愛德士 (IDXX) 2006 Q3 法說會逐字稿

Good day everyone, and welcome to Idexx Laboratories, third quarter 2006 earnings conference call. Just as a reminder, today's conference is being recorded. [OPERATOR INSTRUCTIONS] Participating on the call is Jon Ayers, Chief Executive Officer; Merilee Raines, Chief Financial Officer; and Ed Garber, Director Investor Relations. Idexx would like to preface the discussion today with a caution regarding forward-looking statements.

Listeners are reminded that statements -- members of forward-looking statements -- listeners are reminded that statements that members of Idexx management may make during the course of this call regarding management's future expectations and plans and Idexx future prospects constitute forward-looking statements for the purpose of Private Securities Litigation Reform Act of 1995. Such statements include but are not limited to statements regarding management's expectations for financial results for future periods and the timing of new product introductions. Listeners are reminded that actual results could differ materially from management's expectations.

Factors that could cause or contribute to such differences are described in the Idexx quarterly report Form 10-Q for the quarter ending June 30, 2006. And annual report on Form 10-K for the year ending December 31, 2005 which are on file with the SEC and also available on Idexx website, Idexx.com. In addition any forward-looking statements representing Idexx estimates only as of today and should not be relied upon as representing the Company's estimates as any subsequent date. The Company's disclaim any obligation to update or revise any forward-looking statements in the future. Even if it estimates or expectations change.

At this time I would like to turn the conference over to miss Merilee Raines, please go ahead, Ma'am.

Thank you, and thank you for joining us today. As I share with you our thoughts on our financial performance for the third quarter, I want to refer you to the financial tables in our earnings press release as they provide the foundation for the numbers noted in my comments. Our reported revenues of $187.4 million and diluted earnings per share of $0.76 mark year-over-year increases of 19% and 25% respectively. Adjusting 2006 EPS for the impact of share based compensation cost and 2005 earnings per share for discreet costs associated with integration of acquisitions, the year to year growth is 36%.

To provide you with some context for how this strong performance for the quarter compared to our internal thinking, I note that implicit in the updated full year guidance we provided at the time of our second quarter call was stronger earnings performance in the third quarter versus the fourth quarter. The key drivers for this are gross margin that we anticipate to be lower in the fourth quarter versus the third quarter due to normal seasonal revenue mix. Sequential increases in spending and R&D and sales and marketing as we saw in the first three quarters. And a lower affective tax rate in the third quarter.

However, the third quarter's performance was even stronger than we had anticipated due largely to higher revenues primarily associated with orders from U.S. distributors that resulted in increases in their quarter end inventories for some of our product lines above typical levels. As we believe this ordering activity largely a timing issue and that inventories will decline somewhat in the fourth quarter to more typical levels, we correspondingly project revenues and earnings will be down in the fourth quarter from our previous thinking by the amount of this anticipated inventory adjustment.

Therefore we believe that full year 2006 guidance that we provided at the time of our second quarter call remains essentially on track. We are only making slight revisions to the revenue guidance with the latest projection of 732 to 735 million, up from 730 to $734 million previously. And earnings per share of $2.67 to $2.70 versus previous guidance of 2.64 to 2.70. Note that earnings per share includes $0.04 of discreet tax related benefits that we discussed in the second quarter.

We are also providing preliminary guidance for 2007 at this time. We project revenues of 820 to $830 million. Our year to year growth of 12 to 13%, and earnings per share of $3 to $3.12 which would be a reported growth of 11 to 17% or an adjusted growth of 13 to 19% after taking into account the $0.04 of discreet tax benefits in 2006. Let me now provide you some details on the P&L and the items just mentioned in my overview.

Revenues of 187.4 million as I mentioned grew 19% year to year on a reported basis. Currency contributed 1% to growth in the third quarter and acquisitions contributed 2%. Organic growth adjusted for these two factors with 15%. Our companion animal group with revenues of $153.1 million had the same reported and organic growth rates as the total company, 19% and 15% respectively. Looking at the companion animal group product and service categories, instruments, consumables, and related services and accessories grew 13% on a constant currency basis. Instrument revenues up $11.3 millions grew 22% on a constant currency basis. Placements were roughly on par with the second quarter and year to date placements are up approximately 15% from the same period last year.

In the third quarter, we began to sell our Idexx VetLab stations, the laboratory information management system for our suite of inclinic blood analyzers as an individual offering. This station which we have continued to upgrade with new hardware and software enhancements had previously been sold only in conjunction with our laser site hematology analyzer. Now customers who own some or all components of our Idexx VetLab suite can achieve efficiencies by running multiple instruments from a single interface, access integrated reports, and reduce errors caused by manual input.

As we enhance our inclinic laboratory suite with broader testing capability and integrated information management, we see the positive impact not only on the placement of new instruments, but also on retention of current customers and on utilization of inclinic testing all important contributors to the growth of our increasingly profitable consumables revenue. Instrument consumable sales of $43.6 million in the third quarter had a currency adjusted growth of 12% or 9% after adjusting further for year to year changes in distributor inventories. We maintain our longer term growth rate guidance of 7 to 9% for instrument consumables.

Our point of care rapid assay products with revenues of $30.2 million grew 17% when adjusted for currency and acquisition. It was this product line most significantly where we saw a relatively large impact from changes in distributor inventory levels. Growth adjusted additionally for this change was 7%. Year to date growth adjusted for currency, acquisitions, and changes in distributor inventories was 12%. A reflection of our very strong first half performance.

As we noted in our first and second quarter calls, the growth came from our canine diagnostic products, particularly our multiple analyte assays. In addition to our unit volume growth we saw the benefit of higher price realization due to conversion of customers to higher price multi-analyte test and also due to changes we made to some of our promotional programs at the beginning of the 2006 heartworm season in the fourth quarter of last year.

We are now entering the 2007 season with program structures similar to last year and so we will not see the same year-over-year price benefit from these programs. We revised upward our longer term guidance for rapid assays to 7 to 9% last quarter and we reaffirm that range. I should also mention that we launched our new 4DX canine test in the third quarter. This assay as a fourth test for another tick borne disease and early interest in this product are strong.

Just a final word regarding U.S. distributor inventory levels, across all product lines inventory levels at the end of the third quarter were just over four weeks based on forward looking demand. While this is within the three to four week range we have cited for some time now, it is at the high end of that range.

More importantly, inventories for our relatively high margin canine product line were about a week above the overall average and the strong sales were the primary contributor to our stronger than anticipated revenue and earnings performance for the quarter. While it is difficult to project precisely where inventories will end up across any given quarter, across our ten or so distribution partners, our experience over the last couple of years would lead us to believe that the overall levels will decline in ensuing quarters.

Laboratory and consulting services third quarter revenues of $47.9 million grew by 15% adjusted for both currency and acquisitions. Organic growth year to date was also in the mid teens. We saw solid double digit growth across all regions in the quarter and we remain very pleased with the performance of labs we have acquired over the last couple of years. This movement of the integration efforts and the contributions they have made to our professional services talent and test menu capabilities. We reaffirm our longer term growth projections for labs and professional services of 12 to 14%.

Our computer systems and digital radiography product line posted revenues of $10.3 million an increase of 44% year to year or 21% when adjusted for currency and the third quarter 2005 acquisition of our direct digital imaging product line. To remind, we launched our companion animal direct digital instrument model in the latter part of the second quarter. And we are pleased with the early interest it has received. For computer systems and digital radiography as well as for our Idexx VetLab suite the fourth quarter is typically the strongest quarter for placements of equipment as our customers look to take advantage of tax benefits available on capital purchases and we are seeing a strong booking of orders as we enter the fourth quarter.

Water sales of $16.6 million for the quarter were strong with an 8% growth year to year on a constant currency basis. A portion of a large order that we had anticipated receiving in the fourth quarter was placed in the third quarter contributing to the strong performance. This appears to be an issue of timing and we continue to believe that water growth over the longer term is in the low to mid single digits. Food diagnostic segment sales were $17.7 million. A year to year organic growth of 21% for the quarter.

Our production animal product line continues to exhibit very strong performance with year to year organic growth of 28% for the quarter. and 32% year to date due in large part to the performance of our livestock test kits including BSE. Our new revenue projection for full year 2006 of 732 to $735 million represents year to year reported growth of approximately 15%. And growth adjusted for acquisitions and currency of approximately 13%.

Looking at the rest of the P&L, gross margin at 52% of revenues was essentially in line with our thinking. As noted last quarter and in my opening comments, we expected some variability in gross margin between the third and fourth quarter as a result of seasonal revenue mix. More specifically the revenue mix in the fourth quarter is traditionally skewed toward relatively lower gross margin capital equipment sales. Gross margin for the fourth quarter should be approximately 51%. Which would produce a full year gross margin of about 51.5%. Operating expenses including R&D and SG&A were 34% of revenues. Also in line with our expectations.

As we have seen in the first three quarters of 2006, we are expecting another sequential increase in R&D and sales and marketing in the fourth quarter and we estimate operating expenses at 35 to 36% of revenues for the quarter. A significant portion of our investment is devoted to recruiting new talent into the organization and with each succeeding quarter we see the full impact of hires brought on during the previous quarter. Investments we are making are geared not only to new product introductions and enhancements and increased commercial capability that drive revenue growth, they are also focused on initiatives to improving quality and efficiency that will aid in driving operating margin leverage over the longer term.

The operating margin for the quarter of $34.5 million or 18% of revenues was in line with our thinking. We are expecting operating margins to decline 300 basis points or so as a percentage of revenue in the fourth quarter as a result of both a lower gross margin and increased investments in R&D and sales and marketing. For the full year, operating margin is still on track to our previous projections of 17 to 17.5% of revenues.

Just a word on taxes and interest. The effective tax rate for the quarter was 29%. This is lower than previous quarters and the dip in the rate is primarily due to a reduction in taxes previously provided as various statutes of limitations expired during the quarter. Net interest income is projected at 2.6 to $2.8 million for the year. Our revised full year EPS guidance up to 67 to 270 would produce reported growth year to year of 16 to 17% and growth of 22 to 23% when adjusted for the anticipated impact of FAS 123R in 2006, and the discreet items of acquisition integration items costs and dividend repatriation totaling $0.08 2005 and the favorability associated with tax incentives of $0.04 in 2006.

The growth reflects the very strong performance in the first half across all of our product lines and particularly of note our high margin rapid assay products and continued solid performance in the second half tempered somewhat from the first half by tougher comparison rapid assays and increases in investments in key areas of R&D and SG&A. The earnings growth in the fourth quarter implicit in our updated annual guidance is projected to be in the single digits on both the reported and adjusted basis.

As noted, this is due largely to anticipated seasonal revenue factors, some shift in the timing of revenues from the fourth quarter into the third quarter. A lower tax rate in the third quarter. And a step up in operating expenses in the fourth quarter. The guidance we have provided today for 2007 reaffirms that we are on track for low double digit top line growth and bottom line growth in the mid to upper teens.

Moving to the balance sheet in cash flow, we ended the quarter with cash and investments of $95 million. Cash provided by operations was $27 million and we used $8 million to purchase those assets. Free cash flow as defined in our earnings press release was $21 million, or 85% of net income for the third quarter. Inventories increased by about $8 million from the end of the second quarter to the end of the third quarter to $93 million with increases primarily in the areas of instrumentation related to the ramp-up for product launches and to ready for fourth quarter capital equipment sales.

Additionally, we made a larger than normal purchase of a component that is being phased out by the manufacturer in order to ensure that we have adequate supply through a product transition. We anticipate inventories will increase again in the fourth quarter to 95 to $100 million in conjunction with planned instrument consumable purchases.

For the balance of the year, we project DSO at approximately 40 days. We project full year capital expenditures at 55 to $60 million. And with the completion of our internal planning process for 2007, I will provide more detail on the components of our P&L, balance sheet, and cash flow projections at the time of our fourth quarter call.

However, with regard to capital expenditures, I advise now that we expect higher levels of spending than we have seen in years prior to 2006 and connection with the renovation and expansion of our main headquarters facility that we purchased in the second quarter. The renovation process will take place in a phased approach over a period of five years or so. The first phase of this project will provide us with expanded and enhanced R&D and manufacturing space that will among other benefits support our quality efforts and allow us to achieve operating efficiencies and cost savings in our manufacturing processes.

Now I would like to turn it over to Jon Ayers for some further comments on our business.

Thank you Merilee for a very comprehensive review of our third quarter results. If I were to sum up I would say it's a solid operating quarter that tells us hat we are on track for the full year's guidance. Which remains unchanged at the high end of 270 including the $0.04 Q2 tax benefit.

Like the first half of the year we looked to Q3 and Q4 together to eliminate the noise and factors and timing issues associated with change in distributor inventory. Our 2007 top line looks strong as reflected in our 2007 guidance offered for the first time. And implies revenue growth from the 2006 projected levels of 12 to 13%. Well, into our 10% plus long-term revenue growth guidance that we have provided for sometime. Our earnings guidance also compares solidly to our long-term outlook of mid teens earnings per share growth as Merilee has taken you through.

I'm very excited about the progress we are making in our investments in technology, new product development, and quality across the business portfolio and in particular in the companion animal segment. This progress gives me high confidence about the revenue and growth and profit growth prospects over the next several year's. We will spend about $54 million in R&D this year on new product development compared to 28 to 29 million we spent each of the first three years of the decade. And it is our R&D investment that leads to new product introductions. When you combine the growth in R&D investment with the increase in R&D productivity that we are seeing as a result of adopting a more disciplined approach to new product development and innovation, you get a sense of the sustained growth momentum we are building into the business model.

Along these lines I'd like to highlight a few of the Q3 and quarter today new product introductions before I turn it over to the Q&A. Our most significant launch of the quarter was in our rapid assay business particularly the canine SNAP test line. SNAP 4Dx, our next generation canine parasitic disease screening kit for use pet side had a flawless full launch on September 1. This test leverages the technology in 3Dx by adding another important tick borne bacterial disease called Anaplasmosis to a test that already screens for heartworm, Ehrlichia Canis, and Lyme disease. Anaplasmosis when infecting humans by the same tick is a disease called human grandulocytic anaplasmosis. Previously called human granulocytic Ehrlichiosis, or HGE.

It is a bad bug in the human and the dog. Fortunately treatable with antibiotics once properly diagnosed. We have launched SNAP 4Dx at a realized price premium to 3Dx of between 1 to $2 per test per test depending on the level of new product promotional discounts. We, of course, continue to offer SNAP 3Dx and working to convert 3Dx customers to SNAP 4Dx. New veterinary customer take up of SNAP 4Dx, mostly from accounts already using 3Dx is actually a month or two ahead of schedule even though full launch only occurred on September 1. We are very excited about 4Dx and its prospects to drive growth in the rapid assay business in the next two years.

In the instrument line in October we launched an addition to the Idexx VetLab in a way of a new small instrument for urinalysis called the Idexx VetLab UA along a urine dipstick consumable that works with this instrument. This is the first urine strip that has been customized and validated for use in the dog, the cat, or the horse. While the product launch is a small revenue contributor due to the low price points of the instrument and the reagent, it is significant to our Idexx VetLab customers because of the importance of urinalysis to the standard diagnostic workup. The Idexx VetLab is the only in-house veterinary laboratory system that can do standard urinalysis, providing several unique benefits over a manual approach. First accurate and consistent interpretation with veterinary validated reagents. Second, time technician, time savings, and productivity. And third automatic capture of urinalysis results in electronic form to add to the results printout and electronic medical record.

This electronic data capture has two other benefits. It easily adds to the electronic medical record and the database on the patient and ensures that the clinic captures the urinalysis fee revenue associated with the test. This fee, averaging $26 nationally can easily be forgotten if required to be manually entered into the practices computer system for invoicing. These key benefits provide further reason for a clinic to use Idexx's complete in-house integrative laboratory suite and adds urinalysis to the best in class diagnostic technology we provide in chemistry, hematology, electrolytes, and endocrinology. Merilee already took you through the Idexx VetLab station which provides the customer a further expansion in the flexibility and utility of the Idexx VetLab in-house laboratory suite.

Updating investors on our digital radiography business, obviously you can tell from the reported growth that we are pleased with the overall success of our line of products and customer acceptance of these products. With the launch of the high end direct digital system earlier this summer called the DR1417, we are seeing very positive customer satisfaction and excitement about the extraordinary radiographic images the system generates. The DR1470 system launch has benefited from the experience that we have as a company in launching new diagnostic systems with advanced software. And in doing so providing a high level of customer support. Just as we did with laser site a few years ago and other smaller instrument systems more recently. It is one of the key benefits of our quality focus behind our new product development process.

I talked about our outlook short, medium, and long-term along with Merilee. Our opportunities ahead of us are very exciting on many dimensions. And yet it is all about execution at Idexx and Idexx still has much work to accomplish our key strategies, generate customer satisfaction, and excitement and see the full potential of our unique and extraordinary business model. Our employees remain dedicated to that task. So with that, I will open it up for Q&A.

Thank you. [OPERATOR INSTRUCTIONS] First question comes from Ryan Daniels with William Blair. Please go ahead.

Good morning, everyone. Couple quick question on the Q4 guidance. It looks like $0.58 to $0.61. Can you give me a feel for what tax rate you are assuming in that guidance range?

Sure, Ryan. It's Merilee. As I mentioned, the -- give that the tax rate in the third quarter was below the approximately 33% that we saw in the first half of the year, I would project that we would see a recurring rate of 32 to 33% for the full year. Kind of back into the fourth quarter but it will be more similar to the rates that we had seen earlier in the year.

So it will pop back up maybe even a little above.

Yes.

How about with '07. I know you mentioned you will give more detailed guidance when you report Q4 in January or February. Can you give us a feel for the tax rate. I think we can get to the other pieces but your feel on that. Should that be similar?

Taxes are always a difficult one to project. But I would say at this point I would use the rate of approximately 33%.

Okay, great. And then can you provide a little more detail on the distributor inventories? Was it just -- did that have to do somewhat with the launch of 4Dx where people bought in bulk get that or just the momentum around the rollout that drove that up? Or did they kind of see weakness in the end market perhaps towards the end of the quarter which left them with more inventory? Or is that just something you guys see every now and then? It seems like the five weeks only a week higher but a little bit higher than we have seen in the past. Any more color on that?

Ryan, it didn't have anything to do with the end market. I think it had to do with the fact that we have 3Dx and then launched 4Dx. And they wanted to make sure they had all of their bases covered. They wanted to make sure that they didn't have any kind of inventory stock out in the 60 inventory locations that we have with distributors. I think that was the factor there.

And pretty similar across the whole network, all ten of your national distributors?

Yes, I think it was a similar dynamic.

And then anything to water group, I know you mentioned that was quite strong. We don't tend focus on that a ton. It was strong because you got an early odor. Did you guys see any benefit from the E. coli outbreaks and the need to do more disciplined water testing here in the states because of that noise.

Not really. I wish we did but it's a regulated test and it doesn't really sensitive to -- they test on sort of a standard schedule no matter what. And it's across thousands of customers. No impact from the E. coli outbreak that we know of.

Fair enough. And then I noticed you guys did a small acquisition in the quarter down in South Africa. Any real impact on the quarter from that either in integration costs or if we look forward to what we see in the integration costs or accretion from that or is that pretty small?

Ryan, that was small. There was no impact to the quarter, really. Virtually none in revenues or bottom line. And I wouldn't say that we have a material impact going forward.

Great. Then the last question, I will hop out here and get back in the queue. John, you didn't talk about the chemistry platform. I know guys have you said don't expect it before back half of '07 at the earliest. Any more milestones there? Has it moved into production? Have you made anything you can -- any developments you can share with us on that front?

Ryan, thanks for that question, you are exactly right. I would say a couple things. We are not the point where we are going to give any kind of a launch date. Our '07 revenue guidance doesn't have any revenue in there of any matter, any substance with the chemistry analyzer. We are very excited about the progress that we are making. We are going through the prototype milestones and everything associated with full manufacturer. We have got a very disciplined process. Our strategy is not to launch that until it's customer-ready.

And what I will it tell you is that this is -- this instrument along with everything else that we are doing and have already done, really, with the Idexx VetLab suite, this instrument will take in-house testing to -- put it in a completely different light than it has been historically due to the just house easy, how flexible, how accurate, how comprehensive and integrated into the practice the VetLab with a next generation chemical analyzer will be. This is going to be a very, very significant and exciting offering to our customers. And the early customer work we are doing is actually exceeding our high expectations. I do plan according to our development time frame to give more color on the launch date in the fourth quarter call.

Okay, great. Thank you.

Our next question comes from Rick Wise with Bear Stearns. Please go ahead.

Good morning, Rick.

Couple of questions. Merilee, did I miss it? Did you quantify currency impact, if any, pro or con in the quarter?

Yes, I did. And it was not--.

Not material.

Let me just grab it here for you. It was about a point in the revenue growth in the quarter.

Point positive?

Yes.

And on the bottom line, any positive impact?

No virtually none.

A wash. Going back to the distributor issue, when we try to normalize what the quarter might have been and I realize it's reasonable to think about the second half but see the EPS impact for the quarter we are coming up with something like $0.02, or $0.03, $0.04 something in that range. How would you quantify the EPS benefit or just the pull forward.

I think you're in the right neighborhood.

More toward the upper end?

Maybe in the middle there.

Look. We went from a little bit lower than the lower end to a little bit higher than the higher end of normal range in three to four weeks. And every quarter it's a little bit different. I mean, from the end of the second quarter to the end of the third quarter we had that impact.

On gross margins, you all talked about I guess the impact of depreciation or the cost drag if you will of the new facility. Can you quantify that a little more specifically and how we should think about that going forward on a quarterly basis or however you want to talk about it?

I'm not sure that's what really was the gross margin impact. I don't think there is any cost drag today at the new facility. We will continue to invest in the facility and that will use some capital in the next few years.

No particular impact on cost of goods or SG&A that was incrementally worse? Or more impactful.

You would see the impact spread across different components of the P&L. I don't think it will be a key trend driver for us in what we are seeing.

Merilee, the shares exiting the quarter, you bought -- looks like you bought a little bit more than we expected in the quarter. Where are you exiting and just update us and remind us where you stand on the whole program and what we should expect exiting the year.

Sure. On the share repurchase, you are right, we purchased about 116,000 shares in the quarter. We have remaining or we have purchased for the year now just about 1.2 million shares and then our current authorization we have about 860,000 shares that are remaining.

Great. All right. Thanks, folks.

Thanks, Rick.

Our next question comes from Lee Brown from Merrill Lynch. Please go ahead.

Good morning, how are you?

Good morning.

Quick question on the acquisitions just to break it out between the lab and consulting and the computer systems and digital radiography. I'm estimating the total impact from acquisitions on CAG was about 3.7. Does that sound about ballpark?

Let me just--.

Percent or dollars?

3.7 million, I think in the press release you said 3.9 for CAG was the incremental but it included about 1% of currency.

It's about -- it's about--.

About 3.4 million?

It's about 3% on the companion animal group.

So that is about $3.8 million. So if we were to break that 3.8 between computer systems and digital radiography and lab consulting, can you help us out there? I think you gave up 21% "X" the acquisition on digital radiography, so by my math, let's see here that worked out to about 1.6 for digital so 2.1 for lab. Does that sound about right?

Yes.

Super. Sorry for that. I just wanted to nail that down. Secondly, the water business that one of my colleagues mentioned, you guys talked about stronger volumes offset partially by some lower pricing. What is the outlook for year-over-year pricing going forward and how sustainable is the improved growth rate in water present "X" currency?

Well, as Merilee mentioned, we think it's a low to mid single digit, long term growth rate. We had the growth rate bounce around a little bit from quarter to quarter. But if you kind of -- what we expect on long-term basis, pricing itself, I would say is -- we feel pretty good, about it. It's not going to be a price grower but not a price decliner either.

So if that's the case, and you did about 6% X currency this quarter and that was with a negative--.

8% this quarter.

But you had some--?

But we had some positive.

Positive 2% currency, right?

No 8% is post currency. You are right. I'm sorry. I'm sorry. It was plus ten. I thought it was plus eight. So that even makes the argument even stronger. If you are doing plus eight and that was with negative pricing, why such a low outlook if pricing could improve?

It's flat pricing.

All right. I was wondering if that seemed a bit conservative. And then I wanted to talk about the gross margin outlook for Q4, the--?

Just on the water -- I would remind you, Lee, we had the first quarter was -- we're actually down a little bit in the water business. So it can bounce around a little bit from quarter to quarter. We are just trying to you a sense of a run rate of the business.

Yes. I know that it's been -- it really -- I think more than any of the other divisions gets pushed around by currency. But I just thought maybe, it seems like it's gaining momentum there especially with the increased volume. I do want to switch gears for the 51% target for gross margin. That is just about flat year-over-year which is a little surprising given that you guys were up year-over-year in Q3. And realize there is a different mix in Q4. But on a relative basis that shouldn't be substantially different than the mix in Q4 of last year. I'm just wondering why such a -- there is about a 90 bip bias toward conservativism from my perspective?

And the question is versus fourth quarter of last year?

Yes. You are looking for 51% in Q4 of this year, correct, and you did 50.9% last year so you are basically flat year-over-year where in Q3 of this year you did 52.4 off of of 51.5 last year, so you are basically throwing away 90 bips of underlying gross margin improvement as evidenced in Q3. I'm wondering.

Lee, the -- I think that's mix and, the products we sell through distributor are higher than the average company gross margin. Capital is typically lower than the average company gross margin. Of course, we talked about the distributor inventory and how that moves some of the Q4 sales higher margin to Q3. When you look at a quarter to quarter compare, you are going to see a lot of that noise.

And the other thing, it's small but the impact of share base compensation is also in 2006 and not in 2005. So you just -- there are so many moving parts going on that you need to break it down piece by piece.

One last question, I appreciate your time and I will get off here. Just on the unit volume growth in your instrument business within CAG, in the past you've given placement growth. Could you give a flavor for that?

Well, we haven't given placement growth in a awhile but I would just reiterate that we did see in unit placements about a 15% growth year-over-year on a year day basis.

How is pricing holding up in instruments?

Pretty stable.

Stable. Okay. Super, guys. Thank you so much.

Thanks, Lee.

[INSTRUCTIONS] Our next question comes from Ross Taylor with C.L. King. Please go ahead.

I just have a few questions. First, I missed the numbers you gave out towards the beginning of the call about the impact of the inventories on each of the different product lines. I just wondered if you could repeat those, please?

Okay. Sure. The impact on our instrument consumables was about 2% on growth year-over-year. And on rapid assays it was about a 10% impact.

Thanks. Two other questions. Regarding your 2007 guidance, I wonder if on revenues if that includes any new incremental acquisitions that might occur from this date forward?

That's a good clarifying question. We as a matter really don't include anything and that isn't already part of the Company.

Good. And last question relates to acquisitions. The acquisition you did in South Africa, what -- is there any underlying strategy there? Was that just a good opportunity? Is there any way that you can expand that business within South Africa? Any other areas in Africa that might be attractive to you?

Well, South Africa is a booming economy. This was the premier reference lab in South Africa. Fits very nicely with our European lab network. And lab management team. And also improves our overall companion animal group presence in South Africa which would benefit the instrument and the rapid assay businesses over time. So we are just -- we are very, very pleased that this high quality lab has joined the Idexx family. We are just -- it seems to be another good market to be in internationally.

Great. Thanks very much.

At this time I would like to turn the call back over to Mr. Jon Ayers for closing comments and remarks.

Thank you all. That will conclude our call. And we will be happy to be answering questions individually and looking forward to reporting our full year guidance -- company performance and giving a little bit more detail on the 2007 outlook in our January call. Thank you all.

That does conclude today's teleconference. Thank you for your participation and have a lovely day.