Idexx Laboratories Inc /De Q3 FY2021 Earnings Call

Good morning, and welcome to the IDEXX Laboratories Third Quarter 2021 Earnings Conference Call. As a reminder, today's conference is being recorded. Participating in the call this morning are Jay Mazelsky, President and Chief Executive Officer, Brian McKeon, Chief Financial Officer, and John Ravis, Senior Director Investor Relations. 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 Third Quarter 2021 results, please note all references to growth, organic growth, and comparable growth refer to growth compared to the equivalent period in 2020, 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 in the queue and if time permits, we'll take your additional questions. I would now like to turn it over to Brian McKeon.

Good morning, everyone. We're excited to share another quarter of excellent financial results for IDEXX, driven by continued strong global momentum in our companion animal business. Revenue increased 12% as reported and 10% organically compared to high growth levels from the previous year. Our third quarter results show an 11.5% organic growth in CAG Diagnostic recurring revenues with double-digit gains across both U.S. and international markets. The two-year average annual organic growth for CAG Diagnostic recurring revenues remains at 16%, reflecting mid-to-high teens average gains across our major modalities. We achieved a record third quarter level of premium instrument placements with strong gains globally across our main platforms. High revenue growth and consistent operating margins compared to prior year levels led to earnings of $2.03 per share, a 12% increase on a comparable basis. Our CAG business momentum positions us to achieve 15.5% to 16% organic revenue growth, 200 to 225 basis points in comparable operating margin gains, and 26% to 27% comparable EPS growth in 2021 at the upper end of our previous guidance ranges. I will provide more details about our updated full-year outlook later, but let's start with a review of our third quarter results and recent sector trends. The third quarter organic revenue growth of 10% was driven by 13% gains in CAG revenue and 13% growth in our water business. These gains were tempered by a 23% organic decline in LPD revenues compared to high prior-year levels, which benefited from the escalation of African swine fever testing in China and a $3 million year-on-year decline in human COVID PCR testing. CAG Diagnostic recurring revenues went up 11.5% organically compared to strong prior-year performance, with 10% growth in the U.S. and 14% growth internationally. Over a two-year period, average annual CAG Diagnostic recurring revenue growth was 16% overall, reflecting 16% gains in both U.S. and international markets. The strong CAG results were also backed by 15% organic growth in veterinary software services and diagnostic imaging revenues, alongside benefits from our recent ezyVet acquisition and a 33% year-on-year increase in CAG Diagnostic instrument revenues. Our business continues to achieve very high levels of supply chain reliability, thanks to our operating teams' outstanding performance, allowing us to support high levels of customer service and growth. Strong U.S. CAG Diagnostic recurring revenue growth was bolstered by year-on-year increases in clinical visits. U.S. clinical visit growth overall was 2% in Q3 with solid gains across both wellness and non-wellness categories. This is in contrast to a strong 7% growth rate in the third quarter of 2020, which included effects from pent-up clinical demand with significant growth in wellness testing. On a two-year basis, U.S. same-store clinical visit growth averaged a 4.4% annual rate, which is above annual clinic visit growth trends leading into the pandemic. IDEXX's U.S. CAG Diagnostic recurring revenue growth outpaced U.S. clinical visits by approximately 850 basis points on a one-year basis compared to very strong prior year diagnostic testing growth, which had a 1500 basis point growth premium last year. The average two-year growth premium, considering year-on-year pandemic dynamics, was about 1200 basis points in the third quarter, slightly higher than two-year trends in the first half of the year. Expanding pet healthcare services, including increases in diagnostics utilization, supported a 7% same-store increase in overall veterinary clinical revenues in Q3. Diagnostic revenues per practice grew 7% year-on-year and 13% on a two-year average basis, consistent with recent growth trends. IDEXX's innovation and commercial engagement are driving strong Q3 organic revenue gains across our major testing modalities globally. IDEXX reference lab revenues increased 10% organically in Q3 with similar year-on-year gains in both U.S. and international regions. Global reference lab gains are driven by high same-store volume growth across testing categories. IDEXX VetLab consumable revenues grew 14% organically in the third quarter, reflecting double-digit gains in the U.S. and strong growth internationally. These gains are bolstered by increases in testing utilization, high levels of customer retention, and the expansion of our global premium instrument installed base. IDEXX achieved a record 4,307 premium CAG instrument placements in the third quarter, an increase of over 1,100 units, or 36%, from previous constrained levels, showcasing strong gains globally across our platforms with catalyst placements up 22%, premium hematology up 62%, and SediVue up 30%. The quality of CAG instrument placements remains excellent, reflecting 344 catalyst placements at new and competitive accounts in North America, up 14% year-on-year, and 1,003 new and competitive placements in international regions, up 17%. We also observed continued demand from high-volume customers, leading to 571 second catalyst placements. The rollout of ProCyte One continues to support strong placement momentum with most placements occurring in new and competitive accounts. New instrument placements and continued high customer retention supported a 14% year-on-year growth in our global premium installed base, setting the stage for ongoing high growth in IDEXX VetLab recurring diagnostic revenues. Rapid assay revenues grew 9% organically in Q3 against strong prior-year demand, which was bolstered by pent-up demand for wellness testing. Growth in vector-borne disease testing produced solid year-on-year volume gains in the U.S., and we see global growth benefitting from double-digit gains in international regions. High CAG Diagnostic recurring revenue growth remains largely volume-driven across modalities with consistent overall net price gains of 2% to 3%. In other areas within our CAG business, veterinary software and diagnostic imaging revenues climbed 15% organically and 33% as reported, including benefits from our ezyVet acquisition. Strong growth in veterinary software services was supported by double-digit gains in PIMS placements and related recurring services. We also experienced continued high growth in diagnostic imaging system placements driven by our entry-level ImageVue DR30 platform, with almost 80% of placements at competitive accounts. We continue to witness over 20% growth in recurring digital service revenues, buoyed by the expansion of Web PACS subscriptions aligned with our Cloud-based capabilities. Moving to other business segments, water revenue increased 13% organically in Q3, recovering from a 4% decline in the same quarter last year, as this sector starts tracking back towards pre-COVID growth levels. Business growth was attributable to solid gains in both compliance and non-compliance testing categories. However, Livestock, Poultry, and Dairy revenue fell 23% organically in Q3 compared to 18% growth in the same quarter of 2020. This decline highlights the overall dynamics affecting our China LPD and related export testing businesses, which overshadow growth in other global regions. Consequently, Q3 revenue growth was impacted by the previous high demand for African Swine Fever testing and lower herd health screening levels. We're observing additional constraints on China LPD testing demand due to relaxed local disease management approaches and ongoing impacts from low pork prices and changing government regulations governing livestock infectious disease testing programs. Given these factors, we're preparing for continued lower LPD revenues in the upcoming quarters, which is reflected in our financial outlook for 2021. Reviewing our finances, sustained high revenue growth contributed to double-digit operating profit and EPS increases. Operating profit rose 32% as reported, including benefits from the lapping of a $27.5 million G&A charge related to ongoing litigation, which is excluded from our comparable growth metrics. On a comparable basis, operating profits grew 12%, and operating margins advanced by 20 basis points compared to high prior-year levels that included benefits from pandemic-related cost controls. Gross profit was up 12% in Q3 due to robust revenue gains. Gross margins saw a slight decrease on a comparable basis as the strong growth in recurring CAG Diagnostic revenues and moderate net price gains were offset by business mix impacts from high CAG instrument revenue growth alongside lower LPD and human PCR revenues. We also saw some gross margin effects from investments in our lab businesses to support high growth and customer service. Operating expenses decreased 2% as reported but increased 10% on a comparable basis in Q3. As anticipated, we experienced higher comparable OpEx growth as we advance investments in our global and commercial innovation capabilities and integrate the ezyVet acquisition. In Q3, EPS stood at $2.03 per share, including $4 million or $0.05 per share related to share-based compensation activity. On a comparable basis, Q3 EPS rose 12%. Foreign exchange contributed $2 million to operating profits and added $0.02 to EPS in Q3, net of $2 million in hedge losses. Free cash flow reached $354 million in Q3 and $458 million for the first nine months of 2021. Our net income to free cash flow conversion rate stood at 88% on a trailing 12-month basis. We increased our 2021 full-year outlook for free cash flow conversion to between 80% to 85% of net income, reflecting a refined capital spending estimate of about $150 million, including around $20 million in real estate purchases. As we plan for 2022, we expect to raise capital spending levels to enhance our manufacturing distribution capacity in alignment with our high-growth profile. Our balance sheet remains strong, with debt to EBITDA leverage ratios of 0.8 times gross and 0.7 times net of cash, along with $145 million in cash and no outstanding borrowings on our $1 billion revolving credit facility. We invested $184 million to repurchase 275,000 shares during the quarter. Now, regarding our 2021 full-year outlook, we're updating our projected revenue range to $3,185 million to $3,200 million. Based on our performance in the second and third quarters, we're raising the lower end of our organic growth outlook by 1% while maintaining the upper end aligned with high two-year annual growth trends in CAG Diagnostic recurring revenues. Operationally, this results in a $10 million increase in our full-year revenue outlook at the midpoint. However, these improvements are counterbalanced by a $5 million foreign exchange headwind compared to our last forecast due to the recent strengthening of the U.S. dollar. Our updated revenue growth outlook is now 17.5% to 18%, including an estimated 1.5% annual growth benefit from foreign exchange and 0.5% from acquisitions. Our overall organic growth outlook of 15.5% to 16% includes an estimated 17% to 17.5% organic growth range for CAG Diagnostic recurring revenue. Other elements of our revenue growth outlook consider continued expectations of lower year-on-year LPD revenues in the latter half of the year and a reduction in human COVID testing revenues year-on-year. We have refined our reported operating margin outlook for 2021 to 28.8% to 29%, reflecting expectations for 200 to 225 basis points of full-year comparable operating margin improvement at the high end of our last guidance range. We anticipate moderately lower operating margins in Q4 compared to prior high levels due to mix impacts and advancements in commercial and innovation investments, aligning with our high-growth profile. We're raising our EPS guidance range by $0.06 at midpoint, placing it at $8.30 to $8.38, indicating 26% to 27% full-year comparable EPS growth. We now estimate that foreign exchange will provide $0.16 of positive full-year EPS benefits, which is $0.01 lower than prior estimates, net of our established hedges positions. Additionally, we have updated our overall effective tax estimate to 19%, including a tax benefit estimate of $0.29 per share related to share-based compensation activity. Details regarding our updated estimates can be found in the tables in our press release and earnings snapshot. As we conclude 2021, we are advancing plans for 2022 in alignment with sustaining our strong revenue growth. We are confident in our ability to uphold excellent supply chain performance to support ongoing high growth and manage inflationary impacts while building on our strong profit results from 2021. We look forward to sharing specifics about our 2022 financial outlook during our Q4 earnings call. That concludes our financial review. I'll now turn the call over to Jay for his comments.

Thank you, Brian. Good morning. We're pleased to report another quarter of excellent results for IDEXX driven by sustained momentum in our CAG business. We delivered double-digit organic revenue growth overall, supported by 11.5% organic CAG Diagnostic recurring revenue growth, compared to very strong prior-year growth levels. 2-year average annual organic growth rates across testing modalities were in line with growth in the first half of 2021 with clinical visit trends sustaining above pre-pandemic levels. These strong trends are evidence that veterinary practices worldwide continue to focus on elevating standards of care by leveraging IDEXX as advanced product and service platforms. The IDEXX team is doing an outstanding job supporting continued high-growth of customer service levels, putting us on track towards 2021 financial performance at the high end of our previous outlook and above our long-term goals. Today, I highlight key areas of progress in our product and commercial initiatives that position us to deliver continued high-growth and strong financial returns. Let's begin with a brief update on sector trends. Positive companion animal healthcare trends continued in the third quarter, building on the accelerated demand levels achieved throughout the pandemic. U.S. critical visit growth was 2% in Q3, compared to strong 7% prior year third quarter growth levels, which included benefits from pent-up demand. To normalize for prior-year pandemic dynamics, we are monitoring two-year average annual growth rates, which were 4.4% in Q3. Continuing above the pre-pandemic levels of 2% to 3%. Wellness clinical visit growth of 6% on a 2-year basis points to continued adoption of our preventive approach to pet healthcare. The sustained underlying momentum reflects the continued strengthening of the bond between pets and their owners. The benefit of stepped up growth in the pet population beginning early during the COVID-19 pandemic through early 2021, and sustained focus in the veterinary clinic on medical services. Around the world, veterinarians' passion for their work combined with pet owners' desire for excellent care, have driven this focus on services as they remain extremely busy. U.S. practice revenue growth in the third quarter advanced a healthy 7% versus the prior year, and an even more impressive 9% on a 2-year basis, supported by 2-year average growth of 11% in clinical revenue and 13% in diagnostic revenue. Customers are clearly attracted to IDEXX's broad portfolio of products and services to support the elevated levels of demand, while also growing their practices. These positive dynamics are also true in our international regions. IDEXX's growth is sustaining at an even stronger rate reflected in the 16%, 2-year average annual growth in CAG Diagnostics' recurring revenues in Q3, a premium of nearly 1200 basis points above 2-year average critical visit growth rates. High levels of execution and consistently strong sector trends reinforce our confidence in sustaining strong growth momentum as we finish the year and build our plans for 2022. Outstanding commercial execution has been a key driver of our business performance and our team continues to support our customers at a high level. This is evidenced by 36% year-on-year growth in premium instrument placements in Q3, a record number of third quarter placements for the Company. High-growth across our Catalyst, ProCyte, and SediVue platform supported a 14% overall year-over-year increase in our premium installed base. Veterinarians are using IDEXX's diagnostic tools to build capacity and improve efficiency within the clinic to support future growth, which is also reflected in high levels of second Catalyst placements and continued strong 16% gains in Catalyst placements had new and competitive accounts. Our strong global instrument placement momentum has long-term benefits and gives us further confidence that future consumable streams will also support continued strong growth. These results were achieved despite continued constraints on direct access to customers. Time for our customers is a scarce and valuable resource. In-person sales trends remain at approximately 60% in the U.S. and slightly lower in Europe at over 50%. Despite these constraints, our teams are into high levels of connection to our customers to deliver exceptional results by leveraging their trusted long-term relationships as highly relevant partners. We continue to enhance our commercial capabilities through rolling country-level expansions of our field sales force to build on these results and to address the significant opportunities ahead of us. We've completed our expansions in Germany, France, and South Korea, and are seeing significant positive traction in instrument placements and CAG recurring revenue growth in these countries as a result. In addition, we are expanding our footprint in 3 additional countries as noted on our last call with hiring, onboarding, and training tracking well to our plans in those areas. We expect to be live in all second-wave countries by the end of Q1 of next year. In addition to our commercial footprint, we made progress in the past quarter in expanding our service footprint and capabilities, in order to better support international business and customers. This included targeted investments to expand our European Reference Lab network and enhance our telemedicine service. These capabilities will support our long-term growth goals by ensuring we meet our customers' needs with a broad network and comprehensive portfolio of services. Complementing our world-class Reference Lab facility in Corn West Time, Germany. These advancements support high-growth across our testing modalities as customers continue to take advantage of the flexibility offered by our customer-centric programs such as IDEXX 360 to grow their businesses and elevate standards of care around the world. Innovative products like ProCyte One are helping to build on this momentum. We've seen a very strong response to ProCyte One having delivered over 1,000 units worldwide since launch and on track for the approximately 4,000 annual worldwide premium hematology placement pace we shared during Investor Day. Feedback from customers of all sizes have been overwhelmingly positive, as they rave about ProCyte One's easy-to-use, low maintenance profile, and excellent performance. Our growth trajectory now reflects launches in all 4 of our major regions with a select number of country launches remaining in the fourth quarter of this year and into 2022. ProCyte One provides a great opportunity for increased engagement with customers, supporting strong adoption in its new platform globally, and the broader expansion of our business relationships. As an example, almost 95% worldwide ProCyte One placements and nearly 100% in North America have either included a Catalyst One or have been placed at a customer that already has a Catalyst One, demonstrating the strong multiplier effect of this innovative product. Our Rapid Assay business is another area which provides an opportunity to expand relationships with customers around the globe. Rapid assay test revenues grew solidly in Q3 compared to a very strong prior-year. In 14% on a two-year basis with comparable gains in the U.S. and internationally. Vector-borne disease testing, a critical component of the rapid assay business and the wellness testing in the U.S. more broadly, was the primary driver of this growth as tick-borne disease becomes more prevalent in regions around the U.S. This testing growth continues to be supported by the SNAP Pro instrument, which helps drive engagement and loyalty through enhanced insight, accuracy, and practice workflow benefits. Double-digit growth in the SNAP Pro installed base in the U.S. and internationally in recent innovations like critical decision support, which aids increasingly busy veterinarians in making critical decisions when faced with a positive test, have helped drive excellent 97% customer retention levels within the Rapid Assay business. Our innovation strategy is also reflected in the expansion of our cloud-based software capabilities, which benefited from the Q2 acquisition of ezyVet. The integration of ezyVet into our software portfolio is proceeding to play out with high customer enthusiasm. ezyVet acquisition helped drive 33% reported growth of veterinary software, services and diagnostic imaging systems revenue in the third quarter, which was further supported by strong 15% organic growth in our core software and digital imaging products. This growth reflects solid double-digit year-over-year gains in our profitable recurring revenue software products. It also demonstrates the benefit of a growing installed base of PIMS in industry-leading low-dose diagnostic imaging products. Cloud-based offerings represent the majority of PIMS placements at over 80% as cloud-based offerings provide performance, quality, and life-cycle cost advantages. And within diagnostic imaging, recent updates to the Web PACS product include additional features important to specialty practices, and deeper, more seamless integrations with PIM systems. With a growing installed base and very high retention levels, IDEXX Web PACS has become an important part of our enterprise software ecosystem. Product enhancements like this and others aimed at making clinical workflow and customer communications easier and more efficient, are an impactful example of how our technology for life approach in supporting busy practices. Our commercial sales force and marketing teams continue to balance product sales with advancing the IDEXX Preventive Care program, which provides a structure and incentive for our customers continue driving wellness testing, and raising the standard of care. Enrollments in this program in the third quarter, despite constrained in-person discussions with customers sustained at a rate similar to the second quarter as we executed approximately 150 new preventive care enrollments and continue to track towards our goal of 10,000 engaged customers in the U.S. by 2024. In addition to strong commercial execution, our consistent growth trajectory also reflects the resiliency and agility in our supply chain. This has enabled us to weather the impacts of the COVID-19 pandemic and meet the strong demand within our sector. IDEXX benefits from a number of factors related to our business, including strong long-term supplier relationships, year-shoring and product standardization and inventory buffers. These factors in their proactive approach, managing front-line operational processes have allowed us to achieve 99% customer product availability through the pandemic, resulting in high customer satisfaction and increased retention. We believe we are well prepared to support sustained high-growth and service levels in our business going forward, where there may be relatively higher costs in certain areas to support our growth plans. We're confident we can manage these impacts effectively through our operational capability and focus while building on our strong financial performance. Overall, we feel very positive about our continued strong business momentum as we engage with and support veterinarians around the world who are advancing the care standard. Looking forward, we are proceeding with plans for sustained high-growth aligned with our long-term growth potential. As current momentum positions us well to support investments in infrastructure, solutions, and commercial capabilities necessary to achieve the significant opportunity ahead of us while delivering continued strong financial performance. Finally, I'd like to thank our employees and our customers for their perseverance and flexibility during these dynamic times. I'm extremely proud of what we've accomplished together and look forward to continued excellence in the future. That concludes my remarks, and we now have time for questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Michael Ryskin at Bank of America.

Thanks for taking the question. There were many comments in the prepared remarks about strong instrument placement trends, especially with ProCyte One. I'm curious if you're seeing sequential acceleration there and any increased uptake of SediVue. If you could clarify that, especially considering some of the new competitive introductions in your markets, I'd like to hear your thoughts on those dynamics and what you're observing from others in the marketplace.

Good morning, Mike. In the third quarter, we experienced record placements across our premium instruments, including hematology and chemistry SediVue. We believe this growth is driven more by practices investing in technology to enhance productivity rather than just pent-up demand. Regarding ProCyte One, which we launched in the U.S. in late Q1 and internationally in late Q2, we've noticed a rapid adoption. Most of the ProCyte One placements have occurred in competitive accounts with Catalyst or existing Catalyst accounts, demonstrating strong customer satisfaction. The product has met our expectations in terms of ease of use, performance, and cost-effectiveness. It is also integrated into our pay-per-run and auto replenishment model, and we are excited about the potential here; we identified nearly 100,000 global placement opportunities during Investor Day, with over two-thirds of that being international, and we are just getting started. We have a very encouraging outlook for hematology, and in terms of SediVue, we are making excellent progress, especially in replacing units where we have over 30% market share. We've seen solid uptake in the U.S. and positive sequential progress internationally.

Great, thanks. If I could ask a follow-up just on trends you saw over the course of 3Q and as we just think about 4Q. If we look at the snapshot in clinical visit growth and on revenues per visit, obviously you have the much tougher comps from a year prior, but as you continue going forward and see 4Q and 1Q next year, as we look at the 2-year stack comp on recurring CAG Diagnostics and total CAG revenue growth, are there any other dynamics we should be mindful of as we think of going into 4Q besides the comp dynamics? Anything else you're seeing in terms of changes in the marketplace or the gross volume growth, things like that?

Good morning, Mike. The main theme we want to emphasize is the strong recurring growth trend in CAG Diagnostics over the past two years, which has remained robust. In the third quarter, we focused on this two-year trend due to the challenges of year-on-year comparisons. We observed a 16% average annual growth rate over two years, both in the U.S. and internationally. Additionally, the premium over this period stood at 1200 basis points in Q3. This significant trend is consistent with our higher revenue growth expectations and shapes our plans for next year, where we anticipate sustained strong growth. We are making investments to support this, ensuring high service levels. Regarding broader trends, Jay can provide more details, but the clinical visit trend has moderated somewhat compared to the first half on a two-year basis. We might be experiencing a plateau in the incremental growth benefit we gained from the rise in new pets. While the pet population remains strong, this could reflect clinics being quite busy, but overall, our trends have held up well.

Just to build on that, Mike. All indications are that demand in the marketplace and the trends remain very strong. Clearly, the 1-year growth rate held up quite well. If you think back to Q3 in 2020, there was a lot of pent-up demand. There was increased pet patient visits. So really nice growth occurs tough comps. The 2-year clinical visit trends as we've talked about it, 4.4% is clearly above pre-pandemic levels at 2% to 3%. And then if you take a look at how we've translated that in our own business, 60% in globally CAG Diagnostic recurring revenue, U.S. and internationally. Those are 2-year figures. We've seen nice growth across all modalities, whether you look at the 1-year or 2-year. I think our execution as a Company has been excellent. So the growth momentum remains quite strong and as Brian indicated, we're really positioned to support faster growth by expanding capabilities commercially, innovation, really expanding the resiliency and capacity of our supply chain and manufacturing network.

Great, thank you so much.

Our next question is from Nathan Rich from Goldman Sachs.

Hi, good morning. Thank you for the questions. Following up on the last one, Jay or Brian, could you share your thoughts on the current capacity of veterinary practices? Are there any labor shortages affecting the overall volumes in vet clinics? It would be valuable to hear your perspective on how vet practices are currently operating.

Good morning Nathan. Vet practices are clearly very busy. They have implemented several short-term strategies to increase their capacity. Many practices are extending their hours, hiring more staff, and temporarily bringing on associate veterinary technicians while they train them. However, training higher-skilled staff does take more time. Several practices have improved their workflow and adjusted capacity by adding resources such as exam rooms. From our perspective as a company, there are many promising opportunities. We offer technologies, analyzers, tools, and software that practices can invest in to enhance their medical and clinical performance as well as their productivity, whether in communication or internally with pet owners, or by boosting staff efficiency. A clear indication of this is the notable increase in instrument placements and the rapid growth of software PIMS systems and related systems that support PIMS.

Great. That's helpful. And perhaps a follow-up for Brian. How should we consider the appropriate baseline level for operating margins as we approach next year? This year's cadence has been somewhat unusual with the elevated margins in the first half. I believe the guidance suggests maybe around 26% for the second half. Could you elaborate on what you think the ideal starting point is as we consider the margin trajectory into 2022? Thank you.

Sure. On a full-year basis, I think we said 28.8% to 29%. We do have some quarterly differences in margins normally, I think Q2 tends to be our highest with just some of the wellness testing that goes on Rapid Assay sales and things of that nature. I think we feel good about the growth trajectory in the business, particularly the growth on the CAG recurring revenues, that's a key driver for us, and that really gives us the ability to reinvest and build on the margin performance that we've had. I think we are intending to invest. We have been investing in growth aligned with the higher growth profile and we want to build on that. We see that as a very high return area for us, particularly areas like commercial investment. We get a very quick payback on that. And we're really pleased with the progress we had in our initial wave of international markets. And we'll look to do more with that next year. We'll provide more clarity on that as we get into the year, but our goal is to build on the strong performance that we have this year. And the strong growth trajectory in the business really gives us an opportunity to do that.

And our next question is from Jon Block, from Stifel.

Great, thanks, guys. Good morning. Brian maybe just to start, the gross margin trend, it was down for the third consecutive quarter. And I know you called out some mix headwinds, ongoing investments, but just want to go back to the big deck from the Analyst Day. You talked about gross margin - I'll frame it as that double up green arrow long term. And so I'm just curious, does that double up green arrow take hold in '22 or should we think about some of these investments really spilling out into the next several quarters?

Okay, John. I think it's important to calibrate at just what we're working through, if you go back to last year and just looking at our numbers and year-over-year improvement on a comparable basis. We were up over 200 basis points in Q2 - Q3 last year. We're comparing to some higher numbers in terms of the levels we were at last year where we had really constrained cost conditions. And I think that's a key factor we are investing back now and we're seeing that paying off in terms of high service levels and growth. I think we had some impacts from mix through the X1 instrument placement growth has a little bit of a mix headwind for us. Those are factors we're working through. But I think the overall dynamics in margins are something that we believe we can build upon. We'll provide more insight into that as we get into next year. But I think that longer-term trend, the key driver there is our strong CAG Diagnostic recurring revenue growth rates. And we are well-positioned to build on that with the trends that we've seen in the business so I think that longer-term story still holds for us.

Okay. And then just a follow-up. Maybe we just push you a little bit on the '22 trends in CAG recurring and the 16% CAG recurring 2-year average has been remarkably consistent for the first 3 quarters of '21. The guide implies a slight step down in the fourth quarter of '21. And is that slight deceleration the way to think about the CAG Dx 2-year slope as we head into '22 and to maybe layer on top of that, is there an opportunity for you guys, for price to play a bigger role in CAG Dx into '22, just based on what we hear from some of the practices on their recent ability to realize price? Thanks, guys.

We didn't provide specific guidance for Q4, but I can say that the high end of our range aligns with the trends we've observed over the last two years in CAG Diagnostic recurring revenues for the first three quarters. This is reflected in our guidance. Overall organic growth faces slightly tougher comparisons in Q4, but this does not indicate a change in trend; it's just a matter of working through these comparisons. The high end is consistent with our previous trends. We expect to gain more insights as we move ahead. We are very satisfied with our business execution, and the momentum in our key initiatives, especially in instruments, gives us confidence to build on our strong consumable growth. Our execution in other modalities is also robust. We are closely monitoring market trends, which are quite encouraging. While there might be some moderation in the growth of pet populations and considerations around clinic capacities, these are manageable challenges that we can assist our customers with. A key theme I want to emphasize is our pleased sentiment regarding business trends, particularly in the CAG sector, and our plans to invest in building upon them.

In that price realization, Brian, do you think that one's a bigger opportunity?

Sorry about that, John. We've been in the 2% to 3% range. I believe this is an area we will continue to monitor. Pet owners are increasingly willing to pay more for services over time. There might be some specific inflationary pressures in the business, such as increased input costs for labor and freight, and we are paying attention to that. If we notice sustained impacts in those areas, it's something we can consider over time. Additionally, the market and industry conditions provide an opportunity for us to explore this, given the strength of the bond with pet owners.

Our next question is from Chris Scott from JPMorgan.

Great. Thanks so much. Just this 2 for me. I guess, first on in-person access. I think you mentioned in-person access now in the 50% to 60% range. As that number moves higher, is that a meaningful benefit for your business or have you found that you were able to do pretty much everything you need to do given the access as it is today. And I just had 1 follow-up after that.

Good morning, Chris. We have seen an increase of around 60% in the U.S. and 50% outside of the U.S., and we believe that this can continue to grow. The net result will likely improve as we move past the pandemic. We have become quite effective at determining what is best to handle in-person versus virtually. For the most part, we can manage everything we need to do virtually. However, certain activities like product introductions or visiting competitive accounts and building relationships are better conducted in person. Therefore, we anticipate an increase in this area over time. While we don't expect to return to 100% levels, we foresee it being less than that. This will also benefit our preventive care initiative, as we understand that practices are quite busy, and repeated access is valuable for selling and partnering with customers. We expect this program to gradually move back to pre-pandemic levels over time.

Okay, great. Regarding the current inflationary environment, what are your thoughts on its impact? Are you observing or do you anticipate facing any pressure on gross or operating margins in the near term? You mentioned that if this situation persists, there might be a chance to adjust pricing, but I'm curious to know if any noticeable effects are reflected in the numbers or if there are ways to balance it out through other areas of the business.

We have observed some inflationary impacts on the business, particularly in areas like freight and distribution that many companies are dealing with. For us, the impact on input costs is somewhat selective, focusing on things like electronics and resins, and we are also attentive to labor costs. These are all crucial areas for us. Despite these challenges, we have managed them effectively and are committed to maintaining high service levels for our customers, especially in this high growth market. Our focus and intent are clear, and we are confident in our ability to build on our profit trends while navigating these impacts on our business.

Great. Thanks so much.

Our next question is from Ryan Daniels, from William Blair.

Hey everyone, this is Mitch representing Ryan. Thank you for the opportunity to ask my question. To begin with, considering the limited bandwidth and constraints on capacity, have these issues impacted the selling process or product education negatively, or have you managed to find ways to work around them?

Yes. Good morning. As I had previously indicated, practices are extremely busy and it has affected how we do our sales calls. Once upon a time you could get a fair amount of time with the veterinarian and her staff. We've tried to be very efficient. Previously we may have had 40 minutes or 50 minutes, now we're able to accomplish in 20. So we've adjusted accordingly where we have provided tools to our sales organization so that they're productive and they can get to the point. We continue to provide a lot of training including CE Training virtually into the webinar to our customers, so that they can get the training they need when they have some free windows and moments. We try to be, obviously, respectful but very efficient when we could call it practices. And because I think most practice and practice owners consider it highly relevant to their success, they, at large measure, provide time when we meet with them. I think we’ve achieved good results.

Great, thanks. Brian, on the capital instruments side of things, would you say you worked your way through most of the back-fill, and a lot of this growth is now incremental, practices realizing that they need an addition of a ProCyte or an additional Catalyst or that sort of thing?

Yeah. I think this is that the capital performance we've seen is not pent-up demand, it really represents investments. The practices are making in their capacity and really improving capacity and productivity of their practices. So I think it's just a solid reflection of demand trends.

Our next question is from Balaji Prasad from Barclays.

Hi. Good morning, and thanks for the questions. Couple of them. Firstly, all that you did comment on increased testing for ASF, I wanted to understand if you have visibility into what has led to this, and see if there's any broader read through to ASF trends. In other words, can an increase in testing signal that ASF senses spiking up? Secondly, I'm not sure about this, but obviously in any supply chain disruptions and reach off your segments would be or could be most exposed to the current global supply chain challenges? And lastly if you can, can you just help us understand the CAG dynamics better? Trying to correlate the same-store revenue growth, which is 5% points above the visit growth of 2%. So is this all linked to higher utilization or was there any component of pricing which is above normal trends? Thank you.

I will address your first question about African swine fever. The main developments concerning our China business for LPD include a notable increase in program testing last year to tackle African swine fever. However, there have been changes recently. Local management of the disease in China has shifted, allowing farmers to harvest their animals instead of focusing on treating the disease. This has led to a decrease in demand and presented us with some comparisons to manage. Consequently, this has been the primary effect of African swine fever on our business. We expect this to remain a challenge for us in the upcoming quarters.

I will discuss the supply chain. The resiliency and performance of the business have been excellent. As I mentioned earlier, we have strong long-term relationships with our suppliers. We have been able to utilize these relationships to ensure a steady supply. Additionally, almost all of our manufacturing is local, which guarantees a high level of product standardization. We have kept high inventory levels, allowing us to maintain significant product availability throughout the pandemic. Our customers have clearly appreciated this and have rewarded us with their loyalty. Therefore, we are optimistic about our ability to sustain this moving forward.

I believe your third question was about utilization at the clinic level. To clarify, on a year-over-year basis, we saw a significant increase in wellness testing and pent-up demand last year. The primary factor driving growth in the third quarter compared to the previous year was utilization growth. Utilization gains at the clinic level have remained strong, showing good growth over the past year and a two-year period. However, this was somewhat balanced out by a flat frequency, which was more related to year-on-year comparisons in the number of visits for testing.

Okay. And with that, I'd like to thank everybody for calling in. I'd also like to address the broader IDEXX team, some of which are on the call and say thank you for their continued extraordinary performance. Our employees have demonstrated an admirable commitment to our purpose and excellent ability to execute against our strategy. And I truly appreciate all their efforts. And so with that, we'll conclude the call. Thank you.

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