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

Hi. Good afternoon, everyone, and thanks for joining for the first session of our afternoon lineup. We're very pleased to have IDEXX here today, a leading provider of animal health diagnostic products. On stage with me, I have Jay Mazelsky, President and CEO; and we have John Ravis, from Investor Relations in the audience as well.

Jay, maybe to start sort of an open-ended question. 2022, definitely a year of transition for the industry coming off of the surge of demand that we saw during the pandemic. I guess as we sit here at the start of 2023, how do you kind of feel about the state of the industry, both from in terms of how vet clinics have adapted to kind of the new way of the world as well as the demand that you're seeing from the pet owners, many of them knew since the pandemic.

Yes. Thank you for having us Nate, IDEXX, very appreciate it. The -- we just have an outstanding opportunity, more generally speaking, within animal health, but specifically within diagnostics. Let me just take a step back and maybe context that in terms of you refer to this surge in demand during the pandemic. If you take a look at both pet adoptions and overall patient visits, it really was unprecedented. Let me call out a 12-month period. So from Q1 of 2020 to Q1 of 2021, we saw clinical visit growth of 13%. Typically, if you go back over history and look at trend lines, clinical visit growth pre-pandemic average 2% to 3% per annum. So you saw a 4, 5x plus type of clinical visit growth. From a pet adoption standpoint, dogs and cats, but the majority of which were puppies and kittens, by the way what we saw was 10% increase in overall pet population. These are U.S. numbers, but we saw similar type metrics outside of the U.S., whether you're looking at Germany, U.K. and Australia. Now that compares historically pre-pandemic to 1% or so trend line. So 5% compared to 1%. So this was an enormous surge of both patients and visits. And what practices did is essentially heroically supporting to sometimes longer hours. They hired staff where they needed to hire staff. They did what they needed to adjust and to support that surge. But it was ultimately, I think, not sustainable. So if you take a look at post pandemic, if you recall back to the beginning of 2022 with Omicron and some of the sick out connected with that. I think that was a catalyzing event in some ways. The animal health industry has some of the same challenges with staff and retaining staff and really supporting this increase in capacity, and they -- and we saw moderation and we saw some pullback. In Q3, we talked about a 2.4% decline, 3% in Q2. So the industry is working through it. And there's a number of ways in which they're doing it. We can talk about that. Keep in mind that the overall animal health space is just a terrific place to be. Strengthening pet owner pet bond has gotten just stronger through the years over the decades that the type of innovation that we and others in the therapeutic and information management and specialty diet space are bringing the increase commensurately, the standard of care in adopting these type of solutions that the fact that veterinarian, especially the newer generation of veterinarians and their staff are embracing technology in completely either new ways, very exciting time to be in this market.

And I guess, as we think about kind of how this plays forward from here, clinical visits on track this year to kind of be down low single digits, like you said. Do you kind of feel like we're nearing a level that's sustainable from a capacity standpoint, where practices have adapted some of the staffing constraints with vet techs are kind of working through the system that clinics are in a place where they can kind of get back to that level of historical kind of same visit growth -- same sort of visit growth that we've seen in the past?

Yes. So there's a couple of ways that we're thinking about this. If you take a look, getting back to the pre-pandemic, the industry, the profession has demonstrated that they can support in a sustainable way that 2% to 3% clinical visit growth. There's a surge we talked about, and then there is pull back. And so the question is, how do you get back to where is this new equilibrium? And how do you get back to -- what we think is sustainable and is possible, which is 2% to 3%. And I think practices have really taken this time to say, fundamentally, our industry has changed. We need to think about doing some things differently than we've done. And a lot of practices have done that, and they've been leaders in getting out in looking at staffing max. Currently, again, U.S. data, but it's roughly equivalent outside the U.S., what you see is you see put over 2 technicians -- 2 veterinary technicians per veterinarian. The veterinarian economist who have looked at this said, you could grouse that to 3 or 4 in a poor practice economics and in care and allow your licensed techs and your veterinarians to practice at the top of their license. They're looking at number of practice rooms they have, workflow, how they pay and retain their staff so that they are better able to retain them and provide career tracking. Yet, you add all these things together, plus what we as a company are doing from the standpoint of supplying technology, premium implementation, software, PIMS systems and associated applications. We've had record placement levels in those areas as practices are incredibly hungry for technology that helps them with workflow, that helps them optimize each step of that patient visit. So we're confident that the industry, the profession will work through this, that it's not a question of really identifying a date in a month when that's going to happen, it's progressing if some practices have probably worked through that some practices may be lagging a bit, but it's happening, and I think we'll be able to support as an industry that much higher demand level that's out there.

Got it. And so should we think about that as like I think the bulk of the adjustment, the practices started to make kind of came in, the early parts of 2022 is sort of the visit growth shifted. Is that sort of like a point where we can kind of say that, hey they've had a year to deal with this step down in capacity? It's not an easy solve and something that will take time. But like that's sort of the time line for when the industry potentially gets back to a more normalized level of visit growth.

Yes. So it depends a little bit on geography. We indicated that we began to see some pullback in Q4 in 2021 in Europe. And then in the U.S., we saw it through -- pretty healthy visit growth through Q1. So if you think about those as benchmarks, the -- by geography, practices to your point, have had now some time to work through it. It's not a -- people tend to think about it as sort of a discrete event. At what point have we reached sort of spontaneous combustion and we can get back to normal. And I think what practices have realized is that this is going to be a set of steps cumulatively, which allow to be more productive. We had a veterinarian at Investor Day, Dr. Francke out of Michigan practice, talk about as a practice owner that he takes a step back and looks at different things that they do, including like callbacks to customers and how do I save a minute or 2. And if he's got a 4 or 5 doctor practice and they're all looking for these discrete time saving type things, they can manage their practice better. It adds up. And I think this is what the industry is going through. The other thing is the staff you can never underestimate the importance of retaining the people you have and then hiring. And the quickest path to be able to do that is through technicians, veterinarians go through school and then there's residency. And so that tends to happen at a slower pace, but technicians and nonlicensed technicians, and that varies by state, can support practice productivity fairly quickly.

And I guess when I think about the guidance for 2022 in the fourth quarter, I think it assumed clinical visits were around the same level that you saw in 3Q. I think looking at some of the vet traffic data for the fourth quarter, it seems like that's sort of what we've seen play out. I guess, is that sort of the right way to think about your guidance for the fourth quarter, you kind of assume consistency relative to what you saw in the third?

So we're in the blackout period now, so I can't comment on Q4 per se. But what we said as part of the Q3 earnings call was that we anticipated sort of a stable trend of what we have seen up to that point, they will be continue this moderation. And so that's how we thought about that and built that into the guidance. What I will say is our focus as a company has really been on those what we're calling execution factors. So if you take a look at customer loyalty and retention, never been higher. Price realization has been very strong, instrument placement software, diagnostics adoption. And when they adopt diagnostics as part of a clinical visit, utilization has been growing, in some cases, even hotter than what you've seen. Those are things we can control through innovation, through commercial partnering. It's really our strategy. It's the bottom end of our strategy. That's where our focus is.

Yes. I guess 1 other kind of more near-term question. When we see things like these severe weather event that we had kind of leading up to Christmas or some of the spikes in flu that may cause some disruption in like staffing levels. Do you feel like that typically has like an impact on the volumes that you see through your business? Or is it sort of second or third derivative and so maybe not as acute.

Yes. It depends on the event per se. If we think that it's material, we call it out -- the -- again, I'm not going to comment on past weather events in Q4 because of the blackout period. But the weather happens all the time. So we tend not to necessarily identify it and I say it's particularly severe. So if you think about in the Q3, we had a Hurricane, Ian, I don't believe we necessarily call that out specifically.

Yes. Makes sense. Okay. I guess moving on, I wanted to talk a little bit about price. And I guess with consumers, obviously, their budgets are under pressure. I guess, how do you feel like that plays out at the vet office? Like is the decision, do I take my pet in or not? Or -- and so once the pet owner does show up at the vet, it's really like I want the best standard of care, and so there's less maybe sensitivity to price once you get there? Or do you think that consumers may kind of look at, okay, what am I paying for, what's the vet recommending and maybe trying to find the best solution that fits their budget.

Yes. So a couple of maybe context setting remarks about price. As a company, we really work very hard and are very careful to make sure that the value proposition we have from a solution -- testing solution and information management standpoint, is in line with the price that we're asking for. We tend not to -- we don't want to get over our key tips. Our strategy is really a sector development strategy to encourage adoption in utilization. So keeping that in equilibrium is a very important element of our strategy. And our -- we've talked about technology for life in the past. This is a notion that when you buy our solutions, we continue to update that the feature and capability of our solutions. If you take a look at Catalyst One, over the last decade, for example, we've had 8 menu or parameter extensions over that period of time. So a customer who bought our chemistry analyzer 5, 7 years ago, has the exact same features and capability of the customer to purchase that same instrument a month ago. And so having this technology for life philosophy across our entire suite, allows us to maintain the differentiation and the value that allows us to in turn take products. So that's an important anchoring principle. Secondly, in this year, specifically, the cost of running our business was higher as a result of headline inflation, I think it was 7.7%, thereabouts. And so the cost of fuel and staff and logistics and plastics, resins, microprocessors that all [indiscernible]. When we talk to our customers, our customers tell us, I don't want to have to spend a second thinking about diagnostics. I want -- from a turnaround time standpoint, from a product availability standpoint, from the perspective of giving me what I need when I need it, I need you to do that. I need you to do your job so that we can focus on patient care. And coming out of the 2 years of the pandemic, we grew more than 30% of the CAG business. So we had to invest in capacity and logistics, manufacturing, all those things connected with being able to supply an interrupted product. So we did that, and customers appreciated that investment. So then -- that's the second pillar. The third pillar is that customer, the veterinarian practice themselves. The diagnostics category within the practice is the biggest profit center within the practice. That drives the way veterinarians practice in charge for diagnostics. It's an activity cost. So they tend to do -- they tend to put a markup on it, 2.5 to 3x the cost of the diagnostics. That covers their activity, technicians and the exams that they may -- that they themselves may do. And so with this markup of 2.5 to 3x, it's a very important part of not just diagnosing because you can't treat unless you first diagnose, but practice economics. And so if we increase the price, and we've done it for the right reasons, and we're in balance with the value that we're delivering, they increase their price to the pet owner. So that's the third and they're willing to do that. And because it's such an important part, it's a foundational part of how they practice medicine. And then the fourth part, the way we think about pricing is pet owner. Is the pet owner willing to pay for these type of solutions that you were asking at as part of one of your questions? The truth is that the pet owner considers the pet to be part of their member of their household, a beloved member of their household. And all the survey data sets, independent of the economic segment, whether you're lower income or higher income is that you're willing to -- you see it the same. You're willing to spend on behalf of the pet. And when you take a look at the total spend, it's a little bit -- it's about 2% or so. And that's not just health care and diagnostics, but food and all the things kind of grooming, all the things connected with health care with pet. And then health care is a little bit over 1%, and then diagnostics is a fraction of that. So from a share of wallet standpoint, there's a share of personal consumption expenditure, relatively small. And then you take 1 step even deeper than that and say, you can do -- you can afford it, but do you want to do it? And what pet owners consistently say, very high percentages say, I will prioritize spending on health care for my pet above entertainment, travel, all those things that you might think about as discretionary -- potentially discretionary. So we think we're in a pretty good place. That's a long way of saying. We're in a good place.

Yes. got it. And so like you kind of just said there hasn't really been pushed back from the veterinary community on the price increases that you take. And I think that they understand the value. I think the plan was to take a price increase for January 1. I guess should we think about that as the company kind of targeting that 2% to 3% price realization that you typically like to get in any given year.

So we have not provided any guidance in terms of quantitatively what that price increase is. We have said and we did execute from a cadence standpoint, normal calendar cadence, January 1 price increase. And that built off a summer price increase that we did in August 1, which was off cycle for us and something we haven't done historically. So there is a 5-month price increase in the second half of 2020 to a 7-months benefit into '23.

Yes. Got it. I guess, maybe pivoting to Europe. I guess looking at the international CAG growth in the third quarter, pretty stable, sequentially kind of despite some of the macro pressures facing that consumer over there. I guess how do you feel about the durability of that market near term? And I guess, longer term, I think one of the big opportunities is to kind of continue to improve the standard of care for a lot of those countries relative to what U.S. does in terms of diagnostic testing, what do you feel like is the most effective way to do that?

Yes. So the European region, and that's composed of 23, 24 individual country market, it's a great opportunity. They love their pets as much in Germany and Nordics and the U.K. as we do here, in the U.S. And in fact, if you look at per capita spend in the European region by things like specialty diets or pharmaceuticals, it's very comparable calibrated, normalized to what we see in the U.S. Diagnostic setting is quite a bit lower, about 5% of clinical visits include blood work. And we define blood work as chemistry and/or hematology. In the U.S., it's 19%. That gives you just a sense of how less the wallet that is. And part of our job as a company is to develop this -- develop the sector through innovation, through awareness, education and drive that. And we've done -- if you go back to 2020, we've done 7 market expansions or country expansions with our geographic sales organization. And we think that's the key. We think by having commercial partners who have subject matter experts, who have very strong relationships with customers. They create that awareness, the education and ultimately, the consideration. The other thing that's really important in thinking about this opportunity is product fed. The -- we just recently introduced ProCyte One. We've just very strong growth since introduction. I think in Q3, we're at 26% hematology growth. So just outstanding, it fits from a capability performance, cost and footprint profile in our international markets. Many of these markets are hematology-first markets. So the -- there's a lot of customer receptivity and interest in these products, and they come with an attach rate for chemi there's a multiplier impact. So the attach rate with our chemistry and increasingly SediVue and in some cases, Rapid Assay or -- it pulls along a full suite. It's a very attractive opportunity for us longer term, and it's something we'll continue to invest in.

And I guess along these same lines, when we think either on a global basis or a U.S. basis, how high can we go in terms of the percent of visits that include blood work? And I guess, what do you feel like it will take to kind of continue to kind of push that average up, whether it's 19% in the U.S. or 5% internationally, I think we kind of touched on the international piece, but in the U.S., how much higher can that go?

Yes. We think it can go much higher. If you go back to some data model we presented in the last couple of investor days, we think that there's a 25-year opportunity in front of us. If you take a look at the U.S. at 19%, I think, wellness 10% and non-wellness, which is primarily a sick patient, I think it's like 25% or so. There's a big difference between when they wear and when they use diagnostics as a first point. The other thing that I would say is that the -- when you break down the customer groupings at U.S. by deciles, and you take a look at the top deciles, these customers are using diagnostics in 40% of these clinical visits. So that's not a few customers. We're talking hundreds of customers are already doing that. And that's 40%. So that's -- the future is here. It's just a question of getting the rest of the customer base to do that. And our commercial strategy is really geared to being able to drive those lower decile users into that higher space and driving the higher decile users into an even higher space. If you look at what the professional associations recommend as part of clinical visits. Almost in all cases, they'll recommend to use some diagnostics, if not blood-based diagnostics. So it's -- I think it's a remarkable opportunity. As we've modeled this out, we think there's 25 years of growth. And we think that we can move the U.S. to an appreciably higher standard than it's at today in Europe and our international regions. Obviously, we're starting from a lower base. So that's even more embryonic greenfield.

And how important is wellness testing in like the PCC program, things like that to driving that continued growth in the utilization volumes or...