愛德士 (IDXX) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Idexx Laboratories fourth quarter 2008 earnings conference call. (Operator Instructions) We will now begin the conference.

Good morning, everyone, and welcome to the Idexx Laboratories fourth quarter 2008 earnings conference call. Just a reminder, today's conference is being recorded. Participating in the call this morning are Jon Ayers, Chief Executive Officer; Merilee Raines, Chief Financial Officer; and Susan Astro, Director, Investor Relations. Idexx would like to preface the discussion today with the cautionary guiding forward-looking statements. Listeners are reminded that statements that members of Idexx management may make on this call regarding management's future expectations and plans and Idexx's future prospects constitute forward-looking statements for purposes of the 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 Idexx's quarterly report on Form 10-Q for the quarter ended September 30, 2008 and Form 10-K for the year ended December 31, 2007 in the section captioned Risk Factors, which are on file with the SEC and also available on Idexx's website, Idexx.com. In addition, any forward-looking statements represent Idexx's estimates only as of today and should not be relied upon as representing the Company's estimates as of any subsequent date. The Company disclaims any obligation to update or revise any forward-looking statements in the future, even if it's estimates or expectations change. At this time, I would like to turn the conference over to Merilee Raines. Please go ahead.

Thank you, Bonnie. Good morning, and thank you for joining us today. In our press release this morning, we reported fourth quarter revenue of $243 million and diluted earnings per share of $0.39. As anticipated at the time of our last earnings call, we completed the sale of certain of our pharmaceutical product lines in the fourth quarter and the transaction and related restructuring costs, reduced earnings per share by $0.06. As we had indicated at the end of October, the updated 2008 EPS guidance we gave at that time was exclusive of this discreet item. Fourth quarter EPS of $0.44 as adjusted for this transaction grew 10% year-to-year. Full year earnings per share adjusted for discreet items were $1.90, an increase of 20% over 2007 earnings of $1.58, as similarly adjusted for discreet items. Please refer to the table and our earnings press release for full detail on the discreet items in both years. Adjusted earnings were a $0.01 above the high end of the guidance we gave in the third quarter call, as the impact of slightly lower than anticipated revenues was more than offset by careful control of operating expenses.

Before I further discuss operating results, I would like to briefly discuss our pharmaceutical transaction. The financial details of the product line divestiture have been highlighted in our press release. The net loss of $3.6 million, or $0.06 a share consists of two components. The first is a pre-tax loss of $1.5 million that is inclusive of all transaction-related fees, severance, and restructuring costs. The second is a tax provision of $2.1 million, which results from the tax basis of the divested assets being less than the book basis and consequently, producing a taxable gain. Although the impact to earnings from these transactions is negative. From a cash perspective, the transaction yields $9.7 million, a positive cash flow, consisting of the net proceeds of $5.5 million and the realization of a tax deduction of approximately $4.2 million for the disposition of the [Nitous Oxinide] inventory we wrote off for book purposes in 2007.

There is also the possibility for future cash flows from this transaction if and when the feline insulin product currently in the regulatory approval process becomes commercialized. Additionally, as previously announced, we entered into an agreement with a top tier animal pharmaceutical company to out-license one of our promising pipeline products. We received a $250,000 payment at the time of signing in the fourth quarter, and the agreement provides for development milestone payments and revenue-based royalty payments once the product is commercialized. We do not anticipate any follow-on payments from either the insulin product or the out-license agreement to be significant in 2009.

Now on to fourth quarter operating results. Fourth quarter revenues grew organically 6.5% after adjusting for currency and the divestiture and discontinuance of pharmaceutical products. This growth of 6.5% compares to 10% for the third quarter and 11% for the first half. The third quarter growth just cited is normalized for the acceleration of PZI VET insulin product sales from the second half of 2008 into the second quarter. The first half growth is further normalized for the impact of the pet food recall that occurred in the first half of 2007.

Isolating the impact of the economy on our revenues is not a precise science, and it varies by product and service category and geography. As we have noted in past quarters, the products and services most impacted by the recession are those in our Companion Animal Group related to routine wellness testing and more discretionary treatments. These would be our instrument consumables, lab services, and to a lesser extent, infectious distress rapid assays. The geographies most impacted are North America and Europe. We have attempted to estimate the recession impact by isolating all other known factors influencing growth and triangulating that information with what we can discern about what is happening with activity in vet clinics, based upon aggregate data we are able to obtain from our customers who utilize our practice management software, external surveys, and information we hear from the field. We estimate the economic situation slowed the growth for the Company overall by 3% to 4%, as compared to approximately 2% in the third quarter. I will speak more about this in a moment.

Sales of instruments and our Idexx VetLab suite were solid in the fourth quarter. At $23 million, they grew organically 26% over a strong fourth quarter last year. We placed just over 500 Catalysts, bringing the install base to 750, and we entered the first quarter of 2009 with over 200 orders in hand. SNAPshot Dx placements also ramped, and the install base is just over 800. Our controlled launch at Catalyst is progressing well, and the placements in the fourth quarter more than doubled those of the third quarter. Given this performance, we feel we are on track to place about 2000 instruments in 2009.

As we have stated since the launch began, our first priority is to have satisfied customers, and so we will continue to control our placements in early 2009 to ensure that we are providing the after-sale support that our customers expect and value. Accordingly, we expect to place about 300 instruments in the first quarter, and placements will ramp over the course of the year. We continue to see demand for both Catalyst and SNAPshot Dx to be very strong, and the goal for us is to improve the scalability of the manufacturing process and reduce costs.

As mentioned, the economy has impacted recurring revenue streams from instrument consumables, laboratory services, and rapid assays, to a somewhat greater extent in the fourth quarter than the third quarter. In combination with lower pet visits into clinics, we are observing from purchasing patterns that some clinics are also reducing levels of supplies on-hand in order to improve cash flow. This supply reduction effect is relevant to our instrument consumable and rapid assay product lines. We estimate that the fourth quarter economic impact was 5% to 6% overall across these three product and service lines in North America and Europe, as compared to approximately 3% in the third quarter. As these revenues account for approximately 60% of total Company revenues, this is how we derive the 3% to 4% negative impact of the economy on total Company growth.

Instrument consumable sales of $50.5 million grew organically 1% in the fourth quarter. To remind investors, in the fourth quarter of last year, we had a change in distribution in Japan for instrument consumables and rapid assays. And the resulting initial stocking order, in conjunction with year-to-year changes in US distributor inventory levels, negatively impacted instrument consumable growth by 2 points. So, growth normalized for changes in distributor inventories was 3% in the fourth quarter as compared to a similarly adjusted growth number of 9% for the third quarter. Our rapid assay sales of $30.2 million were down organically 2% year to year, but up 5% when further adjusted for the fourth quarter 2007 Japan stocking order and year-to-year changes in US distributor inventories. This 5% compares to 14% in Q3 and 12% for the first half, as those periods' organic growth rates are also normalized for distributor inventory changes.

In addition to the economy, our rapid assay product line growth is also being negatively impacted by a couple of pricing dynamics. The first being a slowing in the rate of conversion from canine heartworm-only testing to our multi-parasite disease panels as we further penetrate the relevant market. 3Dx and 4Dx test panels now account for 70% of the testing volume. In addition, we are seeing relatively higher growth from larger multi-practice accounts and shelters, who receive more favorable volume-based pricing and lapping of price increases in certain customer segments.

We achieved the full commercial launch in December of our Feline Triple test, which includes a heartworm analyte in addition to FELV and FIV. The early interest is strong, as it supports best medical practice, cited by key opinion leaders to screen cats for heartworm infection and also provides a new source of revenue to practices. We also received USDA approval for this month for our SNAP Feline Combo test to be read on SNAPshot Dx. SNAP Feline Combo and our canine pancreatitis test will both be available on SNAPshot Dx in the fourth quarter. We have other tests in the regulatory process and expect 4Dx as the next approval in the first half.

US distributor inventory levels for instrument consumables and rapid assays average just over four weeks at the end of the quarter based on forward-looking demand. Our laboratory and consulting services with revenues of $65.3 million had organic growth of 8% as compared to 10% in the third quarter. Though this business does appear to experience the similar trends in economic impact on same-store testing volumes as we see in our in-clinic test products, there is no clinic supply reduction impact on the service business. Additionally, we are seeing reflected in the growth rate the benefits of our efforts to continually enhance service levels, expand our proprietary test offering, and integrate our lab offering with our in-house tests and practice information management systems.

Our practice information management and digital radiography system with fourth quarter revenues of $18.9 million, grew 15% organically. As noted in the third quarter, we entered the fourth quarter with a healthy backlog and with continued strong demand, particularly in the US, we also entered the first quarter with a meaningful order book. As we have noted, our development efforts over the past few years in the areas of connectivity and information management are being appreciated by our customers now more than ever as they look to increase practice efficiency and ensure that they capture the revenue for all the services they perform. Our practice management systems and digital product lines are prominent components of the movement to more efficient, paperless practices.

Production analyst service sales of $20.3 million had a 2% decline in organic growth in the fourth quarter, similar to what we experienced in the third quarter. In addition to the impact that the price erosion in BSE testing has had on this business in 2008, we also believe there is a modest impact on the business from the global economic slowdown, as governments in some instances delay or redirect to other programs funding for surveillance testing and disease eradication. To remind you, we anticipate a further decline in BSE test sales in 2009 of approximately $6 million due primarily to a change in European regulations to raise the mandatory testing age of cattle to 48 months from 30 months. Our water business had another strong quarter with revenues of $17.2 million and organic growth of 7%. The collaboration with Invitrogen, which added six points to growth over the first three quarters of 2008, anniversaried in the third quarter. And this is the reason for the stepdown in growth rates from previous quarters. This business does not appear to be impacted to any real degree by the economy, and we see continued growth opportunity, primarily from further geographic expansion.

Looking at the rest of the P&L, gross margin at 49.5% was on par with our thinking. Operating expenses at 34.2% of revenue were about one point below our expectations. This is reflective of our continued vigilance to control spending in these times of slower top line growth. The organization has done a great job in this regard throughout 2008, and we are prepared to continue these efforts in 2009. Our fourth quarter tax rate of 33% was impacted favorably by the recording of the full year federal R&D credit and negatively impacted by the gain on the pharma product sales. The full year effective rate, net of the first quarter discreet items and the pharma sale was 31%, right in line with our thinking.

As for the balance sheet and cash flow, we ended the year with $79 million of cash and $151 million of debt for a net debt position of $72 million. Our free cash flow was $9 million for the quarter, and full year free cash flow of $60 million was 50% of net income as adjusted to exclude the pharma product sales. In looking forward to this year, we now project revenues of $1.02 billion to $1.04 billion. This is down from the first guidance we gave back in October of $1.05 billion to $1.07 billion, due in part to additional unfavorable impact of currency and more significantly due to greater caution about the impact of the economy on growth rates, given what we have experienced in the fourth quarter. This range would reflect reported growth that is flat to 2% and organic growth of 7% to 9%, as we adjust for the 5% anticipated negative impact of currency year-to-year and the 2% negative impact of the divested pharmaceutical products. This compares to the 6.5% organic growth we experienced in the fourth quarter.

Catalyst and SNAPshot Dx are anticipated to contribute roughly 2% to growth. We expect reported growth rates to ramp gradually in the second half, and we will see low single digit declines in revenues year-to-year in the first half. As a reminder, PZI Vet sales in the first half of 2008 exacerbate the reported growth profile for 2009.

We expect the full year gross margin to be about on par with that achieved in 2008. This is the net result of a revenue mix shift toward relatively lower margin instruments, offset by productivity improvements in our lab operations, and instrument and kit manufacturing. Margins are expected to be highest in the second quarter as in previous years, given the somewhat seasonal revenue profiles of the rapid assay business. Our production learning curve for Catalyst will continue to be an important factor in our ability to achieve our anticipated gross margin performance over the year.

Operating expenses should average out to 35% to 36% of revenues for the full year, translating to a full year operating margin of approximately 16% of revenues. We expect the first quarter margin to be lowest at approximately 13.5%, due to the timing of commercial activities such as trade shows. As indicated at the time of our third quarter call, we are not expecting margin expansion in 2009 from 2008, given the increased prominence of our new instrument offerings in our 2009 financial profile. We view them as near-term investments in our longer term strategy to ensure a profitable proprietary consumable stream and to increase our market share, not only for in-clinic instrumentation, but also for other offerings in our companion animal portfolio.

While we are committed to making the appropriate investments to support Catalyst and other new product and service offerings, we are at the same time committed to continuing our close monitoring and control of expenses to achieve our earnings objectives. We have demonstrated our discipline to do this in 2008. We expect the tax rate to be approximately 31% for the full year. Net interest expense to be $2 million to $2.5 million, and the full year share count to decline approximately 3% from the full year 2008 level. All of this leads us to modestly tighten our full year EPS projections to $1.84 to $1.90 from the previous range of $1.82 to $1.92 that we cited in October.

Before I mention the balance sheet and cash flow, I would like to update on currency. Our primary currency exposures are in the Euro, the Pound, and the Canadian Dollar. Our guidance given today assumes the Euro at $1.30, the Pound at $1.40, and the Canadian Dollar at $0.80. We did complete an additional round of financial hedges in the fourth quarter while still being cautious with our purchases for the second half of 2009 so that we would not risk overhedging our exposure. Our revised sensitivity is every 1% strengthening of the US dollar vis-a-vis our basket of currencies yields approximately $4 million of lower revenues and approximately $750,000 of lower operating profit on an annual basis.

As for the balance sheet, we project DSO to remain at approximately 40 days, inventories to trend down from $115 million to $110 million, and capital expenditures to be approximately $55 million, down from $89 million in 2008. We project free cash flow to be approximately 100% of net income. Now on to Jon for further comments on the business.

Thank you, Merilee, for the overview and supporting detail of our financial and business results for the quarter and the year. Given the very challenging economic environment that the world faced in Q4 and the consequent pressures on our customers, I'm very satisfied with these results -- both on the top line and the bottom line. Idexx continues to respond effectively to market conditions with the appropriate focus on cost, efficiency, and execution against objectives. I am also pleased that the pharmaceutical divestiture and out-licensing deals were completed in the fourth quarter in a timely fashion, which allows us to focus on our core diagnostics and information technology strategies. I would like to note that with the reporting of the 2008 fourth quarter and full year revenues, we can confirm that our 11% annual revenue growth propelled us over the $1 billion threshold.

The $1 billion mark was a Company goal established a little over three years ago when we developed a strategic plan we called the Blueprint to a Billion. Since that time, we built out this blueprint by investing in and growing our core businesses, and by making a few selected acquisitions that strengthen this core. I would like to take this opportunity to congratulate the employees of Idexx on the hard work, innovation, and customer focus that achieved this accomplishment. Our Blueprint to a Billion called in part for investment in new product and service innovation that brings value to our customers. And as a result of the sustained level of investment over several years, we continue to introduce new offerings. For example, in a large trade show for the North American veterinary market held just last week, we introduce several new products and services and highlighted others that were launched in the fourth quarter for over -- for a total of over a dozen announcements.

Let me update you on a few. Catalyst Dx, our next generation chemistry analyzer that is the flagship of our point-of-care laboratory instrument suite, has added new menu capability, including electrolytes and automated urine protein analysis, while also adding automated dilution capability. In the fourth quarter, we placed over 500 Catalyst units with customers, while building the backlog for Q1 of over 200 units. As with any major instrument launch, we continue to keep a close eye on ensuring a great customer experience, and thus will continue a controlled launch phase into the first half of 2009 by constraining placements in order to ensure a high level of customer satisfaction.

Customers especially appreciate the higher throughput and efficiency of Catalyst Dx. For example, four patients can be run through the system with a pre-anesthetic protocol in just 16 minutes. And in just eight minutes, a technician can run a complete chemistry panel of 22 parameters with less hands-on time than it would take to prepare that bloodwork to send to the outside lab. This throughput, ease of use, and comprehensive menu capability is unmatched by any other benchtop analyzer.

We also made important progress with SNAPshot Dx, the other analyzer that we introduced in parallel to Catalyst. By announcing that we will be adding two SNAP test kits to the capability of the instrument in the next few months as mentioned by Merilee. By adding SNAP capability to SNAPshot Dx, we are bringing the electronic medical record to the traditionally manually read test kit segment. This capability creates further synergies between two significant Idexx lines of business, our ubiquitous SNAP family of test kits and instruments, allowing us a tremendous cross-selling opportunity.

Speaking of SNAP, we also introduced the full launch of Feline Triple, the next generation in feline disease testing, by adding heartworm to our highly popular SNAP Feline Combo. Feline heartworm has received broad recognition by the profession in the last year. In addition, some of the large animal health pharmaceutical companies have been educating the profession on the importance of feline heartworm prevention. Early customer response to Feline Triple has been greater than we anticipated, and the demand has outpaced our manufacturing capabilities. Our Idexx sales force and third party distributors in the US, who together encompass over 800 reps in the field, are very excited about having a next generation feline SNAP to sell. One which could have higher volume screening applications with practices who are located in heartworm endemic areas. And our customers are excited to have a new reason, feline heartworm testing, to encourage their feline pet owners to come in for their annual exams, thus bolstering cat visits in this economy. We will see where it all goes and any new idea takes time to spread across a veterinarian community, as we all know. But early feedback is very, very positive.

In the labs business, we are introducing yet another new and proprietary test offering, a cardiac marker for both dogs and cats. Cardiac disease is a big topic in veterinary medicine, just as it is in human medicine. Although the specific pathologies are a bit different in both the canine and feline species. This test offering was featured early this year on Good Morning America, as one of the Top Five new pet products of the year, and it was only one of two medical products. Both the veterinarian and the pet owner appreciate a simple blood test to help rule in or rule out cardiac disease. In fact, this test can save a pet owner from significant veterinary bills with more expensive procedures, such as echocardiograph, which could be avoided in the case of the dog if cardiac disease can be ruled out early on. We expect this test, called Cardio PetPro [BMP], to begin to be offered in a convenient form throughout our North American lab network starting in March and in our other international labs in the ensuing months. Cardio PetPro [BMP] adds to our menu of next generation diagnostics offered exclusively by Idexx reference labs.

As investors know, we have built a strategy over the last couple of years of enabling our customers to more easily transition to electronic medical records, a big topic recently in human medicine. Some refer to this as the paperless practice, or at least a paper-light approach. By automating the information transfer between the software that runs the practice and our diagnostic solutions, including both the in-house and the reference lab, as well as digital radiography, we increase technician productivity and satisfaction, enable a consolidated electronic medical record for each patient, and importantly, ensure that no fees are lost from services provided. We call this two-way information communication Smart Link, and in the current economic environment, when practices are facing slow or no growth or even revenue declines in some cases, many customers have become more interested in our Smart Link solutions. All of our Companion Animal Group offering is now Smart Linked, if you will, which provides opportunity for cross-selling and even total solution selling. In fact, we can create the market demand by showing the customer the medical productivity and economic benefit that come from an investment in Idexx. By way of example, we believe it is one of the factors behind our success in the digital radiography business in the fourth quarter, where we had an outstanding performance in placements and orders. We thus seem to have developed a timely solution that is particularly attractive in these economic times. Indeed, anecdotal evidence suggests that customer who is use our Cornerstone software and other elements of the Idexx integrated practice, such as Smart Link, are on average holding up better in this economy.

Idexx serves some markets unaffected by the economy. Our water microbiology test kit business, which generated 18% of our operating profit in 2008, continues its track record of 5% to 7% core organic revenue growth. By continuing its strategy of bringing its technology to markets around the world and gaining regulatory approvals. Most recently, we were excited to introduce a special version of our Colilert product line in China, and initial sales have been very encouraging.

Moving on to staffing, I was delighted to announce in December the addition of a new executive to the management team. Bill Brown, with 25 years of experience at Abbott Diagnostics, most recently as the head of R&D in that division, has joined Idexx as the officer supporting our instrument business and as the eventual successor to our Chief Scientific Officer, Bill Brown, in 2010. Please join me in -- Bill Wallen, sorry, in 2010. Please join me in welcoming Bill Brown.

There is no question that our major in-market veterinary healthcare for the family pet is challenged by the global recession, particularly as the recession impacts the consumer and the pet owner. We're further challenged by the strength of the dollar, as Merilee has enumerated. This will likely make for a very low growth outlook for Idexx in 2009. At the same time, at Idexx, like most companies in the current environment, we remain vigilant in controlling operating expenses, a goal embraced and supported across our entire organization. On the other hand, our strategy of innovation and a focus on solutions for the customer such as Catalyst Dx, SNAPshot Dx, digital radiography, Smart Link solutions, and new test introductions such as Feline Triple, Cardio PetPro [BMP] and Chinese Colilert will help us achieve our organic growth targets. At this point, Cynthia, I would like to open it up to questions for Merilee and myself.

Thank you. (Operator Instructions) We'll first go to the line of David Clair from Piper Jaffray. Please go ahead.

Good morning.

Good morning.

Just a quick question on guidance? You grew 6.5% organically this quarter. You are guiding for 7% to 9% in fiscal '09. Just -- if you can walk us through there. It seems like the economy continues to be a drag here, and just curious how you're getting to the 7% to 9%?

David, I think that really we are just trying to -- we're not -- nobody can really predict where the economy is going to go. And so all that we can do is really with our projections is presume that what we saw in the fourth quarter continues into 2009. So we looked at that as being the impact of the economy and then, as Jon and I both mentioned, we do have some growth that's coming from new products. Our instrument launches will contribute a couple percent to the organic growth next year and so, we just looked at everything all in the mix, economy. And then factoring, growth of -- and contribution from new products as delivering the 7% to 9%.

Okay, and you hit on this in the commentary, but can you give us any clarity on pricing and volume impacts on the consumables and the rapid assay businesses? I mean was -- if you can just kind of split the impact on each of those.

You mean the impact in Q4?

Yes.

Well, in comparison to what? To prior periods?

Well, year-over-year. I mean was pricing up 2% and volume down 2%? How -- ?

In rapid assay in particular, looking year-over-year in the quarter, pricing was a little bit under 2%, and the rest was volume. And this is on the growth of 5% that's adjusted for distributor inventories.

Okay.

So pricing a little bit under 2%, and then volume therefore a bit above 3% or closer to 4%, for the total of 5%.

Okay, great. And then any -- well, I think that's it for me. Thank you.

Thank you.

Thank you. And our next question comes from Ryan Daniels from William Blair. Please go ahead.

Yes. Good morning, John and Merilee. A couple more detailed questions on the outlook. If we think of the share repurchases, I know you guys have been averaging about 3% for the last, I don't know, three to five years. It sounds like you expect that again. Have you considered taking that up, given where the stock i,s and given the fact that your free cash flow should be so strong next year? Is that an option that we might see that tick up a little bit, or maybe provide a little cushion to the bottom line as the year goes on? Any thoughts there?

Ryan, I can -- I think that's our base assumption that we gave you. We continue to be very excited about Idexx's longer term outlook. We think at the current price, the share is an attractive investment opportunity for us. We're going to have strong free cash flow. In this environment, we're going to be balancing share repurchase against other things that we could do with that cash flow, but we do feel very good about an investment in Idexx's stock at this point.

Okay. That's helpful color. Then if we think of the R&D, I know that's run about 7% historically, maybe at $70 million plus or minus run rate. Does that change at all with the divestiture of the pharma business? I don't know what type of R&D spend was related to that? But I'm curious looking out to '09, '10 what we might see on the R&D front?

It is somewhat impacted by the divestiture of the pharma business, but we had been keeping very controlled investment in R&D there and limiting to products that were very near-term. So, I think that we might see -- basically the percentage will hover around 7%. It might be a little bit less than that as a percent of revenues for this year.

Okay, and then you mentioned last quarter specifically about $3 million in pharma sales for '09. Is that still a good metric to be thinking about? I know Navigator, you're not producing anymore. Does that change your assumptions on the pharma side?

The revenues for 2009 will be slightly less than $3 million.

And while they were part of the pharma segment, they are basically some licensing fees and actually an equine diagnostic that just happened to be in the pharma group because of the equine pharmaceuticals.

Okay

From a strategy point of view, it is -- our focus is on diagnostic technology and information technology. And so that $3 million, a little bit less than $3 million is more of a vestige of some other things.

Sure, sure. That's helpful. There's been a little bit of noise, obviously some new competition in the rapid assay market and based on all our channel checks it, sounds like really to compete with some of your 3Dx, 4Dx. That Lyme Disease is pretty critical to have a multi-analyte test. And I was wondering if you could talk a little bit about your patent production around that? Is that something you guys are pretty comfortable with that's going to be hard to replicate? Or just any color you have there I think would be helpful.

Thank you for that question, Ryan. Our 3Dx and 4Dx, you know, of course test for several tick-borne diseases. The one that investors understand most is Lyme Disease, but there are a couple of other tick-borne diseases, ehrlichiosis and anaplasmosis that are also treacherous diseases to test for. We have intellectual -- a variety of intellectual property positions against 3Dx and 4Dx. Some of them are associated with the platform. The ability to do multi-analyte on the same platform. The ability to -- our SNAP bi-directional [aliza] on a test kit is patented. I think what you're also referring to is the technology that we used for Lyme Disease, which is the gold standard in both human and animal -- companion animal Lyme Disease testing. It's called C6 technology. I don't want to get too technical here, but it's actually very difficult to test for Lyme Disease because it doesn't really -- Lyme Disease itself doesn't float around in the blood. It migrates to the tissues. And so what you can only test for is antibodies, and that is much trickier. And our C6 is a very clever technology. That technology, we licensed of course exclusively worldwide for the life of the patent that goes through 2019.

2019, okay, great. And then last question and I'll jump off here. I know to-date, you guys have really just been putting Catalyst and I think SNAPshot too with existing customers. You purposely have not gone after market share shifts. Can we, looking into 2009, expect that to be part of the strategy, too? Obviously, the curiosity here stems because of the consumable sales are probably incrementally better when you upgrade to Catalyst but would be markedly better if you're actually changing shares. I don't know if you want to provide color there, but anything would be helpful. Thanks.

Yes, Ryan, we have been taking care of friends and family as we call it, our existing customers with Catalyst so far through the launch, the vast majority of the Catalyst that we have placed are with existing VetLab customers who had the VetTests and upgraded. They have been waiting for a high throughput ease-of-use platform such as Catalyst, and we felt it important to take care of the customers. We're going to continue with that strategy through probably good part of the first half of this year. But, Catalyst is an extraordinarily efficient instrument for any high volume practice, and when we're talking about high volume here, let's not -- let's understand what that means. That means -- could be five, ten, fifteen tests a day. That would be very high volume in a veterinary practice. But that's good business. And so, I think Catalyst will be a very attractive option, whether it happens to be an Idexx customer or somebody who is not currently using Idexx equipment. And so, we're going to be migrating, as the year progresses, to target the segment that is most appropriate for Catalyst and will be moving beyond the friends and family. As we get into the second quarter, and of course, more into the second half of the year.

Okay, great. Thanks.

Thank you. Next, we will go to the line of Jonathan Block from Suntrust Robinson. Please go ahead.

Thanks, and good morning, guys.

Good morning.

First question, Jon, just the gross margins for both the water and the PAS business were up very nicely year-over-year. And so, a two-part question. One, what drove that? Then two, how should we view the mature margins in both of those businesses?

Jon, It's Merilee, I'll take that one. Actually both of those businesses, because they have a high percentage of international revenues, actually benefited quite nicely from our hedging practices. So, they had gains related to the financial hedges that we put in. And, we also have seen for some of the areas, that there's been a little bit of a favorable price mix that's been going on.

And we also have a -- some licensing fees in the water business that are falling away.

Okay, so Merilee, is there a way to just try to quantify approximately what you think the hedges may have added on the bottom line?

I -- Jon, I wouldn't have that for you.

For instance, as you look over the course of 2008, we had obviously very favorable currency environment for half, a little more than half the year, and then the hedges wouldn't have played a factor there. They were just to the extent that those businesses benefit from volume that's manufactured in the US and exported, which is basically all the water international business and a portion of the PAS international business, then--

Well, and another thing to think about, just looking at year-over-year comparisons, we also last year in the PAS business had done an acquisition in Europe, and so there were some of the integration fees were reflected in gross margin percentage. So, there are just a number of factors that are going on there.

Those are generally very, very good gross margin and operating margin businesses for us.

Okay, okay, great. And then maybe just to move on, you know, thoughts on the Catalyst, I think it was previously thought the controlled launch would last through the end of the year, and then it was sort of gloves-off scenario. That seems to be maybe pushed back a little bit. Jon, when do you think you're going to go after those market share gains, if you would, sort of a question asked a little differently than Ryan. If you could just address the deal with, I believe it was Iris International? What does that give you guys that you didn't have before, and does that alleviate any of the quality control issues?

Yes, thank you. Let me address the second question first because it's relatively easy. That was -- we have a long-standing relationship with Iris, and really what that deal allowed us to do was to move to a high volume manufacturer of consumables to support the volume growth that we would anticipate. What they helped us design was the whole blood separator, which is the little plastic piece that you put the blood in and allows you to run whole blood on Catalyst. And so we're moving that from them as a manufacturer to a supplier with high volume medical plastic manufacturing as their core competency. So, it's a pretty straightforward evolution of the supply base, and we continue to enjoy a very good relationship with Iris. They make the centrifuges and an important centrifuge component for Catalyst Dx. More generally, we are very excited by having now launched some of the remaining capability for Catalyst. As I mentioned in my opening remarks with electrolytes, which gives the ability to do a full chem 22 panel in eight minutes. And also, some important ease of use features, some automated dilution and , automated, something we call urine protein creatinine ratio, made it far easier to now analyze urine on the analyzer. And so, as we've launched these, and as we've taken care of friends and family, which we continue to need to do in the first quarter. We're going to be opening it up to competitive -- what we call competitive or Idexx places, starting a little bit in the second quarter. And certainly more as the year progresses, and those are factored into our plans and our

Okay, and then just moving on to your guidance. It seems like you got a little bit more conservative on the organic growth. But just curious, implicit in the guidance, Jon and Merilee, are there any assumptions about share losses in your rapid assay market? You've got a new competitor there. You've got 90% of this market. Within your '09, do you assume that you exit -- begin and exit at 90% share?

I think it's important to state that we feel we have a really strong position in the rapid assay business strategically. A vast majority of our products are protected by a variety of patents or even in both the platform and the re-agents. The area that has traditionally not been the case, and there's nothing new about that, is the straight heartworm-only testing segment. That's been an open field since the middle to late '90s, and there have been lateral flow competitors in that segment since that time. What we have been doing has been migrating heartworm-only testing to 3Dx and 4Dx as people appreciated the importance of parasitic disease screening. But, we've always competed in that segment. It's now a relatively small portion of our rapid assay business. And obviously becoming smaller as we continue that migration. But even then, we think we have a superior platform. A product that with third party clinical data has higher sensitivity and specificity, a strong sales and distribution network. And as we put that on SNAPshot Dx and integrate that into the instrument suite, these are I think additional values that we're going to be bringing to our rapid assay business. Now, having said all of that, more because of the economy, we have a very conservative assumption for rapid assay revenues built into our 2009 guidance, just because of -- it's kind of the trends that we've seen in the fourth quarter.

Okay, and just last one and then I'll just jump back in the queue. Past two or three quarters revenue has decelerated. Again, you're pointing to 7% to 9%. I think what you had in '08, and I think I'm correct here, you had a little tail wind, maybe 200 bps from a couple big lab wins that you'll lap in '09. So, Jon, is it safe to say, again, implicit in this guidance, you do think that we shake out of this thing in the back half of the year? Is that sort of the general thoughts on how you get to that 7% to 9%?

Well, we're kind of assuming status quo. That's, if things improve. That would be good. If things deteriorate, that would not be good. We're assuming status quo. Now what happens, of course, is as you get to the fourth quarter, you anniversary the recession. So, your comps become easier in the fourth quarter of 2009. But, I think what we're seeing with our 7% to 9% organic growth is that we feel very good about the markets we're going to create with our new product introductions. Catalyst Dx -- we have a very, very strong digital radiography offering and digital radiography is an area of investment by our customers that saves them money and gives them higher productivity and gives them higher revenue capture. We're right at the most attractive point for substitution from film to digital, and that trend, as is demonstrated in fourth quarter, seems to be a strong enough trend because of its economic impacts, not to be effected by the economy. Just in those two categories, Catalyst and digital, that's going to generate close to half of our -- if you take 7% of the number, it would be close to half of 7% of organic growth alone. So, you take the rest of the assumptions there are pretty conservative. The other thing I would say is, we reported the 6.5% organic growth in the fourth quarter. We do that consistently throughout, but if you listened to Merilee's comments, you know, we don't make an adjustment for changes in distributor inventories. But we felt very good about the quality of that underlying organic growth at 6.5% in the fourth quarter, which gives us confidence with regard to our trends into 2009.

Okay, great. Thanks so much, guys.

Thank you. And next, we will go to the line of Ross Taylor with CL King. Please go ahead.

Hi. I might start by continuing that same thought on distributor inventories. I think Merilee maybe answered this question with some of the numbers she gave, but if you exclude the distributor in Japan, can you estimate how much inventory reduction on the part of distributors and maybe also the vets reduced your instrument consumable growth and rapid assay growth in the quarter?

Well, I gave -- the numbers that I gave included the distributor impact from both Japan and the US so they were all-in numbers. So, for instrument consumables, it was a 2% impact to growth, and on rapid assays, it was a 7% impact from those two categories on growth.

Okay, and--

And then with regard to what happened inside the practices, this is really -- we, of course, don't measure inventory inside the practices. I wish we could. One of the problems, reason why we don't is because the practices themselves don't measure their inventory inside their practices very well, or at all. They consider it supplies, not inventories. When they bought it, they spent the money. Then, they don't think about it when they have used it. The economic concept of inventory is not something they think about. However, as we look at the ordering patterns in the fourth quarter, and we compare them to the ordering patterns of the prior fourth quarter, we noticed a little bit tick-up in the frequency and a little bit tick-down in the size for order. And so, one could speculate that that might have had a small impact, 1%, maybe 2% impact on the growth rate. That they were buying less than they were selling -- that they were using in comparison to the compare quarter of 2007.

Okay. That's helpful. I'm sure that it varies very dramatically by product line, but what would you consider to be a normalized kind of day sales inventory that a distributor and a vet might have in their clinic?

Well, distributors, typically it's three to four weeks. It's been that way for us. That's US. Outside the US might be a little bit more or less. It depends on the distributor. Boy, inside the clinic, it's probably also weeks. I would say, that would be our guess. It would be weeks, not months.

Okay, all right. And just maybe two other questions -- .

And as you say, it varies by product line, too.

Right.

Sometimes, they buy up for the season on parasitic disease screening, for example, and with instrument consumables, it's probably more steady state.

Okay. And just maybe two other questions, but can you all make any estimates as to what might actually be happening at the average clinic level in terms of revenues? Average practice. Do you think their revenues are up, down, flat? Can you make any estimates there?

That's a great question, and we've -- we get reports from our customers, our big customers, our little customers. We also are able to analyze some data -- some sample data -- that comes from our Cornerstone customers and as part of service that we provide them to help them understand what their business is doing. And, as we put all this together it looks like the clinic growth, if you will, in the fourth quarter and the US was somewhere between 0% and 1% or 2%. But, that's very anecdotal. That is not, -- we try to triangulate this three or four ways, and unfortunately the data's just not -- there's no way to get this in a way it would give you a lot of confidence around those numbers. But, it's a ballpark.

Okay. That's actually helpful. And maybe the water business is sometimes hard for -- at least me to analyze, but the Colilert product in China? Do you think that has much potential to accelerate your organic growth within that business?

I think it will allow us to continue our organic growth in that business. We've talked about a 5% to 7% organic growth, and that organic growth really comes from, as we introduce the product into new geographies, we get new approvals and we get take-up in those geographies over time. And China is one of those geographies that we had not yet really penetrated until relatively recently. We were delighted to be the technology that was used in the Beijing Olympics for the potable water in the Village, and I think that gave us some visibility inside the country. And, what we've introduced in there is not too sophisticated, but it's actually -- it's a very similar product. But, it's all in Chinese so they can understand it and use a little bit different marketing and distribution approach, and that seems to be very effective early returns.

Okay, and last question. I want to make sure I understood something that I think Merilee said, but did you mention that the Feline Combo test can now be performed on Catalyst, or was that read by SNAPshot?

It's -- if I said Catalyst, I meant SNAPshot Dx.

Alright.

And that got approval in this month, in January. And so, we expect then it will be out on the market in the second quarter.

As we introduce the software and SNAPshot Dx. So, two products. SNAP CPL, which is the pancreatitis test that we use and which did not require USDA approval, and Feline Combo, which did. We'll be introducing that capability on SNAPshot as the first of our plan to roll out the entire SNAP line on SNAPshot Dx. And that's going to be a -- we've got a lot of excitement from customers. We've done some field trials, and they see productivity with their technicians. They see charge capture. They see information capture in the electronic medical record. It's funny. They don't actually fully appreciate it until they start using it, and then they really see the benefit. And so, we think that's always been a little bit of a sleeper opportunity. But, as we actually show the customers it, and they actually see it -- see how it works. They get pretty excited.

Okay. That's great. That's all I have. Thanks very much.

Thanks, Ross.

Thank you, Ross.

Thank you, and we have time for one final question. That will come from the line of Daniel Owczarski from Avondale Partners. Please go ahead.

Yes, thanks, and good morning. Just had one question on the digital radiography side. You had talked about still having a meaningful order book. Are you seeing your backlog increasing or decreasing? And was just curious as to even customer response? Are you seeing cancellations or delays? And then finally, can you explain again, like who are you -- in this line, who are you competing with? Is it older technology or are you selling into clinics that don't have any of that capability whatsoever?

Thank you. Those are great questions. We're very happy with our digital radiography line. They are actually two different price points that we sell. One is called computer radiography, and one is called direct digital radiography. The computer radiography might be a $40,000 to $50,000 system. The direct digital might be double that -- $85,000, $90,000 system. The only difference between the two is you get one in -- you get the image in the direct digital in five seconds to ten seconds. And in the computer radiography, it takes you 60 seconds to create the image. The image quality is almost -- is indistinguishable between the two, as is stated by third party radiologists. So, we have outstanding image quality across our product line. We use the same software. It's a very, very software-intensive business because you've got to not only take the images, you've got to have software that allows you to read them, store them, manipulate them. And then the other aspect of our offering, which I think is unique, is its ability to integrate with Cornerstone. And as we roll out over the course of 2009 third party software, this high level of two-way integration that we call Smart Link. So people are appreciating that, it's not so easy. If you just order a digital radiography system, you're going to have a whole different medical records system than anything else if it's not integrated. And, they would rather have one medical record than multiple in different systems. We compete against a wide -- there are a lot of people who are getting into digital radiography. I think there will probably be fewer of them a year from now than there are now. Somebody counted something like fifteen different companies in the trade show that we just came back from. We believe we have a very strong, if not leadership position, as a result of our success over the second half of 2008 in digital radiography. Most of the volume is coming from practices who are converting from film to digital so that that's the bulk of the revenue is conversion. There are some who are adding a second system or third system, and in some cases they have a very old technology that they are upgrading. But that's really not as a -- not very big part of the market at this stage.

Okay. But at that price point, you're not seeing -- or are you seeing, delays or cancellations?

Not anything out of the ordinary. We had a very strong fourth quarter. We went into the fourth quarter with a strong order book. We delivered against that order book. We had good year-over-year growth. We developed orders in the fourth quarter that were -- gave us a backlog that went into the first quarter. So, at this point, the market looks very good.

Thank you.

Thank you. And with that, Jon and Merilee, I would like to turn it back over to you for any closing remarks.

Well, I would just like to thank everybody that came on the call. We remain very excited about our business and our market despite the challenges that all of us are facing with the economy. And, again, I would like to congratulate all the employees of Idexx that have crossed the billion dollar threshold and reached our Blueprint to a Billion actually earlier than we originally anticipated. And, we look forward to updating investors on our progress at our first quarter conference call in April. Thank you, and that concludes the call.

Thank you. And ladies and gentlemen, that does conclude your conference call for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.