IDEXX Laboratories Corporation

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Feltl and Company Research Department2100 LaSalle Plaza800 LaSalle AvenueMinneapolis, MN 554021.866.655.3431Ben Haynor, 612.492.8872IDEXX Laboratories CorporationCompany Description: IDEXX Laboratories Corporation develops, manufactures and markets instruments and consumablestargeted at the veterinary, water quality testing, and livestock testing markets. The company sells its products worldwidedirectly and through distributors. In addition, the company offers veterinary diagnostic reference laboratory and otherveterinary consulting services and software. IDEXX was incorporated in 1983 and is based in Westbrook, Maine.Healthcare- Diagnostic EquipmentMarch 15, 2012Not enough leash, initiating with HOLD, 87.50 price target(IDXX - 84.00) HOLDKey PointsFinancial Summary Capital spending by veterinary offices set to return aftersecular decline. IDEXX holds a dominant market position and is still inthe early days of a replacement cycle.Rev(mil)2011A2012E2013E Competition emulating IDEXX’s successful strategy andvaluation makes us cautious. Initiating with HOLD rating and 87.50 price target (16xFY2012 EV/EBITDA).MarJuneSeptDec 292.7A 317.9A 301.0A 307.2A 314.7E 338.6E 319.6E 329.6E 342.6E 368.8E 348.7E 359.1EFYP/Sales 1218.7A4.3x 1302.5E3.8x 1419.2E3.4xEPS2011A2012E2013EMarJuneSeptDec 0.62A 0.83A 0.66A 0.67A 0.74E 0.88E 0.71E 0.74E 0.84E 0.98E 0.77E 0.82EFYP/E 2.78A43.8x 3.07E48.4x 3.41E35.1xDynamics in the veterinarian industry served by IDEXX appear to be changingfavorably. From 2004 through 2009, the number of practicing veterinarians grew 30%,while the number of companion animals (pets) increased only 5%, hurting the financialhealth of veterinary practices. In the last two years, however, this trend has modestlyreversed as the number of veterinarians has stagnated while pet populations havegrown, albeit modestly. We believe that the number of visits per veterinarian per weekhas likely bottomed and that as baby-boomer veterinarians retire and the economyimproves, the financial health of the typical veterinary practice will improve. In addition,both IDEXX and VCA Antech (WOOF – not rated) have noted stabilization in practicevisits the past two quarters after more than two years of declines.IDEXX holds a dominant market position in the early days of an ongoingreplacement cycle. Roughly 90% of veterinary practices have a chemistry analyzerand 60% to 70% have a hematology instrument in-house. IDEXX has far and away thelargest market share in both areas, boasting 32,000 chemistry installs and 23,000hematology installs. The company has rolled out its latest instruments, the Catalyst Dxon the chemistry side and the ProCyte Dx on the hematology side, but is still early on inconverting its customers to the new devices with approximately 23% and 7% converted,respectively, to their latest instruments. The typical replacement cycle ranges from fourto seven years on instruments but this has slowed due to the tough economy andsecular decline in the veterinary market. IDEXX typically sees a 15% to 50% increase inconsumable use as practices move to its latest instruments. We believe this representsa massive opportunity for the company once the replacement cycle begins to respond toan improving veterinary market, which we estimate will occur within 12-18 months.IDEXX’s competition has attempted to emulate their successful strategy ofproviding a full range of products and services. While neither Abaxis (ABAX – Buy 34.50) nor Heska (HSKA – not rated) have as broad of range of products and servicesas IDEXX, they are both attempting to broaden their capabilities in the veterinaryreference laboratory market. Abaxis recently launched their own reference lab andHeska spoke on their most recent call about partnering with local and regional labs tobundle their diagnostic equipment and consumables with the labs’ services, providingdiscounts to clinics in the process. We believe this will result in some pricing pressure.Initiating coverage of IDEXX with a HOLD rating and 87.50 price target, whichrepresents 16x 2012 EV/EBITDA. While we believe IDEXX is positioned well forveterinary market recovery, it currently trades near the high end of its historical multiples.We would like to see additional improvement in the veterinary market, an acceleratingreplacement cycle, or more attractive prices before becoming more positive on theshares.Please see important disclosures on pages 20 to 22.Price:52-Week Range:Target:Rating:Shares Outstanding:Mkt. Capitalization:Ave. Volume:Instit. Ownership:BV / Share:Debt / Tot. Cap.:Est. LT EPS Growth: 84.00 89.49- 63.83 87.50HOLD55.1 mil 4,608mil255,000103% 9.7931%15%

March 15, 2012rops Strong, Pricing Weak, Farm Profits Could SufferINVESTMENT THESISWe believe that IDEXX is well positioned for a recovery in the veterinary market with its large install base and wide range ofproducts and services. The company is a leader in virtually all of the markets it serves. In addition, IDEXX’s research anddevelopment budget dwarfs that of its veterinary market competitors; the company’s research and development spendinglikely totals 75% of the entire industry’s combined research and development budget. Their position within the industry andthe resultant scale should allow them to expand operating leverage. Based upon current multiples of other diagnosticequipment firms and historical multiples at which IDEXX has traded, we think it appropriate to assign the company avaluation multiple of 16x 2012 EV/EBITDA. This valuation methodology leads us to a 87.50 price target, approximately4% above current prices. As the shares presently do not presently have 15% upside to our target, we have assigned thecompany a HOLD rating. Our outlook would improve should the broader veterinary market show accelerating improvement,the company begins converting its chemistry and hematology instrument installed base to the Catalyst Dx- and Procyte Dxgeneration more rapidly, or the shares become more attractively valued.OpportunitiesSecular decline in veterinary market abating. The number of practicing veterinarians has grown 30% since 2004, whilethe number of companion animals (pets) has grown only 5%, hurting the financial health of veterinary practices. However,over the past two years, the number of veterinarians has stagnated while pet numbers have grown, albeit modestly. Webelieve that the number of visits per veterinarian per week has likely bottomed and that as baby-boomer veterinarians retireand the economy improves, the financial health of the typical veterinary practice will improve, leading to greater capitalequipment sales and improved practice visit trends, ultimately resulting in increased consumable usage.Market-leading products with a large install base. IDEXX offers a full range of products and services for both in-houseand laboratory veterinary diagnostics. IDEXX pioneered the in-house testing market and has reaped the benefits, with thelargest install base of chemistry and hematology instruments that is several times greater than its next closest competitor.This scale and range of products and services allows the company to bundle their offerings, providing discounts tocustomers as a way to capture a larger portion of a practice’s business and/or drive testing volume.Still early in the replacement cycle. Roughly 90% of veterinary practices have a chemistry analyzer while 60% to 70%have a hematology instrument. IDEXX has converted 23% of its 32,000-strong chemistry install base over to its latestgeneration instrument, the Catalyst Dx. On the hematology side, the company has placed 1,624 ProCyte Dx instrumentsor about 7% of its 23,000 hematology install base. The typical replacement cycle for instruments ranges four to sevenyears depending on a variety of factors and has been impacted by the difficult economy and secular decline in theveterinary market. We believe the market has stabilized and is likely to reverse in the next 12-18 months. IDEXX tends tosee an increase in consumable use when a practice upgrades ( 15% in the case of Catalyst Dx) to a single currentgeneration instrument, and a considerable increase of nearly 50% when a practice upgrades both its chemistry andhematology instruments to the latest generation.Exclusive distributor relationships with the three largest veterinary distributors. The company has exclusivedistributor relationships with the three largest veterinary product distributors, Butler Schein, MWI Veterinary Supply, andWebster Veterinary, that preclude them from distributing in-house diagnostics made by competitors. This forcescompetitors to sell direct or utilize smaller distributors, providing them less reach than IDEXX has been able to realize.FTC investigation into IDEXX distribution resolved favorably. The Federal Trade Commission is currently investigatingIDEXX’s relationship with the three largest veterinary health product distributors. Should the FTC find that theseagreements are not anticompetitive in nature, IDEXX’s competitors will continue to face distribution difficulties.Superior research and development budget. IDEXX’s research and development budget is roughly three times largerthan all of its competitors combined in the veterinary diagnostic equipment space. Should a competitor develop a productthat leap frogs their offerings, IDEXX would be able to devote significant resources to countering it. Similarly, it should allowthe company to maintain highly competitive product offerings.Economic recovery. It is well known that the recent economic slump has put a damper on physician office visits. A similartrend has also taken place in the veterinary space. An economic recovery would likely see the pet population grow as wellas veterinary visits increase as new pets are acquired and pet owners who put off veterinary care in the past several yearsreturn. Since the economic downturn began, the pet population has aged, and, just as with humans, the more aged petshave more lab tests conducted upon them, increasing the potential demand for IDEXX’s products.Feltl and Company Research DepartmentIDEXX Laboratories Corp. (IDXX )Page 2

March 15, 2012rops Strong, Pricing Weak, Farm Profits Could SufferRisksFTC investigation into IDEXX distribution resolved unfavorably. The Federal Trade Commission is currentlyinvestigating IDEXX’s relationship with the three largest veterinary health product distributors. IDEXX currently hasexclusive agreements with these distributors precluding them from distributing competing products. Should the FTC findthat these agreements are anticompetitive in nature, as their competitors believe, and force distributors to carry competingproducts, IDEXX would obviously face a higher level of competition and may face pricing pressures. However, uncertaintysurrounds the timeline as to when the FTC may render a decision and how long the appeals process would take to play out,but it is likely to stretch over several years.Competition. Two of IDEXX’s smaller competitors, Abaxis, Inc. (ABAX – Buy) and Heska Corp. (HSKA – not rated), areattempting to emulate IDEXX’s long-successful strategy of bundling equipment and laboratory services. Previously, IDEXXwas the only firm with a broad enough scale to offer a full range of instruments, consumables, and services. However,Abaxis has recently entered the veterinary reference laboratory business and Heska’s management discussed partneringwith independent diagnostic labs to offer bundled pricing discounts on their most recent earnings call. We believe that thismay reduce the differentiation between the three companies in the minds of some veterinarians and may result in pricingpressures in the future if Abaxis and Heska are successful in picking up share through discounting.Changing regulatory environment. Weakening regulations may harm IDEXX’s business. For example, in 2009, theEuropean Union increased the age at which healthy cattle are to be tested for bovine spongiform encephalopathy (mad cowdisease) from 30 to 48 months. This has since been raised to 72 months, reducing the demand for IDEXX’s testingproducts of this type.Veterinary practice roll-ups. In certain areas of human healthcare services, such as in the neonatal space, corporationsand private equity have long been acquiring smaller practices, rolling them up into a larger entity to achieve scale. This hasalso been occurring in the veterinary space, with firms such as Banfield Pet Hospital, National Veterinary Associates, andVCA Antech (WOOF – not rated) acquiring practices and leveraging their scale to realize favorable pricing on instrumentsand consumables. Additionally, these firms tend to have their own reference laboratory services to which they send a largeportion of their testing needs, obviating the future need to send the same quantity of samples to IDEXX’s veterinaryreference lab.Thoughts on ValuationIDEXX poses a challenge, in our view, in determining an appropriate comp group. The company is a clear leader in theveterinary diagnostics industry. One could make a case that IDEXX should be valued based upon comparisons todiagnostic/testing equipment manufacturers that serve a broad array of industries. Similarly, one could make the case thatit should be valued compared to medical technology firms that exhibit a similar growth rate while being leaders or innovatorsin their respective markets. The table below details various multiples and metrics exhibited by companies that we believecould potentially serve as the basis for a comp group on which to value IDEXX.IDEXX Possible ,7401,1851,0099389087035054,750Feltl and Company Research 14%8%8%7%SalesTYNY 18,532 19,614 12,327 12,799 7,897 8,221 1,943 2,075 2,161 2,278 457 478 482 532 243 276 217 243 283 314 616 676 155 176 1,303 Laboratories Corp. (IDXX M20%NM13%53%16%12%15%Page 3

March 15, 2012rops Strong, Pricing Weak, Farm Profits Could SufferThat said, we view the challenge of picking an appropriate comp group based on either grouping of medical technologyfirms or diagnostic/testing equipment firms or some average thereof to be somewhat perilous. However, we would bebiased in IDEXX’s case to choose similarly-growing medical technology firms who are leaders or innovators in theirrespective industries.Due to this challenge, our view would be that given IDEXX’s unique positioning within the veterinary diagnostics industryand their 20 year history as a publicly traded company, to set our valuation multiple based upon historical multiples thecompany’s shares have attained under varying growth environments. The charts that follow depict next-twelve-monthEV/EBITDA and P/E multiple ranges for their shares over the past 6 years as well as the revenue growth rates theyachieved historically.IDXX EV/EBITDA(next twelve venue GrowthEV/EBITDA Multiple16.05%4.00%2.0--5%Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 e Growth Y/YIDXX P/E(next twelve months)40.030%35.025%20%25.015%20.010%15.0Revenue GrowthP/E Multiple30.05%10.00%5.0--5%Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 e Growth Y/YBased upon these figures, we believe that the valuation range on forward EV/EBITDA at current growth rates should fallwithin the range of 12x to 16x and that the P/E multiples on the same basis should fall within a 20x to 30x range.Examining the EV/EBITDA chart, it appears that IDEXX shares have generally attained at least a 16x forward EV/EBITDAmultiple in nearly every quarter where the year-over-year revenue growth was 10% or higher. While we estimate that thecompany’s revenue growth rate will be slightly lower than 10% in 2012 as compared to 2011, we believe that the companywill achieve an EV/EBITDA multiple of 16x our 2012 estimate during the next twelve months.Thus, we have set our price target of 87.50 utilizing 16x 2012 EV/EBITDA as our valuation multiple. This corresponds to28.5x our 2012 earnings per share estimate.Key Model AssumptionsWe have taken our cue from management’s 2012 guidance given on their Q4 2011 earnings call, as seen in the followingtable, in constructing our model, although we believe we have taken a slightly more conservative approach to modelingFeltl and Company Research DepartmentIDEXX Laboratories Corp. (IDXX )Page 4

March 15, 2012rops Strong, Pricing Weak, Farm Profits Could SufferIDEXX’s results. Our estimates are below the low-end of guidance for organic growth and total growth slightly. We viewmanagements’ guidance on foreign exchange rates and share count as quite conservative. Simply carrying the share countat year-end 2011 through 2012 results in a 3.4% share count decline; should the company continue its share repurchasesat rates similar to years past, the share count could be several percent lower still. The foreign exchange rates implicit in thecompany’s guidance were at or below spot rates at the time guidance was offered and the company noted that for each 1%movement in their basket of currencies, revenue would differ by 4.5 million and operating income would change by 800,000 over the full year. For example a weakening of the US dollar versus the basket of currencies would result inapproximately 4.5 million in additional revenue and 0.01 in EPS for the full year. We estimate the basket of currencies isroughly 50% Euro, 15% British Pound, 15% Canadian Dollar, 10% Japanese Yen and 10% Australian dollar.IDEXX 2012 Guidance as Compared to Feltl ModelItem/MetricInstrumentConsumable OrganicRevenue Growth(normalized)GuidanceSimilar to2011Feltl Estimate8.6%Rapid Assay OrganicRevenue Growth(normalized)4%4.3%Labs and ServicesOrganic RevenueGrowth10%10.0%Practice InformationSystems and DigitalRadiography OrganicRevenue GrowthLivestock andPoultry DiagnosticsRevenue OrganicGrowthWater OrganicRevenue GrowthHigh-singledigits to lowdouble digits11.8%Mid-to-lowsingle digits3.5%Mid-singledigits5.2%Total Organic GrowthTotal Growth8% to 9%7% to 8%7.9%6.9%Gross Margin54%53.7%Operating Expensesas Percentage ofSales34% to 35%34.1%Feltl and Company Research DepartmentNotes and Feltl Estimate Notes2011 saw instrument consumables growth of 11.4% overallwith 2.7% due to favorable currency movements,representing 8.7% organic growth. We have modeled 8.6%organic growth with -1.9% currency impact for total growthof 6.7%. Volume growth is expected to be offset by reducedpricing due to rebates and discountsGuidance very similar to 2011 results of 4.1% rapid assayorganic growth. Total growth for 2011 was 5.3%, with a1.2% impact from currency. Management anticipatesgrowth will be stronger in the first half and then moderate asproduct launches and price increases anniversary.Driven by increase in volumes due to footprint expansion,increased penetration of specialty tests and minor benefitsfrom economic improvement. Our estimates are inline withguidance; organic growth was very consistent during 2011ranging from 9.8% to 10%, and we expe

Mar 15, 2012 · targeted at the veterinary, water quality testing, and livestock testing markets. The company sells its products worldwide directly and through distributors. In addition, the company offers veterinary diagnostic reference laboratory and other veterinary consulting services and software. IDEXX was incorporated in 1983 and is based in Westbrook .

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