filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10‑K*.* The discussion of our financial condition and results of operations and liquidity and capital resources for the year ended December 31, 2017, is included in our Annual Report on Form 10-K for the year ended December 31, 2018, within Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, and is incorporated by reference herein.
We have included certain terms and abbreviations used throughout this Annual Report on Form 10-K in the **"**Glossary of Terms and Selected Abbreviations.”
Description of Business Segments. We operate primarily through three business segments: diagnostic and information management-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 food, 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. See "Part II, Item 8. Financial Statements and Supplementary Data, Note 3. Revenue Recognition and Note 16. Segment Reporting" to the consolidated financial statements for the year ended December 31, 2019, included in this Annual Report on Form 10-K for financial information about our segments, including our product and service categories, and our geographic areas.
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.
The following is a discussion of the strategic and operating factors that we believe have the most significant effect on the performance of our business.
Companion Animal Group
Our strategy is to provide veterinarians with both the highest quality diagnostic information to support more advanced medical care and information management solutions that help demonstrate the value of diagnostics to pet owners and enable efficient practice management. By doing so, we are able to build a mutually successful relationship with our veterinarian customers based on healthy pets, loyal customers and expanding practice revenues.
CAG Diagnostics. We provide diagnostic capabilities that meet veterinarians’ diverse needs through a variety of modalities including in-clinic diagnostic solutions and outside reference laboratory services. Veterinarians that utilize our full line of diagnostic modalities obtain a single view of a patient’s diagnostic results, which allows them to track and evaluate trends and achieve greater medical insight.
Our diagnostic capabilities generate both recurring and non-recurring revenues. Revenues related to capital placements of our in-clinic IDEXX VetLab suite of instruments and our SNAP Pro Analyzer are non-recurring in nature in that they are sold to a particular customer only once. Revenues from the associated proprietary IDEXX VetLab consumables, SNAP rapid assay test kits, reference laboratory and consulting services, and extended maintenance agreements and accessories related to our IDEXX VetLab instruments and our SNAP Pro Analyzer are recurring in nature, in that they are regularly purchased by our customers, typically as they perform diagnostic testing as part of ongoing veterinary care services. Our recurring revenues, most prominently IDEXX VetLab consumables and rapid assay test kits, have significantly higher gross margins than those provided by our instrument sales. Therefore, the mix of recurring and non-recurring revenues in a particular period will impact our gross margins.
Diagnostic Capital Revenue. Revenues related to the placement of the IDEXX VetLab suite of instruments are non-recurring in nature, in that the customer will buy an instrument once over its respective product life cycle, but will purchase consumables for that instrument on a recurring basis as they use that instrument for testing purposes. During the early stage of an instrument’s life cycle, we derive relatively greater revenues from instrument placements, while consumable sales become relatively more significant in later stages as the installed base of instruments increases and instrument placement revenues begin to decline. In the early stage of an instrument’s life cycle, placements are made primarily through sales transactions. As the market for the product matures, an increasing percentage of placements are made in transactions, sometimes referred to as volume commitments, such as our IDEXX 360 program, or reagent rentals, in which instruments are placed at customer sites at little or no cost in exchange for a multi-year customer commitment to purchase recurring products and services.
We place our Catalyst chemistry analyzers through sales, leases, rental, and other programs. In addition, we continue to place VetTest instruments through sales, lease, rental, and other programs, with substantially all of our revenues from that product line currently derived from consumable sales. As of December 31, 2019, our Catalyst and VetTest chemistry analyzers provided for a combined active installed base of approximately 56,200 units globally, as compared to approximately 50,800 units in 2018 and approximately 47,000 units in 2017. As of December 31, 2019, our premium Catalyst chemistry analyzers provided for an active installed base of approximately 43,900 units globally, as compared to approximately 37,000 units in 2018 and approximately 30,000 units in 2017. A majority of our Catalyst chemistry analyzer placements were to customers that are new to IDEXX, including customers who had been using instruments from one of our competitors, sometimes referred to as competitive accounts. Generally, placement of an instrument with a new or competitive account has the highest economic value as the entire consumable stream associated with that placement represents incremental recurring revenue, whereas the consumable stream associated with a Catalyst placement at a VetTest customer substitutes a Catalyst consumable stream for a VetTest consumable stream. We have found that the consumables revenues increase when a customer upgrades from a VetTest analyzer to a Catalyst analyzer due to the superior test menu capability, flexibility, and ease of use of the Catalyst analyzers, which leads to additional testing by the customer.
As we continue to experience growth in placements of Catalyst analyzers and in sales of related consumables, we expect this growth to be partly offset by a decline in placements of VetTest analyzers and in sales of related consumables.
The ProCyte Dx analyzer is our latest generation hematology analyzer. In addition, we sell the LaserCyte Dx and VetAutoread analyzers. As of December 31, 2019, these hematology analyzers provided for a combined active installed base of approximately 38,200 units, as compared to 35,900 units in 2018 and 33,400 units in 2017. As of December 31, 2019, our premium ProCyte Dx and LaserCyte Dx hematology analyzers provided for an active installed base of approximately 31,500 units globally, as compared to approximately 29,000 units in 2018 and approximately 26,000 units in 2017. A majority of our Procyte analyzer placements were made to new or competitive accounts. We also continue to place a substantial number of LaserCyte Dx instruments, both new and recertified, as trade-ups from the VetAutoread analyzer and at new and competitive accounts. As we continue to experience growth in placements of ProCyte Dx analyzers and in sales of related consumables, we expect this growth to be partly offset by a decline in placements of LaserCyte Dx and VetAutoread analyzers and a decrease in the associated recurring revenue stream.
Our SediVue Dx instrument was launched in North America early in 2016 and in the U.K. and Australia in the fourth quarter of 2016. During 2017, we continued to launch SediVue Dx internationally. As of December 31, 2019, our premium SediVue Dx analyzers provided for an active installed base of nearly 8,900 units globally, as compared to approximately 6,600 units in 2018 and approximately 4,000 units in 2017. This instrument and single-use consumable system provides a highly accurate way to automate the process of examining urine under a microscope. We provide customers with SediVue Dx consumables that are charged upon utilization, which we refer to as pay-per-run, as compared to other instruments where we charge upon shipment of consumables. This new pay-per-run consumable revenue stream is contributing to our continuing growth, however is not currently material relative to IDEXX’s overall revenue.
We seek to enhance the attractiveness and customer loyalty of our SNAP rapid assay tests, including by providing the SNAP Pro Analyzer, which activates SNAP tests, properly times the run, captures, and saves images of the results and, in conjunction with IVLS, records invoice charges in the patient record. Beginning in January of 2017, with our ProRead software, the SNAP Pro Analyzer interprets results. These features promote practice efficiency by eliminating manual entry of test results in patient records and also helps ensure that the services are recorded and accurately invoiced. In addition, SNAP Pro Analyzer results can be shared with pet owners on the SNAP Pro screen or, in conjunction with IVLS, via VetConnect PLUS. We also sell the SNAPshot Dx, which automatically reads certain SNAP test results and, in conjunction with IVLS, records those results in the electronic medical record. We continue to work on enhancing the functionality of our analyzers to read the results of additional tests from our canine and feline family of rapid assay products.
Our long-term success in the continuing growth of our CAG recurring diagnostic product and services is dependent upon: growing volumes at existing customers by increasing their utilization of existing and new test offerings, acquiring new customers, maintaining high customer loyalty and retention, our ability to realize modest annual price increases based on our differentiated products and the growing value of our diagnostic offering. We continuously seek opportunities to enhance the care that veterinary professionals give to their patients and clients through supporting the implementation of real-time care testing work flows, which is performing tests and sharing test results with the client at the time of the patient visit. Our latest generation of chemistry and hematology instruments demonstrates this commitment by offering enhanced ease of use, faster time to results, broader test menu and connectivity to various information technology platforms that enhance the value of the diagnostic information generated by the instruments. In addition, we provide marketing tools and customer support that help drive efficiencies in veterinary practice processes and allow practices to increase the number of clients they see on a daily basis.
With all of our instrument product lines, we seek to differentiate our products from our competitors’ products based on time-to-result, ease-of-use, throughput, breadth of diagnostic menu, flexibility of menu selection, accuracy, reliability, ability to handle compromised samples, analytical capability of diagnostics software, integration with the IVLS and VetConnect PLUS, client communications capabilities, education and training, and superior sales and customer service. Our success depends, in part, on our ability to differentiate our products in a way that justifies a premium price.
Recurring Diagnostic Revenue. Revenues from our proprietary IDEXX VetLab consumable products, our SNAP rapid assay test kits, outside reference laboratory and consulting services, and extended maintenance agreements and accessories related to our CAG Diagnostics instruments are considered recurring in nature. For the year ended December 31, 2019, recurring diagnostic revenue, which is both highly durable and profitable, accounted for approximately 76% of our consolidated revenue.
Our in-clinic diagnostic solutions, consisting of our IDEXX VetLab consumable products and SNAP rapid assay test kits, provide real-time reference lab quality diagnostic results for a variety of companion animal diseases and health conditions. Our outside reference laboratories provide veterinarians with the benefits of a more comprehensive list of diagnostic tests and access to consultations with board-certified veterinary specialists and pathologists, combined with the benefit of same-day or next-day turnaround times.
We derive substantial revenues and margins from the sale of consumables that are used in IDEXX VetLab instruments and the multi-year consumable revenue stream is significantly more valuable than the placement of the instrument. Our strategy is to increase diagnostic testing within veterinary practices by placing IDEXX VetLab instruments and increasing instrument utilization of consumables. Utilization can increase due to a greater number of patient samples being run or to an increase in the number of tests being run per patient sample. Our strategy is to increase both drivers. To increase utilization, we seek to educate veterinarians about best medical practices that emphasize the importance of chemistry, hematology, and urinalysis testing for a variety of diagnostic purposes, as well as by introducing new testing capabilities that were previously not available to veterinarians.
Our in-clinic diagnostic solutions also include SNAP rapid assay tests that address important medical needs for particular diseases prevalent in the companion animal population. We seek to differentiate these tests from those of other in-clinic test providers and reference laboratory diagnostic service providers based on critically important sensitivity and specificity, as demonstrated by peer-reviewed third-party research, as well as overall superior performance and ease of use by providing our customers with combination tests that test a single sample for up to six diseases at once, including the ability to utilize our SNAP Pro Analyzer. We further augment our product development and customer service efforts with sales and marketing programs that enhance medical awareness and understanding regarding certain diseases and the importance of diagnostic testing.
We believe approximately half of all diagnostic testing by U.S. veterinarians is provided by outside reference laboratories such as IDEXX Reference Laboratories. In certain markets outside the U.S., in-clinic testing may be less prevalent, and an even greater percentage of diagnostic testing is done in reference laboratories. We attempt to differentiate our reference laboratory testing services from those of competitive reference laboratories and competitive in-clinic offerings primarily on the basis of a unique and proprietary test menu, technology employed, quality, turnaround time, customer service and tools such as VetConnect PLUS that demonstrate the complementary manner in which our laboratory services work with our in-clinic offerings.
Profitability in our lab business is supported, in part, by our expanding business scale globally. Profit improvements also reflect benefits from price increases and our ability to achieve operational efficiencies. When possible, we utilize core reference laboratories to service samples from other states or countries, expanding our customer reach without an associated
expansion in our reference laboratory footprint. New laboratories that we open typically will operate at a loss until testing volumes achieve sufficient scale. Acquired laboratories frequently operate less profitably than our existing laboratories and acquired laboratories may not achieve the profitability of our existing laboratory network for several years until we complete the implementation of operating improvements and efficiencies. Therefore, in the short term, new and acquired reference laboratories generally will have a negative effect on our operating margin.
Recurring reference lab revenue growth is achieved both through increased testing volumes with existing customers and through the acquisition of new customers, net of customer losses. We believe the increased number of customer visits by our sales professionals as a result of the growth in our field sales organization has led to increased reference laboratory opportunities with customers who already use one of our in-clinic diagnostic modalities. In recent years, recurring reference laboratory diagnostic and consulting revenues have also been increased through reference laboratory acquisitions, customer list acquisitions, the opening of new reference laboratories, including laboratories that are co-located with large practice customers, and as a result of our up-front customer loyalty programs and our volume commitment programs. Our up-front customer loyalty programs are associated with customer acquisitions and retention and provide incentives to customers in the form of cash payments or IDEXX Points upon entering multi-year contractual agreements to purchase annual minimum amounts of products or services, including reference laboratory services. Our volume commitment programs, such as IDEXX 360, 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.
Health Monitoring and Biological Materials Testing. We believe the acquisition of the research and diagnostic laboratory business of the College of Veterinary Medicine from the University of Missouri has allowed us to leverage our expertise in veterinary diagnostics and expand our integrated offering of reference laboratory diagnostic and consulting services and in-clinic testing solutions in the adjacent bioresearch market.
Veterinary Software, Services and Diagnostic Imaging Systems. Our portfolio of practice management offerings is designed to serve the full range of customers within the North American, Australian, and European markets. Cornerstone, DVMAX, IDEXX Animana and IDEXX Neo practice management systems provide superior integrated information solutions, backed by exceptional customer support and education. These practice management systems allow the veterinarian to practice better medicine and achieve the practice’s business objectives, including a quality client experience, staff efficiency and practice profitability. We market Cornerstone, DVMAX and IDEXX Neo practice management systems to customers primarily in North America and Australia. We market our IDEXX Animana offering to customers primarily throughout Europe.
IDEXX Animana and IDEXX Neo practice management systems are subscription-based SaaS offerings designed to provide flexible pricing and a durable, recurring revenue stream, while utilizing cloud technology instead of a client server platform. While we continue to develop, sell, and support our licensed-based Cornerstone and DVMAX software, we are growing our installed base of subscription-based practice management offerings for new customers of IDEXX practice management systems. We believe that once established, this subscription-based model will provide higher profitability as compared to the historical license-based placements. Our Cornerstone and DVMAX customer base continues to be an important driver of growth through enhanced diagnostic integrations and high value add-on subscription services, such as Pet Health Network Pro, Petly Plans, and credit card processing, and we continue to make investments to enhance the customer experience of all of our license-based software offerings. We also offer rVetLink, a comprehensive referral management solution for specialty care hospitals that streamlines the referral process between primary care and specialty care veterinarians. rVetLink’s cloud technology integrates with major specialty hospital management systems, including Cornerstone Software and DVMAX Software.
We differentiate our practice management systems through enhanced functionality, ease of use, and embedded integration with in-clinic IDEXX VetLab instruments and outside reference laboratory test results. Our client communication services create more meaningful pet owner experiences through personalized communication. With our Smart Flow cloud technology, we are able to improve overall patient management through coordination and tracking of every step in a patient workflow. Pet Health Network Pro online client communication and education service complements the entire IDEXX product offering by educating pet owners and building loyalty through engaging the pet owner before, during and after the visit, thereby building client loyalty and driving more patient visits.
Our diagnostic imaging systems offer a convenient radiographic solution that provides superior image quality and the ability to share images with clients virtually anywhere. IDEXX imaging software enables enhanced diagnostic features and streamlined integration with our other products and services. Our newest digital radiography systems, the ImageVue DR50 Digital Imaging System enables low-dose radiation image capture without sacrificing clear, high-quality diagnostic images, reducing the risk posed by excess radiation exposure for veterinary professionals. Placements of imaging systems are
important to the growth of revenue streams that are recurring in nature, including extended maintenance agreements and IDEXX Web PACS, which is our cloud-based SaaS offering for viewing, accessing, storing, and sharing multi-modality diagnostic images. We derive relatively higher margins from our subscription-based products. IDEXX Web PACS is integrated with Cornerstone, IDEXX Neo and IDEXX VetConnect PLUS to provide centralized access to diagnostic imaging results alongside patient diagnostic results from any internet connected device.
Water
Our strategy in the water testing business is to develop, manufacture, market and sell proprietary products that test primarily for the presence of microbial contamination in water matrices, including drinking water supplies, with superior performance, supported by exceptional customer service. Our customers primarily consist of water utilities, government laboratories and private certified laboratories that highly value strong relationships and customer support. We expect that future growth in this business will be partially dependent on our ability to increase international sales. Growth also will be dependent on our ability to enhance and broaden our product line. Most water microbiological testing is driven by regulation, and, in many countries, a test may not be used for compliance testing unless it has been approved by the applicable regulatory body and integrated into customers’ testing protocols. As a result, we maintain an active regulatory program that involves applying for a growing number of regulatory approvals in a number of countries, primarily in Europe. Further, we seek to receive regulatory approvals from governing agencies as a means to differentiate our products from the competition.
Livestock, Poultry and Dairy
We develop, manufacture, market and sell a broad range of tests and perform services for various livestock diseases and conditions, and have active research and development and in-licensing programs in this area. Our strategy is to offer proprietary tests with superior performance characteristics for use in government programs to control or eradicate disease and disease outbreaks and in livestock and poultry producers’ disease, reproductive, and herd health and production management programs. Disease outbreaks are episodic and unpredictable, and certain diseases that are prevalent at one time may be substantially contained or eradicated at a later time. In response to outbreaks, testing initiatives may lead to exceptional demand for certain products in certain periods. Conversely, successful eradication programs may result in significantly decreased demand for certain products. In addition, increases in government funding may lead to increased demand for certain products and budgetary constraints may lead to decreased demand for certain products. As result, the performance in certain sectors of this business can fluctuate.
Our strategy in the dairy testing business is to develop, manufacture and sell antibiotic residue and contaminant testing products that satisfy applicable regulatory requirements or dairy processor standards for testing of milk and provide reliable field performance. The manufacture of these testing products leverages the SNAP platform and production assets that also support our rapid assay business, which also leverages the SNAP platform. The dairy SNAP products incorporate customized reagents for antibiotic and contaminant detection. To successfully increase sales of dairy testing products, we believe that we need to increase penetration in dairy processors and develop product line enhancements and extensions. Our Rapid Visual Pregnancy Test for cattle can detect pregnancy 28 days after breeding. This test provides a quick and accurate identifier using whole blood samples.
The performance of the business is particularly subject to the various risks that are associated with doing business internationally. See “Part I, Item 1A. Risk Factors.”
Other
OPTI Medical. Our strategy in the OPTI Medical business for the human market is to develop, manufacture, and sell electrolyte and blood gas analyzers and related consumable products for the medical point-of-care diagnostics market worldwide, with a focus on small to mid-sized hospitals. We seek to differentiate our products based on ease of use, convenience, international distribution and service and instrument reliability. Similar to our veterinary instruments and consumables strategy, a substantial portion of the revenues from this product line is derived from the sale of consumables for use on the installed base of electrolyte and blood gas analyzers. During the early stage of an instrument’s life cycle, relatively greater revenues are derived from instrument placements, while consumable sales become relatively more significant in later stages as the installed base of instruments increases and instrument placement revenues begin to decline. Our long-term success
in this area of our business is dependent upon new customer acquisition, customer retention and increased customer utilization of existing and new assays introduced on these instruments.
Our facility in Roswell, Georgia develops and manufactures the OPTI product lines using the same or similar technology to support the electrolyte needs of the veterinary market. We leverage this facility’s know-how, intellectual property, and manufacturing capability to continue to expand the menu and instrument capability of the VetStat and Catalyst platforms for veterinary applications, while reducing our cost of consumables by leveraging experience and economies of scale.
The performance of the business is particularly subject to the various risks that are associated with doing business internationally. See “Part I, Item 1A. Risk Factors.”
CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS
The discussion and analysis of our financial condition and results of operations is based upon the 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. See "Part II, Item 8. Financial Statements and Supplementary Data, Note 2. Summary of Significant Accounting Policies" to the consolidated financial statements included in this Annual Report on Form 10-K describes the significant accounting policies used in preparation of these consolidated financial statements.
We believe the following critical accounting estimates and assumptions may have a material impact on reported financial condition and operating performance and involve significant levels of judgment to account for highly uncertain matters or are susceptible to significant change.
Revenue Recognition
See "Part II, Item 8. Financial Statements and Supplementary Data, Note 3. Revenue Recognition" to the consolidated financial statements for the year ended December 31, 2019, included in this Annual Report on Form 10-K for additional information about our revenue recognition policy and criteria for recognizing revenue.
We enter into contracts with multiple performance obligations 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 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 control of the related goods or services is transferred 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.
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 estimate, based on historical experience, and apply judgment to predict the amounts of future customer purchases and expected price adjustments related to these multi-year agreements. Differences between estimated and actual customer purchases may impact the amount and timing of revenue recognition and a 10% change in these estimates would have increased or reduced other assets and cumulative revenue related to these programs by approximately $1.6 million at December 31, 2019.
Our volume commitment programs, such as our IDEXX 360 program, provide customers with 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 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 estimate, based on historical experience, and apply judgment to predict the amounts of future customer purchases and expected price adjustments related to these multi-year agreements. Differences between estimated and actual customer purchases may impact the amount and timing of revenue recognition and a 10% change in these estimates would have increased or reduced contract assets and cumulative revenue related to these programs by approximately $2.2 million at December 31, 2019.
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 a 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. We estimate, based on historical experience, and apply judgment to predict the amounts of future customer rebates related to these multi-year agreements. Differences between estimated and actual customer rebates may impact the amount and timing of revenue recognition and a 10% change in these estimates would have increased or reduced deferred revenue and cumulative revenue related to these programs by approximately $2.4 million at December 31, 2019.
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 as described above.
Valuation of Goodwill and Other Intangible Assets
A significant portion of the purchase price for acquired businesses is generally assigned to intangible assets. Intangible assets other than goodwill are initially valued at fair value. If a quoted price in an active market for the identical asset is not readily available at the measurement date, the fair value of the intangible asset is estimated based on discounted cash flows using market participant assumptions, which are assumptions that are not specific to IDEXX. The selection of appropriate valuation methodologies and the estimation of discounted cash flows require significant assumptions about the timing and amounts of future cash flows, risks, appropriate discount rates, and the useful lives of intangible assets. When material, we utilize independent valuation experts to advise and assist us in determining the fair values of the identified intangible assets acquired in connection with a business acquisition and in determining appropriate amortization methods and periods for those intangible assets. Goodwill is initially valued based on the excess of the purchase price of a business combination over the fair value of acquired net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized.
We assess goodwill for impairment annually, at the reporting unit level, in the fourth quarter and whenever events or circumstances indicate impairment may exist. An impairment charge is recorded for the amount, if any, by which the carrying amount of goodwill exceeds its implied fair value. Our reporting units are the individual product and service categories that comprise our CAG operating segment, our Water and LPD operating segments and goodwill remaining from the restructuring of our pharmaceutical business in the fourth quarter of 2008. A substantial portion of the goodwill remaining from the pharmaceutical business, included in our “Other Segment”, is associated with intellectual property that has been, or that we expect to be, licensed to third parties. Realization of this goodwill is dependent upon the success of those third parties in developing and commercializing products, which will result in our receipt of royalties and other payments.
As part of our goodwill testing process, we evaluate factors specific to a reporting unit as well as industry and macroeconomic factors that are reasonably likely to have a material impact on the fair value of a reporting unit. Examples of the factors considered in assessing the fair value of a reporting unit include: the results of the most recent impairment test, the competitive environment, the regulatory environment, anticipated changes in product or labor costs, revenue growth trends, the consistency of operating margins and cash flows and current and long-range financial forecasts. The long-range financial forecasts of the reporting units, which are based upon management’s long-term view of our markets, are used by senior management and the Board of Directors to evaluate operating performance.
In the fourth quarters of 2019 and 2018, we elected to bypass the qualitative approach that allows the assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount and instead proceeded directly to assessing the fair value of all of our reporting units and comparing the fair value of to the carrying value to determine if any impairment is necessary.
We estimate the fair values of applicable reporting units using an income approach based on discounted forecasted cash flows. We make significant assumptions about the extent and timing of future cash flows, growth rates and discount rates. Model assumptions are based on our projections and best estimates, using appropriate and customary market participant assumptions. In addition, we make certain assumptions in allocating shared assets and liabilities to individual reporting units in determining the carrying value of each reporting unit. To validate the reasonableness of our reporting units' estimated fair values, we reconcile the aggregate fair values of our reporting units to our total market capitalization. Valuation assumptions reflect our projections and best estimates, based on significant assumptions about the extent and timing of future cash flows, growth rates and discount rates.
We maintain approximately $6.5 million of goodwill associated with our remaining pharmaceutical intellectual property, out-licensing arrangements, and certain retained drug delivery technologies (collectively “Pharmaceutical Activities”) that we seek to commercialize through arrangements with third parties. Currently, our primary support for the carrying value of this goodwill is royalty revenue associated with the commercialization of certain intellectual property. There is no guarantee that we will be able to maintain or increase revenues from our remaining Pharmaceutical Activities. The results of our goodwill impairment test for these Pharmaceutical Activities indicate an excess of estimated fair value over the carrying amount of this reporting unit by approximately $4.7 million and 71% of the reporting unit’s carrying value. Excluding these Pharmaceutical Activities, the results of our goodwill impairment test indicate an excess of estimated fair value over the carrying amount for each of our reporting units with a minimum of 217% and an average of approximately 1,060%.
While we believe that the assumptions used to determine the estimated fair values of each of our reporting units are reasonable, a change in assumptions underlying these estimates could result in a material negative effect on the estimated fair value of the reporting units. Our fair value estimate assumes the achievement of future financial results contemplated in our forecasted cash flows, and there can be no assurance that we will realize that value. We use forecasts to estimate future cash flows and include an estimate of long-term future growth rates based on our most recent views of the long-term outlooks for our reporting units. Actual results may differ from those assumed in our forecasts. The discount rate is based on a weighted average cost of capital derived from industry peers. Changes in market conditions, interest rates, growth rates, tax rates, costs, pricing, or the discount rate would affect the estimated fair values of our reporting units and could result in a goodwill impairment charge in a future period. No goodwill impairments were identified during the years ended December 31, 2019, 2018 and 2017.
A prolonged economic downturn in the U.S. or internationally resulting in lower long-term growth rates and reduced long-term profitability may reduce the fair value of our reporting units. Industry specific events or circumstances could have a negative impact on our reporting units and may also reduce the fair value of our reporting units. Should such events occur, and it becomes more likely than not that a reporting unit’s fair value has fallen below its carrying value, we will perform an interim goodwill impairment test, in addition to the annual impairment test. Future impairment tests may result in an impairment of goodwill, depending on the outcome of future impairment tests. An impairment of goodwill would be reported as a non-cash charge to earnings.
We assess the realizability of intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If an impairment review is triggered, we evaluate the carrying value of intangible assets, other than goodwill, based on estimated undiscounted future cash flows over the remaining useful life of the primary asset of the asset group and compare that value to the carrying value of the asset group. The cash flows that are used contain our best estimates, using appropriate and customary assumptions and projections at the time. If the net carrying value of an intangible asset exceeds the related estimated undiscounted future cash flows, an impairment to adjust the intangible asset to its fair value would be reported as a non-cash charge to earnings. If necessary, we would calculate the fair value of an intangible asset using the present value of the estimated future cash flows to be generated by the intangible asset and applying a risk-adjusted discount rate.
We had no impairments of our intangible assets during the years ended December 31, 2019, 2018 and 2017.
Share-Based Compensation
Our share-based compensation programs provide for grants of stock options, restricted stock units and deferred stock units, along with the issuance of employee stock purchase rights. The total fair value of future awards may vary significantly from past awards based on a number of factors, including our share-based award practices. Therefore, share-based compensation expense is likely to fluctuate, possibly significantly, from year to year.
We use the Black-Scholes-Merton option-pricing model to determine the fair value of options granted. Option-pricing models require the input of highly subjective assumptions, particularly for the expected stock price volatility and the expected term of options. The risk-free interest rate is based on the U.S. Treasury yield for a duration similar to the expected term at the date of grant. We have never paid any cash dividends on our common stock and we have no intention to pay a dividend at this time; therefore, we assume that no dividends will be paid over the expected terms of option awards. We determine the assumptions to be used in the valuation of option grants as of the date of grant. As such, we use different assumptions during the year if we grant options at different dates. Substantially all our options granted during the years ended December 31, 2019, 2018 and 2017 were granted in the first quarter of each year. The weighted average of each of the valuation assumptions used to determine the fair value of each option grant during each of the previous three years is as follows:
| For the Years Ended December 31, | |||||||||
| 2019 | 2018 | 2017 | |||||||
| Expected stock price volatility | 26 | % | 24 | % | 26 | % | |||
| Expected term, in years (1) | 6.0 | 5.8 | 5.8 | ||||||
| Risk-free interest rate | 2.4 | % | 2.7 | % | 2.0 | % |
| (1) | Options granted have a contractual term of ten years. |
Changes in these subjective assumptions, particularly for the expected stock price volatility and the expected term of options, can materially affect the fair value estimate. Our expected stock price volatility assumption is based on the historical volatility of our stock over a period similar to the expected term and other relevant factors. Higher estimated volatility increases the fair value of a stock option, while lower estimated volatility has the opposite effect. The total fair value of stock options granted during the year ended December 31, 2019, was $23.1 million. If the weighted average of the stock price volatility assumption was increased or decreased by 5%, the total fair value of stock options awarded during the year ended December 31, 2019, would have increased or decreased by approximately $3.3 million and the total expense recognized for the year ended December 31, 2019, for options awarded during the same period would have increased or decreased by approximately $0.6 million.
We derive the expected term assumption for stock options based on historical experience and other relevant factors concerning expected behavior with regard to option exercises. The expected term is determined using a consistent method at each grant date. A longer expected term assumption increases the fair value of stock option awards, while a shorter expected term assumption has the opposite effect. If the weighted average of the expected term was increased or decreased by one year, the total fair value of stock options awarded during the year ended December 31, 2019, would have increased or decreased by approximately $2.1 million, and the total expense recognized for the year ended December 31, 2019, for options awarded during 2019 would have increased or decreased by approximately $0.4 million.
For a significant majority of our awards, share-based compensation expense is recognized on a straight-line basis over the requisite service period, which ranges from one to five years, depending on the award. Share-based compensation expense is recognized on a grade-vesting methodology for performance-based restricted stock units. Share-based compensation expense is based on the number of awards expected to vest and is, therefore, reduced for an estimate of the number of awards that are expected to be forfeited. The forfeiture estimates are based on historical data and other factors; share-based compensation expense is adjusted annually for actual results. Total share-based compensation expense for the year ended December 31, 2019, was $39.3 million, which is net of a reduction of approximately $3.7 million for actual and estimated forfeitures. Fluctuations in our overall employee turnover rate may result in changes in estimated forfeiture rates and differences between estimated forfeiture rates and actual experience and, therefore could have a significant unanticipated impact on share-based compensation expense.
Modifications of the terms of outstanding awards may result in significant increases or decreases in share-based compensation. During the fourth quarter of 2019, we entered a mutual separation agreement with our former CEO, pursuant to which his outstanding stock options were modified, which resulted in $10.9 million of share-based compensation expense in the quarter related to the acceleration and revaluation of his stock options. There were no material modifications to the terms of outstanding options, restricted stock units or deferred stock units during 2018 or 2017.
The fair value of stock options, restricted stock units, deferred stock units and employee stock purchase rights issued totaled $42.7 million for the year ended December 31, 2019, $34.0 million for the year ended December 31, 2018, and $31.4 million for the year ended December 31, 2017. The total unrecognized compensation expense, net of estimated forfeitures, for unvested share-based compensation awards outstanding at December 31, 2019, was $50.1 million, which will be recognized over a weighted average period of approximately 1.7 years.
Income Taxes
The provision for income taxes is determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the estimated future tax effects of temporary differences between book and tax treatment of assets and liabilities and carryforwards to the extent they are realizable.
On a quarterly basis, we assess our current and projected earnings by jurisdiction to determine whether or not our earnings during the periods when the temporary differences become deductible will be sufficient to realize the related future tax benefits. Should we determine that we would not be able to realize all or part of our net deferred tax asset in a particular jurisdiction in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.
For those jurisdictions where tax carryforwards are likely to expire unused or the projected operating results indicate that realization is not more likely than not, a valuation allowance is recorded to offset the deferred tax asset within that jurisdiction. In assessing the need for a valuation allowance, we consider future taxable income and ongoing prudent and feasible tax planning strategies. In the event that we determine that we would be able to realize our deferred tax assets in the future in excess of the net recorded amount, a reduction of the valuation allowance would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, a reduction to the deferred tax asset would be charged to income in the period such determination was made.
Our net taxable temporary differences and tax carryforwards are recorded using the enacted tax rates expected to apply to taxable income in the periods in which the deferred tax liability or asset is expected to be settled or realized. Should the expected applicable tax rates change in the future, an adjustment to our deferred taxes would be credited or charged, as appropriate, to income in the period such determination was made.
We periodically assess our exposures related to our worldwide provision for income taxes and believe that we have appropriately accrued taxes for contingencies. Any reduction of these contingent liabilities or additional assessment would increase or decrease income, respectively, in the period such determination was made.
We record a liability for uncertain tax positions that do not meet the more likely than not standard as prescribed by the authoritative guidance for income tax accounting. We record tax benefits for only those positions that we believe will more likely than not be sustained. For positions that we believe that it is more likely than not that we will prevail, we record a benefit considering the amounts and probabilities that could be realized upon ultimate settlement. If our judgment as to the likely resolution of the uncertainty changes, if the uncertainty is ultimately settled or if the statute of limitation related to the uncertainty expires, the effects of the change would be recognized in the period in which the change, resolution or expiration occurs. Our net liability for uncertain tax positions was $29.7 million as of December 31, 2019, and $26.0 million as of December 31, 2018, which includes estimated interest expense and penalties. See "Part II, Item 8. Financial Statements and Supplementary Data, Note 13. Income Taxes" in the accompanying Notes to consolidated financial statements for more information.
RECENT ACCOUNTING PRONOUNCEMENTS
In addition to the impacts from new accounting pronouncements included above, see "Part II, Item 8. Financial Statements and Supplementary Data, Note 2. Summary of Significant Accounting Policies (v) and (w)" to the consolidated financial statements for the year ended December 31, 2019, included in this Annual Report on Form 10-K for a complete discussion of recent accounting pronouncements adopted and not adopted.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE
Our purpose is to be a great company that creates exceptional long-term value for our customers, employees, and stockholders by enhancing the health and well-being of pets, people, and livestock. Corporate Responsibility is core to IDEXX culture and is reflected in our environmental, social and governance (“ESG”) performance across the company. We prioritize
community investments and partnerships that are aligned with our purpose, conduct ourselves with the highest ethical standards and demonstrate environmental responsibility in our facilities and operations. Our Corporate Responsibility Report is available on our website and features examples of our ESG activities and performance metrics.
RESULTS OF OPERATIONS AND TRENDS
Effects of Certain Factors on Results of Operations
Distributor Purchasing and Inventories. When selling our products through distributors, changes in distributors’ inventory levels can impact our reported sales, and these changes may be affected by many factors, which may not be directly related to underlying demand for our products by veterinary practices, which are the end users. If during the current year, distributors’ inventories grew by less than those inventories grew in the comparable period of the prior year, then changes in distributors’ inventories would have an unfavorable impact on our reported sales growth in the current period. Conversely, if during the current year, distributors’ inventories grew by more than those inventories grew in the comparable period of the prior year, then changes in distributors’ inventories would have a favorable impact on our reported sales growth in the current period.
In certain countries, we sell our products through third-party distributors and may be unable to obtain data for sales to end users. We do not believe the impact of changes in these distributors’ inventories had or would have a material impact on our growth rates. See “Part I, Item 1. Business, Marketing and Distribution” included in this Annual Report on Form 10-K for additional information regarding distribution channels.
Currency Impact. For the year ended December 31, 2019, approximately 22% of our consolidated revenue was derived from products manufactured or sourced in U.S. dollars and sold internationally in local currencies, as compared to 22% and 21% for the years ended December 31, 2018 and 2017, respectively. Strengthening of the rate of exchange for the U.S. dollar 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 or purchased in U.S. dollars 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 operating 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. denominated revenues. See “Part II, Item 7A. Quantitative and Qualitative Disclosures About Market Risk” included in this Annual Report on Form 10-K for additional information regarding currency impact. Our future income tax expense could also be affected by changes in the mix of earnings, including as a result of changes in the rate of exchange for the U.S. dollar relative to currencies in countries with differing statutory tax rates. See “Part I, Item 1A. Risk Factors” included in this Annual Report on Form 10-K for additional information regarding tax impacts.
Effects of Economic Conditions. Pet owners generally pay cash out of pocket for health care services for their pets from veterinary practices. Demand for our products and services is vulnerable to changes in the economic environment, including slow economic growth, high unemployment, and credit availability. Negative or cautious consumer sentiment can lead to reduced or delayed consumer spending, resulting in a decreased number of patient visits to veterinary clinics. Unfavorable economic conditions can impact sales of instruments, diagnostic imaging and practice management systems, which are larger capital purchases for veterinarians. Additionally, economic turmoil can cause our customers to remain sensitive to the pricing of our products and services. In the U.S., we monitor patient visits and clinic revenue data provided by a subset of our CAG customers. Although this data is a limited sample and susceptible to short-term impacts such as weather, which may affect the number of patient visits in a given period, we believe that this data provides a fair and meaningful long-term representation of the trend in patient visit activity in the U.S., providing us insight regarding demand for our products and services.
Economic conditions can also affect the purchasing decisions of our Water and LPD business customers. Water testing volumes may be susceptible to declines in discretionary testing for existing home and commercial sales and in mandated testing as a result of decreases in home and commercial construction. Testing volumes may also be impacted by severe weather conditions such as drought. In addition, fiscal difficulties can also reduce government funding for water and herd health screening services.
We believe that the diversity of our products and services and the geographic diversity of our markets partially mitigate the potential effects of the economic environment and negative consumer sentiment on our revenue growth rates.
Effects of Patent Expiration. Although we have several patents and licenses of patents and technologies from third parties that expired during 2019, and several that are expected to expire in 2020 and beyond, the expiration of these patents or licenses, individually or in the aggregate, is not expected to have a material effect on our financial position or future operations due to a range of factors as described in "Part I, Item 1. Business, Patents and Licenses”.
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 current year, 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 consider acquisitions to be a business when all three elements of inputs, processes and outputs are present, consistent with ASU 2017-01, “Business Combinations: (Topic 805) Clarifying the Definition of a Business.” In a business combination, if substantially all the fair value of the assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, we do not consider these assets to be a business. 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, 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.
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, was 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 had been on a medical leave of absence since June 28, 2019, stepped down as Chairman of our Board, ceased to be an employee of the Company and transitioned to the role of external Senior Advisor to the Company. Mr. Ayers continues 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, in accordance with the terms of his pre-existing employment agreement, 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 recognized 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, which was offset by a reduction to our provision for income taxes of approximately $1.2 million, resulting in a total charge to net income of approximately $12.2
million, net of tax impacts. This total charge to net income is less than our previously communicated expectation of approximately $15.5 million, as a result of finalizing our income tax provision.
Comparisons to Prior Periods. Our fiscal years end on December 31. Unless otherwise stated, the analysis and discussion of our financial condition, results of operations and liquidity, including references to growth and organic growth and increases and decreases, are being compared to the equivalent prior year period.
Twelve Months Ended December 31, 2019**,** Compared to Twelve Months Ended December 31, 2018
Total Company
The following table presents revenue by operating segment by U.S. markets and non-U.S., or international markets:
| For the Years Ended December 31, | ||||||||||||||||||||||||
| 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 | $ | 2,119,183 | $ | 1,935,428 | $ | 183,755 | 9.5 | % | (1.5 | %) | 0.2 | % | 10.8 | % | ||||||||||
| United States | 1,410,278 | 1,277,146 | 133,132 | 10.4 | % | — | 0.3 | % | 10.1 | % | ||||||||||||||
| International | 708,905 | 658,282 | 50,623 | 7.7 | % | (4.6 | %) | — | 12.2 | % | ||||||||||||||
| Water | 132,850 | 125,198 | 7,652 | 6.1 | % | (2.6 | %) | — | 8.7 | % | ||||||||||||||
| United States | 62,673 | 58,774 | 3,899 | 6.6 | % | — | — | 6.6 | % | |||||||||||||||
| International | 70,177 | 66,424 | 3,753 | 5.7 | % | (4.9 | %) | — | 10.6 | % | ||||||||||||||
| LPD | 132,635 | 130,581 | 2,054 | 1.6 | % | (4.2 | %) | — | 5.8 | % | ||||||||||||||
| United States | 14,230 | 13,932 | 298 | 2.1 | % | — | — | 2.1 | % | |||||||||||||||
| International | 118,405 | 116,649 | 1,756 | 1.5 | % | (4.7 | %) | — | 6.2 | % | ||||||||||||||
| Other | 22,240 | 22,035 | 205 | 0.9 | % | — | — | 0.9 | % | |||||||||||||||
| Total Company | $ | 2,406,908 | $ | 2,213,242 | $ | 193,666 | 8.8 | % | (1.8 | %) | 0.2 | % | 10.3 | % | ||||||||||
| United States | 1,495,516 | 1,357,909 | 137,607 | 10.1 | % | — | 0.3 | % | 9.8 | % | ||||||||||||||
| International | 911,392 | 855,333 | 56,059 | 6.6 | % | (4.6 | %) | — | 11.1 | % |
| (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. We also had 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. Our LPD business growth was primarily due to increased demand for African swine fever testing programs and diagnostic testing for alternative food sources, including poultry, which more than offset lower recurring swine testing in China, as well as increased herd health screening. The impact of currency movements decreased revenue by 1.8%.
The following table presents our total Company results of operations:
| For the Years Ended December 31, | Change | ||||||||||||||||||||
| Total Company - Results of Operations (dollars in thousands) | 2019 | Percent of Revenue | 2018 | Percent of Revenue | Amount | Percentage | |||||||||||||||
| Revenues | $ | 2,406,908 | $ | 2,213,242 | $ | 193,666 | 8.8 | % | |||||||||||||
| Cost of revenue | 1,041,359 | 971,700 | 69,659 | 7.2 | % | ||||||||||||||||
| Gross profit | 1,365,549 | 56.7 | % | 1,241,542 | 56.1 | % | 124,007 | 10.0 | % | ||||||||||||
| Operating Expenses: | |||||||||||||||||||||
| Sales and marketing | 418,193 | 17.4 | % | 387,406 | 17.5 | % | 30,787 | 7.9 | % | ||||||||||||
| General and administrative | 261,317 | 10.9 | % | 244,938 | 11.1 | % | 16,379 | 6.7 | % | ||||||||||||
| Research and development | 133,193 | 5.5 | % | 117,863 | 5.3 | % | 15,330 | 13.0 | % | ||||||||||||
| Total operating expenses | 812,703 | 33.8 | % | 750,207 | 33.9 | % | 62,496 | 8.3 | % | ||||||||||||
| Income from operations | $ | 552,846 | 23.0 | % | $ | 491,335 | 22.2 | % | $ | 61,511 | 12.5 | % |
Gross Profit. The total Company gross profit increase was due to higher sales volumes and a 60 basis point increase in the gross profit margin. The increase in the gross profit margin was driven by mix benefits from high growth in IDEXX VetLab consumable revenues, volume leverage, the favorable impact of lower product costs in our CAG business, as well as the net benefit of price increases in our CAG Diagnostics recurring revenue portfolio and Water business. The impact from foreign currency movements increased the 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. Sales and marketing expense increased approximately 10%, excluding the impact of foreign currency, primarily due to increased personnel-related costs as we continue to invest in and grow our global commercial infrastructure. General and administrative expense increased approximately 9%, excluding the impact of foreign currency, primarily from higher personnel-related costs, including costs associated with the separation agreement of our former CEO, partially offset by 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. 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.
Companion Animal Group
The following table presents revenue by product and service category for CAG:
| For the Years Ended December 31, | ||||||||||||||||||||||||
| 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: | $ | 1,828,329 | $ | 1,654,530 | $ | 173,799 | 10.5 | % | (1.6 | %) | 0.2 | % | 11.9 | % | ||||||||||
| IDEXX VetLab consumables | 693,360 | 617,237 | 76,123 | 12.3 | % | (2.0 | %) | — | 14.3 | % | ||||||||||||||
| Rapid assay products | 232,149 | 217,541 | 14,608 | 6.7 | % | (0.8 | %) | — | 7.6 | % | ||||||||||||||
| Reference laboratory diagnostic and consulting services | 822,497 | 746,794 | 75,703 | 10.1 | % | (1.5 | %) | 0.4 | % | 11.2 | % | |||||||||||||
| CAG Diagnostics services and accessories | 80,323 | 72,958 | 7,365 | 10.1 | % | (1.9 | %) | — | 12.0 | % | ||||||||||||||
| CAG Diagnostics capital - instruments | 132,685 | 134,264 | (1,579 | ) | (1.2 | %) | (2.0 | %) | — | 0.9 | % | |||||||||||||
| Veterinary software, services and diagnostic imaging systems | 158,169 | 146,634 | 11,535 | 7.9 | % | (0.3 | %) | 0.9 | % | 7.3 | % | |||||||||||||
| Net CAG revenue | $ | 2,119,183 | $ | 1,935,428 | $ | 183,755 | 9.5 | % | (1.5 | %) | 0.2 | % | 10.8 | % |
| (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 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 instruments 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 from higher sales volumes across our SNAP product portfolio, driven by SNAP® 4Dx Plus tests, and to a lesser extent, higher average unit sales 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 SDMA™ and fecal antigen testing, and to a lesser extent, higher average unit sales prices.
CAG Diagnostic services and accessories revenue growth was primarily a result of the increase in our active installed base of instruments.
CAG Diagnostics Capital – Instruments Revenue. The decrease in CAG Diagnostics capital instrument revenue reflects the impact of foreign currency movements, which reduced revenues 2.0%. Excluding the impact of foreign currency movements, our revenues increased slightly, primarily due to higher Catalyst and Procyte instrument placements, partially offset by product mix, including lower Sedivue Dx placements compared to high prior year levels, as well as the lower allocated revenue per unit on our IDEXX VetLab instruments related to increased international placements under our customer volume commitment programs.
Veterinary Software, Services, and Diagnostic Imaging Systems Revenue. The increase in revenue was primarily due to increased veterinary software and hardware upgrades, 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 volume commitment programs. Our acquisition of a software company in the second half of 2018 contributed 0.9% to reported revenue growth.
The following table presents the CAG segment results of operations:
| For the Years Ended December 31, | Change | ||||||||||||||||||||
| Results of Operations*(dollars in thousands)* | 2019 | Percent of Revenue | 2018 | Percent of Revenue | Amount | Percentage | |||||||||||||||
| Revenues | $ | 2,119,183 | $ | 1,935,428 | $ | 183,755 | 9.5 | % | |||||||||||||
| Cost of revenue | 938,423 | 868,919 | 69,504 | 8.0 | % | ||||||||||||||||
| Gross profit | 1,180,760 | 55.7 | % | 1,066,509 | 55.1 | % | 114,251 | 10.7 | % | ||||||||||||
| Operating Expenses: | |||||||||||||||||||||
| Sales and marketing | 378,302 | 17.9 | % | 345,737 | 17.9 | % | 32,565 | 9.4 | % | ||||||||||||
| General and administrative | 212,794 | 10.0 | % | 204,425 | 10.6 | % | 8,369 | 4.1 | % | ||||||||||||
| Research and development | 98,062 | 4.6 | % | 86,864 | 4.5 | % | 11,198 | 12.9 | % | ||||||||||||
| Total operating expenses | 689,158 | 32.5 | % | 637,026 | 32.9 | % | 52,132 | 8.2 | % | ||||||||||||
| Income from operations | $ | 491,602 | 23.2 | % | $ | 429,483 | 22.2 | % | $ | 62,119 | 14.5 | % |
Gross Profit. Gross profit increased primarily due to higher sales volumes, as well as a 60 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 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 the gross profit margin by approximately 10 basis points, including the impact of hedge gains in the current year, compared to hedge losses in the prior year.
Operating Expenses. Sales and marketing expenses increased approximately 11%, excluding the impact of foreign currency, primarily due to increased personnel-related costs as we continue to invest in our global commercial infrastructure. General and administrative costs increased 5%, excluding the impact of foreign currency, primarily from higher personnel-related costs. The increase in research and development expense was primarily due to increased personnel-related costs, with an immaterial impact from foreign currency. The overall change in currency exchange rates resulted in a decrease in operating expenses of approximately 1%.
Water
The following table presents the Water segment results of operations:
| For the Years Ended December 31, | Change | ||||||||||||||||||||
| Results of Operations*(dollars in thousands)* | 2019 | Percent of Revenue | 2018 | Percent of Revenue | Amount | Percentage | |||||||||||||||
| Revenues | $ | 132,850 | $ | 125,198 | $ | 7,652 | 6.1 | % | |||||||||||||
| Cost of revenue | 36,915 | 37,106 | (191 | ) | (0.5 | %) | |||||||||||||||
| Gross profit | 95,935 | 72.2 | % | 88,092 | 70.4 | % | 7,843 | 8.9 | % | ||||||||||||
| Operating Expenses: | |||||||||||||||||||||
| Sales and marketing | 15,980 | 12.0 | % | 15,900 | 12.7 | % | 80 | 0.5 | % | ||||||||||||
| General and administrative | 13,388 | 10.1 | % | 13,005 | 10.4 | % | 383 | 2.9 | % | ||||||||||||
| Research and development | 4,132 | 3.1 | % | 2,580 | 2.1 | % | 1,552 | 60.2 | % | ||||||||||||
| Total operating expenses | 33,500 | 25.2 | % | 31,485 | 25.1 | % | 2,015 | 6.4 | % | ||||||||||||
| Income from operations | $ | 62,435 | 47.0 | % | $ | 56,607 | 45.2 | % | $ | 5,828 | 10.3 | % |
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 including the U.S. The impact of currency movements decreased revenue by approximately 2.6%.
Gross Profit. Gross profit for Water increased due to higher sales volumes as well as a 180 basis point increase in the gross profit margin. Foreign currency movements increased the gross profit margin by approximately 70 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 distribution costs.
Operating Expenses. While both sales and marketing and research and development expenses had higher personnel-related costs, the limited increase in sales and marketing expense and significant 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 higher personnel-related costs. The overall change in currency exchange rates resulted in a decrease in operating expenses of approximately 2%.
Livestock, Poultry and Dairy
The following table presents the LPD segment results of operations:
| For the Years Ended December 31, | Change | ||||||||||||||||||||
| Results of Operations*(dollars in thousands)* | 2019 | Percent of Revenue | 2018 | Percent of Revenue | Amount | Percentage | |||||||||||||||
| Revenues | $ | 132,635 | $ | 130,581 | $ | 2,054 | 1.6 | % | |||||||||||||
| Cost of revenue | 54,145 | 55,621 | (1,476 | ) | (2.7 | %) | |||||||||||||||
| Gross profit | 78,490 | 59.2 | % | 74,960 | 57.4 | % | 3,530 | 4.7 | % | ||||||||||||
| Operating Expenses: | |||||||||||||||||||||
| Sales and marketing | 22,808 | 17.2 | % | 24,594 | 18.8 | % | (1,786 | ) | (7.3 | %) | |||||||||||
| General and administrative | 17,651 | 13.3 | % | 19,159 | 14.7 | % | (1,508 | ) | (7.9 | %) | |||||||||||
| Research and development | 12,657 | 9.5 | % | 11,795 | 9.0 | % | 862 | 7.3 | % | ||||||||||||
| Total operating expenses | 53,116 | 40.0 | % | 55,548 | 42.5 | % | (2,432 | ) | (4.4 | %) | |||||||||||
| Income from operations | $ | 25,374 | 19.1 | % | $ | 19,412 | 14.9 | % | $ | 5,962 | 30.7 | % |
Revenue. Overall LPD revenue increased despite the unfavorable impact of foreign currency movements which decreased revenue 4.2%. The prolonged outbreak of African swine fever in Asia, which began 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 in China. Revenue growth for the year also benefited from increased herd health screening, partially offset by lower bovine testing, primarily in Europe.
Gross Profit. The increase in LPD gross profit was due to higher sales volume and a 180 basis point increase in the gross profit margin. The impact from foreign currency movements increased the gross profit margin by approximately 130 basis points, including the impact of hedges. The remaining increase in the gross profit margin was driven by favorable product mix from higher herd health screening.
Operating Expenses. Sales and marketing expense decreased primarily due to lower personnel-related costs, including cost control initiatives. General and administrative expense decreased primarily due to lower third-party services. Research and development expense increased primarily due to increased personnel-related costs. The overall change in currency exchange rates resulted in a decrease in operating expense of approximately 2%.
Other
The following table presents the Other results of operations:
| For the Years Ended December 31, | Change | ||||||||||||||||||||
| Results of Operations (dollars in thousands) | 2019 | Percent of Revenue | 2018 | Percent of Revenue | Amount | Percentage | |||||||||||||||
| Revenues | $ | 22,240 | $ | 22,035 | $ | 205 | 0.9 | % | |||||||||||||
| Cost of revenue | 12,154 | 11,785 | 369 | 3.1 | % | ||||||||||||||||
| Gross profit | 10,086 | 45.4 | % | 10,250 | 46.5 | % | (164 | ) | (1.6 | %) | |||||||||||
| Operating Expenses: | |||||||||||||||||||||
| Sales and marketing | 1,366 | 6.1 | % | 1,806 | 8.2 | % | (440 | ) | (24.4 | %) | |||||||||||
| General and administrative | 1,991 | 9.0 | % | 3,741 | 17.0 | % | (1,750 | ) | (46.8 | %) | |||||||||||
| Research and development | 1,789 | 8.0 | % | 974 | 4.4 | % | 815 | 83.7 | % | ||||||||||||
| Total operating expenses | 5,146 | 23.1 | % | 6,521 | 29.6 | % | (1,375 | ) | (21.1 | %) | |||||||||||
| Income from operations | $ | 4,940 | 22.2 | % | $ | 3,729 | 16.9 | % | $ | 1,211 | 32.5 | % |
Revenue. The increase in Other revenues was due to higher royalties associated with intellectual property related to our former pharmaceutical product line, partially offset by lower volumes of our OPTI Medical products and services. The impact of foreign currency movements on revenue was immaterial.
Gross Profit. Gross profit for Other decreased due to a 110 basis point decrease in the gross profit margin primarily due to higher OPTI Medical service costs, partially offset by lower product costs, as well as mix benefits from increased royalties. 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.
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 Years Ended December 31, | Change | ||||||||||||||||||
| Results of Operations*(dollars in thousands)* | 2019 | Percent of Revenue | 2018 | Percent of Revenue | Amount | Percentage | |||||||||||||
| Revenues | $ | — | $ | — | $ | — | N/A | ||||||||||||
| Cost of revenue | (278 | ) | (1,731 | ) | 1,453 | (83.9 | %) | ||||||||||||
| Gross profit | 278 | 1,731 | (1,453 | ) | (83.9 | %) | |||||||||||||
| Operating Expenses: | |||||||||||||||||||
| Sales and marketing | (263 | ) | (631 | ) | 368 | (58.3 | %) | ||||||||||||
| General and administrative | 15,493 | 4,608 | 10,885 | 236.2 | % | ||||||||||||||
| Research and development | 16,553 | 15,650 | 903 | 5.8 | % | ||||||||||||||
| Total operating expenses | 31,783 | 19,627 | 12,156 | 61.9 | % | ||||||||||||||
| Income from operations | $ | (31,505 | ) | $ | (17,896 | ) | $ | (13,609 | ) | 76.0 | % |
Unallocated Amounts. The change in unallocated amounts was primarily due to our CEO transition costs of $13.4 million in the fourth quarter of 2019 and higher other unallocated employee incentive costs, partially offset by lower foreign exchange losses on settlements of foreign currency denominated transactions, lower unallocated employee benefit costs, and lower unallocated corporate function and research and development costs.
Non-Operating Items
Interest Income. Interest income was $0.4 million for the year ended December 31, 2019, as compared to $1.2 million for the same period in the prior year. 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 $31.1 million for the year ended December 31, 2019, as compared to $34.7 million for 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.
Provisions for Income Taxes. Our effective income tax rate was 18.1% for the year ended December 31, 2019, and 17.6% for the year ended December 31, 2018. Our effective income tax rate for the year ended December 31, 2019 was higher primarily due to lower tax benefits related to share-based compensation, partially offset by a nonrecurring item recorded in the first quarter of 2018, that resulted from the 2017 Tax Cut and Jobs Act.
During the third quarter of 2019, 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 through 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.
Our effective tax rate for the year ended December 31, 2019, was reduced by approximately 3.5% from the tax benefits related to share-based payments. We anticipate the tax benefit related to share-based payments to reduce our 2020 effective income tax rate by approximately 1.5%, based on recent settlement trends and stock price levels. These impacts may vary significantly based on the timing of actual settlement activity.
LIQUIDITY AND CAPITAL RESOURCES
We fund the capital needs of our business through cash on hand, funds generated from operations, and amounts available under our Credit Facility. We generate cash primarily through the payments made by customers for our diagnostic products and services, consulting services, and other various systems and services provided to the animal veterinary, livestock, poultry, dairy, and water testing markets. Our cash disbursements are primarily related to compensation and benefits for our employees, inventory and supplies, taxes, research and development, capital expenditures, rents, occupancy-related charges, interest expense, and acquisitions. At December 31, 2019, we had $90.3 million of cash and cash equivalents, as compared to $123.8 million on December 31, 2018. Working capital, including our Credit Facility, totaled negative $45.7 million at December 31, 2019, as compared to negative $116.3 million at December 31, 2018. Additionally, at December 31, 2019, we had remaining borrowing availability of $559.8 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 manage our worldwide cash requirements considering available funds among all of our subsidiaries. Our foreign cash and cash equivalents are generally available without restrictions to fund ordinary business operations outside the U.S.
The 2017 Tax Act was enacted on December 22, 2017, and includes significant changes to the U.S. corporate tax system. The 2017 Tax Act reduced the U.S. federal corporate tax rate from 35% to 21%, effective as of January 1, 2018, and transitioned the U.S. federal tax system from a worldwide tax system to a territorial tax system. In converting to the new territorial tax system, a deemed repatriation tax on previously tax-deferred earnings of certain foreign subsidiaries was required to be recognized as of December 31, 2017, and will be payable over eight years. We are no longer asserting indefinite reversal under ASC 740-30-25 for undistributed earnings of non-U.S. subsidiaries and have accrued for related tax liabilities as of December 31, 2019.
The following table presents cash, cash equivalents and marketable securities held domestically, and by our foreign subsidiaries:
| For the Years Ended December 31, | ||||||||
| Cash and cash equivalents (dollars in millions) | 2019 | 2018 | ||||||
| U.S. | $ | 1.1 | $ | 2.0 | ||||
| Foreign | 89.2 | 121.8 | ||||||
| Total | $ | 90.3 | $ | 123.8 | ||||
| Total cash, cash equivalents and marketable securities held in U.S. dollars by our foreign subsidiaries | $ | 6.5 | $ | 11.1 | ||||
| Percentage of total cash and cash equivalents held in U.S. dollars by our foreign subsidiaries | 7.2 | % | 9.0 | % |
Of the $90.3 million of cash and cash equivalents held as of December 31, 2019, greater than 99% was held as bank deposits. Of the $123.8 million of cash and cash equivalents held as of December 31, 2018, greater than 99% was held as bank deposits.
Should we require more capital than is generated by our operations, for example to fund significant discretionary activities, we could raise capital through debt or equity issuances. These alternatives could result in increased interest expense and dilution of our earnings. We have borrowed funds domestically and continue to have the ability to borrow funds domestically at reasonable interest rates.
The following table presents additional key information concerning working capital:
| For the Three Months Ended | |||||||||||||||
| December 31, 2019 | September 30, 2019 | June 30, 2019 | March 31, 2019 | December 31, 2018 | |||||||||||
| Days sales outstanding (1) | 40.5 | 41.8 | 41.7 | 42.0 | 42.6 | ||||||||||
| Inventory turns (2) | 2.2 | 2.0 | 2.1 | 2.0 | 2.3 |
| (1) | 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. |
Sources and Uses of Cash
The following table presents cash provided (used):
| For the Years Ended December 31, | ||||||||||||
| (in thousands) | 2019 | 2018 | Dollar Change | |||||||||
| Net cash provided by operating activities | $ | 459,158 | $ | 400,084 | $ | 59,074 | ||||||
| Net cash (used) provided by investing activities | (205,528 | ) | 138,602 | (344,130 | ) | |||||||
| Net cash used by financing activities | (286,409 | ) | (597,799 | ) | 311,390 | |||||||
| Net effect of changes in exchange rates on cash | (689 | ) | (4,768 | ) | 4,079 | |||||||
| Net change in cash and cash equivalents | $ | (33,468 | ) | $ | (63,881 | ) | $ | 30,413 |
Operating Activities. The increase in cash provided by operating activities of $59.1 million during 2019 as compared to 2018, was primarily due to the increase in net income, net of noncash items, offset by changes in operating assets and liabilities.
The following table presents cash flows from changes in operating assets and liabilities:
| For the Years Ended December 31, | ||||||||||||
| (in thousands) | 2019 | 2018 | Dollar Change | |||||||||
| Accounts receivable | $ | (22,472 | ) | $ | (18,401 | ) | $ | (4,071 | ) | |||
| Inventories | (37,306 | ) | (25,623 | ) | (11,683 | ) | ||||||
| Accounts payable | 1,957 | (166 | ) | 2,123 | ||||||||
| Deferred revenue | (12,360 | ) | (7,719 | ) | (4,641 | ) | ||||||
| Other assets and liabilities | (34,788 | ) | (39,731 | ) | 4,943 | |||||||
| Total change in cash due to changes in operating assets and liabilities | $ | (104,969 | ) | $ | (91,640 | ) | $ | (13,329 | ) |
Cash used due to changes in operating assets and liabilities during 2019, as compared to the same period in the prior year, increased approximately $13.3 million. The increase was primarily due to higher inventory levels to support greater demand. Additionally, other assets increased due to higher instrument placements under our customer commitment programs, which are offset by lower deferred revenue from placements under our instrument rebate programs, as well as increases in accrued liabilities and accounts payable due to growth and timing.
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 and for the annual period 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 $205.5 million during 2019 as compared to $138.6 million provided during 2018. The increase in cash used by investing activities during 2019 as compared to 2018 was primarily due to 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 the current year, as we expand our Westbrook, Maine headquarters and relocate our core
reference laboratory in Germany. During 2018, in connection with the passage of the 2017 Tax Act in the fourth quarter of 2017, we liquidated our marketable securities and used the cash to partially pay down our Credit Facility.
Our total capital expenditure plan for 2020 is estimated to be approximately $140 million to $155 million, which includes the completion of the expansion of our headquarters, the relocation and expansion of our German core reference laboratory, other capital investments in manufacturing and reference laboratory buildings and equipment, investments in internal use software and information technology infrastructure, and the renovation and expansion of our facilities and reference laboratories.
Financing Activities. Cash used by financing activities was $286.4 million during 2019 as compared to $597.8 million used during 2018. The decrease in cash used by financing activities during 2019 as compared to 2018 was due to a larger repayment on our revolving Credit Facility in 2018 from repatriated foreign cash, an issuance of $100 million senior notes during the first quarter of 2019, and a decrease in repurchases of our common stock.
Cash used to repurchase shares of our common stock decreased by $67.7 million during 2019, as compared to 2018. From the inception of our share repurchase program in August 1999 to December 31, 2019, we have repurchased 66.0 million shares for $4.1 billion. During 2019, we purchased 1.22 million shares for an aggregate cost of $303.8 million, as compared to purchases of 1.77 million shares for an aggregate cost of $368.7 million during 2018. 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 "Part II, Item 8. Financial Statements and Supplementary Data, Note 19. Repurchases of Common Stock" to the consolidated financial statements included in this Annual Report on Form 10-K for additional information about our share repurchases.
The $850 million unsecured revolving Credit Facility matures on December 4, 2020 and requires no scheduled prepayments before that date. All amounts borrowed under the terms of the Credit Facility are reflected in the current liabilities section in the accompanying consolidated balance sheets. Applicable interest rates on borrowings under the Credit Facility generally range from 0.875 to 1.375 percentage points above the LIBOR or CDOR, based on our leverage ratio, or the prevailing prime rate plus a maximum spread of up to 0.375%, based on our leverage ratio. For more information regarding risk associated with interest rates based on LIBOR, see "Part I, Item 1A. Risk Factors, Restrictions in our debt agreements or our inability to obtain financing on favorable terms may increase our cost of borrowing and limit our activities."
Under the Credit Facility, the net repayment and borrowing activity resulted in less cash used of $145.8 million during 2019, as compared to 2018. At December 31, 2019, we had $288.8 million outstanding under the Credit Facility. At December 31, 2018, we had $398.9 million outstanding under the Credit Facility. The general availability of funds under the Credit Facility was further reduced by $1.4 million and $1.3 million for letters of credit that was issued in connection with claims under our workers' compensation policy at December 31, 2019 and 2018, respectively. 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, and certain restrictive agreements and violations of laws and regulations. The financial covenant is a consolidated leverage ratio test that requires our ratio of debt to earnings before interest, taxes, depreciation, amortization, and share-based compensation not to exceed 3.5-to-1. At December 31, 2019, we were in compliance with the covenants of the Credit Facility. The obligations under the 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 the Multicurrency Note Purchase and Private Shelf Agreement, dated as of December 19, 2014, among the Company, Metropolitan Life Insurance Company, and the accredited institutional purchasers named therein, and pursuant to such amended agreement, we issued and sold through a private placement an aggregate principal amount of $100 million of unsecured senior notes at a 4.19% per annum rate, due March 14, 2029 (the "2029 Series C Notes"). The 2029 Series C Notes proceeds were used for general corporate purposes.
Since December 2013, we have issued and sold through private placements unsecured senior notes having an aggregate principal amount of approximately $700 million, including the $100 million 2029 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. See "Part II, Item 8. Financial Statements and Supplementary Data, Note 12. Debt" to the consolidated financial statements included in this Annual Report on Form 10-K for additional information regarding our senior notes.
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 Agreement, 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 each year as the value of the U.S. dollar relative to the value of the foreign currencies change. A currency’s value depends on many factors, including interest rates, 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, as reflected in "Part II, Item 8. Financial Statements and Supplementary Data, Note 12 Debt" and "Part II, Item 8. Financial Statements and Supplementary Data. Note 15. Commitments, Contingencies and Guarantees" to the consolidated financial statements for the year ended December 31, 2019, included in this Annual Report on Form 10-K, respectively.
Financial Covenant. The financial covenant is a consolidated leverage ratio test that requires our ratio of debt to earnings before interest, taxes, depreciation, amortization, and share-based compensation, as defined in the Senior Note Agreements and Credit Facility, not to exceed 3.5-to-1. At December 31, 2019, we were in compliance with the covenants of the Senior Note Agreements. The following details our consolidated leverage ratio calculation:
| (in thousands) | Twelve months ended | ||
| Trailing 12 Months Adjusted EBITDA: | December 31, 2019 | ||
| Net income attributable to stockholders | $ | 427,720 | |
| Interest expense | 31,055 | ||
| Provision for income taxes | 94,426 | ||
| Depreciation and amortization | 88,011 | ||
| Share-based compensation expense | 39,278 | ||
| Extraordinary and other non-recurring non-cash charges | 968 | ||
| Adjusted EBITDA | $ | 681,458 | |
| (in thousands) | Twelve months ended | ||
| Debt to Adjusted EBITDA Ratio: | December 31, 2019 | ||
| Line of credit | $ | 288,765 | |
| Long-term debt | 698,910 | ||
| Total debt | 987,675 | ||
| Acquisition-related consideration payable | 3,000 | ||
| Financing leases | 103 | ||
| Deferred financing costs | 512 | ||
| Gross debt | $ | 991,290 | |
| Gross debt to Adjusted EBITDA ratio | 1.45 | ||
| Cash and cash equivalents | $ | (90,326 | ) |
| Net debt | $ | 900,964 | |
| Net debt to Adjusted EBITDA ratio | 1.32 |
Other Commitments, Contingencies and Guarantees
Under our current employee healthcare insurance policy for U.S. employees, we retain claims liability risk per incident up to $1 million per year in 2019, 2018, and 2017. We recognized U.S. employee healthcare claim expense of $59.3 million, $52.7 million, and $47.2 million for the years ended December 31, 2019, 2018, and 2017, respectively, which represents actual claims paid and an estimate of our liability for the uninsured portion of employee healthcare obligations that have been incurred but not paid. Should employee health insurance claims exceed our estimated liability, we would have further obligations. Our estimated liability for healthcare claims that have been incurred but not paid as of December 31, 2019 and 2018, was approximately $5.0 million.
Workers’ compensation and automobile claim expenses recognized during the years ended December 31, 2019, 2018 and 2017 and our respective liability for such claims as of December 31, 2019, 2018 and 2017 were not material. For the years ended on or prior to December 31, 2017, based on our retained claim liability per incident and our aggregate claim liability per year, our maximum liability in excess of the amounts deemed probable and previously recognized is not material as of December 31, 2019. As of December 31, 2019, we had outstanding letters of credit totaling $1.4 million to the insurance companies as security for the claims in connection with these policies.
We are contractually obligated to make the following payments in the years below:
| (in thousands) | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||||||
| Long-term debt obligations (1) | $ | 837,602 | $ | 24,447 | $ | 169,512 | $ | 186,569 | $ | 457,074 | ||||||||||
| Credit facility (2) | 288,765 | 288,765 | — | — | — | |||||||||||||||
| Operating leases | 99,025 | 18,016 | 31,392 | 16,015 | 33,602 | |||||||||||||||
| Purchase obligations (3) | 298,370 | 224,394 | 48,135 | 22,412 | 3,429 | |||||||||||||||
| Minimum royalty payments | 1,320 | 421 | 317 | 157 | 425 | |||||||||||||||
| Total contractual cash obligations | $ | 1,525,082 | $ | 556,043 | $ | 249,356 | $ | 225,153 | $ | 494,530 |
| (1) | Long-term debt amounts include interest payments associated with long-term debt. |
| (2) | Credit facility amounts do not include interest payments. |
| (3) | Purchase obligations include agreements and purchase orders to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including fixed or minimum quantities, pricing, and approximate timing of purchase transactions. |
These commitments do not reflect unrecognized tax benefits of $26.8 million and $1.7 million of deferred compensation liabilities as of December 31, 2019, as the timing of recognition is uncertain. See "Part II, Item 8. Financial Statements and Supplementary Data, Note 13. Income Taxes" to the consolidated financial statements included in this Annual Report on Form 10-K for additional discussion of unrecognized tax benefits. As of December 31, 2019, our remaining obligation associated with the deemed repatriation tax resulting from the Tax Act is $27.0 million, which is expected to be paid in installments through 2025.
Not reflected in the contractual obligation table above are agreements with third parties that we have entered into in the ordinary course of business under which we are obligated to indemnify such third parties for and against various risks and losses. The precise terms of such indemnities vary with the nature of the agreement. In many cases, we limit the maximum amount of our indemnification obligations, but in some cases those obligations may be theoretically unlimited. We have not incurred material expenses in discharging any of these indemnification obligations, and based on our analysis of the nature of the risks involved, we believe that the fair value of these agreements is minimal. Accordingly, we did not record any liabilities for these obligations at December 31, 2019 and 2018, and do not anticipate any future payments for these guarantees.
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