IDEXX Laboratories, Inc. (IDXX) Earnings Call Transcript & Summary

Here with us, we have Brian McKeon from -- CFO of IDEXX; and Tina Hunt, Head of VetLab for IDEXX Labs. We'll follow the same format, about 30 minutes of fireside chat and then some Q&A. Last session before lunch. So just hold on. So maybe just to start, recap of where you are at the end of 2019, beginning of 2020, sort of what's your view of the market? How it's evolved? And sort of what are the big takeaways you have from us -- from the last year?

Yes. We had a very good 2019 as a company, very much aligned with our long-term performance goals. A key metric that we focus on is our CAG Diagnostics recurring revenue growth. So think of that as the recurring annuity revenues of the business, high margin, recurring revenue is about 75% of our total revenues. And normalized, they grew roughly 12% last year, 11% in the U.S., 13% internationally. Those metrics are all very well aligned with our long-term goals, and actually quite consistent with the trend in the last few years. So we feel very good about the progress that we're making, expanding the business that had nice flow through to our bottom line. We had 120 basis points of constant currency margin improvement, and our EPS was up 21% on a comparable constant currency basis. So again at the strong metrics at the higher end of our long-range goals, and our outlook heading into 2020 was very consistent with that. We're looking to sustain 9% to 10.5% organic revenue growth and a 11% or 12% CAG recurring diagnostic revenue growth and to build on the margin expansion that we've been able to achieve the last few years and deliver continued strong double-digit EPS growth. So business is strong. Market has -- I think, the Companion Animal market, which is our core business, has remained strong. One of the metrics we focus on is clinical visit growth. So how many times -- about 56% of visits to the veterinary clinics in the U.S. or for clinical visits, and they were up 2.5% on a same-store basis in 2019, and that was actually up from 2.1% in 2018. So the underlying clinical market growth is healthy, and we think that there is -- you see a lot of investment in Companion Animal space. So I think that's helping to reinforce what we're really trying to do, which is to expand the standard of care. Here, you see this as a very long-term opportunity for us, a $30 billion market opportunity over time. And we're in the early innings of developing that. And I think we're executing well in the markets in a good place.

Great. That's a good intro. I'd say of all of the things you touched on there, one of the things that stands out to me is your emphasis on strong growth, consistent growth, consistent results that we've certainly seen. When we think about animal health in general, doubly so when we think about diagnostics and then especially when we think about IDEXX. So what are the key factors that make this such a strong market, such a consistent market, such predictable results quarter after quarter?

Yes. So there is just, as you said, a very, very positive market outlook. They are long-term drivers that we look at. The first off, of course, is the very strong pet-human bond. And it is -- everybody loves their pets around the world. So no matter where you are in the world, that bond is getting stronger. And then there is also the generational strengthening of the bond. So the younger generations tend to be even more attached to their pets. 95% of pet owners consider pets as part of their family, and the millennial generation, the Generation X, is really willing to spend a lot of their discretionary income. So that is a very strong underlying dynamic there. But then as you think about diagnostics itself, the veterinarians are increasingly appreciating the power of diagnostics in the whole as very foundational to the fair equation for pets. If you look at just U.S., today, only about 17% of the clinical visits get any sort of blood work done. And if you think about that, if a pet is coming in and the pets can't talk, so veterinarians are not doing the diagnostics to the level they should be in order to understand what could be going on with the pet. And we're starting to see that change. Internationally, that's even lower at about 6%. So there is a lot of opportunity from that perspective. And then you think about IDEXX innovations, and we really are about facilitating the growth of the market. So what are some of the new innovations that we're bringing in that is expanding the diagnostics that veterinarians can do. And then lastly, there is that whole dynamic of -- the other parts of the clinic are under pressure. So if you think about therapeutic diet or pharma, they're under pressure from alternative channels. So diagnostics is becoming more and more meaningful. Today, in the U.S., only about 15.5% of, on average, the clinic revenue comes from diagnostics. And so there's a lot of opportunity to increase that over time. And so a lot of really strong underlying dynamics that are great for the continuing enduring growth of this industry.

Great. That's really helpful, Tina. I want to follow-up on a couple of those points, just to unpack that. So some of the numbers you talked about, 17% of U.S. clinical vet visits get blood work done. I remember 3 or 4 years ago, I think that number was 13%.

Yes, yes, yes, yes.

I think last year, it was close to 15%, so definitely trending high. And that's your own...

Yes. It is -- let me just break that down a little bit more. So if you look at that 17%, that is for both wellness and non-wellness. Those are sick patient visits, as we call it. So the sick patient visits are at about 22%. And again, this is a U.S. metric. But if you look at the, what we call the, wellness visits, the preventive care, where we have been driving quite a bit, it's only at about 8%. And there is a great variation when you look at -- from a clinic to clinic, so the deciles that we see, the top deciles in both the cases do about 5x, making -- in Preventive Care, they do about 5x of what the average does. And same with the sick animal testing, it is pretty high. What we see is in U.S., that the top 2%, instead of 17%, they're doing 37%. So that -- they're showing what is possible with diagnostics. So we're working very diligently on moving the needle on just increasing developments of diagnostics.

And so -- and what's driving that number higher? Is it that you're focused on Preventive Care Challenge and things like that? Or are you seeing uprising across the board, in sick visits as well?

Yes, yes, yes, yes.

There's been ongoing, over a very long period of time, growth, as you pointed out, in just the standard of care in general and diagnostics specifically. And I think the -- some of the metrics that Tina just mentioned, naturally in terms of the market growth, are going up 20 to 30 basis points a year. And that's largely driven just by rising standards of care, and diagnostics kind of like growing even faster than what has been healthy growth in the market. I think we -- it's an important part to understand about our business strategy. I think for us to be successful, we're very much focused. We point to metrics on spending 80% of the R&D in the industry. And really, we're a major player, obviously, in diagnostics. For us to be successful, we need to expand the market. So initiatives like Preventive Care are looking to accelerate that rate of growth. And as an example, these are -- the practices that we work within Preventative Care programs, which are now at 3,800 practices in the U.S., we're tracking their growth pre- and post-engagement with the Preventive Care program and versus that 20 to 30-basis point of improvement that the overall market is seeing, we're seeing these practices growing at 100 basis points annually. And so that is -- yes, this will be a long-term initiative for us, and it requires practice engagement and training in change management and pet owner awareness of what we're trying to achieve as well. But we think these initiatives, which are very much aligned with the innovations that we uniquely bring, can help accelerate the market growth. And if we're successful, we'll capture a significant share of that growth.

And what do you think is the ceiling for that statistics? I mean we try to find comparables in human health, but it's really -- it's hard to find something that really matches, given some of the difference we're seeing in the industry. And you cite that the top decile is 5x higher -- 3 to 5x higher. Is that realistic to get that across the board? Sort of like what's the runway with utilization?

Those higher levels are actually aligned with recommended standards of care that the industry is recommending. What's interesting, too, is we try to pull this apart and figure out where are the higher standards of care are being applied. There is no correlation with practice size, income levels. This is all about working with veterinarians to see the value of providing diagnostic care and helping them to facilitate providing those services through their practices. In many cases, these are smaller businesses. They have a number of things that they're focused on. And one of the reasons we're working actively to add resources to work with them is to help facilitate that over time.

And if we just look at from -- the industry also, American Animal Hospital Association, from their recommendations, blood work should be done on annual. So annually, you should bring them, your pet in, and blood work should be run. So that's what the industry recommendation is. And now clinics are not as comfortable doing that. The pet owners want this. They want the best for their pets. It's really helping the veterinarians get comfortable with that. So that's what Brian is talking about, is how do you have the conversation with pet owner and feel that the pet owner is going to be accepting of that. And we help veterinarians with that whole change management process.

Yes. And one of the things we're leveraging is data. I think we are, through our solutions, we are actually connected through the cloud to close to 50,000 practices globally. And benefit from having access to information, understand how medical care is being delivered. And I think that what we're learning through that process as we can demonstrate to veterinarians that the clinical value of doing annual testing. As an example, in our Preventative Care initiative, we found that 1 out of 4 adult in senior dogs, when -- these are well patients. When their blood work is run, in 1 out of 4 cases, there's indicated need for follow-up -- significant follow-up work. So that type of clinical data, which we provide, not just through our sales organization, but through a large network of professional service veterinarians, allows us to be credible with veterinarians and helping them to see the value of expanding the care envelope that they're providing. And hopefully, over time, building to the kind of potential we see in the marketplace.

And what about international markets? You mentioned that it lags behind so much even -- yes, I think it's like 17% versus 6%.

Yes, yes, yes.

What -- why is it so much lower? I know we've seen some of the data even for developed markets like Western Europe, it's still nowhere near where it is in the U.S. Why is the standard of care so different?

Yes. So first off, if you just start with, everybody loves pets everywhere. Internationally, no matter whether it's Germany, Japan, the U.K., they love their pets just as much. I think if you look at fundamentally what happens internationally, it's more of a sick animal testing. And even in that case, they do more of an exception-based, so rule out testing. A part of it is because of how they were taught in schools, which is also evolving over time, and part of it is just the availability of solutions. So if you just look at providing platforms and services to veterinarians globally, for example. Catalyst One being an example where we made it very economical and affordable to veterinarians around the globe, and now we're seeing that veterinarians are really using diagnostics. So it'll take time. There is -- the standard of care is definitely a lot behind where we are in U.S., but it will take time to get it there. And then once we have the Preventive Care opportunity when you start talking, especially in the Western countries, we're having some of those conversations. It just reinforces the importance of doing testing when it's a sick pet. And I mean, they're not doing testing even then. So a lot of opportunity for us, but that's what we do, spending time with veterinarians and really making sure they understand the power of diagnostics.

I want to pivot a little bit and touch on something you talked about earlier, Brian, some of the innovation angles you mentioned. You announced a wave of new product launches at VMX Conference just about a month ago. Could you just talk about what you've seen in terms of reception from vets and sort of the feedback? And then more broadly, how do you focus the R&D engine? Because you've got so many different areas you could go after with the breadth of the business. Sort of where do you -- how do you identify what the best opportunities are?

Do you want me to talk? Or maybe Tina can provide an overview of the innovations.

Sure. Yes, I'll talk about the innovations. So for -- we announced a series of innovations. We announced a digital cytology service in our Reference Labs, which is really by revolutionizing the speed with which we are able provide expert interpretation for cytology. So typically, a pet shows that with lumps or bumps and the sample is sent out to our Reference Lab, it can take 2 days or sometimes 4 or 5 days to get the results back. And with our digital cytology service, we are able to turn it around in 2 hours, providing expert interpretation. And it's 365 days a year, 24 hours a day. So really around the clock, and we're able to do that because of our IT infrastructure, our global network of pathologists. So around the clock, we -- somebody is awake to be able to provide that interpretation. So that was one of the service that was received very, very well by customers. We're in betas right now with that. And it's a lot of excitement by that service. We also announced our newest assay on Catalyst platform. With Catalyst platform, we're always looking to increase the value of the platform to our customers. So we've introduced 8 new tests in 8 years in bile acids, our newest addition, really helps them assess liver function. And again, the veterinarians are very happy to have the ability to do that in clinic. It's really something that they need to be able to do in clinic. And then we also -- for SediVue, we keep advancing that platform, and we announced Advanced Bacteria Detection with both our Neural Network advancement as well as with proprietary agents. And all of the innovations were very well received by customers, and we'll start rolling them out next month.

And I think those are great examples of the themes that we focus on, your question about where do we think about investing. Basically, our R&D efforts are focused on 3 main areas. It's platform development, and I think examples like digital cytology and SediVue as a platform are excellent examples of ongoing innovation that we're bringing to platforms in services that we offer that increase the value of those platforms over time. And a second bucket is assay test development. And obviously, bile acids, I think, is another advancement, 8 tests in 8 years on the Catalyst platform. Different -- I think, maybe there are some other business models where we're relatively less focused on how much revenue can you add from a specific incremental test. It's more about how do we bring the capabilities that are in Reference Labs at the quality that are offered in Reference Lab to an in-clinic solution. And through that process, make the Catalyst platform or other platforms that we offer more valuable or basically an appreciating asset to the veterinary clinic over time. And the third bucket of R&D is around broadly information management, but that's including software and increasingly things like artificial intelligence and connectivity. And I think the SediVue solution, the bacterial testing capability, is an example of us leveraging is -- hundreds of millions of images that we've been able to accumulate over time and leveraging machine learning to build that into our algorithms and come up with better solutions to help support expansion of veterinary care. So we think in integrated ways, it really comes back to the concept of, we're at one level of testing and diagnostics. So we want to grow that significantly over time, is how do we enable that through what are increasingly integrated platforms of medical science and information technology that work well together and make it easier for the veterinarian to provide those kind of services.

And one of the things you touched on there was thinking about the -- some of the innovations-as-a-platform approach, so going back to digital cytology. I mean, it is an instrument that's kind of takes the image and then sort of uploads it to your internal pathology group or expert network. Is there an opportunity to leverage that instrument with additional testing down the road? Sort of what's the -- are there any other tests in the vets arsenal today that will be amenable to something like this? Because we think of cytology is somewhat of a unique opportunity there, right, where you may not have the expertise in every single vet, but you still have that urgency, the 2-hour turnaround time is a great selling point.

Right.

So are there any other areas like that?

We're always focused on looking at from our platforms and investing in our platforms. At this time, we're very focused on ensuring we have an excellent customer experience with digital cytology. But over time, we take a platform approach to every type.

I think as a team, it is an area that we're seeing a lot of growth meaning it's an integrated service rather than just a piece of hardware, if you will. And I think we've seen, as a company, very strong growth in areas like telemedicine, and I think applying these kind of technologies is -- in integrated ways with our service offerings adds a very high-growth area for IDEXX. And I think, to your point, we've demonstrated the ability to add kind of testing capability and services around these platforms over time. So we look to -- look forward to building on the success we have with this so.

Yes. And as much as we can remove friction and we make it very easy for veterinarians to do something, we tend to find that they to do more of it.