愛德士 (IDXX) 2003 Q2 法說會逐字稿

Good day everyone, and welcome to the IDEXX Laboratories second quarter 2003 earnings review conference call. Just a reminder, today's call is being recorded. For opening remarks and introductions, we will now turn the conference over to Mr. John Ayers, Chairman and Chief Executive Officer of IDEXX Laboratories.

Good morning. As is the usual custom, I would like to start by asking Conan R. Deady, our Vice President and General Counsel, to review our Safe Harbor statement.

The statements that we may make on this call regarding management's future expectations and plans and the Company's future prospects, constitute forward-looking statements for purposes of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations of future events, which are subject to risks and uncertainties.

These risks and uncertainties include the timing and success of new product introductions; demand for our products and market acceptance of new products; availability of products and materials supplied to us by third parties; intellectual property protection of products; and the impact on our business of government regulation and government approvals, competition and technological change and litigation.

A further description of these risks and uncertainties is contained in our quarterly report on form 10-Q for the quarter ended March 31, 2003, which is on file with the SEC. In addition, any forward-looking statements represent our estimates only as of today, and should not be relied upon as representing our estimates as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change.

I would like to now introduce the other members of the management team joining me today. Sitting with Conan and me are Merilee Raines, Vice President of Finance; Bob Hulsey, Vice President of the Companion Animal Group; and connected by phone, Dr. Erwin Workman, head of IDEXX Pharmaceuticals.

We have more than the normal amount of news today and some good developments. First and importantly, the second quarter came in very strong, with lots of things going right in the Company and in our markets. Second, the LaserCyte program is right on track with the ramp up. We recognized revenue on 266 units in Q2, which is a little better than our thinking at our last update at the May annual meeting.

Third, we have some good news in pharma, specifically a reasonably certain launch date for BNTZ (ph). And finally, we have an important evolution in our board, with two new outstanding independent members and the announcement over Erwin Workman's upcoming retirement.

So I would like to start with a review of the second quarter performance and some comments about our product lines and businesses, and then, per for our usual custom, I'll ask Merilee Raines to review our financial performance for the quarter. Then I will discuss our current outlook for the year and open it up to your questions.

As you saw in the press release, with revenues in the second quarter of around $122m, we achieved 15% year-over-year growth, consistent with our expectations for double-digit revenue growth in 2003. 4% of this growth this quarter was due to favorable currency translation. We have again this quarter reported a record level of quarterly sales for the Company.

Fully diluted earnings per share came in very strong, at 47 cents, an increase of 27% over Q2 2002. Investors might recall that Q2 2002 was also a strong quarter for the Company, with EPS growth of 28% over Q2 2001. I might comment that this quarter's results were good, solid earnings, without any unusual level of net nonrecurring pluses or minuses.

Free cash flow was $29m for the quarter and $55m year-to-date, which was also very strong. To remind investors, our definition of free cash flow is pretty straightforward, and takes into account changes in operating working capital and capital expenditures, but excludes cash from options exercises, any acquisitions, divestitures, stock repurchase or other financing activity.

We feel free cash flow is a useful measure because it indicates the cash the operations of the business is generating after appropriate reinvestment. A table reconciling operating cash flow to free cash flow is included in our press release, which, if you have not seen it, is posted on our website, www.IDEXX.com.

Cash and investments on the balance sheet were $210m at the end of the quarter and debt remains below $1m. We are certainly very pleased with this financial performance for the quarter. We achieved strong growth in revenues and volume. As a result of this increased volume, favorable product mix, continued improvements and operating efficiency, and the year-over-year favorability and non-dollar currencies, we generated earnings growth that was a good deal higher than our sales growth.

I would like now to turn to our two business segments, starting first with the Companion Animal Group. As you all know, the Companion Animal business is the bulk of the Company, and in Q2 this segment comprised 81% of the Company's revenues. In the second quarter, the Companion Animal group revenues were up 17% year-over-year, 4% of which was due to favorable currency translation.

We are very pleased with the results from the ongoing rollout of our next generation LaserCyte hematology platform. We delivered, installed, and recognized revenue on 266 units in the second quarter, a 45% sequential growth over Q1. Average unit price, or AUP, continues to exceed our expectation, and this quarter came in a little over $17,000. We estimate that the AUP for the full year will be over $16,000, which is a bit higher than our previous estimate of $15,500.

This average realized AUP is lower than our list price of $18,900, primarily because we give the customers credit for any existing hematology that they may want to trade, either our own (indiscernible) or (indiscernible) equipment -- the credit, depending on the machine age and type. Our realized AUP was over $17,000 this quarter, in large part because a lower percentage of our sales included a traded in instrument. Of course, with a revolutionary technology such as LaserCyte that brings so much to the clinic, it is important to note that we're not offering any meaningful discounts or unusual deals.

Our backlog at the end of the quarter stands at 245 units, and I might comment, customer demand for the new analyzer is strong. Please note, though, that we do not expect that we will run a large backlog after these first two quarters, as customers typically would prefer a shorter lead-time between order and installation. High backlogs, all other things being equal, translates into longer lead times experienced by the customer, and customer satisfaction is always our first objective. We are very pleased with the progress we have made with our disciplined ramp up of the program in Q2.

First, we have been building our sales and support organization as well as moving down the learning curve in this area, and we have a high level of customer satisfaction with the system as a result. We measure the customer experience assiduously with a variety of metrics, and we have seen a steady trend of improvement since the launch of the program.

Second, we have shipped to customers the next version of software, easily field installable, which further improves the customer experience. Third, we now have demonstrated a higher rate of production consistent with our volume targets for Q3 and Q4.

Speaking of targets, we are looking to generate revenue on 375-400 units in the third quarter, which would be another about 45% sequential quarterly growth, and continue to see 1300-1400 units for the full year. It's really exciting to see clinic veterinary hematology go to a whole new level, with 24 hematological parameters available from LaserCyte, including a 5-part white blood cell differential and an absolute (indiscernible) count.

The instrument is also noted for its ease-of-use as well as for the advanced analytical capabilities of our proprietary vet station software. This software, and the PC that comes with the LaserCyte system, provides historical data retrieval and connectivity to the rest of the IDEXX vet lab as well as to the IDEXX practice information management system.

Moving on to instrument consumables and rapid assays. First, please keep in mind that year-over-year revenue growth in our in-clinic diagnostic business can fluctuate from quarter to quarter due to a variety of factors, some of which are unrelated to demand at the clinic level. In the US, changes in distributor inventory levels from this year relative to last year and other miscellaneous factors can affect reported results, and sometimes substantially. Internationally, we also have currency as an added factor.

So, because reported revenue growth in a particular quarter is not always indicative of what we would believe to be the underlying growth for a particular product line, I also give our estimate of this underlying rate of growth of market demand that we see in each of our major product lines.

For instrument consumables, overall worldwide reported revenues grew 14%, or 8% in constant currency. Given all of the trends in the business, we see underlying worldwide demand in instrument consumables growing in the 4% - 6% range. Consumable growth is supported by three strategies. First, a variety of marketing programs to support the practice of better medicine, and thus, consumable unalization (ph) in our customers.

Second, continued instrument placements of both hematology systems. That would be LaserCyte and the QBC AutoRead -- and chemistry -- that would be our VetTest platform. Then third, customer loyalty and retention. LaserCyte consumables do not generate any meaningful incremental volume in 2003, due to the low installed base and the replacement in many locations for currently operating IDEXX QBC auto read systems.

Turning to our rapid assay line in this segment, and these are the single use point-of-care kits that test for the presence of certain infectious or vector born diseases. Worldwide reported sales were up 21%, or 19% in constant currency. Our estimate is that the growth in underlying demand for rapid assays is in the 7% - 9% range. This quarter, we're launching a new marketing program for our feline combo product to educate veterinary customers and their clients, cat owners, on the benefits of testing for FIV and FELV in at-risk cats, sick cats and kittens.

Turning now to distributor inventories. As you all know, we sell most of our test kits and instrument consumables in the US through distribution. At the end of the quarter, we had $9.7m of inventory in US distribution, or 3.1 weeks of demand for test kits and consumables, which is down $0.4m from the end of the first quarter. While we continue to improve our processes with distribution, the ending level of 3.1 weeks is at the low end of a normal range, which we would now characterize with new efficiencies at 3-4 weeks.

During the second quarter of 2002, we took distributor inventories down significantly from the first quarter, far more so than this year. Last year's greater relative decrease in distributor inventories has created a relatively easy compare, and thus, has a positive impact on this quarter's reported growth for kits and consumables.

Turning to our lab services line of business, the key service offering of IDEXX's Companion Animal Group. Laboratory services worldwide continued to show very nice growth in sales of 13% versus second quarter 2002, with 3% coming from favorable currency translation. Lab services has done well in implementing productivity programs that have driven continuing improvement in its operating margin.

The underlying growth and demand that we see in this business is in the 8% - 10% range. Our computer systems business sales growth in the second quarter was 2% over last year, which is lower than normal, although orders and backlog were strong, suggesting higher growth for the back half of the year. In fact, the backlog in this business has not been this strong since the surgeon orders in 1999 as a result of the Y2K concern.

In the Companion Animal Group, we have also continued to have good progress with the rollout of our practice developer program with our US veterinary customers, our loyalty program that allows clinics to earn points with purchases, depending on the number of product categories they purchase from and the volume of those category purchases. We have enrolled almost 1000 additional clinics this quarter, with total membership now over 5400 clinics. With practice developer points earned from prior purchases, the clinic can, among other things, apply those points towards the purchase of a variety of IDEXX products. Some clinics like to save up points to apply towards capital outlay, such as the LaserCyte analyzer.

At IDEXX Pharmaceuticals, our pipeline includes three products currently in the regulatory phase. The first, nitazoxanide (ph), or NTZ, is our proposed treatment for equine (indiscernible) encephalitis, a debilitating neurological condition that, left untreated, can cause permanent nerve damage. This is an attractive market currently estimated at about 40,000 treatments annually.

Nitazoxanide has an 81% success rate with EPM (ph) diagnosed cases in open trials. As investors will recall, in December we received a letter from the FDA that indicated that our application for nitazoxanide was not yet complete in terms of labeling but was complete in substantially all other aspects. In February of this year, we resubmitted the nitazoxanide New Animal Drug Application, or NADA, with revised labeling.

Over the last several weeks, we have been in discussions with the FDA on these final labeling revisions. All issues are now resolved with the FDA on labeling, and we expect the FDA product approval in late Q3 with a launch in Q4. It will be great to get this therapeutic on the market this year, as we believe its high level of efficacy will be appreciated by equine veterinarians and horse owners alike when they learn their horse is diagnosed with this dangerous parasitic disease.

Note that we do not expect much in terms of revenues to come from nitazoxanide until the 2004 season.

Another product in FDA review is our topical non-steroidal anti-inflammatory drug, or NSAID, the drug diclofenac (ph). This product is being developed for the treatment of lameness in horses, and the active diclofenac is formulated in a liposomal delivery system which provides targeted drug delivery that is applied topically at the point of lameness, typically the knee or (indiscernible)lock. The topical application avoids undesired side effects, such as the gastrointestinal problems that can be seen with the systemic non-steroidal therapies.

We believe this is a very attractive market. Currently, there is about $60m spent annually on lameness and sore joints in horses, and this product could very well expand that market by being prescribed, in some cases, as an adjunctive therapy.

Again, to review the product's status, as announced in our May press release, we learned that the FDA had additional comments related to labeling, documentation of analytical methods for finished product testing and completion of inspections of third party manufacturing and testing facilities. Activities to address the first two of these matters are nearing completion, and one of the key outstanding FDA facility inspections has now been successfully completed.

Barring additional questions resulting from the remaining outstanding preapproval inspection, we anticipate resubmitting the NADA within the next 30 days. At that point, we would expect the normal 6-9 months for FDA approval process to complete before we are able to launch.

The third product in FDA review is our tilmicosin antibiotic product for cats. All of the various technical sections of the NADA -- including pivotal efficacy, pivotal safety, chemistry manufacturing controls and labeling -- were submitted in Q2 to the FDA under their so-called phase review process. We are now essentially in a waiting period with respect to this product.

Now a brief review of our other operating segment, the Food and Environmental Group, which contributes 19% of our total revenues. We saw top line growth of 9% in the quarter, primarily as a result of strength in foreign currencies. Our production animal services business had year-over-year growth of 8%. Currently contributed 10% of the growth to this lines significant European customer base.

The comparison for this business was especially tough because the 2002 period was unusually strong for PAS. Notably, at the end of the quarter, we signed a joint venture agreement in China with a local partner that positions us extremely well for this company's strong future market. I might note that even though much of China's production animal business is still on small farms, this is changing. To give you an illustration of the scale in this country, China has an estimated 15b poultry.

The water testing business achieved 13% growth for the quarter, due to strong volume, particularly in Europe, and 5% of the growth was from currency. Dairy reported revenues of up 2% with the benefit of currency.

At this point, I would like to turn it over to Merilee for a more in-depth review of the financials before I conclude and open up to your questions.

A few of these numbers you have already heard, but they are worth repeating. Total revenues for the quarter were $121.8m, which was in increase of 15% from the second quarter of last year. International revenues of $36.7m increased by 18%. Strong currencies augmented overall top line growth by about $4.6m, or a little bit better than 4%.

Relative to guidance for the second quarter, exchange favorably impacted revenues by about $1.5m and earnings per share by about a penny, based on the net impact of hedging, local currency expenses and transaction gains.

For the third quarter, we expect revenues to grow by 13% - 14%, with continued ramp of LaserCyte and favorable exchange augmenting growth in our core businesses. Revenue growth for the full year 2003 should be approximately 14% to $470m, with about 5% or so of that growth coming from LaserCyte. The gross margin, at 49%, was about 2 points better sequentially and year-over-year, and at the high end of our guidance of 48% - 49%. Growth from the prior year was driven by favorable sales mix of high margin rapid assays, exchange, chemistry rental units becoming fully amortized and volume leverage from higher revenues.

As expected, even at higher than forecasted selling price, LaserCyte produces a drag on the gross margin percentage until we are able to achieve greater efficiency in manufacturing and after sales service. For the balance of 2003, we believe we are on track to achieve margins between 48% - 49%, to produce a total year gross margin of about 48%.

Turning to operating expenses, research and development came in at $8.3m in the quarter, or 7% of revenues, compared to $7.7m, or 7%, for the second quarter last year. We expect R&D to remain at the 7% level for the balance of the year.

SG&A expenses at $27m, or 22% of revenues, compared to $23.5m, or 22% of revenues for the second quarter last year. The spending, which was relatively flat sequentially, was somewhat below our expectations, primarily due to slower than planned ramp and staffing. For the balance of 2003, we would expect SG&A to range between 23% - 24% of revenues.

Operating profit at $24.3m was 20% of revenues, compared to $18.7m, or 18% of revenues last year. The margin was about 1.5 points above expectations, driven by a combination of strong revenue performance and improved gross margin and lower operating expenses. Based on our thinking about gross margin and operating expenses for the balance of 2003, we expect that total year operating margin will be approximately 18% of revenue.

Net income of $16.7m, or 14% of revenues, compares to net income of $13m, or 12% of revenues last year, an increase of 29%. EPS of 47 cents for the quarter compares to 37 cents for the second quarter last year, an increase of 27%. As mentioned in our press release, we expect EPS to be 39-41 cents for the third quarter and EPS for the year to be approximately $1.62.

With regard to the balance sheet, cash and investments increased by $26m in the quarter to $210m. Cash from operations was $36m, and we purchased $7m of fixed and other assets. Inventory at $70m was essentially flat with the first quarter, and turns were approximately 2.

Receivables for the quarter were $51m, down $1m from the end of the first quarter, and days sales outstanding at 38 days was down 3 days from the first quarter, and down 5 days from the second quarter last year. We repurchased approximately 400,000 shares of stock for $14m in the second quarter, which brings the total repurchase under our 10m share authorization to 9.3m shares.

Looking at the balance of 2003, we would expect to see DSO remain relatively constant and inventory levels between $70m - $75m. Fixed asset purchases are forecasted at approximately $18m - $20m.

I would like to take this opportunity to welcome our two new independent directors. Dr. Rebecca Henderson is the Eastman Kodak LFM (ph) Professor of Management at the MIT Sloan (ph) School. Rebecca brings a focus on strategy formulation, competition, research management and product development in pharmaceuticals and high-tech industry -- all pretty relevant for IDEXX. Among her other accomplishments, she has been honored as teacher of the year by her Sloan School students in 2001. Rebecca has degrees from Harvard and MIT.

Our second new director is the Brian McKeon, CFO of the Timberland Company. Brian brings a strong strategy and finance background from many years at PepsiCo, and before that, Coopers & Lybrand and Alliance Consulting. For the last three years, Brian has served as Timberland's Chief Financial Officer. As some of you may know, Timberland is a publicly traded New York Stock Exchange company that is a premium provider of outdoor footwear, apparel and accessories. Brian has degrees from the University of Connecticut and Harvard Business School.

Rebecca and Brian both bring outstanding backgrounds and relevant expertise to our Board, and complement nicely our current standing directors.

Erwin Workman is also announcing his retirement from the Company and the Board at the end of the month. I would like to thank Erwin for his amazing contributions to the Company since its founding 19 years ago, and the strong partnership that he has had with me, the Board, the senior management team and the scientific talent at IDEXX. We wish Erwin much happiness in his retirement. However, fortunately, we'll continue to have access to Erwin in a consulting capacity while we complete a search and evaluation of candidates for his replacement. Since we have had Erwin's retirement in the planning stages for several months, we are well underway with the search and evaluation process and have several promising candidates.

Now let me wrap it up. You heard the guidance from Merilee. Based on new trends, current trends in our business, we raised 2003 guidance earnings per share fully diluted to $1.62 and the revenue growth outlook for the year 14% over prior year $470m. Just to conclude my remarks here, IDEXX Laboratories is a great business model, with market leadership in our related businesses and a very unique combined position in animal health.

In the second quarter of 2003, we continued to report double-digit revenue growth, great earnings growth and strong cash flow. Our priorities continue to be focused on topline growth through new product innovation, such as LaserCyte and the pharmaceutical pipeline, and further penetration of our underserved markets through great sales and marketing of our existing products and service offerings. And, of course, continue our track record of continuously improving operational excellence, supporting our gross margins and asset management performance.

So now, we would like to open it up to your questions.

Rick Wise with Bear Stearns.

On LaserCyte, can you give us some sense of where LaserCyte gross margins are today -- roughly averaging somewhere in the range -- and when you expect them to get to the corporate average, or will they get above? Just give us some sense of that?

I will pass the first part of that question on to Merilee, but let me first comment that our target for LaserCyte margins will and has always been at a lower level than the corporate average gross margin. And an instrument is typically a lower gross margin type of sale, and, of course, the consumable that comes with it is significantly higher gross margin. That's the normal business model, but let me turn it to Merilee to be more specific.

I think in the quarter, LaserCyte probably had a gross margin of approximately 25%. Again, the issues there are really getting production up to scale and gaining some efficiencies in that process.

What will be normal, and roughly when do we get there?

I think we can expect to see margins improve so that they are maybe in the 30s, and that probably should happen next year.

Can you give us a sense of consumable use -- what you expect looking at 2004, and what kind of growth we can expect in 2004 as the user base builds and installed based grows?

It's still pretty early. Let me make a couple of comments with regard to what we have seen on consumable utilization. We have been selling LaserCytes to, weighted average, our higher utilization type customers than the average in-clinic hematology utilizer. So we start with people who are higher users in the first place.

Second of all, again, it is very early and this is lumpy, but we are seeing a higher level of hematology utilization for those customers who have moved from a QBC VetAutoRead system to a LaserCyte, as we expected. But it is still pretty early to get conclusions as to what that high-level of utilization will be, but it is clearly higher. Merilee?

In terms of overall consumable growth, I think when John was citing what the underlying growth rates are for consumables overall, the 4% - 6%, that encompasses the impact of the increased utilization on hematology. Obviously, the LaserCyte consumable itself will grow significantly more than that. I think (multiple speakers)

(multiple speakers) What about free cash flow? Clearly cash is building. Given -- and you are at the end of your authorized share repurchase -- do you plan to continue on, number one. And number two, given the change in tax laws, might you all pay a dividend at some point?

Yes. First of all, we are extremely attentive to our stewardship responsibility with that cash, and to use it in a way which creates shareholder value, and those would typically be acquisitions that we think generate a return higher than our cost of capital, and other forms of what I call cash distribution to the shareholders. And a share buyback and dividend would be in those categories. -

I don't think you should take any message by the fact that we are coming to the end of our authorization. I am sure that if we come to the end of our authorization, our Board will actively consider extending that, authorization. We certainly plan on continuing with share buyback on a regular basis, as we have been doing over the last several -- over the quarter since I have been here.

Timothy Lee with Merrill Lynch.

First, in terms of LaserCyte, what's the selling process? Going to 375 to 400 systems this quarter is a pretty good step up here from Q2 levels. Is the selling process a 12-week process units from the initiation of the first sales call? Kind of just walk us through that entire process please?

First of all, I might comment that we are selling the units in the US, in Canada, in the UK, and in the third quarter in continental Europe. So we are selling it across several different geographies. And I would say the selling process varies by customer. Sometimes it's very quick, sometimes it takes a little bit longer. I would say 12 weeks might be on the outside of that process, but -- the outside end of how long that takes.

Generally, when we sit down with customers, and we take them through the capabilities of the system -- and hematology is, like with a lot of medical issues with veterinarians, they have got a lot of different things they need to do in their business. It's something they always want to learn more about. As they learn more about it and they learn more about the capability of LaserCyte, that is when they get interested.

It is a matter of sitting down with them and taking them through that, and then also taking them through the capabilities of the system and its impact on their clinic economics. So it can take 12 weeks, but it can take a shorter period of time, and we have got conversation -- we've got 245 units in backlog, and you can bet we've got conversations with a number of clients that are along that decision process.

Are these prequalified accounts that showed some interested at a trade show that said -- hey, once it's available, please call me? Or are these rather your reps making cold calls saying -- hey, here's some high-volume users, let me see if these guys would look at this device?

It's all of the above. I would say the prequalified accounts we have, those were ones that we probably have already shipped a LaserCyte to. But we are always qualifying more accounts. We know our customer base pretty well. There are roughly 25,000 clinics in the US. So at this point, we are just entering and continuing conversations with folks.

Erwin, if I can turn to you? In parting, could you share with us any other compounds that happen to be in the development pipeline beyond (indiscernible)?

I would love to spill my guts, but I don't guess I can.

I will say, though, that we do have other products that are not as far along as the ones that we have talked about, and they are generally leveraging the same technology platforms as these.

Brett Carson with GARP Research.

I was wondering if you could talk about or address the potential revenue ramp you expect from NTZ, and the seasonality of that business?

I think with regard to NTZ for 2003, where the launch is coming late in the year, we don't expect any meaningful revenues from that in 2003. And I think beyond that, we have said that a few years out, a couple of years out or so after launch, we expect peak year sales to be somewhere in that $15m - $20m range.

Is that enough revenue for the pharma division to hit profitability as a whole?

It depends on our reinvestment rate, so we have got a couple of products in the pipeline here, and more that we are investing in. So we could reach profitability today, but we think it is one of our most attractive areas for investment. I also just say on seasonality, horses generally pick up the parasite when they are grazing outdoors. So it's generally more frequently diagnosed in the second and third quarter than it would be in the first and fourth one there -- more likely in the barn.

Regarding the candidates to replace Erwin, are those internal or external candidates?

We have some external candidates that we are talking to. We are not precluding internal candidates, but with recruiting it's, as I said, we are fairly far along, but until you have made a mutual decision, it would be inappropriate to forecast anything.

And you expect a decision when?

When we are able to find someone that we are sure would be a great fit and bring the right capabilities. We are not really predicting a particular timeframe.

Christopher Arndt with Select Equity Group.

First towards Merilee -- the projection on the gross margin in the mid 30s once you get a little more volume on LaserCyte, would that be accounting for the discounts that you offer for trade-in?

Yes. That's already baked into the average unit price. (inaudible)

Could I just clarify one thing? It is not just a scale issue, which helps with the gross margin, it is also, of course, a typical classic learning curve. As we get better at these things, we continue to lower our costs.

Is there the prospect of doing better over time in the mid 30s, as well as -- do you expect this machine to be 50% gross margin, or something that at times other capital equipment has been.

No. I am hesitating because we don't have much capital equipment, I think, that has ever reached gross margin. Typically, the capital equipment would be lower than the average and the consumable would be a higher than average.

When you sell a LaserCyte, do you offer the customer disposables, for a certain period of time along with that initial sale, for free? How long is that period?

I think that there is an initial provisioning (indiscernible) that comes with the LaserCyte, and I think that is roughly 50 disposables. And then after that, they purchase.

Okay. Is there any -- you all don't speak much about the digital radiography product -- the product you have for horses and for small animals -- but is there any reason why you don't speak about that? It seems like that might be a pretty good opportunity.

Actually, maybe I could ask bob just to give a brief update. We have Bob Hulsey here, who will give us a brief update on that. No particular reason why we don't speak about it, other than a lot of news already -- but go ahead.

As you probably know, we launched the equine version of our compact system about 1.5 years ago, and we placed approximately 40 of those. This last quarter, we have finally launched and installed our first Companion Animal version, and it is going in very well. We have quite a few instruments and orders in backlog. So we do expect it to be a major lag of our sales growth going forward.

Can you quantify that a little bit more, in terms of what you might expect? Or is it premature to do that?

I think it is premature. This isn't going to be like LaserCyte, where it's 500 a quarter or anything remotely like that. But I will tell you, it does have a lot of positive customer -- the customers who see it and the customers who are using it now are very, very happy with it. So it is an important product from a customer franchise point of view, and yet it is really a niche from our overall -- although, of course, it is a brand-new category for us -- but it's a niche in terms of our overall product. We haven't really given much forecast for that product, and really include the revenues from that product in our overall guidance for sales growth for the Company.

Timothy Lee with Merrill Lynch.

Could you comment on the sales of the QBC system? Are we seeing a drop-off in terms of placements given the rollout of LaserCyte, or are we still seeing pretty good placements on that unit?

Both. We are seeing a little bit of a drop -- as would be expected -- but it is still being placed. And of course, as we take QBC auto read and trade, we have the opportunity to refurbish it and factory certify it and sell it in the market as a refurb unit -- which is a little bit lower AUP than a new unit, but from our cost position, an attractive cost. So we expect the QBC auto read to be a continuing element of our product line for a long time, although the placements are obviously going to be a little bit lower with the launch of LaserCyte.

We have not heard anything in terms of the mad cow disease front -- kind of give us an update on where things stand on development tests for that?

As you know, this is a product potential in our production animal services business, and we continue development work on a diagnostic test for what I more generally call prion-based diseases. I know you know this but others may not, that it manifests itself in different species with different names -- mad cow disease, or BSE, in the bovine species; chronic wasting disease in deer and elk; and scrapey (ph) in sheep.

We have developed a novel assay for a post-mortem test, and we are in the process of developing a diagnostic product and commencing the regulatory approval process. So we would not expect anything this year, but the TSE (ph) market, I think, is a very attractive market for us. We are continuing to work away on our product development with our novel essay.

Rick Wise with Bear Stearns.

Clearly, the sales this quarter were very strong for LaserCyte, but can you tell us where things stand in terms of have all manufacturing issues basically been resolved, or the product performance issues? Are you seeing any unusual levels of returns or problems in the field? Have they been completely resolved, almost resolved? Can you give us some color around that?

The level of returns are immaterial. We have made significant progress on resolving, and I would say essentially have resolved what I would call any issues of concern, although we are continuing to fine-tune and tweak the product. For example, we have not yet completed the process of qualifying it for equine blood, and we are working on that. We are continuing to work on minor tweaks and improvements in the system. As I said, we have demonstrated now, for a period of time, manufacturing capacity to serve our needs in the next two quarters. So we just continue to fine-tune and tweak and improve.

You mentioned that, alluding to the customers, that these are being bought by the high-volume centers -- high throughput centers. Of the 60,000 or so sites out there, can you give your latest thoughts on the opportunity for the product? Is it limited to 10,000? What do you think the market is?

We have really not any change in our outlook for the market. We felt that there is a pretty robust market out there, and I think you mentioned 60,000; I would think there is maybe 45,000, roughly, clinics, depending on how you define them globally. Certainly not every clinic globally is going to own a LaserCyte, and our long-term projections for the product assume a, what I would call -- in relation to 45,000 clinics globally -- a modest penetration rate. But that's still going to be pretty attractive for us, given that our current year production will be 1300-1400. And we continue to think that 2000 would be a good annual target, once we have reached scale.

Computer business up 2%. As you said, we should expect a stronger second half because orders and backlog are up. What kind of growth should we see in the second half, and maybe looking out to 2004, what kind of normalized growth would you expect to see for that business?

I think if you look at the year overall, where the growth in the first couple of quarters has been around 2%, maybe it would average out for the year to be about 5% growth, and maybe about a similar level for next year.

We would certainly like to do better than that, but I think Merilee is being appropriate in her forecast. But I will say we have a pretty good backlog, and I will mention that the computer business is a little bit different than the LaserCyte business, because changing a computer system in a clinic is no small decision.

That is a backlog business; it would be appropriate to have a backlog. It takes several months of planning to go through a computer change, and so we feel pretty good about the prospects of that business the second half. We think we have got some real order momentum that we have established in the first half of the year that will translate into certainly higher than low single digit growth in the business.

Food and Environment Group ex currency was also not very strong. Can you give us your latest thoughts there on the outlook, and why we should see better ex currency growth going forward?

It really varies by business. I think we feel that the water business is growing about the rate that it naturally grows, high single digits. The PAS business had a very strong year last year, and so the growth this year is currency adjusted low -- and that's just mention how that business goes. It has good years, and other years it's kind of flat. We have got prospects in future years for -- in addition to normal growth in our normal product lines, the addition of a TFC test. Our goal in dairy is to have that business be flat in constant currency terms.

Just to make sure I understood -- the backlog of LaserCyte is 245. Where should we expect to see it in the second half?

As I mentioned, we don't think that the optimal way of selling this unit is with a long lead-time. We would say that lead times between sale and install would be more in the 4 to 6 week timeframe. So you sort of can do the math on that and figure out what the appropriate backlog would be. There's also maybe people who, towards the end of the year they want to get it in before the end of the year. So we might have a lower backlog at the end of the year just because people really wanted it delivered before the end of the year.

There are no further questions at this time. I will turn the call over to Mr. Ayers for any additional or closing remarks.

Thank you all for joining. We do believe we have had a good quarter and some good momentum in the business. We appreciate your attendance on the call. Thank you very much, and that concludes the call.

That concludes today's conference call. We do thank you for your participation. Have a nice day.