愛德士 (IDXX) 2012 Q4 法說會逐字稿

The IDEXX Laboratories fourth-quarter 2012 earnings conference call. As 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 IDEXX's future expectations, plans, and 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.

Actual results could differ materially from those indicated by such forward-looking statements. Factors that could cause or contribute to such differences are described in IDEXX's quarterly report on Form 10-Q for the quarter ended September 30, 2012, in the section captioned Risk Factors, which is on file with the SEC, and also available on IDEXX's website, IDEXX.com.

In addition, any forward-looking statements represent IDEXX's expectations only as of today, and should not be relied upon as representing the Company's expectations as of any subsequent date. The Company specifically disclaims any obligation to update or revise any forward-looking statements in the future, even if its 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 reconciliation of these non-GAAP financial measures to the most directly comparable GAAP 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 10.00 AM Eastern. In order to allow broad participation in the Q&A, we ask that each participant limit his or her questions to one, with one 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 us today as we discuss our fourth-quarter 2012 results and outlook for 2013. As we reported this morning, our fourth-quarter revenues were $319.5 million, yielding organic growth of 4%. And diluted earnings per share were $0.78, a year-to-year increase of 16%. Organic revenue growth was a couple points shy of our expectation at the time of our third-quarter call, with the primary shortfalls coming from revenue associated with capital placements, and our reference labs and consulting services. As I will explain in further detail momentarily, there were some transitory factors that impacted results such as weather, most notably Hurricane Sandy, as well as the timing of the Christmas and New Year holidays. We estimate that their combined impact reduced top-line growth by nearly 1 point.

In looking at the components of overall growth, the metrics for the fundamental growth and value drivers in our principal companion animal businesses, which are chemistry and hematology instrument placements, instrument consumable growth, reference laboratory and rapid assay growth, are all very sound, and portend well, in our view, for accelerating growth in 2013.

Earnings per share, exclusive of the third and final milestone payment of $3.5 million, or $0.04, related to the sale in late 2008 of our feline diabetes therapeutic were a couple of pennies above our thinking, due primarily to efficiencies achieved in operating expenses. Currency had an immaterial impact on EPS versus our expectations.

Before discussing our fourth-quarter performance, as we customarily do, I want to share what we are seeing in the US veterinary market based on data from a subset of our Cornerstone Practice Management customers. In the fourth quarter, patient visits grew by about 3%, and practice revenues grew by 5%. Growth in patient visits in October was roughly a point lower than the average for the quarter, and based on the geographic trends, we attribute this largely to the effects of Hurricane Sandy. Normalizing for Sandy's impact, we project patient visit growth for the quarter would have been about 3.5%, very much in line with the second- and third-quarter metrics. Quite consistently throughout the year, we have seen practice revenue growth a couple of points higher than patient visit growth, which we believe indicates that practices are achieving some modest price realization.

In Europe overall, our Companion Animal Group businesses grew organically at just over 4%, about a point step down from the growth rate for the first nine months. Though Spain remains troubled, and we saw slight deterioration in the growth in France, performance in Italy improved, and Germany remains solid and steady. We were pleased with a nice acceleration in growth in the UK and emerging markets in Eastern Europe. Q4 was a quarter of readying for our transition to a direct companion animal sales force in the Nordic region, and we expect that to be a growth contributor in 2013. Organic growth in Asia-Pacific, across our total portfolio of businesses, was mid-teens for the quarter, and just shy of 20% for the year.

In sum, as we enter 2013, we continue to expect little contribution from the macro environments in the US and Europe to our top-line growth. However, the continued development of earlier stage markets, combined with our rollout of new product and service innovations internationally, will be an important growth factor for 2013 and beyond.

Let me now give some further detail on the revenue performance of our Companion Animal Group. VetLab instrument and consumable revenue of $109.5 million grew 7% organically. Instrument revenue, at $24.6 million, declined 14% organically year to year. As we have noted on several occasions, the success of our protocol-based rebate program that was introduced in the third quarter of 2011 in North America makes for difficult comparison in the second half of 2012.

Additionally, instrument revenue growth was negatively impacted by roughly 8 points, and total Company top-line growth by about 0.75 points with the launch of a reagent rental program in the fourth quarter. Under this type of program, revenue on the instrument placement and its related cost are not recorded at the time of installation, but are instead recognized as consumables are purchased over the term of the arrangement, which is typically five years. We have seen this program resonate with larger clinics that have relatively higher consumable usage, and the consumable annuity stream and associated economics for us are also particularly compelling. In part due to the success of this program, and with impressive performance internationally, we had solid chemistry performance in the fourth quarter, that translated to 3% unit growth for the year, in line with expectations we shared at the time of our third-quarter call.

Commercial focus on new and competitive accounts, armed with our medical information and workflow advantages, as well as program tools such as protocol-based rebates and reagent rentals, contributed to high quality of placements in the fourth quarter. The percentage of new-to-IDEXX chemistry accounts, including both Catalyst and VetTest, was in excess of 60% for the fourth quarter. Focusing on Catalyst alone, nearly 50% of our placements were to customers new to IDEXX, compared to 40% for the first three quarters of the year, and 30% in the second half of 2011. This metric was consistent across all geographies. We noted last quarter the overall value to IDEXX of a new Catalyst customer is 4 to 5 times that of an upgrade of a VetTest customer based on gross profit of the instrument and the five-year consumable stream for an average placement.

For hematology, we continued to see strong performance for the quarter in our ProCyte placements. For the year, ProCyte placements grew 20% on a worldwide basis, the major driver of 11% growth in hematology placements overall. As with Catalyst, we saw an increase in the percentage of ProCyte placements to new accounts, climbing to about 40% in the quarter. Also, in Q4 and for the year, roughly 80% of ProCytes were sold to Catalyst customers, with approximately 60% of that subset being a contemporaneous purchase of both instruments, evidence of the important role that the duo plays in enabling real-time care.

For 2013, we expect chemistry placement growth to be low-single digit, about on par with what we experienced in 2012. For hematology, we expect low-teen growth aided by the recent launch of LaserCyte Dx and continued strong international performance. Based on the success of the reagent rental program with large accounts, both existing VetTest customers and competitive accounts, we will likely continue with a similar program in 2013. While the accounting treatment for such a program result in muted instrument revenue growth in the near term that is reflected in our overall guidance, the annuity benefit to consumable growth is very compelling from both a revenue and an operating-profit perspective.

Consumable revenues, of $72.4 million, grew organically 16%, or 13% when further normalized for changes in distributor inventory levels. This strong result, our highest growth quarter for the year, brought our full-year 2012 normalized organic growth to 10%. Our growth continues to be a function of our increasing install base, and the quality of those placements, increased testing as current IDEXX customers upgrade their in-house lab with Catalyst and ProCyte, and enhanced loyalty from our base of Catalyst customers who now account for more than 80% of our US chemistry consumable sales volume, exclusive of corporate accounts.

For 2013, we expect the fundamental trends driving consumable volume growth to continue. In addition, we expect revenue growth will be further enhanced by price realization, due to changes in our sales channels, both with the MWI margin in the US, and from the move from distribution to a direct sales model in Scandinavia, as well as a lower unfavorable price impact from protocol-based rebate programs that have reached more of a steady state. All of this translates to an expectation of 11% to 13% normalized organic growth for instrument consumables for 2013.

In the fourth quarter, our rapid assay sales of $33.7 million declined organically by 5%. When normalized for changes in distributor inventory levels, revenues were flat for the quarter, and grew by 5.5% for the full year, which was in line with our expectations of 4% to 6%. To remind, we had anticipated a step down in normalized organic growth from the 7% experienced through the first three quarters of the year. About half of the step down in growth reflects the impact of a smaller price increase in October of 2012 versus the prior year. Additionally, based on geographic revenue data we receive from distribution, we believe there was a modest impact of approximately 0.5 points to rapid assay growth related to Hurricane Sandy. The remainder of the step down is primarily related to the timing of marketing programs within the second half of the year.

Our expectation for 2013 is to see normalized organic growth rates in the range of 4% to 6% for the rapid assay business, on par with 2012. Growth will come primarily from further expansion of our canine vector-borne disease testing in North America, as fostered by 4Dx Plus. Recall that 4Dx Plus was launched in 2012, as the vector-borne disease testing season was winding down. In 2013, it will be available for the full testing season. Additionally, continued ramp of specialty tests in Europe, and the anticipated launch of other enhancements to the product line, as well as some price realization from distribution margin changes in both the US and Japan, and list price increases, all contribute to rapid assay growth expectations.

US distributor inventory for instrument consumables and rapid assays averaged a little over four weeks at the end of the fourth quarter, based on forward-looking demand, which is within their normal and customary range.

Our reference laboratory and consulting services business, with revenues of $97.7 million, grew organically 6% in the fourth quarter. Based on daily testing volume trend data, we estimate that our growth rate was impacted by both the mid-week timing of the holidays in 2012 versus prior year, as well as Hurricane Sandy. When combined, we believe these transitory factors reduced lab and consulting services revenue growth by approximately 2% in the quarter. Normalizing for these events, labs and consulting services growth was approximately 8% for both the quarter and the year, and the sequential normalized growth marked a continued modest acceleration from the growth rates experienced in Q2 and Q3.

As we stated in our third-quarter call, in October we opened our new core lab in Germany, which will serve as a centralized hub for testing samples picked up by our European logistics partner, DHL. We believe this lab will enable us to replicate in Europe the successful strategy we have employed in the US in our Memphis lab, greatly enhancing our reach and service levels across Europe. It will also enable scale economies and other operating efficiencies.

We were in a controlled launch in the fourth quarter to ensure smooth operations and a superior customer experience. Our operational, quality, and customer service expectations were achieved in the fourth quarter, and as a result, we have now moved into full launch in the first quarter, accepting and processing samples from a number of countries across Europe. This is one of several key initiatives in 2012 that strengthened our lab business and positions us well for 2013 and beyond.

For 2013, we are projecting organic growth of 8% to 10% for Labs and Consulting Services. This acceleration in growth will be driven by a step up in growth from both volume and price. Volume growth will come from continued focus on our core strategies. First, coverage. That is, increasing our footprint, including the ramp in volume from the four labs added to our network in 2012. Second, content, which encompasses expanding our specialty test menu and continued penetration of recent introductions such as allergy. And third, connectivity, as enabled by VetConnect and VetConnect PLUS to both gain new customers and enhance loyalty of existing customers. We expect improved price realizations as we move forward the timing of annual list price increases, and anniversary the ramp in late 2011 and early 2012 of instrument lab bundle marketing programs with their associated accounting treatment that negatively impacted lab revenue.

Our practice management and digital imaging systems business, with revenues of $22.7 million, grew 4% organically in the fourth quarter to yield full-year growth of 11%. Performance was a bit light from our expectation at the time of our third-quarter call of low- to mid-teen organic growth, primarily from lower digital systems placements due to timing of orders within the quarter. We had a strong book of orders in December, but the lead times for installation are longer in this business. And so, we are entering 2013 with a healthy backlog and good momentum as some newer sales reps come down the learning curve.

Our practice management systems business continues to grow in the mid-teens, driven by Cornerstone, which, with the latest software release, is fully integrated with VetConnect PLUS and Pet Health Network Pro. Looking to 2013, we expect to achieve mid-teen organic growth for the year in this business. Factors contributing to this accelerated growth include the recent launch of Cornerstone 8.3, the full commercial launch of Pet Health Network Pro in the first quarter, and our partnership with the American Animal Hospital Association, announced late in November, to advance the client-centric animal hospital with tools that include Cornerstone and Pet Health Network Pro. In addition, the recent acquisition of DVMAX practice management software will provide cross-selling opportunities for the loyal base of approximately 1,200 practice subscribers.

Livestock and poultry diagnostic revenues of $22.6 million declined organically 4% in the fourth quarter and for the full year, pretty much in line with our expectations at the time of our third-quarter call. To remind, the principal driver for this performance is lower testing of cattle in Europe due to reductions in government spending and some highly successful eradication programs come to end-of-life. Secondary contributors are lower swine testing in the US due to drought, and new products ramping up a bit more slowly than originally anticipated.

Beginning in 2013, we will be combining our dairy line of business, which represents about 2% of our total Company revenues, with our livestock and poultry line of business. We are combining the management of these businesses because of market synergies between the product lines, as well as operational efficiencies we achieve. Through 2012, our dairy financial results were included in the segment labeled, Other, along with our OPTI Medical human point-of-care diagnostics, and our remaining pharmaceutical products and out-licensing arrangements.

For 2013, we expect revenues for the combined livestock, poultry, and dairy business to decline organically in the low- to mid-single digits with flat to slightly negative growth for the livestock and poultry line, as we have reported historically. For livestock and poultry, we anticipate further declines in government testing programs that will be partially offset by higher growth from new products, as they continue their adoption ramp. Dairy is expected to decline roughly 10% due to a difficult comparison to high testing in early 2012 in China for a milk toxin outbreak that subsided over the course of the year.

Our water business had sales of $20.9 million for the quarter, or 5% organic growth, reflecting contributions from our core Colilert testing business, particularly in the Americas. We expect growth for Water in 2013 to again be in the mid-single-digit range, driven by continued market penetration from recently launched products, as well as geographic expansion from regulatory approval.

Turning to the rest of the P&L, gross margin at 53% was largely consistent with our expectations. Operating expenses at 33% of revenues were somewhat below our thinking in October, reflecting the $3.5 million milestone payment, which is netted against operating expenses on the G&A line, as well as somewhat lower spending. Operating expenses, normalized from the milestone payment, were 34% of revenues.

Our effective tax rate of 31.3% was in line with our expectations. As I will touch on further momentarily, the benefit of the reinstatement of the Federal R&D tax credit for 2012 will be recognized in 2013, as the measure was approved in 2013.

Turning to the balance sheet and cash flow, we ended the quarter with $224 million of cash and $215 million of debt, for a net cash position of $9 million. Our inventory balance of $141 million was $6 million lower than at the end of the third quarter, as anticipated; the result of solid instrument placements. DSO at 40 days remains a very consistent and healthy metric. Our free cash flow was $59 million, or 136% of net income. Free cash flow for the year was 104% of net income.

Now, as we look forward to 2013, we project revenues to be approximately $1.405 billion to $1.42 billion. Our revenue guidance implies reported growth of approximately 8.5% to 9.5%, which translates to organic growth of 8% to 9%, as favorable impacts of currency and acquisitions together contribute approximately 50 basis points. Organic growth of 8% to 9% compares to 7% achieved in 2012.

I have discussed growth drivers by business area, but to summarize at a total Company level, growth acceleration can be categorized by two primary themes. First, price realization from changes in distributor margins in the US and internationally, moving to a direct sales model in the Nordic countries, reduced headwind from marketing programs that have reached steady state, and timing and impact of list price increases. Second, growth from recent commercial investments, and product and service innovations, including Pet Health Network Pro, VetConnect PLUS, the core lab in Germany, and expanded reach into the bioresearch market. Bioresearch revenue growth is anticipated from both expanding geographically, and augmenting our offering to address not only send-out testing performed at the reference lab, but also the markets' point-of-care needs with our VetLab platform.

We expect organic growth to accelerate sequentially throughout 2013, as commercial initiatives, and product and service innovations, gain increasing traction. Additionally, the first quarter faces a difficult comparison for livestock, poultry and dairy, as I just described, as well as for companion animal product and service lines, given the mild winter last year that manifested in relatively higher clinic traffic. Accordingly, we anticipate first-quarter organic revenue growth to be in the mid-single digits.

We expect full-year gross margins to be approximately 54%, roughly in line with our full-year 2012 rate. While targeted initiatives in our two largest businesses, VetLab and reference laboratories, will continue to generate margin expansion, the impact of these initiatives will be muted by headwind, to the tune of about 50 basis points, from 2012 currency hedge gains that are not projected to recur in 2013.

Operating expenses should average out to be in the range of 34% with a quarterly profile that is highest as a percentage of revenue in the first quarter due to commercial activities such as trade shows and sales meetings. We expect operating margin to be between 19.5% and 20%, which would yield operating margin expansion of roughly 50 basis points, when you normalize for the pharma milestone payment in 2012, and impacts of FX. As I just stated, this margin expansion is occurring at the gross margin line.

We expect the tax rate to be between 30% and 30.5% for the full year. The decrease in the tax rate relative to 2012 is the result of the recent extension of the Federal R&D tax credit for 2012 and 2013, which we expect to lower our 2013 tax rate by almost 200 basis points. The full effect of the extension for both years will be recognized in 2013, with the 2012 credit recognized in total in the first quarter, and the 2013 benefit recognized ratably over the year.

Net interest expense is expected to be about $2.5 million, and weighted average share count is expected to be down 2% to 2.5% from full-year 2012 levels. All of this leads us to raise our full-year earnings-per-share guidance to $3.47 to $3.57, up $0.10 from $3.37 to $3.47 that we guided to in our October call, primarily due to the benefit of the R&D tax credit, which is expected to be $0.04 to $0.05 for each of 2012 and 2013, for a total impact of $0.08 to $0.10. We are also increasing the low end of our range by $0.02 to reflect our increased confidence in the dynamics of the Business. Earnings-per-share growth for 2013, when normalized for hedge gains and Pharma payments in 2012, and the 2012 R&D tax credit recognized in 2013, is projected to be 10% to 13%.

Now, I'd like to turn it over to Jon for further comments on the business.

Thank you, Merilee. As you can tell, we are very pleased with the fundamentals of the Business, and the growth rate of the core annuity revenue streams that generate most of our profit. I want to touch lightly on a couple things before we open it up to Q&A. First, I'd comment on the VetLab instrument and reagent business performance, which investors know is a razor-and-blade business model. While we realized lower instrument revenues than expected in Q4, the number and quality of placements was strong, specifically considering the increase in competitive Catalyst placements from 40% to nearly 50%, and the size of accounts that we upgraded.

In addition, we are seeing even higher growth in consumable usage from customers who upgrade from VetTest to Catalyst, than we have seen in the past. Our more recent placements show increased testing in the neighborhood of 20% to 25%, as current IDEXX customers upgrade their in-clinic lab with Catalyst and ProCyte, 5 points higher than what we saw for customers upgrading in prior years. Clearly, real-time care works for our customers and for IDEXX, as they are running more in-house diagnostics with IDEXX's new products. This is because, in part, our instruments, both Catalyst and our pair of hematology units, are designed for just this goal, as they have superior workflow, a more complete test menu, and much shorter turnaround time than anything else on the market.

We continue to see impressive loyalty of our Catalyst customers, greater than 99% in 2012. In fact, even with a significantly higher install base, we had roughly half of the number of Catalyst losses in 2012 than 2011. Once a customer experiences our in-house lab, including Catalyst and our hematology offerings, they don't ever want to go backward. I remind investors that our two hematology offerings, consisting of ProCyte Dx and the new LaserCyte Dx, remain in a class of their own. Even after 10 years, no other company has managed to introduce the gold standard of laser flow cytometry in a bench-top hematology offering, the only technology that gives complete results, and yet we provide a choice of two systems to customers.

The net result of our instrument placements and this extraordinary loyalty is accelerating consumable growth in 2012 over 2011, as well as over the course of 2012. Q4 had 13% instrument consumables growth, normalized for US distributor inventory changes, up from the 9% in the first three quarters. Importantly, this 10% revenue growth for all of 2012 was driven more than entirely by consumable unit volume growth, which was offset by a small amount of negative unit-price realization.

We believe this double-digit unit growth for the year bodes well for our outlook in 2013 of 11% to 13% consumable revenue growth in the following way. We expect to realize unit-volume growth similar to 2012, ie, greater than 10%, for all the reasons we did so in 2012, and have very modest price realization in 2013 as a result of the evolution of our pricing strategies.

As investors know, a sustainable and growing the annuity of consumables is the important profit driver in the instrument and consumables business, and unit-volume growth is the most strategic goal. This unit-volume growth is also a core validation of the fact that our customers are using our instruments to deliver increased diagnostic testing real-time, slowly increasing the percentage of chemistry and hematology run at the point of care.

In 2013, we expect to further extend our transformation of the veterinarian's diagnostic experience through the continued customer adoption of VetConnect PLUS, our cloud-based service that allows the veterinarian to view results in a completely new, insightful, interactive, and intuitive way. We are moving from paper to mobile with all the attendant benefits. You might consider what is happening to the print media industry as a good analogy for this transformation that we are bringing to diagnostic information. As of today, we have reached 4,500 VetConnect PLUS activations in the US, almost double the number we had three months ago.

In addition, our sales organization is learning more and more how to use this transformational service, which comes free as part of our IDEXX diagnostic offerings, to win new accounts for both in-house equipment placements and reference lab services. Note that, at this time, more of our customers use only one of the two halves of our diagnostic offering -- that is in-house instruments and reference labs not including our rapid assay offering, than use both together. So, the opportunity for cross-selling IDEXX diagnostics with VetConnect PLUS is high.

One interesting result of VetConnect PLUS is the increase in customer loyalty in our reference labs that comes from practices who have activated the new service. As you know, we launched VetConnect PLUS back in July. We are accumulating data on the impact of customer loyalty, and while it is still very early days, we see a clear trend that customers on VetConnect PLUS seem to be more loyal than those not on it. Enough to increase customer retention somewhere in the range of 2% to 4%. All other things being equal, that would result in a 2% to 4% increase in the revenue growth from the cohort of practices that have adopted this service.

Of course, we are still somewhat early in the adoption phase with our reference lab customer base, even with 4,500 practices. Note, some of which only use our in-house equipment right now. But we have plans to approach 100% adoption in the US in 2013. This increased loyalty trend helps provide us confidence in our outlook for 8% to 10% growth in the global reference lab line of diagnostics in 2013.

Our goal in 2013 for our North American sales and distribution organization is to continue to grow our effectiveness in communicating the transformational value of VetConnect PLUS to all of our customers, both those that use in-house, reference lab, or both. Both in terms of advanced medical insight, and as a tool to demonstrate value to the pet owner. Ultimately, this value will help vets appropriately increase their use of diagnostic testing with sick pets, those with chronic conditions, and then the growing category of preventive care. We also plan to launch VetConnect PLUS in some important international markets in 2013.

We are also pleased to be able to launch the commercial marketing of Pet Health Network Pro at the recent North American Veterinary conference. This is our cloud-based subscription service that helps practices engage clients before, during, and after the visit to increase the veterinarian's relevance in the pet owner's life, and to increase visits and income per visit. So far, we have had hundreds of customers signed up. The large majority are actively using the system as an advanced beta before we go to full production later this quarter. We were pleased to see the extraordinary response at the North American Veterinary conference, with crowds around the booth during most of the show.

Pet Health Network Pro benefits IDEXX in multiple ways. First, it generates a revenue stream from subscriptions and consumables, such as reminder cards sent by traditional mail. Second, it will grow visits and usage of diagnostic as it shares information back and forth by IDEXX's other software products such as Cornerstone and VetConnect PLUS. Third, it gives us yet another cross-selling opportunity across the entire IDEXX product offering for the Companion Animal Group.

In summary, we have a clear road map for organic growth of 8% to 9% in 2013, and consequent bottom-line growth in a way that positions us well for the years beyond 2013.

So, at this point in time, I'd like to open up the call, Cynthia, for questions and answers.

(Operator Instructions)

David Clair, Piper Jaffray.

Good morning Jon and Merilee, thank you for taking my questions. I was just curious on the reagent rental program. Is that just for Catalyst Dx? Then, secondly, do you expect the accounts with the reagent rental agreements to generate higher consumables compared to accounts buying instruments?

Yes, that's exactly right. They are really for higher volume accounts.

I would say that that also is true for the first part of your question, David. Generally, the reagent rental programs work best from both the customer perspective and our perspective on when they are higher consumable usage accounts, whether that would be high VetTest or Catalyst, that would be the case. But, primarily we are seeing success with this with Catalyst.

I guess what I'm trying to ask is, are you setting the bar a little bit higher in terms of the consumable agreement with these accounts, so that they are expected to actually use a little bit more?

Yes, exactly.

Okay.

I think you have it exactly right, David.

Okay. Then, for the 8% to 10% reference lab growth target, what are your expectations for volume versus price in there? And, should we expect additional lab openings during the year?

The breakout between price and volume is about -- probably about 70% of that growth would be due to volume and about 30% for price.

We have a couple lab openings, but I think it's really just -- the primary growth driver is going to be leveraging our whole network of 60-plus labs and the hub and spoke. And, the other driver of growth is growth in our specialty testing, which are generally speaking, new categories of testing that can't be run in-house and uniquely accrue to the benefit of the reference lab.

Okay. Thank you.

Ryan Daniels, William Blair.

Good morning it's Kristina Blaschek for Ryan, today. To start, on the change in distributor margin from MWI, have you thought about how that will be reinvested? I assume some of it will be OUS with the Scandinavian opportunities? Anything domestic, though, that you have thought about specifically?

Thank you for the question. It's -- I'll tell you, it's kind of hard to allocate here or there. We continue with an appropriate and aggressive investment in our commercial organizations, whether they be the sales, support. We have a couple of dozen people who support specifically our distribution, as well as other elements of the marketing mix. So, I think we are comfortable with that mix, and it was really a modest change.

Referring to the Scandinavian situation. What we are doing there is going direct -- we obviously have a number of customers who use our equipment today. The distributor that we had wasn't very effective in placing new instruments. We think that's a very attractive market. So, with direct, we think we will be much better positioned to place our instruments, which are well designed for the Scandinavian markets. It's an excellent match. But, of course, we get the uplift of going from distribution in 2012 to direct in 2013. So, yes, we are investing in commercial resources in Scandinavia to go direct. Although, we are already leveraging our warehouse and distribution network because we are direct in many of the other countries in Europe. But, that is, in essence, being more than paid for by the pickup in the margin in those same countries.

Great. That's helpful color. I guess staying on the distributor topic, at NAVC this year, it seemed like your two large exclusive distributors were more engaged than in the past with Henry Schein even commenting they were much more active in attempting to place IDEXX analyzers OUS. Can you share with us your view on how these relationships have improved since going through the distribution review last year?

Thank you. We have -- we are really pleased with the relationships that we have with our US distribution, and I think, one of the hallmarks of IDEXX is that over two decades of having worked with distribution, we are continuing to learn how to make that partnership stronger and stronger. So, we are pleased with the engagement of our exclusive distributors that you mentioned and increased level of engagement. We are also pleased with the continued high level of engagement of MWI, which remains an important partner for us. So, distribution is an important element that supplements, of course, our direct sales organization in the US market. They work hand in glove. We are very pleased with where things are as we move to 2013 and the ability of this entire commercial organization to communicate the benefits of the transformational value of -- that our diagnostics provide.

As I mentioned in the call, I think it's kind of important -- when people make that transition, they just realize they never want to go back. Because -- they kind of ask themselves, we should have been doing this all along. So, our challenge is really to bring people to that point across the market. With our direct sales and our distribution engagement that we have now, they are pretty excited about things like VetConnect PLUS and the product line. We are thinking we are in a good position to do so.

Great. Thank you for all the color.

Erin Wilson, Bank of America.

I guess, can you speak to what you're seeing as far as the competitive dynamics on the reference laboratory front in the domestic market? But, also can you speak to the dynamics internationally?

Yes. Thank you. In the competitive situation in North America -- in the US, is different than international. Every country is a little bit different. We are really not seeing any change in what I would characterize has historically been a very competitive market that we participate in in the US, and indeed, all of North America. It's really the same level of competition. I think what we are excited about is we are bringing a new wave of innovation on top of things like the specialized testing and the expansion of our coverage of our lab network in North America. This new wave of innovation really driven by VetConnect PLUS. As I said, it's a different way to see the value and have much higher value in the usage of diagnostic information in the clinic. So that's really the biggest change we are seeing, is what we are bringing to the market.

Internationally, we face very different -- none of our competitors in North America are competitors outside of North America. It's usually country-specific competitors. In rare cases, may have moved across a couple of countries. For example, we are really the only reference lab network in Europe that is across the continent -- let alone, in the UK, and let alone, of course, leveraging our global scale and capability. The same is true in Australia and in Japan. Just a very different local competitive environment.

So, what we are excited about is we can bring innovations that really come out of our global investment reference lab, and they might be in specialized testing, in advanced lab technologies, and Lynxxs, which is our new laboratory information management system that we are over the course of several years rolling out to the global lab business, an internally developed system that we put over $10 million of investment in. I'm very pleased, by the way, to be able to say that we've launched our first lab in the US under Lynxx, after having successfully rolled Lynxx out to our four labs in the UK and our four labs in Australia. That rollout will continue, and the US, of course, is a pretty big opportunity to get a significant ROI on that Lynxx investment. So, we can bring those types of scales internationally -- the scale benefits internationally. And, we are dealing really with local competition.

Okay. And then, how do you expect, I guess, VetConnect PLUS to ultimately impact reference laboratory retention longer-term? I guess I understand how VetConnect PLUS links the equipment and the reference lab results, but what happens, when for instance, its rapid assay tests when it's not used, I guess, with the SNAPshot Reader. It seems like that would maybe be a little bit more vulnerable to competition?

Well, first of all, we really do think that VetConnect PLUS will be transformational in the way that diagnostic results are viewed and used. It's kind of the move to digital media from print media would be the analogy there. Right now, of course, it applies quite relevantly to the reference lab offering and to the in-house instrument offering. We do have a couple different ways that rapid assay results can be entered into VetConnect PLUS through SNAPshot, as you mentioned, or also directly through IDEXX VetLab station. One of the benefits of doing so is now VetConnect PLUS has what we call client-friendly reports. In the case of our rapid assay business, preventative screening using 4Dx for parasitic disease screening, VetConnect PLUS can generate a report that can congratulate the customer on having protected their pet from vector-borne diseases, which gives a lot more value to that 4Dx comprehensive test than just saying, there wasn't any negative results. That is all integrated into VetConnect PLUS. It's one of the benefits, but clearly as we look forward, we are going to be looking for ways to continue to leverage VetConnect PLUS as a way of communicating and disseminating diagnostic information and rapid assay included. Erin, thank you.

Thanks.

(Operator Instructions)

Ross Taylor, CL King.

Hi, I wanted to circle back to the instruments and the reagent rental program. What factors led you to adopt that program now? I guess, related to that, intuitively, I would think that larger clinics like -- would be better able to afford just an out-right purchase of the instrument. Why is that proving to be popular with the larger clinics at this point? Is Catalyst just getting more mature or fully penetrated since it has been in the marketplace for about five years now?

I think we've been very successful in placing Catalysts in larger accounts since we launched it in 2008. As you know, we launched what we call the in-house protocol agreement, the IPA, about a year and a half ago. So, we are continuing to find ways to move these larger accounts to the IDEXX diagnostic advantage with in-house equipment. I think what we found was, there -- every account is a little different. They all have a little different needs. They all have a little different way of thinking. Many accounts do want to purchase the equipment. There are programs that are beneficial to them that place equipment, and there are other accounts that are more interested in this type of arrangement.

The economics are actually not different, although the revenue recognition is a little bit different. The economics and the cash flow isn't really that different between different types of programs. We just found that there is a segment of the market that this works, and, of course, we really want -- we really see that any account -- certainly the large accounts. But, any account, when they move to -- when they move to Catalyst and ProCyte and they are integrated with the complete solution and VetConnect PLUS, they realize that they never want to go backward again. So, we are just finding ways to be able to bring them to that solution. We found that for a segment of customers, a minority of customers, that this happens to be an effective tool.

Okay. Good. If I could just squeeze in a second question. The 2% impact you mentioned for the reference labs of Hurricane Sandy and the holidays. Can you quantify how much might be due to each one of those?

Yes, about maybe 0.5% was due to Sandy, and about 1.5 point would be due to the timing of the holidays.

Okay.

With Christmas and New Year's falling on a Tuesday, that's the toughest calendarization of the calendar cycle.

Going from a weekend to the middle of the week, basically is the --.

Yes.

It's a challenge.

That's helpful. Thank you.

Jonathan Block, Stifel Nicholas.

Great thanks guys and good morning, maybe the first one, just on the instrument placements. I think, Merilee, you said about 3% for the year for 2012. Expectations for low single digits in 2013. It seems like you lowered the bar a little bit by the consumable reagent program. So, can you talk to just market share? I know, Jon, you're going to say - well it's about where the box goes. I realize that. You're chief competitor on the point of care side has been placing instruments closer to about 7% to 9%. You guys have decelerated, and it's now steady at about 2% to 3%. Can you just talk to the dynamics of box placements with market share going forward?

Yes. We are a global business. So, there are a lot of moving parts there, Jon. The purpose of placing the box is generate the consumables. That's where the profit driver is in a razor-and-blade business model. And our objective is to find ways to grow, and in fact, accelerate as we have seen, that consumable revenue. We are very pleased with what we are seeing, over the course of 2012, with accelerating volume. As I mentioned, the unit volume is even higher than the revenue in 2012. We think that will equalize volume and revenue in 2013, which will help drive that 11% to 13% growth. So, if you look at the 11% to 13% growth in the profit driver, which is three quarters of the business, we think that compares favorably with the market growth.

Okay. Fair enough. Maybe just one or two more if I can slip it in. The first one, Merilee, you mentioned a lot of areas where you might be able to realize price in '13. Jon, you just alluded to the consumables, the Scandinavia market going direct, some price at the lab. But yet, gross margin guidance of 54% would be flat in '13 -- flat versus '12, excuse me. Can you talk to just sort of where you are giving back in the COGS if you are able to realize a lot more price in '13 than '12?

Yes. Again, currency, and the impact of hedge gains this year that we do not project would recur in 2013 create quite a bit of headwind. It masks gross margin expansion --.

In the cost of goods sold.

Right. It masks gross margin expansion that would be about 50 basis points if you were to normalize for that. So, we are expecting gross margin expansion and price. Some price is a piece of that, as well as manufacturing efficiencies, and just really, volume leverage and other things that we have been driving, in again, primarily our reference lab and our VetLab business. Those kind of recurring themes -- we still see them manifesting or expect to see them manifesting continued margin expansion in 2013.

That's a little bit offset by some of the areas that we're investing in that will generate attractive revenue streams in the future such as the Pet Health Network Pro and the expansion of bioresearch with our point of care line of instruments and associated consumables. Those are going to be a little bit -- those will be negative -- those will be unfavorable to the gross margin, in terms of mixes as they pick up in the near term. But, attractive in the long term.

Understood. Maybe one last one I wasn't able to ask in 3Q '12, so I'll try to pull going forward. Here we are in the first month of the year. Distribution has changed, Jon. I understand MWI is still a very important partner. Anything you have seen in the first 30 days of -- now that we are in the new regime or a different dynamic, that you can speak to? I'm guessing you really don't expect much, if any impact, because if you isolate your rapid assay growth of 4% to 6% for '13, that's the line item that might be most vulnerable. Do you really expect little to no noise on the distribution front? Thanks guys.

Thank you for that question. I'll tell you, we are very pleased with our engagement. We have a very -- just turning to the rapid assay business -- these are very unique, valuable, combination assays. 4DX Plus, which of course, is by far the largest product line, and the rapid assay business tests for six different vector-borne diseases that are prevalent in one test. It's the gold standard. We have a lot of benefits we can easily distinguish in many cases between a vaccinated animal and an infected animal, which is unique to that assay. It's easy to use. People know it. There's just nothing else that compares on the market.

So, I think the strength of our products, which particularly on the rapid assay side, speaks well for our position. And of course, we are continuing to innovate in the rapid assay line and have a pipeline in the rapid assay line as we do in our other lines. So, we are never standing still.

Thank you.

Thank you.

Nicholas Jansen, Raymond James and Associates.

Hey guys, on the rental reagent agreements, do you get higher margins on the consumables under the new deal relative to, let's say, if they were associated under the old methodology?

I really think this is more about the utilization. It's not really -- it's not so much about a higher margin on those consumables.

Probably about the same.

What we really have found is that, with particularly as we have now focused on customers that are new to IDEXX -- that has been an increasing focus for us. We found that there are plenty of high test users out there. Because they are very confident about their consumable usage, that this type of program -- they feel very comfortable with it because they are already very confident about their consumable usage. So, this is about high-volume users and really appealing -- and, this is something that, again, different things appeal to different customers. But, this particularly resonates in some cases with some of these higher volume clinics.

Thanks. And then, speaking of Pet Health Network Pro, what do you guys have embedded in terms of your expectations for '13 for revenue growth? Certainly, it's probably more of a longer term revenue opportunity. Just trying to get a sense of how many customers you think you could add on this year vis-a-vis competition or new market growth? Thanks.

Nick, yes thank you for that question. We do have very specific plans in that area. I really don't, for competitive reasons, want to go into much detail. But, it is a contributor to our accelerated revenue growth. I would mention with Pet Health Network Pro, that these are annuity revenues. It's different than the instrument business, where in the vast majority of cases, a good majority of the cases, even with the reagent rental program you get the instrument revenue upfront, and then you get the consumables after this. This is just the consumables business. In other words, an annuity business that comes from the subscription and the usage of traditional mail, which generates incremental revenue. So, while it's growing, I think it will be a new revenue stream in 2013. It will be one which will build nicely in an annuity fashion in the years to come.

We are very excited with the market response to Pet Health Network Pro and really just had an unbelievable show at the North American veterinary conference. Of course, we are very pleased that the American Animal Hospital Association, which has tremendous credibility with 5,000 more sophisticated practices, gave the endorsement for -- exclusive endorsements for Pet Health Network Pro combined with Cornerstone as the way to take it to the next step in practice management. So, we are -- we think we are well positioned to achieve our objectives in 2013 with Pet Health Network Pro.

Merilee, if I could just maybe -- the 1Q tax rate considering it's going to include the 2012 R&D portion? Can you just give me that? I know you gave us the full-year, but 1Q would be helpful. Thanks.

Let's see -- probably, we are talking about something in the neighborhood of 27% or something of that nature.

Tax rate.

Tax rate, yes.

Thank you.

Ben Haynor, Feltl and Company.

Good morning, thank you for taking my questions. You mentioned the instrument organic growth was impacted by about 8% due to the reagent rental program. Could you quantify the impact of the consumable organic growth during Q4?

I would say it really didn't have much of an impact, because generally, those instruments are placed over the course of the quarter. Usually, it's a little bit more toward the end of the quarter. So, not really -- I would think any noticeable or material impact in Q4. Really, the impact will be in the quarters to come.

Okay. And then, do you expect differential reference lab growth rates outside the US versus inside the US in 2013?

Yes. We have -- we expect a growth in all of our reference labs, in every single country, market, or region that we participate in. They will all contribute to the growth. There are very different economies and different situations in each economy. We generally don't go through each one, one by one. But, for instance, in Europe, we have the new Leipzig opening, which will really help Continental Europe. We have good momentum in our other markets whether they be UK, Canada, Australia, Japan, and of course, we are really excited about the US, because the US will be the first -- is the first beneficiary of the benefits of VetConnect PLUS in terms of a transformational way to experience and use diagnostics in practice. So, all the regions will contribute to growth.

Thank you.

Jeff Frelick, Canaccord.

Good morning folks. Did you say the reagent rental program, you are able to combine hematology with chemistry? Then, should we also assume, in general, the reagent rental program, the business should be a little bit more sticky given the five-year contracts that are engaged?

The program is really mostly geared towards chemistry. I don't know -- there may have been a hematology or two that was placed along with that, but it primarily is geared at the chemistry market.

I wouldn't say just to the answer of stickiness, it's hard to get stickier than 99%-plus. So, I think what -- our instrument line is already amazingly sticky. So, this is not going to really change that, I don't think. It will continue to be amazingly sticky. Not just because of the reagent rental, but because of the value that people see in these instruments in bringing to their practice and the capabilities that, once they start using, they appreciate, and that are unique to the IDEXX offering. That really runs across so many different dimensions, whether it's the speed of the instruments and being able to deliver results inside an appointment, to the far more complete menu -- to menu flexibility. To the ease-of-use, to integration into practice management software, and of course, the benefits of VetConnect PLUS. The list goes on. I think people, once they experience that, they really don't want to -- they don't to lose any of that. That's why these are so sticky.

Okay. Just a quick follow-up to that then, Jon. The success you had with the Catalyst, and you had said about, I guess, in excess of 60% had been into competitive accounts. What was the practice doing previously for chemistry? Were they using a competitive in-house instrument? Or, were they sending out to reference labs?

In terms of Catalyst placements, I think we said nearly 50%.

That was a combined Catalyst and VetTest was 60% to new accounts. To clarify.

Right.

But, the VetTest -- we are still placing a lot of VetTest in emerging markets. Even some markets you would consider established markets are emerging markets from a veterinary perspective. So, a lot of that is new instruments -- where the practice is adding the instrument for the first time. But, with regard to Catalyst placement of nearly 50%, which is up from the 40% in the first three quarters of the year and 30%, really, last year, so nice tick-up. That's really going into accounts that have existing -- mostly accounts that have some kind of existing analyzer that doesn't provide the same capability as Catalyst. That's why they upgrade to Catalyst. In a minority of cases, it's new practices. There are some practices out there, it's true. Not too many, but some that don't have in-house instrumentation. But, that's more rare than customers who are using exclusively or primarily another analyzer, not from IDEXX, and they decide to upgrade to the IDEXX diagnostic advantage.

Okay. Great. Thanks, Jon, for the color.

With that, Mr. Ayers, I'd like to turn it back over to you for any closing comments.

Well, thank you very much, everybody, for listening in on the call. I want to congratulate the IDEXX team for all of our successes in 2012, and the momentum that we've established going into 2013. We look forward to updating investors at our first-quarter call with -- as we continue to achieve our strategic objectives over the course of 2013. Thank you.

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