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

Good morning/afternoon to folks. Welcome to the Morgan Stanley Global Healthcare Conference. My name is Erin Wright. I'm the lead health care services analyst at Morgan Stanley. We're happy to have IDEXX Laboratories with us today, Chief Executive Officer, Mike Erickson; as well as Chief Financial Officer, Andrew Emerson. For more important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And with that, we'll get started with our fireside chat. Thanks so much for joining us.

Thanks for having us, Erin.

Yes. So you recently had an Investor Day in Maine that I was fortunate enough to attend. And you highlighted the innovation drivers. You reaffirmed the long-term growth targets calling for 10% plus organic growth, 15% plus kind of EPS growth. Walk us through some of those key building blocks in terms of bridging to kind of from -- in terms of today's environment and what we're seeing with vet office visit trends and then the long-term growth algorithm?

Yes. Great. So let me just start by talking a little bit about the year, and then I'll talk about the building blocks and tie back to some of those things. So we had an exceptional Q2 and really start to the year. We've got terrific momentum in the business. Erin, we talked at our Investor Day about how we're in the very early stages of this broad-based innovation cycle playing out across really multiple different platforms at the point of care in reference labs and in software, supported by what we're doing commercially to help our customers adopt these innovations. And we're seeing that flow through into double-digit growth, both in reference labs recurring revenue and in our VetLab recurring revenue. And on that basis, in Q2, we took up our guide for the overall year, as you know, and just reflecting that momentum that we see. And when we are in this sort of dynamic period that we're all in trying to manage signals and understand where things are headed, with IDEXX, we step back and kind of look through that haze and to your point around the long-term view, it just reaffirms the conviction that we have in the strength of the sector and the long-term potential. We can see our way to the $45 billion TAM that we've talked about in diagnostics globally. And we know that diagnostics are dramatically underpenetrated around the world relative to the outsized value that diagnostics create in the practice. Pets can't speak. It's diagnostics that give them a voice in the health care equation. And then we also know that diagnostics drives 80% of all the activity in the practice. And so our entire strategy as a company is to move that needle through what we do on the innovation front and commercially, and we've been successfully doing that now for decades. And we measure that through the building blocks that you asked about. We've seen really robust new customer growth. But really, the core of our strategy is to drive volume-based growth through innovation and utilization, and we've seen that across the sector. And we know that customers that adopt our IDEXX innovations grow faster. Sector-wide, we're driving about a 50 basis point increase in blood work inclusion annually, and that translates to about 150 basis points of CAG diagnostic recurring revenue for IDEXX. So we build that up across new customer growth, innovation and utilization and modest price tied back to the value that we're creating in the practice.

Yes. I think just to round out the financial model, obviously, that recurring revenue growth stream really enables the rest of the P&L as well. We see high incremental gross margin drop-through when we look at the ability to continue to grow our recurring revenues. We benefit from scale. We're focused on productivity. And to Mike's point, part of our growth algorithm is price in which we're creating value through various different sources of value to our customers. Some of that's innovation, some of that's things like our software capabilities and a really keen focus on making sure that we can deliver product to them when they need it because these are medical services, and they're often looking at making sure they can manage their own patient when it comes into the clinic. So that gives us a really nice robust ability to reinvest back in the business in R&D and our commercial efforts and be able to deliver operating margin improvement over a long period of time, ultimately to achieve that 15% plus EPS growth. So we see really significant opportunity and headroom for us, both on the revenue and top line, but also our ability to continue to expand our margin profile and EPS.

Yes, the high-margin drop-through of that recurring revenue, we always feel is underappreciated part of the story, too. But in bigger picture, you have shown the ability to grow even in a down market. So -- but it is a question that I have to ask in terms of underlying vet demand trends. I think your guidance calls for what, negative 1.5% to 2% kind of vet office visit trend this year, what gets this market to normalize longer term? How confident are you in that? Or just does it matter in light of the innovation drivers that you're seeing and the growth that you are seeing in light of that?

Yes. So to your question, we have seen this modest headwind to visit growth now playing out over multiple quarters, really more on the wellness side, as you know, Erin, which on the margin can be maybe seen as a little bit more discretionary than non-well. We have to step back on that, though, as well and maybe just again, see the kind of broader arc through the ups and downs of the pandemic and the dynamic period since then. So if we compare where we're at today to before the pandemic, we have substantially more pets in the system, 22 million more pets through that period. And if you look at medicalized pets, also substantially more on the order of 8 million to 9 million more medicalized pets. And we have a lot more visits as well from a total visit volume standpoint. And if you take any one of those factors just on a CAGR basis, they've been growing at or above the historical norm, again, through these ups and downs and this dynamic period that we're in. So we feel good about those things. But I think the bigger point that often gets lost in the conversation around visits is really looking at care, the demand for care, the intensity and quality of care that's happening in the visits when those visits take place. And that's, again, the core of our strategy is to drive that. On that dimension, what we've seen is this continuous expansion in blood work inclusion and wellness visits, 50 bps annually, growing inclusion, blood work inclusion and wellness visits. This overall step-up that we've seen continuously quarter-over-quarter, we reported again in Q2 in diagnostic frequency and utilization, which is a very good proxy again for the quality of those visits. And when I sit down and talk to our corporate group, our large partners, this is a big focus for them because they understand that this drives their business model, and they want to grow this, too. And so it's a natural point of alignment. And when you kind of break down what are all the things that are driving this, IDEXX innovation is playing a big role, but there are a number of really important underlying trends also. So we have these COVID pets that were adopted and are aging. And so if you double-click into the visit growth, we actually see positive visit growth, well and non-well for pets over 5. So that's a pretty -- that's that bolus of pets coming through. And we also know that as pets age, just like people, they need more care. So they visit more, but they also need more care in those visits. And not only that, it turns out that pets are living longer, which is incredibly profound when you look at the data. So just over the last decade, dogs and cats are living about 1.5 years, 1.5 years longer. And so that's about a 12% expansion in lifespan. But because they require more care as they age, that translates to a 16% or more increase in diagnostic lifetime value. And then on top of that, we're seeing an interesting trend around the mix of breeds coming into the practice. And that reflects consumer choice. Consumers are opting into breeds like the doodles, for example, and golden retrievers, breeds that actually require more care. And they realize that they require more care, but this is what they want. So between the age mix, pets living longer, breed mix, all of these factors drive a higher demand for care. And so as we dive into our incredibly large data set of not just practice management data, but now consumer data, what we see is a very high resilience around demand for care across every single consumer economic cohort. So we know it's a dynamic time, and we know that people feel pressure in the broader economy. But when they have pets, they're spending on those pets, and that's true across every economic demographic.

Would you say, though, that even with an aging pet population, are you still going to see pressure on vet office visits, but it's just about the nature of the visit is just so different than it was before. How structural is this shift in terms of you're now posting high single-digit utilization metrics. Is that durable here? Or do we see things shift back to the way that vet office visits were? Like where do things shake out? And is it really just a structural shift in terms of the nature of each underlying vet office visit seeing higher utilization, greater flow-through, those dynamics?

Yes. The nature of the visit keeps improving in quality, and that's translated into that higher diagnostic frequency and utilization step-up that we've seen quarter after quarter. And the reason why we feel highly convicted that, that can keep growing is because if you just look at today, what's the average inclusion of blood work in a visit, it's about 1 out of 5 visits get blood work. Wellness visits, it's about just over 1 out of 10, 13% in the U.S., and it's less internationally, about 1/3 of that. And when you consider the incredibly outsized role that diagnostics plays in the visit, that's a low number. So sometimes we ask, do we have a 1 out of 10 problem or do we have a 9 out of 10 opportunity? And of course, we see it as a 9 out of 10 opportunity. And so for us, the way that we focus on that every day at IDEXX with a tremendous amount of focus, wake up thinking about our innovations, things like Cancer Dx, inVue Dx, what we're doing on Catalyst, paired with a large commercial organization whose job is to support the adoption and change management of those protocols and innovations in the practice. And that's what translates into customers using IDEXX innovations grow faster, that sector-wide growth of wellness inclusion of 50 bps that I talked about. And so that's why we see this long into the future.

And given those drivers that you're calling out, without necessarily giving formal guidance, I mean you can, if you want, for 2027. But how do you think about sort of the moving pieces as we head into 2027? Should we anticipate still kind of sluggish vet office visits with durable price innovation drivers continuing? Like what would deviate from your long-term projections?

Yes. So as you highlighted, we're not providing a 2027 guidance today. And certainly, we're not updating our guidance for 2026 today either. But I think the clinical visit headwind that we have seen, we've highlighted even in our initial guidance that we expected that to be a decline in 2026. It's come in slightly better than that in the first half, and we're anticipating about 1.5% declines on clinical visits in the second half as part of our guided midpoint, and there's obviously a range around that dynamic. But what we're really continuing to benefit from is a lot of the building blocks that Mike highlighted. We've launched a number of new, both transformational innovations with inVue Dx and Cancer Dx, but we've also continued to add new menu additions to our core platforms. We have almost 80,000 Catalyst instruments across the globe, and we've added around 5 new innovation menu to that instrument installed base over the last 3 years. So we get continued benefits of that as customers adopt these new menu benefits, whether that's cortisol or pancreatic lipase -- and we highlighted that we have proBNP coming here in October. So a number of new innovation, new elements that really benefit clinicians' understanding of the overall pet health that we see rapid adoption of in that installed base. So we have a number of innovation drivers that we really continue to be excited by that we've publicly announced, and we have a really robust menu of options there, too. The other component that I would highlight is we've continued to invest in our commercial or our field based employees, which are really the core customer engagement engine that we have. In particular, we've seen strong double-digit growth in our international regions as we continue to broaden our customer base as well as just partnership, really changing behavior and mentality around how to use diagnostics globally, which is a key part of our overall strategy, to Mike's point, on expanding the utilization. So a number of factors that we continue to be excited about. But when time is right, we'll continue to highlight 2027.

There's really 3 ways that our innovations translate into the utilization growth that you're asking about to kind of build on what Andrew said. So we come forward with entirely new categories like Cancer Dx, completely unmet need. We'll probably talk a little bit more about it because there's 25 million dogs out there that are at risk for cancer, and there's been no solution. That's a whole new category. And when we bring through a breakthrough technology with highly accessible pricing like we've done, we basically create all that volume, both for our customers and for IDEXX. The second type is we come into a category like cytology, where there's 150 million of these being done all around the world, and we're able to address that in a transformational way with inVue Dx starting out with blood morphology, ear cytology and now fine needle aspirate. And we can provide -- take out all the manual work, a much better quality diagnostic. And we take the volume that's being done and we enable them to do more and then we also translate that into IDEXX volume. So we're growing together there. And the third way is, as Andrew mentioned, as we keep adding new menu into our existing platforms, our customers have their existing workflow, they get the benefit, and then that grows for them and for us, too. So we can draw a straight line between the investments we're making in innovation and how that drives volume growth for our customers and for IDEXX.

So let's talk about innovation. You're rolling out FNA on inVue right now. InVue has tracked well above my expectations in terms of placement trends to date. But what I care more about is that consumables flow-through. And where do we stand now in terms of that 3,500 to 5,500 range that you initially kind of targeted. Are you within that range with your existing installed base? Or do you ramp to get there? And does that -- is that inclusive of FNA as well?

Yes. So we've been exceedingly pleased with inVue Dx, the reception to it. It's one of the most successful launches, new product introductions that we've had in the history of the company. And we focus on the quality of placement. We focus a lot on that utilization number, as you know, Aaron. And so what we're seeing is we're very comfortably within that range with the $3,500 to $5,500 per instrument in recurring revenue. And that's really at these very early stages, I should say, of fine needle aspirate FNA being rolled out, still controlled launch on track for the end of year broad availability that we talked about. And so we see headroom to that. The reception has been exceptional. It hits the mark. I mean, as I was talking about cytology, every practice around the world does cytology. They have a microscope. They do it. It's a very manual process, very technique sensitive. InVue Dx is paradigm changing because it takes the slide out of the equation. So all that manual effort and subjectivity is gone and enables a really high-quality diagnostic. In the case of FNA, you're looking for -- generally, this is a dog coming in, let's say, with a lump or a bump. And the question on the pet owner's mind is, is this cancer? So it's a pretty high-stakes question. Is this cancer? And today, we know that there are 12 million FNAs being done around the world, but that represents 10% or less of all of the lumps and bumps that are coming into the practice. And the reason why it's so low is because it's really hard to do these. It's hard to make a slide and do all the steps, the multiple steps to stain it and dry it. It's 25 minutes or so of work. And then you've got to read it or you send it into the lab, and that can be expensive. And with inVue Dx, it takes all that effort out. You get a real-time result right there. And what we're seeing is with the customers using FNA and inVue Dx, they're doing twice as many lumps and bumps. And by the way, at an 85% lower cost. So this is a great example, again, of our innovations are driving volume-based growth in the practice, transforming how care is done.

And as Mike did highlight, the 3,500 to 5,500, we're in that range today. But we always said that, that does include the launch menu, which was inclusive of FNA. And so we feel really good about kind of where we're at with the instrument recurring revenue. And these are really large categories that will continue to ramp over time. Yet we also know that there's a number of extensible new options that we could also put on this platform in the future. And that's the way we tend to think about these innovations. They're really platforms that we can continue to innovate on. And so there's a really large economic value associated with this platform, and we continue to see, again, a robust innovation road map ahead of us.

Yes. If you look at what we did on the Catalyst, and Erin, you know this over a decade, we expanded the economic value of the catalyst in our customers' hands and for us by 2.5-fold. And that was a combination of menu innovation, supporting utilization, all of these things. That's exactly the type of thing that we see in the future for inVue Dx as well.

I think we saw a 25% uplift in consumables volume for every upgrade for Catalyst. Significant. But the -- I think for FNA, in particular, you're already hitting the mark where I remember SediVue, I don't think we hit the mark right out of the gate in terms of hitting that consumables flow-through. But for FNA or for inVue, you already are even without that broader FNA launch. But why is it more of a measured launch still and it's still on track, I think, as you just said, for year-end broader launch. I guess, anything else to comment on in terms of the early feedback on FNA?

Yes. This is our standard launch process for any new platform. And I think maybe the one sort of nuance here to appreciate -- when we roll out, let's say, a new slide on Catalyst, customers have Catalyst, they have their workflow. Through our software, we're able to push out that new capability. They just have to order the slide and they can use it the next day, and they love that experience. Each of the applications on inVue Dx is like a new one of those platforms. You think about ear cytology, blood morphology and then the third platform within a platform now is find needle aspirate. So this year alone, we've rolled out multiple upwards of 4 new red cell morphologies within the blood morphology category in inVue Dx. And now that customers are trained on that and they're using that, we can just provide that over the software, and they love that experience and they get all that additional value. Now as we're rolling out fine needle aspirate, again, it's like a new platform. So we want to make sure we nail that we get the customer experience right, the training right, all the components. This also has the opportunity for customers should they want because, again, high-stakes cancer, if they want one of our pathologists to look at it, they just press a button and the image is usually just sitting there already for our pathologists to take a look. So we want to make sure we nail all of those things because the long-term value creation tail on these is very, very compelling. And so just like we do, whenever we roll out a new platform, we have this controlled launch process where we make sure we nail all those details. That's what our customers expect from IDEXX. And so that's what we do.

And presumably, all the future platform additions to inVue would be in a similar format in terms of being able to quickly...

That's exactly.