IDEXX Laboratories, Inc.

Good morning, and welcome to the IDEXX Laboratory's first quarter 2022 earnings conference call. As a reminder, today's conference is being recorded. Participating in the call this morning are Jay Mazelski, President and Chief Executive Officer, Brian McKeon, Chief Financial Officer, and John Ravis, Vice President, Investor Relations. IDEXX would like to preface the discussion today with a caution regarding forward-looking statements. Listeners are reminded that our discussion during the call will include forward-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 first quarter 2022 results, please note all references to growth, organic growth, and comparable growth refer to growth compared to the equivalent period in 2021 unless otherwise noted. To allow broad participation in the Q&A, we ask that each participant limit their 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.

Good morning, and welcome to our first quarter earnings call. Today, I'll take you through our first quarter results and review our recalibrated financial outlook for 2022. IDEXX delivered solid financial performance in Q1 compared to very strong prior year results. In terms of highlights, revenue increased 8% as reported in organically driven by organic gains of 10% in our CAG business and 8% in our water business. CAG diagnostic recurring revenues increased 9% organically compared to high prior year levels, which included benefits from a significant expansion in new pet patients during the pandemic. Our commercial execution was excellent, reflected in 22% organic growth in CAG instrument revenues and continued strong momentum in expanding cloud-based software solutions. EPS was $2.27 per share of 3% on the comparable basis. As expected, comparisons to high prior year gross margin levels and increased commercial investments constrained year-on-year operating profit gains in the quarter. CAG diagnostic demand levels and IDEX commercial execution continue to build on the significant step-up achieved during the pandemic, supported by ongoing gains in diagnostics adoption and utilization. We have seen a moderation in clinic visit levels compared to second-half 2021 growth trends, which form the basis for our original 2022 CAG diagnostic recurring revenue organic growth outlook of 12% to 14%. In the U.S., in addition to early Q1 impacts from higher COVID cases globally, visit levels have been affected by constraints on veterinary service capacity and availability in a challenging labor market, following a period of significant demand expansion. We saw similar COVID and capacity constraint dynamics in international regions like Europe, with additional recent impacts from more challenging macro conditions, which have also constrained clinical visit growth compared to strong prior year baselines. Factoring in our Q1 results in near-term CAG sector trends, we're recalibrating our 2022 full-year organic revenue growth outlook. We're adjusting our overall organic growth outlook to 7.5% to 10%, primarily reflecting an adjustment of 3% in our targeted full-year CAG diagnostic recurring revenue growth range, now projected at 9% to 11% compared to strong prior year levels. We're also factoring in an additional $40 million impact from the strengthened U.S. dollar. Combine these changes, reduce our reported growth outlook by 3.5% or approximately $105 million at the midpoint of our guidance range. We believe these adjustments are appropriate as we work through near-term CAG sector dynamics and more challenging comparisons in the first half of 2022. We're targeting higher growth in the second half of 2022, with the high end of our four-year growth outlook reflecting return to our original targeted CAG diagnostic recurring revenue growth range in H2. We continue to be encouraged by the increased demand for companion animal diagnostics globally, building on the strong gains achieved during the pandemic. We're confident in the sustained long-term growth potential for our business, supported by our ongoing focus on innovation and customer engagement in driving CAG sector developments. Aligning with this conviction, we're advancing high return investments in innovation and commercial capability this year, including approximately $80 million in discrete investments related to the in-license of technology during the second quarter, which Jay will discuss in his remarks. Our 2022 EPS guidance of $8.11 to $8.35 per share factors and updates to our operating outlook, including $0.72 of discrete impact from the in-license of technology as well as a $0.10 per share adjustment related to the stronger U.S. dollar and $0.05 of EPS impact related to higher interest rates. We'll discuss our four-year outlook in more detail later in my comments. Let's begin with a review of our first quarter results. First quarter organic revenue growth of 8% was supported by 10% organic gains in our CAG business and 8% growth in our water business. These gains were moderated, as expected, by a 19% organic decline in LPD revenues, which included impacts from reduced African swine fever testing in China, as well as by a $3 million year-on-year decline in humid COVID testing revenues. Combined, these factors reduced overall IDEXX organic revenue growth by approximately 1% in the first quarter. Comparisons on both these fronts will improve in the second half of 2022. CAG diagnostic recurring revenues increased 9% organically in Q1 compared to strong prior year levels, reflecting 10% gains in the U.S. and 8% growth in international regions. First quarter CAG diagnostic recurring revenue growth benefited by approximately 1% from equivalent day effects. Overall Q1 CAG gains were also supported by 22% organic growth in CAG instrument revenues and 13% organic growth in veterinary software and diagnostic imaging revenues, in addition to benefits from the EasyVet acquisition. In terms of U.S. CAG sector demand drivers, same-store clinical visits in the first quarter were approximately 2% below strong prior levels. This compares to 2% to 3% increases seen in the second half of 2021, when we began to lap the step-up in testing demand that we saw during the pandemic. As noted, a factor influencing these trends is a near-term challenge related to capacity management of vet clinics that we've seen across global regions, which has resulted in constraints on clinic hours and access to veterinarians. Jay will speak more to these dynamics in his comments. At the U.S. practice level, same-store diagnostic service revenue growth was a solid 7%. Underlying demand for pet health care services remains high, reflected in robust multi-year growth trends. Compared to the 2019 pre-pandemic base, U.S. same-store clinical visits and diagnostic revenues increased 4 percent and 11 percent, respectively, on a three-year compound annual growth basis. IDEXX's U.S. CAG diagnostic organic recurring revenue growth of 10 percent in Q1 continues to outpace sector growth trends, reflected in a 1,150 basis point premium to clinical visit gains, in part supported by relatively higher net price realization and equivalent day benefits. Globally, IDICS achieved solid organic revenue gains across our modalities in the first quarter. VetLab consumable revenues increased 11% organically with double-digit gains across U.S. and international regions. Consumable gains were supported by 14% year-on-year growth in our global premium install base, reflecting double-digit gains across our Catalyst, premium hematology, and CETA-B platforms. CAG premium instrument placements increased 31% in Q1, reflecting 24% gains in the U.S. and 35% growth internationally, as clinics show confidence in investing towards support of increasing demand for diagnostics globally. The quality of instrument placements continues to be very strong, reflected in 12% growth in new and competitive catalyst placements. Procite 1 momentum continues to build, supporting 1,924 premium hematology placements in the quarter, of 101 percent. Rapid assay revenues expanded solidly in Q1 compared to high prior year growth levels. Global rapid assay revenues increased 8 percent organically supported by solid volume gains in the U.S. and benefits from net price increases. Global lab revenues increased 8 percent organically in Q1 as double-digit growth in the U.S. was moderated by low single-digit gains in international regions impacted by pressure on clinical visit levels in Europe. Reference Lab new business momentum and customer retention remain strong globally, supported by expansion of IDEXX 360 agreements. We achieved relatively higher benefits for net price gains in the first quarter, with 4% to 5% average gains on U.S. CAG diagnostic recurring revenues and solid levels of increases across international regions. In other areas of our CAG business, veterinary software and diagnostic imaging revenues increased 13% organically and 34% on a reported basis, including benefits from the EasyVet acquisition. Results were supported by double-digit organic gains in recurrent software and digital imaging revenues and continued strong momentum in cloud-based software placements. Water revenues increased 8% organically in Q1, reflecting benefits from price gains and a continued solid global recovery in testing demand from constrained pandemic levels. Livestock, poultry, and dairy revenue decreased 19% organically in Q1, as expected tough comparisons to high prior year revenue levels for African swine fever and core swine testing in China offset moderate overall organic revenue gains in other areas of our LPD business. We expect to see relative improvement in LPD growth rates in the second half of the year as we work through challenging comparisons in the Asia-Pacific region. Turning to the P&L, solid revenue growth supported moderate operating profit and comparable EPS gains compared to high prior year levels. Gross profit increased 6 percent in Q1 as reported and 7 percent on a comparable basis. Gross margins were 59.6 percent, a decrease of 120 basis points on a comparable basis. Comparable gross margin declines reflect the lapping of high Q1 2021 levels, business mix impacts from lower LPD and higher CAG instrument revenues, and impacts from higher freight and distribution costs. CAG recurring revenue net price gains and lab productivity initiatives help to offset select inflationary impacts. We're also seeing benefits from improvement in software service cost margins as we expand our recurring revenue base. Operating expenses increased 12 percent year-on-year as reported in the first quarter and 13 percent on a comparable basis. Higher operating expense growth reflects comparisons to controlled prior year levels as well as investments advanced in recent quarters related to our expanded global commercial capability. We also saw relatively higher travel costs compared to low prior year levels. We expect relatively higher year-on-year comparable OpEx growth in the second quarter as we lap these impacts, in addition to the second quarter impacts projected from discrete R&D in license activity. EPS was 227 per share, an increase of 3% on a comparable basis. Q1 EPS included benefits of $5 million or $0.06 per share related to share-based compensation benefits, which was down $0.11 per share from high prior year levels. Ford Exchange reduced operating profits by $4 million and EPS by $0.03 per share in Q1, net of $2 million in hedge gains. Free cash flow was $83 million in the first quarter. On a trailing 12-month basis, our net income to free cash flow conversion rate was 84%. For the full year, we now estimate free cash flow conversion of 65 to 70 percent, approximately 10 percent below earlier conversion estimates. This outlook reflects approximately 5 percent of free cash flow conversion impact from the discrete R&D investments, modestly higher inventory levels to sustain high levels of product availability, and higher deferred tax assets driven by increased R&D credits. We're maintaining a consistent four-year outlook for capital spending of $180 million, including approximately $50 million for our new manufacturing and warehouse expansion project. Our balance sheet remains in a strong position. We ended the quarter with leverage ratios of 1.1 times gross and 0.9 times net of cash. We allocated $273 million of capital and purchased 523,000 shares in QI. Our financial outlook assumes capital allocation to share purchases align with maintaining a similar net leverage ratio, supporting a projected 1.5% full-year reduction in share count. Turning to our 2022 full-year outlook, we're updating our organic revenue growth ranges to reflect Q1 performance, recent CAG sector trends, and projected impacts related to the Ukraine war. We're also adjusting our reported revenue growth outlook for the significant recent strengthening of the U.S. dollar. Our updated full-year revenue growth range of $3,390,000,000 to $3,465,000,000 reflects a $105 million reduction at midpoint compared to earlier estimates. This includes $10 million of projected revenue reductions related to our Russia, Belarus, and Ukraine businesses, and a $40 million adjustment related to the recent strengthening of the U.S. dollar. We now project foreign exchange will reduce year-on-year revenue growth by approximately 3% for the full year, with approximately 4% of year-on-year headwinds expected in Q2. Our full-year organic revenue outlook of 7.5% to 10% reflects an adjustment to our original guidance range of 2% to 2.5%, primarily reflecting a recalibration of our full-year growth outlook for CAG diagnostic recurring revenues. We're planning for overall organic growth at the lower end of this range in the first half of 2022, reflecting more recent CAG sector trends and challenging comparisons in the second quarter. We're targeting improved growth rates in the second half of 2022 as vet clinics work to adapt to capacity challenges, and we benefit from our commercial initiatives. Our recalibrated CAG diagnostic recurring revenue growth outlook is 9% to 11% for the full year, building on strong prior year gains. As noted, the high end of our four-year growth range reflects second half CAG diagnostic recurring revenue growth aligned with our original four-year goals. At our updated revenue growth rates, we're now planning for operating margins of 26.8% to 27.3%, down 170 to 220 basis points on a reported basis compared to strong 2021 performance. This includes approximately 230 basis points of margin impact related to the discrete R&D investments, This outlook incorporates effects from high-return commercial investments aligned with our long-term growth potential and captures projected inflationary effects on IDEX's business this year. Adjusted for the discrete R&D investments and approximately 10 basis points in year-on-year net margin benefit from forward exchange hedges, this outlook reflects updated goals for zero to 50 basis points in operating margin gains in 2022 compared to strong prior year levels. Our EPS outlook is $8.11 to $8.35 per share, a decrease of $1.20 at midpoint. This includes $0.72 of impact from discrete R&D investments, an additional $0.10 per share headwind related to point exchange, and $0.05 per share of impact from higher projected interest rates. Our guidance for comparable EPS growth of minus 1 percent to plus 2 percent includes unfavorable growth impacts of 9 percent from the discrete R&D investments and an estimated 2% impact in 2022 from international tax rate changes. We provided details on our updated estimates in the tables and our press release and earnings snapshot. That concludes our financial review. I'll now turn the call over to Jay for his comments.

Jay Haynes Thank you, Brian, and good morning. IDEX had a solid start to 2022. building on a significant gains in demand for companion animal diagnostics and software solutions achieved over the last two years. Veterinarians continue to see increased demand in their clinics compared to pre-pandemic trends and routinely choose IDEX's innovative products and services to meet rising standards for pet health care. This is reflected in our continued solid CAG diagnostics recurring growth and record Q1 global premium instrument placements. supported by our global rollout of ProSite 1. IDEXX's business strategy is focused on inspiring adoption and increasing the utilization of diagnostics. And our results reflect continued strong progress on this path. Our integrated solutions not only help veterinarians expand capacity and grow their businesses, but also support an enduring recurring revenue stream in the future. While we've seen some moderation in CAG sector growth metrics from very strong growth levels during the pandemic, We have high confidence in the durability and ongoing growth potential of our business and our strategy to drive the significant long-term growth opportunity we see for companion animal health care. Today, I'll focus on discussing IDEX's performance and progress in advancing key growth initiatives that are enabling us to build on our strong growth and financial performance as we serve our mission-driven purpose of enhancing the health and well-being of pets, people, and livestock. Let me start by providing some context on recent trends in the CAG sector. Overall, CAG sector demand trends continue to expand at a solid rate, building on the very strong increases in diagnostics demand seen through the pandemic. As Brian noted, U.S. practice same-store diagnostics revenues increased 7% in the first quarter, compared to very strong prior year results. IDEXX's growth strategy has been consistently focused on driving diagnostics adoption and utilization at the clinic level, supported by our investments in commercial engagement and innovation. First quarter results show continued progress on this front. We've provided some additional information in our quarterly snapshot, which breaks down practice-level diagnostics revenue growth dynamics into three key drivers, clinical visit growth, Diagnostics frequency, or the percentage of clinical visits including diagnostics, and diagnostics utilization, or diagnostics revenue per visit that include diagnostics. This breakdown highlights benefits from both continued solid increases in diagnostics frequency and expanded growth rates in diagnostics utilization ahead of pre-pandemic levels, building on the very strong gains seen over the last two years. These impressive gains were moderated in Q1 by 2% year-on-year decline in clinical visits, which is a change from the very solid 2% to 3% clinical visit growth trends we saw in the second half of 2021. As we've analyzed these recent changes, it appears that in addition to some effects from COVID case spikes and weather dynamics in the first quarter, there are near-term constraints on vet clinic capacity that are impacting clinical visit levels. Veterinarians and their staffs are continuing to adapt to the extraordinary growth in demand over the last two years, when the U.S. pet population expanded approximately 10%, resulting in double-digit increases in same-store clinical visit levels, reflective of the sustained pressure on their time, as well as staffing challenges that many sectors are facing currently to have clinics of scaled back hours. The metric we can track is the percentage of clinics with weekend appointment activity which declined to 42% in Q1 from 54% levels pre-pandemic, as clinics and vets themselves are looking to achieve more near-term balance in their workloads. As many pet owners wait longer to secure appointments, underlying demand for pet health care remains strong, but these factors have had the near-term effect of moderating the extraordinary growth pace we've seen in the CAG industry over the last two years. We've seen similar dynamics in international regions like Europe in terms of clinical visit levels, with some additional pressures potentially related to the more recent macro headwinds. Given the near-term clinical visit and macro dynamics noted, we felt it was prudent to recalibrate our 2022 outlook. Our full-year outlook for CAG diagnostics recurring revenue organic growth of 9% to 11% builds on our 17% average annual growth over the last two years. with goals to accelerate gains in the second half of 2022, benefiting from continued advancement of our commercial and innovation efforts. The longer-term outlook for pet healthcare remains very strong, benefiting from increases in pet ownership, favorable demographic trends, and the continued strengthening of the pet and pen owner bond. IDEX is well-positioned to drive sector growth and help customers service growing demand through our broad array of point-of-care and reference laboratory products and services. all connected by cloud-based software capability, which supports clinic efficiency and workflow enhancements. The IDEX team is focused on driving this potential and continues to operate at an exceptional level. This is reflected in continued solid new business gains, record instrument placement levels, high growth in software services, and a continued very high levels of customer satisfaction, reflected in record high retention levels. Our high-touch customer commercial model and innovative diagnostics and software solutions positions us well to help customers work through near-term management challenges to extend the strong growth momentum in our business. Let's discuss some recent progress on these key strategic fronts. High levels of commercial engagement that support sector growth remains a pillar of our growth strategy, and we continue to build on our leading commercial capability globally. As noted, we continue to drive strong performance in terms of new business acquisition with solid net customer gains across modalities and regions. Our highly skilled commercial teams delivered outstanding premium instrument placement performance in Q1 across our platforms, supporting strong growth in our EVI metric and a quarter. We achieved strong growth overall across new and competitive and loyal customer segments, as well as within corporate accounts. as veterinarians are clearly looking to use IDEX technology to manage elevated demand within their clinics. And despite highly variable access levels globally, our sales teams demonstrate that they have strong and trusting relationships with their customers, regardless of clinic type, and a keen ability to meet customer needs with IDEX products, each of which are driving strong customer retention and healthy global install-based growth. This momentum has been supported by the strengthening of our commercial capabilities in international regions. We're encouraged by the early performance measures like reach to customer and reach to revenue from our recently completed international country expansions. These include Germany, France, Spain, South Korea, Italy, and Brazil. We'll advance smaller, targeted investments in our commercial capabilities to complement these efforts as opportunity warrants, including in our largest region, the U.S. Commercial expansions are supported through our center of excellence approach, which enables efficiency, speed of execution, and high return on our investments. Innovation is a critical enabler of our growth strategy, and key advancements such as ProSite 1, IDEX's innovative and easy-to-use hematology analyzer, continues to gain momentum and provide multiplier benefits for our business. Just one year after its launch, ProSight One is now commercially available around the world and has a global installed base of almost 4,000 units, demonstrating the power of the right product in the hands of a dedicated commercial sales force. This trajectory aligns our premium hematology business with the approximately 20,000 placement outlook we shared at our most recent investor day, and utilization rates are trending favorably for customers upgrading from laser sighted. Cross-I-1 attach rates with catalysts are high in the mid-90% range, highlighting the multiplier benefit to our broader point-of-care business. This innovative hematology platform is a key enabler to support penetration of our estimated 200,000 worldwide premium instrument placement opportunity. Another key advancement in our innovation agenda is 40X+, the gold standard diagnostic for vector-borne disease in canines. which will provide customers with benefits from multiple product enhancements this year, including the more sensitive anaplasma detection, clinical decision support, and USDA approval for two times longer room temperature storage for our point-of-care test, SNAP 40X+. It's an example of IDEX's whole product approach of enhancing assay performance, workflow, and clinical decision support. Additionally, the SNAP Pro Analyzer, which has had excellent momentum in global placements during Q1, improves clinic workflows by seamlessly adding test results to our powerful diagnostics portal, Vecunic Plus, and ensuring charge capture of all tests run through the instrument. These innovative products help our customers improve clinic efficiency and supported solid growth in our rapid assay franchise in the first quarter, as we saw seasonally aligned increases in demand for tick-borne disease testing. As we capture near-term benefits from our existing innovations with customers, We continue to advance our long-term innovation agenda as well. As noted in our financial guidance update, we made investments with two companies to in-license technology for worldwide exclusive use in developing point-of-care diagnostics platforms and applications. IDEX has a long track record of partnering with companies to apply technology that enhances the quality of pet health care. We look forward to sharing more on these initiatives in the future. as we build on our compelling real-time care portfolio. Another key area of strategic focus for IDEX involves delivering whole-product software solutions that address a broad jobs-to-do capability within a single platform. Our PIM solutions, along with VAT radar and payment processing solutions, VAT Connect Plus, with clinical decision support and WebPACs, are all increasingly interconnected. offering our customers a seamless experience across these important clinical and productivity applications. Consequently, our customers purchased more of these applications in Q1 than in any previous quarter. We also had record global placements with over 350 PIMS installations, with the vast majority of customers choosing a cloud-based solution. Notably, we made significant headway in outfitting Greenfield practices, that the IDEX is a key partner as they establish and equip a new clinic. With many customers' capacity constrained, veterinarians have a significant investment appetite for modern, mobile, and well-integrated cloud-based software technology. These software solutions allow our customers to focus on providing care instead of maintaining technology. With our recent acquisition of EasyVet and as preference for cloud-based solutions accelerate, our software revenue base continues to move towards a highly profitable recurring revenue stream. As we advance our commercial and innovation capabilities, we are highly committed to sustaining outstanding levels of customer support, reference lab service turnaround time, and product availability enabled by our highly capable operations organization. The manufacturing and supply chain capabilities that we've built over multiple decades allow us to support our busy customers and keep up with the strong growth in industry demand while managing through a dynamic supply chain environment. IDEX customers benefited once again from product availability close to 100% and continuously high levels of on-time deliveries. These excellent service metrics demonstrate the benefit of our long product life cycles in deep supplier relationships, as well as our investment in highly skilled manufacturing centers. And while we continue to monitor the impacts of inflationary dynamics and regional COVID-19 outbreaks, we feel confident in our ability to build upon strong financial performance, as Brian outlined in our full-year financial outlook. In concluding our first quarter review, I'd like to welcome Michael Johnson to IDEX as our new Chief Human Resources Officer. Michael brings over 22 years of experience in developing HR leadership capabilities across multiple disciplines and geographies, most recently at Abbott Laboratories, where he was Divisional Vice President of Diversity and Inclusion. The Chief Human Resources Officer role is a key enabler of our long-term growth strategy in supporting employee engagement, talent development, and organizational effectiveness, and we look forward to Michael's leadership in continually advancing our initiatives and performance in these areas. Welcome, Michael. This concludes our review of our first quarter performance. Before opening the line for Q&A, I want to extend our deepest sympathies to the people of Ukraine, as the escalating war has taken a devastating toll on people and pets in the region. As a purpose-driven company, we strongly condemn the invasion and violence there. We have been focused on supporting our customers, the health and safety of our employees in the region, and true to the heart of IDEX, the pets that are part of their families. We have significantly scaled back operations in Russia, including suspending sales of veterinary diagnostic equipment in the country. Instead, our focus has been on supporting the essential care of pets to the extent that we can through our existing veterinary customers. To support the humanitarian needs of the region, we have leveraged the IDEXX Foundation to provide funding to the International Medical Corps, the World Central Kitchen, and the International Fund for Animal Welfare. We're also providing free rabies tests for displaced Ukrainian pets all over Europe. Going forward, we will monitor the situation to identify additional ways to support Ukrainian refugees and their pets. We would like to thank our employees around the world who have taken part in the IDEXX Foundation Matching Program to make personal donations to these organizations. With that, we will turn to Q&A.