IDEX Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 26, 2022

There are 12 speakers on the call.

Operator

Greetings, and welcome to IDEXX Corporation Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Allison Lasse, Vice President and Chief Accounting Officer.

Operator

Thank you. You You may begin.

Speaker 1

Good morning, everyone. This is Alison Losses, Vice President and Chief Accounting Officer for IDEX Corporation. Thank you for joining us for our discussion of the IDEXX Q2 2022 Financial Highlights. Last night, We issued a press release outlining our company's financial and operating performance for the 3 months ended June 30, 2022. The press release along with the presentation slides to be used during today's webcast can be accessed on our company website at idexcorp.com.

Speaker 1

Joining me today are Eric Ashelman, our Chief Executive Officer and President and Bill Grogan, our Chief Financial Officer. The format for our call today is as follows. We will begin with Eric providing an overview of the state of IDEXX's business. Then Bill will discuss IDEXX's 2nd quarter financial results and update on segment performance in the markets they serve And our outlook for the Q3 and full year 2022. Following our prepared remarks, we will open the call for your questions.

Speaker 1

If you should need to exit the call for any reason, you may access a complete replay beginning approximately 2 hours after the call concludes By dialing the toll free number 877-660-6853 and entering conference ID 137 24,804 or simply log on to our company homepage for the webcast replay. Before we begin, a brief reminder. This call may contain certain forward looking statements that are subject to Safe Harbor language In last night's press release and in IDEXX's filings with the Securities and Exchange Commission. With that, I'll now turn this call over to our CEO and President, Eric Aschleman?

Speaker 2

Thank you, Alison, and good morning, everyone. I'm on Slide 6. IDEXX delivered outstanding results in the 2nd quarter. We achieved record sales levels, 12% organic growth supported by double digit contributions from each of our operating segments. Our backlog grew by $43,000,000 and we now sit at record levels to continue momentum into Q3.

Speaker 2

Core profitability continues to be strong Even as we return to more normal discretionary spend levels, allowing us to fully invest in our best growth investments, we delivered record adjusted EPS of $2.02 an increase of 15% over the prior year's Q2. Last quarter, I described how our IDEXX teams leveraged eightytwenty to Our decentralized operating model, which aligns decision making at the point of impact close to the customer drives the speed and agility required for us to outperform. Our lead times were a competitive advantage and enabled share gain in pockets across the company. Inflationary pressures remain, but the rate of increase decelerated while we continue to capture price equivalent with our differentiation. Gross price capture increased and we expanded our price cost spread, trending back towards historic levels.

Speaker 2

We remain committed to our capital deployment strategy and M and A remains a top priority for us. This quarter, we closed on the acquisition of KZ Valve, a complement to our agriculture business within FMT. Our pipeline is Strong and we continue to evaluate opportunities in higher growth markets that support our style of competition. We have a healthy balance sheet and are And increased capacity to support our growth. We continue to make investments in commercial, engineering and M and A resources that enable us to execute on our strategy.

Speaker 2

During the quarter, we increased our share repurchases and deployed $88,000,000 to buy back 475,000 shares of IDEX stock. We remain disciplined with our methodology to create long term value for shareholders when we see a disconnect between our intrinsic assessment of IDEXX Enterprise value in our public valuation. Lastly, in the Q2, our Board approved an 11% increase in our dividend. Rising interest rates, continued inflation and geopolitical dynamics all present some uncertainty for us as we consider and head into the second half of the year, But we're not yet seeing any major signals of near term slowing within our commercial environments. We have good line of sight to the next 90 days and we continue to see strength in almost All our end markets.

Speaker 2

As we look across the industries we serve and our portfolio of differentiated technologies, we're confident that IDEXX is well positioned to outperform during any Short term market volatility. It's been a really strong first half of the year and our teams have a lot to be proud of, but it's not easy to over deliver in

Speaker 3

this environment. I'd like to thank our IDEXX employees around the globe for their hard work, diligence and agility as they execute for all our stakeholders. With that, let me turn it over to Bill to discuss our financial results. Thanks, Eric. I'll start with our consolidated financial results on Slide 8.

Speaker 3

Q2 orders of $839,000,000 were up 12% overall and up 7% organically. We experienced strong orders growth in HST and FMT, But saw contraction in FSD driven by Dispensing North America's strong replenishment orders received last year. 2nd quarter sales of $796,000,000 were up 16% overall and up 12% organically. We experienced record sales with double digit increases across all three of our segments. 2nd quarter operating margin was 23.4%, up 30 basis points compared to prior year.

Speaker 3

Adjusted operating margin was 23.8%, down 60 basis points. Incremental amortization related to Aehrtec, Nexite and KZ Valve acquisitions unfavorably impacted adjusted operating margin by 80 basis points. 2nd quarter net income was $138,000,000 which resulted in EPS of $1.81 Adjusted net income was 100 and $54,000,000 resulting in an adjusted EPS of $2.02 up $0.27 or 15% over prior year. Finally, free cash flow for the quarter was $97,000,000 or 63% of adjusted net income. This reflects higher accounts receivables driven by the significant increase in sales versus last year as well as elevated inventory levels.

Speaker 3

Inventory has increased to buffer supply chain challenges and leverage material availability as a competitive tool to take share in the market. We have spent a lot of time with our teams reviewing their inventory reduction plans and are targeting to bleed down our inventory positions in the second half of the year. Moving on to Slide 9, which details the drivers of our adjusted operating income. 2nd quarter adjusted operating income increased $23,000,000 Compared to last year, our 12% organic growth contributed approximately $22,000,000 flowing through at our prior year gross margin rate. We levered well on the volume increase.

Speaker 3

Our teams drove operational productivity and we had strong price capture to offset inflation headwinds. Price cost was accretive to margins and is trending towards our historic levels. We experienced positive mix of $2,000,000 across the portfolio. We reinvested $4,000,000

Speaker 2

mainly in

Speaker 3

the form of engineering and commercial resources to drive long term growth and additional resources to support our accelerated M and A activity. Lastly, discretionary spending increased by $9,000,000 versus last year and up $7,000,000 versus the Q1 of 2022. Our teams across the globe are backed in person partnering with our customers, actively marketing our products and investing to support innovation. As we look ahead to the second half of the year, we do not expect this level of sequential increase to continue. We've now ramped to our pre pandemic spending rate, but on significantly higher sales.

Speaker 3

Our organic flow through is 23%, In line with the flow through expectations we set at the beginning of the year, but most likely the lowest rate we will experience this year. Flow through is then negatively impacted by the dilutive impact of acquisitions and FX, getting us to a reported flow through of 21%. With that, I'd like to provide a deeper look at our segment performance. I'm on Page 10. In our Fluid and Metering Technologies segment, we experienced a strong second quarter for both orders and sales with organic growth of 8% 13%, respectively.

Speaker 3

FMT adjusted operating margin expanded by 170 basis points versus last year. The increase included 60 basis Points of headwind due to incremental amortization related to the NexSight and KZ Valve acquisitions. Volume leverage, Strong operational productivity and favorable price costs were the main drivers of the increased adjusted operating margin. Our industrial markets are exhibiting stable demand with consistent quote activity over the last few quarters. We are seeing small to midsize Projects coming through in the oil and gas and petrochemical markets as well as in applications tied to mining, asphalt and lithium ion battery production.

Speaker 3

Agriculture continues to perform well. Farmers are experiencing record inflation and look to our technology and precision ag to drive productivity. The KZ Valve integration is going extremely well and our automation project at Banjo is on track. Market conditions remain favorable in our municipal water business. We continue to see a strong commercial funnel and long term optimism driven by government funding On the energy side, upstream markets are experiencing healthy demand with oil prices providing strong support.

Speaker 3

Midstream investments have yet to see a bump in activity due to customer supply chain constraints and caution on long term price sustainability. Moving on to Health, Science and Technology. Stellar commercial performance continues with organic orders up 13% and organic sales up 12%. HST adjusted operating margin contracted by 130 basis points versus the Q2 of 2021. Incremental amortization related to the Aehrtec acquisition unfavorably impacted adjusted operating margin by 130 basis points.

Speaker 3

Additionally, adjusted operating margin was driven by strong volume leverage and positive price cost, partially offset increased employee related costs, discretionary spending and resource investments. HST continues to benefit from strong secular growth trends within Life Science, Analytical Instrumentation, Semiconductor and Food and Pharma Markets. The life sciences market is experiencing strong demand for next gen sequencing instruments and consistent core diagnostic market performance. Analytical Instrumentation and Material Processing results remain strong on continued Pharma and Biopharma Demand. On the semiconductor side, we continue to see growth, but at a slower pace.

Speaker 3

We've been able to offer shorter lead times than our competitors enabling ShareGrain across a variety of applications. We continue to see strong growth in our optics businesses tied to broadband satellite technology and strength in our industrial businesses similar to the FMT results. Finally, turning to our Fire Safety and Diversified Products segment. Orders contracted by 5%, but sales were strong with organic increase of 11%. FSD adjusted operating margin contracted by 280 basis points versus the Q2 of last year.

Speaker 3

This was driven by higher volume being more than offset by higher employee related costs and discretionary spending as well as pressure on price cost Due to aged OEM backlogs on the fireside and automotive exposure with more metal content within BAND IT. As we noted in prior calls, we have taken action to address this gap and expect the price cost will improve in the second half of twenty twenty two as those increases pull through our backlog. Our dispensing business performed well, driven by delivery of North American project volume and an overall positive global paint market. BAND IT had strong results across the industrial, automotive and oil and gas markets. On the automotive side, we continue to outperform the market and capture share on new platforms.

Speaker 3

In energy, we see strong downhold market demand and capture share due to material availability with shorter lead times for our customers. Within fire and safety, we are seeing strong demand with our E3 Rescue tools. On the fire side, core North American and European markets remain choppy due to OEM supply chain constraints, but we are starting to see some modest improvement. With that, I'd like to provide an outlook for the Q3 and our full year 2022 results. I'm on Slide 11, which lays out our updated guidance.

Speaker 3

For the Q3 of 2022, we are projecting organic revenue growth of 9% 10% and operating margin of approximately 24%. Q3 forecasted op margin is up slightly versus 2nd quarter due to improved price cost partially offset by lower seasonal volume leverage. We expect GAAP EPS to range from $1.80 to 1 0.85 and adjusted EPS to range from $1.98 to $2.03 Turning to the full year, Given our strong performance in the first half of the year, we are raising our full year guidance. We now expect full year organic revenue growth of approximately 10%. This reflects our confidence in line of sight for the Q3, but some caution in the Q4 due to the short cycle nature of our business.

Speaker 3

We expect GAAP EPS to range between $7.19 to $7.29 and We are expecting free cash flow as a percent of adjusted net income to range from 75% to 80%, down from our previous guidance. With our higher revenue expectations for the back half of the year, elevating our year end receivables balance and a slower than expected inventory bleed, This is our best estimate as we head into the second half of the year. Our long term goal remains to be above 100% and consider the current guidance a reflection of the volatile external environment versus a structural shift in our cash generation capabilities. With that, let me pause and turn it over to the operator for your questions.

Operator

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. Our first question comes from the line of Mike Halloran with Robert W. Baird. Please proceed with your question.

Speaker 2

Hey, good morning, everyone. Good morning, Mike.

Speaker 4

So let's start with the comment, Eric, that you said you're really not seeing anything yet In terms of deterioration, things are going well and you can certainly hear that from all the end market commentary you guys gave. And then balance that with the guidance outlook that says you're taking a little bit more of a cautious outlook into the 4th quarter, Given short cycle business, you don't know what you don't know. So maybe just talk about those 2 competing things and what Things you're looking for in your portfolio to say that things are going to keep this pace, maybe decelerate, could be the bandit business, could Something else, but would love to kind of compare, contrast all that stuff.

Speaker 2

Yes. Well, thanks. So we're always looking at what we Refer to as our canaries in the coal mine businesses. Those are the shortest cycle, more industrial businesses that are very, very close to the actual consumption What's going on out there in the industrial landscape? And those have held up really, really well.

Speaker 2

I mean, I think that's the story of this Whole post pandemic recovery is just an industrial system that's been working feverishly to try to catch up. So Yes. That for us is always something that we're looking at first to see if there's an indicator of weakness there that usually sends up a signal and then you start to see things come after that. And so far, As I said in the comments, that's holding in. And then I'm sure we'll talk about this more in the call, but then we balance that with some of the exposure we have across Whole host of markets on the project side, that's more of an indicator for us of overall future confidence How people are tilting towards uncertainty, those things.

Speaker 2

And there's a couple of places where we've seen that slow down. I mean, it's an interesting story overall, where in many ways it's That kind of business has just struggled to get traction in this whole recovery cycle. But other than a few indicators and pockets there, Once I think point out a bit further into the future, we sort of keep a look at all of those and then look at our own backlog support on top of all of it that gives us At least the assurance in the short term and of course we'll always adjust that and recalibrate it and that's the joy of a short cycle business. You can do that pretty quick.

Speaker 3

Yes. And just to frame that, I mean, our implied guidance, Mike, is kind of a 1 percentage sequential deceleration in Q4. So it's small, just A little bit of noise that could potentially be out there, but right now what we have line of sight to and the confidence in our order patterns, we still think the back half is going to be really strong.

Speaker 4

No, that makes sense. And I think you said the backlog built in the quarter by $39,000,000 something like that. Is that are you seeing lead times extend come in? Is that more a reflection of that underlying order strength through the quarter? Maybe just talk a little bit about the backlog piece.

Speaker 2

I mean, it's really broad based. We're looking at it the other day to see if it was coming in pockets and chunks and it's not. I mean, it's kind of layered across a lot of things. Our lead times in aggregate are Holding or decelerating, I mean, we made a comment there that we are seeing some pockets where frankly our advantage lead times that are reducing are giving us some I'd say on balance, we're not doing anything to drive that in the wrong direction. It's going in the right direction.

Speaker 2

And the backlog build is very, very broad based.

Speaker 4

Last question for me. You made a comment in there that you invested to support accelerated M and A processes. Is that a reflection of a pretty healthy pipeline? I know the environment has gotten a little more challenging on the M and A side. So I'd like to understand what you're seeing and what you hope those investments can get you?

Speaker 2

Yes. I'd say, I mean, look, I think the environment for high quality assets It's held up pretty well as we've gone through this, but a lot of this is very deliberate work on our part to say that we want to go deeper frankly into our insight into those sort of concentric circles that surround our best applications. So there's a purposeful step up in work of that type, Both resources and some things we're doing with 3rd party analytics to make sure that we understand it as well as we can in an environment that so far is holding up Pretty well for high quality assets.

Speaker 4

Makes a lot of sense. Thanks. Really appreciate it. Thank you, Mike.

Operator

Our next question comes from the line of Deane Dray with RBC Capital Markets. Please proceed with your question.

Speaker 2

Thank you. Good morning, everyone. Good morning, Deane.

Speaker 5

Maybe we could start with the free cash flow guidance cut there. And look, we're seeing this across the sector. This is Getting to be pretty familiar, but the idea of carrying more buffer inventory and then the expectation with all this demand likely resulting in higher receivables towards year end. So we get the way the math works. But Bill, can you expand on The timeframe for bleeding the inventory down, I guess it really does depend on how the supply chain begins to normalize, but just take us through the math on that.

Speaker 3

Yes. No, I think that's exactly right. Yes. As we sit here now and lead times, as Eric just talked about on our side are improving, we're starting to see that across the broader aspects of our supply chain. So our Increased purchases to buffer some of the longer lead times to continue to deliver for our customers is shrinking.

Speaker 3

Now it's just catching up with our production and Getting that through our system. So, yes, as we look at Q3, there'll be some improvement, but more material decreases in the 4th quarter Leading into the 1st part of next year. So, again, we spent a lot of time with the teams to understand and calibrate around Still having this robust demand, measuring what our vendors and their capabilities are from a lead time perspective and then drawing down our open POs And then increasing the throughput as we have here in the Q2 to the first and maintaining that as we progress through the back half of the year.

Speaker 5

Is there anything on product shortages, semiconductor related, where your Corey, is you've got nearly finished goods, but they're waiting on a particular product That's adding to your inventory. Is that an issue at all?

Speaker 3

Yes. That is a component as we've had customers Who other suppliers for them haven't been as capable to produce have held up some of their receipts. So We have finished goods at a higher level than we have had historically, because of issues our customers are facing With other suppliers.

Speaker 2

And maybe, Dean, to the extent you were I think you were also asking about maybe unfinished things that we have in our own Factories or something waiting on a part, much like you see in the auto world. You don't and I wouldn't say that it's completely devoid of our environment. You don't see it all that often because we have pretty quick rapid turn 1 piece flow kind of build. So it doesn't do well with Something that's half done, there's really nowhere to put it. And our production process is quick enough, you're better off not starting it just because in general, most of our businesses, that's

Speaker 5

That's helpful color there, because you do hear like for the autos, where they've got all these cars lined up that They'll need semiconductors and

Speaker 6

Yes.

Speaker 2

We wouldn't put a pump for something into the building schedule because we'll Make 40 of them in a couple of hours, those kind of things.

Speaker 5

Good. All right. Last question for me. Eric, you kind of begged the question earlier to Mike's When he's asking about the macro, you said there are some pockets of slowing on projects. So and absolutely, that's a reflection And of kind of what we say CEO confidence, are they going to move ahead?

Speaker 5

I think you made a reference to midstream, And we've heard plenty of that. It just really hasn't realized in full kind of spending given oil prices. But Where and how would you describe some of these pockets of projects slowing or just not getting the release that you thought you were going to get?

Speaker 2

Yes. I'd say probably more of the second category, not getting the release or not coming on the line, something we've been thinking about or projecting for a while now. And some of these just get extended out. So you mentioned the midstream side, I mean, there's some pockets in our chemical markets exposure, maybe more on the European side than elsewhere. A little bit in the paint dispensing area.

Speaker 2

We're just kind of coming off the end of a big replenishment cycle there. And then a few things in just specific industrial markets, food expansion, places like that. I mean, they're pretty isolated. It's not a massive part of our business, but they're good indicators things to watch. And I would just say, it's been interesting over the cycle here is Because this category never really took off.

Speaker 2

I mean, I think in the beginning, it was very much clouded with uncertainty, the nature of the recovery, then it turned into a Kind of a bandwidth issue, can anybody put together the materials or the time and energy to work on it? Maybe here in the later innings of it, It's sort of all of those factors and uncertainty creeping in back a bit. The bandwidth issue is still there and now inflation and the cost of these projects is causing Some recalibration for in certain markets, we feel like to kind of go back and run the math again.

Speaker 5

That's real helpful. Thank you.

Speaker 2

Thanks, Steve.

Operator

Our next question comes from the line of Allison Poliak with Wells Fargo. Please proceed with your question.

Speaker 7

Hey, guys. Good morning.

Speaker 2

Hi, Allison.

Speaker 7

Keeping in mind with that project comment, I know you talked verticals, but is it any like weighted towards a specific geography or is it seem very broad based by vertical at this point, Just in terms of what you're seeing?

Speaker 2

Well, I mean, I'd say it's broad based in terms of the way I just described it. I mean, we are seeing a bit more geographic strength in North America than Europe for all the reasons I think we would suspect in terms of Things people are watching there on the geopolitical side, the energy side, those things, but both are positive for us. But if I had to call it, I would say a little bit more positive on the American side then Europe.

Speaker 7

Great. And then just kind of going back to the free cash flow and just CapEx in general, tepid start to sort of that You talked about Banjo and then investment in emerging markets. I mean, are those still on track or does You kind of risk that some of that gets pushed to next year just because of the uncertainty right now?

Speaker 3

No, that's what's going to drive the increased spend in the back half. Yes. We're expecting both the India and China facilities to open later this year. And then Banjo, Yes. I think it's kind of late Q3, early Q4.

Speaker 3

So there's a those projects I think are on track. Obviously, that's a subset of the $60,000,000 ramp $30,000,000 ramp, dollars 60,000,000 spend in the back half. That relative to supply chain delays and things, we have seen some items, smaller items push from the first half 2nd, so there's a little bit of play in that number, but for the large ones, we're confident that those will hit here in the next couple of months.

Speaker 7

Great. Thank you.

Operator

Our next question comes from the line of Rob Wertheimer with Melius Research. Please proceed with your question.

Speaker 8

Thanks. Good morning, everybody.

Speaker 2

Hi, Brad.

Speaker 8

My question is just a little bit more on M and A. Can you talk about just what the feel is like From potential sellers out there, whether I don't know whether things get repriced as you kind of edge through different parts of the process and the markets corrected and interest rates are higher. I I love if there's a standoff as people adjust to different pricing or not? And then any comment you'd make on how big your funnel and kind of pipeline are versus prior periods? Thanks.

Speaker 2

Yes. So as I said before, I mean, all this is bracketed a bit by the step up in intentionality and work that we're doing. So In that respect, again, there's a lot of things we're looking at, a lot of analysis that we're doing and a lot of conversations that we're having. You would say that just activity level is north of where it has been, much of it driven by our work. Now in those conversations, probably much like The conversations you have, there is definitely more discussions around near term prospects and what's going on with the forecast and how do you see the Sales tracking out and to the extent that all links back to valuation, it's just more intense than it has been for all the reasons you suspect.

Speaker 2

As Bill and I have always said though, when you're looking at assets of the quality that we look at, you're generally looking at a history that's Very sharp, well positioned, driving in strong ways. And then a reasonable projection path, especially if we're the owners that kind of picks that up again. So that doesn't mean that both sides are going to be able to see that and get through it. So that's always a possibility. But Our perspective is very long term in nature for the kind of assets that we're looking at.

Speaker 2

So long story short, more activity on our part, which means I think it's a strong funnel for us, a lot of activity, engaging with people, more near term discussions around what this all means and where it's going to go, but then Kind of just take a deep breath, stare over the horizon and be confident that for quality, I think ideally both sides see it that way and stay engaged.

Speaker 8

Perfect. Thank you. If I can, I guess, follow-up on that, on the uncertainty and so forth? You touched on backlog earlier. I don't know if you're Willing to give any more color on where your backlog stands versus prior cycles or versus prior record levels, etcetera?

Speaker 8

It seems there's a A bit of a standoff in that everybody is uncertain about the future, but the future doesn't look bad currently. I don't know if the backlog will help us triangulate that a bit.

Speaker 3

No, definitely. I mean, our backlog is kind of 2x of what it has been historically. Normally, we'd go into a quarter with 50% of The quarter sales and backlog, we've got close to 2 thirds now. So we have a lot more visibility to temper any dramatic short term fall off. So again, relative to The next couple of months, we're fairly confident in our numbers.

Speaker 3

So I don't think there's a huge pause that would come because our backlog could support any short term Decrease in orders.

Speaker 8

Thank you. I'll turn it over. Thanks.

Speaker 2

Yes.

Operator

Our next question comes from the line of Matt Summerville with D. A. Davidson. Please proceed with your question.

Speaker 9

Thanks. Just a couple of quick questions. With respect to price, can you comment on where you were price realization 2nd quarter year over year? And how much incrementally on top of that you expect to realize in the back half? And then I have a follow-up.

Speaker 3

We're a little over 4% here in the 2nd quarter, which ramped from a little over 3% in the 1st quarter. We won't guide the balance of the year price, but we're really confident in what the teams have gone out with to combat inflation, which seems to have leveled off. So I mentioned we have an expectation that our price cost is going to continue to improve through the back half of the year to support some of our higher margin profile expectations.

Speaker 9

In certain areas of the commodity market, certainly in metal, steel, aluminum, copper, things have come off their Pretty materially still elevated from historical standards, but certainly off peak. When does some of that start to actually Add some incremental benefit to your P and L?

Speaker 3

I would say a couple of things. One, relative to We have a couple of businesses that have direct exposure to commodity prices from a materiality level. We're buying Components that are a couple of phases through that value stream. So obviously, we didn't have the vast inflation impact On the way in that a lot of other companies did, again, 4% price increase is still price cost positive and we're building. Yes.

Speaker 3

That will, I think, wean out over time. It won't be a material impact, but we will keep all the incremental pricing that we've had. Again, We've holistically gone out with price increases versus surcharge. So we like where we're positioned here going forward.

Speaker 9

Understood. Thank you very much.

Speaker 6

Sure.

Operator

Our next question comes from the line of Jeff Sprague with Vertical Research. Please proceed with your question.

Speaker 6

Hey, thanks. Good morning, everyone. Hey, Eric, can we come back to what you said really on deal cultivation, right, and the activity Being more of a function of your internal efforts, maybe you could elaborate on that. Have you significantly up resourced The deal teams, does this heavy level of activity indicate any interest in kind of pursuing new adjacencies? Just Maybe a little bit of kind of strategic and tactical color on what's going on there.

Speaker 2

Yes. I mean, we're not a massive center led This might sound more dramatic than it probably is from a headcount perspective. I mean, it's a few well positioned ads from the outside, some That we're doing on the 3rd party side. And then frankly, the biggest component is just the higher level of engagement overall business to business. I This is something we've been driving now for a couple of years.

Speaker 2

As we really focus to combine growth outperformance on top of our just sort of Institutional, great, well deserved execution chops. And so a lot of it's that way. In terms of where we're looking and what it looks like, I We've always favored I always come back to this analogy of concentric circles around these applications that we kind of currently sit in. We know these environments really well. We know what's to the right or left of us.

Speaker 2

And the best word for me is really starting to understand where is this market heading? Should we make a move slightly left or right and how would we do that? The recent acquisitions that we've layered into the company are perfect examples of that. As we said before, we're also thinking about the broader world in general and where problems are presenting themselves and where IDEXX like Styles of competition could come in play and maybe that would open up a flank for us and some applications that are new to the company. So that's in the mix as well.

Speaker 2

But if you really had to overgeneralize it and think of it, think of it as just radiating circles from the best parts of the company with more intensity, A lot of it from the ground up. That's the way we like to do it.

Speaker 3

Yes, I think those actions the depth and quality of the funnel is probably at an all time high. That work that the team has done across a variety of different end market applications, those consensus circles that Eric highlighted. And one of the main reasons why we are so confident in our ability to deploy capital much more consistently as we progress.

Speaker 6

Great. And unrelated, just back to this, I mean, everybody's got their ear to the ground trying to sit down an issue with the economy. Any gut feel that actually these improving lead times are actually the canary in the coal mine? Anything happening in just kind of the supply dynamics and kind of order the shipment dynamics or anything that Maybe earlier precursor of some deceleration.

Speaker 2

That's a good question. I mean, it's hard to say though because In many ways, we've been running us, others at such a hot level. It's pretty abnormal. Pulling back from that in any way, even if it's Simply the deceleration of the tremendous acceleration we've been feeling is going to have a material Noticeable impact inside just how it feels in the business. But I don't know that that's the same thing as a broader call on economic conditions, maybe more than Okay.

Speaker 2

It's not at peak levels. We can catch a breath. We can actually be a little bit more planful, mindful. And that's for us and that's for others as well. So I Think of it more in those terms than let's say, since there's nothing else to do, we can get product quicker.

Speaker 2

I don't see it as an indicator of that.

Speaker 6

Great. Appreciate the color. Thank you.

Operator

Our next question comes from the line of Vlad Baeshiqa with Citigroup, please proceed with your question.

Speaker 5

Good morning, everyone. Thanks for taking my call.

Speaker 6

Hi, Glenn.

Speaker 3

So I just wanted to ask kind of following up

Speaker 5

on these macro related questions. In your Businesses that go through distribution, can

Speaker 10

you give us some color on what you're seeing and hearing in terms of distributor inventories and whether Are there any areas where you're more concerned about a potential for destocking in the event of a slowdown?

Speaker 2

Yes. Well, I always kind of preface this question with a reminder that we have a lot of configured customized products with quick replenishment, which means Not a ton of our inventory on shelves. So it's a small number. I will say, we've got some good visibility to it line of sight Minimum, you can see it visually when you go visit them. And so you can see some slight increases there for our product.

Speaker 2

I would Assume that's applicable to more stockable components as well. In our world, we think of that as If ultimately that bleeds off over time, in some ways it's pretty similar to the way that it works in our own business. It takes a while because of the wide variety of The use that are out there, none of it's really clumped around a standard solution that if you made a deterministic call on it, which is flow out in a big pocket or chunk. So We think about it a lot for IDEXX, mainly just as more of an indicator of health overall, but from a meaningful impact to the numbers Up or down, it extends over a large time horizon. It's not a giant piece of the business and it usually is Kind of lost in the math, to be honest.

Speaker 5

Okay. That's helpful. And then Maybe just stepping back. So you talked about obviously the intent to bleed down some inventory here over the back half and into 2023.

Speaker 10

But your availability has been, I think, a competitive advantage for you.

Speaker 5

So can you talk about what you're Seeing

Speaker 10

in terms of your own supply chain availability and logistics that gives you the confidence to begin to bring down inventory without Giving up any of the competitive advantage that you've gained through the recovery?

Speaker 2

Yes. Well, I mean, some of it The inputs are fact based. So we can see and we track our own our suppliers' performance and their lead times and their on time delivery to us. You basically start there and say, well, we can see factually some improvement. The logistics loops are quite a bit better than where they have been On the 1st part of the year and frankly, our teams are really good now at navigating them when they kind of run astray.

Speaker 2

I think the biggest thing for us and anybody that wants to go tackle this now is some ways you got to take advantage of the ability to take a breath. I would say as we've improved throughput momentum and we're executing stronger here that does buy us a little bit of time, space and energy to go back and recalibrate the systems, Which is what you actually have to do to go attack inventory. You've got to go change demand signals. That's part by part. It's you do it Lines of paper laid out across the desk.

Speaker 2

And so and Bill talks about our engagement with our teams, that's the kind of work we're making sure is happening that People are kind of racking and stacking at 80s to 20s and making the calls based on fact based patterns that they can see and taking advantage of the time and energy they have to go do it.

Speaker 3

And in some of the areas we've been able to take share, it's because we have an 80 position with that vendor and we're getting a higher allocation than some of our smaller competitors. So If they don't have the material availability, we're able to go in and then take their volume.

Speaker 10

Perfect. That's really helpful color, guys. Thanks.

Operator

Our next question comes from the line of Nathan Jones with Stifel. Please proceed with your question.

Speaker 2

Good morning, everyone. Hi, Nathan.

Operator

Just a let's start with

Speaker 11

a question on Health and Science and the organic order growth that you're seeing there. Yes, everybody is focused on the economy going up and down at the moment, but that's a business that's less cyclical for you and still showing extremely strong orders. Maybe you can just talk in a bit more detail about what's driving those? Are these product cycles that have Do you think duration? What the outlook is for continued growth there?

Speaker 11

Just any more color you can give us on the strength around

Speaker 2

that business? Yes. I mean, it's exactly the way you described it. I mean, it's very much tied to strong trends that we're going to, I think you run out for quite some time here. So we like everything else in IDEXX, we break it down into all sorts of little components and drivers and specific application sets.

Speaker 2

Yes, some of the ones that are going well there, the AI space is healthy. That's a decent part of the business, analytical sorry, analytical instrumentation. And then the genomics space has been very, very active. A lot of that is involving initially COVID and COVID surveillance. I think now as the pandemic has kind of moved on and entering in its 3rd year, we're We're seeing now some more targeted work around taking some of that technology and applying it for things like targeted medicine and all the things that were always out there for that Field of study.

Speaker 2

So those have been healthy as well. We continue we have some isolated pockets where we do support for vaccines and things of that nature that Stay strong to the duration as they're continuing to work on different targeted vaccines and things like that for both COVID as well as other So it's definitely picking up most of the macro dynamics and trends that we have long known are out there and that's why we Spend a lot of time investing in it and talking about it.

Speaker 11

Thanks for that. Maybe one on gross margins. I You obviously have very strong gross margins for an industrial company to begin with. They've been pretty consistent over the last few years in this 45 plus or minus kind of range. Is there a negative impact that you've seen to gross margins with all of the disruptions around Supply chain in COVID that maybe are less related to price cost, but modest inefficiencies within your manufacturing That maybe go away that could lead to higher gross margins or anywhere else that you see opportunities to expand gross margins?

Speaker 3

Yes. No, I think the biggest pressure has been price cost. With 45% gross margins, you have to have a price cost spread well in excess of that To expand, so that has put constant pressure and then we continue to invest in engineering resources, which reminds everyone that is included And our gross margin number. So we've been able to maintain through robust productivity across the portfolio to offset some of those headwinds. So I do think pricecost getting back to historical levels and then our continued Volume leverage that we get and the high contribution margins we have in our business, once we stabilize a little bit from an operations perspective, We'll be able to pull through some increases with again just the very difficult operating environment we've been The ability to have discrete productivity projects across the portfolio that we've historically been able to Execute on.

Speaker 3

It has been muted a little bit too here is another point. So, I think as things normalize, we'll get another kicker off of that.

Speaker 11

Great. Thanks for taking the questions.

Speaker 2

Yes. Thanks, David.

Operator

Our next question comes from the line of Scott Graham with Loop Capital. Please proceed with your question.

Speaker 6

Thank you for taking the question. Good morning all and congratulations on what was a really good quarter from you guys. I have one quick one for Bill. Kind of, could you give us an idea of where sort of your sales are running OpEx Versus

Speaker 3

CapEx? We don't really Close that externally, to be honest, we don't look at it internally. It goes a little bit to the project comment that Eric talked about a little bit earlier. It's not a huge part of our business. So I would say holistically, most of our projects are OpEx replacing like for like Current IDEXX volume and then some incremental market share gains that we have.

Speaker 3

The CapEx, we have Some specific things that we would be able to realize with plant expansions, new plant creation, but Overall, relative to our portfolio, it's not an overly material number. So the short answer would be holistically, it's more OpEx related on our sales.

Speaker 6

Got it. Thank you. So now I want to maybe understand dispensing a little bit. There's a comment in the deck Talks about non repeat orders, quarter back, maybe 2 quarters back, we talked about how dispensing should weaken Fairly materially in the second half of this year, I'm just trying to triangulate what that means now for the second half Of the year, how does dispensing look? Is it does it look better now or not?

Speaker 3

No, I think it's in line with our expectations that we had at the beginning of the year. I mean orders pressure in the second Quarter will have more pressure in the 3rd, but they'll continue to have sales growth in the 3rd quarter with sales finally falling off a little bit kind of post those Replenishment projects in the Q4. So still a great business, very global, still having wins in emerging markets. They're launching new technologies on the software side. So although they're going to lose the replenishment, their core business continues to grow.

Speaker 3

So it's been Cyclical over its lifespan, but a little bit of pressure here in the short term As those projects roll off, but holistically, lots of additional opportunity through software and emerging markets growth.

Speaker 6

Got it. And if I could just squeeze this last one in on the fire business where the OEMs, your customers are still saying that they're Pretty supply chain restrained. Has anything changed in the last couple of quarters there? Because It's a pretty good business for you guys, particularly now with your having a nice little beachhead in Europe. Could you give us an idea of Where that business goes in the next couple of quarters?

Speaker 2

Yes. I'd say the headlines there, the supply chain constraints And for the larger folks that are in that space are still there, still challenging, still fighting that. I will say that there's kind of smaller to medium specialty Players have done a decent job jumping in, so that's helped us a bit. It's just not the biggest part of the market. We remain really, really focused in that business on technology.

Speaker 2

So there's only so much we can do to help out on the supply chain side. Eventually that will You'll come to a better place. As it does, we want to be ready with all of the automation that we've been talking about, not only the pieces that we have in the water path of the mobile platform, But we've got a nozzle now that's got connectivity in it and diagnostics. We're doing the same thing on the rescue tools piece. So we've got some really, really good things there Just presented in a giant global show here in the Q2.

Speaker 2

So that for us is kind of the longer term headline on an industry that we think will Ultimately start to dial in and improve. Got it. Thank you. Thanks, Scott.

Operator

Our next question comes from the line of Brett Lenzey with Mizuho. Please proceed with your question.

Speaker 3

Hi, good morning all.

Speaker 6

Just wanted to come back to the orders, so the underlying run rates in the quarter, very strong, even more encouraging on a 2 year Stack basis, what is your expectation for year over year order growth in the second half as customers are no longer advance ordering or some of this back Logan Wines, I mean, do you think you can grow orders and anything that July would inform you here?

Speaker 3

So obviously, back half, we got much tougher comps in the Q3, at least relative to where we have visibility. We think we'll still be Positive from an organic perspective, highlighted a little bit of the dispensing pressure that will continue, but overall IDEX Still positive. And from a July perspective, no material changes versus the trends that we've experienced here across the portfolio.

Speaker 6

Okay, great. And then just was hoping you could spend a moment on the KZ Valve acquisition, how that performed on a standalone basis Heading into the close relative to expectations. And then what are you calibrating for accretion within the guidance framework for this year?

Speaker 2

Sure. I'll cover kind of the general state of the business, let Bill answer the financial question. So I mean that has been a really, really strong Acquisitions, strong integration process, it is a very, very close complement to our Banjo franchise in the ag space within FMT. It's conveniently not very far away. And so the teams have really attacked it.

Speaker 2

It's performed strong as all our agricultural Businesses have both in North America and Europe. And so this has been in some ways one of the easier integrations because the commercial linkage is So strong in the business and everybody speaking the same on the same page with technology and the broader market supports it. So Very, very strong out of the gate, excited on the long term prospects here and I'll let Bill talk about the specifics.

Speaker 3

Yes. EPS in the back half $0.02 to $0.03

Speaker 6

Okay, got it. Thanks for the questions.

Speaker 2

You bet.

Operator

Our next question comes from the line of Michael Anastasia with Cowen. Please

Speaker 6

You mentioned the strength you're seeing more broadly, but obviously the macro is deteriorating. What types of initiatives are you doing internally to prepare for those macro data points ultimately if they start impacting the business?

Speaker 2

Yes. No, thanks for that. So I mean, yes, we've seen a lot of these cycles before. We have kind of a standard way that we look at it. I think For us, the first lever would be looking at discretionary spend.

Speaker 2

We've called that out a few times because we came off a base with almost none of it. Now we are out engaging with customers going to trade shows, so it's elevated a bit. But we know, frankly, if we learned anything over the last couple of years, you can make it through with a Much lower level of discretionary spending. That'd be the first lever. As Bill mentioned, I think there is an opportunity here for a Pretty hard look at productivity across a factory setting.

Speaker 2

If things were to cool off a bit and we actually got some bandwidth back On the team's perspective, rethought how Flow is working, how different product lines are in different positions than where they may have been a couple of years ago. So we go there next. The one area that might be a little bit different, we've talked about it a lot, is on the headcount side, on the people side. I mean, even today, we still have we're still looking for people. The war on talent is real.

Speaker 2

Some of the communities we live and work in, it's been Harder to find labor. I mean that's improved here more recently, but it's still there's still pressure in that area. So that's probably the area given all the focus we have on growing the Long term, in that dynamic, we would be the most thoughtful about where we would make choices, investments and things along the way. Otherwise, I'd say it's a pretty familiar process for us. The short cycle nature helps us get at it fast.

Speaker 2

And So it's never far away the playbook to run that. Anything Bill you add there?

Speaker 3

No, I think you said it well. It is At least our expectation for decrementals will be a little bit higher than they have been historically, because of Relative to current profit levels and the war on talent that Eric highlighted, so maybe we would historically have been in the low 30s. We're probably closer to 40% here if there's a slight hiccup here as we progress over the next couple of quarters.

Speaker 6

Thanks. That's really helpful. Just one more, if I may. I know we had mentioned orders before, but declining Sequentially over the past quarter, what are you seeing from a cadence perspective going forward?

Speaker 3

Yes, I think there's always our Q1, we generally get our annual blankets from a lot of our customers. So it's generally inflated relative to sequential profile of the balance of the year. So, that's the real driver from the Q1 to Q2. And for us now, it's kind of leveling off with keeping an eye on just our daily order rates, which have sustained here in the Month of July.

Speaker 6

Great. Thank you.

Operator

There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.

Speaker 2

Okay. Well, thanks everybody for joining today. We're really, really proud of our first half performance here. And as I close, just I guess the one thing I'd want you to take away is it's really a story of and not or here at IDEXX. I mean, We've long, I think, earned our reputation for tactical execution, good times, difficult times.

Speaker 2

We're seeing that in the performance that we're addressing here today. And we're working deliberately to drive growth outperformance as an additive component of value creation on top of it. We basically do that by picking the top bets that align really, really well to the macro trends that are going to Great. Over the long haul, we rally resources around those. And then here, as I spoke a few times, we very deliberately complemented those efforts With organic and inorganic investments and we'll continue to do that as we go forward.

Speaker 2

So I think you're seeing it play out. You're seeing it play out in acquisitions we made That celebrate precision ag or alternative energy in the pneumatic space or water solutions and what that can be. So you're seeing that come together and I just want I'll highlight the additive component of those two things and we'll continue to talk about that as we move forward. Thanks very much for your interest in joining today.

Operator

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.

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Earnings Conference Call
IDEX Q2 2022
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