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

All right. Perfect. Great. Thanks. Good afternoon. Jon Block with Stifel. And we're transitioning to animal health in IDEXX. Thanks guys for joining us. We have with us Jay Mazelsky, President and CEO; and Brian McKeon, Executive Vice President and Chief Financial Officer. Same sort of approach. I've been saying I've got a bunch of questions. Guys, if you have questions, please raise your hand or just shout out, and we'll get after them.

I'm going to start with trends. And so we get a decent look on U.S. Vet volumes from other sources throughout the quarter, which seems highly correlated to your visits. And overall, U.S. clinical visits for IDEXX in 1Q '23 was basically flat. I think Brian you mentioned it, it weakened a bit exiting the quarter. But you talked about wellness and emergent moving in tandem. Have you started to see any divergence of late between the two?

Why don't I -- Thanks, Jon. And thanks, everybody, for attending. Just before I get into this, we will speak today about trends through the first quarter, so what we've talked about publicly. And it might be helpful to take a step back and just set some context here for those of you who may not be as familiar with our space. But what we saw in terms of trends in diagnostics in the U.S. market was in -- through the pandemic, there's a significant step-up in demand for diagnostics. So we actually saw a 1/3 increase in our total business, high-teen organic growth in diagnostics through 2021 into 2022. And we've continued to see strong demand for diagnostics at the clinic level. So the -- we look at metrics like clinic revenue growth, same-store growth for clinic revenues and diagnostics. The veterinary practices, they were solid growth through 2022, nearly 10% growth in the first quarter this year. So the underlying demand in the market has been strong. Our growth is even faster than that. We were nearly 14% organic growth in the first quarter, and that's driven by really the factors that we think of as execution drivers. So that includes things like new business gains, driving increased utilization, frequency and utilization. Diagnostics continues to grow at the practice level, sustained high levels of customer retention and we got additional benefits from that pricing this year. So we feel quite good about the overall trends at our execution. Clinical visits were one metric. They were flat in Q1 in the U.S. We see that as a positive factor and that we had been working through a pullback in capacity at the clinic level. Basically, what happened with veterinary clinics in the U.S. is there was a significant step-up with the pet population. It was 10% over a 2-year period, grew another 2% last year. And clinics kind of kept up with that for a while and made a decision to pull back on capacity last year. And as we have thought going into this year, those headwinds would alleviate and that's basically what I think we saw in Q1 was kind of a stabilization of those trends. So that's a positive factor, something we'll continue to work on with our customers. And so a solid start to the year for us in terms of the U.S. Internationally, I think we've also had excellent results in terms of our own execution. We had 8% organic growth to start the year, double-digit growth benefits from our execution drivers including record new instrument placement levels. We've seen somewhat more of a headwind in terms of the same-store clinical visit levels. In international markets, the macro backdrop is a little more challenging. And -- but in line with kind of how we were planning this year. So solid start, and I think we're monitoring the trends at the practice level, but I think the things that we can drive a control in terms of our execution, we're feeling very good about the start to [ 2022 ].

Yes. Maybe just to add one bit of color wellness versus nonwellness. In the U.S., we've seen for the last 5 quarters, those have pretty much moved in lockstep. So we haven't seen the divergence. You may recall at the beginning of the pandemic back in 2020, we saw a little bit more of a drop off from the wellness piece as that was preferred. So it's nice to see over the last 5 quarters, those move in.

Okay, more on lockstep. That's helpful. And that was great context, Brian. I think maybe just to dig a little bit deeper, let me start on the international side. The 8% -- I believe you said you're aiming for the high end of your CAG Dx recurring of 8.5% to 11%. The 8% for international, that's sort of the expectations to still land toward the high end. In other words, you're not embedding a big reacceleration on the international to get towards the upper band of your 8.5% to 11%. Is that fair?

So our higher end of the range, the 11% reflects what we're targeting this year. We shared our original guidance at the Q4 call. We were targeting 11.5% at the high end for the U.S., 10% for international. And our overall growth range we factored in at that time, a 2.5% kind of calibration for potential headwinds, execution risk, macro risk. And so really Q1, we had better -- the better performance in the U.S. was 13.5%; and International, we were at 8%, both within kind of the range that we had expected. And again, I think for International, it's a continuation of some of the same-store headwinds that we saw in 2022.

Okay. And Jay, you mentioned it's been relatively consistent for wellness and emergent. Admittedly, I'm relying on some third-party data, but it had been consistent, but we've seen it start to diverge as of late. And so I know you can only speak to your results through 1Q '23. But where I'm going with this is you guys have talked about a tepid vet visit environment because of capacity issues and that will sort of resolve itself. The vets will get more efficient, adopt technology. If we fast-forward to your second quarter call, and you guys give a lot of granularity, and we see the divergence between emergent and wellness, which would sort of mimic what we're seeing in that third-party data. Does that argument shift for you guys? Do you sort of say, "Hey, it's not just a capacity thing, we're seeing wellness start to fray and that might be more indicative of a consumer that's more tepid"?

Yes. So a couple of things. Keep in mind that the data that we publish is clinical visit data versus practice data. So some of the practice data includes things like boarding and grooming visits and picking up pharmaceutical. The clinical visit for us is the -- we think the driver of diagnostics usage is when the veterinarian actually sees the pet. The clinical visit piece is just one element of our overall growth formula. Our growth profile focuses on clinical visits, obviously, but retention, frequency of when they visit, do they use diagnostics utilization, the intensity of the diagnostics they use, all those things that are more in our control than the macro factors, Jon, that you described. Our innovation strategy, our differentiation strategy, our commercial engagement piece are things that we use to drive those other factors. And we think from an execution standpoint, have done well.

Okay. Fair enough. Looking forward, and I know we're not going to get into specific 2024 numbers today. But I do want to ask about the moving parts. And so we've been pretty vocal about some of these things, but I've been following IDEXX for a long time and you guys used to take 2% to 3% price roughly per annum. This year, it's going to be 7% to 8%. It's actually greater in the first half relative to the second half. Maybe, Jay, for you for price your thoughts around the elasticity of demand. And Brian, I don't know if this falls in your bucket, but are the days of 2% to 3% price gone? And when we think about future price increases, maybe at least in the more immediate term, it should be in line with the rate of inflation, which could fall around mid-single digits next year?

Yes. So let me start with pricing from just maybe a philosophical standpoint. We work hard to really make sure that we are in balance from a value delivery standpoint and the price we get in the marketplace. We see the opportunity before us as being multiple decades, and we want to make sure that we continue to deliver differentiation and don't get too far over our ski tips from a pricing standpoint. Though given the macroeconomic environment and the different scenarios, we think we've priced appropriately given the cost of running the business. We continue to deliver, I think, it's fair to say outsized differentiation. Our customers appreciate the investments we've made in the profession in solutions that help them run their practices. And they've been able to, I think, pass that on in a number of instances to the pet owner, to their end customer. Keep in mind, you can't treat unless you first diagnose. And so diagnostics plays this anchoring role within the practice where the medical services piece is really the core reason -- for being the core reason that they run a practice. And so we're very comfortable with what we've been able to deliver. All the metrics around customer retention, around diagnostics frequency and utilization continue to perform well. So we think we're doing fine from that standpoint. I don't know, Brian, did you want to address...

Yes. Maybe to just talk about our longer-term growth algorithm, we broke this down in detail at our 2021 [ IDay ], but kind of the building blocks of growth. And if we look at the long-term growth potential of 11% to 14% that we shared at the time for Global CAG Diagnostics, I think we use 10% to 13% for the U.S., the biggest driver of that is expanding utilization of diagnostics. And we've seen consistently through 2022 into 2023 increased diagnostic frequency and utilization. We're expanding the amount of our premium to growth versus per clinical visit, sustained at levels that we saw prepandemic. We feel very good about the things that we're driving in terms of execution. We have been facing lower than historical levels of visits by pet owners following this period of significant expansion that happened during the pandemic. All the long-term trends that we are seeing is -- indicate significant underserved demand for pet health care, pet owners who are very willing to spend for pet health care. We saw a 12% expansion in the pet population over the last 3 years. We think the -- our long-term algorithm accounts on 3% to 4% kind of expansion of clinical visits that includes like same-store visits plus practice formation, which tends to correlate with pet growth. And so we think over the long term, we're going to have the benefit of innovation helping us to continue expand utilization, a return to positive growth on the clinical visit front, supported by the expanded pet population and the focus on pet health care and drivers like pricing will be additive to that and can help us to achieve our long-term goals. So I think we're working through a period of transition now related to coming out of the pandemic where our business expanded significantly. I think will be -- we built on that in 2022, we look forward to building on that as we go forward.

Okay. And maybe if I try to get a little bit more granular. One of the things that we've talked about is backfilling the step down in priority. So let's go back to some of the numbers: 7% to 8% this year. It sounds like you're not going to tell us today what it is next year, but let's just sort of say it's a step down of 400 basis points. It's roughly 3.5% next year, it's slightly north of where we usually are, 7.5% this year. How do you -- The Street has your CAG Dx recurring accelerating next year. I don't. I'd be down 100 bps. Street has you 100 bps accelerating. How do you backfill those 400 basis points? Just talk to us. I mean, Brian, you mentioned vet visits 3% to 4%, it's 0% to 1% maybe this year for those. What are the main variables? Would it be vet visits improving, contribution from innovation stepping up and international CAG Dx improving margin? Like give us the building blocks of the '23 to '24 and how you backfill the lower contribution from [ price ]?

So the way we think about growing the business, again, going back to the long-term growth algorithm for the company is, first and foremost, expanding utilization of diagnostics globally. So in the U.S., we expect to continue to have growth in diagnostics frequency and utilization. We've seen that grow historically. One metric we use is percentage of visits where blood work is -- diagnostics use blood work and that grew about 50 basis points a year. It was, I think, 19% of visits at the end of last year. . That accelerated during the pandemic to about 100 basis points and continue to grow in 2022. So that is the biggest driver of growth in our overall model. We'll continue to emphasize that. In terms of our growth, we're bringing new innovations to market to support that. We do believe there's underserved demand and that over time, we will continue to see expansion of clinical visits. And the pet population, that will be additive to growth. And internationally, we have an incremental growth opportunity just related to 200,000-plus placement opportunities for chemistry and hematology analyzers and urinalysis analyzers. We've had record instrument placements through last year through the last couple of quarters, really great momentum on that front. So those will be all the things that we're driving to achieve our growth objectives, and we continue to feel very optimistic about the long-term growth potential. In fact, just working through this period of time, the continued expansion of the frequency and utilization of diagnosis is just reinforcing our optimism on the long term growth potential...

Yes, let me get back to a number that Brian said, which I think is foundational, which is the pet population, this is U.S., but we've seen similar numbers outside the U.S., expanded over that 3-year period by 12%. Prepandemic, that was growing 1%. So if you think about this notion of underserved demand against that template that Brian described around diagnostics utilization, we think practices working through the capacity constraints. The sheer number, absolute number and relative growth of number of pets and clinical visits will converge, and we'll control those things that we can control, which we think are very substantial part of the formula.

And I appreciate that. I guess what I'm trying to admittedly push a little bit on is, you're talking about the long term, but there is a unique scenario specific to '23 to '24, where your step down in price contribution is different from all your past years. And I've been fortunate, I've been covering you guys for 15 years and [indiscernible] for like 13 of those 15 years, it's been a good place to be, as you guys have been incredibly successful. But what I'm trying to drill down on is the unique factors around '23 to '24 because price had been consistent 2% to 3%. So you put on the building blocks and you get to a certain place. Here, I think, arguably, you might have a 400 basis point gap on the pricing contribution and how you get people comfortable and where you make that up specific to next year, that's just what I'm trying to get at...

Yes. I guess coming out, Jon, it's not exactly how we think about it. I think we think about building and growing the business and where it starts with is increasing adoption of our innovations, working with our customers to their practices faster, helping them to serve, what we see as underserved demand, so we get back to positive growth in terms of the clinical visit growth. And those will all be the positive drivers as well as thinking about price realization as we continue to build our plans, I'm sharing with you how we think about it long term, but we'll share more as we're thinking about next year as we get closer to that. And I think we're really pleased with the momentum that we have in executing in the business and the positive feedback we continue to get from the market.

That's fair. And that's helpful, Brian. Maybe, Jay, one more for you, and then I do want to switch to innovation because you guys have a lot to talk about there. We never got this work done and actually published, I think I can allude to. Just -- what are you seeing from your customers? I think -- The Street always sometimes has a bearish view of you're increasing price, they're also passing that fully along. Let's just take an example, like you got a panel of 30 box and they're charging 3x and they're charging the pet owner 90. And you go to 35, them charging 90 is still a pretty good value proposition for the veterinarian. . It's one of the highest margin areas. It hasn't been disintermediated. So importantly, for investors, are they passing it along? Because I think investors are worried, the 30 to 90 is going 35 to 105 and might hit utilization for someone who's a little more price sensitive. But are you seeing them pass it along -- they sort of say, "You know what, a 2.9x markup is still a pretty good business, and I'll go ahead and absorb the price increase"?

Yes. So we -- the way we think about it, and I think the way our customers think about it is there's 2 sides of the transaction. There's the pet owner and there's the caregiver. Let me start with the pet owner piece of this. In terms of overall spend as a percentage of personal consumption expenditure, PCE, the amount that pet owners spend on their pets is under 2% and the amount that they spend on pet health care spending is about 1% and under 1%, and then diagnostics is a smaller percentage of that. Pet owners uniformly tell market researchers, and we have our own market research which validates this that they prioritize the spend on their pet vis-a-vis things like entertainment and travel and going out to eat, all those other things that they could. And by the way, this is true across different demographics, whether you are under 50,000, more than 200,000, we see very, very similar spending trends and prioritization. So from the standpoint of the pet owner, there is the willingness and capacity. Now what veterinarians will tell you is, as a result of some of the trends, Jon, that you described, is intermediation from the e-shops and what have you, is that medical services is the key growth driver in their practice. You can't treat unless, in many cases, you first diagnose. So diagnostics plays this foundational role. Your dog can't tell you I'm not sleeping well or I have this pain right where my spleen or pancreas may be located. You have to use diagnostics. And practice owners know that the diagnostics area of their practice is significant. It's the fastest growing, and it's a significant profit generator. So not only is it good for the pet from a health care delivery standpoint and outcome standpoint, it creates healthy economics in the practice. So we think those factors that gets the overlay that we continue to deliver differentiation and are in balance how we price for that differentiation means that the overall environment will remain attractive.

Got it. Helpful, Jay. I'm going to pivot. I'm going to try to go 5 minutes on innovation, 5 minutes on others, so I'll move quickly. When I think about IDEXX, a highly innovative company, a bunch of new innovations over the years. But I think in the more singular product launches, Catalyst One, ProCyte One, SediVue, they never really overlapped. At your recent Analyst Day, you talked about 2 new point-of-care systems. What would be the go-to-market strategy there? Would it be a singular approach? Or do you sort of say, "You know what, Jon, we're one of the few companies in animal health that has a direct massive sales force, so we can go ahead and launch them simultaneously and our commercial organization can properly digest...

Yes. Let me just nuance that your setup to the question because I think -- we're often thought of as a company that has a singular sort of, as you described, more or less blockbuster-type products. We differ from the pharmaceutical side in that our model is really driven, as Brian was describing it, around diagnostics utilization. That is a function of the cumulative impact of innovations, whether it's [ 9 new ] parameters for our chemistry analyzer over a decade, whether it's continuing to provide upgrades to our SediVue, Urine Sediment Analyzer; menu expansion, like flea tapeworms for Fecal antigen, all those things contribute to the overall growth. So when we introduced SediVue, for example, or ProCyte One on the hematology side, there is a significant multiplier impact as a result of the way we place it at customers through an IDEXX 360-type marketing placement program that drives not just attach rates for catalysts, but also a pull-through in our reference labs and point-of-care and software business. So we think we have the overall approach in terms of how we've approached launches and the multiplier impact on the business creates this utilization flywheel.

Sure. And you've talked about the technology for life and introducing new innovations through the cloud. I guess, Jay, what I'm trying to get at is just from a new instrumentation standpoint, going back, I didn't Catalyst One and ProCyte One and SediVue all launched simultaneously. So when we think about the new platforms because you've talked about them being incremental, not cannibalizing current chemistry, hematology and clinic urine sediment. Is this something that the organization would launch simultaneously or should we think about singular product launches?

Yes. So we get closer to launch or launches, we'll -- I'll give you more specificity and granularity about that, but we're not prepared to actually talk about the specific launch today.