愛德士 (IDXX) 2011 Q3 法說會逐字稿

Good morning, everyone, and welcome to the IDEXX Laboratories third quarter 2011 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 Pete Levine, 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, believes, 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, 2011, and annual report on Form 10-K for the year ended December 31, 2010, 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. Also during this call, we will be discussing certain financial measures not prepared in accordance with Generally Accepted Accounting Principles or GAAP. A definition of these non-GAAP financial measures is provided in our earnings release, which can be found on our website, idexx.com. Finally, we plan to end today's call by 10 AM Eastern, and in order to allow broad participation in the Q&A, we ask that each participant limit his or her questions to 1, with 1 follow-up as necessary. We do appreciate you may have additional questions, so please feel free to get back into the queue and if time permits, we will be more than happy to take your additional questions.

I would now like to turn the conference over to Merilee Raines. Please go ahead.

Good morning, and thanks for joining our call today.

The quarter's financial performance overall was largely in line with our expectations at the time of our second quarter call in July. Our third quarter revenues of $301 million grew organically 8%, after adjusting for a 4% favorable impact from currency. The mix of revenues was somewhat different from our thinking back in July, with relatively stronger performance in our VetLab instrument placements offsetting somewhat lighter performance in our digital radiography and practice management product lines. Diluted earnings per share of $0.66 were slightly above our expectation, due largely to the receipt of the final balance owed to us a just over $1 million for inventory sold when we divested certain pharmaceutical product lines at the end of 2008. This payment, which contributed $0.01 to earnings, was recorded as reduction to G&A expense. Beyond this payment, lower operating expenses offset a slightly lower gross margin, primarily a function of revenue mix.

Our organic revenue growth performance continues to get little to no benefit from the macroeconomic environment. Our internal gauge for the vitality of the US companion animal health market, practice metrics from a consistent subset of veterinary clinics who use our Cornerstone Practice Management System, shows that in aggregate, patient visits were flat year-to-year in the third quarter, and practice revenue growth was about 3%. This is ever so slight an improvement from what we observed in the previous 2 quarters, when patient visits were down 0.5% and practice revenue growth was about 2%. In our view, this indicates a market that continues to stabilize and reaffirms our belief that improving trends will be very gradual. Though Europe has its own set of fiscal and monetary issues, our Companion Animal business in that region had strong performance in the third quarter, with organic revenue growth of about 10%.

Now for some further detail on revenue performance in some of our businesses. Our IDEXX VetLab instruments and consumables, with third quarter revenue of $99.7 million, posted organic growth of 9%. Sales of instruments in our IDEXX VetLab's suite, at $24.8 million, grew organically 14% year-to-year in the third quarter, a 9-point increase over our second quarter instrument organic growth. Our ProCyte and LaserCyte hematology placements increased 38% year-over-year, and our Catalyst and VetTest chemistry placements increased 19% year-over-year. Once again, ProCyte with third quarter placements of 279 units, was a significant contributor to our overall instrument growth. With year-to-date placements of nearly 800, we are well on track to exceed our initial 2011 target of 1,000 units by 10% to 15%. LaserCyte placements were also solid, up 16% year-to-year, and roughly two-thirds of those placements were instruments that we had taken in trade and certified for resale.

We were very pleased with the placements of our chemistry instruments, Catalyst and VetTest. Combined placements of nearly 1,100, when added to our first half performance, keep us on track our full-year projection of 4,000. We placed over 700 Catalysts, a nearly 40% increase over the third quarter of last year. While placement performance was strong in all geographies, we were particularly pleased with the 44% growth in the US, which we believe is a function of increased sales force effectiveness and more effective marketing programs. About 30% of both ProCyte and Catalyst placements were to new and competitive accounts.

We continued to see growth in our SmartService users, with over 1,200 installations in the third quarter, which brings our active install base to over 10,700 customers. We expect to have approximately 12,000 customers on SmartService by the end of the year. This is important because, in addition to SmartService providing us with real-time data on customer testing activity in support of our incentive programs for customers to a larger profiles per patient sample, this Internet connection between IDEXX and our customers enables us to monitor that instruments are performing optimally, which is a key requirement in support of real-time care. Instrument consumable sales of $63.3 million grew organically 7%, or 8% when further normalized for changes in distributor inventories. This normalized growth is consistent with what we've been seeing this year and is about double the normalized organic growth rate for last year.

Our third quarter rapid assay sales, up $36.1 million, showed flat organic growth with the prior year. When normalized for changes in distributor inventory levels and the estimated timing between quarters due to marketing initiatives, revenues grew on par with the approximately 2% we've experienced during the first half of this year. The step up from the modestly negative growth rates we experienced in 2010 continues to be driven primarily by increased canine parasitic disease testing volumes, as well as the successful worldwide launch of our SNAP feline pancreatitis test in the second quarter. Offsetting these areas of strength is the weakness we have been seeing for some time in feline testing, reflecting -- reflective of year-over-year declines in patient visits for cats. US distributor inventories for instrument consumables and rapid assays averaged just under 4 weeks at the end of the third quarter, a level we consider normal and customary. Our Reference Laboratory and Consulting Services business, with revenues of $94 million, achieved organic growth of 10% in the third quarter, consistent with the first half of the year. Growth was strong across all regions, and the majority of the growth came from higher test volume, driven primarily from the addition of new customers.

We have continued to expand our worldwide lab footprint, supporting the goal of strengthening our service levels, and we recently opened a new day lab in Houston and have expanded internationally through a new day lab in Seoul, South Korea. During the quarter, we also consolidated 2 of our labs in South Africa, which brings the total global network to 52 labs across 5 continents. We plan to open additional labs in the fourth quarter of this year.

In addition to the operating margin benefit we derived from increased testing volumes, we continue with other operating initiatives to increase lab margins. In the third quarter, our Canada labs in particular showed strong year-over-year improvement, as we benefited from structural changes and lean processing initiatives. During the quarter, we expanded our core lab in Memphis, adding significant capacity by tripling our lab square footage at that location. This facility expansion will allow us to further consolidate night testing in Memphis and take advantage of scale economies. At this facility, we also have plans to take advantage of automation, advanced lab technologies, and lean processings to drive further efficiencies.

Our practice information management and digital radiography systems, with revenues of $18.3 million, grew organically 11% year-to-year. As noted up front, this performance was just a bit below our expectations in July, leading us to now project full-year organic growth in the low single digits. Order books are strong going into the fourth quarter, a reflection of the innovations we continue to introduce in both product lines, and Jon will expand on some of these in his comments. Our livestock and poultry diagnostic revenues grew organically 10% to $20.7 million in the third quarter. This growth was in line with our expectations and reflected a continuation of higher sales volumes from the eradication programs in Germany that we have discussed in earlier calls, as well as strong gains in smaller emerging markets, such as Latin America and Eastern Europe.

As anticipated, growth did moderate from the approximate 20% rate achieved in the first half, due in part to a decline in BSE testing, as countries begin to adopt the new EU rules that increased the mandatory testing age for BSE from 48 months to 72 months, which was effective July 1. For the full year, we continue to expect organic growth of about 10%, which implies relatively flat growth in the fourth quarter, due to 2 factors. First, we expect sales growth associated with the bovine testing programs in Germany to level off, because the programs ramped significantly in the fourth quarter of 2010. And second, we anticipate further price and volume declines for BSE tests. Our water business had sales of $21.6 million for the quarter or 4% organic growth, which is reflecting gains in our core Colilert testing business in Latin America and Europe. Third quarter growth was in line with our thinking and consistent with our expectations for mid-single digit full-year organic growth.

Turning to the rest of the P&L, as mentioned up front, gross margin at 53% was slightly lower than anticipated in July, as placements of in-clinic analyzed -- analyzers with relatively lower growth margins were a higher portion of our revenue mix. Operating expenses, at 34% of revenues, were also somewhat below our thinking in July, due in large part to the receipt of the farm inventory payment, which I also mentioned earlier. In addition, lower health care costs, for which we are self-insured, lower and discretionary spend were modest contributors. Our effective tax rate of 30.8% was in line with our expectations and a bit below the previous 2 quarters, due to the release of reserves in conjunction with the expiration of certain statutes of limitations. Share count was also largely in line with our expectations for the quarter.

Turning to the balance sheet and cash flow, we ended the quarter with $182 million of cash and $158 million of debt, for a net cash position of $24 million. Our inventory balance of $137 million was approximately $3 million higher than the end of the second quarter, as a result of chemistry consumable receipts. We expect inventory levels to come down $3 million to $4 million in the fourth quarter. Days sales outstanding, at 43 days, remains in good shape, and our free cash flow was $65 million or 168% of net income.

Looking forward, we project full-year revenues of approximately $1.215 billion. Our revenue guidance implies 10% reported revenue growth, which translates to organic growth of approximately 8%. Though organic growth is unchanged relative to the high end of our outlook in July, the components of this growth have changed slightly, with somewhat higher revenues expected from instruments and consumables and somewhat lower revenue from our digital radiography and practice information management offerings. We continue to project gross margin to be approximately 53% of revenues and operating expenses to be approximately 34% of revenues for the year. We are increasing our full-year EPS projection to $2.71 to $2.74, compared to our July guidance of $2.68 to $2.73.

The $0.01 increase in guidance at the high end of the range reflects the $0.01 of favorability related to the inventory payment in the third quarter. We believe that the business performance in the fourth quarter will be able to offset the anticipated $0.01 of expected unfavorability related to currency. For a little bit more detail on currency, the rates implicit in our guidance today are the euro at $1.35, the pound at $1.55, and the Canadian dollar at $0.97. To remind, every 1% weakening of the US dollar vis-a-vis our basket of currencies increases revenues by slightly more than $4 million and operating profit by about $750,000 on an annual basis.

As we look to 2012, we project revenues to be $1.295 billion to $1.315 billion, a year-to-year increase of 6% to 8% reported growth or 7% to 9% organic growth and earnings per share up $3 to $3.10, a reported growth of 10% to 15%. With regard to currency, our 2012 guidance assumes that currencies remain at the rates implicit in our latest 2011 guidance. As these rates reflect a relatively stronger US dollar versus the average for 2011, currency is expected to reduce our 2012 reported revenue growth by about 1%, as just noted. Similar to 2011, every 1% change in the US dollar versus our basket of currencies changes revenues by slightly more than $4 million on an annual basis. Because we have not fully hedged our 2012 exposure at this time, the impact of a 1% change in the US dollar versus our basket of currencies has a larger, $1.2 million impact on operating profit. Our customary practice is to layer in hedges over the course of the year for the following year.

Our projected revenue growth assumes only a very minimal and gradual improvement in the economy. We expect our organic growth to be largely driven by continued successful execution of our strategies to bring to our principal markets innovative diagnostic products, services, and information technology that provide valuable insights to our customers and help them operate more efficiently and to more effectively communicate the value of their services to their customers. We anticipate operating margin expansion in 2012, led by focused initiatives, many already underway in our 2 largest businesses, IDEXX VetLab and Reference Laboratories. The impact of these initiatives will manifest primarily in the gross margin line, and we will also continue to make targeted investments to drive healthy top line growth beyond 2012.

Our share repurchase program will generate earnings per share growth above operating profit growth, and as we are 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 in January. However, I will note that today's guidance for 2012 does not incorporate any benefit from the federal R&D tax credit, which is set to expire at the end of 2011. The credit has provided us with $0.03 to $0.04 of earnings per share benefit in each of the last couple of years.

Thanks, and now I'd like to turn it over to Jon with some further comments on the business.

Thanks, Merilee.

We've seen nice momentum in our business, both in terms of our products and services on the market and our new product pipeline. The strategy of our Companion Animal Group, which as investors know contributes 82% of the Company's revenue, is coming into sharper focus this quarter. Our customers, veterinary practices, can achieve growth in the current economy if they work to build their relevance and bond with their clients, pet owners. We see this clearly in the practice growth data.

First, our veterinary customers that use our Cornerstone practice management software, usually combined with some or all the elements in our diagnostic products and services, are growing their revenues from 2% to as much as 4% faster than other practices in the US. Second, the practice-by-practice variation is wide, 27% of our sample set -- and this is of 400-plus Cornerstone practices -- are growing at 5% or more year-to-date, and 12% of this sample set are growing 10% or more. This is not generally explained by geography. Instead it appears to be a function of the effectiveness of the local practice in generating growth in the intensity of care provided per pet served.

Our IDEXX products and services are designed to support practice growth and efficiency. One element of driving practice growth is the adoption of IDEXX tools that allow the practice to communicate to the pet owner the value of the medicine practice. Somewhat unique to veterinarian medicine, the pet owner pays cash for their pet's healthcare services and thus makes an economic decision on the level of that care. When the practice effectively communicates the value, the pet owner generally responds in accordance with the strength of bond with their pets, which is generally quite strong. And in this world, this new world of consumerism, this communication becomes critical to practical success. One of our strategies that allows that to communicate clear values, what we call real-time care, are the ability to provide immediately diagnostic results during exams, be they blood work or radiographs. The real-time care experience gets a wow reaction from pet owners and helps the practice stay highly relevant in this new, more challenged consumer economy.

A great anecdotal example of this is an article recently published in Healthcare Communication News entitled My Dog Has Better Medical Records Than My Daughter. It turns out the daughter -- the author had a wow experience at a practice that was fully integrated with IDEXX Diagnostics and Cornerstone software, was provided blood work results during the visit, and had made -- and the practice had made the move to [electronical] medical records and had given them a report card at the end of that visit. Unlike most of human medicine, in the veterinary world, the electronic medical record that a practice compiles during the course of the exam can also serve as the pet visit report, provided to the pet owner at the end of the exam before the bill is presented. This is the type of communication that inspires pet owners in this new world to make the wise investment in the health and well-being of their beloved four-legged companion.

In this light, we've achieved a number of objectives in Q3 and our Companion Animal Group. First, we were extremely pleased with the increase in the rate of instrument placements. Obviously, the use of our advanced instruments like Catalyst and ProCyte allows the practice to effectively and easily deliver real-time care. Our nearly 40% increase in Catalyst placements and the 38% increase in combined ProCyte and LaserCyte hematology instrument placements year-over-year has accelerated the growth in the base of customers who will benefit from the ability to provide comprehensive real-time blood work results.

So why the big jump in Q3? As I indicated in the July call, we have refined our positioning and redesigned our customer discount and incentive programs on new customer instrument sales, including the use of the real-time care protocol framework. Our sales organizations moved down the learning curve on how to execute this more medically-based sale. So, if a customer upgrades a patient's blood work from chemistry-only panel to a larger complete panel that includes electrolyte chemistries, as well as a complete hematology run, a combined 45 parameters in all, then they can earn a rebate from IDEXX once they have bought the new equipment.

This idea of providing increasingly attractive pricing as additional tests are added to the blood sample has been prevalent in the outside labs for a long time, so it is very familiar to veterinarians. The sum of the rebates that a customer can earn as they move to these larger profiles can offset the new monthly lease and maintenance costs of the IDEXX equipment. When a pet gets a complete diagnostic profile, the pet owner wins, the practice realizes a higher standard of care and a rebate, and IDEXX obviously wins, as you can see by the placement success. Also, early returns suggest that the customers that are using these protocol incentives increase the number of patient samples run on their new IDEXX in-house lab as much as 10% to 20% versus other customers. Even the reference lab wins, as we consistently find that test results discussed with the pet owner in person lead to higher compliance with recommendations for follow-on care, all types of follow-on care, but including tests that would be sent to the outside lab. In this way, testing begets more testing.

With this instruments marketing strategy, note that we are leveraging 3 unique capabilities of the IDEXX VetLab suite and the innovations we have brought to the market. Namely, first, the ability to run a complete chemistry, up to 22 parameters, and a complete hematology profile, with less technician hands-on time then it would take to prepare that simple to send to the outside lab. Second, the ability to easily and efficiently provide real-time results real time, during the pet owner exam. Our instrument turnaround time, our cycle time, is unique to IDEXX's system design. And third, the ability to monitor and track the number of tests run across multiple instruments on a single patient. We do this through our real-time SmartService connection with the in-house lab, again, a capability unique to IDEXX. Tracking as a prerequisite to awarding the rebate so as to identify the specific type and number of consumables used with the patient sample.

Our success with this approach to marketing instruments is obvious with our Q3 placement numbers in North America. We are very comfortable with our overall equipment placement goals for the full year of 2011, as laid out by Merilee, 4,000 chemistry systems, including both Catalyst and VetTest, and please note that we've not even had a meaningful Catalyst placement growth contribution from Japan. We do expect that Japan will ramp in Q4 as we begin to take advantage of the preparation and limited launch accomplishments of over the last six months.

Our digital business has launched a really exciting capability that supports real-time care and the communication of medical value to the pet owner during the exam, with the introduction of the iVision mobile app for iPad and Android tablets. We started selling this new mobile capability at the beginning of the month to much customer acclaim. The app allows a veterinarian to access digital radiographs generated seconds ago on their IDEXX system, real time within the practice on their mobile tablet.

Interestingly, the form factor of the tablet is uniquely suited to facilitating a one-on-one medical conversation between the veterinarian or technician and the pet owner. With the right integrated app on a tablet, a powerful conversation can be achieved regarding the health of the pet and the recommendations for follow-on care. A picture tells a thousand words, and a radiographic picture of a pet that can be zoomed or otherwise manipulated on a tablet is an effective device showing the medical value of the sophisticated medicine that is being practiced. In addition, the staff can order additional images right from the tablet app, as well as e-mail the images, a capability that leverages our internally developed digital pack software and its full integration with the practice management software. We are the first to market with this digital iPad and tablet capability.

Speaking of radiography, one of our businesses within CAG is IDEXX Telemedicine Consultant, our service that has a team of board-certified radiologists ready to interpret imaging studies on behalf of primary care veterinarians. We are the leader in this fragmented and small but growing market, and in the third quarter, we furthered our leadership with the acquisition of another telemedicine service offering called DBM Insight. It is a great little acquisition that will accelerate the already impressive growth of this line of business and extends the comprehensive nature of our diagnostic product and service offering.

Our global reference labs and consulting business again achieved 10% organic growth. During the quarter, we introduced the first molecular diagnostic test that provides a medically relevant quantitative result, used for the diagnosis of canine distemper. This is a great example of continuing innovation with new, unique, and value-added diagnostic testing capabilities. We have further innovations in the pipeline and expect to introduce a new menu on our existing instrument suite, on our SNAP platform, and also in the reference labs in 2012.

Finally, we are excited about the continued momentum of our flagship practice management software, Cornerstone. Placement volume has grown at mid-teens rate year to date and now the orders are up further year over year. We also just completed a highly successful Cornerstone users conference, with over 500 Cornerstone customers in attendance, up 33% from last year's conference and over 100% from 2 years ago. At the conference, we highlighted the exciting new features of our just released Cornerstone 8.2, features which help better communicate medical value to the pet owner while increasing practice productivity and efficiency.

So with these introductory comments, Cynthia, we are happy to open it up to Q&A.

Thank you. (Operator instructions) Our first question will come from the line of Ryan Daniels with William Blair. Please go ahead.

Good morning, everyone, and thanks for taking my question.

Jon, I wanted to go back to some of the commentary you provided on the strength in the instrument placements and some of the novel marketing initiatives that appear very effective. So, is it fair to say that the marketing pitch today is if you go out and upgrade equipment and do enough testing that your rebates will effectively offset the lease cost. So, the practice will generate more practice-level sales and margins, but in effect pay for the new equipment?

Yes. And the one addition I would add is, when you said run enough tests, I would say expand the profiles that they are running. So, obviously you see a bigger -- you see an increase in utilization per pet, if you will, or per pet sample. And then, you would earn enough rebates to pay for the new cost, monthly cost that you would incur associated with leasing the instrument and maintenance costs.

Okay, very helpful.

And then I guess it's my allotted follow-up, I just want to talk a little bit more about some of the R&D investments. You've obviously had some good announcements in the Cornerstone and digital radiography with the cloud and mobile solutions. I'm curious if you've begun to invest in any clinical decision support tools that might help vets more effectively practice real-time care protocols or perhaps ID high-risk patients for more diagnostic work, et cetera, as kind of the next level of driving more intensity of services, if you will.

Yes. I'd say, we are generally investing in that area and the digital application, I think is the first of a whole area. I would say where we see the real value is not just medical decision support, but communication support in that conversation. Because medicine that can be practiced but can't be communicated to the pet owner, where the pet owner therefore doesn't appreciate it and doesn't do it, then isn't medicine that's practiced. So, it is all up to the pet owner to decide yes, I want to do this.

And I think what vets are appreciating is that they are -- in some ways they are under attack. They are under attack by the Internet in all sorts of different ways, Internet pharmacies, looking on the Internet to self-diagnose pets. They are under attack by retail, and they've got to stay relevant. But they can stay relevant, because they have a relationship, that one-on-one relationship. We can give them the tools to really deepen that relationship. That increases their relevance, and as we've seen from the data, they can grow effectively.

There's plenty of demand by pet owners for care for their pet if they appreciate the value. That is really not the constraint here. The constraint is the appreciation of that value.

Thanks for that. That's helpful color.

Thank you. Our next question comes from the line of David Clair with Piper Jaffray. Your line is open.

Good morning, everybody. Thanks for taking my questions.

I guess the first one here from me, just kind of going back to the rebate, the incentives that you talked about. What percent of your customers are hitting the targeted levels that you are offering here? And then, where do you see this metric going in coming quarters, and is this something that you are offering to all your customers or just new accounts?

We have a -- this has evolved over time, and these are generally new account placement strategies. Although we have another form of debate that has some similarities to this that we had converted our customer base to in 2011, from a prior rebate structure that we had run for a number of years. So, there's really a lot of different flavors. But we see -- we are very excited by how this really inspires customers to advance the standard of care they can provide by really using the instruments as they were designed to be used. They can now run complete profiles -- full 22 chemistries, that's a good complete profile, and a CDC that is really not different than they would get from the reference lab. That's been the hallmark of IDEXX's hematology strategy for many years, and certainly augmented by the ProCyte. And so, what this does is it's the final step here to move them to in-house for standard first-line diagnostic testing.

Okay. And then just a quick one on the 2011 guidance. Typically, we see like 4% or more sequential revenue increase from the third quarter into the fourth quarter, and your guidance implies less than 1%. Just wondering if there's something going on there or, I guess, how should we look at that?

David, I think that the driver here in -- and it's top down -- we're going from pretty high growth in livestock and poultry to pretty flat growth in the fourth quarter, as I indicated. I think if you were to look at our Companion Animal lines of business, you'd see very consistent organic growth.

Okay. Thanks. Congratulations.

Thank you, David.

Thank you. Our next question comes from the line of Miroslava Minkova from Leerink Swann. Your line is open.

Hi, Merilee. Hi, Jon.

Hello, Miroslava.

Let me start with the economy, and I thought your comments were interesting, that you are seeing many more and gradual improvement in the economy, and yet we've been through some pretty volatile economic data here, at least from what we see. I was just curious, maybe if you could tell us, anecdotally, what you're hearing from the vets and what you're hearing from the customers. How they feel about their patients coming in and patient traffic. And what's driving your optimism that things are not going to get any worse out there?

I guess, Miroslava, thank you for the question. Let me start with the last one first. I guess what's driving our optimism is, like you said, there was a tremendous amount of economic volatility in the third quarter, stock market and other things, and yet our trends held and were ever so slightly improved over the first 2 quarters. So, they seem to be somewhat robust to the noise that we may hear.

We are hearing -- it is all over the map, in terms of what we hear from practices. But what we are hearing more and more is, okay, I get it. It is not going to improve that much. We're not going to wait for a turnaround. What can I do in my practice to be more successful? What can I do to take control over my own destiny, because the market is not going to help me? And then they are inspired when they see their colleagues who are effectively growing with those strategies, and so we see a slow and broader adoption of this change.

The veterinary profession, historically, never really had to worry about inspiring pet owners, because they just came in and they just asked for everything. Now they've got to move to -- it has become more of an economic necessity in the current environment, where the consumer is skeptical about everything, to communicate the value of the rather sophisticated medicine that they are able to practice. But of course, they are finding if they do so that the pet owner responds. And so, there's obviously -- there's practices in all stages of change that are going on, and we see it as incumbent upon us. And, of course, we're working with industry partners, too, to do that because the veterinary profession is our channel to the ultimate market, which is pet healthcare demand.

Thanks for these comments.

And then, the strong VetLab placements that we saw this quarter, I appreciate there's a marketing program which clearly are working for them, but what does this mean for the fourth quarter, Jon? Obviously, they were extremely strong this quarter. Was there any demand that perhaps was pulled into the third quarter that might have otherwise occurred into the fourth quarter? And then finally, my final question is, any updates on the SEC investigation? When would you hope to get it behind?

Okay so, we gave our guidance for the full year, which of course implies the fourth quarter. No, we didn't pull anything in from the fourth quarter to the third quarter with instruments. They usually get -- in fact, if anything, we had a little bit ever so stronger backlog going into the fourth quarter, although it was relatively small. We are very confident of the fourth quarter and the full year placements, based on the momentum that we have.

And then I did mention that what did not really kick in, in the third quarter was Japan for Catalyst. We are launching Catalyst in Japan. We had a limited launch to ensure a really, really good customer experience. Japanese customers are the most discerning in the world on quality, and it was a great limited launch, and we will ramp it up in Q4. So, we will get a little bit of benefit from that. So, we're very confident of our full year numbers.

With regard to the FTC, I have a couple of comments. First, we did receive a request for additional information in August from the FTC. We provided a response to that request. We have no reason to believe that the focus of the investigation has changed from really where it was been the whole time. Prior to this request, we had believed the FTC was getting fairly close to deciding on a resolution to the investigation. At this time, we believe the FTC has not made any decision and is still considering all the information that has received over the last 18 months.

I think it is fair to say that there is no particular process here. We cannot really predict how long the investigation will continue or how it will be resolved. As we've said before, we think we have many reasons -- we have a strong legal position, including the 2 federal court decisions in our favor on the same issue. As well as the obvious intense competition that we see in the marketplace, which benefits customers and tends to indicate that our distribution contracts do not foreclose competition.

I think there are many ways to access the market, and people are being quite successful. Our competitors are being quite successful, and I'll tell you, it is a very intense competition. Our strategy is to continue to innovate, and as a result of that innovation provide new value to veterinarians to handle the economy and to move the practice of medicine forward.

Thank you. Great quarter, and I will move back in queue.

Thank you. Our next question comes from the line of Jonathan Block with SunTrust. Your line is open.

Thanks, and good morning, guys.

Just maybe the first question on the 2012 guidance, Jon and Merilee. The 7% to 9% organic looks real solid, but the $3.05 mid-point, just back of the envelope, implies about 50 or so bps about margin expansion, versus prior years when you've gone 100 or north of 100. So, maybe, can you speak to a little bit on why that's the case. Because also, when I think to '12, you should have some of the big instrument placements that you've been experiencing in '11 alleviate, and you would think consumable would really drive the top line, which is higher margin. Maybe if you can speak to that dynamic. Then I will just also layer into that question, Merilee, does the '12 guidance also reflect the share, the accelerated share repurchase that you announced this morning?

Let me start with the last question first. Yes, we did announce that the Board had -- our Board of Directors had increased our share authorization by 4 million shares. This is something that we do typically as we find ourselves working through our repurchase program. So, it is not really -- we are not indicating with this that we are looking at any sort of acceleration in the program. More I would say a continuation of a program that's been quite consistent over a long period of go time now, with repurchase that reduces our weighted average share count by 2% to 3% per annum. So, I think that's what we are looking at here as we talk about 2012.

I guess one thing that I would say about the guidance, just to reiterate, because I know there were a lot of numbers that were mentioned, but we do not have in this guidance $0.03 to $0.04 of benefit from the federal R&D tax credit that, of course, we are experiencing in 2011. That's just something to keep in mind. But as well, I think if we -- that we haven't given all of the line item details for 2012, yet, for our P&L. I think that what we continue to target here, as we've said in the past, is something that on an annual basis you'd see 50 to 100 basis points of operating margin expansion over the next few years. And it will vary a bit from year to year, but that's about what we are targeting.

That balances the initiatives that we are getting out of our 2 major businesses, or in-clinic instrument VetLab business and as well our Reference Lab. It is going to show up in the gross margin line, but we are going to continue to make investments. They are going to be in product innovation. They are going to be in our commercial activities and things then, we are going to see those show up in OpEx. So, I think between the balance of those 2, we do expect that we are going to see some margin expansion. We will fine-tune all of that and share that with you more explicitly in January.

Just a follow-on, the opportunity to innovate is as exciting as ever. And of course, what that does is drive long-term growth and shareholder value creation. We balance that with the need to generate good returns on the investments we've made historically, as you would expect and you would see in margin expansion in our 2 big businesses.

The other thing, Jon, I would say is -- and I don't think it is any surprise to anyone -- we are in a world of pretty big uncertainty. There is, of course, the economic uncertainty around the world. There's currency uncertainty. You have the currency assumptions that Merilee gave that are implicit in our 2012 guidance. There is policy uncertainty. So, we are in a period of uncertainty, and we think the guidance is appropriate, given all the factors that we've just discussed.

Okay, very helpful. And I guess just other question. I guess, one of the other elements of uncertainty is the FTC, and I appreciate the update. Just to tie that back to maybe some of the rebates that you are offering. I guess the first question is, Merilee, can you just lay out for us how you're accounting for that? Is it netted out of the top line, or how that's literally flowing through the P&L?

And then the second one. Jon, is there anything to the fact that you sort of accelerate this rebate program ahead of an FTC decision, and clearly, if you get the instrumentation into a practice, that's going to likely make them a lot more sticky, even if the decision goes against you? Or am I just looking a little too far into it? Thanks, guys.

Alright, I will handle the accounting first. Yes, the discounts, they do get recorded in the top line. We allocate those discounts across both the instruments and the consumables, so there's a reduction in the stated sales price of both the instruments and then the consumables, as they are sold.

And that's been our consistent practice. We've always had marketing incentive programs, I think, as long as I can remember over the last decade, across our equipment and rapid assay business. And they are netted against revenues.

Our marketing strategies really have absolutely nothing to do with the FTC. They are just the right things to do from an innovation point of view. There's absolutely no connection. As I said, we are very confident -- and quite frankly, it is possible this thing could resolve in our favor, sooner rather than later. But I think the other scenario is, it doesn't resolve for a long time. I think -- but we are not -- we are operating in an environment where we are focused on competition, we are focused on innovation, and we are focused on a commitment to our distributors has been consistent with our strategy over a couple decades.

Great. Thanks, guys.

Thank you. Our next question comes from the line of Nicholas Jansen with Raymond James & Associates. Your line is open.

Good morning, guys.

Just a quick question on the practice information management system segment. Certainly, a little less than your expeditions for the quarter, and then the first half of the year was a little sluggish as well. I'm just trying to get a sense of what you're doing there to kind of reinvigorate the top line growth heading into 2012. Thanks.

Those are really 2 related businesses. One is the practice software business, and the other one is the digital radiography business. I think the weakness has been more in the digital radiography business. The practice management software business has performed very well. As I mentioned, the mid-teens growth in the Cornerstone placement revenue, although there are other elements of the Cornerstone -- of the practice management software, other components of the revenue, But that's the most the strategic one, because placements follow on relationship.

But on the digital side, I think the -- we are very excited about the new innovation that we brought in the mobile app, and that's really -- that really gets people excited. And it is something that we can do uniquely, because we've developed our own digital packs of software that's veterinary-specific. We didn't license the third-party software. We have developed our own. We have full control over that code, and it allows us to move -- and it's all in current technology code, all Java-based. And it allows us to move very quickly on software innovations that are not just on the surface, but fully integrated into the practice.

I think what's important here is it that you can do things quickly on the surface, but they don't really work very well in the practice if they are not fully integrated into the medical record and into the billing system. More and more, that is the standard, and we've been the leader in that area, and it allows us to introduce these new things like the digital app that are -- continue to have the benefit of that full integration.

Great. And just maybe on the international front. At the analysts' day, you did talk a lot about kind of the opportunities overseas. Is there any areas of strength right now that you are seeing on the placement side? And then, corollaries or any areas of kind of the economic uncertainty over there kind of causing weakness? Thanks.

I think we are very pleased and impressed with our performance of our colleagues in Europe. It had the highest growth rate region, which is at odds to what you may hear in the news. I think it is because we are bringing innovations in our primary businesses, of the in-house and the Reference Lab to Europe. And it just seems like there's a lot of growth opportunity, irrespective of economy.

And as -- I think the other thing I would reinforce is, despite the fact that Japan has had a tough economy, a Catalyst is very, very perfectly suited to the Japanese market. So, we are excited we are going to be ramping the Catalyst placements after a very successful limited launch period starting in the fourth quarter.

Great. That's all I had. Nice quarter. Thanks.

Thank you. Our next question will come from the line of Ross Taylor with CL King. Your line is open.

Hi. My question relates to that 10% to 20% increase in panels that you see customers run with some of the new marketing initiatives you have. I just wanted to get a bit of clarification around that. Number 1, I think you said that those placements are really to new customers, so I was curious as to exactly what you are comparing against. Is that an average for your installed base of Catalysts or something else? Did I understand that correctly?

Yes. We've had a variation of these types of protocol incentives with new product placements for the last 3 or 4 quarters. But not every instrument it is placed with that. We have a lot of different ways that we will place an instrument. So, we compare instruments that are placed with those -- like a real-time care protocol, versus an instrument that was placed without that, with some other marketing program. And so, we do compare it to a control group, as best we can.

We are scientists here as well as business people, so we take a scientific approach to analyzing our financial data. So, it is 10% to 20% more profiles being run. So, we are talking about more samples being run, let alone the intensity of the number of tests that are run on that sample. Of course, the intensity is partially offset by the rebate. But let me just say that the intensity certainly makes up for the rebate.

I will say that these are early returns, and we are tracking this. It is better to have more numbers rather than less. And at risk of parsing the data too finely, it does appear that they are improving -- these returns are. I mean, the growth and the impact and the change are getting better, to the extent that it is able to parse that data.

I think it is generally consistent. We have stepped back from all of this. This is what's driving a lot of moving parts in our consumable growth. There's domestic, there's international, there's existing customers, there are new customers.

Do they have a ProCyte? Do they have a LaserCyte? Have the added a ProCyte to an account that previously had a LaserCyte? That, as we have indicated in the past, that gives 5% to 10% increase in the slide sales when they add a faster hematology analyzer, the ProCyte replacing the LaserCyte. These are all the different factors, the goes ins and goes outs, which I think give us confidence to accelerating a consumable growth, really under the umbrella of the value of point of care testing and real-time care testing.

As I said in the script, I really don't believe this actually takes away from the lab. I actually think it actually helps -- certainly helps the practice. We've seen many, many individual cases where other areas of the practice have grown as result of doing more testing right at the point of care, including lab services, including supply sales, including treatments. And I think it is because practices are learning that this helps them with -- they've always focused on the pet, and now they are focusing more on the pet owner too.

Okay. And I think I have just a follow-up related to that. How much of your installed base currently is able to take advantage of some of these marketing programs, where they really get an incentive to expand the number of panels they run, expand the number of consumables? I know you answered that in part to a prior question, but I just wanted a little more clarity.

I would say if we look at kind of consumable volume generally in North America, generally over half of the customers that generate over half of the consumable volume are taking advantage of some kind of incentive -- protocol-based incentive program. That's because we moved, and there are a lot of different flavors, depending on -- I think we really refined it in the third quarter with new instrument placements. But there are a lot of different flavors, and that's because we moved from a prior incentive program that was kind of not as effective. It was sort of a frequent flyer program-type thing -- the more IDEXX stuff you bought, the more discount you got -- to ones that are really based on specific protocols that they run. And we were able to do that because of the -- as Merilee mentioned, the ability to move our installed base to SmartService. So, SmartService happens to be a huge enabler to us being able to move to this different, more medically relevant incentive program.

Okay. That's helpful. Thanks very much.

Thank you. It looks like we have time for one final question, and that will be from the line of Erin Wilson with Bank of America. Your line is open.

Hi. Thanks for taking some time for my questions. Most of them have been answered, but I know you don't give specific product pipelines, but if you could talk about maybe where you focus is. Is it all on IT now? Or basically where should we be expecting new drivers in the form of, I guess, new products, near term?

It is not all in IT, although we think IT is a very exciting area, and that certainly was the basis of a lot of the things I talked about in the call, Erin. So, thank you for the question and the opportunity to say it is beyond IT.

We see opportunity for additional tests, whether they be run on our existing equipment, which is a very nice thing. When you expand the menu on the equipment, you expand utilization, you expand the differentiation of that equipment, and you didn't have to place the equipment. You already have a ready installed base who can adopt it. We have some exciting developments in the area of our SNAP platform in the pipeline, and we are continuing to develop medically relevant specialized tests for the Reference Lab.

So, the whole area of the diagnostic technology, I think is just as an attractive a pipeline as IT. What I would -- the reason why I focused on some of the technology, IT areas is because it has been becoming more important to us, but it doesn't reduce the importance of the diagnostic innovation.

Okay. And I understand that you can't -- you don't really have too much visibility on the FTC. And other than their formal disclosure, how -- will there be some sort of filing when you do get some sort of decision with potential ramifications?

It is really hard -- we will let investors know, as we know things. Because there's no particular set process, it's not like going through the USDA and a new product approval. It is really hard to speculate exactly how things might unfold. But as we've done, I think from the very beginning, we discussed this from the very moment that we received an inquiry from the FTC, before was ever moved into a formal investigation with the subpoena, we've kept investors informed. And we'll actually be coming up on 2 years on this investigation soon.

Great. Thanks.

Thank you. With that, I'd like to turn it back over to you, Mr. Ayers.

I want to thank everybody for joining the call, and we look forward to discussing our full year results in January. Also, want to congratulate all the employees at IDEXX on continuing to be able to innovate and grow in what is, I think, otherwise a somewhat stagnant economy. Thank you very much.

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