IDEXX Laboratories, Inc.

Good morning, and welcome to the IDEXX Laboratory's fourth quarter 2018 earnings conference call. As a reminder, today's conference is being recorded. Participating in the call this morning are John Ayers, Chief Executive Officer, Brian McKeon, Chief Financial Officer, and John Ravis, Senior Director, Investor Relations. IDEXX would like to preface the discussion today with a caution regarding forward-looking statements. Listeners are reminded that our discussion during the call will include forward that are subject to risks and uncertainties that could cause actual results to differ materially from those discussed today. Additional information regarding these risks and uncertainties is available under the forward-looking statements notice in our press release issued this morning, as well as in our periodic filings with the Securities and Exchange Commission, which can be obtained from the SEC or by visiting the investor relations section of our website, IDEX.com. During this call, we will be discussing certain financial measures not prepared in accordance with generally accepted accounting principles or GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure is provided in our earnings release, which may also be found by visiting the investor relations section of our website. In reviewing our fourth quarter 2018 results, please note all references to growth, organic growth, constant currency growth, and comparable constant currency growth refer to growth compared to the equivalent period in 2017 unless otherwise noted. To allow broad participation in the Q&A, we ask that each participant limit his or her questions to one with one follow-up as necessary. We appreciate you may have additional questions, so please feel free to get back into the queue, and if time permits, we'll take your additional questions. I would now like to turn the call over to Brian McKeon.

Thank you, and good morning, everyone. I'm pleased to take you through our fourth quarter and four-year 2018 results and provide an update on our financial outlook for 2019. IDEXX achieved continued strong financial performance in Q4. This concluded another year where we again delivered revenue and EPS gains above our long-term financial goals. In terms of highlights, we achieved 10% organic revenue growth in the fourth quarter, on track with our expectations, driven by consistent 13% organic growth in CAG diagnostics recurring revenues. We achieved full-year organic revenue growth of 11.6%, aligned with our long-term financial goals of 10% plus annual gains, supported by 13% organic growth in CAG diagnostics recurring revenues in both U.S. and international markets. Our full year EPS was $4.26, an increase of 36% on a comparable constant currency basis. This performance reflected strong top line growth, a 130 basis point improvement in operating margins on a constant currency basis, and benefits from U.S. tax reform. We're well positioned to build on these results in 2019. We're maintaining our outlook for 9.5% to 11% organic revenue growth reflected in our consistent guidance range of $2,385,000,000 to $2,425,000,000 in annual revenues. We're raising our EPS guidance to $4.66 to $4.78, our growth of 15% to 18% off our 2018 results on a comparable constant currency basis, aligned with our long-term goals. This is an increase of $0.04 per share at midpoint reflecting flow-through of $0.06 per share of 2018 profit upsides supported by operating margin gains at the high end of our goals and upsides from approximately 50 basis points of favorability in our effective tax rate, which we expect will sustain in 2019. These gains are partially offset by a $0.02 per share reduction in our estimate for share-based compensation tax benefits related to changes in our stock price, which is excluded in our comparable constant currency EPS growth calculation. Our guidance reflects consistent expectations for year-on-year foreign exchange impacts. We'll walk you through the details of our 2019 guidance later in my comments. Let's begin with the review of our fourth quarter and four-year 2018 results by segment and region. Q4 results were driven by ongoing momentum in our companion animal group. Global CAG revenues were $479 million, up 12% organically, reflecting continued strong gains in recurring CAG diagnostics revenues. Global CAG diagnostics recurring revenues increased 13% organically, including $4.5 million, or 1.3%, in growth benefit from the new revenue accounting standard, primarily related to our modified retrospective restatement. By region, U.S. CAG diagnostic recurring revenues increased 13.3% organically, driven by mid-teen growth in consumables and reference lab sales, and continued solid growth in rapid assay revenues. U.S. CAG diagnostics recurring revenue growth was primarily volume-driven, with overall net price gains of approximately 2%. U.S. recurring CAG diagnostics customer retention metrics sustained at high levels, reinforcing the durability of a recurring revenue base. IDEXX's U.S. recurring CAG growth performance continues to outpace U.S. veterinary practice market growth reflected in our data set from approximately 5,000 clinics. In Q4, patient visits were up 0.3% and clinic revenues increased 4% per practice compared to the prior year period, a relatively lower level of overall practice level and growth compared to recent trends. This same store growth data is for veterinary visits of all types, and appears to be impacted by moderated growth in non-clinical visits, as we've seen growth for clinical visits trending closer to 2%. These solid clinical visit trends are aligned with our continued strong business results. We're refining our data tracking and analysis of clinical versus non-clinical visit trends and look forward to sharing more of this front on future conference calls. International CAG diagnostic recurring revenues increased 12.5% organically in Q4 2020, driven by 20% plus organic growth and international consumable revenues. Mid-single-digit reference lab growth improved relative to our third-quarter results, with overall gains constrained by continued softer performance in select markets, impacted in part by a commercial focus in 2018 on driving very strong in-clinic revenue gains. Veterinary software services and diagnostic imaging systems revenues increased 9% globally in Q4, reflecting 8% organic gains and benefits from our recent acquisition of SmartFlow. These results were supported by solid growth in recurring software services associated with our practice management platforms and continued strength in our diagnostic imaging business, which posted a 20% increase in digital imaging system unit placements for the full year 2018. For the full year, overall CAG revenues increased 13% organically, driven by 13% gains in CAG diagnostic revenues, strong premium instrument placements, and solid growth in our veterinary software and digital imaging business. Full-year CAG diagnostics recurring revenue growth included 1.3% in non-recurring growth rate benefit from the new revenue accounting standard changes. Adjusting for this effect, our 2019 goals target continued low-teen organic growth in our CAG business, building on our strong business momentum. Our water business revenues grew 8% organically in the fourth quarter to $30 million, driven by strong gains in international markets, which were offset to a degree by the timing of year-end U.S. shipments, which moderated overall Q4 growth. For the full year, water revenues reached $125 million, up 9% organically, with faster operating profit growth, reflecting 45% operating margins. We're very pleased with our continued momentum in the water business and are targeting continued high single-digit organic growth in this highly profitable business in 2019. Livestock, poultry, and dairy revenue in Q4 was $34 million, down 5% organically, as expected, reflecting comparisons to high 2017 year-end government program and distributor ordering. Quarterly growth was also pressured by end-market impacts related to African swine fever outbreaks in China, which is our largest market for swine diagnostic testing, and the continued impact of low milk prices in key markets, which has constrained demand for dairy testing and growth in bovine pregnancy test sales. For the full year 2018, our LPD revenue was $131 million, up 1% organically. As our LPD revenues are 90% international, macroeconomic pressures in markets like China can have a relatively larger impact on the LPD business segment than the company as a whole. Given these factors, our 2019 outlook factors in expectations for relatively flat organic growth in our LPD business. For the full year 2018, total U.S. revenues reached $1,358,000,000, up 13% organically, and international revenues increased 10% organically to $855,000,000, or approximately 39% of IDEX's total revenues. Full-year revenue gains were driven by 13% growth in CAG diagnostic recurring revenues in both U.S. and international markets, solidly within our long-term target growth ranges. Our strong Q4 and full-year results reflect continued benefits from global expansion of our premium instrument base. Globally, we placed 3,957 premium analyzers in Q4, an increase of 8% compared to high 2017 Q4 levels, bringing full-year 2018 premium placements to 13,047, up 14%. We placed 2,042 catalysts in total in Q4 globally, a 10% year-on-year increase, 1,170 premium hematology instruments, up 13%, and 745 set of views, in line with very strong prior year levels. Our focus on high economic value placements drove a 15% global increase in global catalyst placements at new and competitive accounts in Q4 and solid EBI gains in both North America and international. In North America, we placed 421 catalyst placements at newer competitive accounts or 76% of total North America catalyst placements. International catalyst placements at newer competitive accounts increased 29% year-on-year in Q4 to 710 instruments contributing 48% of total international catalyst placements. For the full year, our new and competitive catalyst placements totaled 3,626 globally, an impressive 20% year-over-year increase. In addition to strong premium instrument results, we've placed 2,345 Snap Pros in Q4, supported by over 2,000 placements in North America, bringing our worldwide install base to over 25,000. CAG diagnostic instrument revenues in Q4 were $37 million, a 3% increase organically off a strong compare in 2017, with gains moderated in the quarter by instrument program mixed impacts. Q4 instrument revenues included $10.5 million in revenues attributed to the accounting standard, primarily related to expansion of the IDEXX 360 customer program. Our strong Q4 instrument placement results capped a year of substantial progress in expanding our premium instrument base. We finished the year with 37,000 catalysts, up 24%, nearly 29,000 premium hematology analyzers, up 11%, and nearly 6,600 set of views, up 69%, reflecting a record 2,719 set of view placements in 2018. Combined, our premium instrument base increased 21% globally in 2018. Our expanding instrument base and benefits from new test innovation and our strength in commercial capability continues to drive strong recurring CAG diagnostic revenue gains. Instrument consumable revenues of $157 million grew 19% organically in Q4. Results reflect continued 20% plus gains in international markets and sustained mid-teen growth in the U.S. High volume-driven consumable gains were supported by expansion of SETAview paper run and SDMA slide revenues, which again contributed about 4% combined to year-on-year consumable revenue gains in the quarter. Reference laboratory and consulting services with revenues of $178 million grew 11% organically in the fourth quarter. U.S. lab momentum remains strong, reflected in mid-teen volume-driven organic revenue gains. Global lab revenue growth was moderated by mid-single-digit gains in international markets, which, while up from Q3, were impacted by continued soft growth trends in select markets. We're forecasting continued moderate lab growth in our international reference lab business in the near term as we enhance our commercial focus to build on the very strong progress we've driven in developing our IDEX vet lab business in international markets. Rapid assay revenues of $48 million grew 5% organically in Q4, reflecting solid gains across U.S. and international markets. Rapid asset gains were primarily volume-driven, supported by continued growth of 40x plus specialty and first-generation products. Turning to the P&L, gross profit was $300 million in Q4, up 10% on a reported basis. Adjusting for foreign exchange impacts, gross margins increased about 70 basis points, supported by continued solid net price gains and strong growth in consumable revenues. Foreign exchange hedge gains, which benefit gross profits, were $1 million in Q4. Operating profit in Q4 was $115 million, up 18% as reported, or 20% on a constant currency. Operating profit results benefited from strong revenue gains and operating expense leverage, supporting a 170 basis point improvement in constant currency operating margins in the quarter. Operating expenses in Q4 were up 6% as reported or 7% on a constant currency basis, driven by growth investments in sales and market and supporting G&A resources in our CAG business, with overall OPEX growth mitigated by discipline, cost control, and LPD. For the full year, operating profit was $491 million. This reflects an operating margin of 22.2% for the full year, an increase of 130 basis points on a constant currency basis. This outstanding result reflects approximately 30 basis points of constant currency gross margin gains or about 50 basis points of improvement adjusted for impacts related to cost reclassifications in our lab business. Our strong full-year operating margin results also reflect significant operating expense leverage benefiting from our accelerated revenue growth while we expanded our sales and marketing capability globally and increased investment in products and software R&D which reached $118 million in 2018, or nearly $130 million on a cash basis. EPS in Q4 was $0.98 per share, including $0.01 per share in tax benefit related to share-based compensation activity, and $0.02 in negative impact related to year-over-year FX changes. On a comparable constant currency basis, EPS increased 40%, including net benefits from U.S. tax reform. For 2018, EPS was $4.26, including $21 million, or $0.24 per share, in tax benefit related to share-based compensation activity. For the full year foreign exchange, rate changes increased EPS by $0.01 per share, net of FX hedge loss impacts of $1 million. Adjusting for these factors and prior year discrete tax impacts, 2018 EPS growth was 36% on a comparable constant currency basis. Our effective tax rate for 2018 was 17.6%, including approximately 5% of rate benefit related to share-based compensation activity. This tax rate was approximately 3 cents per share favorable to our earlier guidance estimates, including about 2 cents of additional benefit related to share-based compensation activity. Free cash flow was $284 million for 2018, or about 75% of net income. Our free cash flow was net of $116 million of capital investment, including $42 million of combined investment related to our Westbrook, Maine headquarters expansion and German Core Lab relocation. We also supported $60 million in instrument program investments for the year, an increase of $44 million year-on-year associated with our very successful IDEXX 360 program in the U.S., in support of strong premium and replacement growth internationally. We allocated $369 million in capital towards share repurchases for the full year 2018, including repurchases of 489,000 shares in Q4 for $103 million. Our balance sheet is in an excellent position. We ended the year with $1.6 billion in debt, $124 million in cash, and $450 million in capacity under our revolving credit facility. Our leverage ratios as a multiple of adjusted EBITDA were 1.67 times gross and 1.46 times net of cash. Our strong performance and disciplined capital allocation supported achievement of a 49% after-tax return on invested capital, excluding cash and investments for 2018. We're well positioned to build on this strong performance in 2019 with a financial outlook aligned with our long-term goals. We're maintaining consistent 2019 guidance for 9.5% to 11% organic revenue growth and revenue of $2,385,000,000 to $2,425,000,000. This outlook equates to reported revenue growth of 8% to 9.5% net of a consistent projected 1.5% FX growth headwind at the rates assumed in our press release. We finalized the components of our revenue guidance as part of our year-end planning and refined our CAG diagnostic recurring revenue organic growth outlook to 11% to 12%, building on our exceptional 13.2% organic growth in 2018, which included 1.3% of non-recurring growth rate benefit related to the implementation of the new revenue standard. We're raising our 2019 EPS outlook to $4.66 to $4.78, an increase of $0.04 per share at the midpoint, reflecting approximately $0.06 per share in flow-through of 2018 profit upsides, offset by a 2% per share reduction in estimated tax benefits from share-based compensation activity. This outlook factors in an estimated $0.03 negative year-on-year impact from FX, net of $10 million in projected hedge gains, consistent with our preliminary guidance estimates. As a sensitivity, a 1% change in the dollar from rates assumed in our press release would impact 2019 revenues by approximately $8 million and operating profit by approximately $2 million net of hedge positions currently in place. We've refined elements of our P&L outlook as we finalize our 2019 plans while maintaining a consistent comparable EPS growth outlook of 15% to 18%. We're now targeting 50 to 80 basis points of constant currency operating margin improvement a slight reduction to the high end of our targeted improvement range, with targeted year-on-year gains driven primarily by gross margin improvement. This refinement is offset by favorable updates to our projections for interest expense and year-on-year share count reduction. We're now projecting $37 million to $38 million in net interest costs in 2019 and a 1% to 1.5% reduction in average shares outstanding with both metrics aligned with an assumed maintenance of our net leverage rate levels at approximately 1.5 times EBITDA. Our outlook for effective tax rate in 2019 remains at 20% to 21%, as sustained 2018 upsides are offset by updated estimates for tax rate benefits of stock-based compensation, reflecting more recent share price levels. We now project $6.5 million to $8.5 million or approximately 2% in tax benefit from exercise of stock-based compensation in 2019, approximately $0.02 per share below prior estimates, and $0.15 per share below high 2018 levels. In terms of free cash flow, we expect to continue to invest in high-return instrument growth programs globally and to deploy $160 million to $175 million in capital spending, including approximately $70 million related to completion of our Westbrook Headquarter and German Core Lab projects. For 2019, this results in an outlook for free cash flow of 60% to 65% of net income, where approximately 80% of net income normalized for these two major projects. In terms of our first quarter outlook in 2019, we expect Q1 reported revenue growth in the 6% to 7.5% range, reflecting organic gains of 9% to 10.5%, net of a projected 1% equivalent day's headwinds. Q1 operating margins are expected to be at the lower end of our full-year improvement goals of 50 to 80 basis points as we continue to advance implementation of our international commercial resource expansion. We expect our effective tax rate in Q1 to be 18.5% to 19%, including projected benefits from share-based compensation exercise activity. That concludes the financial overview. Let me turn the call over to John for his comments. Okay.

Brian, thank you. A little color commentary, and then we'll open up to questions. We finished 2018 with strong revenue growth and impressive bottom line results, even as we're making significant incremental investments in business to support our customers, and that will generate sustained growth for years to come. Companion Animal Diagnostic recurring revenue, which constitutes 75% of IDEX's overall revenues in 2018, grew organically 13% for the quarter and the full year, consistent with our expectations. diagnostic recurring revenue, which represents almost two-thirds of the total global, generated organic growth of 13.3%, while international generated 12.5%. International growth was supported by 20% plus instrument consumable organic revenue growth. Clearly, pet owners have an increasing appreciation of the importance of health care for their pets. Our growth trends as 2018 wraps up are also a testament to the value our customers see in IDEX's unique diagnostic offering and the importance the IDEX technologies play in health care. The market for medical and technician talent is really competitive right now, as you can see from this morning's job report. In fact, it's been reported that there is one veterinarian available for every five veterinarian job openings. And so practice owners need to attract and retain valued staff by providing them essential tools and a partner to support their job well and take the best care of patients. Thus, the importance of IDEX is far more advanced innovations. And so our customer retention metrics, which are the foundation of growth in a recurring revenue model, continue at exceptionally high levels in Q4, if not inching up ever so slightly. Our organic growth remains primarily volume-driven, augmented by continued modest price realization, the latter reflecting the benefits of how our offerings advance with the benefit of almost 130 million of cash R&D and diagnostics and software in 2018, and a projected almost 150 million in cash R&D in the same, in 2019. This technology-for-life approach includes the behind-the-scenes software upgrades that happen regularly for our point-of-care instruments, like the recently announced Neural Network 4.0 for SEDview Advancing Menu and the progesterone test for our Catalyst platform, our seventh new test in seven years on the Catalyst platform, as well as regular advances in VetConnect Plus, our cloud-based diagnostic software. For 2018, placements of catalysts to new and competitive counts were up 20%. New and competitive catalyst placements over the course of the year are an important contributor to the 19% organic relative and IDEXX VetLab instrument consumables Q4. We're pleased with the instrument placement results that Q4 contributed to the year that Brian has enumerated, as well as the completion of the rollout of Catalyst-1 analyzers at over 1,000 Banfield hospitals. We're entering 2019 having completed important commercial expansions around the world. The U.S. expansion with the greater customer coverage from a deeper field-based professional organization was in place for the start of Q4. There's always some settling in during the first quarter of an expansion as our professionals, including newly recruited professionals, develop relationships with their customers in their new or reconfigured territories. Especially in this light, the North American growth metrics, also against a strong compare, were very strong. As we enter 2019, we're beyond this initial settling in period in our US market, our largest, with an experienced world-class team of professionals and frontline leadership. This team is focused on growing diagnostic and software category, advancing customers' adoptions of new protocols such as preventative care diagnostics, fecal antigen testing, your analysis unit instead of you, and growing the overall number of customers that benefit from IDEX's unique technologies. Our U.S. field footprint isn't in place with our U.S. field footprint in place a quarter ago. Our 2019 U.S. focus is on the productivity that comes from rapid development and time and territory. Our commercial investments in the U.S. in 2019 will focus on high ROI opportunities beyond the field footprint. Our international teams expansion plans were timed generally about a quarter later than the US. At this point, we're largely complete in hiring expanded commercial resources to advance instrument placements and companion animal group diagnostic recurring revenue growth in accordance with our plans. Our international teams are building competencies with our key commercial strategies. For example, the economic value index of an instrument placement to prioritize high value chemistry placements which is one of the reasons why we saw a 29% growth in new income competitive catalyst placements in Q4 internationally to a record over 700 units, which was up 100 units from Q3 of 2018, which itself was a quarterly record. Another strategic competency being adopted by international is leveraging the IDEXX 360 program to accelerate instrument placements and drive recurring revenue growth. This type of program selling is generally new to our IDEX teams outside of North America, and I'm pleased with the team's progress here as the year wrapped up. Our international teams are poised to have a great 2019, spreading the benefits of IDEX's innovations such as IDEX SDMA, including on catalyst placements, and our best-in-class hematology offerings as the expansions complete their settling period in the first quarter of 2019. These international commercial expansions, along with a unique diagnostic and software technology offering, gives us confidence in our revenue growth targets, primarily driven by volume testing gains with secondary support from modest price realization and net new customer additions. While current economic times bring a steady din of broader macro noise, IDEX's growth remains solid, reflecting the durable, recurring nature of our revenues, the benefit of our differentiation enabled by our industry-leading investments in innovation, and supported by the growing bond between pets and their owners. In sum, we are sustaining solid growth momentum as we enter 2019, which gives us confidence for the 11 to 12% projected organic growth of CAG diagnostic recurring revenues in 2019, similar to the 2018 growth trends on an adjusted basis. Before I open the call to questions, I want to express my deep gratitude to our employees for their accomplishments in 2018 in the pursuit of our purpose to enhance the health and well-being of pets, people, and livestock, and also my gratitude to the continued confidence our customers have in IDEX as a value-added technology partner. So with those comments, Cynthia, we'll open the call to questions.

Thank you. And ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touchtone phone. You will hear a tone indicating that you have been placed in queue. You may remove yourself from queue by pressing the pound key. If you are using a speakerphone, please pick up your handset before pressing the numbers. And once again, for any questions or comments, press star and then one. And our first question will come from the line of Ryan Daniels with William Blair. Your line is open.

Yeah, good morning, and thanks for taking the questions. Two somewhat disparate ones. First off, John, for you, as we think about the expanded international sales force and your potential rollout of IDEXX 360 and kind of integrating the reference and point of care more actively, is there an opportunity to push the preventive care protocols and challenge in those markets as well, or is it still a bit too early in those markets to think that could be an organic growth driver?

Yeah, thank you for that. We're actually beginning to look at that in some of the more advanced international markets. I think it's an opportunity we have. And in addition, when we talk about the benefits of diagnostics in a preventative care scenario, it reinforces the importance of running diagnostics when it is not a wellness presentation. And so I think we'll see it early days, international in 2019, very early days, kind of where we were at the U.S. several years ago. But preventative care really has come of age in 2018, and it's a big component of our growth in 2019 in the U.S. and now more and more in the Canadian market.

Okay. And then if we look at the U.S. market, I thought it was somewhat noteworthy in the press release. You called out millennials and, you know, that being a focus for the organization. Can you speak to that note in a little bit more detail as it relates to how that could serve as a tailwind for the industry and then anything you'll do specifically given the large size of that millennial market and their proclivity to spend more on vet care? Sure. Thanks.

Yeah, so millennials, which we generally define as the 15-year span from 37 to 22, are now taking care of their own pets. They're also an important and growing part of the professional community of veterinarians and technicians. And all the evidence that we see is that the millennials visit the vet more. They're more in tune with their pets. And, you know, I think that one metric kind of calls it out that, you know, while maybe 20% of other prior generations feel their pets have special health needs, 46% of millennials think their pets have special health needs, which really I think is an indication of how millennials are in touch with their pets. And so we see this as, and then the early evidence is even the generation beyond that maybe taking it even a bit further. But this is obviously the largest component of the consumer category right now, and I think will be a key long-term driver for the growing importance of pet health care.

Okay, great. Thank you. I'll hop back in the queue.

Thank you. Our next question will come from the line of Erin Wright with Credit Suisse. Your line is open.

Great, thanks. Looking at the patient visit growth metrics that you gave, You gave some new color on the clinical visits, which were up 2%. How has that metric trended over the past few years? And how would you characterize kind of underlying demand trends across the U.S. companion animal market? I assume that is a U.S. metric you're giving there. And what does your guidance assume in terms of underlying demand trends for the year? Can you speak to some of the more resilient aspects to your business that can withstand those sort of fluctuations in underlying demand trends? Thanks.

Yeah, I want to start with the last part. What we're doing is we're growing the utilization importance of diagnostic and all kinds of presentations. I think people are realizing that just by doing a physical exam and a history, you're missing a lot of pieces of the equation without running diagnostics. And of course, you're missing other pieces of the equation if you're not running IDEX diagnostics. So even though we've seen some moderation in the pet visits you know, over the course of the second half of 2018 in the U.S. market, which is really the only market that we have industry data. And as you know, I think the clinical visits are, you know, moderating at less – still we've got, you know, 2% growth in clinical visits, which is, of course, the only type of visit that is important to IDECs. The non-clinical visit is, you know, not really a factor for IDECs. We're seeing good demand growth, and so our expectation in 2019 is consistent with really what we saw in 2018. Second half of 2018.

I think we're factoring in the recent trends, and our outlook is very much in line with the adjusted growth that we're driving coming out of the back end.

Let's also recognize we're seeing growth in the instrument consumables associated with our new tests. you know, catalyst SDMA on a slide, and the growing installed base of Cetiview, and, you know, the growing use of preventative care. So we have a number of growth drivers that, you know, make up the total companion animal diagnostic recurring revenue projected growth for 2019 of 11 to 12% on an organic basis.

Okay, great. Thanks. And on the international side, I'm going to ask another question on international reference lab, but when will the sales force more meaningfully kind of mature there and how quickly is that relative to what you typically see kind of in the U.S.? And then how should we think about that quarterly cadence in international reference lab? When do you really expect that to start to improve over the course of the year? Thanks.

But, you know, I like to look at, you know, the results as a whole. And what we've done is we've prioritized the catalyst placements to new and competitive accounts, which is a little bit harder sale than a catalyst placement to a, you know, to an existing IDEX chemistry customer using vet tests. And while we've largely upgraded the vet test volume in the international market, you know, there are some, I think it's 10% of our, chemistry consumable volume in the international market with that test remaining to go. This is the 29% year-over-growth, I think, is really showing that the international is prioritizing the highest ROI work. And let's recognize, once we place a catalyst, loyalty internationally on catalysts is virtually 100%. So these are going to be customers that are going to be using catalysts for life. This is very enduring recurring revenue, let alone any growth we get in utilization from menu or utilization or adoption of additional protocols. We saw a couple percent tick up in the International Reference Lab organic growth in Q4 over Q3, which really I think validates that part of what we saw in Q3 was weather, and part of it was some selective slowdown in markets as we prioritize those chemistry placements. To get to really where will the IDEXX 360 program and our overall focus on both catalyst and reference lab, I would say that's probably going to, we'll probably see that in the second half of 2019 start to kick in. But the productivity of the sales forces are pretty high on the important instrument placement side of the equation.

Okay, great. Thank you.

Thank you. Our next question comes from the line of Michael Riskin with Bank of America, Maryland. Your line is open.

Thanks, guys. Thanks for taking the question. I want to dig deeper on a couple of the moving pieces in the updated 2019 guide just to get some clarity. So I think you mentioned that the CAG recurring revenues outlook, you refined to 11% to 12%. versus the 11.5 to 12.5. It sounds like the accounting standard is now a little bit more. I think you said 1.3 and previously it was 1.0. So this is a bit of a two-part question, but I'm wondering if that's the entire reason for the shift and it's just a bit of a rounding. um decision and then the second part of the question is if that's now 11 to 12 but the full the total company guide is reiterated at nine and a half to 11 is there an offset somewhere else you know it looks like lpd is still going to be challenged because of african swine fever is it something better in water quality or is this just a rounding between the various buckets yeah mike it's it really is kind of the rounding uh effects as we're just finalizing our plans but the um

We try to provide input for each of the segments in the call. So we said low teens, CAG, high single-digit water, and relatively flat LPD. And it really is a refinement to finalizing our plan. It's not related to the accounting adjustment. And, you know, that kind of implies high single-digit growth in areas like VSS and digital and and our instrument placement revenues. So it's just wrapping up our plans, very much in line with our trends coming out of the end of the year. If you look at the CAG recurring growth adjusted for that 1.3% effect, it's very consistent with that. We provided the extra decimal point. It's been slightly above 1% through the year. We've just been rounding, and we wanted you to have that exact number as we finish the year. But again, that is a non-recurring growth rate benefit. We should be through the Accounting change adjustments and, you know, kind of fully normalized heading into 2019.

Yeah, Mike, I think, you know, in support of Brian's comments and your comments, I think you've characterized it right. You know, we're pretty unique in providing revenue and profit guidance in October of the year before for the following year, which really shows the enduring nature of our and predictable nature of it. And it's really just as we finalize our plans and outlook, we're talking about some roundings.

And I would say we had an outlook in Q4 for the international labs of mid to high single digit. We're a bit at the lower end. We did see improvement, and some of that's factored in as well. So we think that we've got that well calibrated.

Okay. And then just if I could squeeze in one other quick one on the VET volume data you provided for 4Q, the 0.3% increase. I'm just wondering if you saw anything weird in the U.S. in terms of weather in the quarter. You know, we had the California wildfires in October. Or if you think there's any potential impact there from some of the macroeconomic data, the GDP data that came out late in the year. You know, the stock market had a negative move throughout the year. So I was wondering if You thought there was anything there that led to that decrease in event clinic visits?

You know, that's a lot of moving parts. I would say, and then you have to throw in the calendarization of December, too, with the holidays and where they fell. You know, I think the 0.3%, that's total visits. We're getting a better understanding. I don't think we're ready to talk in detail about it yet, but we're getting a better understanding of what portion of of those visits are clinical visits and what the clinical visit trends are. Our preliminary analysis is the clinical visits are closer to 2% growth in Q4, and so some of that deceleration may be really just revenue going from out of the practice management system into other channels. Some channels are channels that benefit the veterinarian through like a direct sales from the veterinarian but doesn't go through the practice management software, which is, of course, what we're measuring. But I think the overall trends and certainly our companion animal diagnostic recurring revenue growth of 13.3% in the U.S. speaks for the fact of solid state of the growth in our portion of the industry.

All right. Much appreciated. I'll get back in the queue.

Thank you. And once again, for any questions or comments, press star and then one. We will go to the line of John Block with CFO. Your line is open.

Great. Thanks, guys, and good morning. I'll also ask probably a couple of guidance-related questions. So, Brian, the first one, I think if I heard you correctly, the midpoint of the 1Q organic was about 9.75, and that's with a 1% days headwind. That's largely in line with the 9.5 to 11 organic for the year. So I guess where I'm going with this is anything to call out from a cadence perspective for the year? On a top line, should we think stable and then maybe the op margin expansion is a bit back in weighted? Any color would be helpful.

I think that's a fair call, John. I think we're not – I don't think we have any meaningful – Targeting calendarization differences are things to note. You always have segment by segment, you know, specific compares as we work through the year. But I think that's fair. And, yes, on the operating margin, the full year is 50 to 80, and we're likely at the lower end of that coming out of the blocks. And some of that's just the lapping of the investments that we made on the commercial expansion. We're still advancing some of the international aspects of that. And as John noted, we've got, you know – plans to increase our R&D spending this year as well. So that's all factored in, but we will expect to build on that through the year. And I did note that we are targeting primarily improvement from gross margins this year. So we expect that will be consistent too.

Okay. Very helpful. And that's probably a good segue into the second question, which is, Brian, I haven't pushed on margin expansion for some time, so maybe I'll go back there for my second question. In 2017 and 2018, the out margin expansion, I believe, was around 120 to 130 bps. Guidance this year, like you said, is 50 to 80 bps. Obviously, to be fair, the baseline is higher now. you know you have lapped a lot of um investments notably in the sales force that you've made over the past 12 to 24 months so maybe at a high level you can just speak to the incremental investments and why the amount of out margin expansion in 19 would be more muted versus the past 12 to 24 months thanks guys it really is an operating expense story where we've uh we've been highlighting the additional uh commercial expansions which will be as i noted laughing heading into this year and uh

The cash R&D metrics that John highlighted would imply close to a 15% growth in R&D this year. So we've had very high return on our ongoing investment in the organic growth of the business, as highlighted by our 49% after-tax return on invested capital. An investable business. We are very pleased with the growth, and want to keep investing towards that. And look, if we deliver at the higher end of our revenue goals, which we've had the last couple of years, that can have some favorable flow-through benefits, but we're very comfortable with the outlook that we're providing at this point.

Okay. And maybe one quick one, if I can. The quality of the beat was really high in the quarter. Notably, the R&D expense came in ahead of what we were looking for. You've talked about for your comments, Brian, solid R&D expectations for 2019. So, John, maybe can you talk about the turnaround time, if that's a good term to use for some of those projects? Would we expect that pipeline to materialize at all in 2019, or is that something more of a 2020 event? Thanks for your time, guys.

I'm not going to talk about anything specific in the R&D pipeline that we haven't already talked about, but I do want to reinforce that Some of our R&D, a significant portion of R&D, is about our products expanding menu, advancing their capabilities. Not only do we have cloud-based software that's continually advancing, whether it's in our veterinary software and services, our digital imaging, or, of course, VetConnect Plus, and R&D investments are going to that. So it's no big product launch, but it's a continual advancement and the capability that we're giving the customers, which of course supports recurring revenue growth, our instruments are almost, you could consider them as cloud-based software. They're continually advancing behind the scenes for our customers. And this is the new model. Anyone who's got something powered by software better be continually advancing it through the cloud. I know that's what Tesla's doing on automobiles, and that's what we've been doing you know, for quite some time with now seven new menu items on Catalyst in seven years and the advancement in hematology offering that we talked about over time with four new parameters on ProCite and the advancements in a neural network, the incremental capability we have in IDEXX VetLab Station. So there's a steady diet of things that don't necessarily get a lot of, you know, individual play, but they have a very meaningful impact on the sustainability of our growth. And we have a very good pipeline across the diagnostic and software categories. Our R&D group is very, it's an amazingly productive, combined with our knowledge of the business and our customer requirements and our ability to leverage and access and input third-party technology into our offering. So the continued part As I said, with close to $150 million of cash R&D and diagnostics and software investment in 2019, we see this as a core part of IDEX being the sole innovator in the industry. Thanks, Hans. Thank you, John.

Thank you. Our next question comes from the line of Mark Massaro with Canaccord Genuity. Your line is open.

Hey, guys. Congrats on a nice quarter. My first question is on the mix between U.S. and OUS. Historically, your international growth has trended higher than your U.S. growth. largely given a lower base of business in international, but also based on stronger trends OUS. When we think about Q4, in your prepared remarks, you talked about soft growth in select markets OUS. So can you just give us a sense of where those markets are and what your expectations are for OUS in 2019?

Yeah, so Mark, that was specifically a reference to international reference labs. So we had consumable growth in international. The 20% growth overall was strong across all of our markets. It was really exceptional performance. If you look at the instrument placement growth and the resulting consumer gains, we're very pleased with that progress this year. That was the key driver of the recurring revenue gains. As we've been highlighting, the the mid-single-digit growth in reference labs, what we saw in Q4 was a recovery from the summer in some of our key markets. And we don't like to highlight specific markets for competitive reasons, but we saw a recovery from some of the weather impacts that we had highlighted. And we do continue to have relatively lower growth in some markets, and we think this is largely related to the fact that we really shifted the commercial focus on driving the high in-clinic gains this year and weren't as focused, not by intent, but just outcome on the reference lab business. We're working to get that back on track, and we expect that we'll be successful with that. But we'll take an annuity business. The growth rate is really a reflection of what's happened in the last few four quarters, so we'll hopefully be highlighting progress on that front.

I do want to take the opportunity, big shout out to our German lab and our German commercial organization. The lab, of course, supports more than just Germany, but they really had a great Q4 across the board. That's a team we moved to the veterinary diagnostic consulting model we had in the U.S. at the beginning of the year, and they really, really executed well. Of course, that is the largest lab where we're building the new Corn Westime facility, which you noted in the capital expansion. So I think we're putting the money where the performance is. And so that's the one market I'd really give kudos to.

Great. And then as we think about your new point-of-care progesterone test launching in the coming weeks ahead, I know that you haven't raised your 2019 guidance, but can you give us a sense for the size of the market, how you intend to price it, whether it's a premium to other innovations such as like STMA in a slide, for instance, and what type of market potential you think there is for progesterone?

Yeah, the list price of that test per test will be $34.99 in the U.S. market. Obviously, international markets, it's going to be market-specific, so that is a very attractive list price. But it's really a very small direct contributor. I think what it is is two things that are relevant to investors. One is This continues to advance both the loyalty of catalyst customers and it gives us the opportunity to place catalysts that have a requirement to serve responsible breeders. Second, it's an indication that we're not done adding menu to our in-house instruments. This is one of the things about our instrument platform. It's very flexible. to menu addition because each slide can be developed individually, and we have the capability to do that. It really puts us in a unique position in chemistry as well as hematology and urinalysis to continue to advance the installed-based capability in what we call technology for life.

Excellent. And then if I can, are you seeing any competitive dynamic changes as a result of some of the consolidation in the space and Zoetis acquiring Abaxis? Just as we think about Abaxis becoming more meaningful in Europe and outside the U.S., do you see any changes to your strategy OUS this year?

You know, it's always been a competitive market. I would say, you know, with regard to major markets, the U.S. is the most competitive market. And, you know, as you can see, our loyalty, even with vet test customers outside of the U.S., is in the high 90s. So it's always been a competitive market. We don't really see any changes that have come to play that have been a consequence of the change in ownership of Avaxis.

Great, thank you.

Thank you. Next, we will go to the line of Michael Riskin with Bank of America Merrill Lynch. Your line is open.

Thanks, guys. Just had a couple quick one follow-ups I wanted to throw in there. You mentioned the minus one selling day in the first quarter. Just for our modeling purposes, could you give us the day's impact throughout the rest of the year and just to confirm that there was no impact in 4Q of 18?

So, 2019, we have a favorable day benefit in Q3, and I think the other quarters are not material enough to highlight. Q4, we had a favorable day benefit, but we believe it was offset by the timing at the year-end of the Christmas and New Year's holiday, which really impacted kind of year-end timing. both clinic activity but also our shipments. And so we didn't call that as a factor because we really think we had offsetting effects there. So that was not an adjustment to our Q4 results.

Okay, I appreciate that. And then just to follow up on one of the other questions asked earlier about the international reference lab, it sounds like you had the improvement from the low single digits to mid single digits in the quarter. I'm just wondering, you know, and you called out the relative focus of the Salesforce and driving point of care versus reference lab. As we think through to 2019, how quickly – Should that move up? Is this something that is reasonable to think can take another step higher in one queue, or is this a little bit more gradual to get the international back to the more high single-digit range?

In the near term, it will take time.

I think we'll see gradual improvement over the course of 2019. I think we are coming back to our German organization, which moved to – a veterinary diagnostic consultant model where you have one account manager representing in-house and reference lab. They moved to that in the first quarter of 2019 and they had a very good fourth quarter across the board. I think that really shows what happens when we get with a little bit of time and territory and learning the new model. I mean, every market's a little different. Some of them were already there. Some of them are making changes to that model. Some of them are distributor markets where that's not really relevant or markets where we don't have a reference lab business. So there's a lot of different models internationally. But I think that's an indication of what we expect to see over the course of 2019. Okay.

Much appreciated. Thanks.

Thank you. And our final question will come from the line of David Westenberg with Guggenheim Security. Your line is open.

Hi. Thanks for squeezing me in. The instrument placement number blew away my estimates, but the instrument actual revenue number was a little bit below, or at least in trend line. Is that a function of strong international placements, or is there an increase in rental-style contracts?

It's a great question, David. It was up 3%. Some of that is compared to the very strong results last year. We really had an exceptional Q4 in 2017. And the other factor we did note was instrument program mix impacts. And as you pointed out, very strong performance internationally can drive that. And the growth of programs like rental programs internationally and 360 can have an effect, too, on the instrument revenue recognition. They're all great programs, very high return, but can have a bit of a moderating effect on growth. So those were the primary drivers.

Yeah, I also want to call out, David, the U.S. did a great job. You know, they had a tough compare where they were really rocking and rolling in Q4 2017. Q4 2018 was the first quarter of the expansion, well, the most recent expansion of And in the context of a strong compare and the first quarter expansion, they had very strong results, as Brian laid out, and were up year over year. But to your point on revenue, there can be program mix impacts. I think international placements are going to generate, are generally smaller practices. That's a fair point. And so each placement generates a little bit less revenue. incremental recurring revenue than a U.S. placement. But having said that, I think we're very, very pleased with the instrument placements globally in Q4.

Maybe just one follow-up on the revenue build side. You had 17% consumable growth. That's That number, you know, great number right there. Can you maybe help us parse out contribution from SDMA versus kind of organic, you know, kind of consumable utilization to kind of help us, you know, understand, you know, really what SDMA on a slide is kind of doing there?

Yeah, I highlighted that 4% of the consumable growth, the organic consumable growth in Q4 was combination of SDMA in a slide and CETAV paper run, they're pretty equal. I think we're both contributing, I think, around at about 2%.

Yeah, and we're very pleased with the Catalyst SDMA adoption. We've now topped a million runs on Catalyst with SDMA. This adds to the close to total 20 million of SDMA results when we include the reference lab. In the U.S., we have 58% of our practices who have run Catalyst SDMA in the last quarter and 64% who have purchased it. These are really amazing adoption metrics and of course SDMA is unique to the IDAX solution. Globally, the metrics are very similar. It's actually a 58% adoption in the US and 56% adoption, meaning they're actually running it. Of course, we can uniquely measure that because we have smart service on our instruments, which brings all sorts of benefits, including our ability to measure. And about 64% of global install base has purchased the SDMA slide. So in the first year launch, these are amazing adoption metrics. And it really shows the progress we've made on on providing education to the field of the importance of SDMA as being highly correlated with GFR, the kidney, meaning that elevated SDMA. So something is going on and you need to look more closely and you're not going to see that with traditional parameters. So it's a great story and we're going to continue with our investments in SDMA education as part of our 2019 marketing plans, but I'm certainly pleased with the adoption rate. As you've at least mentioned, it also contributes to the organic instrument, consumable revenue growth. I appreciate it. Thank you. Thank you.

With that, I'd like to turn it back over to Mr. Ayers for any closing comments.

I want to thank everybody for calling in. I know we've got You know, we've got some employees and other constituents. And, again, I just want to express my gratitude for really a fantastic 2018. You know, we run the company in a way that delivers the day and secures the future. And I think we had a great delivering the year as we've enumerated here on this call and with the work that our employees do across the world. I think we also made significant progress in securing the future for IDEX and our customers in the veterinary market, in the water market, in the livestock, poultry, and dairy market, and in the human blood gas market through our Opti medical systems. And so with that, we will conclude the call and get started on 2019. Thank you.

Thank you, and ladies and gentlemen, that does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.