future tax benefits; business trends, earnings and other measures of financial performance; the effect of economic downturns on our business performance; projected impact of foreign currency exchange rates; projected charges related to our leadership transition; demand for our products; realizability of assets; future cash flow and uses of cash; future repurchases of common stock; future levels of indebtedness and capital spending; interest expense; warranty expense; share-based compensation expense; the adoption and projected impact of new accounting standards; future commercial efforts; and competition. Forward-looking statements
can be identified by the use of words such as “expects,”“may,”“anticipates,”“intends,”“would,”“will,”“plans,”“believes,”“estimates,”“should,”“project,” and similar words and expressions. These forward-looking statements are intended to provide our current expectations or forecasts of future events; are based on current estimates, projections, beliefs, and assumptions; and are not guarantees of future performance. Actual events or results may differ materially from those described in the forward-looking statements. These forward-looking statements involve a number of risks and uncertainties, including, among other things, the matters described under the headings "Business,""Risk Factors,”"Legal Proceedings,""Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Quantitative and Qualitative Disclosure About Market
Risk" in our 2018 Annual Report and in the corresponding sections of this Quarterly Report on Form 10-Q, as well as those described from time to time in our other periodic reports filed with the SEC.
Any forward-looking statements represent our estimates only as of the day this Quarterly Report on Form 10-Q was filed with the SEC and should not be relied upon as representing our estimates as of any subsequent date. From time to time, oral or written forward-looking statements may also be included in other materials released to the public. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates or expectations change.
You should read
the following discussion and analysis in conjunction with our 2018 Annual Report that includes additional information about us, our results of operations, our financial position, and our cash flows, and with our unaudited condensed consolidated financial statements and related notes included in Part I. Item 1. of this Quarterly Report on Form 10-Q.
Business Overview
We develop, manufacture, and distribute products and provide services primarily for the companion animal veterinary, livestock, poultry and dairy, and water testing markets. We also sell a line of portable electrolytes and blood gas analyzers for the human point-of-care medical diagnostics market. Our primary products and services are:
•
Point-of-care
veterinary diagnostic products, comprising instruments, consumables, and rapid assay test kits;
•
Veterinary reference laboratory diagnostic and consulting services;
•
Practice management and diagnostic imaging systems and services used by veterinarians;
•
Health monitoring, biological materials
testing, laboratory diagnostic instruments and services used by the biomedical research community;
•
Diagnostic, health-monitoring products for livestock, poultry, and dairy;
•
Products that test water for certain microbiological contaminants;
•
Point-of-care electrolytes and blood gas analyzers
used in the human point-of-care medical diagnostics market.
Operating Segments. We operate primarily through three business segments: diagnostic and information technology-based products and services for the veterinary market, which we refer to as the Companion Animal Group (“CAG”), water quality products (“Water”) and diagnostic products and services for livestock and poultry health and to ensure the quality and safety of milk and improve dairy reproductive efficiency, which we refer to as Livestock, Poultry and Dairy (“LPD”). Our Other operating segment combines and presents products for the human point-of-care medical diagnostics market (“OPTI Medical”) with our out-licensing arrangements because they do not meet the quantitative or qualitative thresholds for reportable segments.
CAG
develops, designs, manufactures, and distributes products and performs services for veterinarians and the biomedical analytics market, primarily related to diagnostics and information management. Water develops, designs, manufactures, and distributes a range of products used in the detection of various microbiological parameters in water. LPD
30
develops, designs, manufactures, and distributes diagnostic tests and related software and performs services that are used to manage the health status of livestock and poultry, to improve bovine reproductive efficiency, and to ensure the quality and safety of milk and food. OPTI Medical manufactures and distributes point-of-care electrolyte and blood gas analyzers and related consumable products for the human
medical diagnostics market.
Certain costs are not allocated to our operating segments and are instead reported under the caption “Unallocated Amounts.” These costs include costs that do not align with one of our existing operating segments or are cost prohibitive to allocate, which primarily consist of our R&D function, regional or country expenses, certain foreign currency revaluation and settlement gains and losses on monetary balances in currencies other than our subsidiaries’ functional currency and unusual items. Corporate support function costs (such as information technology, facilities, human resources, finance and legal), health benefits and incentive compensation are charged to our business segments at pre-determined budgeted amounts or rates. Differences from these
pre-determined budgeted amounts or rates are also captured within Unallocated Amounts.
Executive Officers and Directors. As reported previously, effective October 23, 2019, our Board of Directors (our “Board”) appointed Jonathan (Jay) Mazelsky as our President and Chief Executive Officer and as a director of the Company. Mr. Mazelsky had been serving as our Interim President and Chief Executive Officer since June 28, 2019. Prior to that time, since August 2012, Mr. Mazelsky had been an Executive Vice President of the Company. In addition, effective November
1, 2019, Lawrence D. Kingsley, a Company director since October 2016 and Lead Independent Director since May 2018, will be appointed as Independent Non-Executive Chairman of our Board. Also, effective November 1, 2019, Jonathan W. Ayers, our Chairman and former President and Chief Executive Officer, who has been on a medical leave of absence since June 28, 2019, will step down as Chairman of our Board, cease to be an employee of the Company and transition to the role of external Senior Advisor to the Company. Mr. Ayers will continue to serve as a member of our Board. While we cannot provide assurances as to whether we may experience management or other challenges in connection with our leadership transition
that could adversely affect our future success, we believe that under the leadership of Mr. Mazelsky as President and Chief Executive Officer and Mr. Kingsley as Independent Non-Executive Chairman, we will continue to successfully execute our strategy and create long-term value for shareholders, customers and employees.
In connection with the foregoing, Mr. Ayers and IDEXX entered into a mutual separation agreement pursuant to which severance payments will be made to Mr. Ayers and his outstanding stock options were modified. As a result of his severance payments and the modification of Mr. Ayers’s outstanding stock options, we expect to recognize a charge to operating income of approximately $13.4 million in the fourth quarter of 2019, representing the cost of the severance and an acceleration of the cost of the equity awards. In addition, we expect to increase our provision
for income taxes by approximately $2.1 million, including a reduction of deferred tax assets related to previously recognized stock option tax benefits, resulting in a total charge to net income of approximately $15.5 million, net of tax impacts.
Effects of Certain Factorsand Trendson Results of Operations
Currency Impact. See “Part I. Item 3. Quantitative and Qualitative Disclosures about Market Risk” included in this Quarterly Report on Form 10-Q for additional information regarding the impact of foreign currency exchange rates.
Other
Items. See “Part I. Item 1. Business - Patents and Licenses” and “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2018 Annual Report for additional information regarding distributor purchasing and inventories, economic conditions, and patent expiration.
Critical Accounting Estimates and Assumptions
The discussion and analysis of our financial condition and results of operations is based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. The critical accounting policies and the significant judgments and estimates used in the preparation of our unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2019, are consistent with those discussed in our 2018 Annual Report in the section under the heading
“Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates and Assumptions.”
31
Recent Accounting Pronouncements
For more information regarding the impact that recent accounting standards and amendments will have on our consolidated financial statements as described in Note 2 to the unaudited condensed consolidated financial statements in Part I. Item 1. of this Quarterly Report on Form 10-Q.
Non-GAAP
Financial Measures
The following revenue analysis and discussion focuses on organic revenue growth, and references in this analysis and discussion to “revenue,”“revenues” or “revenue growth” are references to “organic revenue growth.” Organic revenue growth is a non-GAAP financial measure and represents the percentage change in revenue during the three and nine months ended September 30, 2019, as compared to the same period for the prior year, net of the effect of changes in foreign currency exchange rates, certain business acquisitions, and divestitures. Organic revenue growth should be considered in addition to, and not as a replacement for, or as a superior measure to, revenues reported in accordance with
U.S. GAAP, and may not be comparable to similarly titled measures reported by other companies. Management believes that reporting organic revenue growth provides useful information to investors by facilitating easier comparisons of our revenue performance with prior and future periods and to the performance of our peers.
We exclude from organic revenue growth the effect of changes in foreign currency exchange rates because changes in foreign currency exchange rates are not under management’s control, are subject to volatility, and can obscure underlying business trends. We calculate the impact on revenue resulting from changes in foreign currency exchange rates by applying the difference between the weighted average exchange rates during the current year period and the comparable prior year period to foreign currency denominated revenues for the prior year period.
We also exclude from
organic revenue growth the effect of certain business acquisitions and divestitures because the nature, size and number of these transactions can vary dramatically from period to period, and because they either require or generate cash as an inherent consequence of the transaction, and therefore can also obscure underlying business and operating trends. We exclude only acquisitions that are considered to be a business from organic revenue growth. In a business combination, if substantially all the fair value of the assets acquired is concentrated in a single asset or group of similar assets, we do not consider these assets to be a business and include these acquisitions in organic revenue growth. A typical acquisition that we do not consider a business is a customer list asset acquisition, which does not have all elements necessary to operate a business, such as employees or infrastructure. We believe the efforts required to convert and retain these acquired customers
are similar in nature to our existing customer base and therefore are included in organic revenue growth.
We also use Adjusted EBITDA, gross debt, net debt, gross debt to Adjusted EBITDA ratio and net debt to Adjusted EBITDA ratio, in this Quarterly Report on Form 10-Q, all of which are non-GAAP financial measures that should be considered in addition to, and not as a replacement for, financial measures presented according to U.S. GAAP. Management believes that reporting these non-GAAP financial measures provides supplemental analysis to help investors further evaluate our business performance and available borrowing capacity under our Credit Facility.
Comparison to Prior Periods
Our fiscal
quarter(s) ended on September 30. Unless otherwise stated, the analysis and discussion of our financial condition and results of operations below, including references to growth and organic growth and increases and decreases, are being compared to the equivalent prior year periods.
Total Company. The following table presents total Company revenue by operating segment:
For
the Three Months Ended September 30,
Net Revenue
(dollars in thousands)
2019
2018
Dollar
Change
Reported Revenue Growth(1)
Percentage Change from Currency
Percentage Change from Acquisitions
Organic Revenue Growth(1)
CAG
$
533,130
$
478,097
$
55,033
11.5
%
(1.2
%)
—
12.7
%
United
States
357,810
319,561
38,249
12.0
%
—
—
12.0
%
International
175,320
158,536
16,784
10.6
%
(3.6
%)
—
14.2
%
Water
34,906
33,108
1,798
5.4
%
(1.7
%)
—
7.1
%
United
States
16,794
15,878
916
5.8
%
—
—
5.8
%
International
18,112
17,230
882
5.1
%
(3.3
%)
—
8.4
%
LPD
31,370
29,420
1,950
6.6
%
(2.9
%)
—
9.5
%
United
States
3,649
3,502
147
4.2
%
—
—
4.2
%
International
27,721
25,918
1,803
7.0
%
(3.3
%)
—
10.3
%
Other
5,897
4,823
1,074
22.2
%
—
—
22.2
%
Total
Company
$
605,303
$
545,448
$
59,855
11.0
%
(1.3
%)
—
12.3
%
United
States
380,184
340,692
39,492
11.6
%
—
—
11.6
%
International
225,119
204,756
20,363
9.9
%
(3.5
%)
—
13.4
%
(1)
Reported
revenue growth and organic revenue growth may not recalculate due to rounding.
Total Company Revenue. The increase in both U.S. and international organic revenues was driven by strong volume gains in CAG Diagnostics recurring revenue, supported by our differentiated diagnostic technologies and expanded commercial organization that are driving increased volumes from new and existing customers in our reference laboratory business and high growth in consumable revenue, supported by the impact of the continued expansion of our CAG Diagnostics instrument installed base globally, as well as a 1% growth benefit from greater equivalent business days. The growth in our LPD business was primarily due to strong performance in Asia compared to a weaker performance in the prior year
in that region, including impacts from the African swine fever outbreak. Our Water business also contributed to our overall growth, primarily from higher sales volumes of our Colilert® test products and related accessories. The impact of currency movements decreased revenue by 1.3%.
33
The following table presents total Company results of operations:
For
the Three Months Ended September 30,
Change
Total Company - Results of Operations
(dollars in thousands)
2019
Percent of Revenue
2018
Percent of Revenue
Amount
Percentage
Revenues
$
605,303
$
545,448
$
59,855
11.0
%
Cost
of revenue
260,353
239,805
20,548
8.6
%
Gross
profit
344,950
57.0
%
305,643
56.0
%
39,307
12.9
%
Operating
Expenses:
Sales and marketing
104,551
17.3
%
95,146
17.4
%
9,405
9.9
%
General
and administrative
66,337
11.0
%
63,955
11.7
%
2,382
3.7
%
Research
and development
34,260
5.7
%
29,192
5.4
%
5,068
17.4
%
Total
operating expenses
205,148
33.9
%
188,293
34.5
%
16,855
9.0
%
Income
from operations
$
139,802
23.1
%
$
117,350
21.5
%
$
22,452
19.1
%
Gross
Profit. Gross profit increased due to higher sales volumes and a 100 basis point increase in the gross profit margin. The increase in the gross profit margin was driven by several factors, including the net benefit of price increases in our CAG Diagnostics recurring revenue portfolio, mix benefits from high growth in IDEXX VetLab consumable revenues, volume leverage, and the favorable impact of lower product costs in our CAG business. The impact from foreign currency movements increased gross profit margin by approximately 35 basis points, including the impact of higher hedge gains in the current period, as compared to the prior period.
Operating Expenses. The
changes in currency exchange rates, including foreign exchange losses on settlements of foreign currency denominated transactions recorded within Unallocated Amounts, resulting in approximately a 1% decrease to our overall operating expenses. Sales and marketing expense increased approximately 11%, excluding the impact of foreign currency, primarily due to increased personnel-related costs from our expanded global commercial infrastructure. General and administrative expense increased approximately 4%, excluding the impact of foreign currency, primarily due to personnel related costs, partially offset from the benefits of cost control initiatives. Research and development expense increased primarily due to higher project and personnel-related costs, with an immaterial impact from foreign currency.
34
Companion
Animal Group
The following table presents revenue by product and service category for CAG:
For
the Three Months Ended September 30,
Net Revenue
(dollars in thousands)
2019
2018
Dollar
Change
Reported Revenue Growth(1)
Percentage Change from Currency
Percentage Change from Acquisitions
Organic Revenue Growth(1)
CAG
Diagnostics recurring revenue:
$
460,974
$
409,162
$
51,812
12.7
%
(1.2
%)
—
13.9
%
IDEXX
VetLab consumables
177,276
152,509
24,767
16.2
%
(1.6
%)
—
17.8
%
Rapid
assay products
58,930
53,821
5,109
9.5
%
(0.5
%)
—
10.0
%
Reference
laboratory diagnostic and consulting services
204,919
184,103
20,816
11.3
%
(1.2
%)
—
12.5
%
CAG
diagnostics services and accessories
19,849
18,729
1,120
6.0
%
(1.3
%)
—
7.3
%
CAG
Diagnostics capital - instruments
32,608
31,561
1,047
3.3
%
(1.6
%)
—
4.9
%
Veterinary
software, services and diagnostic imaging systems
39,548
37,374
2,174
5.8
%
(0.3
%)
—
6.1
%
Net
CAG revenue
$
533,130
$
478,097
$
55,033
11.5
%
(1.2
%)
—
12.7
%
(1)
Reported
revenue growth and organic revenue growth may not recalculate due to rounding
CAG Diagnostics Recurring Revenue. The increase in CAG Diagnostics recurring revenue was primarily due to increased volumes in IDEXX VetLab consumables and reference laboratory diagnostic services, and to a lesser extent, higher realized prices. Greater equivalent business days contributed approximately 2% to revenue growth.
The increase in IDEXX VetLab consumables revenue was primarily due to higher sales volumes across all regions for our Catalyst® consumables and, to a lesser extent, Procyte Dx®
consumables. These increases were supported by an expansion of our instrument installed base, growth in testing by new and existing customers, our expanded menu of available tests, and to a lesser extent, benefits from higher average unit sales prices. Greater equivalent business days contributed approximately 3% to revenue growth.
The increase in rapid assay revenue resulted primarily from higher sales volumes across our SNAP® product portfolio, driven by SNAP® 4Dx® Plus, and to a lesser extent, higher realized prices. Greater equivalent business days contributed approximately 3% to revenue growth.
The
increase in reference laboratory diagnostic and consulting services revenue was primarily due to the impact of higher testing volumes throughout our worldwide network of laboratories, most prominently in the U.S., resulting from increased testing from new and existing customers, supported by our differentiated diagnostic technologies, such as IDEXX SDMAand fecal antigen testing, as well as higher average unit sales prices.
The increase in CAG Diagnostics services and accessories revenue was primarily a result of the increase in our active installed base of instruments.
CAG Diagnostics Capital – Instruments Revenue. The increase
in instrument revenue reflects higher Catalyst One, Procyte Dx, and LaserCyte® Dx instrument placements. These increases were partially offset by lower allocated revenue per unit on our IDEXX VetLab instruments related to increased international placements under our customer volume commitment programs.
35
Veterinary Software, Services and Diagnostic Imaging Systems Revenue.The increase in revenue was primarily due to increased veterinary
software, subscription-based services, as well as higher realized prices on these service offerings, and to a lesser extent, higher diagnostic imaging services as a result of the increase in our active installed base. These increases were partially offset by lower allocated revenue per unit on our diagnostic imaging systems related to increased placements under our customer volume commitment programs, as well as comparisons to high digital imaging system placement levels in the prior year.
The following table presents the CAG segment results of operations:
For
the Three Months Ended September 30,
Change
Results of Operations
(dollars in thousands)
2019
Percent of Revenue
2018
Percent of Revenue
Amount
Percentage
Revenues
$
533,130
$
478,097
$
55,033
11.5
%
Cost
of revenues
235,041
216,235
18,806
8.7
%
Gross
profit
298,089
55.9
%
261,862
54.8
%
36,227
13.8
%
Operating
Expenses:
Sales and marketing
94,234
17.7
%
85,655
17.9
%
8,579
10.0
%
General
and administrative
54,424
10.2
%
52,113
10.9
%
2,311
4.4
%
Research
and development
24,941
4.7
%
21,853
4.6
%
3,088
14.1
%
Total
operating expenses
173,599
32.6
%
159,621
33.4
%
13,978
8.8
%
Income
from operations
$
124,490
23.4
%
$
102,241
21.4
%
$
22,249
21.8
%
Gross
Profit. Gross profit increased primarily due to higher sales volume as well as a 110 basis point increase in the gross profit margin. The increase in gross profit margin was driven by the mix benefits from high growth in IDEXX VetLab consumable revenues, volume leverage, lower product costs, as well as the net benefit of price increases in our CAG Diagnostics recurring revenue portfolio, partially offset by incremental investments in reference laboratory capacity and software services field resources. The impact from foreign currency movements increased gross profit margin by approximately 20 basis points, including the impact of higher hedge gains in the current period, as compared to the prior period.
Operating
Expenses. The increase in sales and marketing expense was primarily due to increased personnel-related costs related to our expanded global commercial infrastructure. The increase in general and administrative expense was the result of higher personnel-related costs. The increase in research and development expense was primarily due to increased personnel-related costs and higher project costs. The overall change in currency exchange rates decreased operating expenses by approximately 1%.
36
Water
The
following table presents the Water segment results of operations:
For the Three Months Ended September 30,
Change
Results
of Operations
(dollars in thousands)
2019
Percent of Revenue
2018
Percent of Revenue
Amount
Percentage
Revenues
$
34,906
$
33,108
$
1,798
5.4
%
Cost
of revenue
9,536
9,685
(149
)
(1.5
%)
Gross
profit
25,370
72.7
%
23,423
70.7
%
1,947
8.3
%
Operating
Expenses:
Sales and marketing
4,012
11.5
%
3,823
11.5
%
189
4.9
%
General
and administrative
3,290
9.4
%
3,086
9.3
%
204
6.6
%
Research
and development
1,023
2.9
%
640
1.9
%
383
59.8
%
Total
operating expenses
8,325
23.8
%
7,549
22.8
%
776
10.3
%
Income
from operations
$
17,045
48.8
%
$
15,874
47.9
%
$
1,171
7.4
%
Revenue.
The increase in revenue was primarily attributable to the benefit of price increases and higher sales volumes of our Colilert test products and related accessories used in coliform and E. coli testing, with strong volume growth rates in most regions, including the U.S. The impact of currency movements decreased revenue by approximately 1.7%.
Gross Profit.Gross profit increased due to higher sales volumes, as well as a 200 basis point increase in the gross profit margin. Foreign currency movements increased the
gross profit margin by approximately 90 basis points, including the impact of higher hedge gains in the current period, as compared to the prior period. The remaining increase in the gross profit margin was primarily due to the net benefit of price increases and favorable product mix, partially offset by higher product costs.
Operating Expenses. The increases in sales and marketing and research and development expenses were primarily due to higher personnel-related costs. The realignment of certain personnel within operating expense categories also increased research and development costs and reduced sales and marketing costs. General and administrative expense increased primarily due to increased personnel-related costs. The overall change in currency exchange rates resulted in a decrease in operating expenses of approximately
2%.
37
Livestock, Poultry and Dairy
The following table
presents the LPD segment results of operations:
For the Three Months Ended September 30,
Change
Results
of Operations
(dollars in thousands)
2019
Percent of Revenue
2018
Percent of Revenue
Amount
Percentage
Revenues
$
31,370
$
29,420
$
1,950
6.6
%
Cost
of revenue
13,225
12,187
1,038
8.5
%
Gross
profit
18,145
57.8
%
17,233
58.6
%
912
5.3
%
Operating
Expenses:
Sales and marketing
5,716
18.2
%
5,728
19.5
%
(12
)
(0.2
%)
General
and administrative
4,174
13.3
%
4,684
15.9
%
(510
)
(10.9
%)
Research
and development
3,261
10.4
%
2,814
9.6
%
447
15.9
%
Total
operating expenses
13,151
41.9
%
13,226
45.0
%
(75
)
(0.6
%)
Income
from operations
$
4,994
15.9
%
$
4,007
13.6
%
$
987
24.6
%
Revenue. The
prolonged outbreak of African swine fever in Asia, which began with the first reported outbreak in August 2018, continues to negatively impact the swine population in China, however demand for new diagnostic testing programs has increased and diagnostic testing for alternative food sources has also increased, including poultry, which more than offset the lower recurring swine testing volumes. Revenue growth in the quarter also benefited from a favorable comparison to soft prior year results in Asia, in part impacted by the African swine fever outbreak. These favorable factors were partially offset by lower herd health screening, which compares to very strong prior year levels, and the unfavorable impact of foreign currency movements that decreased revenue by 2.9%.
Gross Profit.The
increase in gross profit was primarily due to higher sales volume, partially offset by an 80 basis point decrease in the gross profit margin. Foreign currency movements increased the gross profit margin by approximately 170 basis points, including the impact of higher hedge gains in the current period, as compared to the prior period. The overall decrease in the gross profit margin was driven by higher product related costs and product mix impacts from lower herd health screening volumes.
Operating Expenses. The decrease in sales and marketing expense was primarily due to lower personnel-related costs mostly offset by third-party costs. The decrease
in general and administrative expense was primarily due to lower third-party services and travel costs, as a result of cost control initiatives. The increase in research and development expense was primarily due to increased personnel-related costs. The overall change in currency exchange rates resulted in a decrease in operating expenses of approximately 2%.
38
Other
The following table presents the Other results of operations:
For
the Three Months Ended September 30,
Change
Results of Operations
(dollars in thousands)
2019
Percent of Revenue
2018
Percent of Revenue
Amount
Percentage
Revenues
$
5,897
$
4,823
$
1,074
22.3
%
Cost
of revenue
3,032
2,171
861
39.7
%
Gross
profit
2,865
48.6
%
2,652
55.0
%
213
8.0
%
Operating
Expenses:
Sales and marketing
357
6.1
%
423
8.8
%
(66
)
(15.6
%)
General
and administrative
683
11.6
%
1,557
32.3
%
(874
)
(56.1
%)
Research
and development
446
7.6
%
229
4.7
%
217
94.8
%
Total
operating expenses
1,486
25.2
%
2,209
45.8
%
(723
)
(32.7
%)
Income
from operations
$
1,379
23.4
%
$
443
9.2
%
$
936
211.3
%
Revenue.The
increase in revenue was primarily due to higher volumes of our OPTI Medical products and services, partially offset by lower realized prices. Revenue growth also benefited from a favorable comparison to soft prior year results in the Middle East and Asia. The impact of currency movements on revenue was immaterial.
Gross Profit. The increase in gross profit was primarily due to higher volumes, despite a 6.4% decrease in the gross profit margin primarily due to lower price realization, higher service costs and unfavorable product mix. These decreases in the gross profit margin were partially offset by lower costs on OPTI Medical products and lower distribution expense. The overall change in currency
exchange rates had an immaterial impact on gross profit.
Operating Expenses. The decrease in sales and marketing expense was primarily due to lower personnel-related costs. The decrease in general and administrative expense was primarily due to the recovery of previously established bad debt reserves in the Middle East. The increase in research and development cost was primarily due to higher personnel-related and project costs.
39
Unallocated
Amounts
We estimate certain personnel-related costs and allocate these budgeted expenses to the operating segments. This allocation differs from actual expense and consequently yields a difference that is reported under the caption “Unallocated Amounts.”
The following table presents the Unallocated Amounts results of operations:
For
the Three Months Ended September 30,
Change
Results of Operations
(dollars in thousands)
2019
2018
Amount
Percentage
Revenues
$
—
$
—
$
—
—
Cost
of revenue
(481
)
(473
)
(8
)
1.7
%
Gross
profit
481
473
8
1.7
%
Operating
Expenses:
Sales and marketing
232
(483
)
715
(148.0
%)
General
and administrative
3,766
2,515
1,251
49.7
%
Research
and development
4,589
3,656
933
25.5
%
Total
operating expenses
8,587
5,688
2,899
51.0
%
Loss
from operations
$
(8,106
)
$
(5,215
)
$
(2,891
)
55.4
%
Unallocated
Amounts. The change in unallocated amounts was due to higher unallocated employee incentive costs and higher unallocated employee benefit costs, partially offset by lower unallocated corporate function costs due to cost control initiatives.
Non-Operating Items
Interest Expense. Interest expense was $7.1 million for the three months ended September 30, 2019, as compared to $8.5 million for the same period in the prior year. The decrease in interest expense was the result of lower average debt levels, offset by slightly higher interest
rates. We also realized lower interest expense from the benefit of our cross currency swaps, as well as increased capitalized interest related to the expansion of our Westbrook, Maine headquarters and relocation of our core reference laboratory in Germany.
Provision for Income Taxes.Our effective income tax rate was 18.0% for the three months ended September 30, 2019, as compared to 14.5% for the three months ended September 30, 2018. The increase in our effective
tax rate was primarily driven by lower tax benefits from share-based compensation.
During the quarter, the Swiss government enacted changes to Swiss federal tax laws and required all Swiss cantons to make conforming changes to their own laws. As the cantons consider how to implement the required changes throughout this year and in early 2020, we will continue assessing the impact, if any, of the canton’s adoption of Swiss federal tax reform. The impact of any such change will be recorded upon the date of canton's enactment.
Total Company. The following table presents total Company revenue by operating segment:
For
the Nine Months Ended September 30,
Net Revenue
(dollars in thousands)
2019
2018
Dollar
Change
Reported Revenue Growth(1)
Percentage Change from Currency
Percentage Change from Acquisitions
Organic Revenue Growth(1)
CAG
$
1,589,397
$
1,456,417
$
132,980
9.1
%
(1.8
%)
0.1
%
10.9
%
United
States
1,062,715
962,712
100,003
10.4
%
—
0.1
%
10.3
%
International
526,682
493,705
32,977
6.7
%
(5.5
%)
0.1
%
12.1
%
Water
99,980
94,909
5,071
5.3
%
(2.9
%)
—
8.3
%
United
States
48,157
45,539
2,618
5.8
%
—
—
5.8
%
International
51,823
49,370
2,453
5.0
%
(5.7
%)
—
10.7
%
LPD
95,980
96,658
(678
)
(0.7
%)
(4.8
%)
—
4.1
%
United
States
10,221
10,496
(275
)
(2.6
%)
—
—
(2.6
%)
International
85,759
86,162
(403
)
(0.5
%)
(5.4
%)
—
5.0
%
Other
16,105
15,872
233
1.5
%
—
—
1.5
%
Total
Company
$
1,801,462
$
1,663,856
$
137,606
8.3
%
(2.1
%)
0.1
%
10.3
%
United
States
1,127,347
1,024,889
102,458
10.0
%
—
0.1
%
9.9
%
International
674,115
638,967
35,148
5.5
%
(5.4
%)
0.1
%
10.9
%
(1)
Reported
revenue growth and organic revenue growth may not recalculate due to rounding.
Total Company Revenue. The increase in both U.S. and international organic revenues was driven by strong volume gains in CAG Diagnostics recurring revenue, supported by our differentiated diagnostic technologies and expanded commercial organization that are driving increased volumes from new and existing customers in our reference laboratory business and high growth in consumable revenues, supported by the impact of the continued expansion of our CAG Diagnostics instrument installed base globally. Our Water business also contributed to our overall growth, primarily from higher sales volumes of our Colilert test products and related accessories. The impact of currency movements decreased revenue
by 2.1%.
41
The following table presents total Company results of operations:
For
the Nine Months Ended September 30,
Change
Total Company - Results of Operations
(dollars in thousands)
2019
Percent of Revenue
2018
Percent of Revenue
Amount
Percentage
Revenues
$
1,801,462
$
1,663,856
$
137,606
8.3
%
Cost
of revenue
767,062
722,675
44,387
6.1
%
Gross
profit
1,034,400
57.4
%
941,181
56.6
%
93,219
9.9
%
Operating
Expenses:
Sales and marketing
312,499
17.3
%
291,502
17.5
%
20,997
7.2
%
General
and administrative
186,653
10.4
%
185,966
11.2
%
687
0.4
%
Research
and development
98,033
5.4
%
87,725
5.3
%
10,308
11.8
%
Total
operating expenses
597,185
33.2
%
565,193
34.0
%
31,992
5.7
%
Income
from operations
$
437,215
24.3
%
$
375,988
22.6
%
$
61,227
16.3
%
Gross
Profit. Gross profit increased due to higher sales volumes and an 80 basis point increase in the gross profit margin. The increase in the gross profit margin was driven by several factors, including the net benefit of price increases in our CAG Diagnostics recurring revenue portfolio, mix benefits from high growth in IDEXX VetLab consumable revenues, volume leverage, and the favorable impact of lower product costs in our CAG business. The impact from foreign currency movements increased gross profit margin by approximately 20 basis points, including the impact of hedge gains in the current year, as compared to hedge losses in the prior year.
Operating
Expenses. The overall change in currency exchange rates resulted in a decrease in operating expenses of approximately 2%, including lower foreign exchange losses on settlements of foreign currency denominated transactions recorded within Unallocated Amounts. Sales and marketing expense increased approximately 9%, excluding the impact of foreign currency, primarily due to increased personnel-related costs related to our expanded global commercial infrastructure. General and administrative expense increased approximately 2.5%, excluding the impact of foreign currency, primarily due to personnel related costs, partially offset from the benefits of cost control initiatives across our business segments. Research and development expense increased primarily due to higher personnel-related costs, with an immaterial impact from foreign currency.
42
Companion
Animal Group
The following table presents revenue by product and service category for CAG:
For
the Nine Months Ended September 30,
Net Revenue
(dollars in thousands)
2019
2018
Dollar
Change
Reported Revenue Growth (1)
Percentage Change from Currency
Percentage Change from Acquisitions
Organic Revenue Growth(1)
CAG
Diagnostics recurring revenue:
$
1,382,196
$
1,252,876
$
129,320
10.3
%
(1.9
%)
—
12.2
%
IDEXX
VetLab consumables
519,646
460,642
59,004
12.8
%
(2.4
%)
—
15.2
%
Rapid
assay products
181,966
169,200
12,766
7.5
%
(1.0
%)
—
8.5
%
Reference
laboratory diagnostic and consulting services
621,469
568,308
53,161
9.4
%
(1.8
%)
—
11.1
%
CAG
diagnostics services and accessories
59,115
54,726
4,389
8.0
%
(2.3
%)
—
10.3
%
CAG
Diagnostics capital - instruments
92,883
97,000
(4,117
)
(4.2
%)
(2.5
%)
—
(1.8
%)
Veterinary
software, services and diagnostic imaging systems
114,318
106,541
7,777
7.3
%
(0.4
%)
1.3
%
6.4
%
Net
CAG revenue
$
1,589,397
$
1,456,417
$
132,980
9.1
%
(1.8
%)
0.1
%
10.9
%
(1)
Reported
revenue growth and organic revenue growth may not recalculate due to rounding
CAG Diagnostics Recurring Revenue. The increase in CAG Diagnostics recurring revenue was primarily due to increased volumes in IDEXX VetLab consumables and reference laboratory diagnostic services, and to a lesser extent, higher realized prices.
The increase in IDEXX VetLabconsumables revenue was primarily due to higher sales volumes across all regions for our Catalyst consumables, and to a lesser extent, Procyte Dx consumables. These increases were supported by an expansion of our instrument installed base, growth in testing by new and existing customers,
our expanded menu of available tests, and to a lesser extent, benefits from higher average unit sales prices.
The increase in rapid assay revenue resulted primarily from higher sales volumes across our SNAP product portfolio, driven by SNAP 4Dx Plus, and to a lesser extent, higher realized prices.
The increase in reference laboratory diagnostic and consulting services revenue was primarily due to the impact of higher testing volumes throughout our worldwide network of laboratories, most prominently in the U.S., resulting from increased testing from new and existing customers, supported by our differentiated diagnostic technologies, such as IDEXX SDMAand
fecal antigen testing. The increase was also the result of higher average unit sales prices.
The increase in CAG Diagnostics services and accessories revenue was primarily a result of the increase in our active installed base of instruments.
CAG Diagnostics Capital – Instruments Revenue. The decrease in instrument revenue reflects the impact of product mix, including lower SediVue Dx placements compared to high prior year levels, as well as the impact of lower allocated revenue per unit on our IDEXX VetLab instruments related to increased international placements under our customer volume commitment programs, partially offset by higher Catalyst and Procyte Dx instrument placements.
Veterinary
Software, Services and Diagnostic Imaging Systems Revenue.The increase in revenue was primarily due to increased veterinary software, subscription-based services, as well as higher realized prices on these service offerings, and to a lesser extent, higher diagnostic imaging services as a result of the increase in our active installed base. These increases were partially offset by lower allocated revenue per unit on our diagnostic imaging systems related to increased placements under
43
our volume commitment programs. Our acquisition of a software company in the second half of 2018 contributed approximately 1.3%
to reported revenue growth.
The following table presents the CAG segment results of operations:
For the Nine Months Ended September
30,
Change
Results of Operations
(dollars in thousands)
2019
Percent of Revenue
2018
Percent of Revenue
Amount
Percentage
Revenues
$
1,589,397
$
1,456,417
$
132,980
9.1
%
Cost
of revenue
692,181
646,712
45,469
7.0
%
Gross
profit
897,216
56.5
%
809,705
55.6
%
87,511
10.8
%
Operating
Expenses:
Sales and marketing
282,240
17.8
%
259,429
17.8
%
22,811
8.8
%
General
and administrative
158,785
10.0
%
153,241
10.5
%
5,544
3.6
%
Research
and development
72,096
4.5
%
64,600
4.4
%
7,496
11.6
%
Total
operating expenses
513,121
32.3
%
477,270
32.8
%
35,851
7.5
%
Income
from operations
$
384,095
24.2
%
$
332,435
22.8
%
$
51,660
15.5
%
Gross
Profit. Gross profit increased primarily due to higher sales volume as well as a 90 basis point increase in the gross profit margin. The increase in gross profit margin was driven by mix benefits from high growth in IDEXX VetLab consumable revenues, volume leverage, lower product costs, as well as the net benefit of price increases in our CAG Diagnostics recurring revenue portfolio, partially offset by incremental investments in reference laboratory capacity and software services field resources. The impact from foreign currency movements increased gross profit margin by approximately 10 basis points, including the impact of hedge gains in the current year, as compared to hedge losses in the prior year.
Operating Expenses. The increase
in sales and marketing expense was primarily due to increased personnel-related costs as we continue to invest in our global commercial infrastructure. The increase in general and administrative expense resulted primarily from higher personnel-related costs. The increase in research and development expense was primarily due to increased personnel-related costs and higher project costs. The overall change in currency exchange rates resulted in a decrease in operating expenses by approximately 2%.
44
Water
The
following table presents the Water segment results of operations:
For the Nine Months Ended September 30,
Change
Results
of Operations
(dollars in thousands)
2019
Percent of Revenue
2018
Percent of Revenue
Amount
Percentage
Revenues
$
99,980
$
94,909
$
5,071
5.3
%
Cost
of revenue
27,595
28,045
(450
)
(1.6
%)
Gross
profit
72,385
72.4
%
66,864
70.5
%
5,521
8.3
%
Operating
Expenses:
Sales and marketing
11,968
12.0
%
11,991
12.6
%
(23
)
(0.2
%)
General
and administrative
9,936
9.9
%
9,484
10.0
%
452
4.8
%
Research
and development
3,087
3.1
%
1,931
2.0
%
1,156
59.9
%
Total
operating expenses
24,991
25.0
%
23,406
24.7
%
1,585
6.8
%
Income
from operations
$
47,394
47.4
%
$
43,458
45.8
%
$
3,936
9.1
%
Revenue.
The increase in revenue was attributable to the benefit of price increases and higher sales volumes of our Colilert test products and related accessories used in coliform and E. coli testing, including strong volume growth across all regions. The impact of currency movements decreased revenue by approximately 2.9%.
Gross Profit.Gross profit increased due to higher sales volumes as well as a 190 basis point increase in the gross profit margin. Foreign currency movements increased the gross profit margin by approximately 80 basis points, including the impact
of hedge gains in the current year, as compared to hedge losses in the prior year. The remaining increase in the gross profit margin was primarily due to the net benefit of price increases, partially offset by higher product and distribution costs.
Operating Expenses. While both sales and marketing and research and development expenses had higher personnel-related costs, the overall decrease in sales and marketing expense and increase in research and development expense were primarily due to the realignment of certain personnel within operating expense categories. General and administrative expense increased primarily due to personnel-related costs. The overall change in currency exchange rates
resulted in a decrease in operating expenses of approximately 2.5%.
45
Livestock, Poultry and Dairy
The following table presents the LPD segment results
of operations:
For the Nine Months Ended September 30,
Change
Results
of Operations
(dollars in thousands)
2019
Percent of Revenue
2018
Percent of Revenue
Amount
Percentage
Revenues
$
95,980
$
96,658
$
(678
)
(0.7
%)
Cost
of revenue
39,098
41,091
(1,993
)
(4.9
%)
Gross
profit
56,882
59.3
%
55,567
57.5
%
1,315
2.4
%
Operating
Expenses:
Sales and marketing
16,898
17.6
%
18,847
19.5
%
(1,949
)
(10.3
%)
General
and administrative
13,013
13.6
%
14,399
14.9
%
(1,386
)
(9.6
%)
Research
and development
9,334
9.7
%
8,882
9.2
%
452
5.1
%
Total
operating expenses
39,245
40.9
%
42,128
43.6
%
(2,883
)
(6.8
%)
Income
from operations
$
17,637
18.4
%
$
13,439
13.9
%
$
4,198
31.2
%
Revenue.
The decrease in revenue was primarily due to the unfavorable impact of foreign currency movements that decreased revenue by approximately 4.8%. On an organic basis, the increase in growth was primarily due to increased herd health screening, new diagnostic testing programs in Asia, higher poultry testing volumes across our Asia Pacific and European regions, and higher pregnancy testing in our European and Asia Pacific regions. These increases were partially offset by lower bovine testing across most regions, primarily in Europe, and a decline in diagnostic testing related to African swine fever outbreaks in China.
Gross Profit.The increase in gross
profit was primarily due to higher sales volumes as well as a 180 basis point increase in the gross profit margin. The impact from foreign currency movements increased gross profit margin by approximately 140 basis points, including the impact of hedges. The remaining increase in the gross profit margin reflected favorable product mix from higher herd health screening, as well as lower product costs.
Operating Expenses. The decrease in sales and marketing expense was primarily due to lower personnel-related costs, including cost control initiatives. The decrease in general and administrative expense was primarily due to lower third-party services.
The increase in research and development expense was primarily due to increased personnel-related costs. The overall change in currency exchange rates resulted in a decrease in operating expenses of approximately 3%.
46
Other
The following table presents the Other results of operations:
For
the Nine Months Ended September 30,
Change
Results of Operations
(dollars in thousands)
2019
Percent of Revenue
2018
Percent of Revenue
Amount
Percentage
Revenues
$
16,105
$
15,872
$
233
1.5
%
Cost
of revenue
8,487
8,533
(46
)
(0.5
%)
Gross
profit
7,618
47.3
%
7,339
46.2
%
279
3.8
%
Operating
Expenses:
Sales and marketing
1,039
6.5
%
1,382
8.7
%
(343
)
(24.8
%)
General
and administrative
1,556
9.7
%
3,134
19.7
%
(1,578
)
(50.4
%)
Research
and development
1,366
8.5
%
752
4.7
%
614
81.6
%
Total
operating expenses
3,961
24.6
%
5,268
33.2
%
(1,307
)
(24.8
%)
Income
from operations
$
3,657
22.7
%
$
2,071
13.0
%
$
1,586
76.6
%
Revenue.The
increase in revenue was due to higher volumes of our OPTI Medical products and services, partially offset by lower realized prices. The impact of currency movements on revenue was immaterial.
Gross Profit. The increase in gross profit was due to a 110 basis point increase in the gross profit margin primarily due to the benefit of product mix within our OPTI Medical product line and, to a lesser extent, lower OPTI Medical product costs. These increases were partially offset by higher OPTI Medical service costs and lower realized prices. The overall change in currency exchange rates had an immaterial impact on the gross profit margin.
Operating
Expenses. The decrease in sales and marketing was primarily due to lower personnel costs. The decrease in general and administrative cost was primarily due to the recovery of previously established bad debt reserves in Africa and the Middle East. The increase in research and development cost was primarily due to higher personnel-related and project costs.
47
Unallocated Amounts
The
following table presents the Unallocated Amounts results of operations:
For the Nine Months Ended September 30,
Change
Results
of Operations
(dollars in thousands)
2019
2018
Amount
Percentage
Revenues
$
—
$
—
$
—
—
Cost
of revenue
(299
)
(1,706
)
1,407
(82.5
%)
Gross
profit
299
1,706
(1,407
)
(82.5
%)
Operating
Expenses:
Sales and marketing
354
(147
)
501
(340.8
%)
General
and administrative
3,363
5,708
(2,345
)
(41.1
%)
Research
and development
12,150
11,560
590
5.1
%
Total
operating expenses
15,867
17,121
(1,254
)
(7.3
%)
Loss
from operations
$
(15,568
)
$
(15,415
)
$
(153
)
1.0
%
Unallocated
Amounts. The change in unallocated amounts was due to higher unallocated employee incentive costs, partially offset by lower unallocated corporate function costs, lower unallocated employee benefit costs, and lower foreign exchange losses on settlements of foreign currency denominated transactions.
Non-Operating Items
Interest Income. Interest income was $0.2 million for the nine months ended September 30, 2019, as compared to $0.9 million for the nine
months ended September 30, 2018. The decrease in interest income was primarily due to the liquidation of our portfolio of marketable securities during the first quarter of 2018.
Interest Expense. Interest expense was $23.7 million for the nine months ended September 30, 2019, as compared to $26.2 million for the same period in the prior year. The decrease in interest expense was the result of lower average debt levels, offset by higher interest rates. We also realized
lower interest expense from the benefit of our cross currency swaps, as well as increased capitalized interest related to the expansion of our Westbrook, Maine headquarters and relocation of our core reference laboratory in Germany.
Provision for Income Taxes.Our effective income tax rate was 18.5% for the nine months ended September 30, 2019, as compared to 16.9% for the nine months ended September 30, 2018. The
increase in the effective tax rate was primarily driven by lower tax benefits from share-based compensation, partially offset by a nonrecurring item recorded in the three months ended March 31, 2018, that resulted from the 2017 Tax Cut and Jobs Act.
48
Liquidity and Capital Resources
We fund the capital needs of our business through cash on hand, funds generated from operations, proceeds from long-term senior note financings, and amounts available under
our Credit Facility. At September 30, 2019, we had $104.0 million of cash and cash equivalents, as compared to $123.8 million on December 31, 2018. Working capital, including our Credit Facility, totaled $76.8 million at September 30, 2019, as compared to negative $116.3 million at December 31, 2018. Additionally, at September 30, 2019,
we had remaining borrowing availability of $619.1 million under our $850 million Credit Facility. We believe that, if necessary, we could obtain additional borrowings at similar rates to our existing borrowings to fund our growth objectives. We further believe that current cash and cash equivalents, funds generated from operations, and committed borrowing availability will be sufficient to fund our operations, capital purchase requirements, and anticipated growth needs for the next twelve months. We believe that these resources, coupled with our ability, as needed, to obtain additional financing on favorable terms will also be sufficient to fund our business as currently conducted for the foreseeable future. We may enter into new financing arrangements or refinance or retire existing debt in the future depending on market conditions. Should we require more capital in the U.S. than is generated by our operations, for example
to fund significant discretionary activities, we could elect to raise capital in the U.S. through debt or equity issuances. These alternatives could result in increased interest expense or other dilution of our earnings.
We manage our worldwide cash requirements considering available funds among all of our subsidiaries. Our foreign cash and marketable securities are generally available without restrictions to fund ordinary business operations outside the U.S.
The following table presents cash, cash equivalents and marketable securities held domestically and by our foreign subsidiaries:
Days sales outstanding represents the average of the accounts receivable balances at the beginning and end of each quarter divided by revenue for that quarter, the result of which is then multiplied by 91.25 days.
(2)
Inventory turns represent inventory-related cost of product revenue for the 12 months preceding each quarter-end divided by the average inventory balances at the beginning and end of each quarter.
49
Sources
and Uses of Cash
The following table presents cash provided (used):
For the Nine Months Ended September 30,
(in thousands)
2019
2018
Dollar
Change
Net cash provided by operating activities
$
303,745
$
264,436
$
39,309
Net
cash (used) provided by investing activities
(109,617
)
178,446
(288,063
)
Net cash used by financing activities
(212,020
)
(479,993
)
267,973
Net
effect of changes in exchange rates on cash
(1,906
)
(3,687
)
1,781
Net change in cash and cash equivalents
$
(19,798
)
$
(40,798
)
$
21,000
Operating
Activities.The increase in cash provided by operating activities of $39.3 million was driven primarily by the increase in net income, partially offset by changes in the benefit of deferred income taxes. The following table presents cash flows from changes in operating assets and liabilities:
For
the Nine Months Ended September 30,
(in thousands)
2019
2018
Dollar Change
Accounts
receivable
$
(24,451
)
$
(33,041
)
$
8,590
Inventories
(36,582
)
(27,415
)
(9,167
)
Accounts
payable
1,181
(1,336
)
2,517
Deferred revenue
(10,826
)
(6,314
)
(4,512
)
Other
assets and liabilities
(54,770
)
(58,214
)
3,444
Total change in cash due to changes in operating assets and liabilities
$
(125,448
)
$
(126,320
)
$
872
Cash
used due to changes in operating assets and liabilities during the nine months ended September 30, 2019, as compared to the same period in the prior year, decreased approximately $0.9 million. This decrease was primarily due to lower cash used in accounts receivable as a result of the quarter-end timing on a weekend in the prior year, which resulted in certain customer payments being delayed until the start of the fourth quarter, offset by increases in inventory to meet anticipated demand.
We have historically experienced proportionally lower net cash flows from operating activities during the first quarter and proportionally higher cash flows from operating activities for the remainder of
the year driven primarily by payments related to annual employee incentive programs in the first quarter following the year for which the bonuses were earned and the seasonality of vector-borne disease testing, which has historically resulted in significant increases in accounts receivable balances during the first quarter of the year.
Investing Activities.Cash used by investing activities was $109.6 million for the nine months ended September 30, 2019, as compared to cash provided by investing activities of $178.4 million for the same period in the prior year. This change in
investing cash activity was primarily due to the sale of marketable securities in 2018, as a result of our repatriation of cash and investments held by our foreign subsidiaries, as well as increased capital spending in 2019 as we expand our Westbrook, Maine headquarters and relocate our core reference laboratory in Germany.
Financing Activities.Cash used by financing activities was $212.0 million for the nine months ended September 30, 2019, as compared to cash used by financing activities of $480.0 million
for the same period in the prior year. The decrease in cash used by financing activities for the nine months ended September 30, 3019, was due to a decrease in repurchases of our common stock, as compared to the same period in the prior year, an issuance of $100 million senior notes during the first quarter of 2019, and a larger repayment on our revolving Credit Facility in 2018 from repatriated foreign cash.
Cash used to repurchase shares of our common stock decreased $102.7 million during the nine months ended September 30, 2019, primarily in the second quarter of 2019, as compared to the same period in the prior year. We believe that the repurchase of our common stock is a favorable means of
returning value to our stockholders and we also repurchase our stock to offset the dilutive effect of our share-based compensation programs. Repurchases of our common stock may vary depending upon the level of other investing activities and the share price. See Note 12 to the unaudited condensed consolidated
50
financial statements in Part I, Item 1. of this Quarterly Report on Form 10-Q for additional information about our share repurchases.
Net repayment activity under our Credit Facility resulted in cash used of $169.5 million during the nine
months ended September 30, 2019, as compared to $240.5 million of cash used in the same period of the prior year. At September 30, 2019, we had $229.5 million outstanding under the Credit Facility. The general availability of funds under our Credit Facility was further reduced by $1.4 million for a letter of credit that was issued in connection with claims under our workers’ compensation policy. The Credit Facility contains affirmative, negative, and financial covenants customary for financings of this type. The negative covenants include restrictions on liens, indebtedness of subsidiaries of the
Company, fundamental changes, investments, transactions with affiliates, certain restrictive agreements and violations of laws and regulations. The obligations under our Credit Facility may be accelerated upon the occurrence of an event of default under the Credit Facility, which includes customary events of default including payment defaults, defaults in the performance of the affirmative, negative and financial covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, defaults relating to judgments, certain events related to employee pension benefit plans under the Employee Retirement Income Security Act of 1974 ("ERISA"), the failure to pay specified indebtedness, cross-acceleration to specified indebtedness and a change of control default.
On March 14, 2019, we amended
our Existing Agreement with MetLife, submitted a request for purchase and drew $100 million of our Shelf Notes at 4.19% interest per annum rate, due March 14, 2029 (the "Series C Notes"). Series C Notes proceeds were used for general corporate purposes, including a partial repayment of our Credit Facility.
Since December 2013, we have issued and sold through private placements senior notes having an aggregate principal amount of approximately $700 million, including the $100 million Series C Notes, pursuant to certain note purchase agreements (collectively, the “Senior Note Agreements”). The Senior Note Agreements contain affirmative, negative, and financial covenants customary for agreements of this type. The negative covenants
include restrictions on liens, indebtedness of our subsidiaries, priority indebtedness, fundamental changes, investments, transactions with affiliates, certain restrictive agreements and violations of laws and regulations.
Should we elect to prepay the senior notes, such aggregate prepayment will include the applicable make-whole amount(s), as defined within the applicable Senior Note Agreements. Additionally, in the event of a change in control of the Company or upon the disposition of certain assets of the Company the proceeds of which are not reinvested (as defined in the Senior Note Agreements), we may be required to
prepay all or a portion of the senior notes. The obligations under the senior notes may be accelerated upon the occurrence of an event of default under the applicable Senior Note Agreements, each of which includes customary events of default including payment defaults, defaults in the performance of the affirmative, negative and financial covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, defaults relating to judgments, certain events related to employee pension benefit plans under ERISA, the failure to pay specified indebtedness and cross-acceleration to specified indebtedness.
Effect of Currency Translation on Cash. The net effect of changes in foreign currency exchange rates are related to changes in exchange rates between the U.S. dollar and the functional currencies of our
foreign subsidiaries. These changes will fluctuate for each period presented as the value of the U.S. dollar relative to the value of the foreign currencies changes. A currency’s value depends on many factors, including interest rates and the country’s debt levels and strength of economy.
Off-Balance Sheet Arrangements. We have no off-balance sheet arrangements or variable interest entities, except for letters of credit and third-party guarantees.
51
Financial
Covenant. The sole financial covenant of our Credit Facility and Senior Note Agreements is a consolidated leverage ratio test that requires our ratio of debt to earnings before interest, taxes, depreciation and amortization and certain other non-cash charges (“Adjusted EBITDA”) not to exceed 3.5-to-1. At September 30, 2019, we were in compliance with such covenant. The following details our consolidated leverage ratio calculation:
Adjusted EBITDA, gross debt, net debt, gross debt to Adjusted EBITDA ratio and net debt to Adjusted EBITDA ratio are non-GAAP financial measures which should be considered in addition to, and not as a replacement for, financial measures presented according to U.S. GAAP. Management believes that reporting these non-GAAP financial measures provides supplemental analysis to help investors further evaluate our business performance and available borrowing capacity under our Credit Facility.
Other Commitments, Contingencies and Guarantees
Significant
commitments, contingencies and guarantees at September 30, 2019, are described in Note 16 to the unaudited condensed consolidated financial statements in Part I, Item 1. of this Quarterly Report on Form 10-Q.
52
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For quantitative and qualitative disclosures about market risk affecting us,
see the section under the heading “Part II. Item 7A. Quantitative and Qualitative Disclosure About Market Risk” of our 2018 Annual Report. As of the date of this Quarterly Report on Form 10-Q, there have been no material changes to the market risks described in our 2018 Annual Report, except for the impact of foreign exchange rates, as discussed below.
Foreign Currency Exchange Impacts. Approximately 21% of our consolidated revenue was derived from products manufactured in the U.S. and sold internationally in local currencies for both the three and nine months ended September 30, 2019, as compared
to 21% for the three and nine months ended September 30, 2018. Strengthening of the U.S. dollar exchange rate relative to other currencies has a negative impact on our revenues derived in currencies other than the U.S. dollar and on profits of products manufactured in the U.S. and sold internationally, and a weakening of the U.S. dollar has the opposite effect. Similarly, to the extent that the U.S. dollar is stronger in current or future periods relative to the exchange rates in effect in the corresponding prior periods, our growth rate will be negatively affected. The impact of foreign currency denominated costs and expenses and foreign currency denominated supply contracts partly offsets this exposure. Additionally, our designated hedges
of intercompany inventory purchases and sales help delay the impact of certain exchange rate fluctuations on non-U.S. dollar denominated revenues.
Our foreign currency exchange impacts are comprised of three components: 1) local currency revenues and expenses; 2) the impact of hedge contracts; and 3) intercompany and monetary balances for our subsidiaries that are denominated in a currency that is different from the functional currency used by each subsidiary. Based on projected revenues and expenses for the remainder of 2019, excluding the impact of intercompany and trade balances denominated in currencies other than the functional subsidiary currencies, we project a 1% strengthening of the U.S.
dollar would reduce revenue by approximately $2 million and operating income by approximately $1 million. Additionally, we project our foreign currency hedge contracts in place as of September 30, 2019, would result in incremental offsetting gains of approximately $0.5 million. The impact of the intercompany and trade balances, and monetary balances referred to in the third component above have been excluded, as they are transacted at multiple times during the year and we are not able to reliably forecast the impact that changes in exchange rates would have on such balances.
At our current foreign currency exchange rate assumptions, we anticipate the effect of a stronger U.S. dollar for the remainder
of the year will have an unfavorable impact on our operating results by decreasing our revenues, operating profit, and diluted earnings per share for the year ending December 31, 2019, by approximately $42 million, $6 million, and $0.06 per share, respectively. This unfavorable currency impact includes a favorable impact of approximately $12 million from foreign currency hedging activity. The actual impact of changes in the value of the U.S. dollar against foreign currencies in which we transact may materially differ from our expectations described above. The above estimates assume that the value of the U.S. dollar will reflect the euro at $1.09, the British pound at $1.26, the Canadian dollar at $0.75, and the Australian dollar at $0.67;
and the Japanese yen at ¥110, the Chinese renminbi at RMB 7.22 and the Brazilian real at R$4.21 relative to the U.S. dollar for the remainder of 2019.
The following table presents the foreign currency exchange impact on our revenues, operating profit, and diluted earnings per share as compared to the respective prior period:
For
the Three Months Ended September 30,
For the Nine Months Ended September 30,
(in thousands, except per share amounts)
2019
2018
2019
2018
Revenue
impact
$
(6,910
)
$
(5,892
)
$
(34,101
)
$
21,715
Operating
profit impact, excluding hedge activity
$
(3,024
)
$
(3,979
)
$
(15,082
)
$
6,619
Hedge
(gains) losses - prior year
(256
)
893
2,412
(935
)
Hedge gains (losses) - current year
3,171
256
7,091
(2,412
)
Hedging
activity impact
2,915
1,149
9,503
(3,347
)
Operating
profit impact, including hedge activity
$
(109
)
$
(2,830
)
$
(5,579
)
$
3,272
Diluted
earnings per share impact, including hedge activity
$
—
$
(0.03
)
$
(0.05
)
$
0.03
53
Item
4. Controls and Procedures
Disclosure Controls and Procedures
Our management is responsible for establishing and maintaining disclosure controls and procedures, as defined by the SEC in its Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as amended (the “Exchange Act”). The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures at September 30, 2019, our Chief Executive Officer and our Chief Financial Officer have
concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the three months ended September 30, 2019, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART
II — OTHER INFORMATION
Item 1. Legal Proceedings
Due to the nature of our activities, we are at times subject to pending and threatened legal actions that arise out of the ordinary course of business. In the opinion of management, based in part upon advice of legal counsel, the disposition of any such currently pending matters is not expected to have a material effect on our results of operations, financial condition, or cash flows. However, the results of legal actions cannot be predicted with certainty. Therefore, it is possible that our results of operations, financial condition or cash flows could be materially adversely affected in any particular period by the unfavorable
resolution of one or more legal actions.
Item 1A. Risk Factors
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors discussed in “Part I. Item 1A. Risk Factors” in our 2018 Annual Report, which could materially affect our business, financial condition, or future results. There have been no material changes from the risk factors previously disclosed in the 2018 Annual Report. The risks described in our 2018 Annual
Report are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, or future results.
54
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds
During the three months ended September 30, 2019, we repurchased shares of common stock as described below:
Period
Total Number of Shares Purchased
(a)
Average
Price Paid per Share
(b)
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)
(c)
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (1)
The
total shares repurchased include shares purchased in the open market and shares surrendered for employee statutory tax withholding. See Note 12 to the unaudited condensed consolidated financial statements in Part I. Item 1. of this Quarterly Report on Form 10-Q for additional information about our share repurchases.
(1)
On August 13, 1999, our Board of Directors approved and announced the repurchase of our common stock in the open market or in negotiated transactions pursuant to the Company’s share repurchase program. The authorization
has been increased by the Board of Directors on numerous occasions; most recently, on May 2, 2017, the maximum level of shares that may be repurchased under the program was increased from 65 million to 68 million shares. There is no specified expiration date for this share repurchase program. There were no other repurchase programs outstanding during the three months ended September 30, 2019, and no share repurchase programs expired during the period. Repurchases of 330,490 shares were made during the three months ended September 30, 2019, in transactions made pursuant to our share repurchase program.
(2)
During
the three months ended September 30, 2019, we received 966 shares of our common stock that were surrendered by employees in payment for the minimum required withholding taxes due on the vesting of restricted stock units and settlement of deferred stock units. In the above table, these shares are included in columns (a) and (b), but excluded from columns (c) and (d). These shares do not reduce the number of shares that may yet be purchased under the share repurchase program.
XBRL
Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Companion
Animal Group
Water
Livestock, Poultry and Dairy 