IDEXX Laboratories, Inc.

Good morning and welcome to the IDEXX Laboratory's third 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 gaps A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is provided in our earnings release, which may be also found by visiting the investor relations section of our website. In reviewing our third 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 third quarter earnings call. In terms of highlights, IDEXX achieved solid organic revenue and profit growth in Q3, building on strong prior year results. Overall IDEX revenues increased 8% organically, supported by 9% organic growth in CAG diagnostic recurring revenues. Key execution metrics remain strong. This is reflected in record Q3 premium instrument placements, double-digit growth in veterinary software and digital imaging revenues, and 10% organic growth in U.S. CAG diagnostic recurring revenues. Operating profits and EPS increased 12% and 13%, respectively, on a comparable basis, reflecting solid gross margin gains and controlled operating expense growth. Outstanding execution in the quarter has us on track to deliver a strong full-year financial performance aligned with our updated guidance range. In terms of our full-year operational outlook, we've incorporated our Q3 organic growth results and maintained a similar midpoint estimate for EPS performance, supported by strong second-half comparable operating profit gains. We've also adjusted our reported revenue and EPS outlook to reflect updated estimates for foreign exchange impacts. We'll walk through the details of our four-year outlook later in my comments. Let's begin with a review of our third quarter results. Third quarter organic revenue growth of 8% was supported by solid organic gains across our major business segments, including 8% organic growth in our CAG business, 12% organic growth in water, and 7% organic growth in LPD revenue. CAG diagnostic recurring revenue increased 9% organically in Q3 compared to strong prior levels, reflecting 10% gains in the US and 6% growth in international regions, net of a 1% equivalent day growth headwind. We achieved double-digit organic growth benefits from key execution drivers, including expansion of our premium instrument base, consistent new business gains, sustained high customer retention levels, and solid expansion of diagnostic revenues per clinical visit, including benefits from higher net price realization. These gains helped IDEXX deliver continued solid CAG recurring revenue growth, offsetting near-term headwinds related to year-on-year declines in clinic visit levels globally, including effects from a pullback in clinic capacity this year and macro impacts in international markets. Overall organic revenue gains were also supported by 15% organic growth in veterinary software and diagnostic imaging revenues. CAG instrument revenue was down modestly compared to high prior levels, as strong placement gains were moderated by mixed effects. In terms of CAG sector demand drivers, continued healthy trends supported solid increases in diagnostic revenues at U.S. clinics. Diagnostic revenue increased 7% on a same-store basis in the U.S. in Q3, or approximately 9.5% on a per-visit basis, reflecting continued solid gains in diagnostic frequency and utilization, including benefits from higher net price realization at the practice level. Clinical visit levels in Q3 were down 2.4%, a slight improvement from Q2 trends as we continue to work through impacts from reductions in vet clinic capacity from peak levels and the lapping of the significant step-up in demand for pet healthcare during the pandemic. We anticipate year-on-year visit growth headwinds will continue in the fourth quarter, which is factored into our outlook. IDEX's U.S. CAG diagnostic organic recurring revenue growth of 9.6% in Q3, which included a 1% in equivalent days growth headwind, continues to outpace sector growth trends. This strong performance was supported by a 1300 basis point normalized growth benefit from IDEX execution drivers. This included consistent growth benefits from IDAC utilization and innovation gains and customer additions, and an estimated 6% net price benefit in the U.S., supported by our second half price initiatives. Globally, IDACs achieved solid organic revenue growth across our modalities in Q3. IDAC's VetLab consumables revenues increased 9% organically, reflecting solid gains across U.S. and international regions. Consumable gains were supported by 14% year-on-year growth in our global premium instrument install base, reflecting double-digit increases across our catalysts, premium hematology, and set of view platforms. We placed 4,737 CAG premium instrument placements in Q3, an increase of 10% year-on-year, building on the record placement levels achieved in the third quarter of 2021. The quality of instrument placements continues to be excellent, reflected in 13% growth in new and competitive catalyst placements compared to strong priority levels. ProSite 1 momentum also continues to build globally, supporting a 26% year-on-year increase in premium hematology placements in the quarter. Global rapid asset revenues expanded 7% organically in Q3, compared to high priority of demand levels, supported by benefits from net price increases. Global lab revenues increased 8% organically in Q3, as double-digit growth in the U.S. was moderated by modest organic revenue growth in international regions, reflecting pressure on same-store clinic visit growth in Europe, including macroeconomic impacts. We continued to achieve solid new business momentum and sustained high customer retention levels across our major modalities, supporting sustained solid volume growth. CAG recurring revenue growth included debt price benefits in the range of 5% to 6% to worldwide CAG diagnostic recurring revenues in the quarters, reflecting product and service enhancements and coverage of inflationary impacts. In other areas of our CAG business, veterinary software and diagnostic imaging revenues increased 15% organically. Results were supported by double-digit organic gains in recurring software and digital imaging revenues and continued strong momentum in cloud-based software placements. Water revenues increased 12% organically in Q3, reflecting strong performance across our major regions, including benefits from solid volume gains and net price improvement. We completed the acquisition of TechTip PDS in the quarter, an automated microbiology testing platform which complements our existing water offering and expands our capabilities in this highly attractive business segment. Livestock, poultry, and dairy revenue increased 7% organically in Q3. Results benefited from growth in herd health screening and improved results in China, where we worked through comparisons to high prior year revenue levels for African swine fever core swine testing. Turning to the P&L, Q3 profit results were supported by solid gross profit gains. Gross profit increased 7% in the quarter as reported and 10% on a comparable basis. Gross margins were 60.2% of 120 basis points on a comparable basis. Benefits from net price gains, lab productivity initiatives, improvement in software service cost margins, and business mix offset inflationary cost effects. Operating expenses increased 6% year-on-year, as reported in the third quarter, and 9% on a comparable basis. As planned, operating expense growth was more in line with revenue gains as we prioritized investments and gained leverage from our prior commercial expansions. EPS was $2.15 per share, an increase of 13% on a comparable basis. Q3 EPS results did not include tax benefits related to share-based compensation, which were down 5 cents per share from high prior levels. Foreign exchange reduced operating profits by $8 million and EPS by 8 cents per share in Q3, net of $9 million in hedge gains. Free cash flow was $151 million in the third quarter. On a trailing 12-month basis, our net income to free cash flow conversion rate was 67%. For the full year, we've updated our estimate of free cash flow conversion to 60% to 65% to incorporate expectations for continued higher inventory levels aligned with sustaining high product availability. The full year outlook reflects approximately 20% of free cash flow conversion impact this year from discrete R&D investments, higher inventory levels, higher deferred tax assets driven by increased R&D tax credits, and an investment in a major facility expansion. We've updated our full-year outlook for capital spending to approximately $165 million, including $40 to $50 million in 2022 spending for our new manufacturing and warehouse project. Our balance sheet remains in a strong position. We ended the quarter with leverage ratios of 1.4 times gross and 1.3 times net of cash. We increased our financing flexibility with the recently completed credit facility amendment, which provides for a $250 million term loan on attractive terms with proceeds applied to reducing our revolving credit balance. In Q3, we allocated $167 million of capital to purchase 453,000 shares. Capital allocation to share repurchases supports our projected 2% full year reduction in share account this year. Turning to our 2022 full European outlook, we're narrowing the organic revenue growth range to incorporate our solid Q3 performance and a consistent outlook for Q4 organic revenue growth aligned with the midpoint of our prior second half guidance. We're also maintaining our full year outlook for comparable operating margins, which sustains strong prior year levels, adjusting for the impact of the discrete $80 million R&D investment recorded in Q2. We're updating our reported revenue EPS outlook to reflect the recent strengthening of the US dollar, which we estimate will reduce 2022 revenue by $10 million and EPS by $0.04 per share compared to our last outlook. We're also factoring in a $0.01 per share adjustment for projected changes in interest rates. Overall, our updated full-year revenue growth range of $3,325,000,000 to $3,365,000,000 is consistent at midpoint with earlier estimates, as FX impacts offset improvements to our operational outlook. We now project FX will reduce year-on-year revenue growth by 4% for the full year, with approximately 6% of year-on-year headwinds expected in Q4. Our updated full-year organic revenue growth outlook is now 6.5% to 7.5%, reflecting a full-year CAG diagnostics organic recurring revenue growth outlook of 7.5% to 8.5%. Our updated CAG diagnostic recurring revenue outlook implies fourth quarter organic gains of 5 to 10% aligned with earlier estimates, which factors in a 2.5% organic growth risk estimate at the low end of the range for potential macroeconomic impacts on demand. We've updated our estimated full-year operating margins to 26.3% to 26.8%, reflecting a consistent operational outlook at midpoint and an estimated 10 basis points in year-on-year net margin impact from updated foreign exchange estimates. This outlook reflects a projected 230 to 280 basis point decrease on a comparable basis compared to strong 2021 performance, including approximately 230 basis points of operating margin impact related to the discrete R&D investments. Our updated EPS outlook is $7.74 a share to $7.98 per share, including the 72-cent impact from the discrete R&D investments. This represents a decrease of approximately 5 percent per share at midpoint, reflecting updated estimates for FX and interest rate impacts. For the full year, we estimate foreign exchange will reduce full-year operating profits by approximately $28 million and EPS by 25 cents per share. This is net of an estimated $29 million or 26 cents per share benefit from projected 2022 hedge gains. Our outlook factors in no EPS impact from stock-based compensation tax benefits in the second half. We've provided details on our updated outlook in the tables and our press release and earnings snapshot. Looking forward, we're advancing our planning processes for 2023. We're targeting sustained strong execution that supported delivery of solid organic revenue and comparable profit growth, building on the substantial financial gains IDEX achieved through the pandemic. Given the significant strengthening of the U.S. dollar this year, in 2023, we estimate that foreign exchange will reduce reported revenue growth by approximately 3%, reported operating margins by approximately 70 basis points, and EPS by approximately 45 cents per share at the rates assumed in our press release with current hedge positions. We'll provide updates on these estimates as we share our 2023 guidance on the year-end conference call. That concludes our financial review. I'll now turn the call over to Jay for his comments.

Thank you, Brian, and good morning. I'm pleased to share that IDEX delivered strong results in the third quarter, as teams across the company continued excellent execution to advance our strategic priorities. Demand for companion animal health care remains high, building on stepped-up levels during the pandemic and supported by a continued focus on service within veterinary clinics. Veterinarians are looking for partners to support their growth while they provide high levels of care in an efficient manner. These professionals continue to turn to IDEX for the support in the third quarter. This was reflected in yet another quarter of record placements of premium capital instruments, strong momentum in PIMS placements amidst its continued desire for cloud-native products, consistent new business gains, and sustained high customer retention levels. These continued trends demonstrate that veterinarians appreciate IDEX's integrated ecosystems, and the layers of innovation would support and improve each step of clinic workflows. The result was expansion across IDEX execution growth drivers, including relatively higher net price realization, which drove IDEX CAC diagnostics recurring revenue growth to significantly outpace clinical visit growth. This supported solid same-store diagnostics revenue growth in the U.S., despite moderating impacts from reductions in clinic capacity levels this year. This morning, I'll highlight how IDEXX continued to advance our key strategic initiatives in the quarter while delivering strong financial results. I'll begin with a review of recent trends in the companion animal sector. Third quarter CAG sector trends were supported by solid global demand for veterinary services, building on a significant step up in pet ownership in patient visits during the pandemic. U.S. same-store diagnostics revenues grew 7% per practice during the third quarter, a sequential increase from the prior quarter and well above total same-store practice revenue growth of 4% in a quarter. Services remain a key focus for veterinarians, and within services, diagnostics is a key component in providing valuable healthcare insights, supporting practice economics and driving revenue growth. Consistent with trends through this year, Diagnostics revenue growth at the practice level continues to be driven by increases in both the frequency and utilization of diagnostics, resulting in 9.5% growth in diagnostics revenue per visit for the quarter, building on the strong gains seen through the pandemic. IDEX grew overall U.S. CAG diagnostics recurring revenue at approximately 10% normalized, despite recent clinic visit growth headwinds. as we benefit from decades of focus and investment, which brings differentiated value to our customers. As Brian noted, IDEX execution drivers contributed approximately 1,300 basis points to U.S. growth in Q3 on a normalized basis. This reflects benefits from continued expansion of our premium instrument installed base, adoption of IDEX innovations, consistent business gains, record retention levels, and increased price realizations. On a multi-year basis, clinical visit growth was healthy in the quarter, with solid growth in both wellness and non-wellness visits. Three-year, CAGR wellness visit growth in particular, was in line with historic trends of 2% to 3%, demonstrating that U.S. pet owners are continuing to prioritize pet health care. This trend continues to be supported by IDEX's turnkey preventive care program, which included approximately 200 new U.S. enrollments in the quarter. This is the second quarter of year-over-year increased enrollments, showing that customers continue to appreciate the simple yet comprehensive testing and pet owner communication tools included in this program. This program is just one example of how we are engaging with our customers to support them through near-term challenges related to managing clinic capacity and meeting growing demand for health care services. We are building on our strong customer relationships to drive continued solid organic growth in our CAG business. With that, let's now turn to discuss IDEX's strong progress against our key strategic growth initiatives. As mentioned, excellent execution across the IDEX organization supported strong performance during a dynamic third quarter, with commercial teams delivering the day while also building the foundation for long-term growth across regions. Record quarterly placements of premium instruments supported another quarter of double-digit growth at our worldwide premium instrument install base. Global premium instrument placements grew 10% in a quarter, and placements in new and competitive accounts grew even faster at 13%, supporting strong EVI gains across regions. These results, combined with continued sustained new business gains and 98% catalyst customer retention rates, will support future recurring revenue growth aligned with a long-term financial framework shared at our recent investor day. Sustained high levels of commercial performance were aided in part by continued improvement in the rate of in-person visits for account managers, up to 75% in the U.S. and nearly 70% in Europe. IDEC sales representatives are welcome in the clinic as trusted advisors to their customers, adding value by helping customers provide high-standards medical care drive strong practice economics, and improved practice efficiency. These results are also supported by our world-class innovative products like ProSciOne and customer-friendly marketing programs that help support the adoption of IDEX innovations. ProSciOne provides customers with an efficient, lower-cost hematology platform at the point of care, and is especially sought after in international regions where veterinarians have been trained to do hematology testing first when doing a basic workup on a patient. This platform is integral to our strategy to address the approximately 230,000 long-term global instrument placement opportunity that Dr. Tina Hunt shared at Investor Day, and third quarter results continue to be very encouraging. ProSite 1 was a key driver of 26% growth in premium hematology placements in the quarter, with international regions representing approximately 75% of ProSite 1 placements. and more than 60% of its installed base. Attach rates for ProSite 1 are consistently high. Over 95% of ProSite 1 customers overall and more than 80% of competitive customers also utilize our chemistry platform, demonstrating the excellent placement quality and strong multiplier benefit of this platform. These results are further supported by benefits from investments we have made to expand our global commercial organization. where we are seeing positive reach to revenue trends and deeper customer relationships. Customer survey work in Germany and France demonstrates that customers have had an overwhelmingly positive experience during the first year of the new commercial ecosystem. Over 90% of customers in Germany, for example, indicate that their commercial experience is the same or better than a year ago, with the highest satisfaction rates and practices to receive continuous commercial engagement. This feedback highlights the benefit of our high touch commercial model where diagnostic subject matter experts partner with practice owners and staff to drive practice patient care and business objectives. Our commercial and operational teams in the Asia Pacific region are also driving successful execution against their strategic plans. Asia Pacific premium instrument placements are at a record high and were delivered while hiring and onboarding new sales professionals in Japan. and opening a new reference lab in Brisbane, Australia during the quarter. Concurrent, seamless execution of our commercial investments across multiple regions is not easy to do, and to do so while also delivering against our business goals. This demonstrates the value of the investments we've made in these teams, which will continue to benefit us as we work to address the significant long-term addressable opportunity outside the U.S. In addition to these excellent commercial results, we also delivered multiple new technologies to our customers during the quarter. Since VMX in January, we have announced eight new product, service, and software solution enhancements across IDEX modalities, each of which add value to the relationship that customers have with IDEX, while demonstrating our commitment to a technology-for-life strategy. Five out of eight of these projects were launched in the third quarter. These are, number one, expanding the comprehensiveness of our fecal antigen reference lab tests, by adding a flea tapeworm assay, which now detects up to five times more than traditional methods. Number two, providing faster access to PCR results for North American customers by opening a next-day PCR lab in Louisville. Number three, improved veterinary insight into the treatment of feline chronic kidney disease by adding an improved disease marker, FGF23, to our reference lab menu. Number four, improving the efficiency, convenience, and sustainability of the Catalyst STMA test by reformulating the test to include onboard reagents, and number five, delivering enhanced accuracy and longer room temperature storage in our best-in-class 40X-plus test. The rollout of these new products and services was enthusiastically received by our customers and highlighted the IDEX team's ability to deliver high-quality new products, which will help increase standards of animal health care and develop our sector, while also providing very high customer service levels. Another strategic area of innovation is IDEXX's software and diagnostic imaging businesses, which include a full suite of software product offerings to create a connected ecosystem within the clinic that supports each step of clinic workflow through the patient appointment. The practice information management system and its easily updatable, customer-friendly front-end interface is the center of this solution. Record third quarter PINs placements highlight strong customer interest in the whole product solution that IDEX offers. Furthermore, the shift to cloud-based products that we highlighted at Investor Day continued in the quarter as over 90% of placements were cloud-based subscriptions, reflecting 50% growth in cloud-based placements compared to the prior year and demonstrating the value that last year's EasyVet acquisition continues to bring to the business. Strong results across this business in a quarter were not limited to PIMS products. Diagnostic imaging systems placements, Webpack subscriptions, PIMS application adoption like payment processing, and VetConnect Plus with clinical decision support engagement all advanced at healthy levels in the quarter. We know veterinarians are looking for ways to obtain, understand, and communicate diagnostics insights in a digital and streamlined way. and our software portfolio is well-positioned to provide them with these solutions. The benefits of these products and solutions to IDEX and our customers are compelling. They have highly favorable economics, given the recurring nature of their revenue stream and high incremental gross margins. They also drive customer engagement, which supports our high levels of retention, since they improve our customers' productivity and overall experience. IDEX's innovation agenda also extends beyond our companion animal business. We recently took the opportunity to advance our water business by acquiring TECTA, Pathogen Detection System, with an automated microbiology detection platform that uses patented technology to automate the incubation, reading, and results notification for E. coli and total coliform testing in drinking water supplies. This application provides an automated, data-enabled instrument in EPA-approved coliform testing solutions that complements our core water solutions by providing value for customers operating under rush conditions. We're excited to be able to invest in the attractive area of water testing and leverage our commercial resources to scale this new technology. This innovation agenda demonstrates a relentless focus on providing our customers with world-class products that increase in value over time. Products that not only provide them with important insights, but also help increase workflow efficiency and effectiveness. In addition to these top-notch products, our customer focus is supported by extremely high service levels to ensure customers have a wonderful experience with IDEX, allowing us to earn their business every day. Our frontline supply chain and customer service teams continue to deliver high levels of service, reflected in another quarter of approximately 99% product availability, despite ongoing challenges in the external environment. This strong performance leverages years of investment in our supply chain and customer support resources as we continue to deliver on the operational needs of our customers. That concludes our review. I'm proud to report another quarter of strong results as IDEXX remains well positioned to deliver solid growth in financial results over the long run, while also delivering on our mission to create a better future for animals, people, and our planet. Our performance reflects the commitment and talents of our IDEXX teams. On behalf of the management team, I'd like to thank our more than 10,000 colleagues for the passion and engagement they bring to our purpose and strategy every day. You're making a meaningful difference to the health and well-being of pets, people, and livestock around the world. So now, we'll end the prepared section of the call and open the line for Q&A.