IDEXX Laboratories, Inc.

Good morning and welcome to the IDEX Laboratories fourth quarter 2019 earnings conference call. As a reminder, today's conference is being recorded. Participating in the call this morning are Jay Mazelsky, President and 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 GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures 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 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. Fourth quarter 2019 and full year 2019 comparable currency operating expense growth, operating profit growth, operating margin growth, and comparable constant currency EPS growth exclude the impact of the fourth quarter 2019 CEO transition charges. 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.

Thanks and good morning, everyone. I'm pleased to take you through our fourth quarter and full year 2019 results and to provide an update on our financial outlook for 2020. IDEX achieved continued strong financial performance in Q4, which supported delivery of full year revenue and EPS gains aligned with our long-term financial goals. In terms of highlights, we achieved 10% organic revenue growth in the fourth quarter, driven by 11% organic growth in CAG diagnostic recurring revenues and 10% organic growth in our LPD and water businesses. Solid fourth quarter gains supported full year organic revenue growth of over 10% and nearly 12% organic growth in CAG diagnostics recurring revenues. Our full year EPS was $4.89, an increase of 21% on a comparable constant currency basis supported by 120 basis points and comparable constant currency operating margin improvement. Note that our comparable growth rates and comparable operating margin improvement metrics now exclude impacts from Q4 CEO transition charges. These charges reduced operating profits by $13.4 million in Q4, aligned with expectations, and EPS by $0.14 per share after tax, approximately $0.04 better than initial projections reflecting updated tax provision estimates. Full year EPS results included $0.22 per share in tax benefit from share-based compensation activity, $0.05 per share above our guidance estimates. We also saw an additional $0.04 of below the line upside to our earlier guidance estimates related to final tax provision estimates and lower than projected interest expense. Well positioned to build on these strong results in 2020, we're maintaining our outlook for Our EPS growth rate was $9.9 to .5% organic revenue growth reflected in our increased guidance range of ,000,000 to ,000,000 in annual revenues, which include updated FX estimates. We're raising our EPS guidance range by $0.12 to $5.42 to $5.58 per share, reflecting 13 to 16% comparable cost and currency EPS growth. Positive revisions to our preliminary guidance range reflect the flow through of our 2019 performance with consistent operational improvement assumptions and favorable updates to projections for interest expense, share-based compensation tax benefits, and FX impacts. We'll walk you through the details of our 2020 guidance later in my comments. Let's begin with a review of our fourth quarter and full year 2019 results by segment. Q4 results were supported by a continued strong momentum in our companion animal group. Global CAG revenues were up 11% organically, driven by 11% organic gains in CAG diagnostics recurring revenues, net of a modest equivalent days headwind overall. By region, U.S. CAG diagnostic recurring revenues increased .5% organically, net of a .5% equivalent days impact. Consistent strong U.S. gains were supported by low to mid-teens organic growth and reference lab sales, double digit gains in vet lab consumables, and solid gains in rapid assay revenues. U.S. CAG diagnostics recurring revenue growth remains primarily volume driven, with net price gains trending in the 2% to 3% range. We also maintained high levels of customer retention across modalities. U.S. CAG diagnostic revenue growth continues to outpace broader market trends. Total visits per practice were relatively flat in the quarter on a same store basis, with a .3% increase on overall same store practice revenue. Total market clinical visit growth was .8% in Q4, following relatively strong Q3 results with some moderation in visit gains earlier in the fourth quarter, offset by stronger gains in December. For the full year, clinical same store visit growth increased .5% of the 7,500 practices in our data set, up from .1% in 2018, reflecting continued solid market expansion and diagnostic services. International CAG diagnostic recurring revenues increased 12% organically in Q4, net of a modest overall equivalent days headwind. International results reflected mid-teens organic growth and consumable revenues supported by a 25% -on-year expansion in our catalyst install base outside of the U.S. Strong consumable gains of nearly 20% in Europe and continued strong gains in Canada and Latin America were moderated to a degree in Q4 by impacts related to the timing of shipments in Asia, which benefited Q3 2019 and prior year Q4 results, as well as equivalent day impacts. For the full year, international consumable revenues increased nearly 20% organically. International reference lab sales increased organically at consistent high single digit rates in Q4, with solid gains across our major regions. For the full year, global CAG diagnostic recurring revenues increased nearly 12% organically, reflecting 11% gains in the U.S. and 13% growth in international markets, aligned with our long-term goals. By modality, global reference lab and consulting services revenues expanded 11% organically in the fourth quarter, supported by nearly 1% equivalent day growth benefit, with an additional 2% of reported growth benefit related to the initial integration of Marshfield labs. Four-year organic growth of 11% in lab revenues was driven by consistent strong growth in the U.S., supported by continued high same-store sales growth at IDEX customers. Global vet lab consumable revenues grew 12% organically in Q4, net of a .5% equivalent day headwind. For the full year, vet lab consumable revenues increased 14% organically, driven by double digit growth across U.S. and international markets, supported by increases in diagnostic test utilization and ongoing expansion of our premium instrument install base. We had another excellent quarter in terms of high quality instrument placements in Q4, supporting double digit -on-year growth in our economic value index, or EVI. Global premium placements increased 13% -on-year in Q4, driven by 23% -on-year growth in catalyst placements, supporting a 19% -on-year growth in our global catalyst install base. Overall, we placed 2,517 catalysts in the quarter, with 456 at new and competitive accounts in North America, up 8% -on-year, and 1,119 new and competitive placements in international markets, a 24% -on-year increase. We also achieved 1,248 premium hematology placements, up 7% and 713 new and competitive placements, down 4% compared to strong priority levels. Overall, our -A-View global install base is now over 8,900 instruments, of 35% -on-year. Rapid assay revenues grew 4% organically in Q4, reflecting solid gains across U.S. and international markets, net of a .5% equivalent day headwind. For the full year, rapid assay revenues grew nearly 8% organically, reflecting continued solid growth of 40X Plus specialty and first-generation products. Growth, high customer retention, and our rapid assay business continue to benefit from ongoing expansion of our Engage Snap Pro install base, supported by an additional 10,000 placements in 2019, bringing our global install base to over 37,000. Veterinary software services and diagnostic imaging system revenues increased 9% organically in Q4, supported by double-digit gains in VSS and continued solid expansion of digital imaging services. Overall, global CAG revenues grew nearly 11% organically in 2018, and we're targeting continued double-digit organic gains in the CAG business in 2020. In terms of our other lines of business, water revenues grew 10% organically in Q4, including approximately 1% benefit from equivalent days, supported by solid gains across our major regions. For the full year, water revenues increased 9% organically, with faster operating profit growth, resulting in 47% full-year 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 2020. Livestock, poultry, and dairy revenue in Q4 increased 10% organically. Strong Q4 growth results were supported by benefits from the sales of diagnostic testing programs for Appleton's swine fever in China, which offset declines in core swine diagnostic testing, as well as solid growth in poultry testing and herd health screening. Q4 results also benefited from favorable -on-year comparisons related to timing of government and distributor orders. For the full year 2019, our LPD revenue was up 6% organically, with relatively higher operating profit growth, benefiting from productivity improvement and cost controls. We're pleased with our progress in expanding our LPD revenues and profits in 2019 in a very dynamic global climate. In 2020, we're targeting flat to modest organic growth in our LPD business, as benefits from growth in our pregnancy testing franchise and African swine fever testing programs are moderated by expected ongoing pressures on broader swine diagnostic testing in Asia and bovine government disease control programs in Europe. As well as tough compares related to strong 2019 herd health screening levels. Turning to the P&L, gross profit was up 10% on a reported basis in Q4, or 11% adjusted for foreign exchange impacts. Gross margins decreased slightly in a constant currency basis, reflecting increased investment in our reference-led business related to day lab capacity, route expansion, system investments and acquisition integration, which offset benefits from moderate net price gains and continued strong consumable revenue growth. Foreign exchange hedge gains, which benefited gross profit, were $3.5 million in Q4. Operating profit in Q4 was flat as reported, including impacts from CEO transition charges. On a comparable constant currency basis, operating income increased 12%, reflected solid profit and revenue growth. As expected, comparable constant currency operating margin gains were relatively flat in Q4. Operating expense growth increased to 10% on a comparable constant currency basis driven by increases in global CAG commercial capability and R&D. As we'll discuss in our guidance update, investment impacts will carry into the first half of 2020. For the full year, operating profit increased 13% as reported, or 16% on a comparable constant currency basis. This reflects an operating margin of 23% and an increase of 120 basis points on a comparable constant currency basis, which excludes CEO transition charge impacts. Constant currency operating margin gains reflected a balanced 50 basis points of gross margin improvement and 70 basis points of operating expense leverage on strong volume growth. EPS in Q4 was $1.04 per share, including $0.05 per share in tax benefit related to share-based compensation activity. On a comparable constant currency basis, EPS increased 17%. For 2019, EPS was $4.89 of 21% on a comparable constant currency basis. For the full year, foreign exchange rate changes decreased EPS by $0.05 per share, net FX hedge gains of nearly $11 million. Full year EPS results included $19 million, or 22% per share in tax benefit related to share-based compensation activity, which provided .7% of benefit in our 2019 effective tax rate of 18%. We had interest expense of $30.6 million for the year, net of approximately $2 million of capitalized interest related to major facility projects. Pre-cash flow was $304 million for 2019, or 71% of net income. Capital spending came in at $155 million, including $58 million of combined investment, or approximately 14% of net income related to our Westbrook main headquarters expansion and German core library location, with some favorability to earlier estimates related to timing of major project cash deployment. We allocated $304 million of capital towards the repurchase of ,215,000 shares for the full year 2019, at an average price of $250 per share. This included repurchases of 532,000 shares in Q4 for $139 million. Our balance sheet is in an excellent position. We ended the year with $991 million in debt, $90 million in cash, and $560 million in capacity under our revolving credit facility. Our leverage ratios as a multiple of adjusted EBITDA were 1.4 times, 1.45 times gross and 1.32 times net of cash at year end. Our strong financial performance and disciplined capital allocation supported achievement of a 46% after-tax return on invested capital, excluding cash investments for 2019. We're well positioned to build on the strong performance in 2020 with a financial outlook aligned with our long-term goals. We're increasing our reported revenue guidance range to ,000,000 to ,000,000, up $7.5 million at midpoint, including approximately $5 million of benefit from updated FX assumptions. We're maintaining consistent guidance for 9% to .5% organic revenue growth, supported by continued strong CAG diagnostics recurring revenue growth of 11% to 12%. Our guidance assumes .5% growth rate benefit from completed 2019 acquisitions, which is offset by a projected .5% FX growth headwind, resulted in projected revenue growth of 9% to 10.5%. We're raising our 2020 EPS outlook to $5.42 to $5.58 per share, an increase of 12 cents. This aligns with a comparable EPS growth of 13% to 16%, reflecting a consistent outlook for 50 to 100 basis points of comparable constant currency operating margin improvement. The 12-cent increase in the EPS outlook compared to our preliminary guidance includes approximately $0.05 in combined benefit from the flow through 2019 operating performance and favorable updates to assumptions for interest expense and projected reductions in average shares outstanding. We're now projecting approximately $35 million in net interest costs in 2020 and a 1 to .5% reduction in average shares outstanding with both metrics aligned with an assumed maintenance of our net leverage at 1.5 times EBITDA. Our updated outlook also reflects $0.05 in projected tax benefit from share-based compensation activity. We're now projecting an effective tax rate in 2020 of 20% to 21%, including 7.5 to 9.5 million or .5% in tax rate benefit from exercises of stock-based compensation in 2020, which equates to 9 cents to 11 cents per share. Finally, our guidance benefited by 2 cents from updated FX assumptions. Overall, we're now projecting an estimated 9-cent negative -on-year impact from FX, net of $5 million of projected hedge gains in 2020. In terms of free cash flow, we're targeting a deployment of $140 million to $155 million in capital spending, including approximately $35 million related to the completion of our Westbrook headquarters, German core lab projects, and the acquisition of real estate associated with the U.S. core lab. For 2020, this results in an outlook for free cash flow of 75% to 80% of net income, including approximately 7% impact from these discrete investments. In terms of our first quarter outlook in 2020, we expect Q1 reported revenue growth in the .5% to 11% range reflected organic gains of 10% to 11.5%, including a projected 1% equivalent day tailwind related to the leap year. We expect our operating margins will be moderately below prior year levels, reflecting stepped commercial and lab investments advanced in the second half of 2019, and as we continue to integrate our Marshall acquisition and onboard our Westbrook headquarters expansion. We expect operating margin gains in 2020 will be driven by second half performance as we grow into our scaled investments, including our new headquarters and German core lab facility. That concludes the financial overview. Let me now turn the call over to Jay for his comments.

Good morning, and thank you, Brian. IDEX had a strong finish to 2019 with double-digit growth across our companion animal, livestock, and water diagnostic businesses. Poor CAG diagnostics recurring revenue, which now represents over three quarters of overall company revenues, grew 12% organically for the full year. Excellent execution across our businesses enabled us to deliver organic revenue of 10% plus and comparable constant currency EPS growth of 21% aligned with our long-term financial goals. Return on invested capital at 46% for the year was exceptional. The progress we are advancing on key strategic fronts positions us well to build on this performance in 2020. Outstanding commercial execution is an essential pillar in our organic growth strategy, and we consistently see a high return in increasing these field-based capabilities that allow our sales professionals to spend more time with customers. Expansion in the number of our global customer-facing resources and investments in enabling commercial systems in areas like Salesforce's service cloud were two areas of focus in 2019. We completed the U.S. commercial expansion in Q4 and start the year with our expanded U.S. team in SEAT and TRAINED. We now have 530 field-based professionals in the U.S. to support market development, more than double the number from five years ago. As we enter 2020, we anticipate some settling in during the first quarter of the expansion as sales professionals, including those newly recruited, develop relationships in their new or reconfigured territories. Notably, we accomplished this expansion in Q4 while delivering 425 new and competitive catalyst placements in the U.S., a record number. We also continued to make progress with Preventive Care, with 360 new enrollees in a quarter to reach over 3,800 enrollees in the program to date. Customers are embracing the IDEC Preventive Care Turnkey solution and increasingly view it as a foundational pillar in their own practice strategies. We believe that our North American commercial resources are properly balanced at this point with the addressable market opportunity, and in 2020 we will focus on driving productivity in our expanded sales force, which becomes even more effective over time with tenure and with deeper customer relationships. Our commercial capability and performance in international markets also continues to advance as they build tenure and competencies with key commercial programs like IDEC 360. The commercial team's priorities have been driven by the economic value index of an instrument placement that prioritizes high-value competitive chemistry placements, resulting in 24 percent growth in new and competitive catalyst placements in Q4 to a record of more than 1,100 units. Our catalyst-installed base outside of North America grew 26 percent year over year, supporting nearly 20 percent organic revenue growth at IDEC's VetLac consumables internationally in 2019. We expect to gain global leverage and further strengthen execution in 2020 with our enhanced field global commercial organization, as previously announced. Leading with innovation includes expanding our testing platforms is another key growth pillar. We are excited by the new innovations that we announced at VMX earlier this month. These were enthusiastically greeted by customers as clinically rigorous and value-added since the beginning of the year. We are excited to see our veterans embrace new and expanded tools that enable them to raise the standard of care in workflow-efficient ways. This year we are bringing bioassets to our catalyst platform, with shipments expected this quarter. Catalyst bioassets as a measure of liver function brings reference lab test quality in clinic. This is a great example of how we constantly make our catalyst platform more valuable to customers. As we have seen in the past year, catalyst has a steady innovation heartbeat with eight clinically important tests launched over the past eight years. The technology for life benefit of catalyst is supporting continued global expansion of this -in-class testing platform. Following another great year of instrument placements and customer retention, as of the end of 2019, approximately 41,000 practices of catalysts installed. Even with a successful install-based expansion, we estimate there remain approximately 17 thousand addressable placement opportunities for catalysts alone around the world. Our innovation focus increasingly uses large clinical data sets with AI and machine learning to develop highly capable algorithms that assist clinicians with even the most challenging patients. This is the case with SocietyVDX, our groundbreaking platform with NeuroNetwork 5.0 leveraging 350 million images launching this quarter. We are adding advanced bacteria detection capabilities made possible by proprietary reagents leveraging patent-pending technology and no additional charge for our 8,900 customers. Seeing bacteria is clinically relevant and especially challenging because of their very small size, the difficulty of seeing bacteria in highly cluttered image, and because debris can be mistaken for bacteria due to similarity in appearance. Moreover, because our ink clinic analyzers are all connected by smart service, we will be able to quickly update our global install base with no customer disruption. In ReferenceLab, our broad and differentiated service portfolio, including Fecal Antigen DX, continues to support strong, same-sort customer growth. Because the Fecal Antigen test does not rely on the visual confirmation of parasite eggs, it's able to uncover twice as many infections as O&P alone, identifying the presence of intestinal parasites earlier in the life cycle of the infection. We're also further expanding our ReferenceLab offering with an exciting new service, digital cytology, announced at VMX for launch in North America in February. Cytology results often have at least a two-day turnaround time. With our new digital cytology service, we are transforming the speed at which customers receive results with expert interpretation to within two hours, seven days a week, 365 days a year. We're able to do this by leveraging existing capability of an integrated IT workflow, the wide adoption of customer-facing applications like Fec-Connect Plus, a field service diagnostic workforce of about 150 field service reps to install and train customers, and a global network of more than 100 veterinary clinical pathologists. We continue to invest in further improving our lab service offering internationally. We're excited about adding our -the-art core German Reference Laboratory in late spring of this year to our sophisticated global and regional -and-spoke laboratory network. Adoption and utilization of IDEX SDMA continues to advance nicely in clinic and lab diagnostic modalities. In fact, 75% of global catalyst customers have ordered catalyst SDMA and have now run it three and a half million times. In fact, in North America, that number is almost 80% adoption. IDEX SDMA has also been included in almost 28 million chemistry panels at IDEX Reference Labs. Customers are increasingly seeing SDMA, a direct measure of GFR impairment or kidney function, as a standard of care. In fact, the American Animal Hospital Association has updated their K9 Diagnostics Wellness Testing Guidelines by LifeStage, and testing guidelines now for the first time include SDMA. Our veterinary software offerings continue to enjoy robust customer adoption. Customers who use our software applications believe that they are an outstanding enabler to deliver excellent patient care and to running their practices in an efficient manner. Q4 was another strong quarter for new placements of Cornerstone, NEO, Onamana, and SmartFlow systems. In North America, we had record patient management software placements, including cloud-based and on-premise software for 63% -over-year growth and installs for the quarter. We introduced a much improved user experience update with Cornerstone software version 9.1 in March of last year, and we are pleased that well over half of our install base upgraded by the end of 2019. Work on Cornerstone Clouds continued to progress on schedule in Q4, with very positive customer feedback positioning us to scale for commercial launch later this year. IDEX WebPacks enjoyed another strong quarter with 23% -over-year increase in subscriptions and a customer install base of more than 4,500 subscribing practices. We recently released for the end of Q1 delivery a cloud-based software update. It provides new functionality powered by artificial intelligence automatically that corrects image orientation and sorts images by body part, potentially shortening re-time by 25%. Overall, across these multiple integrated software offerings, we are providing the most comprehensive technology stack offering relied on by independent practices and corporate groups around the world. In addition to our progress in our core CAG business, we also had strong performance in our water and livestock diagnostic businesses in the fourth quarter, with both achieving 10% organic revenue growth. We continue to expand our high-return water business globally to focus on commercial execution. Our livestock business has also shown tremendous resilience this year in the face of macro challenges and continued input from the African swine fever in Asia. Looking ahead, we are optimistic about the long-term potential of our business and our ability to sustain its high growth. One of our key strategic goals is to grow CAG diagnostics recurring revenue, which in 2020 we're targeting at 11% to 12%. Major drivers include the strong global momentum and expanding our install base of premium instruments, continued customer adoption of IDEX's differentiators like integration and ongoing new platform features, and our expanded commercial capability aligned with building on this momentum. Over the next 25 years, we see tremendous opportunity for ongoing growth of CAG diagnostics recurring revenues with a global addressable companion animal diagnostics market of over $30 billion, with the majority of that existing outside of the United States. We remain focused on our commitment to providing exceptional service to our customers and improving the standard of care to enable the best clinical decision making and healthy practice growth. Before we open the call to questions, I want to thank our employees and congratulate them for the accomplishments in 2019 in pursuit of our purpose to enhance the health and well-being of pets, people, and livestock. Okay, and with that, we'll take questions.

Thank you. And ladies and gentlemen, if you wish to ask a question, please press 1 and then 0 on your touchstone phone. You will hear a tone indicating that you have been placed in queue. You may remove yourself from queue by hitting the same keystrokes of 1 and then 0. Once again, for any questions or comments, press 1 and then 0 on your touchstone phone. And one moment please for the first question. And we will take the first question from the line of Nathan Rich with Goldman Sachs. Your line is open.

Good morning. Thanks for the questions. Brian, maybe just starting off on how we should be thinking about kind of the cadence of organic growth this year. You know, I think you said the first quarter would be 10 to 11 1 1⁄2 percent. I think that includes 100 basis point benefit from the leap days. So if we back that out, I think the range is consistent with kind of the full year guidance that you gave for organic growth. So should we be expecting sort of a relatively consistent cadence over the balance of the year?

We'll obviously provide more details to work through the year, but I think that's an accurate read, Nate, is that we've got a full year outlook of 9 to 10 1⁄2. We'll have some benefit from days in Q1. We have I think a bit of a headwind in Q2. But net net unbalanced for the year. Those should wash out. And, you know, I think our 11 to 12% recurring CAD growth is very much in line with the trends that we've been seeing if you adjust our fourth quarter results for the days impact and just some of the shipment timing effects we noted in Asia, which were modest but, you know, can affect the growth rate a bit. We're basically right in the middle of that range and looking to build on that in 2020. And

I would add to that, we're well positioned to sustain that 11 to 12% gain that we reflect in our goal for 2020. You know, you start with the fact that it's good market. Factor up. We saw good clinical visit growth over 2019, 2.5%. We have really nice growth and momentum in the expansion of our premium installed base, 16% in total, 19% in catalyst, 35% in set-aview. And those result in consumables growth as customers use those products. We're pleased with the adoption we see around IDEX. Innovation customers are very enthusiastic about the differentiators we've introduced in past years as well as VMX. And we have an expanded sales force, which is out there partnering with customers, driving awareness and education and ultimately consideration. And then we note that, as Brian mentioned in his remarks, we have very high retention across all of our modalities. Customers tell us that they appreciate the differentiators we bring, like integration and the platform extensions that they've come to rely on. So we're feeling like we're in a very good position to sustain that growth.

Thanks, Jay. That's helpful. And just a follow-up on your comments on the end market. You kind of noted a strong 2019. Obviously, 4Q was a little bit softer. I know there's kind of always -to-quarter volatility. Is that sort of kind of what you would attribute the 4Q number to? And I think, Brian, you had mentioned December was maybe a little bit stronger. I'd just be curious to know if you've seen that improvement continue into January. Yeah,

so the Q4 was solid, .8% clinical growth. Keep in mind, we focus on the clinical growth piece. That's where the veterinarian actually sees the patient and where diagnostics is used as a whole. Now, that came off a fairly strong Q3, and it's noted a little soft going into the quarter, but picked up in December. So we're positive on the market. We think it's a strong market in 2020, and we don't see anything from a change standpoint.

Thanks for the questions.

Thank you. Our next question comes from the line of Ryan Daniels with William Blair. Your line is open.

Yeah, good morning, guys. Thanks for taking the questions. A couple follow-ups on the new digital cytology. I'm curious, number one, if you can speak to the early feedback you got, particularly at VMX, and then number two is my follow-up. I'm curious what the revenue will look like from that. I know there's an instrument, but also reading at the reference lab. So will that be in the equipment or reference line lines, or how should we think about the revenue model? Thanks.

Right. Thank you, Ryan. Let me give you just some market backdrop and feedback from VMX. Customers were really very enthusiastic about digital cytology service. Typically, the veterinarian will see patient every day with bumps and bumps, and they'll take a sample, prepare a slide, look at it under a microscope, and then decide whether or not they need to send it out for expert interpretation. That process very often takes a couple days, but it can, depending upon when they send it in, like on a Friday, can take four or five days or so. So they were very, very appreciative and enthusiastic about the ability of being able to send it to us and get a result back with an expert interpretation within two hours, and be able to do that all hours of the day, every day of the week, and all days of the year. And the reason we were able to do that, by the way, is because we were able to fit that into our existing infrastructure and investments that we've made in terms of integrated IT workflow, having a field service organization which is out there who can help install these systems and onboard and train customers on slide preparation, having clinical pathologists around the world to be able to provide that service. In terms of market size, and I'll hand it over to Brian to talk a little bit about revenue. The way we think about this is about 5% of practices are higher volume users of psychology. So we define that as five plus cases per month. About 6,000 of IDEX practices actually send today out, psychology to our reference lab for expert interpretation. At 6,000, about a little over 20,000 practices that we do business with in reference labs in some measure. So it gives you just a scope of what we're talking about. We think as they continue to use this, there's potential benefits in using more of it over time and more customers adopting it.

Yeah, and I think the way to think about it financially, Ryan, is it is a factor that will be supportive of sustaining the 11 to 12% CAG DX recurring growth company, including the strong growth that we've seen in U.S. reference labs. It's a valued service and a differentiator and I think something that we believe can support, continue to expand that franchise. And in terms of instrument revenues, as Jay noted, it's a relatively smaller set of the market that would likely be earlier adopters of the instrument. And we'd anticipate this would be integrated into 360 type program placements more in the second half of the year as we kind of build market awareness and get the service up and running. But it's not calling it out as a distinct material driver. I think it's something we anticipate will build over time. But we're very excited about it as another example of how IDEX is adding to the scope of services that we're providing, adding to our differentiation in value and leveraging that to drive the strong double digit growth and CAG DX recurring revenues that we're shooting to achieve.

Great. Thanks, guys. I'll hop back in the queue.

Thank you. Next is a go to the line of Michael Reiskin with Bank of America. Your line is open.

Hey, guys. How are you doing? I want to follow up on an earlier question just about market conditions. Just to get a little bit more specific, maybe you could, I guess, help put my mind at ease. I've had a lot of questions over recent days and weeks about some international markets, the wildfires in Australia towards the end of the year. You've had similar weather in California or heat waves in Europe affect you. Just curious if that had any impact. And also on the recent coronavirus outbreak in China, just a lot of attention in the market, obviously. And if you could sort of size your China exposure, how much of that is companion versus livestock? And if you've seen anything in terms of that visits or sort of what you're seeing there in that market and how that factors into your expectations for 2020?

Yeah. Why don't I start with that, Mike, and hopefully I can get on some of your specific questions. I'm sure Jay can expand on that. But in terms of the coronavirus as context, China for IDEX is a little less than 2.5 percent of our overall revenues, all of our revenues in China. So we have a relatively smaller exposure to that market. Over half of that revenue is LPD. So in terms of the more consumer-driven aspect of the business, it's a relatively smaller exposure. We have seen limited impact to date. We are monitoring it, of course, but have not factored a specific kind of impact into our outlook at this point. We've got a range for performance. We're comfortable with that. And I think the headline there, it's relatively smaller for IDEX, and it's relatively early on to kind of be calibrating more impacts. I think you had a specific question on the Australia wildfires. We did not see a meaningful impact on that in our results. Again, it's something that we're monitoring, but we had very good results in Australia, continued good results. And I think the European market, we highlighted that we had nearly 20 percent consumable growth in the fourth quarter, outstanding instrument placements, and continued solid results in labs. So I think we feel the market backdrop in Europe looks quite healthy. That's great.

Thanks. Thanks. A quick follow-up. I appreciate all the color there. You also cited a lot of investment on the gross margin line. You saw that in this quarter, and you mentioned some of that's going to continue through 2020 across the reference lab and the rest of the business. Could you help us think through the pacing there, sort of how that progresses over the course of the year? And is this a slight step up in investment? Is this something that's going to be the run rate go forward, or is this sort of relatively one time that should play out over the course of – you'll see the benefits of this over the course of many quarters.

Yeah, I don't think there's any investment in our businesses as truly one time. I think we're always adding capability. But what we were trying to highlight was that we had, through the second half of 2019, a number of investments that we advanced on the lab front in terms of our expanding our capacity, adding day labs. We had some system investments that we've been making, initial integration of Marshfield, which will continue. And obviously some of the investment we made in the commercial organization in the U.S. And just trying to highlight that that is going to be on a -over-year basis carrying into the first half of 2020. And there are a couple of discrete factors that will be additive to that, and that's basically our Westbrook headquarters, which is coming online in Q1. So we'll have the depreciation of that starting to factor into our OPEX growth. And in the second quarter, we will be having the impact of the German Core lab coming online. So the net of that is it wasn't intended to signal incremental investment in the labs other than those discrete areas in the Marshfield acquisition. But just trying to highlight that we anticipate our margin gains that we're targeting for next year will be second half driven. We'll have some moderate pressure in Q1. And basically it's just as we grow into those investments and we would reinforce our long-term goals of 50 to 100 basis points plus of constant currency annual margin improvement supported by strong recurring revenue growth. So no changes on that front.

Thanks, Brian. Really appreciate all the color.

Thank you. And next we will go to the line of Jonathan Block with CFO. You're open.

Hey, guys. Good morning. Maybe just a couple more high level ones for me. You know, Jay, anything on the competitive landscape that's evolved or maybe that you expect to evolve? Zoetis has had a basis for some time now and they purchased a couple labs. I know it's early, but you got another player that's also making a bigger push in the international market. So curious for your thoughts and any color or details that you see on calling it a potential evolution from a competitive standpoint.

Yeah. Good morning, John. Thank you. So the it's always been a competitive market and it's clearly still a competitive market. And we continue to perform very well as we've highlighted this morning. Our focus is really, really on growing and adding value for our customers. A lot of our volume growth, as Brian highlighted, comes from same store sales, comes from existing customers, creating awareness and adoption of relevant testing. So from a strategy standpoint, it's really continuing to be able to work with those customers, introduce the innovations, take our commercial capability, expanding commercial capability partner and help those practices succeed. So that's really the focus. A lot of competitive intensity, but that really hasn't changed. And we continue to do well and we continue to experience moderate price increases on the two to three percent net basis. We're feeling good.

OK, great. And actually a few surprises. I thought I thought in the P&L, so I'll stick high level. You know, Jay, your thoughts on and willingness to work with other players in the industry to help drive diagnostics growth. And what I mean by that is that's what you want to do. You're working with TruePanion and some shape, way or form in pet insurance. But there was chatter at BMX that you're going to partner with Chewy with their sort of their pet scriptions platform. And so, you know, as leading the company, I'd love to get your thoughts on how you see these opportunities evolving for the company over the next couple of years and in IDEX's willingness to to take a more aggressive role there. Thank you.

So we've had ongoing partnerships with the specialty diet and in pharma and software companies in the marketplace. The way we tend to think out address the software piece and the integration piece specifically, the way we tend to think about that is we take an open systems approach. So a group of customers, once it reaches a certain size of critical mass, come to us and say that they would like us to integrate an application into our PIM systems. Then we do it. We want to be able to give the customers the workflow that they desire. But, you know, in terms of overall partnering at BMX, we participated in a TARC study which showed the efficacy, the superior efficacy of fecal antigen. So always looking for ways, inappropriate, you know, sort of partnership structures of developing the market for diagnostics. Okay. Thanks for your time,

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

Great, thanks. I had a similar question just given some of the bundling tactics of your competitors. I was curious if you could better leverage your unique positioning in this market as sort of an agnostic player, but also partner with large pharma manufacturers to do your own creative bundling with therapeutics or other product offerings, I guess. Have you contemplated those sort of partnerships or collaborations more so recently than you have in the past? I'm just curious how that's evolving. Thanks.

Yeah. So when we talk to customers, what customers tell us is that they, when they're looking at diagnostics and they're looking at solutions to adopt, they believe that it's highly differentiated. It's a highly differentiated category in their practices. It's a decision that they make through the lens of how to deliver best care. It tends to be separate from how they think about therapeutics or specialty diets. They are making typically long-term decisions because of systems that they're buying that need to be integrated that they may have in their practice. You know, five, five, ten years. So from a buying standpoint and partnering decision, the customer really separates those two. So the, you know, that hasn't that hasn't changed with the recent acquisition of some of our competitors.

Okay. Okay. That's helpful. And then where do you stand now in terms of market share on your PIMS systems? Where we add across the industry in terms of converting to cloud-based systems? And can you speak to your positioning on the competitive front there as we head into some sort of potential wave of system upgrades as well? Thanks.

Yeah. So we did, we've done very well this year in terms of PIMS placements. Cornerstone, we've been able to upgrade more than half of our installed base of Cornerstone with a completely new user interface. We've been able to do this because we have a field-based organization of field service reps who go out and partner with customers. We also our NEO system, which is really more geared towards general practice customers and mobile customers, is native cloud-based. That's received just, I think, very enthusiastic reception and we've been able to grow that nicely. But the key is it's not so much in the PIMS system per se, it's in the connectivity that we're able to provide between software and our diagnostics and the applications that work together. So what customers tell us is they appreciate our PIMS systems, but what they really like is they like the fact that it all works better together. So the PIMS and the applications and VEC-Connect Plus and the diagnostics and that ability to support their workflow, politically and from a business standpoint in capturing the charges and work that they do is what sets us apart and continues to really provide strong differentiation.

Okay. Thank you.

Thank you. Next, we will go to the line of Andrew Cooper with Raymond James. Your line is open.

Thanks for the question, everybody. A lot's been asked, so I'll keep it relatively brief. But just on Marshfield, has the integration gone as expected? Was there anything that sort of surprised you? And I guess from a customer reaction perspective, I think sometimes we view some of the regional players as sometimes viewed as an alternative to the larger options that are out there in the market. So has there been any pushback from customers? And then from a margin perspective, the gross margin, I think, in 4Q was maybe a little lighter than we had expected. So what's the opportunity kind of on Marshfield and in general, how much maybe did MIX impact the quarter? But on Marshfield specifically, to capture synergies and get kind of that incremental revenue up to similar to your consolidated lab margins or kind of how you view that in terms of the extra capacity that you've added with the acquisitions. So any call there would be great and appreciate the feedback.

Great. Yeah. So the Marshfield integration is on track. We're excited by Marshfield. We've welcomed over 2,000 customers from Marshfield, and they now have access to IDEX's differentiated tests like SDMA and FECO Antigen and VEC-NX+. And the additional reception has been enthusiastic from those customers. We keep in mind that a good number of those customers were IDEX customers already. They used one of our modalities. They may have used our software systems. So it's not like they didn't know us. This just gives us a chance to work more closely with them and to provide reference lab services. I'll turn it to Brian if Brian would you like to make a remark on margin and what we see there? Yeah,

as expected, we, you know, as we're working to integrate Marshfield, there are some impacts from that. And we did highlight that as one of the factors. And that will continue into the first half. We have work going on on that front. But look, over time, I think we've demonstrated and we're confident that the addition of customers into our national lab network and supporting them through our over 50 labs now in the U.S., which is how we think about this business as a national business, is something that we would anticipate and getting leverage from and supporting the longer term goals that we have for margin improvement from our reference lab network. So it was a near term factor. We'll be a near term factor to a degree. And we'll get leverage of that over time. It will support our margin improvement going forward.

Thanks. I'll leave it there.

Thank you. And we'll take one final question.

Yes, this will be our last question. Thank you.

Thank you. That will be from the line of David Westenberg with Guggenheim Securities. Please go ahead with your question.

Hey, thanks for taking my question. So, you know, some of the feedback from veterinarians on the cytology instrument is it starts a conversation in oncology. So I apologize. I'm going to kind of ask an industry kind of wide question here. But, you know, does this, how do you see the oncology market kind of playing out in the next three to five years? Is there opportunities here in diagnostics, in the reference lab? Is there opportunities in therapeutics kind of the way we have in the human market with, say, cancer profiling or early detection of cancer? If you can give me kind of a broad overview of that and maybe just cytology kind of start that conversation.

Yeah. So, you know, the oncology services is something that exists in the marketplace today. It's centered more around specialty practices. And, you know, there's lots of different areas in oncology just like there are on the human side in terms of both drugs and therapeutics and Linux systems and chemotherapy. So it's a very broad question with lots of different areas from a diagnostic standpoint. It's something we're always taking a look at. There's, you know, around genomics and proteomics and being able to detect cancer earlier. Certainly, you know, digital cytology, in many instances, you're looking for cancer. So it does begin that discussion when a patient comes in with lumps and bumps and wants to know whether or not their pet is okay. Okay. And so with that, thank you. With that, we'll conclude the call. I want to thank our employees for the very strong progress and performance in Q4 for the full year of 2019 and for the advancement of our purpose, which is enhancing the health and well-being of pets, people, and livestock around the world.

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