Brian McKeon
Executive Vice President & Chief Financial Officer at IDEXX Laboratories
Good morning, and welcome to our second quarter earnings call. Today, I'll take you through our Q2 results and review our updated financial outlook for 2023.
In terms of highlights, IDEXX achieved strong growth and financial performance in the second quarter, aligned with our full-year performance goals. Overall, revenues increased 10% organically, supported by 12% organic growth in CAG Diagnostic recurring revenues with double-digit gains in U.S. and international regions.
Key execution metrics remain very strong globally, reflected in record second quarter premium instrument placements, continued solid new business gains and sustained high growth and recurring veterinary software revenues. Operating profit results were ahead of our expectations, reflecting solid gross margin gains and operating expense leverage both benefiting from strong CAG recurring revenue growth.
For the first half of 2023, we achieved 10% overall organic revenue growth and nearly 12% growth in CAG Diagnostic recurring revenues. We also achieved better than targeted operating margin improvement. We've made positive refinements to our full year operational outlook incorporating this performance, which we'll discuss later in my comments.
Let's begin with a review of our second quarter results. Second quarter organic revenue growth of 10% was driven by a 11% CAG gains and 9% organic growth in our Water business. Overall, organic revenue growth was constrained by modest gains in our LPD business and approximately $3 million of headwind related to lower OPTI Medical revenues reflecting the wind-down of our human COVID testing business.
CAG Diagnostics recurring revenue increased 12% organically, reflecting 12% gains in the U.S. and 10% growth in international regions. CAG Diagnostics recurring revenue growth in Q2 was supported by global net price gains at the higher-end of our targeted 8% to 9% improvement range for the first half of 2023. Overall organic revenue growth was supported by 13% growth in veterinary software and diagnostic imaging revenues.
CAG instrument revenues were down 6% organically reflecting comparisons to high prior year levels, program pricing effects and global mix. IDEXX CAG Diagnostics recurring revenue growth remained solidly above sector growth levels. In the U.S., we achieved a consistent strong 1,370 basis point growth premium in Q2 compared to the same-store U.S. clinical visit growth levels, which declined an estimated 1.3% in the quarter. These results reflect benefits from IDEXX 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 Diagnostics recurring revenue growth improved organically to 10% in Q2, reflecting positive volume gains and benefits from higher net price realization. International results were also supported by strong IDEXX execution. Reflected in sustained new business gains and record Q2 premium instrument placements, we supported a double-digit expansion of our premium instrument installed base. Double-digit growth rate benefits from IDEXX execution offset impacts from challenging international macro conditions which continue to pressure same-store volume growth trends in the quarter.
Globally, Q2 results were supported by strong growth of IDEXX in-clinic CAG Diagnostics revenues. IDEXX VetLab consumable revenues increased 15% organically, with double-digit gains in U.S. and international regions. Consumable gains were supported by a 11% year-on-year growth in our global premium instrument installed-base, reflecting strong gains across our Catalyst premium hematology and SediVue platforms.
We placed 4,740 CAG premium instruments in Q2, an increase of 7% year-on-year compared to very strong prior year levels, which include benefits from our international launch of ProCyte One. Catalyst placements increased 15% globally, reflecting 8% gains in the U.S. and 19% placement growth in international regions. The quality of instrument placements continues to be excellent demonstrated by 9% global growth in new and competitive Catalyst placements and solid gains in EVI metrics.
ProCyte One momentum also continues to be strong globally, reflected in a global installed base of approximately 10,800 instruments. Global Rapid Assay revenues expanded 12% organically in Q2, driven by strong growth in the U.S., reflecting solid volume gains and benefits from higher net price realization. Global lab revenues increased 9% organically, reflecting double-digit gains in the U.S. and mid-single digit growth in International, with growth in international regions moderated by macro-economic impacts which pressured same store sales.
In other areas of our CAG business, Veterinary Software and Diagnostic Imaging revenues increased 13% organically. Results were supported by continued high levels of organic growth in recurring software and digital imaging revenues and ongoing momentum in cloud-based software placements.
Water revenues increased 9% organically in Q2, reflecting continued solid gains in the U.S., Europe and Latin America, including benefits from net price improvement. The integration and performance of our recent Tecta-PDS acquisition continues to progress well, expanding our capabilities in Water safety testing and adding approximately 2% to reported Water growth.
Livestock, Poultry and Dairy revenue increased 1% organically, as strong gains in the U.S. were offset by impacts from lower herd health screening revenues related to reduced China import testing.
Turning to the P&L, Q2 profit results were supported by solid gross profit gains. Gross profit increased 11% in the quarter as reported and 13% on a comparable basis. Gross margins were 60.7%, up 160 basis points on a comparable basis. These gains reflect benefits from higher net price realization, lab productivity and operational initiatives, improvement in software service gross margins and business mix, which offset inflationary cost effects.
As expected, reported gross margin gains were moderated by a 60 basis point negative impact related to foreign exchange changes, including the lapping of prior year hedge gains. While foreign exchange trends have improved, we're expecting approximately 70 basis points to 80 basis points of negative impact in year-on-year reported gross margin comparisons in the second half of 2023, as we work through lapping of $18 million of prior year foreign exchange hedge gains.
On a reported basis, operating expenses decreased 17% year-on-year, reflecting a 26% favorable growth rate impact from comparisons to prior year levels, which included $80 million in discrete R&D investment. Adjusting for this effect, operating expense growth was modestly below revenue growth in the quarter, supporting operating margin gains.
EPS was $2.67 per share in Q2, an increase of 71% as reported. On a comparable basis, EPS increased 77%, including approximately 54% of growth rate benefit from lapping the $0.72 per share prior year impact from discrete R&D investments. Foreign exchange reduced operating profits by $8 million and EPS by $0.07 per share in the quarter, including impacts from the lapping of $6 million in prior year hedge gains. Impacts from 2023 foreign exchange hedges were limited in the quarter.
Free cash flow was $173 million in the second quarter. On a trailing 12-month basis, our net income to free cash flow conversion ratio was 75%. For the full year, we're maintaining our outlook for free cash flow conversion of 80% to 90%, including estimated capital spending of approximately $180 million.
Our balance sheet remains in a strong position. We ended the quarter with leverage ratios of 0.9 times gross and 0.7 times net of cash. Share repurchases over the last year supported a 1% reduction in diluted shares outstanding. We didn't allocate capital to share repurchases in the second 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 first half operating results and updated estimates for foreign exchange impacts. Our updated full year guidance for reported revenues is $3,660 million to $3,715 million, reflecting an 8.5% to 10% organic growth range. This outlook includes a $15 million favorable adjustment for foreign exchange changes, which we now estimate will have a relatively flat full year impact on reported revenue growth at the rates shown in our press release.
In terms of our operational growth outlook, we're maintaining our performance goals aligned with the high end of our guidance range of 10% overall organic revenue growth, supported by 11% CAG Diagnostics recurring revenue gains. This reflects expectations for consistent strong levels of IDEXX execution, aligned with H1 trends.
Our outlook incorporates approximately 1% of expected H2 headwinds for CAG Diagnostics recurring revenues from equivalent days effects. Consistent with earlier guidance, our high-end outlook for CAG Diagnostics recurring revenue growth reflects expectations for 6% to 7% net price gains and a relative flattening of U.S. same-store clinical visit growth trends in H2.
We raised the low end of our full year organic revenue growth outlook by 1% to reflect our strong first half performance. We've also made positive adjustments to our outlook for operating margin performance in 2023. Our updated outlook is for reported operating margins in the range of 29.3% to 29.7% for the full year. At the high end, this reflects an outlook for approximately 360 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.
Our operating margin outlook reflects expectations for moderated year-on-year comparable gross margin gains in the second half compared to strong prior year levels. We continue to project that foreign exchange will reduce operating margins by approximately 60 basis points this year, primarily related to impacts from the lapping of $26 million in 2022 hedge gains. We estimate that foreign exchange impacts will decrease EPS by approximately $0.21 per share for the full year, with approximately $0.02 per share of negative impact in the second half, including effects from hedge gain lapping.
Our updated EPS outlook is $9.64 per share to $9.90 per share. This is an increase of $0.23 per share at midpoint, reflecting $0.17 in benefit from our raised operational outlook and $0.06 in combined benefit from refined interest expense and foreign exchange estimates.
In terms of our operational outlook for Q3, we're planning for organic revenue growth at the lower end of our updated full year growth range, incorporating expected impacts from approximately 1% of equivalent day headwinds. We expect foreign exchange to provide approximately 1.5% in reported growth rate benefit in the quarter. We're planning for operating margins in the 28.5% to 29% range, reflecting expectations for relatively consistent comparable operating margin performance, adjusting for unfavorable foreign exchange margin impacts of approximately 50 basis points driven by hedge gain lapping.
We've provided details on our updated full year outlook in the press release tables and earnings snapshot. That concludes our financial review. I'll now turn the call over to Jay for his comments.
