IDEXX Laboratories (NASDAQ:IDXX) reported solid revenue growth with operating income and earnings growing even faster allowing the animal diagnostic company to raise 2017 guidance.

But investors looked the gift horse in the mouth and sent shares down 7% on Tuesday, presumably because short-term thinkers believed guidance should have been raised even more.

IDEXX Laboratories results: The raw numbers

Metric

Q2 2017

Q2 2016

Year-Over-Year Change

Revenue

$509 million

$467 million

9%

Income from operations

$123 million

$104 million

18%

Earnings per share

$0.95

$0.74

28%

Data source: IDEXX Laboratories.

What happened with IDEXX Laboratories this quarter?

  • Companion animal diagnostics recurring revenue grew a solid 12% year over year thanks to its razor-and-blade model with an ever-increasing number of installed instruments.
  • The company placed 2,680 instruments in the quarter, almost half coming from the company's mainstay Catalyst system. While instrument placements were down slightly year over year, the year-ago quarter had a lot of upgrades and placements of second machines, which don't add much recurring revenue in future quarters. This quarter the company focused on new accounts in North America, placing 341 Catalyst instruments in competitive or greenfield accounts, an increase of 14% compared to the year-ago quarter. Those new accounts should drive recurring revenue in future quarters.
  • Revenue from reference laboratory diagnostic and consulting services, where IDEXX runs the tests for veterinarians, grew 12% year over year. The company's SDMA test for kidney function continues to drive increased revenue for the reference laboratory.
  • Sales of rapid assay products increased 8% year over year on the back of growth in sales of SNAP 4Dx Plus tests, although management warned that growth in sales of rapid assay products will slow to the mid-single-digit range in the second half of the year given the relatively stronger sales in the second half of 2016 that it'll be compared to.
  • Sales of tests for farm animals increased just 2% year over year. The slow growth was mostly out of the company's hands -- eradication of diseases in Europe and lower milk prices resulting in reductions in the number of cows -- but with the continued growth of companion animal tests, farm animal tests are becoming an even smaller percentage of IDEXX's revenue anyway.
  • Finally, revenue from water testing, which is an even smaller percentage of sales, grew 6% year over year.
  • Operating income grew faster than revenue because IDEXX was able to increase gross margins to 57.5% up from 55.8% in the year-ago quarter.
  • Earnings per share grew even faster, but that's because of new accounting guidance related to share-based compensation -- not something investors can count on every quarter.

What management had to say 

IDEXX's chairman and CEO Jonathan Ayers stressed the increased utilization of testing by veterinarians:

"I think what we're finding is the more we call on customers the faster they adopt our more expanded toolkit of diagnostics and it turns out when you have more tools you use them more frequently and they find more disease and this is a reinforcing dynamic."

Later in the conference call, Ayers continued the theme of a positive feedback cycle of increased testing resulting in even more testing:

"One would normally think, 'Hey, if I'm going to do more in-house, I do less reference lab.' No, the more in-house you do, the more reference lab you do."

One place where IDEXX testing could increase further is in urine tests run on its SediVue instrument. The company offered a day this year when customers didn't have to pay for tests run on their SediVue instruments and Ayers noted a substantial increase in usage:

"We saw over 600 customers run seven times the amount of urine that they would have run on a normal day. And on the incremental results, we found over a third of those results provided remarkable diagnostic findings. This just shows how underutilized urinalysis is. Our current projection is still $3,000 or $4,500 per year in recurring revenue per instrument placement. We hope to grow that gradually over time; we're around 1.1 runs per day on average."

A SediVue machine in use by a technician.

SediVue machine. Image source: IDEXX Laboratories.

Looking forward

Management raised 2017 revenue guidance by $17.5 million at the midpoint of prior guidance to a range of $1.945 billion to $1.965 billion, but $13 million of that is just coming from updated assumptions related to changes in foreign exchange rates.

Earnings per share guidance for the year was also raised, up $0.14 to a range of $3.12 to $3.22, but only $0.04 is coming from increased operating profit. The other $0.10 of the increase comes from a $0.02 benefit from exchange rates and $0.08 from the new accounting guidance related to share-based compensation.

But there's a good reason for the relatively small increase in operating profit compared to previous guidance: IDEXX is making investments now that it thinks will result in future revenue growth. In addition to expanding its sales force to increase the number of visits to customers, which Ayers noted has paid off with increased sales, IDEXX is also increasing research and development and integrating rVetLink, a veterinarian software company it recently acquired.

The R&D investments should start paying off shortly with planned launches for two new products: an SDMA test for the Catalyst machines so veterinarians can do the test in house and not have to send samples to the reference lab, which is due to launch by the end of the year and a SNAP fecal test expected in the middle of 2018.

Brian Orelli has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Idexx Laboratories. The Motley Fool has a disclosure policy.