Good morning, and welcome to the IDEXX Laboratories First Quarter 2022 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, 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, idexx.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. [Operator Instructions]. 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 and 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 higher 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, up 3% on a 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 IDEXX 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 for more challenging macro conditions, which have also constrained clinical visit growth compared to strong prior year baselines. Factoring in our Q1 results and near-term CAG sector trends, we're recalibrating…

Thank you, Brian, and good morning. IDEXX had a solid start to 2022, building on significant gains in demand for companion animal diagnostics and software solutions achieved over the last 2 years. Veterinarians continue to see increased demand in their clinics compared to pre-pandemic turns and routinely choose IDEXX' 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 ProCyte One. IDEXX' 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 IDEXX'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 continued 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…

[Operator Instructions]. And our first question is from Chris Schott from JPMorgan.

On this issue of vet constraints, it seems like we've been hearing about this issue for much of the pandemic. So I'm just trying to get a better understanding of kind of what's changed in 2022 where this is now starting to kind of back up into your revenue guidance, its starting to hit numbers a bit more. So I'm just trying to understand, just finally hit a breaking point where the vets just can't sustain what they've been doing? And maybe as a second part of that same question, what do you think it will take to start to see visit growth normalize? Do we need to just take a little bit of a pause here for some of these vets who need to hire people? I'm just trying to get a sense of just what's the path forward to see growth start to normalize. And then maybe just slip in one other one and some of the same kind of topic. Is the slowdown you're seeing here completely that capacity related? So if there were more slots for visits that there'd be demand for that? Or is there also some elements of lower demand reflected in the guidance today?

Thanks for your question, Chris. Maybe I can set some context and Jay can provide more color. On the clinical visit trends, which we've highlighted really were the main change that's going on here that would cause us to kind of recalibrate our outlook this year, we started lapping the step-up in demand in the pandemic in the second half of 2021. And that was flowing through the benefits of the pet additions and the big increases in services and diagnostics that we saw through the pandemic. And the clinical visit levels were up solidly in H2. So they were growing 2% to 3% off that higher base. And so this is a relatively more recent dynamic. I think Jay can go into this more in color, but it's clearly a significant factor here is the vet capacity. I think that there is a trying to adapt following, a significant expansion of the demand in the industry and just dealing with some of the labor dynamics that many sectors are dealing with in the near term. And we're still working through these tough year-on-year compares. I think that will continue through the first half of this year in terms of the step-up. So that is the primary factor. Other dynamics that are going on here are all incredibly positive. I think our -- at the clinic level, diagnostic frequency and utilization is up. The service, focus on services, service -- same-store service revenues are still growing. Sales are great. Instruments are very strong, software placements, customer retention, record levels. So this is primarily this dynamic, which we think is largely related to the capacity constraint. And that will normalize, I think, as we work through some of these compares and as clinics adapt to this long-term growth in demand that we think will sustain.

Yes. Chris, let me try to address your question from a context standpoint, both from the standpoint of capacity or supply, and then I want to talk a bit about the pet owner dynamics and demand. So all the surveys and all the conversations we've had with veterinarians indicate a good deal of optimism about the future and it includes 2022 in terms of growth and their prospects. Their focus is really, I think, pivoted. The pandemic has only accelerated the pivot towards being able to provide excellent medical services and patient care, as well as a pleasing client experience. So relatively less emphasis on things like product sales, specialty diets. They're also seeing, from a pet owner standpoint, demanding clients who really want full-service care. So speaking with a number of veterinarians just yesterday, they remarked when pet owners come in are still looking to really have sort of an end-to-end approach to care. So I talked about that strong pivot. And if anything, the pandemic, I think, has only accelerated that. And they know that the diagnostics plays a key role in being able to guide care services and the whole clinical envelope. And to Brian's point, at the same time, there's been a very significant step-up in activity, both in terms of number of patients. There's 10-plus percent more pets relative to pre-pandemic, 10-plus percent higher clinical visits. And the practices themselves, they haven't been immune to some of the labor and staff challenges that, to some extent, all businesses are facing. So they're working through that dynamic of higher activity, while trying to create some balance and looking to increase capacity. And they're looking at us in many respects, and have this large appetite for things like IDEXX instrumentation. We saw that manifest itself in higher…

[Operator Instructions]. And our next question is from Michael Ryskin from Bank of America.

Jay, Brian, I want to follow up on some of the points that you just touched on sort of the vet demands and what you're seeing in the channel. Just to put it bluntly, you've got -- if you look at the comps, first half last year, second half last year, obviously, the second half comps on that visit growth gets a lot easier. But if you look at it on a 2-year or 3-year basis, it's actually a little bit more normalized. So we can start getting into the math of you doing a 2-year compare, 3-year compare. But putting all that aside, what is your expectation for vet visit growth over the course of the year? I mean we're at negative 1.5 in the first quarter. There were some Omicron issues in January, but it seems like it didn't dramatically improve over the rest of the quarter. So what's your expectation for vet business growth in 2Q and then over the course of the entire year? And I've got a follow-up.

Yes, Mike. So on your first question, we're trying to look at these multiyear dynamics too. I think that's largely right. The one thing I'd point out is that the step-up in the new patients that occurred through the pandemic, there was an incremental aspect to the growth that I think benefited, we think, second half of 2021 into the first half of 2022. So there's a bit of a growth dynamic that's additive to making the first half a little more challenging. But I think on balance, we agree that the multiyear trends look quite good, and that informs some of our optimism. And in terms of how we're thinking about the year, if you look at the range that we provided, effectively, the higher end of the range assumes that we move back towards a healthy positive growth rate on the clinical visit trends. It's the -- as we noted, the CAG Diagnostic recurring revenue growth for the second half at the higher end reflects our original goals. And so that was what we were seeing coming into the year. And the lower end is more in line with what we're -- we've seen in Q1. So there's some level of pressure year-on-year continues. So we're not explicitly guiding on that metric. But those, I think logically, that's how the full year guidance ends together.

Yes. And I would just add to that, though, clinical visits, it's been an important part of our growth algorithm, but it's just one part. The other thing to keep in mind is the diagnostics adoption and the utilization piece of the business is very strong. We've highlighted that in the earnings highlight where adoption and utilization is at or higher than what we've seen from the pre-pandemic level. So from a customer engagement standpoint, I think we have a pretty well-defined playbook. It's really been honed and optimized over the years to be able to drive and inspire diagnostics adoption and utilization, both through creating awareness and education and ultimately, trialing. But also innovation and continuing to bring innovation that solves the challenging practice and patient problems. So we're optimistic about our ability to continue to do that and do that in an effective way.

Okay. And if I could squeeze in a bigger picture one, hopefully it should be quick. At the Analyst Day last year in August, you guys talked about same strong trends, the same sort of secular drivers. And you pointed to your view of the long-term diagnostic sector growth should be a full percentage point higher than prior because of the higher number of pets, because of the adoption, because of higher sort of diagnostics utilization. But if we sort of flash forward 6 months or 8 months to where we are now, obviously, we're seeing some near-term constraints. So I just wanted to, longer term, are you still sticking with that diagnostics growth of 1% above historical on a multiyear basis?

Yes. Just to revisit, we had a range on the multiyear CAG Diagnostic recurring revenue growth, and we raised the lower end of the range, I think, reflecting our confidence into the range is 11% to 14%. And really what underlies that range, and this underlies our business strategy is our effectiveness as a growing utilization of diagnostics with their customers over time. And the pre-pandemic improvement levels, as you're aware, Mike, we focused in on this, the percentage of -- the percentage of business that use blood work in diagnostics, and we had been seeing roughly a 50 basis point annual improvement in that metric over time, and that was the pre-pandemic trend. And we saw that accelerate in the pandemic to more like 100 basis points. So as Jay highlighted, we're continuing to see very nice improvement on diagnostic utilization. So we're very confident in that part of the strategy. That is the part of the strategy that we influence heavily with our innovation and our customer engagement, and we're very confident in our ability on that front. And so nothing's changed in terms of those dimensions. I think we are working through a period here where we had a big step-up in ownership in pets and demand and through the pandemic, and we're transitioned to growing off this higher base. And we're working through some compares here, but the long-term view of the optimism we have for the business in the long term hasn't changed.

And our next question is from Erin Wright from Morgan Stanley.

Great. I'm surprised a little that the vet capacity constraints are such a surprise to you relative to your prior expectations. But you did mention, Brian, at the beginning of your prepared remarks, a macro dynamic as well. And I was just wondering if that comment was in relation to the labor constraints or actually changes in consumer dynamics as well. And we've obviously seen -- and this goes into a bigger picture question of we've seen your business grow in a challenging economy kind of in the past. And can you remind us the sensitivity of your business to a tougher economic backdrop and what levers you have to grow in even a challenging clinic visit backdrop as well?

Yes. Just on -- let me reflect on the comment I made and then Jay can talk more about the resilience of the business. It was specifically related more to Europe. We saw relatively more softness in Europe than we anticipated. And so we're just signaling that it may be related to some of the impacts indirectly from the Ukraine war and higher energy prices and things of that nature. So we -- that it's harder for us to parse that, but it was -- that was what the comment related to.

Yes. Erin, just in terms of the resilience of the business. If you go back to the Great Recession and the recovery in 2008, 2009, our revenue grew 5%. Now a lot has changed over that 10-plus years, and I think from a very positive standpoint. We worked through other channels, third-party distributor channels. We now have our own direct channel and direct relationships with customers. We know that the human animal bond and the strengthening of the bond has suddenly increased and increased very appreciably. Obviously, there's a lot more pets. And our innovation portfolio, both across the reference labs and our point-of-care diagnostics portfolio, and very importantly, in this environment, software has gotten, I think, appreciably stronger and more capable, not just in the U.S. but globally. So we think we're a very resilient business that has become even more resilient as a result of those factors.

Okay, great. And then in terms of pricing, where is net price realization shaking out now for the year in terms of what's embedded in the guidance and relative to what you disclosed last quarter? And are there further price increases embedded for the remainder of the year?

As I mentioned in our comments our U.S., on average over the overall CAG Diagnostic recurring base was in the 4% to 5% range, so it's a bit better than we had indicated originally, and we've got solid improvements in other markets as well. So I think we feel good about our pricing plans, and that's something we will continue to look at over time. And I also note that I think vet clinics are showing an ability to pass on pricing as well, and that's reflected in their growth numbers.

Our next question is from Jon Block from Stifel.

Maybe just to start, we also picked up capacity constraints in our checks recently for this quarter. But we actually also had a similar amount, roughly a similar amount of vets start to talk about the demand equation. And so a pretty direct question here. But for the revised guidance, Jay or Brian, what are your thoughts there? What are you embedding? Is the new guidance all about the capacity constraints, you give those weekend metrics? Or did you also embed some wiggle room or earmark some stuff for the consumer? And what might be occurring or what might still need to play out, call it, into the back part of the year?

So we haven't explicitly projected changes in the macro environment in our outlook. What I would say is that we are capturing more recent dynamics, including some of the dynamics that have been going on in regions like Europe, which as we indicated, may have some macro impacts. And they signal, we're anticipating that the growth in the second quarter will be at the lower end of our full year organic growth range of 7.5% to 10%. So I think we are -- we're trying to capture what we believe includes the capacity dynamics, but what macro impacts may be going on into our outlook, and that's also reflected in the full year range that I shared earlier. So I think it's not something, again, we forecast specifically, Jon, but I think as Jay pointed out, this has been a business that's always been resilient. If anything, over time, the factors that are supporting our demand, whether it be strengthening of the pet owner bond or just improvements in our own capacity as a company to influence growth and support the industry have only grown. So we think that reinforces we'll have -- we'll be relatively well positioned to changes. And we think we're capturing kind of the more recent trends appropriately in the guidance range that we've shared.

Got it. Okay, fair enough. And then maybe just a follow-up. And I think you sort of hit on this here and there, but let me try to drill down on a little bit or get an answer. The CAG Dx frequency, you guys give a ton of helpful information. But the CAG Dx frequency or the percent of clinical visits, including diagnostics, that was roughly -- it looks like a 0.5% contributor to revenue growth per practice, call it, pre-COVID. Then it went to 3% in 1Q '21, and then it looks like back to 0.5% in 1Q '22. Why that move? Why that step down? And then maybe some color, is that a reflection of curb side stepping down as we're normalized and there's no longer the drop-off of the pet and maybe less friction on what the veterinarian wants to test for. Is that why we're seeing that return to normalization? Is that the anticipation going forward?

Yes. Jon, it's Jay. So keep in mind, that's from -- that 0.5%, which is more of the pre-pandemic historical norm is from a much higher base. So we're building off that 3% base that we saw in Q1 of 2021. And so we both look at -- to the extent that clinical visits include diagnostics, we want to be able to continue to grow that, and we have seen nice growth in this year of that higher base, as well as then when they do use it, are they using more from a volume and dollar standpoint. And that's 8%, which includes some price effect there. So we think that is very healthy in terms of how veterinarians see the use of diagnostics as an enabler to the broader medical services envelope.

And we're hearing anecdotally that pet owners are more invested and interested in what's going on. So as testing is done, they're interested in expanding the scope of services for those owners that are bringing their pets in. So I think the metrics that we're showing here, building off the higher base are reinforcing them.

Yes. Just specifically around your comment relative to curb side, drop off and pick up. We see practices even though we've, I think, transitioned from the pandemic to the endemic business, continue that in -- I mean it's in the minority of cases probably 15-plus -- they like that from the standpoint of supporting the productivity of the practice, a lot of pet owners like that. I think practices have adopted some level of concierge service around that type of thing. So I don't think that, that's going to go away. It will probably continue to remain a smaller part of that whole. Certainly, it's a step down from sort of the peak of the pandemic, but it's still there to some extent.

And our next question is from Nathan Rich from Goldman Sachs.

Maybe the first one on just the margin outlook. Brian, I think if I'm moving -- or looking at the moving pieces correctly, it seems like the core kind of constant currency margin is maybe down 30 basis points relative to what you initially expected. I mean, is that just a function of the lower CAG Dx growth expectation and the deleverage there? And I guess, kind of as we think into next year and what might come back, I mean if you see a return to normalized CAG Dx growth in '23, do you see -- do you get back any of that, the lower margin, I guess, that you might realize this year, does that come back next year? And then I just wanted to clarify, do we sort of get the -- or do we lap the kind of R&D expense in 2023 and so you kind of get that impact back next year?

Right. On the last point, yes, we view that as a discrete investment that will not occur in 2023. We're not projecting that. So that will be a favorable year-on-year, and we try to provide that specific impact, so you can calibrate for that. I think your interpretation is right, Nate, that the -- we originally had an outlook this year, clearing away currency and the discrete R&D impact of a 50 to 100 basis point improvement. As you know, that's our long-term goal. We've been doing relatively better than that over time. It did factor in. We do have inflationary impacts that we're working through this year and some returning costs, things like travel. And we had advanced expansions of our sales organizations internationally in the second half of last year and into early this year. And so it started with a level of growth in costs that we were working to cover through our growth as we always do, while delivering good profit performance. So the 3% calibration in the growth rate is moderating that. I think that's an appropriate kind of flow through as we pull back a bit on the expected growth. And I think your question is, does that come back? It's not that it is going away, it's can we grow off of that and produce good margin expansion over time? And we believe, absolutely we can. We're committed to our long-term goals and believe we have a really good business model to be able to support that.

Okay, great. And if I could just ask a quick follow-up, and I know this has kind of been touched on throughout the call. But what are you seeing the industry do to adapt these capacity challenges? And from your standpoint, is it more a staffing issue? Just, maybe some -- hire kind of out of offices during Omicron. Is it issues with getting kind of vet tax? Or is it more of a clinic or kind of vet capacity issue that might take a little bit longer to play out and solve? I'd just be curious, Jay and Brian, to get some additional thoughts that you have around that.

Nathan, I think it's a bit of all of the above. From the standpoint of -- so there's clearly a much higher level of activity that they're adapting to and we've talked about the staff shortages. And I think there are some staff out, just related COVID even though it's not resulting in hospitalizations. Normally when people get COVID, they have to spend some time at home. But there's a number of, I think, proactive things that practices are doing, including investing in technology. We see just a very significant appetite for software and the productivity that the software can deliver, both from the standpoint of staff productivity as well as really being able to enable standard of care. And our solutions, whether it's the ezyVet solution or clinical decision support because that's part VetConnect PLUS is an important part of that. Also instrumentation and the growth that we're seeing in premium instrumentation, it's really -- it's been very significant, 31% increase in growth in placements, 14% increase in our premium installed base. I think that's reflective of practice owners and veterinarians recognizing that they need to have the latest technology. In other cases, I think practices are looking at staffing mix and staffing formulas and recognizing that they can increase the number of vet techs and in some cases, non-licensed vet techs, at higher ratios than they have right now, and that can generate higher revenues, they had higher pet owner client support relative to their current baselines. So really looking at a broad range of practices to be able to increase capacity.

Our next question is from Balaji Prasad from Barclays.

Thanks, for squeezing me in. So it's kind of an extension of the previous question versus what the veterinary industry can do. I'm curious to see what these challenges mean in terms of capacity constraints for you in terms of the opportunity that it opens up in workflow solutions addressing anything else, both near term and longer term in helping your customers. And secondly, I just wanted to clarify again on the R&D cost front. Will this mean that your EBIT margin expansion should be back on track from 2023 onwards?

Yes. So I'll talk about this, the opportunity. In addition to what I mentioned from a software in a clinic standpoint, our reference laboratory solutions, testing solutions platform really serve as an extension of the practice. So insofar as practices maybe get strained or they want to send out testing and even our medical services. So we have a very large group of pathologists and boarded some radiologists and internal medicine specialists, they can do that. So we think that, that is a net positive in terms of being able to support the practices and continues to open up opportunity to that effect.

And on the R&D question, the $80 million investment that we highlighted that will come through our second quarter results, we view as discrete and nonrecurring. And we are maintaining our long-term goals for operating margin expansion.

Okay. And with that, I'd like to thank everybody on the phone for their participation this morning and to the IDEXX employees listening. I'd like to say thank you for your continued devotion to our purpose and enduring focus on delivering today. Your unwavering support and engagement enable us to continuously execute at a very high level and support our customers despite unpredictable and evolving dynamics in our sector and around the world. We're thankful for your excellent efforts and look forward to continuing our strong momentum through the rest of '22. And so with that, we'll conclude the call, and thank you.

Thank you, ladies and gentlemen. That concludes today's conference. Thank you for participating, and you may now disconnect.