愛德士 (IDXX) 2013 Q3 法說會逐字稿

Good morning, everyone, and welcome to the IDEXX Laboratories third-quarter 2013 earnings conference call. As a reminder, today's conference is being recorded.

Participating in the call this morning are Jon Ayers, Chief Executive Officer; Will Blanche, interim Chief Financial Officer; and Ed Garber, 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. Investors should be aware that any forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the Company's filings with the Securities and Exchange Commission. Please refer to these filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements. All forward-looking statements are made as of today, and except as required by law, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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 measure is provided in our earnings release, which can be found on our website at www.idexx.com. Finally, we plan to end today's call by 9.30 AM Eastern. In order to allow broad participation in the Q&A, we ask that each participation 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 in 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 Jon Ayers. Please go ahead, Jon

Okay. Thank you, Bonnie.

With me is Will Blanche, our VP of Finance and interim CFO, and also Ed Garber, our Director of Investor Relations. I am going to turn the call over to Will now who will take you through the numbers, and I will come back with some color commentary.

Thanks, Jon. Good morning, and thank you for joining us for today's call.

As reported in our press release, our third-quarter revenues were $338.3 million, yielding organic growth of 7.4% versus 2012, and fully diluted earnings per share of $0.86, an increase of 13% versus the prior year period. Third quarter organic revenue growth was driven by strong underlying performance across the annuity portions of our Companion Animal Group business, including lab services, rapid assays and instrument consumables, partially offset by reductions in revenue from instrument placements. Earnings per share growth exceeded revenue growth due to an 80 basis point expansion in gross margins, continued reductions in shares outstanding, and a reduction in the tax rate. Currency had a $0.02 negative impact on EPS versus Q3 last year, slightly favorable to our expectations.

As is typical, we will start with observations on the economic environment, and share what we see in the US veterinary market based on data from approximately 700 of our Cornerstone customers. We are encouraged that during the quarter, patient visits were up 2.6%, and practice revenues grew 6.1% versus the prior year. This is favorable to the numbers we reported in Q2, when we saw patient visits grow 0.7%, and practice revenues grow 4.9%. Our guidance continues to reflect the cautious outlook on the impact the economy may have on our growth rates, given uncertainty both domestically and abroad. In this regard, even with the relatively strong Q3 statistics, total year-to-date growth metrics were 1.1% for patient visits, and 4.7% for practice revenues versus the prior year.

VetLab instruments and consumables revenue of $108 million grew 8% organically versus Q3 2012. Instrument revenue of $19.1 million declined 10% organically. Analyzers placed through buying commitment or reagent rental or other deferred revenue programs in Q3 of this year negatively impacted our year-over-year instrument revenue growth by roughly 2%. Both chemistry and hematology placements declined versus Q3 last year and were different than our expectations for the quarter, due to shortfalls in the US. However, the quality of our placements continues to be high, and we are very encouraged by the positive dynamics we are seeing with our diagnostic sales force, which John will elaborate on in more detail.

Our worldwide chemistry placements declined 5% year-over-year, due to a decrease in Catalyst placements in the US. As I just mentioned, the quality of our placements remains very strong, with 57% of our North American Catalyst placements and 49% of our worldwide Catalyst placements going to customers new to IDEXX. For the full year 2013, we expect chemistry placements to decline in the low single-digits versus our prior guidance of low single-digit growth compared to the prior year. Our worldwide hematology placements declined10% versus Q3 last year. Similar to Catalyst, we continue to see a high percentage of ProCyte placements going to customers new to IDEXX, 45% in fact for Q3. For the full year 2013, we expect hematology placements to decline in the mid single digits versus our prior guidance of flat year-over-year growth.

Instrument consumables revenues of $75.8 million grew organically 13% versus the prior year period, or 15% when further normalized for changes in distributor inventory levels which negatively impacted revenue growth by almost 5%, and certain timing items that favorably impacted revenue growth by over 2%. This strong, normalized growth, which is slightly above Q2 performance, is a result of a number of factors, including the quality of our placements, our increasing install base, increased testing as current IDEXX customers upgrade their in-house labs with Catalyst and ProCyte, and enhanced loyalty from our base of Catalyst customers who now account for 87% of our US chemistry consumable revenues exclusive of corporate accounts. With these continued strong, fundamental volume growth drivers, we are increasing the lower end of our guidance range and now project our full-year 2013 consumables growth to be 13% to 14% versus prior year.

Our third quarter rapid assays sales of $43 million grew 10% organically versus the prior year period, or 5% when further normalized for changes in distributor inventory levels which favorably impacted growth by over 1%, and certain timing items that benefited growth by another 4%. We continue to expect normalized growth to be 4% to 5% for the full year 2013 for rapid assay. US distributor inventories for instrument consumables and rapid assays averaged a little under four weeks at the end of the third quarter, based on forward-looking demand, which is within their normal and customary range.

Our reference laboratory and consulting services business, with revenues of $110.3 million in the quarter grew organically 9% versus the prior year period. All geographies contributed to our solid third-quarter performance, and we benefited from acquisition of new accounts, improved customer retention, and incremental testing from our customer base, in part due to leveraging the North American and diagnostic sales force model and VetConnect PLUS. We continue to expect organic revenue growth for labs and consulting services in the 8% to 9% range for full-year 2013.

Our practice management and digital imaging systems business with revenues of $22.6 million grew organically by 9% in the third quarter versus the prior year period, compared to a modest decline for the first half of the year. As mentioned last quarter, we added several new sales reps toward the end of last year, and earlier this year. We did see improved placements in Q3 as compared to Q2, but digital imaging systems placements were not quite to the level we had assumed at the time of last quarter's call. And because of this, we are now expecting full-year growth in the mid single digits versus our prior high single-digit expectation.

Our Livestock, Poultry, and Dairy revenue declined 2% organically to $25.1 million in the third quarter, in line with our expectations. The decline was driven by reduced testing in government programs in Europe, including BSE and in Latin America. We expect that Livestock, Poultry, and Dairy organic growth for the full year will decline in the low single digits, consistent with our prior guidance. Madasa, a distributor in Sao Paulo, Brazil, that we acquired on August 20, contributed just under $1 million of revenue in the quarter.

Our Water business grew 5% organically versus the prior year period to $23.2 million in the third quarter, in line with our expectations. The increase was primarily due to continued gains in our Colilert testing business in North America. We are maintaining our previous guidance of mid single-digit organic growth for the full year.

Moving to the rest of the P&L, gross margin of 55%, as I mentioned, was 80 points favorable to the prior year period, primarily due to price realization, favorable revenue mix, including higher relative sales of instrument consumables, and continued service efficiencies in our reference labs line of business. Operating expenses were 35.6% of revenue, and our effective tax rate at 29.1% was somewhat favorable to our expectations, due to the release of reserves in conjunction with the completion of tax audits.

Turning to cash flow, our free cash flow was $64.4 million, or 141% of net income in Q3. The improvement compared to the first half of this year is primarily due to lower capital expenditures, and seasonal working capital improvements. We repurchased 801,000 shares during the quarter, slightly higher than our thinking when we provided guidance last quarter.

Looking forward, we project full year 2013 revenues of approximately $1.370 billion to $1.372 billion, which implies a fourth-quarter organic revenue growth rate in the range of 8% to 8.4%. This yields a second-half expected organic growth rate of approximately 8%, which is nearly double our first-half organic growth of 4.4%. This second-half 8% organic growth is different than the 10% growth expected at the time of our July call, and is driven primarily by anticipated revenue from capital placements, both VetLab and digital systems. These capital placement revenue expectations for the second half are lower for two primary reasons, the lower number of placements, as discussed previously, and higher amounts of deferred revenues as a result of marketing programs.

We expect full-year 2013 gross margins to be about 55%, in line with our previous guidance. We expect operating expenses to be approximately 35% of revenue for the year, consistent with our previous guidance as well. 2013 operating margin is projected to be about 19.5% for the full year, which represents a year-to-year expansion of about 25 basis points when normalized for currency, and discrete items consisting of the $3 million [pharma] milestone payment in 2012, and the $4 million Trendset loss reserve recorded in the first quarter of this year.

We expect the tax rate to be 29% to 29.5% for the 2013 full year, a 0.5 point reduction from our previous guidance, primarily due to the reserve adjustments made in Q3. Net interest expense is expected to be $3.5 million, up from our previous guidance of $2.5 million to $3 million, due to higher borrowings from our share repurchase activity. Weighted average share count is expected to be down 4% from full-year 2012 levels, an increase of 50 to100 basis points from our previous range of 3% to 3.5%, reflecting our latest thinking on share repurchase. Integration expenses associated with the Madasa acquisition negatively impacts EPS by approximately $0.01. This leads to updated full-year 2013 earnings per share guidance of $3.44 to $3.48, which compares to our July guidance of $3.42 to $3.48. We expect free cash flow of 95% to 100% of net income, and capital investments at $90 million, both consistent with our prior guidance.

As we look forward to 2014, we project revenues of $1.48 billion to $1.5 billion, a year-to-year increase of 8% to 9% in reported growth, and 7% to 8% in organic growth. Modest favorability from acquisitions and currency contribute approximately 1% to 2014 revenue growth.

Fully diluted earnings per share are projected to be $3.76 to $3.86, a year-to-year increase of 8% to 11%, or 11% to 14% when normalized for three items. First, while currency is anticipated to have a minor favorable impact on revenue growth, our earnings-per-share guidance contemplates roughly $0.02 of headwind from currency due to 2013 foreign exchange hedge gains that are not projected to recur in 2014 based on 2014 hedges in place and FX rates assumed in our guidance. Second, the Trendset loss reserve reported in 2013 was $0.05. And last, the 2012 and 2013 R&D tax credits benefited 2013 by $0.10 and have not been assumed in our 2014 projections.

We are still in the midst our annual internal planning process. And so, we will provide more details on the components of our P&L, balance sheet and cash flow at the time of earnings call in January.

With that, I will turn it back to Jon for his comments

Okay. Nice work, Will.

It is nice to see the revenue growth continue to pick up in Q3. As Will mentioned, our 7.4% organic revenue growth was driven by 8.7% Companion Animal Group growth, and the Companion Animal Group growth is over 80% of our total revenues. That 7.4% third-quarter organic revenue growth was a nice pickup from the prior two quarters of 3.3% and 5.5% in Q1 and Q2 for IDEXX as a whole. And the 8.7% was a nice pickup for the Companion Animal Group from 3.6% and 6.8% in Q1 and Q2 of 2013, respectively. So this growth is reflective of the underlying strength we see in the business, and it gives us confidence to guide to 7% to 8% percent organic revenue growth in 2014.

Now Q3 was a very important quarter, as it was the first full quarter of our CAG diagnostic sales organization in North America, an organization that is responsible for approximately 50% of IDEXX 's revenue globally. I am very pleased with the progress and the team's accomplishments, especially given the magnitude of the change. To remind investors, in April an initial 20% of our North American sales organization for diagnostics moved to new roles and territories associated with our new customer coverage model. We call this first group, wave one. The new coverage model entails a single sales professional serving the customer for all IDEXX diagnostic modalities, including the instruments, SNAP and reference labs, allowing for smaller, more manageably sized territories for each rep, and more frequent and consistent customer contact.

The remaining 80% of the field, in what we call wave two, assumed their new roles in the new model in Q3. So this past quarter clearly had the highest risk, with 80% of North America in wave two, with all the associated changes in roles, in territories, and reporting relationships inherent in such a major shift in field sales strategy. The wave one regions that were in their second quarter of the new model during this past quarter of 2013, moved down the learning curve and performed better than both their first quarter this year and Q3 last year.

Performance, as IDEXX looks at it, includes achieving goals across all three diagnostic modalities, reference labs, rapid assays, and instruments and consumables. On the performance dimension of instrument placements, we were impressed to see wave one regions step up, with instrument placement growth year-over-year that reflects the productivity that comes from more time and position in territory, and the additional number of reps in the field. As we extrapolate the Q4 and beyond, we anticipate that the second quarter and position learning curve benefits we saw for the wave one regions will prove to the far larger number of wave two regions.

A couple of other notes from our experience. Sales professional turnover remains at historically low levels, below even the low Q2 level we experienced. So in turn, tenure in time and territory is building in the field. We completed the quarter with 40% more customer calls per rep than the old model, which speaks to the benefit of the new coverage account model with smaller geographic territories, and thus far greater reach and frequency. We had 13% more sales professionals in the field in Q3, versus the same quarter prior year. And when you combine that with the 40% more calls, we actually achieved 58% total more customer calls in Q3 than prior quarters.

And we enter Q4 with 16% more diagnostic sales professionals in the field than we had in Q4 of 2012. We saw increased loyalty, e.g. fewer lost accounts in Q3, in all three diagnostic modalities than at any time in the last couple of years for this important growth metric. Now high customer account loyalty is certainly an outcome of our new customer call -- customer-centric sales model. But also reflects our highly valued and differentiated diagnostic line, including VetConnect PLUS, advanced and unique menus, and integration with practice management software, just to name a few. Another point, Canada which was part of wave two, performed above expectation in Q3, had strong year-over-year instrument placement metrics, and executed a very successful launch of VetConnect PLUS in July.

And finally, and in other international markets, we had almost 10% growth in Europe, and 14% growth in Companion Animal Group, and 14% growth for the Companion Animal Group in Asia Pacific. And chemistry placements grew year-over-year in both Europe and Asia Pacific.

So in summary, our companion animal business showed strong fundamentals with growth normalized -- with global normalized growth, and the profitable annuity or recurring revenue aspects of our business. We mentioned this,15% for instrument consumables, 9% for reference labs, and 5% for rapid assay. In instrument revenues, while Q3 shortfalls have caused us to reduce our full-year 2013 instrument ready guidance, the quality of instrument placements continued to be as strong, as measured by the percent that are going to new or competitive accounts. We are confident based on a wave one progress in Q3, that our North America sales professional productivity in diagnostics will continue to increase. And that assumption, along with the 16% larger sales presence in North America in Q4 over last year, is factored into our 2013 guidance, and, of course, the foundation of our 2014 guidance.

We continue to innovate in the new product area. In Q4, we are launching a new Catalyst single slide, single test fructosamine, which is a very exciting addition to our chemistry menu, allowing for the diagnosis and management of diabetes in a real-time care model. And diabetes, is as an important a disease category in dogs and cats, as it is in humans. This new slide has been developed, and is manufactured by IDEXX in our main facility, and gives us demonstrated capabilities to further expand the Catalyst slide menu with our internal R&D and manufacturing. While we don't expect the fructosamine test revenue in and of itself to be significant, fructosamine is frequently used and highly valued by customers, because they see a lot of diabetic patients, and thus further differentiates our Catalyst chemistry instrument from other chemistry platforms, in its menu breadth and flexibility, and thus enhances all the factors that drive our instrument consumable growth.

Additionally, we introduced several new innovative products in reference labs, including an allergy screening test and our immunotherapy offering that complements our existing allergy product portfolio. We also introduced in reference labs, a new canine and feline cardiac test that significantly improves the customer workflow when assessing cardiac health. So in regards to our portfolio test for cardiac disease, recall that we will also be launching a new rapid test in early 2004, the SNAP feline proBNP for screening test for heart disease. Thus the improved reference lab tests that we just announced this past quarter and the new point-of-care test significantly advances our cardiac testing franchise, leveraging the same proprietary biomarker technology across multiple complementary modalities.

In practice management and digital imaging systems, since our last call, we launched IDEXX image bank, a cloud-based image archive service. We also launched Pet Help Network 3D, a new subscription-based 3D animation product that supports veterinarians in communicating the value of their services to their patients and to their pet owners, and helps explain some of the conditions of the pet. It also, Pet Help Network 3D, complements our Pet Health Network Pro software-as-a-service offering. Finally, we continue to improve upon Pet Health Network Pro through new releases, with key additional functionality for this cloud-based software service.

We expect to start shipping SNAP Pro in Q1 as mentioned in the last call, and are taking orders this quarter. SNAP Pro is a mobile device that simplifies workflow associated with our Rapid Assay line, while pushing results to the cloud to VetConnect PLUS. Customer and distributor response has been extraordinarily strong. Our forecasted R&D investment in 2013 is about $88 million, and we will build upon this base in 2014. While we don't want to be specific as to what else is in the pipeline, I do want investors know that our pipeline includes new instruments, test menu across all three modalities, and advances in our information technology offerings, with many anticipate announcements in 2014.

In August, we were very pleased to have acquired Madasa, as Will mentioned in Brazil. Madasa is a long-time disturber of IDEXX. This very strong and entrepreneurial organization will help serve to accelerate the adoption of our IDEXX Livestock, Poultry, Dairy and Companion animal lines in this important and growing Brazilian market for Animal Health.

Finally, as we announced last week, I am absolutely delighted with the prospect of Brian McKeon joining our management team at the beginning of 2014, as our new EVP and Chief Financial Officer. We know Brian well from his decade of service as an IDEXX Board member. He brings a tremendous track record and experience base to IDEXX, and thus will become a key leader in helping to achieve our targets for growth, profitability and shareholder returns in the years to come.

So with those introductory remarks, I would like to open it up for Q&A.

Thank you.

(Operator Instructions)

We will go to the line of Erin Wilson, with Bank of America. Please go ahead.

Hi, thanks for taking my questions. Can you, I guess can you speak to the Catalyst placement declines in US, and how much of that you think is associated with the sales force changes? And the dynamics I guess behind the placement trends and how we should think about that going into 2014?

Yes, thank you, Erin for that question. Clearly that was the sole reason for the decline in Catalyst placement was the US. And narrowing it more specifically, it was the wave two regions. In Canada, it actually did very well, wave one did well, internationally did well. But having said that, the quality of the placement was very strong. As we have mentioned, in fact, if you just take the three quarters so far in 2013, we had almost a 20% increase in the number of competitive placement on an absolute basis. And competitive placements are new to IDEXX, generate obviously 100% new consumable growth. And I think is one of the underlying dynamics, along with strong loyalty of our customer base, and the reason why we have the 15% adjusted for inventory and other factors -- distributor inventory change and other factors, 15% of consumable growth for our instrument line globally.

Okay, great. And just one more on the sales force transformation. How should we think about the incremental cost associated with the initiative? I mean is it running better than planned, and how should we think about that going into 2014? And you mentioned better loyalty or retention rates. Where do the retention rates stand now for the reference lab? And does that lab, where do you see that going over the next 12 months?

Yes. So, the -- obviously the cost of the 16% larger sales force is embedded in our operating expense metrics. We did have some one-time costs associated with the transformation that occurred over the first three quarters that we will not be recurring. We are basically through that now, and we are well into the model. But, of course, the vast majority of our costs are associated with providing a good economic experience for our reps, which is what allows them to build tenure and experience in the field, and I think in a market-leading technology company. So --

Jon, just quickly on a point though, what I would add is that even though there was some one-time costs in the first part of the year, we have expanded our sales force. And so we continue to expect that we will not have leverage on the operating --

Right, in general. There is different mixes, so the one-time costs were very small in relation to of course, the expansion in the sales force. With regard to what -- loyalty is very important metric, and we are under -- we are over 98% year-over-year loyalty in the instrument consumables lines. I believe we are over 95% in the Rapid Assay line at loyalty, and in just under 95% in the reference lab line. And all those have been improving metrics over the course of the last -- actually over the last 24 months. And we expect them to continue to improve, because there is -- once people I think are using a highly differentiated line, they appreciate the value. They integrate in it, they are providing a value to their clients, and that is one of the benefits of working with IDEXX as a diagnostic partner

Great. Thanks so much

Thank you. Next we will go to the line of Ryan Daniels of William Blair. Your line is open.

Yes, good morning. Thanks for taking the question. I wanted to do a quick follow-up on the sales force transformation. Jon, a good data point that the initial wave saw a 20% increase in instrument placements. I wonder if you could go a little bit deeper, and talk about how effective they were in other areas? Meaning was the instrument placement more of a focus for that group, or was that a benefit that accrued to the Company, while other companies also outperformed?

Yes. So that is -- it is a great question. In wave one and wave two, the -- there really wasn't much of a learning curve. I mean, they did very well. For example, the sales force has several different performance metrics, of which instrument placement is an important one, but by no means the only one. You have reference labs and rapid Assay and, of course, those loyalty metrics are -- feed into all of that. And as a whole, the wave one exceeded their performance, and the wave two essentially met the goals that we gave them. So obviously, there were some out-performance in some areas that made up for under-performance in other areas

Okay, that's helpful color. About one thing you didn't mention, VetConnect PLUS, I was hoping we could get, one, a little bit of an update there on the number of practices that is at. And then number two, I know a lot of things going on with the transformation and the rollout of VetConnect PLUS. I am curious if you have been able to parse out what kind of favorable impact that specifically has had on loyalty utilization, cross-selling, any metrics you can offer? Thanks.

Yes. We are in terms of number of activations, we are a little over 10,000. 10,200 in North America. Of course, we launched it in Canada in July and Canada had a really a very successful launch. We have a very, very strong reference lab business in Canada. I think that team just looked at the US experience, and went down the learning curve, as they watched the US experience, and got off to a much faster launch then we did in the US, and we have a -- we anticipate towards the end of the year to launch that in one international market. Then over the course of 2014, in other international markets. So it will be a global rollout.

But the next challenge for us with VetConnect PLUS is utilization. One thing is to activate and have it available, and the next thing is to use it. And while the large majority -- the majority of customers who activate it are using, one of the things that our new customer-centric sales model does, is help with the customers with the change management of moving from a sample-centric, getting the results from one sample on a piece of paper, to a patient-centric looking at the results in the context of the diagnostic history that you have in VetConnect PLUS.

So behavior changes, as we all know in the veterinary world happens not as fast as you would like, but it, once it happens, they never go back. So we have a COG rate of customers, of several thousand customers who are very active users of VetConnect PLUS, and that is growing. We measure that now every month, and one of the key roles of the sales organization. It is hard to parse out, why is the loyalty growing as a result of VetConnect PLUS, versus the sales model, or versus our more expanded set of test menu. Much of -- many of our proprietary tests aren't unavailable, other than through IDEXX or a strong customer service model that we have. We think they are all contributing factors. And the loyalty, it is really a key component of our strategy going forward.

Okay, great. Thanks for the color.

Thank you. Next we will go to the line of Jon Block with Stifel Nicholas. Your line is open.

Great, thanks, and good morning. Jon, I think the business model continues to sort of be two different worlds. I mean, the recurring is performance well. The equipment, you could argue poorly. And if you could just help me, I am wondering with -- what changed in the last two months of the quarter? And by that I mean, last call I asked a pretty detailed question just after two negative revisions to the top line, if you felt guidance is where it needed to be. And now even after -- I think it was largely in line quarter, the implied 4Q number sort of moves from up, call 11% and maybe up 8% in change. So can you help us with what changed? I know you might reference the sales force, but what went on in the last maybe eight weeks, that is leading to the revision to 4Q?

Okay, thank you. That is a great question. It is, there are two -- you can put our diagnostics business, which I mentioned is what, 82% 83% of the Company, into two categories. You have a 92% of that business or 93% of that business is what we call recurring revenue or annuity. That is really all of the diagnostic recurring revenue, and the recurring revenue in the practice management and digital systems business associated with customer support, and the growth in Pet Health Network Pro which is a subscription-based product. That is all recurring revenue, right? So 93% of the companion animal business.

If you look at the recurring revenue growth over the last three quarters, Jon. And I am just giving you kind of approximate numbers, went from 7.5% -- this is for [CAG globally] -- 7.5% in the first quarter to 9.5% in the second quarter, to the nearly 11% in the third quarter. Now the instrument placements are [with now we thought] negative. It is what -- a part of that is marketing programs, and part of that is the volume of placement. But what is happening is we are placing in good accounts, and that is helping to contribute. The volume may be down, but the quality of those placements is good. And that is helping to continue, what I think we would say, nearly 11% recurring revenue growth being 93% of the companion animal business, that is a good result. And so we are -- and that is the ultimate objective, how we measure ourself. That revenue is, of course, the more profitable revenue.

I will turn it over to Will, in terms of some the dynamics that have changed from our prior thinking

Thanks, Jon. Yes. I think a really important dynamics there. And I think what is really driving some of that strong annuity growth is the -- I will go back to the quality of the instrument placements. And so while what is causing the decline in revenues in Q2 versus just eight weeks ago, is really the number of placement, the quality of those placements has really made up for it. I think we have mentioned on past calls, that a competitive placement for us produces approximately five times the value of an upgrade of one of our own customers. And the competitive placements do take a little bit more time. And so we think that really has resulted in lower instrument revenues, but producing higher consumables revenues. And so it really is an instrument story, that is VetLab instruments.

Then I mentioned also digital placements. We did have some new reps. We -- our expectation was that they would come up the curve a little bit quicker they have. But they have made really solid continuing improvements, which gives us more comfort with Q4, but not to the extent that we have had before. So those are really the two primary factors, Jon

And then the other area I would mention, would be the bioresearch business which is a strong double-digit grower, but isn't achieving the very high growth rates that we had in our assumptions. So that came down a little bit. And then finally as Will mentioned in his upfront comments, there is an increase in deferred revenues associated with capital placements, that would apply to both the digital as well the -- actually all capital placements, digital instruments and Cornerstone placements, which is associated with our marketing programs, and is the result of how those marketing programs are accounted for.

Okay. And maybe this might be part B of the question, and you could just give it a simple yes or no. So your new 2013 guidance sort of implies low 6% organic by our calculations. And you could argue that 2013 benefited from the new rate with NWI, and also the direct change to Nordic countries. So could you just talk to what gives you the confidence to sort of lay out the 7% to 8% organic next year. Is that just a function of everything you just talked to your through your equipment comps, where you are placing equipment is going to competitive accounts, and therefore you should see a modest acceleration in '14 versus '13?

Yes. If that is a yes or no question, that is a yes, on the 7% to 8% organic growth for 2014. (Laughter). I think you laid out well. Just you did mention our Nordic go direct -- that is really been very, very successful. We have had almost, almost triple digit growth in Nordic's in Q3. And we have just been a very -- it's not a big number. So it is one of the contributing factors to the nearly 10% Europe CAG growth, 9.5% or so. But it is a -- it has been a very, very successful strategy for us.

And now, we have essentially in a little bit different way we have done that in Brazil, acquired a very, very successful distributor for us in the Dairy and Livestock area, and we think they are a great platform. We really don't have a strong presence in Brazil, in either LTD or the companion animal business. It is a -- no one really does. It is an underdeveloped market. It is a big animal health market, and so we're excited about that. We also actually acquired a distributor of ours in South Africa, which is going to give us a bit of a go to BRIC benefit in South Africa, combined with a strong local team. So these are just elements of our global strategy of continuing to get close to customers.

Okay. And last one, if I could just slip it in. Jon, looking back at your placement estimates for both chemistry and hematology. You started the year, chemistry you were thinking, up low single-digits, and hematology, up low teens. And now I think you mentioned both of those are sitting down mid single-digits year-over-year. And you went into the year I believe knowing that you were going to go ahead, and sort of redo the sales force in certain ways. So can you just give us from a high level, what are you seeing out there in terms of competitiveness within placing instruments? And why was that -- why were you experiencing such a big delta, where you will end up, from where you started the year? Thanks.

Thank you, Jon. Well, the other thing we didn't expect is going to do to 55%-plus competitive placements. I mean, that has been a pretty -- that was -- the highest number we have achieved for Q2 was 45%. And in Q2, we are at 55% 56%. So the competitive placements is a percentage of total and absolute number of competitive placements, as I mentioned up nearly 20% for the first three quarters versus prior year was strong. So that was an unexpected benefit to our model going forward. That is where the market opportunity, 87% of our consumable, our chemistry revenue comes from Catalyst customers in North America right now.

And there's still a lot -- there are still customers out there that are upgrading everyday. Obviously that is what makes up the other 44% of our placements. But I think we're getting better and better and more differentiated in talking to customers that are not currently using our technology. And explain to them the benefits, the clearly superior benefits that help them grow their practice, as they move to certainly our in-house platform, and combined with our reference platform, giving them a total diagnostic solution, with or without the wraparound of VetConnect PLUS. We are getting better at that. And there is a big opportunity out there, continuing opportunity to grow the business. The other thing that is happening is we have got higher loyalty. So once we get them, we keep them. And we're growing utilization of accounts, inspiring them with the importance of diagnostics as part of the practice business model.

And just finally, we are adding new tests. What we are adding in the reference labs is good. And we are very, very excited about the fructosamine test. It is probably -- I would call fructosamine the single most important individual test that we have launched in our chemistry platform in the last decade, because it is such an important disease, diabetes. And just so you understand, that this is the equivalent to HvA1c in the human market. In other words, this measures glucose levels in the dog or cat over the past two to three weeks average. It's very, very hard to measure glucose, particularly in a cat, I know because I have a diabetic cat. Now it's very hard to do so-called glucose curves. So fructose is a value test, and we are going -- we are the only major platform that has got it on the in-house now

Thanks.

Just add a little bit of color on what you are mentioning before about the interim placement numbers. And certainly, they are very strong -- and just to go back to them, very strong competitive numbers. And so it really points to the VetTest upgrades. And that is one thing that we really do believe, that in the new diagnostic consultant model that they are going to become partners with these practices. And that could result in us being able to accelerate the continued transition of our VetConnect -- our prior VetTest customers up to Catalyst customers. But even those prior VetTest customers, a very loyal group of customers.

Yes, we like the VetTest customers as much we like Catalyst customers. They give us good business. They have our in-house platform. And depending on what they have surrounding that VetTest, they have got the IDLS we have been selling since 2006. They can connect over that, on the VetConnect PLUS. And that is a good customer for us. We like to inspire them to upgrade, but in the meantime, it is good to have them as a customer of the VetTest

Thank you.

Thank you.

(Operator Instructions)

We will go to the line of David Clair with Piper Jaffray. Your line is open.

Yes, good morning, everybody. So I am sure we don't want to get too deep into the details for your 2014 guidance, but I was hoping just to maybe get some details on your assumptions for instruments? And then, what are you assuming for the underlying economy?

Okay, thank you. Again, yes, we are not really, as you have mentioned in position to get too detailed, but we do have -- I think it is fair to say, we are going to be -- of course having passed the comps of 2013, with the kinds of things that we have done that brought our instrument revenues down, but of course, have done a nice job in growing the recurring revenue portion of the consumables. And so, we also expect that we are going to be really -- in 2014, getting to a state of maturity with the new diagnostic model.

We just went through the first quarter of the fourth quarter. And the fourth quarter, we are primed, we are ready to go. We have got people in position. Fourth quarter is an important quarter. But by the time we get to 2014, we are going to have these reps who really know their customers. An average rep has 150 to 160 customers. They are really going to start getting to know them. And again, these are all relatively new territories. And we are going to really see the benefits of, not only the expanded feet on the street, but the productivity per rep that we think will be a good driver to 2014. With regard to the economy, I don't think we're expecting any great things that are -- I don't think we are expecting it to be much different, than it was in 2013.

Okay, thanks. And then it's been three quarters now since we saw the distribution change. I was just hoping -- I think you have mentioned in the past, that MWI, you continue to see traction there. Any update what -- that you can give us?

It is really the same story as it has been all year. All of our distributors are performing well. The relative performance of the different distributors really has not changed over the course of this year, in comparison to prior year's. I think we have a very engaged distributor group. And it is -- there really isn't any change. Distributors are good partners for us. We also recognize that our sales organizations are the primary ones, in terms of placing instruments and growing diagnostic revenues. We have gotten a really great response from distributors for SNAP Pro. They really get it. They see it as basically an iPhone for SNAPs. And it is going to be fun to introduce that to the market, and our distributors have been strong partners with us in figuring out exactly how to do that.

Okay, thank you.

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

Hi, a lot of my questions have been answered. But you gave out the statistic that about 87% of your consumable volume in the US is coming from your Catalyst owners. And I guess intuitively that you would imply that the VetTests that are still out there in North America are generating pretty low volumes of consumables. And my question is, do these clinics have enough revenue or enough in-house consumable volume to justify upgrading to Catalyst? And is this a challenge that has maybe slowed some of your placements, compared to expectations? And the second part of this question would be, if these clinics do upgrade to Catalyst, I mean how much to their consumable volumes have to increase to really justify the switch?

Well, the fact is their consumable volumes increased about 25%. So that is one of the things that happens. And what we are doing is, we are really inspiring them to use their in-house lab in a more client-centric way with real-time care. And this new coverage model, we are going to be back there after we place an instrument, would help them in learning how to utilize the instrument. And that's one of the nice things about this new model.

You make a good point, that we have got relatively -- the install base for chemistry is mostly Catalyst now, for our own install base. But I have to tell you, there is a tremendous opportunity out there, there is still opportunity for upgrades, although probably not as great as it was in the -- maybe a year ago, but there's still an opportunity out there. But the big opportunity which is no smaller today than it was in the past, is the competitive switch. Which is obviously 5 X value creator for IDEXX shareholders. And, of course, a good value greater for the customer too.

And then addition, there is so much focus in the US. But we are doing really well outside the US. I am very impressed with our teams around the world, whether it is in places like the UK or Germany. And Canada just did a great job with the transformation of the IDEXX diagnostic sales organization. Australia is doing very well. They were actually the original account coverage model. Japan is doing well, other emerging markets. So these are all contributing factors -- as I mentioned, nearly 11% annuity growth that we saw in Q3 for the companion animal group.

Okay, that's helpful. And just one final question. I may have missed this in your prepared remarks, Jon, but I just wonder if you could explain what the differences for the Pet Health Network Pro 3D versus the base product that has been out there?

Right. So the base product is, as you call the base Pet Health Network subscription basis, is a client -- is a software-as-a-service based client communication tool. So this is what allows you to send out electronic minders. It has the Pet lead page, which has got a tremendous response from both practices and pet owners, where all their health information is online. It allows you to book appointments, integrated with Cornerstone. You can send out newsletters. It allows you to manage your reviews online. With Google and Yelp, this is turning to be a more and more important issue. So all, a lot of different functionality in Pet Health Network Pro.

And then, Pet Health 3D is a -- you just have to see it -- and those of you who come to the North American Veterinary conference will -- is an imaging -- it gives you very clear illustrations, interactive images of different pet conditions, so a look inside the pet. And it helps the veterinarian primarily in the office explain what is going on with the pet. And then e-mail a link to the pet owner and other family members, so they can see what is the condition that has been discovered and what will be the treatment plan. So that is the difference between the two.

Okay.

They work together

Okay. That's very helpful. Thank you

They are both -- they are separate subscriptions.

I see, okay, good. Thank you

Thank you. Our next question comes from the line of Nicholas Jansen with Raymond James and Associates. Please go ahead.

Hi. Following up on Dave's question from earlier, on your relationships with your existing distributors. But how have those evolved this year with the new diagnostic model? Are we expecting kind of any changes for '14 and '15? And maybe can remind us when your Patterson and Shine contracts are up for renewal?

We don't expect any changes. The -- all of our contracts with the exception of the one with MWI, which was a two year associated with the change and the moving to non-exclusive and the lower margin, they are all annual. They have always been annual. We would expect the annual renewal. We have good relationships with them. We continue to work closely with distributors to help them grow the IDEXX line. The IDEXX line is in -- obviously when you look at a kind of consumable growth of 15%, that the distributing is an important line. It is a strategic line. And so, we really expect no change in the model in 2014, or even 2015 from where we are today.

Okay, thanks. And then maybe just an update on your German lab venture, kind of how where we are today, in terms of countries penetrated? How much benefit have you had from this rollout, and kind of what should we anticipate over the next two years, as maybe you better penetrate more countries there? Thanks.

Yes. So that, you are talking about our Liepzig IDEXX direct lab, which is co-located with DHL in Leipzig, Germany. And it gives an improved, it gives really that late pickup, early morning turnaround time that we are used in the US, but is not a standard model and the vast majority of Europe. And key countries that is really helping us grow the lab services in Europe would, of course, be Germany, but also Italy. And it has been one of the contributing factors to the success in the Nordic go direct. In fact, we had direct reps there for labs prior to 2013, but now we have the full coverage account model with in-house lab, and we have been very, very successful. And we are going to continue to roll that out to other countries are supported by the DHL network.

If you reflect back strategically -- I think it was 2008 is when we opened the Memphis lab, and it is now the largest lab in North America, because of that very, very successful direct model using FedEx. And we really see long-term strategically that Leipzig could be that too, in a strong partnership with our core lab, that has really advanced testing capabilities that works closely with Leipzig in Ludwigsburg, Germany. So Leipzig is the fast turnaround overnight results the next morning model. And that is really bringing it completely different service level. So we are not only winning new customers, we are aggressively growing existing customers that are benefiting from that service model.

And in fact, Jon, for I think some of the experience better service levels. We are actually seen the customers that are in -- the customers of the Leipzig lab growing 30% faster or 30% versus 10% with our other customers, and so really seen just a very strong growth. Customers are really liking the service that is being provided by that Leipzig lab.

Thanks.

Thank you. Next we will go to the line of Jeff Frelick with Canaccord. Your line is open.

Good morning, folks. Jon, quick question here on the how you characterize the new customers to IDEXX? Are these more competitive instrument conversions, or are you converting the send-outs, moving those more to in-house? And then, how would you characterize the volumes of these new customers to IDEXX?

Yes. So they are -- I think they are primarily those who have another -- don't have IDEXX for their in-house, but have an in-house analyzers, and they switch to IDEXX. There is another category of brand-new practices. It is a small category, but there is always new practices being formed. And with regards to send-out, I think over 90%, I would say 90% to 95% customers already have a chemistry analyzer. So it's not like exactly that we are converting, people who weren't using an in-house lab using an in-house lab, although we may be converted people from using our in-house lab to some degree, to realizing the benefits of real-time care.

The basic question is, why ask a customer to wait, when you can run it now? Why ask the customer to come back? Why ask the customer to come a few days early to run the pre- in when you can run it the morning of the surgery? I mean, in this environment people don't want to wait. They don't want to drive to the practice more often than they have to.

Convenience is the order of the day. And I think practices are understanding the convenience model, and our in-house instruments are uniquely designed to provide results within the practice, within the appointment, because of the fast turnaround time for both chemistry and hematology. And certainly combined with VetConnect PLUS, where you can have those results any time, anywhere in the practice. So it really is uniquely designed for a real-time care scenario.

So many times, when we upgrade the customer to IDEXX technology, they are running more of their work in-house. And I think we have seen a very, very slow -- we have talked about this with you in the past. We are seeing a very, very slow shift of core chemistry and hematology from the reference lab to in-house, very slow. But it's happening. These things can happen very -- in slow motion -- and the veterinary will -- our reference lab is doing well because we are backfilling with new specialized tests, and of course, growing that number of customers. So as we introduce a whole new category of cardiac disease, or allergy or molecular diagnostics, these are -- these things are helping contribute to growth of the reference lab. And these are technologies that are not available and in real-time care modality

Great. Thanks, Jon

Thank you. And we have time for one final question that will come from the line of Erin Wilson with Bank of America. Your line is open.

Hi thanks. Most of my questions are answered, but on capital deployment, I know you didn't give any CapEx guidance, but do you anticipate any major capital expenditures out of the ordinary in 2014? For instance, associated with your Brazil business or in South Africa that you mentioned?

No. I don't think so. I mean, we mentioned the CapEx guidance for the current year of around $90 million, but for next year, no, there is nothing that we are expecting.

Just normal capacity expansion with associated with volumes, but that is a -- that is normal run rate stuff. One of the things we did complete in 2013 was our expansion here of our facility in Maine. So we are not going to have to do that again. But there is always -- we are growing, when you grow consumable volume 15%, you need to continue to invest in production capacity. But that is all in the normal ordinary course of business. We haven't given specific guidance, but I don't see anything unusual in 2014

And where does Cornerstone adoption stand, is that growing [tremendously]?

Yes, we are really pleased with the success with Cornerstone. We have seen -- we had some rep transition issues in our Cornerstone business, kind of like we had in our digital business that hurt us a little bit in the first and second quarter. But where -- Will talked about it taking a little bit longer to get the new digital reps up to speed, we haven't had that issue on Cornerstone. We had a very strong Cornerstone placement. And of course, I think that goes -- it works period very well with Pet Health Network Pro.

I would just remind investors that client communications is really being recognized more and more, as a key capability of the practice. And we are the only partner who can provide a client communications tool that is fully integrated with the practice management. And that turns out to be really important because you want to share, if you want to share exam results, you have got to be integrated. If you want the pet owner to be able to book an appointment, with -- through their [Pet View] page, it has to be integrated with the practice Management software. And so, I think we are really pleased with the success we had, and the momentum we have in both those related product lines that was established in Q3. Thank you for the question Erin.

Okay. Thanks so much

Thank you. With that, speakers, I would like to turn it back over to you for any closing comments.

Okay. I want to thank everybody for being on the call. And I certainly want to -- a huge congratulations to our North American sales and marketing organization. They really stepped up, and there was a lot of change, and we are through that period now, and we are settled down. We are learning the new model, and it has been a tremendous accomplishment. But we have also had, what I would say is extraordinary performance with our regions around the world. So just I do want to -- I do want to thank everybody. And again, we are going to be looking forward to updating you on the full-year performance in January, and giving more details on the 2014 outlook. And that concludes the call.

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