愛德士 (IDXX) 2010 Q3 法說會逐字稿

Good morning everyone and welcome to the IDEXX Laboratories third quarter 2010 earnings conference call. Just a reminder, today's conference is being recorded. Participating on 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 expects, 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 June 30, 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. Good morning and thanks for joining our call today. I would like to begin with a quick overview of our third-quarter results.

In our press release this morning we reported revenues of $269.6 million, our year-to-year growth of 4% and diluted earnings per share of $0.59 -- growth of 13%. Our earnings per share were about $0.03 above our thinking in July, reflecting about $0.01 of benefit from currency and $0.02 of benefit from a lower than planned tax rate.

As relates to more fundamental business performance, revenues excluding a roughly $1 million favorable impact from currency were about $1 million below our thinking at that time, reflecting lighter than anticipated instrument sales primarily in our digital radiography offering. The lower revenues were offset at the bottom line by a slightly more favorable gross margin.

I note that third-quarter earnings include two items that were also not contemplated at the time of our July call. Approximately $1 million for a bad debt provision related to the bankruptcy of one of our US distributors, Professional Veterinary Products, and a $1 million revenue milestone payment related to the sale in late 2008 of our development stage feline diabetes therapeutic. These items, which are both reflected in the G&A line, essentially offset each other.

Organic revenue growth was 5% in the quarter with currency reducing reported growth by about 1%. The impact of acquisitions was virtually nil. The third quarter organic growth is on par with what we achieved in the second quarter and a point below our year-to-date growth given increasingly difficult comparisons to 2009 as we progress through the year.

Despite the recent rise in the stock market and some pockets of improving sentiment, virtually all of our businesses continue to be challenged to a certain extent in the third quarter by the US and European economies. Our view on the US veterinary market, as ascertained from analysis of data from a subset of customers using our Cornerstone Practice Management System, is generally consistent with our second-quarter observations. Patient visits were relatively flat over 2009 in both the second and third quarters and practice revenues were up about 1% for both quarters year to year.

As compared to the first quarter, we've seen only a slight improvement in patient traffic metric, which at that time was down 1%. As we have stated previously, we look for favorable signs and key factors impacting consumer sentiment, the primary one being employment statistics, to generate a return to higher growth levels in this market that are more consistent with historical trends and the underlying fundamentals driving spending on pet healthcare.

Given the current macroeconomic environment, we believe our third-quarter performance was solid and reflective of our focus on innovation and operating efficiency. Given the relatively strong international performance this year, particularly in Asia Pacific, our geographic diversification has also been beneficial to us.

Let me now provide some further highlights of the quarter.

Sales of instruments in our IDEXX VetLab Suite at $21.1 million grew 14% organically in the third quarter. Placements of ProCyte, our new hematology instrument, helped to increase growth above the 6% achieved in the second quarter. We placed 154 ProCytes in the quarter. About 30% of those were into new and competitive accounts.

The customer experience has been extremely positive, which is generating enthusiasm among our sales force and in the market place as awareness of ProCyte increases.

ProCyte aside, other placements in total were slightly below our thinking in July. We believe this is in part due to vacillating feelings about the economy, creating some hesitation to make capital purchase decisions, and in part due to the sales force attention and learning curve on ProCyte.

Chemistry placements were solid at over 900 combined for VetTest and Catalyst. We placed 513 Catalysts, bringing our year-to-date total to just over 1550. Placements to new and competitive accounts again represented about 30% of the total.

Though third quarter Catalyst placements were a little shy of our expectation, given that the fourth quarter is traditionally the strongest capital placement quarter with attractive tax incentives in place, we believe we'll be at or very near the 2400 placement goal we forecasted at the beginning of the year.

As for ProCyte, we believe placements for the year could top 400; a significant increase over our thinking of 250 when we announced the launch back in April. Placements of IDEXX VetLab Station, the management system for the VetLab Suite, were nearly 1000 in the quarter. And SmartService installations were about 1370. The cumulative total for SmartService installation now stands at just over 6000.

These increasingly important components of the VetLab Suite help to promote greater utilization of consumables by turning test result data into more insightful information, improving workflow and by enabling remote monitoring of system performance to ensure instruments are running efficiently.

Instrument consumable sales of $57 million grew organically 3%n or 4% when further normalized for changes in distributor inventories. This normalized growth is consistent with what we've seen for the year.

Also consistent with recent history is the 15% growth in consumable usage for Catalyst donors who were previously VetTest owners when compared to our population of VetTest owners.

Our third-quarter rapid assay sales of $35.6 million declined organically year-over-year by 5%. However, when normalized for changes in distributor inventory levels and the impact of certain marketing programs, revenues declined 2% for the quarter -- essentially the same as what we saw in the first half of this year.

The majority of the decline in the quarter versus prior-year is attributable to two dynamics that we have discussed in previous quarters. The first is the continued pricing pressure we see in the canine heartworm testing market, largely due to an intensely competitive environment for heartworm-only testing, coupled with greater price sensitivity by our customers.

The second dynamic impacting growth is the continued weakness in the feline market which negatively impacted volumes for our feline retrovirus test, SNAP Combo and SNAP Triple. As we have noted in previous calls, the feline segment continues to feel the impact of the slow economy to a greater extent than the canine segment and our internal data suggest that feline patient visits are down about 2% year-to-date from 2009. This is on top of a decline of 5% in 2009.

We were, however, encouraged to see that sales of our multi-analyte 3 and 4Dx tests remained at just over 75% of our overall canine SNAP unit testing volume in the quarter. This demonstrates that despite increased focus on cost, a significant majority of the market recognizes and appreciates the medical relevance and value associated with canine vector borne disease screening with 3 and 4Dx versus testing for heartworm only.

This is further borne out in our reference laboratory business where we saw 4Dx testing volume has increased at a very healthy rate year-to-year. 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 about 2%.

US distributor inventory levels for instrument consumables and rapid assays averaged 4.2 weeks at the end of the third quarter based on forward-looking demand, which is within the range we consider customary. Our laboratory and consulting services business, with revenues of $82.5 million, grew organically 8% in the third quarter consistent with the growth we saw in the second quarter. As in the second quarter, roughly 90% of this growth was the result of higher testing volume.

We continue to see solid organic 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 footprint expansion to increase market coverage and the way our lab services complement and integrate with our other diagnostic and information management offerings.

Related to geographic footprint, throughout this year we've continued to expand our laboratory coverage around the world with new day labs and sample pickup routes. In the third quarter we opened up new day labs in Kansas City and in the United Kingdom. Earlier this month we opened a new day lab in the Cincinnati area.

Operationally we continue to realize meaningful margin and service-level improvements on a global basis driven by volume leverage, global purchasing scale and an array of other laboratory process improvements. Our practice information management and digital radiography systems business, with revenues of $16.3 million, declined 1% organically in the third quarter driven by softness in digital radiography particularly in July and August.

While we had expected growth rates to moderate somewhat in the second half of 2010 given tougher comparisons to the second half of 2009, third quarter digital performance was represent weaker than anticipated for a couple of reasons. First, as we saw to a lesser extent in the VetLab line, clinics appeared to delay making capital purchase decisions, which we attributed to customers' concerns about the economy. From a veterinary clinics perspective, digital radiography is a significant capital investment even relative to other instruments.

Second, we had some open positions in our digital sales force in the third quarter which we believe negatively impacted order volume in the quarter. We did see orders pick up in September as we filled open territories and customer sentiment improved a bit. We finished the quarter with a strong backlog which we believe will get us back on track for improved fourth-quarter performance. We expect that organic growth for the full year will be about 15% which reflects the increasing desire for these offerings in the vet market.

Our livestock and poultry diagnostics business had revenues of $17.5 million in the third quarter which represents organic growth of 15% and brings year to date organic growth to 6%. The sequential spike in year-to-year growth rates was anticipated and is due to the relatively weak comparison to the third quarter last year as a result of order timing between the third and fourth quarters of 2009.

Our third-quarter growth resulted largely from bovine and swine testing revenues. As was the case in the second quarter, bovine testing continues to benefit from higher sales volumes in Germany where the government has undertaken a disease eradication program.

In the third quarter we also introduced in the UK our first rapid assay for livestock in the SNAP format. This will be used by veterinarians for testing animals pen-side to complement existing testing done in laboratories. We believe there are other diagnostic opportunities ideally suited for on-farm testing, and so we're pleased with the launch of this and nonaccrual test. For the year we expect mid-single digit organic growth for livestock and poultry diagnostics.

Our water business had revenues of $20 million for the quarter representing 3% organic growth which was in line with our thinking. Growth came primarily from account acquisition in North America and growth of our core Colilert testing business in Europe. For the year we continue to project low to mid-single digit revenue growth, assuming no significant economic turnaround that would boost our nonregulated testing business.

Looking at the rest of the P&L, gross margin at 53% was slightly above our thinking in July due to improved instrument reliability across our offering including digital, Catalyst another IDEXX VetLab instruments. Operating expenses at 34% of revenues were consistent with our thinking in July, so about 100 basis points above third quarter 2009, reflecting higher legal fees as anticipated related to the FTC investigation for which we incurred about $2 million.

This spending reflects a significant cost associated with a large scale document production exercise in the current era where most documents are stored electronically. We expect that fourth-quarter spending for this matter is likely to be lower than the third quarter and we believe we have it adequately covered in our guidance.

As I mentioned at the beginning of our call, third quarter G&A also reflected two largely offsetting items. First, we recorded about a $1 million bad debt provision related to the bankruptcy in August of one of our US distributors, Professional Veterinary Products or PVP. Second, we learned that the purchaser of the development stage feline diabetes therapeutic that we sold in the fourth quarter of 2008 had achieved the first revenue milestone, entitling us to receive $1 million payment.

Please note that the FTC spend and the PVP provision are reflected in our companion animal segment while the pharma milestone payment is reflected in our segment entitled other.

Net interest expense of $550,000 was in line with our expectations. As I mentioned earlier, our tax rate was favorably impacted by about three percentage points primarily due to the expiration of tax statutes of limitation in certain jurisdictions. This contributed about $0.02 to earnings.

Finally, share count was in line with our projection in July.

Turning to the balance sheet and cash flow, we ended the quarter with $134 million of cash and $126 million of debt for a net cash position of $8 million. Our inventory balance of $132 million was about $10 million higher than the level at the end of the second quarter and about $5 million higher than our expectation in July as a result of timing of receipt of chemistry slide consumable shipments.

Days sales outstanding at 42 days remain in good shape.

Our free cash flow was $48 million or 137% of net income. Looking forward, we now project full-year revenues of approximately $1.1 billion, the high end of the range provided on our July call, due to the weakening of the US dollar since that time. Our revenue guidance implies about 7% reported revenue growth and 6% organic growth.

We continue to project full-year gross margin to be approximately 52%, about 100 basis points above the 2009 full year rate, and operating expenses to be approximately 34% of revenues for the full-year. All of this results in a full-year operating margin of approximately 18%.

We now expect the tax rate to be approximately 31% for the full year, resulting from our lower than planned rate in the third quarter. This is about 100 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 rate by approximately 1 percentage point and increase earnings per share by $0.03 to $0.04.

Net interest expense should be approximately $2 million and the weighted average share count should be down about 2% from the full-year 2009 levels. All of this leads us to raise our full-year EPS guidance to $2.28 to $2.31, an increase of $0.05 to the low end of the range and $0.03 to the high end. This guidance reflects the $0.03 of better than expected earnings in Q2 and about $0.01 of expected favorable currency benefit for Q4 versus our guidance in July.

As relates to the high end of the range, we somewhat temper these factors with continued modest caution regarding the top line. The exchange rates implicit in our guidance today are the euro at $1.40, the pound at $1.57 and the Canadian dollar at $0.98.

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 about $750,000 on an annual basis. As for the balance sheet, we continue to project DSO at approximately 40 days, inventories of $115 million to $120 million and capital expenditures of $45 million. Free cash flow is projected at approximately 110% of net income.

As we look to 2011, we project revenues of $1.18 billion to $1.2 billion. Our year-to-year increase of 7% to 9%, or 6% to 8% organic growth, and earnings per share of $2.55 to $2.65, a growth of 10% to 16% reported or 8% to 14% currency adjusted. Because we're still in the midst of our internal planning process, we will provide more details on the components of our P&L, balance sheet and cash flow at the time of our fourth-quarter call.

Our projected revenue growth assumes only a very modest recovery in the economy and consumer spending, with much of the acceleration in our organic growth coming from our ability to grow diagnostic testing across our portfolio through innovations that provide increased value to our customers. These include strategies such as real-time care in our companion animal business, and farm animal side testing or FAST in our livestock and poultry diagnostics business.

With regards to currency, our 2011 guidance assumes that currencies remain at the rates implicit in our latest 2010 guidance. As these rates reflect a relatively weaker US dollar versus the average for 2010, currency is projected to add about 1% to our 2011 revenue growth.

Similar to 2010, every 1% change in the US dollar versus our basket of currencies changes revenues by about $4 million on an annual basis. Because we have not fully hedged our 2011 exposure at this time, the impact of a 1% change in the US dollar versus our basket of currencies has a slightly larger approximately $1 million annual impact on operating margin. Our customary practice is to layer in hedges over the course of the year the year for the succeeding year.

We anticipate operating margin expansion in 2011 coming primarily from gross margin expansion. Continuation of our share repurchase program will generate earnings per share growth above operating profit growth.

Key factors in our 2011 top and bottom-line performance will be continuing to increase the installed base from our in-house laboratory suite, led by Catalyst and ProCyte, to drive growth of our proprietary consumable revenue stream; maintaining focus on the initiatives to drive operating margin enhancement in our two largest businesses, IDEXX VetLab and Reference Laboratories; increasing the value to our customers by enhancing the integration of our product and service offerings; and investing appropriately and the development and commercialization of new proprietary diagnostic tests and services that provide valuable information to our customers, and further differentiate us from our competitors.

Thank you. And now I would like to turn it over to Jon for some further comments on the business.

Thanks Merilee. My take, overall, we had a solid quarter of sales, profitability, earnings per share and the advancement of our strategic initiatives. As Merilee mentioned, we still don't see any meaningful growth in the US companion animal market when looking at the practice traffic and revenue data that Merilee shared from our Cornerstone customer set.

In looking at a collection of third-party data on US vet practice revenue growth that we've compiled from various sources, we see that our Cornerstone customers may in fact be doing better than the market as a whole. This aggregate data suggests that vet practice growth in 2010, the year-to-date 2010, may be as much as 3% to 5% lower than what our Cornerstone customers are experiencing.

If this is right, it demonstrates that for whatever reason our customers seem to be surviving the tough economy better than the average veterinary practice. Perhaps this is in part because of the adoption of our advanced technology and all it does for practice economics. It is indeed an effective in creating clinic value through greater number of practice visits and a higher average client transaction revenue.

Alternatively, it could mean that we attract customers who are already more sophisticated in practice management. Either way, I think it is a validation of our strategy of providing higher value-added products and services that come from our investment in innovative technologies and strategies such as real-time care, practice integration and automation, electronic medical records and the advanced diagnostic protocols that raise the standard of care.

I'm also pleased that we continue to increase the margins in the business through a dedicated focus on efficiency gains that were reflected in the gross margin line. The third-quarter gross margin increase of 2.3% over the third quarter of 2009 was gratifying, due primarily to margin expansion in the instrument and reference line of business. As investors know, these two businesses which make up over 60% of our total revenue are currently below the Company average operating margin. The sustained continued progress on both businesses is key to expand the operating margin for the total Company and reflected in our guidance, which shows operating margin expanding in 2010 and further margin expansion expected in 2011.

At the same time we continue to make R&D investments that will drive future innovation and product advancements that are core to our strategy of growth. So, why don't we talk about a few of these?

Clearly an exciting highlight of the quarter is the field and market success we're having with ProCyte DX, our next generation hematology analyzer, that supports our real-time care strategy for the veterinarian. Unit sales of 154 exceeded our expectations. Customer experience with units in the field has also been very strong.

Of course, we knew from the field trials conducted prior to the launch that we were going to be able to deliver upon commercial launch a high level of accuracy and reliability, not to mention two-minute run time and ease of use. However the instrument's field reliability exceeded our expectations. As a result, we made the decision to exit limited launch status earlier than planned. In September we entered full launch status mode in North America. In addition we already have installations in five European countries as part of our limited launch planning on that continent.

ProCyte Dx is a powerful and versatile analyzer that spans a wide swath of customer segments. We've been routinely selling it to medium-size practices that run today only two to four CBCs a day in clinic. These customers value ProCyte for their speedy runtime and advanced level of accuracy.

At the other end of the spectrum, we sold ProCyte to an IDEXX customer who was averaging 25 CBCs the day with their in-house equipment prior to receiving ProCyte. On the third day of operation, this customer ran 65 samples on the ProCyte. While this is a neat story of an unusual practice, it illustrates ProCyte extraordinary throughput, start up ease and robustness at the high end of the market. ProCyte is an important component of our strategy of offering an in-house lab that can produce real-time lab results or what we call real-time care.

Chemistry and hematology, although quite different in underlying technologies, typically go hand in hand in the veterinary blood test panel. To remind investors, 90% of chemistry panels sent to the reference lab include the hematology or CBC. On the other hand, our (inaudible) [in house] customers only 50% of chemistry panels include a CBC. ProCyte Dx helps make the in house CBC more convenient, timely and of the highest accuracy and greater value relative to preparing that sample to send to the outside lab and waiting for results.

ProCyte is thus a volume driver for IDEXX, as it drives more CBCs run with chemistry panels and it may stimulate more in-house testing in general.

ProCyte is important, but it isn't the only element of our strategy to drive real-time care. Of course our Catalyst chemistry analyzer continues to excel in terms of field experience, as you can see in our gross margins. We also are continuing to place the [VenTest] chemistry and LaserCyte hematology analyzers, lower entry cost options for real-time care. And we continue to make Catalyst an even faster and easier analyzer.

On October 1 we launched a new consumable for Catalyst, the whole blood separator with lithium heparin. This advancement of eliminates another sample preparation step that every other chemistry instrument and the reference lab requires. They need to put the blood draw for a chemistry panel into a special tube, mix and centrifuge it, or wait 20 minutes for it to clot before it can be run. This new whole blood separator gives Catalyst a unique draw-and-go capability, which makes Catalyst the only true whole blood chemistry analyzer with no sample prep.

The new whole blood separator is a neat advancement available to all Catalyst owners, whether they bought their instrument at launch or just yesterday. In other words, our analyzers just keep getting better.

As in past calls, I indicated we have several other smaller launches that will also facilitate real-time care in the veterinary practice, and the new Catalyst whole blood separator with lithium heparin is only one of them. In January we will introduce an advanced thyroid assay for a SNAPshot Dx that is easier, faster and more convenient to use. Thyroid test disease screening using a test for total T4 is another core component of a diagnostic profile, particularly for sick or older patients.

Over half of the chemistry panels that go to the reference lab include a total T4 test. And our next generation in-clinic assay for a snapshot Dx will make it easier to run a total T4 and get the results at the time of the patient visit.

Speaking of SNAPshot Dx, we will also be adding to the instrument at the end of the year the capability to read and interpret other key SNAP -- another key SNAP test in our rapid assay line, heartworm, along with some ease-of-use improvements running SNAPs on the analyzer. I will admit that getting to this stage with SNAPshot Dx rapid assay capability took longer than we anticipated. However, now with heartworm SNAPTest added, we will have completed the enablement of SNAPshot Dx to automatically run the core set of our manually interpreted SNAP kits including K-9 4Dx in heartworm, Feline Triple and Combo and our SNAP test for canine pancreatitis.

This new SNAPshot rapid assay capability gives our customers the convenience of automated timing, interpretation and electronic capture of the diagnostic result at the point of care for inclusion into the client diagnostic report that may be presented at the time of the patient visit, the practice's electronic medical record and for automatic addition to the client's invoice. The latter feature, the auto charge capture, has proven to drive our customers' revenue growth and profitability by eliminating lost charges that result from manual processes.

With the improvement in SNAPshot for both thyroid and SNAP interpretation, this instrument will become an even more compelling addition to the IDEXX VetLab Suite and thus differentiates and adds value to our overall in-house offering. It is a great example of our strategy of integration is becoming a powerful differentiator by helping practices grow their revenues and increase their efficiency and profitability, even without any help from the economy.

With all of this in-house testing capability, we wrap it all together for our customers with real-time care protocols which are rebate based incentives to expand the science of the in-house panel run on a patient. We have moved to full implementation in October expanding these protocols' availability from 1000 customers to over 5000 in the US. Of course they are supported by our touch-based PC and a touchscreen called IDEXX VetLab Station and SmartService, the real-time Internet connection between the customer's in-house lab equipment and IDEXX.

By the way, we expect to have 7500 SmartService customer connections by the end of the year, up from the previous forecast of 6500, which is a sign of how popular this service is, and you heard from Merilee that with our continued impressive placement of IDEXX VetLab Station.

In October we rolled out two additional real-time care protocols, expanding the incentives for our customer to have a mix and match of expanded customized test panels that fits the patient need, and helping us drive both growth and utilization of the installed base and new equipment placements.

Turning to the reference labs, as investors know, we continue to advance our strategy of developing specialized tests that can be offered through our lab channel. These tests can augment the veterinarian's arsenal of routine disease screening tools, thus detecting disease earlier while they can be better addressed medically, helping to grow practice revenues through follow-on care.

On the human side, think for example the PSA test for prostate cancer and the follow-on medical services that would result from a positive finding.

The most significant on market specialized test that we have launched on the veterinary side is our cardiac test, Cardiopet proBNP. During Q3 Cardiopet proBNP testing growth in North America and nearly doubled from the same quarter last year fueled in part by the successful launch of our national feline cardiac health study. We initiated this study in the second quarter of this year in order to give practices an opportunity to better understand the prevalence of feline heart disease and to quantify how Cardiopet proBNP, when added to the current blood screening protocols, can provide veterinarians with a more comprehensive screening tool that advances patient care and overall patient health assessment.

We are pleased that over 2500 practices are now enrolled in the study, up from 1000 at the end of Q2. The initial results of this very large study are confirming earlier published studies that reported somewhat that [cold] cardiac disease in cats is in the order of one out of every six cats. We plan to continue this study through the first half of 2011 and publish the results.

I would like to turn to our water business where we had three developments in the third quarter that augment our water microbiology testing franchise. First, we recently received approval in the US for fecal coliform testing using our core product Colilert. As background, some wastewater plants test for this subset of coliform bacteria using the traditional, but cumbersome, membrane filtration system. They can now use Colilert to increase their efficiency. Also, labs that test both wastewater and drinking water can now use the same Colilert platform for testing, an operational benefit uniquely offered by IDEXX.

We also launched two new products. The first, Pseudalert, tests for Pseudomonas, the nasty germ that is typically associated responsible for swimmer's ear. Pseudalert is used for testing pools and spas and bottled water.

The second product launch was Enterolert-DW, another drinking water test for the European market. The new approval mentioned above and the two product launches, while each small in scale, help our core customers standardize their labs on our test technology for different applications, increasing their loyalty to IDEXX technology and making us a more attractive option for new customers. It's all part of the process of bringing intelligent innovation to the water business to support mid-single digit growth of this high margin business as the economy eventually picks up.

In our livestock and poultry diagnostics business, as Merilee mentioned, we launched our first SNAP for bovine diarrhea -- bovine viral diarrhea detection in cattle, part of our strategy to generate more value in testing by providing tools for livestock veterinarians and their clients. These tools allow veterinarians to get quick answers efficiently such as checking cows before they are to be purchased.

Finally, our dairy business also launched a couple of new products in Q3 to reduce testing time, alleviate workflow issues and improve our competitive position in the marketplace. In summary, we're executing our strategy of growth through innovation not just in our Companion Animal Group, but across our entire portfolio.

Before we open the call to Q&A, I would like to offer that we remain devoted to the development of a strong pipeline of additional new product growth drivers for our business in the years to come. In the meantime and while the economy has been languishing, we are reporting pretty respectable organic growth and making sustained progress in improving the margins through permanent efficiency gains in our business.

Well, I think we're ready to open the call for questions.

(Operator Instructions) Ryan Daniels, William Blair.

Jon just a quick follow-up question, I thought it was interesting when you talked about the data in growth performance of your clients using Cornerstone being kind of flat to maybe modestly up, versus what we're seeing in the seeing in the rest of the industry being down between 3% and 5%. I'm curious if you have or if you have considered using that as a marketing pitch for your sales force to get out there and kind of drive the value of your protocols and your innovation.

Ryan, in fact we put back data together for our Cornerstone users' conference. We had a record number of attendees at that conference, over 400. It was up 65% year over year from 2009. Obviously the economy didn't help us there, but I think people are more and more interested in learning how Cornerstone can drive their practice growth. And so the original incentive to actually look at that came with marketing in line and then we thought we would share that with investors.

Great, that's helpful. And a question on ProCyte, obviously it sounds like a very good launch thus far. And I'm curious; you kind of alluded to this a little bit, but curious if you're seeing any of the hematology business maybe move away from the reference labs to the point of care. Or is it just kind of an augmented testing, that more the point of care chemistry is also bundled with hematology now, whereas before it was not done that way as much?

I think the first thing is that ProCyte relieves the bottleneck for real time care because of its incredible throughput. And of course the level of accuracy is unprecedented in hematology. And when you're running a blood sample fresh, you aren't in any danger of any degradation that happens with the blood cells over time.

So I think the first driver that ProCyte will have for our business is more CBCs run with chemistry panels. It's just so easy to do so. I think it also makes our entire VetLab offering more attractive for new customers.

It enables real time care. We believe real time care is an important component in the new economy. Gone are the days that consumers will just accept a veterinarian's recommendation regardless of cost. I think they need to see some of the value that they are getting for those recommendations.

And one of the benefits of real-time care is, it is very obvious the value because you have a conversation right at the point of care and you have an immediate follow-up plan if there's any kind of issue. And if you don't, you see what you're getting for your money in doing that testing.

And so, I'm not sure we're seeing that in the numbers yet. We've only placed 154 of these units. It's really a drop in the bucket in terms of the total veterinary market. But the hypothesis here is that this will be a nice driver for a point of care testing.

Very helpful. And then I guess a quick follow-up there on the real-time care; I think you mentioned you had 1000 in the program now on the kind of real-time care protocol rebates. Can you give us a feel with what kind of volume increases you're seeing on the consumables side for them and maybe any expectations as that rolls out to 5000 and continues to grow?

I think it's like everything in the veterinary world is evolutionary. It takes a while for customers to understand and adopt. And so I think it is probably too early.

I think they're being well received. It's part of saying don't just run a chemistry. Run a CBC, and electrolytes and a T4 or -- if you've got a -- a patient is not doing right, maybe a pancreatitis test to rule in and rule out. So this is really just driving the overall growth. I don't think we're -- really have enough experience to have any kind of actual numbers there.

Okay, fair enough. And then two real quick ones and I will hop off. Just in regards to 2011, I'm curious if there's any big CapEx or if you still think free cash flow is going to be a similar percent of net income.

And then the second kind of guidance related, the 6% to 8% organic, which is an acceleration, kind of -- can you define how much of that is your expectation of a better macro and maybe how much of that is really just the innovation driving it? Thanks.

Hi Ryan. It's Merilee. I'll take those. On the CapEx side we haven't completed our capital forecast yet for 2011. I'll start out saying that.

But I think just as we look at the big themes, we wouldn't see any significant changes there. So I think probably free cash flow will be somewhat along the lines of what we're projecting now for 2010.

And as far as the uptick in the organic growth for next year, we're attributing probably say 1% of that growth to come from the economy. But when you look at the growth rates, particularly the organic growth rates that we're projecting for the second half of the year, implicit in the guidance for 2011 organic growth is about a 3.5% growth in organic growth in the second half of 2010 to what we're projecting for 2011. So the majority of that is coming from innovation, from the products that we have launched currently and other things that we will be continuing to launch.

So, just in summary, about a point or so from the economy hopefully and the balance (multiple speakers)

And 3.5% would be at the high end of our organic growth target.

Correct.

Great. Perfect color. Thanks guys.

David Clair, Piper Jaffray.

I guess the first question for me from me, it sounds like you continue to gain accounts on the lab services business. I'm just curious; are these competitive instrument account wins as well? I guess what I'm trying to get at here, is bundling driving the account wins?

Well, I would like to think it is our technology and great sales force execution that is driving account wins. I don't think -- Our experience is that people don't value what they are getting, then a marketing program isn't going to save the day here. You have a [core] -- first and foremost, you've got to have an attractive product offering and service offering in the case of lab services.

Okay. And then just real quick on the guidance, any chance you can give us initial targets for Catalyst Dx and ProCyte?

I think we're going to just hold off on that until January, David.

Fair enough. Merilee, sorry, I missed the consumables number. Can you repeat that for me?

Are you looking for the dollars or what are you looking for exactly?

The dollars this time.

$57 million, organic growth of 3% or 4% when it's normalized for changes in distributor inventories.

Jonathan Block, SunTrust Robinson.

Thanks, good morning guys, and certainly want to lead with you guys have done a great job of getting growth out of an industry that is clearly in the midst of tough times. First question, Merilee, maybe for you. On inventory I want to make sure I heard you right. I think you said you ended the quarter with about 4.2 weeks in the channel. Is that correct?

That's right.

Okay. And then I thought you said that's normal. And if I remember correctly, my history with IDEXX, normal in the channel was three to four weeks. Four was always at the high end. So is the new normal north of four weeks?

Well, I'm saying 4.2 weeks is essentially at the high end of the three to four-week range. And what we have seen I think in the last several quarters is that the inventory levels have been hovering at closer to the four weeks than the three weeks. So we have noted that internally that there seems to be a little bit of a tick up there. Again it's nothing particularly meaningful and we certainly feel that those levels of inventory are normal and healthy.

Okay, but nothing that you guys are doing, discounting or anything, to sort of inflate the channel?

No.

No.

Got you. And then just on the FTC, Jon, I know that you're probably a little tightlipped on what you can or can't say, but can you tell us anything that you can say there?

No. We're really in a status that is unchanged from our prior calls.

Which is we're still awaiting the next update and that might be three to six months?

Yes, it's really hard to predict. There's no particular process for the [FDC] to conduct their investigation and so we don't really know when they'll conclude it. Obviously the third quarter we spent some money producing documents, which is an expensive endeavor in this day and age with electronic documents and everything.

Understood. And then maybe to just shift gears a little bit. Rapid assay clearly you're seeing the pressure on the (inaudible) you guys continue to do a great job of holding in 3Dx, 4Dx. When you provided '11 guidance does that assume any incremental competition on other assays? I don't think your going to get it on the multi-analyte platform, but I think there will be a competitor out there with other indications.

I guess sort of, again a twofold question. Are you assuming more competition there? Or do you just think even if it comes, it's not going to have an impact because you are insulated on your multi-analyte platform?

I would say that we're confident of the position of our NDx, 3Dx and 4Dx. And that is a great platform. It's a unique set of technologies. These are tough diseases because there can be a lot of interference from vaccines and other things that other diseases get around and we have a great franchise.

Perfect. Fair enough, guys, I'll circle back.

Dawn Brock, Kaufman Brothers.

Good morning everyone. So, Jon, I just wanted to do again a little bit. The adoption rate of ProCyte, as Merilee stated, was ahead of expectations for the controlled launch. I was hoping you could talk a little bit about what your expectations were.

Was the upside based on kind of these new and competitor accounts, whereas on your original thinking you might have relied on existing relationships for your original estimates? And then second to that, have you been able to -- and this has sort of been addressed with one of the earlier questions -- but have you been able to better measure whether there is a consumables utilization link between Catalyst and ProCyte where hematology is specifically driving chemistry testing or vice versa? And maybe thirdly, you mentioned that you had some international interest. Could you just give us an idea of what the breakdown was in the initial stage?

Okay. I have to remember all those questions. Remind me of the first one again.

The first one was expectation for the controlled launch.

And (inaudible) placements.

Exactly.

I would say we're -- we had a nice mix of existing customers. Sometimes they go with a Catalyst and they're upgrading an existing customer to Catalyst and ProCyte. Sometimes they go with somebody who has already got a Catalyst.

Sometimes they go into competitive accounts. I think the mix was 70/30 of IDEXX versus competitive accounts, so 30% are competitors.

ProCyte does get us into a segment of the market that does have a higher volume need for CBCs and values the incredible precision, accuracy and speed to result at higher end practices where they had to have two LaserCytes. So it was a little harder for us to have a compelling value proposition, so we feel pretty good about that.

And what's interesting is we will have blanketed the high end of the market. There is absolutely nothing that compares to ProCyte in the high end of the market. Of course because of the full VetLab and integration with Catalyst and IDEXX VetLab, you get the chemistry along with it.

Second, with regard to utilization, anecdotally we've seen a pickup. We would expect to see a pickup in testing overall because we are really relieving the workflow bottleneck by introducing ProCyte. Catalyst was fast and our historical hematology platform, as good as it was, wasn't able to keep up with Catalyst. And now ProCyte basically solves that problem and so -- with a lot of other benefits that ProCyte has.

As we would expect to see -- I think it's too early to say that because we made placements over the course of the quarter. We really just don't really have enough experience to put some analysis behind that. But it's our strategy. It's our hypothesis.

Third, with regard to international, we expect that there is an international market for ProCyte. The vast majority of our 154 placements were North America. So we're really still in the earliest phases of our international launch with ProCyte.

I will say that given that ProCyte is, from a North American perspective, even more attractive to moderate to higher size practices, international practices general in general are smaller than the US. So I think one of the benefits we could see with ProCyte is we take LaserCytes back in trade and then we can replace them at a lower costs in international markets and get a second order benefit there.

But we will. There are large practices internationally. Some international markets do even place a higher value on precision and accuracy.

And of course it's just -- ProCyte -- one of our attractive markets for ProCyte is universities. We're placing them and they love them. We had one university, their hematology analyzer went down. They went to ProCyte as their core testing and had no concerns about doing that. So, it's good.

That's great color. Merilee, I was wondering whether or not you would be even remotely open to giving us a ballpark range of the initial margin for ProCyte?

Yes, surprisingly maybe. We've talked about that ProCyte would have -- it would probably be really the higher end of our normal instrument gross margin. You can look at that. Our instrument gross margins average anywhere from probably 25% to 30%.

That's excellent. And then on the lab side, I think it's obviously very -- it stands out that you guys are able to put up organic growth in the high single digits. I'm curious from a client perspective whether or not you're seeing greater adoption of you as a provider with smaller practices, or whether or not your focus is still on kind of the larger corporate accounts.

I think it is really across the board, Dawn.

Okay, that's fair.

For example, our international lab business, they're all smaller accounts and we're growing that business, too, so.

Okay maybe in the US?

Yes. We had good growth in North America and that's not a [few] -- that's kind of a broad based thing.

Fair enough. And then, just lastly, could you give us an idea? I know that every administration is different. But could you give us an idea of the timeframe that for the last few investigations with the FTC just how long it took from the time you received notice to the time that you were actually able to close the investigation?

I think -- you never know when these things open because usually -- we've been actually -- really talked about this thing earlier than most companies would. Just we felt it was important from a disclosure matter to let our investors know. But I think it's hard to predict the timing.

We do feel confident in our position and we wouldn't have [added] our practices over the years without having that confidence. So we're very confident in our position, but it's hard to predict the timing and whether the FTC will do anything and when they'll do it. I don't think there's any particular timeframe for this.

And just to clarify on that in case there is -- I don't want there to be a misunderstanding. This is the first and only investigation we have had by the FTC. The other times that there have been questions about this matter of distribution were under the Sherman Act.

And that was private litigation.

It was a completely different process.

No, that is well noted. Thank you very much.

Miroslava Minkova, Leerink Swann.

Congratulations on another solid quarter. Let's talk a little bit about organic growth. I appreciate the commentary you made on the call and all the color about the acceleration you're expecting in 2011, but help me understand a little bit. When I look at your organic growth trajectory for the last three quarters, it has been decelerating. Yet you expect -- your comments seem to be a little bit cautious on the market overall and yet you seem to expect an acceleration in 2011. Can you help me understand a little bit further how you're thinking about that?

Yes. Thank you for the comment and the question. And I think that is a correct observation. We really see our strategies, particularly the instrument strategy, the launch of ProCyte which was really a limited launch and a learning quarter, as an example. And then the consumable revenue that will come from that and the incremental consumable revenue that comes from our overall instrument placements are going to be a component of growing growth.

As Merilee said, we've got an expectation of a very, very modest improvement in the economy in 2011, and so that is a comment -- that is a component. And then really it's a lot of little things in other businesses that are contributing to an expectation of a couple of points higher organic growth in 2011 than 2010. Merilee, do you have anything else you would add?

I think that answers it.

That's why I wanted to comment that we really have innovation across the entire portfolio and it's a lot of things, a lot of little things that add up.

Thank you. And the gross margin you're still guiding to 52% for the year, yet you've been running well ahead of that for all of the past three quarters. Why so conservative on the gross margin, Merilee?

The gross margin is -- it's really driven by revenue mix in the fourth quarter with that being the strongest capital quarter. And as I just indicated, the instrument gross margins are lower than our Company gross margins. So that's what drives it. And I think if you look at history you would see that that is fairly consistent.

Finally, ProCyte, how prepared are you with your sales force to support the full launch? Your comments seem to imply a little bit that maybe some of your other instruments suffered a little bit in the third quarter because of your focus on ProCyte. And now we're heading into the fourth quarter, which is the strongest quarter for instrument selves in total. How prepared are you to handle both ProCyte and maintain the growth strategy of your other offerings?

Another great comment there. The real issue in third quarter with ProCyte is our sales force had to learn how to -- learn the product and learn how to sell it. It wasn't -- typically we would do our full training at the beginning of the year. This was a midyear launch, so we had to take some time to teach them to sell it and then they had to get confidence in that.

All of that happened in a very short quarter. And I think we've achieved all of those objectives now. I think they feel very confident. I think they feel very trained. Of course it improves the Catalyst story, too.

We continue to succeed in areas of SmartService and the IDEXX VetLab Station. So, there was a -- this was a very significant new instrument launch and there was a learning curve, a training curve that was a component. And yet despite that, I think we had impressive results in ProCyte placements.

And so it is not an easy capital environment. I'm not saying it's easy. It's not an easy economic environment. Maybe people feel slightly better today because the stock market is up than where they were six to eight weeks ago. But we always get a lot of enthusiasm momentum for fourth quarter because it is the primary capital quarter, the capital placement quarter of the year.

Great, thank you. Just one more. I just want to make sure that you're not seeing any further deceleration in the market. Your competitor yesterday seemed to -- their comments seem to imply that they saw a little bit of deceleration versus the prior quarter. Is that true? Is that the right way to look at it?

I think as Merilee said, we thought that the third quarter was really within the range of error, not different than the second quarter. It's hard to refine these too much.

Great. Thank you so much and congratulations on the quarter.

Ross Taylor, CL King.

I think you covered almost everything, but a couple of simple questions left. First, with regard to the SNAPshot, I don't think you've given us an update of your installed base anytime recently. And I just wondered if you would be willing to share those numbers with us.

We have just under 3700 SNAPshots.

And then the enhancements you're planning to make in January, is that to the SNAPshot instrument itself, or is that to the T4 snap kit? Or can you elaborate at all on that?

It is to both, actually, both the software [of] the instrument. So these improvements will be available to the entire installed base that we just gave you the number to.

Also, it is an -- for the T4 itself, because of course you've got an instrument and you have a set of assays. SNAPshot runs some quantitative amino assays, the T4, of course (inaudible). It also provides an option for an instrument interpretation of the manual assay.

So a 4DX can either be interpreted manually or it can be stuck in the instrument, timed, interpreted and recorded electronically. Take your pick. So those improvements will be available to the entire installed base. But the assay, the T4 assay will actually be a new assay combined with the instrument that will give us the capability that I discussed.

Just two other questions, how much more opportunity do you all have to open new day labs or expand your geographic service coverage for the reference labs, whether it is the US or the international markets?

We think there's a lot of opportunity around the world and North America.

Okay. And sort of any specifics on timing? Can we kind of expect to see some occasional openings like the one in Cincinnati you just mentioned?

Yes. I think that is more of the same.

Last question. I think Merilee mentioned the milestone payment is being recorded in the other revenue line. If that's the case, I know this is a small revenue item for you all, but it looks like that revenue probably have negative organic growth in the quarter. It had been growing pretty strongly. Am I, number one, interpreting that correctly? And if so, is there any reason for the deceleration or slowdown this quarter?

Let me first just clarify. The payment was included in G&A (inaudible) segment. It wasn't included in the revenue line.

That explains it, then. Thank you. That's all I have. Thank you.

Thanks Ross.

And Mr. Ayers, I will turn it back over to you for any closing comments.

Thank you all for your attention on IDEXX. We feel good about the quarter, we feel good about our strategy and we look forward to updating everybody at our January call as we complete the year and look forward to 2011. That concludes our 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.