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

Good morning. Jon Block of Stifel. And welcome to Jaws & Paws Virtual. The first company we're meeting with today is the #1 player in in-clinic and reference lab market in animal health, IDEXX Laboratories. We have with us from IDEXX, Jay Mazelsky, President and CEO; and Brian McKeon, Executive Vice President and CFO. Guys, thanks for participating, and you've been incredibly helpful participating over the years.

Jay, I want to -- just going in a different direction to start just because of the very helpful data that you guys released last night, the amount of data you have at your fingertips is pretty astounding, the look that you have in the animal health market. I think on your first quarter conference call, you guys openly talked about a V-shaped recovery for the industry. And you were one of the few that I thought was that bold and willing to stick your neck out. And I think that data last night sort of speaks to that in many ways. So if we can just start there, Jay. Talk to the data that you guys released and maybe why you're seeing such a significant bounce back and how you think that might play out in the coming months.

Sure. So good morning, Jon. It's a pleasure to be at the Stifel conference. So as we said on the earnings call, we did see a meaningful impact to clinical visits and associated revenues from diagnostics in late March and early April. It was related to the COVID-19 pandemic and the social distancing guidelines that states and different countries had put in place. We published updated U.S. clinical market data yesterday, that's what you were referencing, really through the 7-day period that ended May 22. And it does support a V-shaped recovery, but I would just caution that it's early but we're encouraged by the overall resilience of the marketplace. Just a couple of highlights from a trend standpoint, what we saw are that clinical visits were up 1% so higher than last year. Over the last 7 days, the sick patient visits up 1%; wellness was up 2%; the total visits down 4%, and that could reflect a number of different factors like product sales and -- that have been prepurchased and not as many pet owners going to the practice. The other thing we did with this data is we provided some regional cuts, which across the U.S., I think, would show some different performances based on the regions. Northeast, for example, was still a negative territory though it's climbing out from the trough, or other regions like the South, for example, and the West region showed positive growth. What we continue to believe is true and what we emphasized on the earnings call is that the impacts that we've seen are really proportional to the strength and the implementation of the social distancing protocols and prioritization of care, you know, from a sick in favor of sick versus wellness. And as states relax those, the impacts really rebound fairly quickly and I think the data supports that. I think it also supports the fact that these veterinary clinics have done a really nice job in reacting to COVID-19 impacts, alternative workflows like patient curbside drop-off and pickup and are adjusting well to those challenges.

And maybe Jay, just to ask you 1 or 2 more down this road, we had a survey last night that came out, essentially the same time as your press release. I'm happy it agreed with your trends actually. But we talked about 99% of practices being open in our sample size and 85% that are performing elective procedures. Maybe if you could talk to that, again at a high level, do you think that's a pretty good dart through as to what you're seeing out there, almost all practice open and then 8.5 out of 10 practices that are doing all services?

Yes. So what we thought was that initially, as practices, as the COVID-19 impacts were implemented, between 5% and 10% of practices were temporary shut down or took some time to pause to adjust to the new guidelines and deciding how they were going to implement the safety protocols. But what we've seen and had previously communicated is that practices are now open in same numbers as pre-COVID. So certainly, I think we're aligned on that. And what we are seeing is that increasingly, it varies a little bit by region, as we indicated, region that wellness visits and the elective surgeries are now being reimplemented, and consequently, we've seen growth from that trough. Keep in mind that even in the most severe point of the COVID-19 impacts, there were still a number of wellness visits being conducted. They were just being deprioritized from a care management standpoint, so not surprising.

Got you, perfect. I'm going to move forward. I'm going to ask you about the China data point that you alluded to on the first quarter conference call. And then Brian, I want to go into some P&L impacts. Maybe to start off with on the China data point. On that conference call, in the first quarter conference call, you talked about China's chemistry slide returning to double-digit growth in March and April. And China, to be clear, is a small market for you. I think per the 10-K, it's only about 2% to 3% of revenue. But can you get a little bit more granular? What was China chemistry growth pre-COVID and where is it now? And then is China a good proxy for the U.S. when we look out a couple more months?

Yes. So let me give you a couple of benchmarks. As you pointed out, China's a relatively smaller market for us. It's about 2.5% of company revenue but a little bit less than that is CAG. The rest of it's the other businesses like Livestock, Poultry and Dairy. Prior to COVID-19, our CAG Diagnostics recurring business has been growing mid-teens in Asia Pacific over the last 5 years. That's something that we've shared at Investor Day. China's an in-clinic market for us. It's not a reference lab market. Last year, I think what we shared was that the VetLab's consumable growth internationally was nearly 20%. So I think it gives you some swim lanes in which to think about our performance in China. And as you pointed out, we did see double-digit chemistry slide lab growth over the last 8 weeks or so. I think COVID-19 impacts hit China earlier. We began to see that in January and February. So that's obviously an indicator of what later came in Europe in March and in the U.S. And I think it's very much in line with the theme that as markets have moved further along from a case management standpoint and have relaxed those lockdown controls, we've seen solid recovery in demand. So it's an overall reflection. It's encouraging reflection actually of the resilience we see in the whole Companion Animal market.

Okay, very helpful. And I'm sorry, Jay, just to circle back on that, you talked about APAC mid-teens but China as more of a point-of-care market. So maybe China was at a [indiscernible] or 20% and then slide growth returned to more mid-teens in March and April. So it was almost all the way back a couple of months after COVID hit. Is that fair? Not fully back but almost all the way back when we sat there around the time of the conference call in April?

Yes, I think that's accurate, Jon.

Okay, okay. Great. I'm going to move forward to the P&L impact. And Brian, I want to pull you into the conversation. You spent some time on the conference call talking about the decremental margin impact from lower volume, and due to the bigger decline in wellness, that hits the Reference Lab more than in-clinic chemistry. In your 10-Q, you break out product and service gross margin. It gets very little play from investors but you do break it out. And to be clear, it's not perfect but the service division is mostly the Reference Lab, I certainly believe. So we went back, we did some work. We looked at, call it, decrementals. And in '19, the gross margin of the service division was around 45%. Prior to '19, the incremental margin in that service division was 55% to 65%. I'm throwing a lot of numbers at you, but does that give us the feel for the decremental within the Reference Lab? In other words, that 60% to 65% of the lost dollars might drop down to the gross profit line? And maybe you can comment on that.

What we tried to signal on the call, Jon, was we expect a higher rate of drop-through for a few reasons. One is, as you know, first of all, we -- in terms of the near-term COVID impacts, which were -- we saw earlier in kind of Q2 that were significant, we've got relatively high margins on things like VetLab. And in the Reference Lab, we have a largely kind of near-term fixed cost structure. And we're intending to maintain the operating service capability that allow us to position ourselves for a strong recovery, which fortunately we're seeing. We want to also highlight that coming into the year, as you know, we advanced a number of investments that were strengthening our capabilities and labs, including courier routes and day labs and LIMS system enhancements as well as the Marshfield integration and the onboarding of our new German core lab. So we anticipate that there will be a higher level of flow-through impact in the near term. We are -- think that it's appropriate to manage our business in that construct and glad that we've maintained high service levels. And we did advance some OpEx offsets that we highlighted on the call to mitigate that, that we estimate about $25 million of quarterly savings, including some temporary reductions to salary levels. But on balance, we'll work through these near-term impacts and hopefully get back on the track that we've been on historically in terms of solid revenue and profit gains.

And Brian, per the press release last night and looking at those trend lines, even if the decremental is more severe than what I laid out, it might be somewhat transient, right? I mean, looking at that chart, I mean, it might just be specific to that time period that we saw really throughout March and April, maybe a little bit into May. Is that fair?

Yes. That's -- I think the unknown right now, Jon, is it's clearly early on and we're calibrating impacts. We came into the year with a growth plan that was aligned with our 10%-plus goals and kind of our investments aligned in that context, too. So we'll have to see how this plays out through the year. We feel very confident in the structural health of the veterinary market. I think the thing that we'll have to learn more about through the year is just how does -- how do the changes impact the consumer? And does that have any kind of headwinds for us down the road? I think that's an unknown at this point or at least something that we're trying to learn more about and calibrate. And so we're encouraged. We think we're -- things are aligning with the recovery that we anticipated seeing. And we'll kind of sort through what that all means for our business as we work through the year and provide more updates on that front.

Okay, very helpful color. Brian, I've got one more for you and then Jay, I'll go back to you on PCC. But I want to ask about opportunities on the other side of the COVID-19 curve in terms of OpEx or how you run the business. And just to give you an example, I don't think I'm traveling nearly as much as I used to. I don't believe I am once we get out of this thing in terms of marketing, et cetera. And so if I think about IDEXX and I think about 10% organic growth equal to 100 bps of op margin expansion, just to keep the number simple, are there opportunities, Brian, to further streamline OpEx just throughout this pandemic where you say, "You know what, we were able to run that part of the business in a remote fashion and do it just as well, and I could probably take those particular costs out of the business." Maybe just talk to about if that opportunity if it exists longer term.

Well, I think that is a key enabler of some of the cost savings we've been highlighting. So we've seen an adaptation in our cost structure that enable us to create some efficiencies here. And I think those are things that we and many other companies are going to be evaluating going forward, and as this is not going to be a short-term transition in many ways in terms of how we're all operating until we come out the other end of the pandemic impacts. I think, Jon, for us, the way we've looked at this is we've built a business model around trying to achieve the double-digit organic growth potential that we see on a long-term basis. And as we achieve higher levels of growth, that positions us well to have good operating margin flow-through. We've got 140 basis points of average annual improvement over the last 4 years on a constant currency basis. And we -- I think we are confident, as we get back to those levels of growth, we'll have a strong flow-through. And we need to adapt our investment pace relative to the level of growth. Over time, we'll look at that as well. It's easier to accrete the margins when you're growing as well as we have historically, but we do have confidence that we can grow our profits faster than revenues over time.

Okay. And maybe -- okay, that's great, that's great. I want shift to PCC, Preventative Care Challenge. We actually just had a vet panel. We got very solid feedback on that particular panel. But talking about the opportunity on the panel to increase diagnostic utilization for wellness exams and it was well received in the panel. In our work last night, we talked to the veterinarians or we surveyed the veterinarians and they alluded to, "Hey, I might be losing some of the goods and services to online." When we asked them, "What are you going to do to potentially replace some of that revenue?" They call that highlighting their online stores, signing up if they don't have one but also increasing diagnostics for wellness exams. And you had a good number of sign-ups for PCC in the first quarter of '20, which was certainly a COVID-impacted quarter. You had 400 new accounts sign up. Jay, maybe just talk about the long-term initiative of PCC for IDEXX and if you feel even in the midst of COVID that, that program is starting to gain some traction.

Yes. I'd be glad to. At its core, customers see preventive care as a very foundational practice area within veterinary medicine. They see it as good medicine. They see it as good from a practice economic standpoint. They see it as very beneficial from a client engagement standpoint. So the importance of the medical necessity of it and their own practice health has not been diminished by COVID-19. I think all of those trends are in place. And to your point, they may even be reinforced from the standpoint of product sales, both, I think, specialty diet and therapeutics have been impacted within the clinic as a result of e-tailers. I don't think that those are likely to come back at the same levels. We did have a great Q1 in terms of record number of enrollments at 400. That followed 360 in Q4. So we're, cumulatively, from a program-to-date standpoint, we're at about 4,200 within the U.S. So we feel very good about the program. We think we're well positioned to really continue the momentum with the program, with the expanded commercial capabilities and footprint that we have within North America. I will say that you may see some deferment in additional enrollments during COVID-19 just because it's more getting a practice up and going on preventive care, is a little more people intensive from the standpoint of training and onboarding. But when you talk to veterinarians, what they say is this is going to be a key dimension of their recovery plan. It's part of our philosophy, if you will, of recover together. We think that preventive care with diagnostics, with IDEXX proprietary diagnostics, is a key element of how we can get practices back to health and to get -- deliver excellent patient care.

And Jay, you mentioned the 4,200 cumulative sign-ups on PCC. When I think about IDEXX in North America, I think about roughly 20,000 out of the 25,000 total practices are "IDEXX customers." So I'm sort of converting into 20% PCC penetration. Can you help me out there? Is the 20% good? In other words, is the 20,000 denominator a good number? And then also, how do we think about peak penetration for the PCC program? Is it 30%? Is it 90% as we look out longer term?

Yes. So I mean, keep in mind that all practices go at wellness care that, to some extent, today, it may not be as systematically -- it may not be the type of turnkey solution that we're partnering with practices on. What we said as part of Investor Day last year that our goal was 10,000 customers in the U.S. by 2024, so we think that's a good goal and we're advancing against that. Just I want to flip back to a comment that you made around blood work as part of preventive care because I think this outlines the opportunity that you've described from your panel. Today, 8%, 8% of clinical wellness visits include blood work. We know and we shared this at last Investor Day that the top practices, the top-performing practices are 5x or higher than that in terms of including blood work within wellness panels. So we think -- we do think there's an excellent overall opportunity both in terms of adoption, which is your direct question but also utilization within those customers that do adopt.

Okay, perfect. I'm going to move on and move forward. So a handful, a small handful of topics I want to hit. And the next one's corporates. In some of our recent checks, we asked practices, if a veterinarian have been practicing 10 or more years, they were sort of routed to, "Hey, what do you remember about the last recession?" And a good number of them called out an accelerated pace of consolidation. And so I think the roll-ups are going to continue. Arguably, COVID-19 might accelerate that trend. Can you guys talk about where your market share is within the corporates? And then Brian, maybe if you could allude to or talk about the gross margin versus OpEx dynamics within corporates. Maybe they get better pricing, but hey, is the cost to service those particular accounts lower and what that means for IDEXX? So let's start with the market share within corporates products, if you could.

Yes. So Jon, I agree with your comment that we have seen fairly rapid consolidation of corporates in recent years. We anticipate that, that's going to continue. We're not really in a position to hypothesize whether COVID-19 accelerates that or it diminishes somewhat. But I think that trend is going to remain intact. Not surprisingly, the corporates represent a roll-up of independent practices. So we think our share is roughly comparable within corporates to what we see in independent practices, so not so surprising there. I also think we're in a great position with corporates. We have a great relationship with most of them. We think -- we believe that we're better positioned than the competition to be able to support their needs. It starts with the commercial organization, both centrally and at the practice level. Very often, what the corporates are looking for is a partner to help them implement different programs at the practice level. We have the field organization, both account management but also the field service reps to help them be able to do that with things like PCC. The other thing that's really important to them are the technology solutions, not just diagnostics, which is critically important to them, but also the software and the way it integrates that gives them the productivity, staff productivity that they're looking for and allows communication with clients and all those pieces. The corporates will tell you that one of the biggest issues they have is staff recruiting and then retaining and engaging their staff. And part of the promise that they make to veterinarians is that you can continue to practice best medicine. And so by partnering with IDEXX, they feel that, that goes a long way to being able to deliver on that promise, that they're not this -- the sort of a white-labeled corporate that's just interested in economics and not the medicine piece. So really good position, and I believe we can sustain that. I'll turn it over to Brian to comment on the margin question you had.

Yes, Jon, one of the things that benefits us in working with our corporate customers is that diagnostics is such a high profit contributor for these practices in a relatively higher-growth area within the veterinary clinics. And so I think that allows us to start from a place where we can create a lot of value in partnership with them and allow us to have a mutually beneficial relationship. There's a lot more profit to be gained from the development of diagnostics broadly within the industry, and this is apparent to our corporate partners as well. And so in terms of our -- how does that impact our P&L, which I assume is at the core of your question, is that we believe that allows us to continue to expand our revenues at a faster rate. And because we can leverage value creating and some efficiencies in terms of supporting these large organizations, that kind of supports achievement of our margin goals as well.

But Brian, just to follow up there, is it margin dilutive? I mean, I'm just curious if you can speak to those dynamics. As consolidation continues to occur in the Companion Animal market, is that something that we need to be cognizant of as a pressure point on your margins down to the EBIT line? Or is it, yes, it hits the gross margin a little bit but nets out at the EBIT line just because of the lower cost of service?

We factor this kind of dynamics into our overall goals. And I think that there are multiple things that can impact how we expand our gross margins over time, including the value accreting. And we're confident we can continue to expand that over time as a lever and also create efficiencies and allow room for reinvestment. So we think we can manage that equation well within the context of our growth strategy, and again, given that diagnosis is such a large area for value creation for both us and our corporate partners.

Okay. And last one for me on corporates. Jay, I think you alluded to this earlier but I just want to follow up with it. Because I think people think corporate and they always think they just want the lowest-cost solution out there. But I mean, arguably, it's all about utilization of diagnostics, right? If you're a corporate and you can increase diagnostics attachment on wellness from 8% to 40%, you're going to make a heck of a lot more money than saving 5% to 10% on the sly. I mean, is that what gives you confidence that you'll continue to be well positioned with corporates as we look forward?

Yes, exactly. Corporates understand the strategic value of diagnostics. That's the bottom line. They understand it from a medical standpoint. They understand it from an economic standpoint, which is your point. So from the perspective of driving programs like preventive care, they're very much aligned with that as a corporate strategy. It's a needle mover for them. They see it is good medicine. The doctors see it is good medicine, and they see it as good economics for the corporate. So I think there's really good alignment, whether it's independent practices or corporate practices for diagnostics use.

Okay. A couple of other topics I want to hit on in the last 5 minutes. In-clinic market share, you guys have done a great job gaining share over the past several years at both the Reference Lab and in-clinic. Actually, your work last night laid that out, going back to 2Q '16. Despite having the greatest amount of share, you continued to gain share. Zoetis has had Abaxis for over a year. They're cobbling together a reference lab network that can bundle with novel therapeutics. Just talk to us on why you don't think you're going to lose share over the next 2 to 3 years as they strengthen their overall diagnostics offering and might be able to bundle that with some of their novel therapeutics. Jay, maybe you can kick that off.

Yes. I'll just make a couple of points. We've always said our markets have been highly competitive and nothing's changed really on that front. We do think we're in a good position to continue to advance these commercial goals. I think if you take a look at CAT One, it's just an excellent example. 8 new parameters in 8 years. The platform doesn't just do chemistry but also electrolytes and immunoassay. If you take a look at SediVue, we released Neural Network 5.0 over the last -- the fourth release over the last 4-plus years, this one with advanced bacteria detection. Customers buy the -- from us. They invest with us, and then what they find is the platform gets more and more capable over time. The other thing is our customers grow faster so they continue to use our products. They find that it's -- from a menu and performance standpoint, it allows them to do more, that their investment generates really positive returns over a long period of time. So they're very pleased with that. From a bundling standpoint, we've always said this is a performance category. Customers are making investments not just for a year or 2 but over a long period of time. They want to make sure that the investments that they make are going to continue to really deliver for them and that -- and they're willing to invest in something that provides that premium performance.

Okay. And so that bundled with therapeutics, which obviously is one of the only things you arguably can't replicate, at least on your own, that's not overly concerning to you guys as you look forward?

Yes. We continue to do well because what we're focused on is diagnostics and delivering value through diagnostics. And customers, in large measures, say that they -- again, they see this as a performance category and it's not something they're willing to necessarily compromise on.

Okay. Last minute so last question, it's a big picture one. Without cutting the numbers, we ran your North American CAG recurring versus the underlying market growth figures that you guys provide, and North American CAG recurring's at roughly a 700 basis point premium to the underlying industry growth metrics. So if the industry is growing 4%, you guys are growing 11%-ish. And here's something that I always struggle with a little bit. If the rate of your share gains at the Reference Lab and point of care are slowing, I don't think you're losing share, but if the rate of share gains slow and innovation isn't as steep as it was a couple of years ago with SDMA and SediVue, what allows you to keep that 700 bp premium that I think is essential to preserving the multiple that your stock currently has? And Jay or Brian, I don't know if either of you guys want to lead there.

I'll make some general thematic points and then hand it to Brian for maybe some closing comments on that. Look, at the end of the day, diagnostics is under-penetrated as a category and from a usage standpoint. We've talked about the runway we see before us that extends over decades. We've been able to grow fast, to your point, premium to the underlying marketplace and PCE because of the -- because of our business model and the approach that we take. Our focus on innovation, for example, is a really important differentiator. Thinking -- VMX wasn't that long ago and we had 3 big notable product launches, digital cytology, advanced bacteria detection, bio assets. So yes, this is on top of the first and only products that you highlighted like SDMA and SediVue, and I would add fecal antigen and others to that. The second piece is our customer-facing organization. This is such a capable organization and it's relatively new in the scheme of things. These subject matter experts, the reach and frequency they have, the customer relationships, the trusted advisers they're able to form, I think, brings those innovations to life at the practice. And then we continue to invest in customer experience. I think our reference lab piece is a great template of what we'd be able to do there with superb turnaround times. And we can service digital cytology, which is an around-the-clock under 2-hour-type service. So in combination of innovation, our customer-facing partnerships, the customer experience we're delivering, I think it does give us confidence that we can continue to grow strongly.

Yes, Jon, just quickly, our strategy has always been more about growing the pie than share gains. And I think that's reflected in the primary driver of our growth has always been our customers growing faster, rather than adding more customers. Not that we don't get a benefit from that, but our strategy is very much aligned with growing the industry. And we're very confident in the global expansion opportunity, the long-term total addressable market opportunity that we've highlighted as supporting sustained double-digit growth over time. So we're confident in our strategy, our focus. And we believe if we're successful growing the market as we have in the past, that that will support a continued growth premium for IDEXX.

Great. Guys, we're going to conclude there. As always, thanks very much for your participation and your time. We're going to move on to Covetrus next. But IDEXX, thanks again and talk soon. Take care.

Okay, thank you.

Thanks, Jon. Take care.