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

We're ready to get started here. So my name is Erin Wright, I'm the health care services analyst at Morgan Stanley. We're happy to have with us today, IDEXX Laboratories' CEO, Jay Mazelsky with us as well as CFO, Brian McKeon thank you so much for coming, especially hot off their Investor Day last month as well. Before we get started, I do have some disclosures, so for important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. If you do have any questions, please reach out to your Morgan Stanley sales representative. With that, we will get started with Q&A.

So a bigger picture question here and coming off of that Investor Day that I was mentioning up in Maine, which was beautiful, highlighting a bunch of the new innovation drivers was one of the key areas of focus. You reaffirmed your long-term growth goals calling for 10% topline organic growth, 15% to 20% EPS growth, can you talk about some of those moving pieces to get there in terms of that long-term growth profile on some of those key drivers, especially when it comes to innovation and especially as sort of the industry is recovering here from a vet office visit or...

Thank you for hosting us and having us Erin, Much appreciated. Let me address the innovation piece, and then I'll ask Brian to talk a little bit about the growth algorithm and the buildup connected with that. We're at, I think, a next big wave of innovation as a company. If you take a look at the approach, it's really across the board in our point-of-care business with new platforms and extension to existing platforms and I'll provide some specifics on that. Our Reference Laboratories business and our software and data business. It has come at a great time for customers. I think they have a hunger for technology that helps them run their practices better and differently and in a sense, in a more professional way. Let me talk about each in turn because I think it deserves some mention. If you take a look at our point-of-care business, these are really [indiscernible] laboratory suites within the clinic itself. They consist of existing point-of-care platforms, and we call it Technology for Life, but it's the ability to really keep technology current in our chemistry platform, which is really chemistry, electrolytes and immunoassays. We announced Catalyst Pancreatic Lipase test as well as a Smart-QC test. These represent, I think, very important clinical innovations in and of themselves as well as our InVue Dx, which is a completely new platform, which enables practices without a slide to be able to do ear cytology, blood morphology. Another thing we announced was FNA for lumps and bumps testing in 2025. In our Reference Lab business, a lot of innovation, really geared or focused on disease franchises in the case of our renal disease franchise, Cystatin B. Fecal, we announced over the last couple of years an extension with tapes and Cystoisospora and really continuing to build out our network on a global basis, now more than 80 Reference Labs. And then in software, really continuing to provide a full cloud-based application suite, not just PIMS, but client engagement applications. We call it Vello, it enables practices to connect digitally with our customers. And then putting that together in a very integrated, seamless way that helps really drive a better medical care, staff productivity, workflow optimization, all the things, practices they're hungry for. That's a big picture. Brian, can you talk a little bit about the growth algorithm and how innovation supports the growth algorithm?

Yes. We highlighted our long-term growth algorithm for the company. As Erin mentioned, we see the potential for 10%-plus long-term organic revenue growth. The biggest driver of that is our CAG Diagnostic recurring revenues, which is about 80% of our overall revenue base, and we have a long-term goal there of 11% to 14% growth, which is consistent with the long-term potential we've highlighted over time in the last few years. And in terms of the building blocks, a key building block is what Jay was just highlighting was the benefit that we expect to get from IDEXX innovation as well as from ongoing improvement and increases in diagnostic utilization. So a key metric we look at in the company is the percentage of business that have blood work included as part of a diagnostic testing profile that's grown consistently over time. We believe we can continue to grow that, and we believe we can get 2%-plus growth from new innovations that we'll be bringing to the sector. And so in terms of building blocks, that's 3.5% to 4% of the overall growth algorithm that we see. We anticipate continuing to get benefits from new business gains and expansion of our core premium instrument installed base that can contribute 2.5% to 3% to growth over time. The premium base opportunity is substantial. It's 240,000 global placement opportunities that are 3x our current installed base levels. So we have very long-term runway on growing our premium installed base, particularly in international regions and new platforms will add to that. And we think that, that supports a long-term view of 10%-plus growth in our instrument installed base annually. So that will obviously be a foundational supporting element of being able to grow our overall revenues. And in terms of execution drivers, we also anticipate solid net price realization, which we've been able to achieve over time, aligned with the value that we deliver to our customers and our longer-term view on that is 2.5% to 4% annually. And so those are the execution drivers that we see contributing 8.5% to 11% of long-term growth algorithm, and that will build on what we anticipate will be positive clinical visit growth over time. That's been really the key headwind that we've been working through in this post-pandemic period. After we saw a rapid acceleration in the business, there's been a calibration of that in terms of vet clinic capacity and more recently, some macro impacts but as we look at the longer-term potential for clinical visit growth, there's been a 10% expansion in the pet population. People are more connected to pets than they've ever been, reaffirming the importance of pet health care as an area that they prioritize in their spending, and we anticipate all that will support as we've seen historically solid positive growth for clinical visits. So reaffirms our confidence in our business. We feel like -- I know Jay can reinforce this, I think, as confident as we've ever been in terms of the innovation that we're bringing to the sector and our competitive positioning, the value that we're adding to our customers and that all supports the high growth potential that we continue to see for the business.

And taking a look at some of the fundamentals across vet office visit trends and what's incorporated into your guidance for the second half of the year. You took down guidance mainly because we're still seeing sort of lackluster vet office visit trends. I think implied is about negative 2% kind of growth in the second half. I guess, is that right in terms of what's contemplated? How are trends to date relative to your expectations on that front? And when do you think we do get back to kind of flat to even low single-digit kind of growth from a vet office's visit standpoint? And what are some of the factors contributing?

So maybe I can set the analytical foundation and have Jay talk to the long-term view. But we entered the year with an outlook for 7% to 9% growth. And that -- when we started the year, we anticipated relatively flat U.S. clinical visit trends and what we saw in the first half was basically minus 2% and that was the principal adjustment that we made. So our updated outlook that we shared on our most recent call is at the lower end of the original guidance range, and it's driven entirely by this -- the clinical visit headwinds, which we believe reflect a level of macro impact in the near term that we'll continue to work through, and that was captured in our second half and implied second half outlook as well.

Yes, just in terms of the overall industry, what we see is when pet owners visit the practice, veterinarians are still using and prescribing diagnostics. We see an increase in diagnostics utilization as part of wellness visits, we've seen nice increases in overall utilization. The mix has been more weighted towards price recently. And I think it speaks to the underlying role that diagnostics plays in the overall care equation. You can't treat unless you diagnose, you can't treat a chronic condition unless you provide follow-up monitoring. You can't assess the basic health line status of a patient without doing some level of diagnostics. And so it really drives the entire medical services envelope. Obviously, there's been some headwinds specifically related to patient traffic within the practices. What we see is that there's a couple of factors that give us confidence that this is being worked through. The underlying demand is still there. We shared some data from Investor Day that when veterinarians recommend diagnostics, pet owners are receptive across all demographics. The challenge is sometimes veterinarians are -- there's a bias in terms of whether or not they recommend the diagnostics. They're tiering pet owners by whether or not they think that you're able to pay or want to pay and that's a challenge, and that's more an awareness and education challenge. Pet owners themselves, all the research, all indications are that pet owners haven't walked away from really prioritizing pet health care and pet health care spend vis-a-vis other discretionary categories, this is a priority for them. Clearly, the cumulative, I think, impacts of price at the margin are impacting the practice and practice visits. So our strategy is to be able to continue to provide practices and the profession with technology and tools that help them really drive the productivity and patient traffic within their environment. So for example, we talked a lot about our software and data business at Investor Day. And we have moved from more of a PIMS based strategy, cloud-based to more of an application suite to include pet owner engagement applications like Vello. It's early days, but very interesting. We've seen on a smaller data set, a significant reduction in patient no-shows, a significant increase in the number of clinical visits, 2%, as a result of just using this application. If you think about it, if as a pet owner, you have an appointment for 2:00 on Thursday and you don't show up, the veterinarian and her staff are essentially nothing to do, but it's nonproductive time. So the ability to bring the type of tools that we see in the dental industry in our own personal experience to the veterinary practices has the ability to really, I think, move the needle. There's time and distance, obviously connected with some of these changes. I think there hasn't been a slowdown in terms of the investment profile of customers, whether it's in clinic instrumentation or software, if anything, we've had some record quarters. So we have a lot of confidence that demand and supply will balance out over time.

And talking about price a little bit here, historically 3% to 4% or around 3% kind of in terms of price realization annually, you're at about 5% this year, 5%, 5.5% this year. Last year was high single-digits. What's your ability and what's the durability of price realization as we had going forward into 2025? And are you seeing any sort of pushback from customers? Are you doing more promotional activity just in response to that? And just how sustainable are the price increases that you're seeing? And where are you kind of competing for wallet share, I guess?

Yes, I'll say just a couple of things about price. We don't set end market pricing, our customers do that. In that, there's 30,000 clinics in the U.S., and probably there's 30,000 variations in terms of how they price their services. And in terms of 2025, we don't disclose that in advance. We'll communicate what our expectations are when we provide some guidance. What I would say with regard to prices, we work hard to keep the value equation in balance between innovation and what we charge our customers. And in many cases, and I don't think this is completely appreciated, we deliver a lot of biomarkers, do assays at no additional charge to our customers. Let me give you a couple of examples. If you're an IDEXX customer, you use fecal antigen and we've come out with tapes and Cystoisospora over the last couple of years, you get that just as part of the fecal antigen panel. Cystatin B as part of an acute kidney injury marker was included as part of a urine panel at no additional cost. VetConnect PLUS what it includes, DecisionIQ, which is our decision support system, that's -- we give that away. That's free to customers who use our diagnostics. So there's a lot of instances where we just continue to provide an uplift from a value standpoint. And some of that obviously gets captured as part of an annual price increase. But we look to be able to really keep that value equation on the right side.

Yes, okay. And do offerings like Vello for instance, offer upfront pricing to help with that patient engagement where there is potential pushback from a pricing perspective?

Yes. We price Vello as -- because it's cloud-based and software-as-a-service, there's a monthly fee that customers pay for Vello. Now that can be when they -- typically, they would buy that upfront when they buy a PIMS system. So because Vello has -- come when it has -- we have a large installed base of customers we'll go back and sell into. But it's priced and charged as a Software-as-a-Service model.

I guess what I was asking more so from the patient perspective, like from the pet owner perspective as they think about pricing visibility before they walk into the vet clinic, does Vello offer some sort of engagement...

Yes. We have the ability to preposition with a pet owner. The visit, the purpose of the visit, the role of diagnostics. And over time, it's up to the veterinarian whether or not they choose to communicate the price connected with those services, including diagnostics. But they have the ability to do that.

Okay. And then switching to kind of innovation and at your Investor Day, you announced the upcoming launch of Cancer Dx platform, through your Reference Laboratory offering. Can you remind us of the size of the opportunity there in oncology? And then what lessons have you learned from other oncology diagnostic offerings that have been out in the market previously and that you've even partnered with? And how are you approaching this differently? It is part of a broader panel. It will be priced differently. It will be a premium wellness panel presumably. How are you approaching this a little differently and then kind of the size of the market?

Yes. So lots of questions in there. So let me unpack this in a sequential way. We think that this is a very compelling opportunity. And we've pegged that at about $2.5 billion disease franchise opportunity. And we think about disease franchises as a collection of tests. And I provided some examples at Investor Day, whether it's vector-borne disease, fecal and oncology. Now renal also, where we've developed over time a set of tests. If you think about cancer testing today, it's a single biggest -- cancer is a single biggest disease and cause of mortality in dogs by a factor of 3x over the next largest cause. So that's very, very significant with a high prevalence rate. And in fact, certain breeds -- and there's probably 20, 25 breeds have even an outsized rate of cancer, I have a Labradoodle and that happens to be one of the breeds itself. Just to set the landscape, the challenge today is that by the time a patient is symptomatic, clinically symptomatic and they come into the practice. And the veterinarian has to go through a workup because it's not specific. The symptoms of cancer, whether it's lethargy or abdomen pain or shortness of breath, it could be cancer, but it may be any number of other clinical conditions or use cases. So they go through an elaborate work-up. And by the time the patient is clinically visible with these symptoms, it's typically Stage III, Stage IV cancer. And unfortunately, at that point, the outcomes are rather limited and very often, more often than not, it's more of the veterinarian and pet owner pursues more of a palliative approach. Now we get about 1,500,000 cancer tests on an annual basis that are sent to our Reference Labs. It's primarily pathology, histopathology, there's some cytology and teleradiology, looking at the images of tumors. So that the unmet need in the sector was to really diagnose and screen earlier because when you catch it earlier, you can do something about it, whether it's surgery or chemotherapy or therapeutic drugs or just monitoring. And the test currently on the marketplace are nonspecific. And so what I mean nonspecific, it could be cancer, but it doesn't tell you -- it doesn't classify the type of cancer. It's not distinguishing between lymphoma, osteosarcoma, hemangiosarcoma, mast cell, it's not making that classification distinction. And it may be in just as many cases, inflammation -- because if you are -- depending upon what you're detecting, it's nonspecific. So it doesn't classify and it's nonspecific. So we believed and we believed for a long time that there is a very significant unmet need in cancer screening and diagnostics. So we said about and we've been working on this a very long time, both on detection, platform technology on biomarkers on really understanding different clinical classification and use cases that have developed, I think, a very compelling approach where that from a price and performance standpoint, it -- let me talk about economics first, that it can be inclusive to a wellness screen or a wellness panel. So some of the tests that are in the market today, $400, $450, $500. In the case of human test where they're using sequencing, like GRAIL, it's $900, $1,000, very expensive. So that's not appropriate for the veterinary animal health marketplace, unfortunately. So the ability to get the economics right, the ability to have the performance characteristics, sensitivity when it's there, you're picking it up, specificity, there aren't false positives and to classify a cancer type one from another very, very, very important. And what we said is in 2025, we're going to come out with our first cancer screen for lymphoma in that within a period of three years, we would have six tests that represent the majority, 50% or more of all cancers that impact canines.

Okay. And so as we think about the ramp-up, first of all, will this be January 1 launch or VMX type of launch. And as we think about the ramp-up of an add-on to a wellness panel versus the ramp-up you would see for like launching a new box, how do we think about that? And are there any comparisons in your innovation history that you can kind of point to that would be similar?

Yes. A couple of things. So right now, all we've specified is 2025. So more to come as we get closer. In terms of the benefit of a screen is that you can include it as part of a wellness panel, call it a premium wellness panel, if you will. So you have the ability to plug and play, a pet owner who may be worried about cancer for their dog, typically, today is doing a screening panel, chemistry, hematology and in the future would also do cancer, especially if they have a breed, one of the 20, 25 breeds that are prone the cancer. And this speaks to the enablement capability we have with our software and data business. The ability to identify which breeds at which ages would benefit from cancer means that veterinarians won't have to wait and pet owners won't have to wait until the adult senior dog or geriatric dog is coming in for a screen, that the 4-year-old Bernese Mountain Dog or my 4-year -- now 12 years old, but my 4-year-old Labradoodle could have been and should have been screened early on. So the ability to get the economics right to get the breed, and age, and really drive appropriate screening, I think, is a major, major differentiator.

Okay. And you haven't discussed, I guess, price point for that in terms of what relative premium this will be offered at in terms of the wellness panel but presumably, it will be priced appropriately. And then will this be material in terms of contributions in 2025?

Yes. So all we said is from a pricing and economic standpoint, it will be priced and positioned so that it's appropriate for a wellness screen. And we'll -- as part of our 2025 guidance, Brian will provide some insight in terms of what the various components are. But we tend to include the innovations as part of our broader guidance range.

Since you mentioned it, will you be providing 2025 guidance on the third quarter conference call or...

Fourth quarter.

Just curious, you've done that in the past.

You have to be patient on that one. Well it is -- to Jay's point, these innovations are all captured in that 2% plus incremental growth potentially we talked about, they'll obviously build over time, but we're very excited with the opportunities that we have on that front.

And also on innovation, InVue, I do want to talk a little bit about what is the feedback on the pilot program so far? Are you piloting all the indications right now in terms of what you've announced in terms of the ear and blood morphology as well as the FNA, are you piloting all of those now? And FNA, I guess, is slated for 2025, what is the feedback there?

Yes. So the feedback has been outstanding, both from -- we trained our entire North American field organization in July. And the feedback from both our field, and the confidence and conviction they had as well as from customers has been outstanding. It really hits the sweet spot. The product is in what we call customer experience trials. This is sort of the last stage of a product development effort. So when we deliver the product, it works out of the gate, it works at a very high level. This is a tried and true product development process as a company. We've really perfected over time. InVue itself is a product that have a number of discrete breakthroughs, technical breakthroughs, use-model breakthroughs. Let me just quickly describe it. I use it in advanced optics module that interrogates cells within their natural state, 3D state, we've taken 10 million plus images that have been interpreted by our global pathology organization, in a slide-free format, using and -- then using this AI algorithm produces results. And both ear cytology and blood morphology are very high-volume, clinically well-understood or well-characterized use cases within the practice. So we think it really hits the sweet spot of what customers are looking for.

Okay. And why is [ 20,000 ] the right number in terms of InVue placements by year 5? How did you get to that number? Did you leverage kind of your experience from SediVue, for instance, and that's how you got to that number? Could you...

Yes, we did. I mean it's just -- it's the classic. It's been, from an experience standpoint, sort of a classic curve of building an installed base. And we'll be able to provide -- we'll get some insights at launch in terms of what the customer receptivity has been. But I think it's a good starting point.

And then switching gears a little bit. You launched Catalyst Dx in 2008, you launched Catalyst One in 2014, what would you consider the life cycle of core chemistry right now. This is more of an upgrade cycle type of opportunity potentially for you? I remember when you launched Catalyst Dx back in the day that you saw a tremendous uplift in consumables volume when you saw those customers adopt. What is the next replacement cycle opportunity for you across the chemistry installed base where you have a meaningful share position that you can kind of leverage and then also bundle in and you bundle in your Cancer Dx offering and your broader Reference Lab offering as well. How do you think about the opportunity there in terms of launching a new box?

Yes. So from a chemistry standpoint, I think, one of the very significant design breakthroughs that we achieved, we call it Technology for Life but essentially, it's the ability to keep feature and capability of the chemistry analyzer at current. So let's say your veterinary customer, you purchased the catalyst last week, you have the exact same feature and functionality of the customer who invested in an IDEXX Catalyst analyzer from 6, 7, 8 years ago. And so there's been 12 new slides over the last 10 years, and I think it -- I am sorry, 10 slides over the last 12 years. And from a capability, whether it's progesterone or Total T4 or SDMA or pancreatic lipase that we introduced, so you have, you're current, you have the best and most current features and capabilities as there are on the marketplace from us or from anybody else. So the ability to really ride that platform without sacrificing performance. I think it's something that differentiates us in the overall sector itself.

And you do have another box though that you're working on that doesn't cannibalize existing platforms, right?

That's correct.

And what is the time line there? Is that still in the pipeline for you? Any sort of details you could give that?

We do have a fifth premium instrument box that we're working on. It's fully staffed, we're working it hard. We think it represents an excellent, very compelling opportunity. And it doesn't -- as we've indicated in the past, it doesn't cannibalize our existing business.

Right. Okay. Let's talk a little bit about margin levers across our business. I thought what you've been able to do thus far in a very difficult backdrop has been impressive and your ability to get to EPS numbers, there does tend to be a lot of focus on the topline and that office visitors, big swing factor for you. But you do have a lot of levers kind of from a margin perspective. Can you talk a little bit about where there's the biggest opportunity near-term that gets you to that long-term 50 or 100 basis points of kind of margin expansion?

Yes. We've had a very good long-term track record in terms of expanding our operating margins effectively. Last 8 years, we increased them 1,200 basis points on a comparable basis. And that was balanced across gross margin enhancement and OpEx leverage. We see gross margin expansion as an ongoing area of opportunity, very much aligned with our focus on innovation as a business as we grow our CAG Diagnostic recurring revenues, which I mentioned before, kind of the biggest part of our revenues and our key financial driver. They have very high incremental margin flow-through. We have ongoing opportunities to improve productivity in our operations, in our Laboratory business. That's been a key gross margin driver for us as well as more recently, we're getting benefits from our growing software business. And the benefits from the cloud-based focus of our strategy there. So I think gross margin should be a continuing area of opportunity for us. And we intend to leverage OpEx as well in areas like G&A as we reinvest towards the long-term growth potential we see for IDEXX. We anticipate continuing to support our innovation, R&D investments and high-return investments and expanding our commercial capability globally. But as a company, I think we benefited over time from a consistent strategic focus and a focus on executing very well that enables us to deliver good financial performance to prioritize investments as we grow and make sure we continue to deliver strong financial results as we pursue the long-term opportunity that we see for IDEXX.

And across Reference Laboratory in particular, there's always an area that you can focus on from a margin-leverage standpoint. And what sort of changes are you making there? And we've heard changes in turnaround times, changes in overnight testing? What was the impetus of some of those? Is that driving savings across that business as well?

Yes. Most of -- if you take a look at our Reference Lab business, we've built really over 30 years a global network. There's now more than 80 Reference Labs, both core regional as well as day labs. And it's a business that has a number of drivers. It's a science, medicine, driver around innovation and menu we've talked a bit about that today. There's also a customer experience driver, which is super important to us and the investments that we make. A lot of the margin improvement that we've seen is really being able to automate and digitize to enable a better customer experience. And we've been very successful at doing that. That was the impetus, by the way, behind -- the original impetus behind VetConnect PLUS to be able to provide trended test results. And that will continue to be an area of emphasis going forward. The way we look at and hold ourselves accountable from a customer experience standpoint, is obviously customer retention, which is in the high 90s for our Reference Lab business, and Net Promoter Score, where we have a 15-plus percent advantage over our next largest competitor. So we think it's working pretty well. It's an area of opportunity for continued margin expansion as we thoughtfully execute the plan.

Okay. And then can you talk a little bit more about, I guess, your ability to take even incremental [indiscernible] than where you're at today? And could this accelerate with the new innovation and the potential disruption at competitors as well? And how would you characterize your overall relationship with corporate accounts? Anything coming up for renewal that we should be aware of?

Yes. So let me start with the second half of your question, and I'll go to the competitive landscape. We have an excellent relationship with the corporate accounts. In some cases, we're both -- I wouldn't say enemies, but competitors and partners with them. And I think depending upon what businesses they're in, I think they value our overall solutions. From a corporate account standpoint, I think what corporates appreciate is that the scale of our offering, the ability to follow them wherever they are, the ability to service a broad set of needs. And I think we do that in a very compelling way. From a competitive landscape standpoint, if you look at the growth algorithm that Brian described as part of his opening remarks, most of the growth actually comes from really growing testing utilization with existing customers, sometimes through innovation, sometimes through geographic expansion. And we do very well when it comes to penetrating competitive accounts, we're pretty transparent in the data that we provide in terms of competitive chemistry placements, for example. But the sector itself provides opportunities for, I think, broad participation beyond our own success. But we like what we're doing and we think our innovations that we've talked about will continue to allow us to advance.

We're excited for what's to come. Thank you so much. I appreciate the time today.

Thank you so much, Erin. Appreciate it.