IDEXX Laboratories, Inc.

Good morning, and welcome to the IDEXX Laboratory's first quarter 2023 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 2023 results, please note all references to growth, organic growth, and comparable growth refer to growth compared to the equivalent period in 2022 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 if 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. Today's prepared remarks will be posted to the investor relations section of IDEX.com after the earnings call concludes. I would now like to turn the call over to Brian McKeon.

Good morning and welcome to our first quarter earnings call. IDEX had a solid start to 2023. In terms of highlights for the quarter, overall revenues increased 10% organically, supported by nearly 12% organic growth in CAG diagnostic recurring revenues. CAG diagnostic recurring revenue gains were driven by nearly 14% organic growth in the U.S., supported by solid volume gains and benefits from a higher net price realization. Key execution metrics remain strong globally, reflected in record first quarter premium instrument placements, continued solid new business gains, and sustained high growth and recurring veterinary software revenues. Operating profits in EPS increased 18% on a comparable basis, reflecting solid organic revenue growth, better than expected gross margin gains, and benefits from a $16 million customer contract resolution payment. These strong results reflect the durability and resiliency of the IDAC's business model and benefits from our ongoing focus on execution. We've incorporated our Q1 results and positive adjustments to our four-year financial outlook, which we'll discuss later in my comments. Let's begin with a review of our first quarter results. First quarter organic revenue growth of 10% was driven by 11% CAG gains and solid 8% growth in water. Overall organic revenue gains were moderated by 2% declines in our LPD business and approximately $4 million of revenue headwind related to lower humid COVID testing revenues, a business area that we winded down completely in Q1. TAG diagnostic recurring revenue increased 12% organically, reflecting 14% gains in the U.S. and 8% growth in international regions. TAG-diagnostic recurring revenue growth was supported by global net price gains in the 8% to 9% range, consistent with our expectations. Overall organic revenue gains were also supported by 14% organic growth in veterinary software and diagnostic imaging revenues. TAG instrument revenues were down 7% organically, reflecting comparisons to high prior year levels, program pricing effects, and global mix. IDAC's CAG diagnostic recurring revenue growth remained solidly above sector growth levels. In the U.S., we achieved a 1,350 basis point growth premium compared to relatively flat same-store U.S. clinical visit growth levels in Q1. These results reflected benefits from execution drivers, including higher net price realization. Solid U.S. volume growth was supported by new business gains, high customer retention levels, and continued increases in diagnostic frequency and utilization at the practice level. International CAG diagnostic recurring revenue gains were also supported by strong IDEX execution, reflected in higher net price realization, sustained new business gains, and a double-digit expansion of our premium instrument install base. Double-digit growth rate benefits from these drivers were moderated by impacts from challenging international macro conditions, which continue to pressure same-store volume growth trends in the quarter. Globally, IDEX achieved strong organic revenue growth across our modalities in Q1. IDEX VETLAG consumable revenues increased 12% organically with double-digit gains in the U.S. and international regions. Consumable gains were supported by 11% year-on-year growth in our global premium instrument install base, reflecting double-digit increases across our catalyst, premium hematology, and CETAV platforms. We placed 4,425 CAG premium instruments in Q1. an increase of 3% year-on-year compared to very strong prior year levels, building on the record placement levels achieved in the fourth quarter of 2022. The quality of instrument placements continues to be excellent, reflected in 7% growth in new and competitive catalyst placements. ProSite 1 momentum also continues to be strong globally, reflected in a global install base that more than doubled over the last year to 9,400 units. Global rapid assay revenues expanded 12% organically, driven by strong growth in the U.S., reflecting solid volume gains and benefits from higher net price realization. Global lab revenues increased 11% organically, reflecting strong gains in the U.S. and mid-single-digit growth in international, with growth in key international regions moderated by macroeconomic impacts, which have pressured same-store sales. In terms of other areas of our CAG business, veterinary software and diagnostic imaging revenues increased 14% organically. Results were supported by continued high levels of organic growth and recurring software and digital imaging revenues and ongoing momentum in cloud-based software placements. Water revenues increased 8% organically in Q1, reflecting solid gains in the U.S., Europe, and Latin America, including benefits from net price improvements. The integration and performance of our recent tech-to-PDS acquisition has progressed well, expanding our capabilities in water safety testing. Livestock poultry and dairy revenue decreased 2% organically, as solid gains in the US and Europe were offset by comparisons to high prior year sales levels and herd health screening, and reduced revenues from non-core food and safety products in certain regions. Turning to the P&L, Q1 profit results were supported by a 150 basis point improvement in reported operating margins, reflecting 10% organic revenue growth, solid gross profit gains, and benefits from a $60 million customer contract resolution payment. Gross profit increased 9% in the quarter as reported and 12% on a comparable basis. Gross margins were 60.3% of 120 basis points on a comparable basis. Benefits from higher net price realization, lab productivity initiatives, improvement in software service gross margins, and business mix offset inflationary cost effects. Later timing of lab staffing increases and select operational upsides also supported KeyOne gross profit results. As expected, reported gross margin gains were moderated by a 50 basis point negative impact related to court exchange changes, including lapping of prior year hedge gains. Operating expenses increased 5% year-on-year as reported in the quarter and 7% on a comparable basis. This was net of a $16 million or 6% operating expense growth offset related to the customer contract resolution handout. As planned, we saw higher growth in sales and marketing and R&D expense in the quarter related to specific factors, including the return of in-person sales meetings this year and advancement of key innovation initiatives. EPS was $2.55 per share in Q1, an increase of 12% as reported and 18% on a comparable basis. Foreign exchange reduced operating profits by $12 million and EPS by 11 cents per share in the quarter, including impacts on the lapping of prior year hedge gains. Free cash flow was $144 million in the first quarter. On a trailing 12-month basis, our net income to free cash flow conversion ratio was 65%. For the full year, we're maintaining our outlook for free cash flow conversion of 80% to 90%, including estimated capital spending of $180 million. Our balance sheet remains in a strong position. We ended the quarter with leverage ratios of 1.1 times gross and 1 times net of cash, down modestly from Q4 levels. Share purchases over the last year supported a 1.9% reduction in diluted shares outstanding. We did not allocate capital to share repurchases in the first quarter as we manage our balance sheet relatively more conservatively in the current interest rate environment. Turning to our 2023 P&L outlook, we're refining our full-year outlook to incorporate our solid Q1 operating results and updated estimates for foreign exchange impacts. We're updating our full-year guidance for reported revenues to $3,615,000,000 to $3,700,000,000. This includes a $10 million positive adjustment for foreign exchange impacts, which we now estimate will provide a relatively modest four-year headwind to reported revenue growth. Our updated outlook for overall organic revenue growth is 7.5% to 10%. Our Q1 results track towards the high end of this range, and we're maintaining consistent high-end targets for our performance this year, reflecting benefits from execution drivers and the potential for reduced clinical visit growth headwinds. As part of our financial management approach, we incorporated risk estimates toward targeted growth performance in the low end of our organic revenue growth range, including potential effects from macroeconomic conditions. We raised the low end of our full-year organic revenue growth outlook by 0.5% in our updated guidance, incorporating our solid start to the year. We're maintaining our outlook for solid operating margin performance in 2023. with an expectation for reported operating margins in the range of 29% to 29.5% for the full year. At the high end, this reflects an outlook for approximately 340 basis points in comparable operating margin expansion. This includes approximately 280 basis points in combined benefit from the $16 million Q1 customer contract resolution payment and the lapping of $80 million of discrete R&D investment in the second quarter of 2022. We now estimate that foreign exchange will reduce reported operating margins by approximately 60 basis points this year, slightly higher than earlier projections, which included impacts from the lapping of $26 million in 2022 edge gains. Our updated EPS outlook is $9.33 to $9.75 per share, reflecting a 6 cents per share increase in our low-end estimates. We continue to estimate that foreign exchange impacts will decrease EPS by approximately 23 cents per share for the full year, with the bulk of this impact in the first half. In terms of our operational outlook for Q2, we're planning for overall organic revenue growth consistent with the midpoint to higher end of our full-year growth outlook range, with approximately 1% of reported growth headwind from year-on-year FX changes. In terms of Q2 operating margins, we're planning for reported operating margins in the range of 29% to 29.5%. This reflects expectations for relatively consistent operating margin performance year on year, adjusting for about 70 basis points in negative foreign exchange impacts and benefits from comparisons to prior results, which included $80 million in discrete R&D investment. We provided details on our updated outlook in the press release tables and earnings snapshots. Overall, we're applying a disciplined financial approach that advances our growth strategy and mitigates potential macro risks to ensure delivery of continued strong financial performance. 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 had a very strong start to 2023, driven by sustained execution of our growth strategy. Demand for companion animal medical services continues to grow. supported by IDEXX innovation and direct customer engagement. Veterinarians continue to focus on meeting these high levels of demand with the best possible medical care, with diagnostics as an essential component of this care equation. IDEXX remains a chosen, trusted partner to veterinarians who appreciate how our world-class products and connected ecosystem enable high standards of care while resulting in growth of a significant profit center within their clinics. IDEXX's strong execution is reflected in double-digit total company organic revenue growth, supported by strong expansion of global CAG diagnostics recurring revenues. Growth in this recurring revenue annuity was supported by solid contribution for new business gains, sustained high customer retention rates, and net price realization aligned with our expectations. Our commercial teams drove another record quarter for global premium instrument placements and excellent levels of cloud-based software placements. IDEXX products and services offer solutions to improve clinic productivity and support the significantly expanded and underserved demand we've seen for pet healthcare in recent years, including net pet additions in the U.S. of 2% in 2022, twice the pre-pandemic trend line. These efforts supported strong IDEXX growth as we continue to work effectively through the near-term sector headwinds related to clinic capacity constraints and global macro conditions. Today I'll discuss how IDEXX's sustained execution against our strategy to drive the adoption and utilization of diagnostics helped deliver continued strong financial results. First, I'll provide an update on our commercial execution, which, through education and customer engagement, drives relevant utilization of IDEXX's innovative solutions. IDEXX commercial teams delivered another record first quarter global premium instrument placements to start 2023. building on very strong prior year results. Our commercial teams demonstrated a continued ability to advance placement quantity and quality. This is reflected in strong growth in catalyst placements and new and competitive accounts globally, driving solid EVI achievement. These commercial results are highly encouraging as we address a significant opportunity for an estimated 220,000 worldwide premium instrument placements. and give us confidence that we have the right strategic playbook in place. IDEXX professionals provide world-class software-enabled products that are in high demand and supported by a wide menu of customer-friendly marketing programs that enable adoption of new technology. These results also reflect continued strong clinical interest in using IDEXX's products and services to not only meet the increased demand for pet healthcare, but to deliver the best possible level of care. Our commercial execution is supported by the multiplier benefits that flow from IDEX innovations, as evidenced by the success of our newest hematology analyzer, ProCy1. ProCy1 provides customers with an attractive in-clinic hematology solution. Its small footprint, easy paper-run model, and lower cost come without sacrificing CBC performance. IDEX premium placements have benefited from strong ProCy1 adoption to date, thanks to sustained high attach rates with Catalyst. as defined by ProSite 1 placements either with a catalyst or at an existing catalyst customer. The result is a multiplier benefit supported by clinics who choose to outfit their in-clinic suite with IDEXX products. As a result, we are nearly halfway to the incremental 20,000 premium hematology placement objective we shared at Investor Day following ProSite 1's launch. While the strong attach rate should also help IDEXX penetrate the long-term worldwide placement opportunity. Key to developing this long-term opportunity will be increasing customer engagement in international regions. We're leveraging our successful VDC model to build strong relationships with international customers, as evidenced by sustained strong new business gains and a 19% increase in catalyst placements. This strong performance is allowing us to deliver solid CAG diagnostics recurring revenue growth in international regions, despite continued macro headwinds, which are pressured same-store clinic visit levels. Customer engagement remains excellent, as evidenced by high reach-to-revenue levels in the first quarter, including benefits from our expanded commercial sales force in targeted regions. The flywheel is beginning to turn in these countries, where we've seen excellent gains from new business, strong interest in engaging with customer marketing programs, and solid overall volume growth. Commercial expansion is an important early step in our international strategy. supporting recent efforts to optimize our reference lab network, roll out highly relevant products like ProSciOne, and drive further adoption of software tools like VetConnect Plus, our cloud-based diagnostics portal. Software innovation continues to be a key driver of our growth strategy globally. IDEC software solutions are a key enabler of diagnostic civilization, creating a connected ecosystem that helps improve diagnostics workflow while providing deeper clinical insights and supporting pet owner communication. It's an attractive standalone business as well. Strong PIMS placements in the first quarter were supported by continued preference for cloud-native products, with IDEX well-positioned to address this trend. Placements of cloud-based products maintained the strong velocity we saw coming out of 2022 and represented greater than 90% of total placements. supported by continued high interest in our EasyVet and Neo solutions, which are seamlessly integrated into our product offering. This provides customers with options when it comes to picking the best, most relevant PIMS solution for their clinic size and workflow complexity. Our strong first quarter placement performance supported double-digit recurring revenue growth with an attractive gross margin profile, and we're on track to achieve this year a PIMS footprint that is over 50% cloud-based. This milestone is especially important in the current veterinary clinic environment, where productivity is a priority in addressing the sustained high levels of demand due to the pandemic. By embracing IDEX's cloud-based ecosystem, customers gain the advantage of an easy-to-use software stack that touches every area of the veterinary clinic. And the benefit of these tools is enduring for our customers, evidenced by strong engagement metrics across applications. including increasing rates of our WebPACs user base that are power users, as well as sustained rates of DetConnect Plus users who use the software as part of their daily routine. Adoption and continued use of these products allows veterinarians and their staff to spend more time focused on the care they deliver to their patients rather than on costly, time-intensive administrative activities. Our software strategy is to increase cloud adoptions. and build increased business and clinical functionality into IDEX software solutions. Another use case of our innovation agenda is our 40X Plus test, the gold standard test for canine vector-borne disease testing. The current 40X Plus test is our fourth version of a multiplexed canine vector-borne disease diagnostics over the past 20 plus years with improved sensitivity of anaplasma and two times increase in the ability to store the product at room temperature. This is a true testament to our technology for life strategy and supported 12% global organic rapid assay recurring revenue growth and solid customer gains in the first quarter. A full vector-borne screen using 40X Plus is recommended over a heartworm-only test given significant increases in incidence and prevalence of vector-borne diseases over the past 10-plus years. And yet, in 2022, less than one in every five dogs received this comprehensive level of testing, 40X Plus enables veterinarians to deliver this higher standard of care with follow-up testing and care protocol guidance provided through Decision IQ, which aims to drive better health outcomes while encouraging increased diagnostics testing. Furthermore, our entire rapid assay franchise is supported by the SnapPro Analyzer. The analyzer not only simplifies the workflow when running a SNAP test, but also ensures the diagnostic results flow seamlessly to VetConnect Plus, and ultimately result in charge capture and invoicing at the point of sale. This is a clear case of how our product's integral components of our connected software ecosystem have proven value over time while delivering a multiplier benefit to our customers and drive IDEX CAG diagnostics recurring revenue. The sustained execution against our commercial and innovation agendas is made possible by an unrelenting focus on our customers. and ensuring they have world-class experience with IDEX. This takes multiple forms, all focused to ensure our customers have the resources they need to provide the best possible levels of medical care. Continued 99% plus product availability and reliable, fast reference web service turnaround times provide them with important business continuity and are the result of our investment in manufacturing and supply chain logistics teams, facilities, and relationships. Additionally, the support of the high-touch, highly knowledgeable sales teams that we have built out over the decades ensures they have the products and services that are right for their busy clinics. Our customers realize the benefits of the IDEX partnership every day and, in turn, reward us with their business and their enduring loyalty as measured by another quarter of consistent high customer retention rates. Providing our customers with reliable, consistent support is even more essential right now given the dynamic backdrop of our sector. High demand for animal medical services combined with sustained labor supply constraints continue to create productivity and growth challenges at the clinic level. Taking our customer support efforts a step further, we recently published an empirically-based study which examines the drivers of productivity within a practice It helps customers to understand their productivity strengths and areas for opportunities. Through this rigorous effort, we found three key drivers of practice productivity. Number one, workflow, which includes staffing models like optimized technician-to-veterinarian mix and staff and patient-friendly physical layout to the practice. Number two, technology. We're digitizing each step of the patient workflow to remove high-effort administrative routines. And number three, the role of culture. including clarity of roles and responsibilities, investments in training and staff effectiveness, and aligned incentives to drive teamwork and achievement of practice goals. As a result of this initiative, we believe there's still great opportunity for clinics to improve productivity measures, and we look forward to educating and supporting our customers in these efforts. Opportunities to do so could result in 30% or more incremental visit capacity. even for practices that are in the top cohort of productivity. We are integrating elements of these efforts into our strategy and commercial approach this year. With that, I'll now conclude the prepared remarks portion of the call by thanking our nearly 11,000 IDEX colleagues for the commitment and passion they bring to our purpose-driven work every day. Your efforts not only help provide a better future for animals, people, and our planet, but you also supported IDEX in starting 2023 on a strong financial note. We have an attractive sector and a strong track record, and the opportunity ahead of us, which is significant, is to work with our customers to elevate companion animal health care standards to increase diagnostics utilization. The tireless work of the IDEX team has positioned us well to deliver solid growth and financial results into the future. So on behalf of the management team, thank you for your continued focus on enhancing the health and well-being pets, people, and livestock.