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

But maybe we could go there next. So we've heard some numbers from the vet community. It seems to indicate that pricing growth for '24 will be slightly higher than that 3% to 4% longer-term range. I guess, could you maybe just talk about how you think about setting price, the factors that go into a decision in any given year as we think about from the company's standpoint, how you make that?

Sure. I mean from a pricing philosophy standpoint, we think that this is a really terrific investable market. And the type of horizons, we typically think about our 20-plus years at really being there's just tremendous runway in front of us. So we don't want to be too far over our ski tips to make sure that pricing reflects the value that we deliver as a company, the differentiation of our solutions. And obviously, in this inflationary environment, that it's come down a bit now but it's higher than what we've, I think, seen for a very long time. The cost of running the business has been higher. So we've priced to really be able to continue to reflect the value that we're delivering to our customers as well as the fact that the inflationary effects on labor and components and services have been higher. And we make sure we have a number of, I think, ways of monitoring the fact that the -- we're not getting too far in front of where that value equation is. Obviously, we look at our diagnostics still being used. Are they still growing? And what we saw in Q3, I think you cited for the wellness visits, frequency and intensity of diagnostics continues to grow, and it's been an ongoing trend. We look at retention. Our retention levels across all our modalities are in the high 90s. And so we look at customer satisfaction surveys, Net Promoter Score, all of those things. And when we look at product sets that may have more of a screening profile to them. Like if you think about the vector-borne disease 4Dx screening, that's a test that typically, the dog may appear to be well that they aren't yet exhibiting clinical symptoms. So if we were too far in front of the market there, you might see some pullback on that, and that business has been strong. So that's our side of it. But then there's the veterinarian side of it and the practice side of it, which is diagnostics for them as a profit center. It's not a cost center. So from a profit center standpoint, they market up, they're capturing medical activity within that -- within the practice, that's how they recover those costs from an activity costing standpoint. So it drives their medical services envelope within the practice. So it's a core part of who they are, why they got into medicine, what the practice exists. And then we look at it from the pet owner. All of our perspective, pets members, beloved members of our family. We want to make sure that as a pet owner, you're still prioritizing this over other things you can spend your money on. And so we're very comfortable with where we are.

And just following up on that, that concept of sort of the value equation, not wanting to get too far out. Is competitive analysis also a part of that value equation?

I mean it's a very competitive marketplace. Customers have a lot of choices. So we do look at what the overall marketplace as a whole is doing. It often comes down to from a -- when you talk to veterinary customers, they'll tell you, Diagnostics is a performance category. It's the accuracy, the usability, the support once they get a test result are the primary factors in which they judge our solution vis-a-vis others in the sector. So our focus is on making sure we get those pieces right because it's a profit center, because it drives their medical services piece. They tend to be more sensitive to that than whether they're paying couple plus percent more per solution.

And just lastly on this. You kind of touched on it but the potentially like price elasticity that the consumer might have to what they spend at the vet and how that maybe factors in. And I don't know if you can frame the spending on diagnostics for an appointment versus what they're spending overall? And have imagined that's kind of an important piece because diagnostics is only one component.

Yes. There's 2 pieces to your question. We do look at overall spend on pet, let's say, a pet envelope -- pet spending envelope. And we shared those at Investor Days, it represents about 2% of personal consumption expenditure across different demographics. And then we look at the spend on pet health care and then as a subset to pet health care, diagnostics. And diagnostics is about 0.2%, not really much more than 0.2% of the total PCE envelope. So it's a fairly small piece of the whole. I mean -- but it's still real and we look at that. The interesting thing is, just to add some additional color to this. As a pet ages and they advance through different life stages, they consume more health care. As mammals, they're not so different in that respect than humans. But the percentage that is spent on diagnostics proportionally grows. So they -- you may have a young adult where on average those that visit the vet $325, $340 they spent on health care, about 12% of that is spent on diagnostics. These are average numbers. Now you go up to seniors and geriatrics, maybe $650 or plus is spent on health care, about 20% are spent on diagnostics. So all those things factor into it. And then not to draw this out too long, we also look at from a scatter plot standpoint, spend by urban, suburban, rural pet owners, different ZIP codes, different economic demographics. And what we find is there isn't a good correlation. In other words, the person making $50,000 a year working in a -- living and working in a rural area, spends proportionately the same on diagnostics as somebody more than $200,000 a year living and working in an urban area. So just fascinating from that standpoint.

And you mentioned that the diagnostic frequency and utilization components of growth to remain pretty robust. I guess, what do you kind of see as the key factors of being able to sustain that growth? Obviously, it's a key component of the company's overall growth is that growing utilization of diagnostics. Maybe just what are the kind of biggest opportunities in your mind to continue to see the same level of growth as well?

Yes. We -- this falls under what we consider to be in our control. Once a pet comes into a practice for a clinical visit, whether or not diagnostics gets used or prescribed as a function of, have we -- do we have the right innovation that addresses the clinical problem, the veterinarian may be looking for is, have we created awareness and education and that advocacy that the veterinarian decides from a diagnostic standpoint makes a lot of sense. Let me benchmark this a bit in terms of the opportunity and gives us confidence that there's a lot of runway still in front of us. In the U.S., which is the most developed market in the world. And by the way, still tons of runway, still in the early innings, to use a baseball analogy. 19% of clinical visits include chemistry and/or hematology. Now if you just took a look at any diagnostics, which might be just a heartworm test, or fecal test, it's a little bit south of 50%. That's much higher. But in terms of actual blood work, chemistry or hematology, it's 19%. Now if you go a level deeper into non-wellness it's about 25%, and wellness is less than 19%, 10% or so. But very, very, very underpenetrated. If you look at -- if you go to VHA or any of the professional associations, all the clinical guidelines will tell you, 70% to 80% of these clinical visits, especially the non-wellness ones, should include diagnostics. If you go outside the U.S., so let's take Europe as a geography, only 7% of clinical visits, 7% of clinical visits include chemistry and/or hematology. And the reason for that is that it's a test rollout market. So as a pet owner you bring your dog to a veterinarian in France, which you may suspect based on vomiting and lethargy that your dog has pancreatitis. So shall use a CPL test, which is an enzyme test for pancreatitis and see if that comes back positive. Whereas in the U.S., you'd have chemistry, hematology, you might have urinalysis and a specialty test all at once. And so you're moving forward with a broader database. So our strategy as a company is through innovation and subject matter expertise to create these commercial and customer partnerships that drive relevant testing of the utilization, better outcomes, healthier pets, happier pet owners.

And how do you go about kind of figuring out what the unmet needs are from the vet population in terms of either additional tests or additional ways to drive utilization given that it's such a key component of growth?

Let's take SDMA because I think that's a fascinating example. For those of you who may not be familiar with SDMA, it's a renal test, it tests kidney impairment, GFR impairment. And if you talk to veterinarians, when we were developing that test, they would say, creatinine is fine. And then they were using creatinine for decades. I think it was invented or discovered over almost 100 years ago. The problem with creatinine is that 70% of the kidney is damaged, 70% of GFR impairment before your creatinine level goes above your reference ranges. Okay, it's too late to that. The kidney can't self-repair. And so by the time the pet owner and the veterinarian discovers that there's a problem, you almost have both kidneys destroyed or impaired, which creates, obviously, a very sick patient and a shortened live. And so -- but veterinarians would never tell you we need a better kidney test, the GFR impairment test, but we understood the science behind what creatinine in this case, was measuring. And we set about to really do the research and do the science in developing a new test, whereas much earlier, you could actually do something at that point. We can all live off one kidney from a physiological standpoint, and detected even earlier then 15%, 14% or lower. And so it was an example of really just bringing science to bear in a way that was very cost effective, that was included at no additional cost in every chemistry panel that was sent to the Reference Labs. Now how do you get, how do you develop, which is the second part of your question, that advocacy and that use behind it. Well, in this case, we included in all Reference Lab panels, we published a host of scientific papers that demonstrate that science is real, the efficacy was proved out, it provided answers to the follow-on question. If it's elevated, then what do you do? What stage does it indicate? What stage of kidney disease does the test tell you you're at? What are the therapeutic options? And we work with the International Renal Interest Society, IRIS, in this case, that have this test incorporated in staging guidelines. And in other cases, to continue to develop the marketplace, we let customers use it for free and when we came out with the point-of-care solution for catalysts, they cut around trials. They use it for a month or 2 months, decided it really worked as well as we said it would work and the scientific paper supported that, and then they started to use it. We do the same thing with fecal antigen. So there's -- the fecal is the most commonly used test -- diagnostics test in the marketplace today. It's done through an O&P, which is a central fecal float where you're looking for eggs. The problem is patients get infected before eggs are produced invisible under a microscope. So we developed fecal antigen test, which looks for the protein before that egg, it's called the pre-patent period, between 3 and 4, 6 weeks before. So it's just a great example of, again, looking at the problem, sometimes the customer tells you what the problem is. Sometimes because we have over 750 veterinarians that work, they know what the problem is. They've been practicing veterinarians, they've experienced it, and they're helping to guide our product development efforts.

I wanted to move over maybe to the software side. I think that's another one of the longer-term growth drivers that you see you raised your guidance for revenue growth from the segment to 15% from 10% at the Analyst Day in August. I guess where is there opportunity to bring additional value? You have a very deep installed base. Kind of how do you maybe maximize the amount of revenue that kind of the software component can drive?

Yes. So I mean software has been a fast-growing business for us. We reported it as part of a diagnostic imaging and software sector but we've provided some insights. The way I think about this is practices, whether they're corporately owned or independent practices are just businesses. They're in the business of providing medical care but there's also -- there's a cash register side of it and then there's a medical or clinical side of it. And the software, just like in any business, has a foundational role to play in terms of supporting workflow, optimizing workflow, client communications, internal staff communications, charge capture as part of a cash register function. And the better software you have that supports this workflow that's integrated with diagnostics, which is the data point, I think the more optimized your practice is going to run. So we've been investing in software for decades, as a company. The -- I would say that the animal health and veterinary profession has historically been a little slow in terms of adopting cloud-based software and for very good reason. By the way, it's not a criticism. It's just -- it comes down to the fact that their whole practice, the value of their practice is on these patient records, and they were very nervous about migrating data to a completely new system for all the reasons that you might be nervous. What happens if the data gets lost? What happens, it's a format is different? What about all these customized reports that they created? And so we've invested in a company from a technology standpoint, of being able to provide cloud-based software products that support this optimized workflow that allows them to do this data migration, that supports quick onboarding and training that just helps them run their practice better. And what we have seen as a result of that is they're more productive. They're able to -- when they use all of our solutions, it's sort of like this, the Apple ecosystem, it all works better together. . They grow faster, they grow diagnostics revenue faster, they do more clinical visits. It's a -- and we, as a company, obviously, benefit from it. And so we've seen that faster growth. And in this capacity constrained world, software is one of the things -- one of the go-to technology solutions that customers are looking for.

In the time we have left, I want to hit a few additional topics. So I want to touch on the international specifically, a lot of the discussion has been U.S. International, I think has been under a bit more macro pressure the past year plus. It actually outperformed the U.S. for the first time in 2 years in the third quarter. I guess, does that kind of suggest maybe a thawing of some of that macro pressure? Obviously, you've had like the ProCyte One launch has been big in that market. Can you maybe just like break apart the components of maybe where you're seeing that launch?

Sure. We started -- and we shared this, we started to see what we thought -- they have the same capacity challenges in Europe that we've seen in the U.S. We're starting to see some potentially macro pressures in Europe in Q4 of 2021. But if you think about the Russian, Ukraine conflict, the impact that had on gas and natural gas prices, energy inflation, all of those things. . So it's a little bit sooner than what we saw in the U.S. in terms of similar impacts. And -- but taking a step back, the market, the sector opportunities, we think, is very attractive. It represents 2/3 of the addressable sector opportunity that we've talked about at Investor Day, where 2/3 of the actual business is actually happening in North America. So it's flipped in terms of where the longer-term opportunity is. And it really comes down to the 7% of clinical visits where diagnostics is used. And so as a company, we made to a very sizable and we think wise investments, we've expanded our commercial organization 7x since 2020. Our biggest Reference Lab in the world was open in Kornwestheim, Germany, 50% bigger than the next biggest lab. We've invested in customer experience and really all those pieces from an infrastructure and enablement standpoint that allow us to tap into this opportunity. . And so we've seen a premium instrument placement growth. We've seen, to your point, relatively better performance. We've seen sequential improvement in CAG Diagnostics recurring revenue, 3 quarters in a row. And we think there is just excellent longer-term opportunity to continue to develop that sector.

And you've been making investments in the sales force like you said, sort of on a rolling basis. I guess when it comes to margins, could you maybe talk about the balance of continuing to make those regular investments, sales force, R&D, et cetera, against showing progress on that 50 to 100 basis point constant currency margin goal that you have. And how dependent is it on the revenue line because the last couple of years have maybe been a bit below the longer-term trend that you'd be targeting. Is that -- how does that factor into kind of the ultimate ability of the company to deliver margin expansion?

Yes. So what we talked about at our Investor Day last August was that, that 50 to 100 basis point annual improvement is, we believe, very achievable. It represents an average number. There are a number of we provided sort of the bridge build up to it. But keep in mind that some of this comes down to growth, to your point, where the consumables drop-through and the margin is very high. And so when we grow and that margin drops through to the bottom line, obviously, that benefits us. The mix in the business, we've just spoke that the software is accretive and so that's very high margin, and we see that growing nicely. Obviously, price comes into it to some extent and continuing to execute well across productivity and cost-out measures that in any business you would focus on. So we think as a combination of all those things that I've described, we can continue to execute well, invest in the core elements of our business, in innovation, in commercial and customer experience like our customers expect us to do and still deliver that margin improvement.

Got it. And maybe just as we're looking to wrap up. Last year, you -- 2 competitors of yours that you know very well, Antech and Heska merged. Mars being 1 of the kind of largest owners of animal hospitals. How does that change your conversation with corporate accounts, if at all? Obviously, you work with some of the Mars-owned practices. There's also ones that aren't owned by Mars and maybe don't want to work with the competitor. So just be curious maybe how the conversation in the market has changed if at all, since that deal went through.

Yes. Keep in mind, we have excellent relationships with corporate accounts. They see diagnostics also as a performance category, as a profit center. It enables them to help operate their groups, which tend to be distributed in lots of different geographies in a very, I think, coherent way. They value the integrated solutions that we, as a company, bring. We also have an excellent relationship with Mars. So we compete and we cooperate. And obviously, they see diagnostics as attractive and they invested in Antech now over 6 years ago and Heska more recently. And so clearly, over time, we think it's a really attractive, large growing marketplace that having somebody else in addition to other competitors talking about it is good from the overall development standpoint. Our focus really is in supporting our customers, our corporate customers in their mission. We know that software and how we integrate that with our diagnostic solutions and how we provide support, both internal medicine support and specialty services like in radiology and cardiology is at the end of the day, what they're looking for. So we think it's -- overall, it's a -- it doesn't really affect our longer-term plans in terms of how we work with corporates.

Great. And maybe just lastly and then we can wrap up. When it comes to capital deployment, can you maybe just talk about you've kind of done bolt-on deals, where the priorities for those might be, kind of how you see the pipeline today? And you have a pretty prescriptive formula in terms of share repurchases, I guess that probably wouldn't change but just how you're thinking about capital deployment?

Yes. So in terms of -- let me just address your specific -- your specific question around acquisitions. We're always interested in, I'd say, primarily bolt-ons in software, data, Reference Lab, maybe telemedicine, reading services, that fit our business model and support us because we see such an attractive opportunity in front of us. We're typically not looking for things that maybe are [indiscernible] in the animal health space. So really being able to grow our capability, our footprint or in some cases, in-license technology like we did for our point-of-care platforms is where we put our acquisition and corporate development dollars.

Great. All right, Jay. Well, thank you very much. I really appreciate you having here today.

Yes. Thank you. My pleasure. Thank you. Great being here.

Thank you, everyone.