愛德士 (IDXX) 2010 Q2 法說會逐字稿

Welcome to the IDEXX Laboratories second quarter 2010 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 Ostrow, Director Investor Relations.

IDEXX would like to preface the discussion today with a caution regarding 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. Forward-looking statements can be identified by the use of words such as, expect, may, anticipates, intends, would, will, plans, believe, estimates, should, and similar words and expressions.

Such statements include but are not limited to, statements regarding management's expectations for financial results for future periods. 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 March 31, 2010, and Form 10-K for the year ended December 31, 2009. 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 its estimates or expectations change.

At this time, I would like to turn the conference over to Merilee Raines. Please go ahead.

Thank you, Julia and good morning. Thanks for joining our call today. First a quick overview of our second quarter results. In our press release this morning we reported revenues of $281.5 million. A year-to-year growth of 6%, and diluted earnings per share of $0.62, a growth of 13%.

Revenues excluding a roughly $4 million unfavorable impact of currency were in line with our thinking at the time of our April call. Earnings per share were about $0.02 above our thinking at that time, as improved instrument reliability, greater operational efficiencies, and control of operating expenses, more than offset a $0.02 negative impact from currency. Second quarter revenues grew organically 5%, after adjusting for just over 0.5% contribution from acquisitions. Changes in currency rates although effecting performance relative to April outlook, had only a de minimis year-to-year impact on revenue growth. This organic growth of 5% compares to 9% for the first quarter.

We anticipated the first quarter would show the highest revenue growth in our 2010 quarterly profile, due to the easy comparison to the first quarter of 2009 with its relatively weak capital sales. A key factor that remains an important back drop for evaluating our current and future performance is the macro economic environment, both in the US and international markets. As we have done for several quarters, in order to gauge the fundamental activity levels in our largest market, the US veterinary healthcare market, we analyzed the patient visit and revenue data that we derive from a subset of customers using our practice management software.

The metrics we saw for the second quarter did not show any meaningful improvement from what we have seen for the last couple of quarters. Patient visits were flat year-to-year versus down 1% in both the first quarter of this year and the fourth quarter of 2009, and practice revenues were up about 1%, which showed no change from the first quarter growth. We do not observe any consistent trends within the month of the quarter, and this reinforces our thinking that until we see an improvement in factors that influence consumer spending, such as unemployment and consumer confidence, a return to sustained growth in this market will be very gradual. The European markets have also been faced with issues, such as sovereign credit risk.

Though we cannot measure in a direct way the impact of European economic challenges on our businesses, we remain cautious about some tangential negative impact over the near term. This is true not only for our Companion Animal businesses, but also certain customer groups in our water and livestock and poultry diagnostic businesses. Given this macro economic context, we believe we delivered very solid operating performance in our businesses, and I will now provide further detail. Sales of instruments in our IDEXX vets last week at $19 million, grew 6% in constant currency in the second quarter. This is down from the 15% growth we experienced in the first quarter, as the year-over-year comparison for the first quarter was somewhat easier, given that first quarter 2009 capital sales last year were relatively weak as has been noted.

Placements of Catalyst and VetTest, the most significant consumable sales generators in our IDEXX Vet lab offering, totalling approximately 950, were up nearly 15% year-to-year. We placed 556 Catalyst instruments in the quarter, to bring the first half placements to 1,040, and the installed base to over 3,800. We believe we remain on track to place 2,400 Catalysts for the year. For the first time we placed in the quarter more than 1,000 IDEXX VetLab station units. The management system for the IDEXX VetLab suite. Though not directly a source of consumable sales, the IDEXX VetLab station is a key point of integration and information management, not only for the in-house instrument suite, but also to the practice management system. Furthermore when a practice uses our smart service capability with the IDEXX VetLab station, they have a connection to IDEXX, which makes it possible for us to more efficiently monitor and service the instruments in the suite, and observe the tests that are run. Smart service installations were 1,450 for the quarter, and now stand cumulatively over 4,700.

Just over 30% of the Catalyst placements in the second quarter were to new and competitive accounts, the third sequential increase in this measure. As we have noted over the last couple of quarters, the value of integrated information and work flow efficiency that can be obtained by purchasing other components of our instrument offering, have helped to promote sales of multiple instruments per transaction. Consistent with the fourth quarter of 2009 and the first quarter of this year, about 80% of the instruments we sold in North America in the second quarter were placed with others in our line. Instrument consumable sales of $57.5 million, grew organically 2%, or 4% when further normalized for changes in distributor inventories. This normalized growth is consistent with what we saw in the first quarter. Catalyst placements are an important contributor to year-over-year consumable growth.

In addition to the placements to accounts new to IDEXX, we continue to see growth and testing overall is approximately 15% higher for our Catalyst customers who were previously VetTest owners, compared to the population of VetTest owners. However, we believe the continued slowness in patient traffic, and reductions in testing related to fewer discretionary procedures, will keep growth rates over the balance of the year relatively consistent with the first half, to up maybe 1% or so. Our second quarter Rapid Assay sales of $40.5 million declined organically year-over-year by 3%, leading to first half performance that was essentially flat versus the first half of 2009.

When further normalized for changes in distributor inventory levels and the impact of significant marketing programs, including one conducted with a major pharmaceutical partner in the first quarter of 2009, we had the same 3% decline for the quarter, and a 2% decline in revenues for the first half. The majority of the decline in the quarter is attributable to a reduction in test volumes for K-9 parasitic disease testing in the United States. We estimate approximately half of this reduction in test volumes is attributable to loss of accounts, primarily customers who test for heartworm only. The remaining reduction in K-9 volume is related to reduced same-store sales, which we attribute to the economy, as manifested by fewer patient visits and lower testing associated with wellness and preventive care, which are considered to be more discretionary. As noted in previous quarters, we have seen this dynamic with feline patients as well to an even greater extent.

Additionally we are seeing growth negatively impacted by lower pricing for our heartworm only product, due to increasing competition for that offering, combined with greater price sensitivity from our customers in this economic climate. Our Multi-analyte 3 and 4Dx tests represented 76% of our overall K-9 SNAP unit testing volume in the quarter. We believe this demonstrates the customer appreciation for the medical relevance and value associated with K-9 vector borne disease screening with 3 and 4Dx, versus testing for heartworm only for the significant majority of the market. In the feline market, the SNAP Feline Triple Test for Feline leukemia virus, feline immuno deficiency virus, and feline heartworm, now accounts for almost three-quarters of our world-wide testing volume, when we look at the combined sales of SNAP Feline Triple and the SNAP combination for FIV and FeLV.

Given the market and competitive dynamics we continue to see, we now expect that organic growth for Rapid Assay for the full year 2010 will be down 1% to 2% from 2009. US distributor inventory levels for instruments and consumables and rapid assays averaged 3.8 weeks at the end of the second quarter, based on forward-looking demand, this is within our customary 3 to 4 week range. Our laboratory and consulting services business with revenues of $86 million, grew organically 8% in the second quarter, compared to 9% in the first quarter. Roughly 90% of this growth was the result of higher testing volume, with the remainder due to price. We continue to see solid organic revenue growth across all of our major geographies, including North America, Europe, Japan and Australia.

Higher testing volume in the quarter was driven primarily from the acquisition of new customers. This was fostered by a number of factors, including our growing specialty test menu, our geographic foot print expansion to increase market coverage, and our commercial organizations ability to demonstrate to customers the benefits to work flow and information management that come from our broad and integrated offering of services and products.

Over the past 12 months we have expanded our sample pickup routes in Europe and Asia, and have opened three new day labs in major metropolitan areas in the US, including a new lab in the Philadelphia area, which opened during the second quarter. Operationally we continue to realize meaningful margin and service level improvements on a global basis, driven by volume leverage, global purchasing scale, the continued roll-out of our recently launched proprietary global laboratory information management system, which we call LYNX, and an array of other laboratory process improvements.

Our practice information management and digital radiography systems with revenues of $19.3 million, grew organically 34% in the second quarter, driven primarily by continued strong demand for digital radiography. As we have noted in previous quarters, this is a product line that despite its relatively high price for a veterinary capital expenditure and the challenging economy, continues to see strong demand as veterinarians migrate from older film-based systems to digital as the standard of care. Though we expect that growth rates in the second half will moderate some, given the tougher comparisons as performance strengthened over the course of 2009, we expect that organic growth for the full year will be about 20%.

Let me first note with regard to production animal services that we are in the process of changing the name of the business to Livestock and Poultry Diagnostics. We believe this is a better descriptor of the business from the perspective of our customers, investors, and employees. Accordingly Livestock and Poultry Diagnostics had sales of $19.2 million for the second quarter, representing flat organic growth, which was down from first quarter growth of 5%, and largely in line with our think in April. A significant portion of revenues for this business are generated from government testing programs, and the quarterly sales are subject to variability due to the timing of orders.

In the second quarter we continued to experience growth in bovine testing, particularly in Germany where the business has won government tenders for testing to a country-wide eradication program for a virus impacting beef and dairy production yields. For the year we expect organic growth to be 4 to 5%, up from -1% for the full year 2009. Our Water business had sales of $19.4 million for the quarter, which translated to 1% organic growth. This is down from 8% growth in the first quarter of the year. The sequential deceleration in growth though a little greater than our thinking back in April was largely anticipated, due to somewhat erratic growth in smaller geographies, and lower growth in larger geographies of North America and Europe, caused by order timing and a more difficult comparison for the second quarter versus last year. For the year we are projecting low to mid-single digit organic growth, with little if any stimulus from the economy on our areas of non regulated testing. This growth comes in part from account acquisitions in our largest market North America, and from core growth of our Colilert testing business in Europe.

Turning to the rest of the P&L, the gross margin at 53% was about 50 basis points above our thinking in April. Part of this favorability was due to improved instrument reliability across our offering, including digital, Catalyst, and other IDEXX VetLab instruments. Our initiatives to drive operational efficiencies across our manufacturing and reference lab organizations also contributed to our better than anticipated gross margins. Operating expenses at 33.6% of revenue were modestly better than our thinking, reflecting our continued focus on managing discretionary spending. Finally our net interest expense of $550,000, and effective tax rate of 31.5% were largely in line with our expectations. Share count was a bit higher than our thinking in April, reflecting slightly lower share repurchase activity and higher exercises of stock options in the quarter.

Turning to the balance sheet and cash flow, we ended the quarter with $118 million of cash and $134 million of debt, for a net debt position of $16 million. Our inventory balance of $122 million was unchanged from the levels at the end of first quarter, and about $5 million lower than our expectation in April. Days Sales Outstanding at 42 days remain in good shape, and our free cash flow was $53 million, or 142% of net income. Looking forward we now project full year revenues of $1.09 to $1.10 billion reflecting primarily the negative impact of currency versus our expectations in April. Our revenue guidance implies 5.5% to 6.5% revenue growth on both a reported and organic basis, as a nearly -0.5% negative impact due to currency is partly offset by some modest acquisitions made in 2009.

We project full year gross margin to be approximately 52%, about 100 basis points above the 2009 full year rate, reflecting a continuation of the favorable factors we saw in the second quarter versus our expectations in April, tempered by some potential mix unfavorability, due to lower revenue contributions from relatively higher margin kits and consumables. We continue to project operating expenses of approximately 34% of revenues for the full year. All of this results in a full year operating margin of approximately 18%. We continue to expect the tax rate to be approximately 31.5% to 32% for the full year, about 150 to 250 basis points above the full year 2009 rate, due primarily to the expiration of the Federal R&D tax credit at the end of 2009.

As mentioned previously, an extension of this credit would reduce our full year tax rate by approximately 1 percentage point and increase earnings per share by $0.03 to $0.04. Net interest expense is still expected to be $2 to $2.5 million. We are increasing our expectations for the weighted share count for the year from our thinking in April, and now project approximately a 2% reduction from the full year 2009 weighted average. All of this leads us to maintain our full year earnings per share projection of $2.23 to $2.28 consistent with our April guidance. Though the guidance is unchanged, the rationale to support it has evolved based on our assessment of events since the end of April. The guidance reflects the $0.02 of better-than-expected earnings in the second quarter, and a continuation of the favorable operational drivers we saw in the first half more than offsetting caution about further impact of the economy on the top line.

These factors essentially balance out an anticipated $0.02 negative currency impact in the second half and $0.01 of unfavorable impact from a slightly higher share count. The exchange rates implicit in our guidance today are the euro at $1.29, the pound at $1.53, and the Canadian dollar at $0.95. This compares to currency rate assumptions previously of $1.35 for the euro, $1.53 for the pound, and parity for the Canadian dollar. To remind every 1% strengthening of the US dollar vis-a-vis our basket of currencies, reduces revenues by slightly more than $4 million, and operating profit by approximately $750,000 on an annualized basis.

As for the balance sheet we project Days Sales Outstanding to remain at approximately 40 days, and inventories to increase $5 million or so in the third quarter, in support of new product launches and then end the year at $115 million to $120 million. Capital expenditures are still targeted to be $45 million, we project free cash flow to be approximately 110% of net income. And now to Jon for some further comments on the business.

Thanks, Merilee for that Company Q2 review. Overall I was pleased with our Company's performance this quarter. Our Companion Animal Group's global organic revenue growth adjusting for changes in our US distributor inventories that do not reflect practice demand was 7%. This was impressive when you consider that we saw essentially zero growth in the US Companion Animal market, looking at practice traffic and revenue data that Merilee shared. Clearly the economic recovery has not yet come to our markets, although at some point it will. Despite the economy in Q2, our strategy of customer focus, technological innovation, and providing an integrated product and service offering, is helping us manufacture sustainable organic growth of mid- to high-single digits company-wide.

Also I think we are benefiting from having a portfolio of businesses with different customer bases, as well as exposure to different geographies. This diversity in our business helps balance out some of the negative affects of the economic environment in the US and European consumers. We saw excellent progression of the Company's cost of goods sold and OpEx productivity. This quarter thus exhibited a nice validation of our long-term plan to grow the overall margins of our business through the productivity initiatives and our two biggest contributors, the IDEXX VetLab Instrument and consumable line and the global Reference line.

As investors know, the margin expansion in these two lines, which make up over 60% of our total revenue is an important element of our focus to drive an increase in returns in the business, and grow the bottom line faster than the top line. And you can begin to see these results in our guidance of an 18% Company operating margin in 2010, up from 17.1% in 2009. And within these numbers we continue to make investments that will drive future innovation and growth, as can be seen by our roughly $70 million annual budget for research and development.

Speaking of innovations and products, I would like to give just a couple of updates before we open it up to questions and answers. Our instrument business continues to develop the realtime care value proposition. That is, the customer value and practice productivity that results from running core diagnostic testing during the patient visit. We know intuitively that having the results while seeing the patient and pet owner generates many benefits for the veterinary practice. Our strategy is to eliminate the barriers to be able to practice this level of care, and that is exactly what we have been doing with a series of new innovations that we have brought to the market over the last couple of years.

Our flagship product Catalyst Dx chemistry analyzer is unique in the market in its ability to permit the veterinarians to practice realtime care, due to its ease of use, time to result, high throughput, complete to menu and flexibility. Last quarter we announced the prospective launch of a new hematology instrument, ProCyte Dx that like Catalyst will play a key role in developing realtime care capability. To remind investors ProCyte Dx brings an unprecedented ease of use, accuracy, completeness, throughput, and speed to results, two minutes, to the complete blood count, or what we call CBC. The CBC is a critical part of the core diagnostic profile, or what one might refer to as first line blood work, in a large majority of cases where blood is run. While our LaserCyte hematology platform remains unique in providing these critical elements to a lower volume practice, ProCyte brings a much higher throughput and a 2-minute run time without compromising the groundbreaking features of LaserCyte, namely inclusion of all of the critical hematology parameters, such as a five-part white blood cell differential and an absolute reticulocyte count. The latter important to characterization anemic patients, i.e. those with a low red blood cell count.

In addition, ProCyte is easy to use and highly reliable in the practice setting. When paired with Catalyst, ProCyte truly delivers realtime care capability to moderate to higher volume practices, in ways not previously possible with any in-house hematology analyzer. In the last three months, we have been right on track with our launch schedule, and have indeed launched the instrument in early July with delivery and installation of revenue generating units at several customer locations. We also completed the presentation of four papers on the instrument's extraordinary accuracy and precision at ACVIM, the all-important conference for veterinary internal medicine that was held in June. Word of mouth continues to spread and we have had customers now routinely calling up our sales reps wanting to know more about the instrument, and in some cases ordering it sight unseen. So the feel of this launch is very different from prior instrument launches that had a slower ramp time.

The reason for success and rapid introduction are two-fold. First we partnered with Sysmex, the world leader in hematology on the human side, taking a platform with extensive field experience and adapting it to the unique requirements of our veterinary customers. This platform already has world-class field reliability, as demonstrated by an installed base of roughly 7,000 units worldwide in the human market. Second, we conducted extensive field beta testing of the version we designed for the veterinary market during our development process, incorporating field learnings along the way, and completing that process by the end of June. So we already had about two dozen veterinary universities and veterinary hospitals using the instrument to run studies, as well as practice routine medicine before the launch in July.

The experience of these beta site customers is what gives us confidence in the commercial launch, and helps generate the incredible word of mouth promotion that we are seeing today. ProCyte compliments Catalyst's capabilities extremely well and monitor higher volume practices, and gives us incredible integrated system capability to provide a complete solution for realtime testing. Note that ProCyte like Catalyst, and all of the other instruments that make up the IDEXX VetLab suite, fully integrates with IDEXX VetLab's station, or IVLS, as Merilee mentioned, the diagnostic hub and touchscreen based information management system. We believe that ProCyte will greatly aid in our ability to acquire new higher volume competitive accounts for our in-house equipment, including for Catalyst Dx placements. ProCyte will also increase the hematology run in house, because it so easy and quick. To remind investors over 90% of chemistry panels run in the reference lab in the US include a CBC, while the in-house ratio of CBCs to chemistries run in-house is in the neighborhood of 50%.

We also see that ProCyte may, and I say may, because we don't really have enough experience yet, cause existing Catalyst customers who upgrade from a LaserCyte to ProCyte to run a greater number of chemistry slides, and that is because LaserCyte wouldn't be the bottleneck to that full chemistry hematology profile. So ProCyte could have a sort of multiplier effect on the usage of in-house testing, driven in part by its two-minute run time and of course associated throughput. This multiplier effect is a key element in our new product strategy, that is innovation through integration of different technologies that can drive growth above that of the underlying market and that the whole of our product and service offerings can in fact exceed the sum of the lines.

As to the ProCyte opportunity for the balance of the year, we continue to believe that we will generate about $5 million in revenue for ProCyte instrument sales in Q3 and Q4, as we move from limited launch to full launch. We continue to believe that ProCyte will be the preferred choice and new standard of care for the upper half of the customer base, as ranked by in-house testing volumes, which of course represents the majority of in-house consumable demand. In the meantime Catalyst's field performance continues to get better and better, and has great momentum and placements in Q2 despite customer concerns about the slowdown in the economic recovery. Our total instrument placements in Q2 including VetTest as Merilee mentioned, were 950 units, a record number for any quarter other than the last two fourth quarters, where instrument placement is generally the highest.

This placement rate is an amazing feat given the economy. In fact we are well on track to exceed last year's record number of chemistry analyzer placements worldwide. I believe part of the reason for our instrument placement success is that a purchases of IDEXX technology that promotes realtime care has a very good intuitive and believable return on investment for the practice owner. In other words, our technologies help practices grow, and increase their profitability even without any growth in their pet visit traffic.

Our realtime care strategy was also supported by IVLS. At the end of 2009 we launched a larger 15" touchscreen that has been extremely successful with 1,000 installations in Q2, as Merilee has mentioned. This is an absolute record number for the quarter, up from 773 in the first quarter, and 799 in the fourth quarter. Our success with IVLS is due in part to the continually-advancing software functionality, the cool new screen, the opportunity to connect it with back and forth communications with the practice information management system. And finally the opportunity to connect it with IDEXX using Smart Service. IDEXX's Smart Service provides not only a far superior support experience for our customers, it is also the platform that enables us to launch realtime care protocols an incentive-based approach to expanding the size and IDEXX derived revenue of the profile run on in-house blood work.

When a customer invests in a new IDEXX VetLab station, they are also solidifying their commitment to their IDEXX system. In fact, if you consider our sales of IDEXX VetLab stations, LaserCyte's and other equipment in Q2 in the North American market, we believe roughly twice the number of customers invested in a new or upgraded an existing IDEXX in-house lab, as would be indicated by Catalyst Dx placements alone. In other words, our installed base of customers is alive and well. And IVLS is proving to be the center of what we might call the IDEXX diagnostic ecosystem. Our focus of enabling realtime care through easy, complete, reliable, and immediate lab testing results during the patient exam will benefit from a couple of other smaller advancements that we hope to launch before the end of the year.

Switching gears for a minute to our global Reference lab business, we continue to make good progress on the launch of our cardiac diagnostic test, Cardiopet proBNP. In Q2, cardiac testing growth in North America increased nearly three-fold albeit off of a smaller space, and awareness of the test has grown along the same vein. In June to wide acclaim, we introduced the National Feline Cardiac Health Study to better understand the prevalence of feline heart disease. Unlike humans where diet and lifestyle can be predisposing risk factors for heart disease, cats have genetic predispositions that can arise at any age. Cat's heart walls thicken over time affecting the heart's ability to provide adequate oxygen to tissues, and can lead to similar medical complications as those seen in some types of human heart disease. Current literature suggests that one in six cats could have heart disease, and so far we are indeed finding a lot of unappreciated heart disease in cats tested as part of the study and getting those cats some help.

We will use our findings to quantify how Cardiopet proBNP when added to the current blood screening protocols can provide veterinarians more comprehensive screening tools than advanced patient care and practice revenues that results from follow-on work of a positive test result. We are very pleased that over 1,000 clinics have enrolled in the study so far. The study will continue through the year, and we anticipate releasing preliminary findings on the prevalence of heart disease later this year.

So in summary and before we open it up to Q&A, I would like to offer a few concluding comments here. IDEXX continues to pursue a strategy of growth through continued innovation in all of our markets. We target to invest close to $70 million in research and development in 2010, bringing our cumulative research and development to over $200 million in the last three years. We remain devoted to the development of a strong pipeline of new product growth drivers for our business. This will help build on strong business platforms that we have put in place over the last several years, including a new and revolutionary set of integrated laboratory systems for realtime testing in the veterinary practice of global growing Reference lab networks, a strong and growing installed base of customers with our computer systems and digital radiography, and market-leading franchises and Livestock and Poultry Diagnostics, and Water testing. So at that point, Julia, we are ready to open the call to Q&A.

(Operator Instructions). Our first question will come from the line of Jonathan Block of SunTrust Robinson. Please go ahead.

Great, thanks. Good morning, guys. First question, Merilee. More of a clarification. You always give a lot of great statistics. But just curious, on the organic revenue growth, are you maintaining that at 6 to 7%, or did you slightly bring that down to 5.5 to 6.5%?

We brought it down approximately 0.5% Jon..

Okay, just so you know, the press release reads 6 to 7%.

Yes, it is with rounding I think. In essence it is a very slight change, yes.

Okay. And then maybe to shift gears for a second, within CAG a lot of stuff showed the impact of the economy, but you guys continued to do a great job in the DR segment, which is a step out from some of the commentaries we have been hearing from other companies, et cetera. Maybe you can speak to the success in DR practice management, is it the bundling, pricing, how are you guys getting such good results there?

Jon, we have been in that business for a number of years, and we have developed a proprietary software system that of course is integral to the package, which applies to both the higher end DR offering and lower cost CR offering. This integrated package, because we developed it it keeps getting better and better. It is integrated with the software system and it has a lot of veterinary specific features. I just think our sales force is being very, very successful because we have a great line right now.

Thanks for that. Maybe just a couple more. On trends, guys, maybe you can speak throughout the quarter. It seemed like at least from our work, over the past couple of quarters March was a good month. People were feeling a little bit better, you guys sounded better on the April call, mentioned some improving trends and then VCA last night. Can you speak to how things trended throughout the quarter, and maybe even into July, if you are willing to share that?

Jon, it is hard for us to really have any kind of precision on trends month-to-month. I would say with regard to consumer sentiment and tone, things really did deteriorate at the end, starting at the end of April. I think the markets declined. A lot of things that were affecting consumer sentiment and unemployment and such, and maybe as much of a sentiment indicator would be helpful here as anything. I would say that the month did not, the quarter did not improve if we look at the quarter as a whole, it certainly did not improve over the trends we were seeing in the first quarter as a whole.

Okay. And last one and I will jump back into queue, Smart Service always sounds like a great and interesting feature. You have got it out there to a fair amount of practices. Maybe just what you are hearing, Jon, in terms of the practices. How are they receiving it? I always struggle a doctor who practices medicine, what does he think about you guys recognizing tests, is he receptive of that, does he fight that? Some color would be great.

I think you are probably referring to the realtime care protocol. Certainly the first thing that Smart Service does, is the customer gets more comfort that the instrument is performing well and if it has an issue, it can be fixed with far less involvement of the technician and over the phone. And also we can download new software, new calibration curves, that kind of thing remotely. Really the first element is customer convenience, and also gives us, of course, the ability to accelerate reliability improvements in the field. With regard to realtime care protocols, those are incentive based, we inspire, we are not telling them how to practice medicine, we are saying, should you want to expand the size of this profile, there is going to be an attractive economic incentive to do so, and then we talk about the medical message behind that. But you are right, veterinarians are independent folks, and you have to approach it in a way that inspires them to do so.

Okay. And sorry, just one last one. Jon, I think you called out the true organic if you normalize for inventory was closer to 7% that 5% but just to be clear. In the first quarter I think your organic was 9%, but your inventory levels looked a little bloated. Am I thinking about it correctly, where 1Q and 2Q is sort of 7% is you normalized for both?

I think that is exactly the way to think about it, Jon.

Okay. Thank you.

Thank you. And next we will go to the line of Ryan Daniels of William Blair. Please go ahead.

Good morning, guys. Just a couple of questions. First, Jon, I want to continue with some of your commentary about how you have been able to grow through a challenging market with some of your innovation and product diversity. Curious if you internally have had to try to accelerate product development or product launches to keep your growth rate intact and as strong as it has been, or perhaps another question or way of looking at this, is if growth decelerates in the market at the back half of the year, do you think you can pull forward maybe the ProCyte launch schedule and activity there, or some new testing to kind of offset market weakness with further innovation?

I would say, Ryan, that what we have learned is that we have to be absolutely disciplined in our product development process, and we need to ensure that that process is done well. Probably one of the innovations in the process is that we get customers to actually use the product in the field before we do the full commercial launch, like we did with ProCyte. Customers were practicing medicine with ProCyte at beta sites, running university studies, doing a number of things with ProCyte before we actually fully launched it.

So our product development process really is rigorous and independent of the market, but having said that, I think it is actually a more disciplined approach and continual improvement allows us to launch more products, with a given level of investment, that is R&D productivity does go up, and we are very focused on R&D productivity and I think we have seen some significant improvements in that over the last couple of years. But still of course there is still an uncertain element of any kind of innovation that you pursue, as to when it is going to be able to come to the market. We are very excited about the ProCyte, and do believe that we will be able to move into the full launch mode very, very rapidly over course of the year.

Thanks for that color. And maybe a little bit more commentary on InterLink, the technology you recently launched with AVImark and ImproMed. I am curious if you think that has been received in the market well, and maybe that is one of the drivers not only of the instrument strength, but it sounds like you continue to swap out more and more competitive instruments or new customers. Curious what you are hearing from the sales force, and how that might be driving demand or a competitive edge for your team?

Yes, Ryan, thank you for that question. We do have so many interesting things going on that we don't always talk about all of them. But that certainly has a lot of enthusiasm with our sales force. When I talk about ROI on investment and IDEXX technology, when you add an instrument system that can fully integrate back and forth with your practice management software, and it might be IDEXX's practicing management software or it might be third-party management software, and now with InterLink and SmartLink, we have roughly 70% the software owned by roughly 70% of customers covered with this fully integrated capability.

You ensure that you are not losing charges on diagnostic tests that are being run, that really helps the bottom line when you capture revenue that was otherwise leaking out of the system just through mistakes that happen in a veterinary practice, that is a good ROI, and they also love the productivity that InterLink and the SmartLink version that runs with Cornerstone is providing the practice staff. And that adds to the ROI. So what we are trying to do here is help veterinarians get through this challenging economic period, and we routinely see when people move to a more integrated approach, their practice revenues go up, and it is not because they are getting more pets coming in the door every day.

Great. That is helpful color. And maybe two more quick ones on the livestock--.

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

Julia, we will probably want to come back to Ryan.

Sorry, it is Ross. Somehow I jumped ahead here. I have two or three quick questions. In your press release you referred to some lower unit sales prices, due to competition in the economy, and I assume that is on the instrument side, and I just wondered how material that was, or if it was much of a change in trend?

Ross, it was a little bit lower. We saw some lower pricing on instruments, as I mentioned in some portions of Rapid Assay as well. I think to a certain extent with some of our water products and our livestock and poultry products, and this is just very consistent with the trend that we have seen over the last year or so, with the economy that everybody is a little bit more price sensitive, and there has been a little bit less price realization.

And we are going to remain competitive.

Okay. Thanks. And with the ProCyte, maybe it is too early, but have you been able to measure the impact at all on hematology consumables or chemistry consumables that you see was up with some of these customers. I don't know if you can measure this effectively with the beta test customers or not. Jon, you maybe alluded to some of this in your comments as well?

One of the exciting things about ProCyte is that many of our beta sites were actually universities, so that is not really a practice setting that allows us to measure that kind of thing. So we have so few practice setting observations that I would hate to extrapolate trends based on 10 customers. But certainly what we would intuitively see, and in fact what we have seen in those customers is that they are doing more testing. It is easy. And the bottleneck is the time and throughput bottleneck of LaserCyte, which they all, these customers that were committed to running a complete and accurate hematology run, but of course it was a lower throughput. In some cases when it is easier, they do simply run more. I am very hesitant to extrapolate based on those trends. We would like to see a quarter or two of field experience with hundred of customers, not 10.

Okay. I understand. And just two other questions. Can you give any update as to how much have you rolled out the realtime care protocols program at this point, and my final question would relate to cardio pad. How big is the feline market versus canine market for this test do you think?

With regard to realtime care protocols, with any kind of a new system and new protocol, it takes some time. We actually started it in Q2, we are getting more learnings in Q3, and I would say there would be full roll-out in Q4. And of course customers need to have an IDEXX VetLab station and Smart Service, so the growth and installations there are certainly helping expand the number of customers that could have the opportunity for realtime care protocol. So I think we are really getting ourselves set up for this being a longer term platform, and we will be in the full roll-out mode by the fourth quarter.

With regard to CardioPet. We are still learning about cardiac heart disease in the dog and the cat. Clearly it is a test, a slightly different form of the test, they are not identical tests for the dog and cat, because what we are looking for is a slightly different chemical composition. It is applicable in both. Although Heart disease manifests itself differently. What is interesting with a cat where it is just a lot more straightforward and clear. You can have what is looks like a perfectly healthy adult cat, a 3 or 4 or 5-year old cat that has occult heart disease, that could end up just dropping dead. That is not a good thing. Yet if you actually found it and detected it early, you could do something about that, and mitigate that chance. The opportunity that we see on the feline side is really as a screening protocol for healthy cats, which of course makes it a very large market opportunity, although cats generally visit the practice less frequently than dogs do.

On the dog it is more a I have got a murmur, and I need to characterize it. Is this an innocent murmur, or is this one that I need to be concerned about and do further diagnostic workup, and prior to CardioTest, there was really no way of making that differential diagnosis. So we are also excited for the dog, although it is not a screening test for just a normal healthy dog.

That helps a lot. Thanks very much.

Thank you. And we will go back to the line of Mr. Ryan Daniels. Please go ahead.

Sorry about that. I just wanted to jump into the old production in the livestock and poultry division. First on Germany, I know there is an eradication program, I am curious if you have visibility through that for the entire year, or is that something that you anticipate just going another quarter or two?

That has got some legs to it, and we are being, we have been extraordinarily successful with our commercial team in Germany, and the technology that we are selling there. I actually think we have won every piece of business that has come up so far in Germany, and that has got some legs to it.

I guess follow-on if we think of all the austerity measures over in Europe with the recent crisis, are you yet seeing any pullback on programs like that, whether it be existing programs or if there are RFPs out there where maybe they are kind of refraining on awarding those, anything of that nature?

No, we really haven't yet. Nothing that is material on that. I think what we have seen is that Europe is still pretty committed to livestock and poultry help, and so we will always have concerns about it. But so far, like Germany which is, it is interesting because of the success we have had with livestock and poultry and also our Companion Animal business, as a single country, Germany is our largest international market for IDEXX, and that is good because it is probably one of the stronger economies.

Sure. Okay. And the last question I had, just trying to get a little more color. I know the FDA has had some recent commentary on using antibiotics in production animals, and I am curious if there is any longer term threat to any of your SNAP Assays there, maybe for antibiotic residue testing, if that could reduce demand, or maybe the counter-question would be, does that open up more longer term opportunities for disease testing if they are not using antibiotics as much, because they might be more prone to transmit diseases?

Are you talking about with regard to our dairy SNAP business?

Yes.

I haven't heard that yet. I think people are still concerned about, probably even more concerned today than they were in the past about antibiotics in the milk. Maybe if they were going to cut back one or two, they are still going to be testing for whatever else they are using. Also I would say it is a pretty small business for us, and the majority of that business is outside of the US. It is really much more of an international business than it is a domestic US business. I don't think there is any impact, and if there would be in the future, I don't think it would be at all material.

Perfect. Okay. Thanks a lot, guys.

Thank you. And next we will go to the line of David Clair of Piper Jaffray. Please go ahead.

Thank you for taking my questions. The first question is on the heartworm side. I am just curious, is your heartworm only competitively priced with the recent market entry there, and can you talk about pricing for 3Dx and 4Dx, are we seeing any kind of price pressure with those?

It is obviously, the heartworm only is a very price competitive market, and we have seen an increasing level of competitive rivalry. And so I think that is impacting the heartworm portion of the business, which is I don't know, roughly I want to say a quarter of that business. But on 3Dx and 4Dx we have got innovative and also proprietary technologies, well characterized technologies for expanding that to a parasitic disease screen. I will say in this sensitive market there are going to be some, certainly some geographies where tick-borne disease is well understood, and the importance of that testing is bedrock. But there are others where it is a little bit, it is not as prevalent and people trying to save money every way they can, so sometimes we do see a little bit of price pressure on the premium that we can charge for a 3Dx or 4Dx versus a heartworm-only test.

Thanks. On ProCyte, I appreciate the $5 million revenue target in the third and fourth quarter. I was just curious if you could give us any placement targets for the instrument, and it sounds like we are still on track for an early 2011 full commercialization maybe even before that?

Yes. Probably as we get to the end of Q4, we would be in full commercialization mode, which would be timely with the fact November/December is the prime time for capital, as our customers consider their tax situation, and are looking for ways to save on taxes by investing in capital and of course with Section 179, getting the write-off. And so I think roughly our unit target is 250 units for the year on that 500. That would translate into net of trade-ins and everything else that we typically provide to existing LaserCyte customers, a $20,000 net price on the analyzer.

What I will say is that we are going to have several customers, a meaningful subset, who actually have two LaserCytes, because they bought two LaserCytes to get the throughput to keep up with their practice demand and their Catalyst analyzer. And so in some cases, we are going to take two LaserCytes back in trade, which is really what brings a list price of $29,500, down to an AMP that is closer to $20,000. What is interesting about that model and it is really the same model of Catalyst and VetTest, is we take those LaserCytes back and we put them through the factory and bring them up to current configuration and quality certify them, and we have got a low cost recycle opportunity to replace those LaserCytes in markets with a more competitive price, and still have an attractive margin, so it is a nice second order benefit to launching an advanced instrument. Is that we take these instruments back in trade, and they can replace them for an attractive margin, and of course generating consumable revenue for us.

Okay. And just kind of a Catalyst Dx and a ProCyte question here, are both of these still cash sales? There is no reagent rental going on, or no plans to start a reagent rental program?

They are all cash sales. I don't know. For all intents and purposes, it is a cash sale business at this point in time. Typically just to be clear here, they are cash to us. The customer may lease them, but that would be of course a non-recourse lease. We are selling it and then the leasing company is doing the financing for the customer.

Got it. And Merilee, sorry, I actually missed this, but what percent of Catalyst Dx placements were competitive takeaways in the quarter?

Just over 30%, David.

Great. Thanks a lot.

Thank you. And we have time for one more question, and that question will come from the line of Dawn Brock of Kaufman Brothers. Please go ahead.

Good morning. Thank you for taking the question. I wanted to get into the fundamentals a little bit in an effort to better understand kind of the type of demand in the market. Merilee, you had cited that patient visits were relatively flattish versus what I thought was a relatively persistent negative 1% level. And if I look at the performance of the different segments within CAG, Rapid Assay was down maybe a little bit more than we had expected, in what is typically the seasonably strong heartworm season. We saw strong, solid but not necessarily strong consumables growth. And yet the overall organic growth for CAG was really quite solid. If I am trying to marry all of this with the strength in the labs, I guess my question is, do you guys feel as though you are getting feedback that you are seeing fewer sicker animals, and/or are you seeing the competitive landscape on the lab side really going your favor, and you are taking some market share there?

Maybe I can answer that, Dawn. Really it is difficult for us, because we are not in the veterinary clinic business. We serve them to be able to see what is the reason that people are using our diagnostic tests. So we can't tell for the most part whether it is a sick patient or a well patient. My sense is that the trends are really no different than they have been over the course of the economic recession. As we said you could say maybe there was a slight pickup in the quarter. I don't really think it is a statistically pickup from negative to zero. And so I think, and of course we are not just in the US market, we are in international markets. I think we have great businesses. We have a great product offering. Some of that is on the capital side, and some of it is on the consumable side and on the services side and it all comes together I think, to be very compelling to our customers, and a reflection of the investments we have made in our technology over many, many years. It is kind of hard, there are just so many moving parts and so many moving geographies. I can understand the challenge that you are facing, I think that is the nature of IDEXX.

Fair enough, Jon. Maybe I can ask you to break down a little bit, you are incredibly diversified and versatile, and it is one of the reasons why clearly you have been able to put up growth in a market where really nobody else has. Is there a way that maybe you could give us a little bit of color? The breakdown of geographic strength directionally, i.e., US, Asia Pacific was up considerably in 2009, I think it was somewhere around 100% in 2009. Can you give us directionally what you guys are seeing geographically?

I think that 100% number happened to be specific to China, where we really had some significant new product success in China in 2009. But Asia is the fastest growing region, of course it is the smallest region, and Merilee, do you want to comment?

I would just say as far as it goes for 2010 when we look at the overall organic growth in Asia, and you looked across all of our product lines, I am not breaking it down specifically by the different segments, it was double-digit growth, low double-digit growth for the first half, versus kind of a mid- to high-single digit growth for total Company organic.

Perfect. That is excellent. And then my last question is on ProCyte, is that going to be, I should probably know the answer to this, but is that going to be included in organic growth?

Yes. Of course there will be some customers who would have purchased a LaserCyte or maybe a second LaserCyte, who instead would purchase a ProCyte. We would certainly, a ProCyte is a significant new product launch for us, is one of the drivers of organic growth, both in the instrument placement, and also to the extent it helps us place new Catalyst analyzers in existing, and also even more interestingly, customers who do not have an IDEXX in-house lab, we think ProCyte will be helpful. Just to give you a little background on ProCyte, there is a subset of customers who just basically said I need throughput and I was willing to sacrifice, as much as I didn't want to, I was willing to sacrifice not getting a complete hematological parameter but I need throughput, there is a technology out there that has really come from the human market called Impedance. It is not a great technology to provide a full hematology profile. But it did give, not two minutes, but it gave three or four minutes timed results. Some customers said I just need that, that is more important to me.

Well now they don't have to make the compromise, saying I want a partial hematology, now they can get a complete hematology and a 2-minute time to result, and those are customers we haven't, and they are typically higher volume customers, because throughput is really only important to higher volume customers, and so we think that is going to be an interesting new small segment that we will be very appealing to that we haven't been historically, and that is going to help drive our organic growth, not only for instrument placements of course, but also for the follow-on consumable demand.

Excellent color, Jon. Let me ask you this, and I don't know if you have this data yet, in the early stage launches of ProCyte, I know that you guys have only just started with this controlled launch, but I know you did some pilot before that, did you see the same sort of consumable utilization increase with ProCyte that you did with Catalyst in the next generation?

I just don't think we have enough data to give you a database answer to that. We do expect that when it takes two minutes to run a hemogram instead of 11 to 14 minutes, you will have more of a run.

Fair enough.

That is an intuitive answer.

Fair enough. And quickly, Merilee, there was a statement in the press release about kind of diminishing D&A, and how that might have added a little bit to the gross margin, is that de minimis, on the instrument side?

That actually is. It is a nice driver. I think we had probably over the course of last year something like $10 million of amortization, and this year it will be something like $3 million to $3.5 million. That is again one of the benefits as we have been able to innovate and get new products out, like Catalyst, and with the coming of ProCyte, and with the cash sale of these instruments, we don't have that kind of burden on our balance sheet.

It is nice to be able to do a cash sale versus what we have historically done on the chemistry side up through really the end of 2007, which was a placement that we had to amortize over time, and that amortization is rolling off.

Perfect. Thank you very much.

Thank you, Dawn.

Thank you for your questions. And Mr. Ayers, we will turn the conference back over to you for your closing remarks.

Again I want to thank investors for their continued interest in IDEXX, and our story, and their confidence in us, and I also want to thank all of the employees of IDEXX, who have worked very, very hard in what has not been the most enjoyable economic circumstances, to produce great innovation and great bottom line results. That concludes our call.