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

I think we're all set, the music died down. Jon Block, with Stifel. We're transitioning to animal health in the afternoon, and IDEXX is going to kick us off. So with us, we have Jay Mazelsky, President and CEO; and Brian McKeon, Executive Vice President and CFO. We're going to hit on 5 or 6 main topics, guys. As you heard me say throughout the day if you have any questions, just fire away.

But I want to start with trends. And Jay or Brian, in the first quarter of 2022, you talked about overall lower visit -- vet visit growth. And that seemed to be a function of -- you talked about capacity constraints and some transient issues like weather and COVID. Maybe let's start with those transient issues. Are they improving? Is that at least in the rearview mirror when we think about the couple of different dynamics that impacted 1Q?

Yes. So Jon, let me start with a little bit of context. Coming out of the pandemic, and then I'll go into some of the trends. We've -- over the last couple of years, '20, '21, we've had really a significant step-up, both in terms of absolute number of net new pets, 10% over those 2 years and a number of pet visits. And we have about 10% plus also. And as a company, we have grown very strongly, 17% per annum CAG in diagnostics recurring revenue. So from a -- if you take a look at just the -- and that's the U.S. numbers. So if you take a look at just the U.S. for a minute, this is really an unprecedented step up both in terms of demands within the -- on the veterinary practices and really overall activity. So it's not surprising coming into 2022, practices and veterinarians took a step back and they're working through those capacity issues. So we did see in the first part of, really, January, Omicron and COVID and related to that, some staff outs. But practices are really looking to adapt to be able to add staff, retain the existing staff that they have, investing in technology, IDEXX technology with software and capital equipment to improve productivity. So we think that, that is a challenge for the industry, but there's a number of short-term and longer-term activities they're taking to address that.

Okay. And...

Do you want to -- I just -- Brian, would you want to add anything to that?

I think Jay summarized it well, it's been a significant step-up that's, I think, challenged our company. I know just to keep up with all the strong growth and the increase in demand operationally. And I think some of the changes that we saw are really just reflective of the clinics themselves trying to adapt to this much higher demand environment with the backdrop of challenges around things like staffing that many industries are dealing with. But I think the good news is the underlying demand dynamic is strong. I think the long-term outlook for our sector is as good as it's ever been, and we feel really good about the levers that we can execute against and drive. And I think we demonstrated that in our performance in terms of new business acquisition, new premium instrument placements, utilization growth, the key levers that we're really trying to drive as a company.

Okay. So a couple of things that I want to clean up upfront and then I want to spend a lot of time on innovation and looking out. But one of the questions that I always get, and it's not just specific to you guys or animal health, it's certainly pervasive and dental, is the question about the pull forward in demand, right? And Jay, you just mentioned plus 10%. I think I heard you talk about some metrics about pet adoptions up or net pets up 6% in 2020, 4% in 2021, correct me if I'm wrong. How do we view that in the context of is that a pull forward in demand in now '22 and '23? Hey, the Block family was thinking about getting a dog, and they got it in 2020, and that would have occurred in 2022. So is that pulling forward or no? Was it, call it, expansion of the overall market. And even in '22 and beyond, we're still going to be on a normalized trajectory of plus 1% and change of pet population?

Yes. So we haven't seen that in the first -- through the first quarter as a pull forward in demand. To your point around the 1% historical adoption rate pre-pandemic is right, and then there were 6% and 4%. In fact, it's hard to get at some of the numbers, but when you take a look at surrenders, let's say, as a proxy for pet owners returning their pets, we haven't seen any evidence that pet owners have become less enthusiastic or less dedicated, the dogs and cats that are parts of their household. In fact, a lot of the market research and survey indicates that first-time pet owners are actually interested in potentially adopting a second pet. So we think that's a good thread. The other thing to keep in mind is when you take a look at the adoptions, they have been primarily puppies and kittens. And so over time, these puppies and kittens we know will consume more care driven and enabled by diagnostics. So we think the overall trends supporting a really healthy longer-term growth path is there.

And I want to get into that sort of evolution of care and how it sort of trends throughout a number of years. First, let me just hit on the capacity issues or capacity constraints. It's been there for a number of quarters. You guys highlighted it in 1Q, you lowered the guidance a little bit. That's very un-IDEXX like. But the pushback I got from investors were okay, the stock traded off but how can I even buy it here because what alleviates the capacity constraints? It's like you guys raised the big red flag on capacity issues. And we know that you grow sort of like clockwork on CAG Dx recurring at a certain premium, pretty tight band, 1,000 to 1,200 bps off that underlying vet visit growth. But what can you do or what's the industry going to do to alleviate the capacity constraints, right? How do we think about that going forward?

Yes. So there's short-term and longer-term actions. The industry obviously owns some of the actions that we can partner and help them with others. So let's take a look at the industry as a whole. In terms of the longer-term things, absolute number of veterinarians, there's a pipeline for that. That takes -- there's 4 years of veterinary school residency and then getting training. That's not a short-term fix in terms of absolute number of veterinarians. But if you actually take a look at veterinarian staff, whether it's licensed technicians or unlicensed technicians, that can be addressed relatively quickly. And depending upon the state, you can, as an unlicensed technician, do some things that I think help the veterinarian. What you typically see from a mix standpoint is about 2 veterinary techs to a single veterinarian. By increasing that 2.5 to 3, that obviously takes time, but to increase the productivity of the veterinarian and let him or her practice at the top of their license. So there -- the veterinarians we talked to, practice owners are working hard to retain the existing staff within the practices and then working hard through increases in salary and benefits and better working conditions to attract more to the industry for the first time.

In the techs, Jay, the techs are more readily available? It's just sort of a question of pay and...

Yes. So the techs -- if they're licensed techs, that there's a time lag in terms of going to school and getting the type of training they need. If you're unlicensed, let's say, you're out of high school, maybe you've taken some courses at community college. You can come join a practice and be trained and do some things to help from a capacity standpoint. The other thing that practices are doing is they're investing in technology. We've seen record in-service placements in Q4 and Q1, the software, cloud-based PIM systems, which help with staff productivity internal client, external client communications. So there's money, there's capacity to invest in technology to really drive that step function of productivity they need.

Yes. I think building on this a way to think about long term, near term, what the dynamics are as we shared last summer, a long-term algorithm for growth for our business. And I'll focus on our U.S. CAG diagnostic recurring revenue to make it a little easier. But we have a long-term view that we saw a 10% to 13% organic growth, and we were growing at the high end of that range over the last 5 years. The building blocks of that include clinical visit growth, right? So it's -- that algorithm had 3% to 4%. That was the 2% to 3% same-store growth, some plus some benefit from practice formation. The bigger part of the growth equation that builds to the 10% to 13% are 4% to 5% annual benefit from utilization growth, 1% net benefit from net customer gains versus customer losses, which is something we've delivered consistently and 2% to 3% on pricing. And so to your point, Jon, about like what can you do about it? If we put clinical visits aside for a moment, the utilization gains in the first quarter that you saw were all very healthy within the industry. We had the record retention levels, very strong new business performance. We actually had 4% to 5% net price improvement rather than 2% to 3%. So the things that are within our control are all very healthy. We feel we can build on that and very much align with our long-term view. The temporal challenge we're working through is an environment that was having positive clinical visit growth. After a step -- a huge step-up in demand, the industry is struggling with adapting to that higher level of growth in a challenging environment. I think this is the clinics historically have found a way to be able to support growth. So this is not something that we think is a long-term trend of decline and the ability to support growth. I think there's a transition here trying to support the higher level of growth at a time when there's a lot of demands on labor and many sectors are working through that. So that's the near-term challenge that we're working through, but I think we can do things to help that, with the clinics in terms of our software solutions in terms of the insights that we can bring, and we have confidence that that's something that the sector will work through over time. So I think this is a -- there is a near-term dynamic. We'll work through it as a change. It did happen relatively quickly relative to the trends that we were seeing in the second half last year, but we think this is something that we can influence both in terms of variables that we can drive independent of that, but also ways that we can help the sector adapt.

And maybe one more down this road and then I'll pivot and Brian started to throw out numbers on you sort of real time. But as part of the solution just getting to the back part of the year when the vet visit comps ease, like in terms of how the vet visits have tracked, they were down, but off of a really tough comp. They were still running, I think, up high single digit on a 2-year stack? Or is it, no, that's not the right way to think about it, and it goes to a 3-year CAGR. And you might know where I'm going with it, but it's going to be hard for vet visit growth to remain negative in the back part of this year, when you look about -- when you look -- take the comp into consideration, unless you don't think that's the right way to think about it, it's more of a 3-year CAGR basis. So let me know if that made some sense.

Well, I think it's -- look, last year was strong throughout the year. So I think the -- you had year-over-year growth dynamics last year, but I think it was a building year of strength. So I think we're going to have -- we're going to -- the good news is demand went up and we're growing off higher demand, but we're going to have those comparisons through this year. To your premise, though, over time, I do think we're highly confident we -- the industry is going to figure a way to have staffing and ways to support positive clinical visit growth. So it's really a question of how long that takes. And in the meantime, what we're going to be doing is working very actively to drive the things that are within our control and execute well. And that kind of informs our goals for the year.

That's a pretty good segue of where I want to spend some time to what's in your control and increasing that premium to underlying visit growth. I think a big part of that would be innovation, right? And that's some stuff that's in your control. Maybe talk to us about the in-license agreements that you called out on the first quarter call. I guess first, just a technical question. The $0.72 cost for the year, Brian, that all gets recognized in the second quarter?

That's correct. It's an upfront P&L recognition of multiyear.

So that's a June event?

Yes.

And then, Jay, how do we think about the timing from you enter into these agreements until commercialization of these initiatives take place?

Yes. Let me give you some backdrop in terms of how we think about innovation. Yes, it's clearly the lifeblood, and it has been a major factor in our success as a company. There are lots of challenging clinical problems that are out there begging for solutions. We're particularly, in this case, interested in bringing point-of-care platforms and applications that are in clinic environment. The nice thing about testing in clinic is you have this patient, pet owner window, 10, 15 minutes, if you can test and get a quick result, you can either treat or reflex test and communicate right there to the pet owner. Historically, what we've done is if there's nothing out there in the human health side or the world and for us to bring to the veterinary market, the animal health marketplace, we invent it ourselves. That tends to be a longer time line to be able to do that. It takes a lot of internal resources in this. And -- but we've been very successful in doing that. If you take a look at Catalyst, if you take a look at ProCyte One, we have a long track record of bringing these type of internally developed innovations to the marketplace. Now where there are situations where there's very interesting technology. There's the opportunity to in-license technology that we think will work in the animal health marketplace. Our track record is outstanding in terms of being able to adapt that technology to the marketplace and create completely new markets. So we're excited to be able to do that. We -- to have been working with 2 different companies. It just so happened to come together within this time frame, and we announced it. In terms of telegraphing what they are, we've made a decision for competitive and other reasons to talk about it much closer to launch.

Okay. So 2 different opportunities came together at the same time, both point of care, right, which lends itself to a razor, razor blade approach for those. Is there any benchmark that we can go back into where you in-license previously and from when you went and entered into the agreement until when commercialization took place, was that 6 months, 12 months, 24 months? Anything else to sort of draw on?

Yes. I mean there's not a model you can point to. I mean, there are solutions like SediVue, where we -- there was a urine sediment solution on the human marketplace. We brought that in, but it required a fair amount of adaptation and that was measured in a short number of years to be able to do that. That's -- I think that's not an exact analog. It just depends on the technology and the readiness of the technology and the work we need to do.

Okay. Fair enough. Got it. And let me just go down a different road for innovation. So I think when I first picked up coverage for IDEXX, I was going out to Maine and I remember Catalyst and you guys are trying to ramp, right? Catalyst, this was '08?

Catalyst Dx was '08.

Yes. Catalyst Dx, '08. So Catalyst Dx was '08. I think Cat One was '14.

'14, that's correct.

So they hired me for my math, right? So that's a 6-year interval. And here we are in 2022, 8 years. And chemistry would just be tremendous for you guys. Now I'll sort of talk to both sides. One is, Cat One is a very smart device where it's innovated to cruise value over time, you're able to expand the menu. That being said, it's still 8 years after your prior iteration was 6 years. Talk to us about the want or the need to get out there with the next-gen Catalysts analyzer?

Yes. So the way to think about the transition from Catalyst Dx to Catalyst One, essentially, it performs it did the exact same thing that Catalyst Dx did. So if you think about it used the same dry slide, the only real difference in terms of capability was the Catalyst Dx from a throughput standpoint could do 2 patients at the same time, where Catalyst One have the exact same performance, turnaround time, overall capability, but did single patient. The benefit to that is that we are able to expand menu. By the way, it's not just chemistry, it's electrolytes, chemistry and immunoassay, expand the capability in the menu of our Catalyst platform without requiring the customer to buy a new piece of capital. So what you see with some of our competitors is when they come out with a new assay, whether it's an immunoassay or a new chemistry, you have to attempt to buy another piece of equipment. So Catalyst One from the standpoint of footprint, capability, expansibility cost was just enabled us to reach different parts of the marketplace, vis-a-vis Dx, which is more of the -- which was more of the performance and value end of the marketplace. And the same thing with ProCyte One, by the way. ProCyte One relative to ProCyte Dx does almost the exact same menu and performance as ProCyte Dx, but allows us to reach pieces of the market that we couldn't get to before. So we're extremely happy with our technology for life approach to Catalyst One, and I think we still have a winning solution, which allows us to really grow strongly.

So don't think about that platform being integrated even though that 8-year window quickly going to a 9-year window versus the prior 6. It's not really that platform that needs to be iterated?

We iterate it through menu. And so if you take a look at over the last decade or so, we've come out with 10-plus new assays, SDMA, total T4, progesterone, bile acids. So this is a platform that does appreciably more today than it did when it first came out, then every Catalyst One owner can use all of this menu. So they don't have to buy a new analyzer. They don't have to invest in new capital, they can use what they have. We call it technology for life.

Okay. Maybe just talk about some of your other initiatives, and you're saying not having to buy another analyzer you guys had a digital cytology approach and then urine sediment, you've got some other guys that are trying to do what urine and fecal and then someone else is trying to do sort of cytology and fecal. Are you well positioned in those parts of the market? Do you need to refresh those product lines in order to be a little bit more competitive there?

Yes. We think our urine sediment analyzer, the SediVue was groundbreaking. We released it back in 2015. So we had between a 5- and a 7-year at start on a marketplace, 13,000 placements in the installed base. It's on its sixth generation. So the thing to keep in mind about the algorithm and IA-based diagnostics is the number of images you have drive performance and accuracy. With SediVue, we have over 800 million images.

So you'll always have that benefit just due to you're launching much sooner than everyone else, and you have an installed base that's much bigger.

Yes. So for example, in terms of like bacteria performance and being able to distinguish between rods and cones and sensitivity and specificity connected with that. This has enabled us as a result of that performance advantage to stay ahead of the competition, and we've done extremely well there.

Brian, over to you. Maybe I'll have some questions on the supply chain. Product availability was close to, I think, 100% in the first quarter of 2022 and is really impressive in this environment, but things are so fluid and dynamic. We hear from so many different companies. So just talk about product availability and maybe even more broadly, the supply chain and how you guys have been navigating that scenario?

Yes. As a company, we've been -- our primary goal is to ensure that we have continuity for customers, so whether that be lab services or consumables to replenish kind of the recurring revenue model, we want to make sure that we're fully supportive of our customers. And as you pointed out, we've been able to achieve a very high of reliability on their front. We've -- we're managing through -- we have long-term customer supply relationships that we can build upon to ensure that we don't have any kind of disruption. And I think that's been a focus of the operations team and also just dealing with a very high-growth environment, the 17% compounded growth over the last couple of years adds an additional layer of complexity just trying to keep up with the demands that go along with that. I think there have been inflationary dynamics that are -- there have gone along with those changes, whether that be freight and distribution costs and labor costs being adaptive so that we're ensuring we've got the right levels of staffing. We've been able to manage that effectively. We have taken relatively higher price increases than we normally would to help mitigate that. But we feel good about how we've been able to manage that and think we can continue to do that effectively going forward.

On the pricing front, it usually runs 2% to 3% per annum. I think you alluded to 4% to 5% in the first -- is that for 2022 we should think about 4% to 5%?

We didn't explicitly update that component, but I think we're confident we can sustain build on those kind of levels, and we think it's appropriate given the value that we're delivering and also some of the consideration I just mentioned in terms of higher costs.

And does the competitive environment allow you to sustain that sort of pricing into 2023?

I think we'll continue to monitor that. I think that we're not alone in dealing with whether it be in the lab services area, higher frontline labor costs or just higher input costs, higher freight costs. So I think that's the context that all the competitors are dealing with. So I think we'll evaluate that as we go forward and ensure that we're balanced in how we think about that and...

Because I guess why I'm pushing so hard here between like underlying vet visits and pricing premium and innovation and having Jay going to finally tell me when these 2 R&Ds are going to hit the market is because right now, you're pulling the lever of additional 2% to 3% in price, right? In 2022, if that goes back to 2% to 3% and vet visits don't really improve, you're 200 to 300 bps in the hole. And it seems like The Street expects an acceleration off the reduction. So how do we just think about that? Do we -- pardon me, like cross our fingers and hope that vet visits improve? Do you replicate price? Do you have more innovation? Walk us through that bill to get us comfortable that the growth rate can accelerate in '23 off of '22.

Yes. So let me talk specifically about pricing and some of the dynamics as to how that works. From a standpoint of pricing, we've always, as a philosophy, try to maintain a balance between value we deliver and the price we take. And I think 2022 with inflation, as Brian indicated, has really been an exceptional year relative to the last 5, 10 years. The way practices, think about diagnostics, is it's something -- it's a profit center for the practice. It's probably the biggest profit center within the practice. They do a standard markup. It's 2.5 to 3x, it's a factor in their PIM system, and they pass that on to the pet owner. There's -- I think there's a very strong belief and evidence that pet owners are willing to pay higher prices to get the type of care that they need in -- from the veterinarian and enabled through diagnostics. So from the standpoint of price increases is good end market demand and there's the ability of the veterinarian to pass it on and obviously make money from that. So those are, I think, things that are important. The other thing that veterinarians tell us is what they need from us and what they really value the most is customer experience and product continuity. They don't want disruptions. This is not something that they want to have to worry about. They have enough challenges on their plate in terms of staffing and labor. And they appreciate the fact that we've invested in reference lab networks, logistics, warehouses, customer technical support, the things that enable them to have a seamless, frictionless customer experience. So they value that and they value that differentially in terms of what we've been able to deliver versus others in the marketplace. So I think that keeps us in a good position with customers.

I think, Jon, we've always been comfortable with the ability to realize price increases for the value that we're providing. I think we're -- we continue to feel good about the value that we're providing and the ability to leverage that. And we -- the environment that we're in, it is a bigger part of the growth equation and that very well may continue.

Okay. And just one more to the guidance, maybe just to focus on 2022. Brian, I think when you updated the guidance, you said, look, there's obviously a range there, and maybe the lower end of the range assumes that the bed visits don't really improve all that much. Maybe the high end -- correct me if I'm wrong, the high end improves some sort of a modest improvement. But I asked a question about macro on the call and you said, hey, in the international markets, we're seeing a little bit of macro pressure. But our guidance does not assume here in the U.S., any macro headwinds. In the U.S., there's a bigger wellness component than what you see in your international markets. One, did I have that right in terms of the context of guidance? And two, talk about your conviction on why some of these macro headwinds, which are already starting to show up internationally don't necessarily manifest here in the U.S.?

Well, we really tried to reflect the -- in our outlook, the trends that we were seeing early in the year and the CAG Diagnostic recurring revenue growth is a key metric that we talk about, and that was 9.4% in the first quarter. We probably had about 100 basis points of benefit from days. And so it's more like an 8.5% range. And on the full year, the outlook, the lower end of our full year guide is basically reflective of similar trends continuing. The upper end reflects that in the second half of the year, some of the dynamics that we think are in areas like the capacity management, if those get resolved, we can get back towards the original kind of goals that we had at the start of the year given the other levers that we're trying to drive that are in our controller, we're executing quite well against. We -- to your point, we didn't explicitly try to project macro factors in the back half. We're not trying to say that our business isn't impacted by changes in the economy. We just didn't at that point in time of a basis to say, here's what we think it is, other than what was embedded in kind of the trends in the early part of the year, which, candidly, we did not think in the U.S. were being impacted by changes in consumer behavior. So that's something we'll continue to monitor, and there are a number of factors that can go in either direction in terms of our business, and we'll adapt and we'll continue to focus on the things that we can control and drive and continue to deliver strong financial results as we do that.

Okay. Please?

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Yes. So just to restate the question so everybody can hear it. The question was around whether reference labs is more commoditized. We haven't talked about innovation necessarily. And the second question had to do with TAM growth relative to our own growth. Let me -- so Reference Labs is highly differentiated. It's highly differentiated across a number of different dimensions, menu being an important dimension. We announced there were some product releases. We announced the VMX in January, connected with 4Dx. There's also a number of very innovative things we've done relative to our network relative to turnaround time and customer experience that we think customers value. Keep in mind that when we talk about reference lab services, it's very expansive. It includes things like chemistry and hematology, but also things like consulting services, teleradiology, cardiology, pathology. And we announced some important product releases connected to oncology diagnosis and staging. So Reference Lab continues to be an area of high innovation for us and really high interest. In terms of the total market growth, we'll update that as part of Investor Day. I think what we've seen over time as the market continues to expand, obviously, we think we're developing the market and potentially expanding faster than the competition. But we tend to do a snapshot of that on an annual basis.

Great. Thank you. And guys, we're going to have to stop there. IDEXX, thank you very much for your time. Appreciate it.

Thank you, Jon. Appreciate it.

Thanks, Jon. Thanks, everybody.