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

Good morning. I'm Andrew Cooper, part of the animal health research team here at Raymond James. I'm going to be quick here because I've been told that Jay's presentation is 29 minutes and 45 seconds. But we're excited to have IDEXX here, leading player in animal health diagnostics markets, fast-growing market and a business that's really been able to outpace that market and drive a lot of the, frankly, market growth as well with nice margin expansion as well and a 15% to 20% EPS growth goal long term that trying to think any time there's been a slip on that and can't come up with one. So with that, I'll leave it to Jay.

Thank you, Andrew, and good morning. I'd like to welcome everybody to a strategic overview of IDEXX. I'm Jay Mazelsky, I'm CEO of IDEXX. I'd like to welcome everybody here in the room as well as those participating in the webcast. I'd also like to mention we have John Ravis, Head of Investor Relations, also here in the audience. And to start, let me quickly remind everybody of our safe harbor disclaimer. As background for those of you who may be less familiar with IDEXX, our business is really focused on diagnostics and related information management solutions. We have 3 primary focus areas in business: our Companion Animal testing business; Water; Livestock, Poultry and Dairy. I'm going to focus on the 88% that you see in front of you. It's the biggest and fastest-growing part of our business. You'll hear a lot about the leadership of our diagnostics and information management, which is growing faster than total pet spending. We're the global leader in point-of-care diagnostics and related information. The point of care is where we provide instrumentation in clinic suite and testing for the veterinarian, typically in under 10 minutes when the pet is still in the practice. We're also the global leader in our Reference Lab business. Reference Lab is where the veterinarian sends out the test results to a reference lab to access typically from the widest and broadest possible menu. Our leadership is based on a continuous commitment to innovation over a period of decades and new product development. That includes information management, technology, applications, data and artificial intelligence. World-class innovation is not an end in itself. It's joined by a world-class commercial team. We bring these innovations to customers, helping make them relevant to subject matter experts, who have deep partnerships with their customers and form trusted advisory roles because we've learned that that's the best way of getting customers through the awareness, education, consideration, and ultimately, adoption pace. The result is a business model that's based on durable double-digit organic revenue growth of our companion animal recurring business. To fully understand the market for veterinary services, it's important to understand the connection between the pet owner and pet. There's an incredibly strong bond between the pet owner and the pet, and it's growing even more strongly. This is the bond that drives health care decision-making in terms of what the pet owner decides to spend for the care of the pet, whether it's just sick or extends the wellness, that enhances the health and well-being of the pet. This is something that we study a lot. We believe that it's a forecast that portends a really healthy underlying marketplace. For those of you who may have seen the Super Bowl and this ad that appeared from the -- on the right-hand side from the CEO of WeatherTech, a 30-second ad costs about $6 million. He took out an ad to thank the University of Wisconsin veterinary team for caring for his dog, Scout, who had cancer. Now not everybody has that kind of money to spend at an ad or to thank a veterinary team, but I think it's highly indicative of the percentages you see on the left-hand side. 95% of pet owners say they can't imagine giving up their pet for any reason. So the human-animal bond is strong, it's getting stronger, and it drives our confidence in the business. At IDEXX, we say demographics is hardwired math into how to think about the future. It helps us understand how those responsible for pet health care will evolve over time. And what you see is, on the chart, it's a chart that describes the willingness to pay. Let me give you some backdrop in terms of the different demographics, starting with the younger generation: millennials and Generation Z. Today, they are approximately -- they're a bit less than half of all pet owners. 5 years out, they are forecasted to be about 60%, a bit less than 60% of pet owners. So how does this younger generation think about pet ownership? Well, as it turns out, they have some characteristics that are a bit different from the boomers, for example. They believe that their pet has healthy -- has special health care needs. That causes them to form relationships with the veterinarian, to rely on veterinarians to guide them through the care process. The survey data also shows, not only do they have a special relationship with the veterinarian and formed the majority of pet ownership, but there's a willingness to spend. And the second and third columns before you show what their stated spending was over the last 30 days, $50 and $75. And what you see there is a -- from a stated standpoint, they spend more than the boomers. So not only is there willingness, but there's also the actionality in terms of being able to spend itself. So with that as a backdrop, let me talk a little bit about our business model and what's important to understand about our business. At the center of it is a business model where we have a recurring annuity stream with exceptional durability and customer retention. In fact, 89% of IDEXX revenues are coming from recurring revenue, and that's up from 81% in 2010. And the biggest component of this is a Companion Animal Group, where recurring revenue is 76% and that compares to 70 -- 67% in 2010. And it's really the story of appropriately driving relevant testing, bringing innovation to the marketplace and to veterinarians. That's all pressing clinical and business problems that drive testing utilization. And when they grow, we grow, and you see it reflected in the numbers. And we've sustained very consistent growth, 11% to 12% CAG Diagnostics recurring revenue growth since our decision to go direct in 2015 in the North American marketplace. And as we think about this overall market, in the U.S., it's growing high single digits. Internationally, it's growing 10-plus. We've been growing faster than the marketplace as a whole. And the key drivers of our success in terms of being able to grow faster are multifaceted. First, it's premium instruments. We're able to grow our premium instruments installed base through innovations, and I'll talk about what that looks like fast. In fact, in 2019, we grew our installed base by 16%. We're also able to expand the use of diagnostics utilization, whether it's reference labs or point-of-care in the clinic by expanding the menu and working with partners to drive appropriate testing. The foundation of any growth model, and this is the third point, is customer retention and loyalty. And we have very high customer retention across all of our modalities, 96% to 99%. And then the customers want more than just diagnostics. They're increasingly looking for information management solutions. And what they say is, that our practices are very data-intensive, people-intensive places. In information management solutions that fill out the solution, that support workflow productivity, client communications is an increasingly important part of our overall solution. So we continue to grow faster than the marketplace, and we're very excited in terms of continuing to drive this innovation equation. The other thing to keep in mind about our business model is that it's highly resilient. This is a chart and there's a lot of lines there that show diagnostics recurring revenue growth from 2010 onwards. We didn't have that data before 2010. So we have total revenue growth, and we map that versus personal consumption expenditures of the lower part of the chart, and you see a growth premium. And the interesting thing is that during the height of the Great Recession in 2009, we still grew 5% from a total revenue standpoint. So even in tough economic times, pet owners, who see pets as members of their household, are willing to spend on the health and well-being of the loved ones that are part of their house. Let me shift a little bit and talk about the innovation piece of our business, it's our DNA. We think it explains a lot of our success. It's an area of focus for the company and will continue to be an area of focus. And the way we think about innovation and R&D spend is a multiyear, multi-decade type investment in building capability. It's something that you just can't buy and decide for 1 day to the next, we're going to spend more money and then have them -- and then develop innovation. It takes years and years to develop. And companies I worked for, and I have a lot of experience in product development, they tend to be very good in one dimension of innovation. Let's say, instrumentation. What's so special about IDEXX is we're world-class in instrumentation, world-class in assay development and software, including applications, connectivity, the underlying AI in machine learning. So we bring a holistic, integrated approach to innovation, which allows our solutions to solve the broadest possible set of medical and business problems. And diagnostics, it's hard to do. It's a complex field. We've seen a lot of companies, whether the start-ups, so they have hundreds of millions of dollars from VCs or more established companies take a run at this business and really struggle to get the type of performance and quality that customers expect. But it's not just about the innovation dollars in spend. We do this at a very focused way that drives differentiation. And our point-of-care diagnostics suite, I think, is a case in point of what we've been able to do. Our chemistry analyzer is the center of this. It generates the majority of recurring revenue. But we also have similar quality, and I'll share that with you, in hematology as well as a completely new category that we developed called automated urine sediment with our SediVue. Then we've taken our Rapid Assay business, which is a handheld point-of-care testing, and we've connected it to the IDEXX ecosystem through SNAP Pro. And virtually, all of our instruments are connected to IDEXX. This is called the Internet of Things. We've been doing the Internet of Things 10 years before anybody started calling it the Internet of Things. Consequently, we have 50,000, approximately 50,000 clinics in 116 countries connected to IDEXX. And this enables our customers to order and run diagnostics in the clinic to populate the test results in the patient medical record to bring it to VetConnect PLUS so the veterinarian could use it. It has context, the decision-making results as well as to capture the charges for their work. And this is a complicated capability that has taken us really over a decade to get right. We also get a tremendous amount of data from these instruments. It allows us to assess and monitor performance of the instrument suite in the hands of customers. So we very often identify a problem before the customer knows that there's a problem and can intervene appropriately to fix it. Let me give you an example. Let me highlight how our innovation template works. This is our chemistry analyzer, CAT One. And this year at VMX, we introduced a new reference lab quality measurement for bile acids, which is an indicator of liver function. This is the eighth test we introduced in a year. There's nothing quite like this on a marketplace catalyst. It does chemistry, it does electrolytes, does amino acids. It's not just a single test, which drives capability. It's the fact that cumulatively, we've been able to introduce bile acids; and the year before that, progesterone; the year before that, SDMA and SDMA with T4. And it's this capability in the hands of our customers that is so important. When they bought a Catalyst 5 years ago or 6 years ago, and it keeps getting more valuable for them from a clinical standpoint, I see that as an investment in the profession and in their practice. And we earn their loyalty as a result of that. And it's just a wonderful story and it's enabled us to continue to grow strongly. We, in fact -- we placed over 7,500 Catalysts in 2019, approximately 5,400 were internationally. And the opportunity is still -- there's a very long runway of opportunities still before us. In fact, internationally, there's approximately 58,000 opportunities. In the U.S. and North America, 14,500. And keep in mind, that doesn't include hematology or SediVue or other measures. Most of our growth, actually, the majority of our growth actually comes from existing customers, where we continue to work with them to test more, whether it's menu expansion or using tests that we already have. So we're very excited by the market potential, both in the U.S. and outside the U.S., and I think that there's a remarkable opportunity to continue that. Let me give you a second example. This technology for life concept, this notion of a platform versus a box, a platform that grows with the customer. And this is an example of SediVue, and we've placed over 8,900 SediVues in clinics on a global basis, the majority of which are in the U.S. where you do 5 drops and get a result back in 3 minutes. Now automated urinalysis, automated urine sediment analysis is something that had never been done in a veterinary clinic before. And when we introduced this product, it was a great product, but we continue to improve it by able to crowdsource images. And at VMX this past year, we announced Neural Network 5.0 based on -- that has advanced bacteria detection based on 350 million images, 5 million patient samples. And it's dedicated to taking one of the most difficult things to do with urinalysis, which is to identify bacteria. The challenge with bacteria is it's very small. It looks a lot like debris. It hides behind cells and crystals. So it's very hard to see it. We developed a proprietary reagent that declutters the image, you can see on the right-hand side of the chart what a typical image may look like, which enables the analyzer to find the bacteria and definitively identify it. And so both the software and the proprietary reagent is free of charge. So we think that this is a great example of how we continue to invest in our instrumentation and our customer relationships, which, over time, has a multiplier impact on what customers use. That same mentality, the same approach has enabled us to also build an awesome Reference Lab business. And I want to talk about the Reference Lab business through the vantage or through the eyes of the customers. And at the end of the day, customers want to partner with a reference lab provider that's there when they're there. And increasingly, they're there into the evening and on weekends. There's 29,000, just to use the U.S. as an example, there's 29,000 practices in the U.S. There's over 46,000 ZIP codes. So if you're there, where they're there, you need to have lab density. You need to have a lab network, a courier route structure that enables the reference lab provider, in this case, IDEXX, to pick up samples 1 or 2 times a day, provide the result same day, but no later than 8 a.m. the next morning. And so to do this, we have 55 -- approximately over 50 labs in North America. We have a LIM system which connects core, to regional, to day labs. And we have an infrastructure that allows customers through software like VetConnect PLUS that in an automated way order these tests and get the results back within the time period that I described. You also by the way, need a biomarker research program because when customers send samples out to the lab, typically, they want the deepest and broadest possible menu. So it's not like in clinic, where you may be doing chemistry or hematology or vector-borne disease start urinalysis testing, you're doing things like molecular diagnostics and pathology. It's a really complicated testing category. And customers tell us we do this extremely well. They tell us because we have a very high level of retention, very high customer sats scores and very high Net Promoter Scores, far in excess of what the competition is able to do. And what this has enabled us to do is come out with breakthrough the services. This is an example of digital cytology, which we announced at VMX. Let me give you the clinical background. Today, if you're a pet owner, you may bring your dog in to a vet because you see a lump or bump. And veterinarians will tell you that this happens in their practices on a daily basis. They'll take a sample, they'll look at the sample, and they'll say, it looks fine, it's an abscess, it's going to resolve itself over the next couple of weeks. Or they'll say, "Uh... It...". I'm concerned about that. And Keep in mind that most veterinarians are general practitioners. They're not board-certified clinical pathologists. So they -- if they see something that makes them nervous, they may send it out. And typically, it takes at least 2 days, and it can take longer if they send it out, let's say, on a Friday. And so what we've been able to do is we introduced a new service that you no longer have to wait 2 days or 3 days or 5 days, it's 2 hours. 2 hours, 24 hours a day, 7 days a week, 365 days a year. That's not an enhancement to a service offering. That's a step function transformational change in what we've been able to do. And we've been able to do it because we've been investing in reference labs over the last couple of decades, and we have over 100 clinical pathologists globally who could read these and interpret these tests. And we have 150, approximately 150 field service reps who call on customers, can install the instruments, can integrate it into the workflow, and train on slight preparation, if that's what needed. So this is a capability that I think we're very proud of. The initial receptivity and enthusiasm of customers has just been outstanding. Software. Software is a strategic business for us. It's a strategic business for us because it's a strategic business for our customers. What they tell us is that their practices are busy places. They're data-intensive places. They worry about staff productivity, supporting their workflow, client communications, charge capture, all of those things. They want not just diagnostics, they want diagnostics that fit within this notion or this template of being able to support how they do work. And this is something that we've invested in, again, for decades. We believe that we have the most compelling product value proposition on the marketplace. In fact, in 2019, we upgraded our flagship PIM system, Cornerstone 9.1, which is a completely new user interface and got more than half of our installed base upgraded. So this is something that we'll continue to invest in, in the future. We think it's an important part of the overall business. Let me move now into talking about diagnostics and our growth strategy because we believe that diagnostics utilization is way lower than it should be. And this is a setup to what I'm going to talk about in a bit. But what this shows is that as a percentage of clinical visits, the bar chart on the left-hand side, only 17% of clinical visits include blood work, chemistry and/or hematology. And we break it down by wellness and non-wellness, which includes sick patient testing, procedure and follow-up care. And what you see is even for sick patient testing category, it's only 22%. And for wellness, it's only 8% of wellness visits include blood work. So a huge opportunity. You'll notice that there's a lot of variability that those customers represented by the deciles on the left-hand side of the chart are far lower in utilization than those on the right-hand side of the chart. So our job as a company, our job as a growth strategy, is to move those customers from left to right. And when we do that, we believe that there's a very, very significantly sized marketplace available to us, over $30 billion. Let me just share with you how we built this up. It's a fairly conservative set of assumptions. We asked ourselves, what would happen if we grew diagnostics for the next 25 years, at the same rate that we've grown it over the past 5 years. So high single digits in the U.S., 10% to 11% internationally. And you could see what the numbers indicate. But the sanity check on this is if you take a look at the U.S. and you grow it at that rate for 25 years, only 30%, only 30% of clinical visits include blood work. If you recall from the previous chart, already, today, 30% of the top decile customers use -- are using blood work. The top decile are using blood work at 30%. So that -- those customers exist today in great numbers. It's just a question of getting everybody else to do that. Similarly, if you look at international, if we were to grow at that 10-plus percent internationally for 25 years, blood work would be included in 17% of clinical visits. Remember, 17%, that's what it is in the U.S. today. So we're saying in 25 years, could the international marketplace be at the same level as what we see in the U.S., and we believe that's the case. And we have programs, individual programs in different categories to be able to drive that. And one of the programs we've talked about in the past is preventive care for wellness. And what we have learned is that customers like wellness testing a lot, they believe in its importance. However, it's hard for them to get it established in muscle memory and a practice. And what we've done is we've developed care protocols that consists of our proprietary IDEXX Diagnostics, compliance-driven pricing, engagement with the staff from the receptionist all the way to the pet owner. And then finally, client-facing material to be able to drive that. And the other thing that veterinarians ask for is evidence. They want to be able to, with confidence and conviction, go to their clients and say preventive care is the right thing. And this is a seminal study that shows for wellness -- for dogs, 30,000 dogs, in fact, that went in for wellness testing that use this broad spectrum of diagnostics, 1 in 4 adult and senior dogs had something that was clinically significant that required follow-up. So this is the type of medical data and evidence that we provide to customers to help drive a belief system that gives them the confidence and conviction to recommend this to clients. And these care protocols consist of proprietary diagnostics. This is an example of fecal antigen that detects and uncovers so much more from an intestinal parasite standpoint relative to what you'd see under the microscope when you're looking for eggs. And the reason it's been able to do that is because it's detecting proteins before the eggs are available, and this is called a prepatent period. It lasts between 30 and 45 days. So it's a great example of how we can uncover more that is appropriate testing that drives better medical care. And the same thing with vector-borne disease. Even though 4DX has been out for a long time, what we see is the marketplace is underpenetrated. Only 38% of dogs in the U.S., as an example, undergo some sort of vector-borne disease test. And in fact, the majority of those, it's just heartworm. So this is a performance testing category. It's a category we have clear advantages from -- in the performance and accuracy standpoint supported by peer-reviewed medicine, and so we are really excited by continuing that opportunity. And it also comes down to not just the innovation, as I said in the beginning, but bringing these innovations in a relevant way to customers. And this is why we continue to have really grown our sales organization, of subject matter experts who call on customers, who form trusted advisory roles with them, who understand the needs of those practices to drive relevant testing. And so when you take a look at our model that we presented, a long-term model that we presented at Investor Day, and you combine innovation with a commercial organization that brings us to customers, we see a 10-plus percent growth. We forecast a 10-plus percent growth opportunity over the longer term. It consists of 9% to 13% in CAG Diagnostics recurring revenue in the U.S., slightly faster internationally, 12% to 16%, but contributions from all our businesses, whether it's software, diagnostic imaging, Water, Livestock, Poultry and Dairy. And that model is something that we've been achieving over the last couple of years. Since we've grown direct, you see that we've really outpaced our recurring revenue to historical benchmarks. And it's truly an amazing financial model based on high-margin annuity. We also generate an exceptional return on capital for the business. We achieved 46% ROIC in 2019. And our focus is being able to continue on the growth strategy and driving the long-term opportunity in the business. So let me summarize. I know I'm just about out of time. We have an incredibly attractive enduring recurring growth opportunity before us. There's very long-term favorable demographics in terms of pet ownership and the growing bond. Our innovation is a capability that we've built over multiple decades. Our ability commercially to bring these innovations and make them real for customers, I think, is really unmatched in the industry. And we continue to really generate extremely attractive financial returns, net of investments, necessary to achieve this growth. And with that, thank you very much.