IDEXX Laboratories, Inc.

Good morning and welcome to the IDEX Laboratories first quarter 2019 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. IDEX 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-looking statements 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 GAP. A reconciliation of these non-GAP financial measures to the most directly comparable GAP measure is provided in our earnings release, which may also be found by visiting the Investor Relations section of our website. In reviewing our first quarter 2019 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 2018 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. IDEX delivered continued high revenue growth and excellent financial results in the first quarter. In terms of highlights, we achieved 10 percent organic revenue growth driven by 12 percent organic gains in CAG diagnostics recurring revenues. As expected, FX impacts from the strength in U.S. dollar reduced reported revenue growth by about 3 percent. Operating margins improved 210 basis points on a constant currency basis, better than projected, reflecting strong gross margin gains and operating expense leverage, which benefited from high CAG diagnostic recurring revenue growth, as well as timing delays related to select IT and R&D project spending. EPS was $1.17 per share, up 16 percent on a reported basis or 27 percent on a comparable constant currency basis. Strong revenue growth and operating margin gains drove 21 percent constant currency operating profit growth. We also recognized about 2 cents per share in upside related to higher than projected tax benefits from stock compensation activity. In terms of our full-year guidance, we're maintaining our outlook for 9.5 percent to 11 percent organic revenue growth, reflected in our consistent guidance range of ,000,000 to ,000,000 in annual revenues. We're increasing our 2019 EPS guidance range by 10 cents to $4.76 to $4.88 per share. This incorporates an increase of about 7 cents from an updated outlook for 80 to 110 basis points in full-year constant currency operating margin improvement, 1 to 2 cents per share in benefit from updated interest and expense projections, and 1 to 2 cents in upside related to updated effective tax rate projections. Our operating margin outlook factors in additional investments we're advancing this year in reference lab capacity, corporate customer support resources, and customer-facing software capability, while continuing to deliver strong operating margin improvement and comparable constant currency EPS gains aligned with our long-term financial goals. We'll review our updated 2019 outlook later in my comments. Let's begin with a review of our Q1 performance by segment and region. Q1 results were supported by continued strong performance in our companion animal group. Global CAG revenues were $509 million, up 10 percent organically, driven by 12 percent organic growth and CAG diagnostics recurring revenues. Veterinary software services and diagnostic imaging systems revenues increased 7 percent overall and 6 percent organically, with overall revenue gains constrained by comparisons to very strong prior year digital imaging system placement levels. Veterinary software services revenue grew at high single-digit rates organically in Q1, reflecting very strong sales across – results across our practice management platforms with the continued growth of our PIMS and application install base supporting expansion of recurring software service revenues. Our digital imaging business continued to achieve high levels of digital radiography system placements and high growth in recurring WebPAC subscription revenues linked to our expanding install base. Our water business revenues grew 8 percent organically in the first quarter to $30 million, reflecting continued solid growth in the U.S. and double-digit gains in international markets. Livestock poultry and dairy revenue in Q1 was $32 million, up 4 percent organically. Gains in herd health screening, poultry, and pregnancy product sales were offset by moderate declines in European disease eradication program revenues, continued market demand impacts on our dairy testing business, and continued pressure on swine diagnostic testing revenues related to impacts from the African swine fever epidemic in China. By region, U.S. revenues were $358 million in the quarter of 9 percent organically, driven by 11 percent growth in CAG diagnostic recurring revenues, net of an approximate 1 percent equivalent day headwind. Strong U.S. gains reflected continued double-digit growth in reference lab and consumables and solid -single-digit growth in rapid assay sales. CAG diagnostic recurring revenue gains were primarily volume-driven, with U.S. net price gains continuing to trend in the 2 to 3 percent range. In terms of our broader U.S. market trends, this quarter we've significantly revamped and expanded our reporting from our data set from approximately 7,500 practices, representing five different practice information management systems. We've also refined our weighting framework based on practice size and region, prepared in collaboration with Anibalytics. We're now providing same-store growth in clinical visits per practice, augmenting our quarterly reporting on total same-store visit and revenue growth for companion animal veterinary visits of all types. In Q1, we saw improvement in total visits per practice growth to 1.3 percent -on-year, with clinical visits per practice growing at a greater amount of 2.2 percent, and overall revenue per practice growth of 5 percent. Please note that these metrics are on a same-store basis and do not include growth benefits from incremental practice formation, which we estimate at approximately 1 percent annually. The Q1 2019 earning snapshot on our website shows quarterly data on clinical visit growth for 2018 and Q1 2019, as well as some additional information we've added that describes our measurement methodologies and refinements we've made to our historical data to reflect the additional insight we've gained from our data analysis efforts. International revenues in Q1 were $218 million, up 11 percent organically. International results were driven by strong 14 percent organic gains in CAG diagnostic recurring revenues, including continued 20 percent plus organic growth in consumable revenues, as we benefit from 30 percent -on-year growth in our catalyst install base outside of the U.S. We saw modest benefits from advanced ordering in the U.K. ahead of the Brexit deadline, which added approximately 2 percent to international consumable growth in Q1. International reference lab growth was in the -single-digit range, as we continued to advance commercial efforts targeted on accelerating growth in this line of business, while sustaining strong momentum in expanding our catalyst install base in international markets. In terms of segment performance, Q1 results were supported by continued progress in driving catalyst placements at new and competitive accounts. The quality of our instrument placements was strong in Q1. We achieved 307 placements at new and competitive accounts in North America, up 7 percent, with a high attach rate of premium hematology instruments, which drove a solid increase in EVI, our measure of multi-year economic value of instrument placements. We also placed 122 second catalysts at IDEX accounts in North America, compared to 59 in Q1 2018, supporting growth and customer utilization at larger accounts. Internationally we placed 633 catalysts at new and competitive accounts, of 20 percent. By region, competitive and new catalyst placements represented 69 percent of total placements in North America and 62 percent internationally. Strong catalyst placement results and continued high retention is reflected in 24 percent -on-year growth in our global catalyst install base. Overall we placed 2,775 premium analyzers in Q1, down 2 percent compared to very strong prior year levels. Q1 results were led by 1,463 catalyst placements globally, up 4 percent overall, supported by 443 placements in North America, a 20 percent -on-year increase, and 1,020 placements in international markets, down 1 percent compared to record prior year results, which included high levels of VET test upgrades in emerging markets. As noted, we saw a high attach rate of premium hematology instruments with chemistry placements in Q1, which supported 823 premium hematology instruments globally, up 9 percent. -of-view placements were 489 in Q1, down 26 percent versus very strong prior year levels, impacted by our exceptional -of-view placement performance in Q4, as well as our commercial focus in Q1 on capturing high EVI, new and competitive catalyst placement opportunities. In addition to strong premium placement results, we drove continued momentum with SnapPro with 1,999 placements in the quarter. CAG diagnostic instrument revenues in Q1 were 29 million, a 3 percent decrease organically off a tough compare in 2018, which included mixed benefits from very strong placements of higher price -of-view instruments. Benefits from an expanding instrument-based test innovation and enhanced commercial capability continue to drive strong CAG diagnostic recurring revenue gains across our major modalities. Instrument consumable revenues of 167 million grew 15 percent organically in Q1. Results reflected double-digit gains in the U.S. and continued 20 percent-plus growth in international markets. High volume-driven consumable gains continue to be supported by expansion of -of-view paper-run and SMA slide revenues, which contributed approximately 3 percent combined to -on-year consumable revenue gains in the quarter. Reference lab and consulting services with revenues of 203 million grew 11 percent organically in the first quarter. U.S. lab momentum remains strong, reflected in solid double-digit volume-driven organic revenue gains supported by expansion of our preventative care programs. As noted, international reference lab growth was in the -single-digit range, supported by solid gains in Europe. Rapid-asset revenues of 54 million grew 6 percent organically in Q1, reflecting solid gains across U.S. and international markets. Rapid-asset gains were primarily volume-driven, supported by growth in 40X-plus and first-generation products. Turning to the P&L, operating profit in Q1 was 133 million, up 18 percent as reported, or 21 percent on a constant currency basis, reflecting profit gains across our CAG, water, and LPD segments. Operating margins were 23.1 percent, up 210 basis points on a constant currency basis, supported by solid gross margin gains and operating expense leverage. Gross profit was 332 million in Q1, up 9 percent as reported, or 12 percent on a constant currency basis. Gross margins increased 110 basis points on a constant currency basis, supported by continued moderate CAG diagnostic net price gains, volume leverage and productivity gains in our U.S. reference lab business, NICS benefits from high consumable growth, as well as solid gross margin improvement in our water and LPD businesses. Foreign exchange hedge gains, which are reflecting gross profit, were 1.4 million in Q1. Operating expenses in Q1 were up 4 percent, or 7 percent, on a constant currency basis, resulting in 100 basis points of positive operating margin leverage. Operating expense increases were driven by growth in CAG sales and marketing and R&D spending, with overall spending increases mitigated by modest constant currency growth and G&A costs, including benefits from later phasing of certain IT-related projects. EPS in Q1 was $1.17 per share, an increase of 16 percent as reported, and 27 percent on a comparable constant currency basis. Foreign exchange net of hedge impacts in Q1 2018 and 2019 decreased operating profit by 4 million and EPS by 3 cents per share. Our effective tax rate was 17.7 percent in Q1, including benefits of 4.4 percent to our tax rate, or 6 cents per share, related to share-based compensation activity, which was approximately 2 cents per share higher than projected. Pre-classful was $9.4 million for Q1, reflecting normal quarterly seasonality and increased capital spending related to major projects. We continue to maintain our full-year outlook for free cash flow of approximately 60 to 65 percent of net income for 2019 and 160 to 170 million in capital spending, which includes approximately 20 percent of free cash flow impact, driven by 70 million of combined incremental capital spending related to our Westbrook, Maine headquarter expansion and our German core lab relocation. We allocated $54 million in capital to repurchases of 267,000 shares in Q1. We ended Q1 with $1.052 billion in debt, including $100 million of new 10-year notes issued in the quarter. Our liquidity remains strong, with $117 million in cash and $502 million in capacity under our revolving credit facility. Our leverage ratios as a multiple adjusted EBITDA were 1.69 times gross and 1.5 times net of cash and investment balances. We're maintaining our 2019 full-year outlook for a reduction in average shares outstanding from stock repurchases of 1 to 1.5 percent, which assumes net leverage at 1.5 times EBITDA. We're now projecting annual interest expense, net interest expense of 36 million, incorporating a more favorable full-year interest rate outlook. Turning to our 2019 guidance, we're reinforcing our full-year revenue outlook while raising our EPS range by 10 cents per share. Our full-year reported revenue guidance remains $2,385 billion to $2,425 million, reflecting consistent expectations for 9.5 percent to 11 percent overall organic growth and 11 to 12 percent organic growth and CAG diagnostic recurring revenues. Our reported revenue outlook reflects a consistent projected 1.5 percent full-year FX revenue growth headwind at the rates assumed in our press release. We're raising our 2019 full-year EPS guidance 10 cents per share to $4.76 to $4.88, or 16 to 19 percent growth on a 3-basis point increase, and our outlook for constant currency operating margin improvement now estimated at 80 to 110 basis points for the full year, resulting in approximately 7 cents per share in improvement in our EPS guidance range. We've also refined our outlook for net interest expense and stock compensation tax benefits, which combined add approximately 3 to our full-year EPS, 3 cents to our full-year EPS range. We've updated our outlook for our 2019 effective tax rate to 20 percent to 20.5 percent, including an updated estimate of 8.5 million to 10.5 million, or approximately 2 percent in full-year projected tax rate benefit from exercise of share-based compensation. We estimate that foreign exchange rate gains will decrease reported EPS by 3 cents per share, net of approximately 11 million in projected hedge gains. For the second quarter, we expect reported revenue growth of 7 percent to 8.5 percent, and organic revenue gains of 9 percent to 10.5 percent, supported by consistent 11 to 12 percent CAG diagnostic recurring revenue gains. We expect Q2 operating margins to be approximately 50 basis points higher than priority levels on a constant currency basis. This outlook incorporates a re-phasing of planned first half investments, impacts of higher international commercial staffing levels, and incremental investments in select areas, including increases to our U.S. state lab capacity. We expect our effective tax rate in Q2 to be approximately 21.5 percent, 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. Thank you, Brian. Now

a little color commentary. We had a strong start in 2019 in the first quarter with organic revenue growth of 10 percent and comparable constant currency EPS gains of 27 percent, supported by better than expected margin gains. Globally, we delivered a solid 12 percent organic growth in our CAG diagnostic recurring revenues at the higher end of our full-year growth rate goal, with strong gains across the U.S. and international regions. This expanding, highly durable annuity contributed 77 percent of IDEX's total revenues in Q1. Instrument placements globally, considering both quality and quantity together, were solid, with strength in the U.S., Europe, and Latin America offset by -over-year declines in Asia-Pacific, primarily related to tough comparisons. Our premium install base continues to expand at high rates, and we do not see any change in the competitive environment. In Q1, our U.S. field organization was in its second quarter the latest territory expansion, and so we saw strong momentum in placements of catalyst to new and competitive accounts, up 7 percent, as our field organization inspires customers to trade up to IDEX's advanced technology offering. We also had an exceptional quarter with SNAP Pro placements of almost 2,000, driven by the U.S., up 68 percent -over-year. We are methodically transforming our rapid assay customer base into a razor and blade business model, as the SNAP Pro mobile instrument brings significant workflow and charge capture value to the veterinary practice, and we're seeing higher growth and rapid assay loyalty when customers adopt SNAP Pro workflow. With placements in Q1, we are now well over 60 percent of our SNAP 40X coming from active and connected SNAP Pro customers. Despite tough comparisons to high prior year -of-view placements, new and competitive catalysts in SNAP Pro engage and supported solid growth in the U.S. economic value index in the quarter. They really did a great job. Europe also saw strong, solid Q1 growth in catalyst placements and instrument placement value, which is impressive given they are in their first quarter of the field sales expansions. The European expansions are on their way to completion at 92 percent occupancy. However, 40 percent of field reps are in their first year, and as a result, sales productivity in Europe will be building through 2019 as field experience and time and territory advances. This is the same dynamic we saw in the U.S. when we undertook a similar major expansion in 2015. The U.S. companion animal market is on very solid footing, as is the pet owner in general, based on macro and the trends we see. We are excited to be presenting this quarter a much expanded and improved market growth reporting, as shown on the second page of our earnings snapshot, with an upgrade to our methodology and an expansion in the number of practices, 7,500 in total, coming from a variety of both IDEX and third-party practice management systems. Additionally, weighted to reflect the market in terms of geography and practice size and type, with the support of Animalytics, and we're grateful for their partnership. We are giving back to the industry by publishing these important metrics on a quarterly basis as part of our earnings. This is an industry with otherwise limited to no market data of this kind. Of course, the data also helps investors understand IDEX a little bit better. From this data, we're seeing 2.2 percent clinical visit growth from existing practices in Q1. To get to total market visit growth, we need to add the impact of net new practice formation, which we estimate to be about 1 percent. Pet care in the U.S. is a very healthy market, with existing veterinary practices making investments in technology and infrastructure, and new practices being opened. Outgrowth of the companion group diagnostics recurring revenue in the U.S. was 11 percent in Q1, net of about 1 percent equivalent day headwind. We are and have been growing faster our diagnostic volume than patient visit growth for several reasons. First, we're seeing same strong, same store sales in diagnostic volume growth beyond clinical visit growth, driven by our unique innovations and our focus on driving ongoing increases in the utilization of diagnostics and pet care. Across our modalities, we estimate this adds about 4 percent of incremental volume to clinical visit growth. To this, you add another 2 percent growth in the number of new practices that are utilizing IDEX as their primary diagnostic partner, whether it be in-house, reference lab, or both. Call this customer share gain, if you will. In fact, we topped 20,000 practices, sending at least one sample of IDEX reference labs in Q1, a record for this metric in Q1. We also continue to realize 2 to 3 percent net price realization in companion animal diagnostic recurring revenue. So added all up, 9 percent volume growth from a 3 percent new price realization gets us to low teens DX recurring revenue in the U.S., aligned with the high end of our long-term U.S. growth potential of 9 to 13 percent. Same store sales at the practice level is being driven in part by the adoption of IDEX's fecal offering and by preventative care diagnostics, what we call the Preventative Care Challenge, or PCC. To date, through Q1, nearly 2,800 practices have enrolled in the PCC program since its inception, with over 300 new practices enrolled in the quarter. These 2,800 practices are growing IDEX diagnostics at just under 15 percent on a trailing 12-month basis. Preventative care is a great example of how we are creating new market growth with our innovations incorporated into reference lab PCC profiles, all of which include at a minimum IDEX SDMA with the chemistry, the IDEX CBC fecal antigen, and IDEX's 40X offering. Together, they make an IDEX PCC panel a well-justified annual pet owner investment in their pet and the pet's health by uncovering underlying disease as part of a wellness visit. Just think it this way, running a PCC panel on a pet as part of an annual physical exam is like a human getting a physical blood with blood work every seven years. The only difference is that the blood work is even more important in pet care as the pet can't speak for themselves and we got these dogs running around dog parks sniffing around and drinking from the puddles. It's just a different situation and we're finding there's a lot of value. When a veterinary practice partners with IDEX with our proprietary PCC panels, their overall practice revenue growth accelerates, generally without the addition of any staff. Clearly 2019 is the year where preventative care diagnostics driven by the expanded capabilities of IDEX's unique offering is moving into the mainstream of veterinary medicine to the benefit of the veterinary practice, pets, owners, and IDEX's alike. And yet, we believe IDEX is only serving 10% of the total addressable market for preventative care. We also see nice same store sales growth in the vet lab consumables business from the adoption of new menu, including catalyst SDMA, SETIVU, and now catalyst progesterone. Customer retention rates in the U.S. remain stable in Q1 at world-class levels of 98 to 99 percent. In an environment where our competitors use their only weapon, price, to compete, it's nice to see our customers do not equate price with value and evidence the value of our innovations through their loyalty. New product launches in the quarter included catalyst progesterone, which is off to a strong start both U.S. and availability of poodles. We completed the update of all SETIVU in the field with the newest algorithm Neural Network 4.0, benefit of our Internet of Things strategy with our instruments. In veterinary software, in the veterinary software portfolio, we released Cornerstone 9.1, great excitement and rave reviews. This new release brings a transformed user experience that is more intuitive and reduces clicks, and we're seeing a more rapid take up of this new release as a result. We had strong placements of new Cornerstone, Neo, Anamana, and SmartFlow systems in the quarter. In addition, this month we formally announced the prospective availability of a cloud version of Cornerstone for our customers who value the deep and unique functionality of Cornerstone as the go-to high-end practice management software, but also want the benefits of the cloud, such as full mobile access. We're seeing strong adoption in our IDEX web packs, our cloud-based software as a service offering with its new reference image library and the ability to work with both IDEX digital imaging systems as well as those from third parties. Total web pack subscriptions have seen a 40% growth year over year. Other software offerings from IDEX are advancing nicely, including Pedley plans for wellness plans, Enterprise to support our corporate customers, and of course IDEX Vec-Connect Plus, which continues to make steady advancement in both functionality and utilization. It is indeed a comprehensive and impressive IDEX software technology stack. We're serving a growth market and supporting further market growth through our advanced diagnostics and software technologies. Given our success, we have in the works augmented investments planned in the North America market, including reference lab capacity expansion, corporate account support resources, and further investments in our customer-facing software strategies. Of note, we have no plans for further expansion of our field-based footprint in the U.S. or internationally in 2019 in diagnostics, other than completing the occupancy plans in Europe and a small expansion to serve corporate accounts. With these investments, we're focusing on the remainder of 2019 on driving field sales productivity, which comes from time and territory, advancing our CRN, and advancing programs such as EVI and IDEX 360. In summary, we see very solid trends in our markets globally in 2019 and remain on track to advance our strategy of investments to further our innovation agenda, such as our outlook for about $150 million in cash R&D while delivering on our 2019 revenue goals and an augmented outlook of 16 to 19 percent comparable constant currency EPS gains for the year. And Kevin, with that, I'll open the call to questions.

Thank you. Ladies and gentlemen, if you wish to ask a question, please press star then one on your touch-tone phone. You will hear a tone indicating that you are in queue. You may remove yourself from queue at any time by pressing the pound key. Once again, for questions, please press star then one. First question is from the line of Ryan Daniels, William Blair. Please go ahead.

Yeah, good morning. Thanks for taking the questions and all the detail. Brian, one for you. Operating margins clearly stronger than anticipated. And I think you mentioned in your comments there was some IT and maybe R&D spending that was delayed. So can you dive into a little bit more of the rationale behind that? Was it related to personnel hiring given the economy or just noise and investment spending? And then number two, anything we need to think about regarding cadence in those items for the rest of the year on a quarterly basis?

Thanks, Ryan. On the project spending, it was just a normal executional timing. It wasn't a change in plans, but just when we were able to execute some of the IT and R&D project spends, we're still on track as John highlighted for the cash R&D spending goals this year, which are about a 15 percent increase. And so that'll phase in relatively more through Q2 through Q4. And we'll also continue to execute the IT front. So it was more just a timing versus our estimates. I would highlight that in Q1, we had some favorability that benefited the quarter. We had some favorable compares in our LPD business on the gross margin line. We had very strong consumable growth, particularly in international. Some of that benefited. We highlighted there was some Brexit pull forward that added a couple points to growth. And we got some mixed benefits from those factors. And as we work through the years, we've highlighted today, we'll have some incremental investments going coming online in the second quarter. We'll be adding some day lab capacity in the U.S. And that's factored into our margin outlook balance here. So we're clearly feeling good about how the year started. We raised the full year operating margin goal, but I think some of those factors will moderate the gains as we work through the year.

Okay, very helpful color. Then John, my follow up will be for you in regards to the international sales force. Can you talk a little bit more about what you've seen in regards to their ramp relative to the United States? I know you said 40% are within the first year, so I'm sure there's a nice ramp curve and maybe there's confounding factors like moving to IDEX 360 and some of the other initiatives that make it a little hard to gauge versus historical levels. But what would you anticipate in regards to the productivity of that sales force as it both expands and matures?

Yeah, I think that's a good question. I think it's going to international expansions. We will see the productivity build over the course of the year. Obviously, we've got a phenomenal product line and we've demonstrated that with placements around the world. And it just gets better as we add to it with things like with the progesterone and of course the regular software updates that go to all of our instruments as part of our smart service strategy. But it's the sales expansion. So I would see, this was a very major expansion we undertook over the last four to six months internationally in selected markets. Obviously, we have very strong country organizations there already. But I would say this expansion was kind of more for them was more in the order of expansion that we undertook in 2015 in the US. And so I would use that as a guide to how we think things will progress over the year.

Okay, thanks for the call.

Next question is from a line of Erin Wright, Credit Suisse. Please go ahead.

Great, thanks. You highlighted again in the prepared remarks around the Preventative Care Challenge program. And can you give us a sense on when that will contribute more to financials, if there's anything embedded in your guidance for 2019? Or if there's any other metrics? I think you gave some in your prepared remarks that we can track on a quarterly basis just to measure the success and progress of your efforts on the Preventative Care front. Thanks.

Thank you. That's a great question. With that, it is contributing to the 11% reported growth in the US recurring revenue, which had a day of headwind in it. The Preventative Care is a big deal. And the medical evidence for Preventative Care is getting stronger and stronger as we put together the data and we share it with the industries and the key opinion leaders. And our field organization, and this is one of the reasons why we've done all of these expansions, they are bringing it to the local practice. So we're adding every quarter a couple of hundred practices who are moving to this new way of thinking. They're all being threatened by the retail going out of the practice. And so they're realizing that as they turn to diagnostics, that's not only a nice antidote, but it's a higher, it's a more productive, it's a more satisfying and financially impactful way to grow the practice than retail. It has higher margins and it's a whole lot more satisfying to address issues early than to deal with them very late in their progression with the pet. And so I think we're beginning to see significant momentum. 2800 practices, that's approaching 10% of the market. That is not an insubstantial demonstration of the success of this program. And yet, of course, we're really only early days. We think every practice really should be adopting this as best practices over time. They've got the tools and the support of our field organization to do so.

Okay, great. And then you gave some great points on the underlying market demand trends in the US. I'm curious if you keep track of some of those metrics overseas in terms of same store sales, volume trends, and if so, kind of directionally here how we should be thinking about the underlying health of the international CAG markets. Are you seeing a broader presence from competitors that can also help drive awareness and advance practice protocols in Europe as well as more broadly internationally? Thanks.

Yeah, thank you. We're really pleased to be able to present in partnership with Analytics the much more sophisticated US metrics. And as we all know, there's just like almost no data in this industry and there are reasons for that. It's because, you know, it's not, it doesn't have the standardization we see in human healthcare. In practice management systems, we found 790 different ways to call a dog a dog, which is pretty amazing. So our machine learning AI is really coming into play here. With regard to the comparison to international, we just, we aren't there yet. We don't have that same capability. But generally speaking, they're the same pets and people love their pets and the level of adoption of diagnostics is still a fraction. And so we're bringing attention, but certainly any attention that the industry brings to the profession of the value of diagnostics, we think will help grow the market around the world. And clearly we're seeing that, you know, with the double digit growth in CAG diagnostic recurring revenues that we're seeing routinely outside the US, similar to the more advanced market that we have in the US. And it's really not, it's really a phenomenon that cuts across all cultures and geographies. And really it's the amount of attention that we can bring, support of course by a great product line, that's going to drive this growth, which is why, you know, we've done these expansions internationally to accelerate the adoption of diagnostics in the practice of veterinary medicine.

And just a quick reminder before going to Nick's question, if you do have a question anytime, please press star then one. Next question is from a line of Michael Reisgen of Bank of America. Please go ahead.

Hey guys, thanks for taking the question. A few quick ones just to follow up on some of the things you highlighted earlier. You mentioned some stocking in the UK tied up with Brexit. I think you said 2% to international consumables growth. So I'm thinking that's about 65 to 70 bits to total consumables in the quarter. I just want to make sure that's correct and sort of what's your expectation for that throughout the, you know, the rest of the year? Is the belief that that's going to fade or sort of reverse in two queue or, you know, if you could just tell us how the factors and see how it looks?

That is correct. The number was 2% international and- International consumable. Not that's exactly correct. You know, that's, you know, we're weighted towards the US in consumables relatively, but I think those are reasonable estimates on the overall effect. And we'll see. You know, we don't have full insight into how the many customers we have in international markets or- Or how Brexit will evolve. Exactly. But we were anticipating there was a high level concern, obviously, with the uncertainty in Q1 and we'd anticipate some pullback in Q2, but it's, we'll see how that plays out. We don't have full visibility into that at this point.

Okay, thanks. And then another quick one. On the instrument revenues, I think you mentioned, you know, sort of the disconnect where revenues were down, I think 3% organically, but you saw pretty solid placements across the board. You mentioned some mix in terms of a tough comp on set of you year over year and how that played into the dynamic. But I was wondering if any you could say sort of on an apples to apples basis, how's pricing and instruments? You mentioned, I think it was positive for CAG overall, but I want to focus specifically on what's going on in the capital equipment side of things.

Yeah, I would say it's similar. Similar dynamics. We had, you know, different metrics we can look at on that front, but I think the amount of cash that we put out for in support of instrument placement programs on a quarterly basis was kind of in line with the trend we had last year. We did have a couple of tough compares in the quarter. Set of you, we had an exceptional year last year and we had very strong placements in Q4 and our organization was really focused in Q1 on the big new competitive placement opportunities, which you saw in the quality of the numbers that we posted there. So that was one factor. Another one that we'll see going into the second quarter as well is we had very strong VET test upgrade results in international markets, including China last year. And so just on an absolute revenue basis, we're up against tougher compares, but net-net we're shifting a lot of our focus towards the competitive placements and that's helping us on the EDI front. So we feel very good about the quality of the growth and just to reinforce, we pointed out that year on year we've had a 24% increase in our catalyst install base globally. So that's the big driver of our consumable gains and we have great momentum there and we're feeling very good about that and that's where we're confident in reinforcing

the outlook for the year. And I just want to call it commentary. I'm glad you're asking that question, Mike, and highlighting that. We run the business on the economic value of the instrument placement, which of course includes the pricing of the instrument and the instrument revenues, but also includes our estimate of the economic value of the annuity associated with that placement. And so we don't run it based on instrument revenues. That would be the wrong way to think about the business. It's about creating value with each quarter and it was a very solid and positive growth in the value of those placements and it was really, in one word, it was really mixed up that has the revenues a little bit different than the value.

Very helpful. Thanks guys. I'll get back in queue. Next question is from the line of John Block. Steve, please go ahead.

Great, thanks. Good morning. I'll start with gross margins. They were up real strong, 120 bips. I haven't seen sort of that level, I don't believe, of -over-year gross margin expansion since the first half of 2017. But Brian, some of that expansion was from the other businesses. You have 500 bips -over-year. So if you can talk to what drove that and is that step function to the new level largely sustainable in those divisions going forward?

I think it is. Yes, we should have continued good gross margin performance across the different businesses. I would highlight some factors that are benefiting us in Q1 in LPD. We did a very healthy screening revenues which are relatively higher margin in that business and that is, we don't anticipate that same level of growth as we're moving forward. Some of that was a compare. We had some higher costs last year as well. So I think it's the -over-year growth, John, we anticipate some moderation in that dynamic but I think we're confident we can sustain the good margin performance we've had in the business. And water continues to be a very healthy business for us and I think we hope to build on that. We are obviously expecting this year gross margin to be a key driver of our overall performance. The 80 to 110 basis point improvement, we expect the bulk of that to be delivered by gross margins but there will be some moderation as we move forward, including in the next quarter just as we advance some of the investments we talked about and we have some of the mixed dynamics changing as well but we think we capture that in the full year-over

-year. Just one more thing, John, I want to call out, I was very pleased, we were very pleased with the reference lab gross margin performance in the, and as you know, the US is really doing very well with double-digit growth that is higher than our global 11% growth in the reference lab organically. It's really being led by the US. It's a very, very successful part of our strategy. We're nice seeing nice gross margin growth there. Of course, we're reinvesting some of that for expanded capacity to really continue to provide an exceptional service level across all geographies in the US and we've called that out as incremental investment in the balance of the year. Got

it, very helpful. Just a pivot to my second one, I didn't find the instrument figures too surprising and as you mentioned, clearly where these boxes go dictate the future annuity but the set of you down 26% you over a year on a global basis was a surprise to me. I believe the in-clinic urine sentiment might be around 15% penetrated in the US give or take. John, you're now a couple years into the US set of you launch. How do you view the peak penetration rate of in-clinic urine sentiment and put it in perspective of haematology and chemistry, which might be closer to 70 and 90% respectively? Thanks, Gus.

Yeah, thank you. First of all, the set of you to date has mostly been a North American and a product area and it's been driven by North America and we continue to see that could be in the case in the near future. Our North American organization, in particular our US organization, just had a very strong quarter in competitive catalysts. That adds a lot of economic value. Those are in some ways more challenging than even set of you. So we have the remaining set of you opportunity in front of us that we've talked about, probably over 30,000 analyzers when we compare what set of you penetration could be in relation to chemistry and haematology. I think we've laid those numbers out in conversation with investors in the past. So really, we don't really see any change in the ultimate opportunity for set of you penetration and we really remain a class by our own with regard to set of you. And it keeps getting better. The Neural Network 4.0, which is a silent upgrade that went across our entire installed brace brought a new menu and a greater overall experience and we're not done yet with continued software investments in set of you and our customers know set of you just gets better and better. So I think it was a quarter where the field worked on the competitive catalyst placements and I've got to tell you, I was pretty proud of our accomplishments in that regard. Also, hey John, one more thing. I know you've talked about it in the past. You've got to be impressed with that 68% -over-year growth in SNAP-PRO placements. That's really turning out to be a great strategy and of course, that also takes field effort to accomplish.

Next question.

Next question in the line of Mark Massaro of Canaccord Genuity. Please go ahead.

Hey guys, thanks for the questions and congratulations to your team for putting together this really large data set. I wanted to ask if you could maybe help me think of where the additional 2500 practices of data came from. I think you reported out 5000 previously and then this is probably nitpicking but last quarter I think you called 30 basis points of increase and it looks like you revised that down to 30 basis points of decrease. Is that largely a function and I'm referring to Q4 total visit growth. Is that largely a function of the additional practice data or was something else revised like geographic location changes?

Yeah, let me first take the first part of your question and then Brian can answer the second part. So the 7500 practices includes, while the 5000 always included practices beyond our cornerstone which is a go to PIMS, we greatly expanded the number of practices across the five major practice information management systems that are out there, only some of which are ours and some of which are third party. And in addition, not only that, we haven't just taken a straight growth, we've weighted the growth across these practice by segmenting them and getting them proportionally represented to the market in terms of geography. We may have more in one geography than another but we've adjusted for that and it's really been with the support of animalitics that we've been able to do that weighting. So it really is a comprehensive revamp and we've been able to apply our machine learning algorithms to figure out what are the clinical visits versus what I would call maybe the retail or non-clinical service visits such as boarding and grooming, which of course these are the higher quality visits and they're the ones that have diagnostics and prescribed medications and veterinary services that involve the veterinarian. So these are the more important practices and they give more important visits so they give greater visibility to I think long term trends. Brian, you want to?

Yeah, to John's point, we've refined the methodologies to make this even more accurate and just went back in time and adjusted the prior data to be consistent with that. So you'll see some minor changes in the historical data but it's all intended to be Apple.

I think we look at this practice visit growth at the clinical level not including net new practice formation which we do not capture in this information because we're looking at same stores sales year over year. I think we see a very robust market. I would generalize stepping apart from the quarter as a whole. I think we're seeing in same store sales .5% to approaching 3% on a sustainable basis practice visit growth on a same store sales basis and as we said we would estimate that about 1% to that. So I think it's a very healthy market and it's nice to see the first quarter. It does bounce around a little bit from quarter to quarter but it was nice to see the first quarter metrics.

Okay, great. That's helpful. And then as more and more animal clinics choose to join larger groups the value of these contracts become increasingly important. Can you just speak to how you feel you're positioned as maybe some of your competitors may have won some large deals whether it was three or four years ago. Some of these might be up for renewal. Can you just speak to the opportunities in front of you and how you think your position's going forward?

Yeah, we thank you. We think we're exceptionally well positioned and we have very high loyalty among our corporate practices. Our corporate practices value us for a couple of reasons. First of all, we help them drive same store sales growth which has a very nice drop through benefit in a practice that has high fixed cost leverage. Diagnostics is a great place to improve both the revenue and the profitability and our field reps along with our technologies such as preventative care and the underlying diagnostic technologies embedded in preventative care help them drive same store sales growth. Second, the number one issue that corporate practices have is staff engagement and retention. It's hard to recruit in the current environment. And the staff likes our products and they're very loyal to our products and our corporate practices appreciate on that. And so they really want to be able to support the local staff with the best technology and that's one of the reasons why we have such high loyalty because they acquire practices with our products and they keep them. And if they decide to take them out that really usually has a pretty negative impact on engagement which can lead to issues on staff retention which of course has a pretty dramatic impact on the economics of that practice. You lose a key producer and you've got to go find someone. That's not a pleasant experience. So our model works in the corporate and you can see it in our recurring revenue growth even in the period of the slow evolution of the industry to a larger corporate sector. Our recurring revenue growth is quite strong in that regard and those loyalty factors that I mentioned in my prepared remarks of 98 to 99 percent that's all in. That's individual and corporate all embedded.

Great and if I can sneak one last one in, you performed more or less strong across the board and kind of in line with consensus for Q1. On the reference lab segment you are going up against tough comps from the first half of last year and I think we kind of saw the growth rate sort of moderate based on the comp. But in particular on OUS, it came in at mid single digits. How should we think about the underlying demand of OUS reference lab and can you speak to whether or not this might change when the Germany reference lab opens?

We are on track with opening the new core lab in Germany which will really replace existing lab. In Q1 of 2020, I think your comments are correct with regard to first half and second half compares on the international reference lab. I think it's all part of that growing, the highest and most productive use of these reps is placing instruments because that's got very, very, that's a very, very profitable business force. But of course we are growing our labs too. And so it's really, it's putting all that together. There's some time and experience to pull that off. And so we've got moderated expectations on the reference lab impact of the expansion in relation to what we hope to achieve with regard to instrument placements.

Next question is from the line of Andrew Cooper, Raymond James. Please go ahead.

Hey guys, thanks for the questions. Just a couple for me. Kind of to the point that I think John was asking about, when we think about the margin dynamics that we saw in 1Q and then the increase in the guide, it looks like these relative to what we had modeled, really the bulk of the outperformances in 1Q and there's not a whole lot of change in the performance of the model. We're seeing a lot of change in the rest of the year. So just any color you could provide on sort of how some of that fell versus your expectations and how much is, to his question, a sustainable step up in the gross margins as opposed to a little bit more of a one-off in the first quarter.

We did see more benefit than we anticipated. And some of it we try to highlight here. I think the broader theme is we're on track. We're reinforcing the full-year outlook. We're flowing that through. And maintaining our outlook while we're advancing some investments that we didn't have in our prior outlook. So I think it was a number of things moved in a good direction in Q1 and we're comfortable with our full-year goals and it's all aligned with the long-term goals we have for operating margin improvement. But I think you're right. There's some upside there that we're not projecting out in

the balance of the

year.

This is, you know, generally speaking, this is an amazing business with a very, very high ROIC. It's an investable business. And so, you know, we are continuing to invest for sustained long-term growth in the profitable and enduring recurring revenues. So, you know, we look, our plans, of course, extend way beyond the year 2019. And it's really factored into what we shared with you as our outlook for the year is the maximizing the growth and the value to our customers and our investors over a five-year or five-year plus time frame.

That's helpful. I guess, is there any way you can sort of help size, you know, were you to not make those incremental step-ups that you've kind of layered in with this update, what, you know, you think the margin profile might have looked like otherwise? It's

a relatively small difference. It's, you know, we haven't broken that out. But it's, we're just trying to highlight that we're advancing some additional investments and, you know, that's factored into the guide.

Okay, that's helpful. And then my last one will just be sort of higher level and again, along some lines that I think Aaron asked about in terms of international and sort of how we think about the growth there. You know, you've seen really strong same store growth like you talked about in the U.S. Has that pace in terms of same store been consistent internationally or faster or, you know, is there too, not too much, but much more of a focus on kind of the new accounts and not as much on the same store kind of drivers. So you think there's, you know, a lot more opportunity there, but it maybe hasn't kept up with the U.S. or any color on that would be great.

Well, what I will say is, and thank you for that question, I think we are driving growth through new instrument placements. We do see a nice, you know, you don't get to double digit recurring revenue growth without both new customer and store dynamic and some modest price realization. But we don't yet really have an appropriate focus on preventative care outside of North America yet simply because I think it just tests the sick pets. We would be a lot higher utilization than we have today. So we're just convincing them to add diagnostics as part of the sick pet visit, which is obviously outside the U.S. with overall lower standards, higher proportion total practice visits. And yet the preventative, there's no reason that preventative care couldn't be an opportunity, broadly speaking, outside the U.S. We have it, we have started it in very, very selective markets, but it's a relatively small thing. It's something I talked about last quarter. But it is ahead of us. At some point, we will turn to preventative care globally because we have a great proprietary platform in that regard and the sales organization and the diagnostic modalities to pull that off. It's just not quite ready for that. The opportunities internationally are where we're taking advantage of them today with the new instrument placements and utilization growth in sick animal testing.

We

have time for one more question.

And that question is from the line of Michael Reisgen. Please go ahead, sir. And questions have been answered. Thanks.

Okay, great. Thank you all. With that, we'll conclude the call. I want to again thank our employees for the phenomenal progress and the performance in Q1 and advancement of our technology and commercial strategies around the world. And also, I'm grateful for the attention and confidence that our investors have in the IDEX business model. So with that, we will conclude the call. Thank you very much for calling in.

Thank you. Ladies and gentlemen, that does conclude your conference. We do thank you for joining. You may now disconnect.