IDEXX Laboratories, Inc. (NASDAQ:IDXX)
Q3 2011 Earnings Call
October 21, 2011 9:00 am ET
Jon Ayers - CEO
Merilee Raines - CFO
Pete Levine - Director, IR
Ryan Daniels - William Blair
David Clair - Piper Jaffray
Miroslava Minkova - Leerink Swann
Jonathan Block - SunTrust
Nicholas Jansen - Raymond James & Associates
Ross Taylor - C.L. King & Associates
Anne Wilson - Bank of America
Good morning everyone and welcome to the IDEXX Laboratories Third Quarter 2011 Earnings Conference Call. Just a reminder, today’s conference is being recorded. Participating in the call this morning are Jon Ayers, Chief Executive Officer; Merilee Raines, Chief Financial Officer; and Pete Levine, Director, Investor Relations.
IDEXX would like to preface the discussion today with a caution regarding forward-looking statements. Listeners are reminded that statements that members of IDEXX management may make on this call regarding management’s future expectations and plans and IDEXX’s future prospects constitute forward-looking statements for purposes of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements can be identified by the use of words such as expect, may, anticipate, intend, would, will, plans, believe, estimate, should and similar words and expressions. Such statements include, but are not limited to statements regarding management’s expectations for financial results for future periods.
Listeners are reminded that actual results could differ materially from management’s expectations. Factors that could cause or contribute to such differences are described in IDEXX’s quarterly report on Form 10-Q for the quarter ended June 30, 2011 and annual report on Form 10-K for the year ended December 31, 2010 in the section captioned Risk Factors, which are on file with the SEC and also available on IDEXX’s website, idexx.com.
In addition, any forward-looking statements represent IDEXX’s estimates only as of today and should not be relied upon as representing the company’s estimates as of any subsequent date. The company disclaims any obligation to update or revise any forward-looking statements in the future even if its estimates or expectations change.
Also during this call, we will be discussing certain financial measures not prepared in accordance with Generally Accepted Accounting Principles or GAAP. A definition of these non-GAAP financial measures is provided in our earnings release, which can be found on our website idexx.com.
Finally, we plan to end today’s call by 10 AM Eastern and in order to allow broad participation in the Q&A, we ask that each participant limit his or her questions to 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 our call today. The quarter's financial performance overall was largely in line with our expectations at the time of our second quarter call in July.
Our third quarter revenues of $301 million grew organically 8% after adjusting for a 4% favorable impact from currency. The mix of revenues was somewhat different from our thinking back in July with relatively stronger performance in out VetLab instrument placements offsetting a somewhat lighter performance in our Digital Radiography and Practice Management product line.
Diluted earnings per share of $0.66 were slightly above our expectation due largely to the receipt of the final balance owed to us of just over $1 million for inventory sold when we divested certain pharmaceutical product lines at the end of 2008. this payment which contributed $0.01 to earnings was recorded as a reduction to G&A expense. Beyond this payment, lower operating expenses offset a slightly lower gross margin primarily a function of revenue mix.
Our organic revenue growth performance continued to get little to no benefit from the macroeconomic environment. Our internal gauge for the vitality of the US companion animal health market practice managed practice metrics from a consistent subset of veterinary clinics who use our Cornerstone Practice Management System showed that in aggregate patient visits were flat year to year in the third quarter and practice revenue growth was about 3%. This is ever so slight an improvement from what they have observed in the previous two quarters when patient business were down 0.5% and practice revenue growth was about 2%. In our view, this indicates a market that continues to stabilize and reaffirms our belief that improving trends will be very gradual.
Though Europe has its own set of fiscal and monetary issues, our companion animal business in that region had strong performance in the third quarter with organic revenue growth of about 10%.
Now, for some further detail on revenue performance in some of our business. Our IDEXX VetLab Instruments and Consumables with third quarter revenue of $99.7 million posted organic growth of 9%. Sales of instruments in our IDEXX VetLab suite at $24.8 million grew organically 14% year to year in the third quarter, a nine point increase over our second quarter instrument organic growth.
Our ProCyte and LaserCyte hematology placements increased 38% year-over-year and our Catalyst and VetTest Chemistry placements increased 19% year-over-year. Once again ProCyte, with third quarter placements up 279 units, was a significant contributor to our overall instrument growth. With year-to-date placements of nearly 800, we are well on track to exceed our initial 2011 target of 1000 units by 10 to 15%.
LaserCyte placements were also solid, up 16% year to year and roughly two-thirds of those placements were instruments that we had taken in trade and certified for resale.
We were very pleased with the placements of our Chemistry instruments, Catalyst and VetTest. Combined placements of nearly 1100, when added to our first half performance, keep us on track for our full year projection of 4000. We placed over 700 Catalyst, a nearly 40% increase over the third quarter of last year. While placement performance was strong in all geographies, we were particularly pleased with a 44% growth in the US, which we believe is a function of increased sales force effectiveness and more effective marketing program. About 30% of both ProCyte and Catalyst placements were to new and competitive accounts.
We continued to see growth in our Smart Service users, with over 1200 installations in the third quarter, which brings our active installed base to over 10,700 customers. We expect to have approximately 12,000 customers on Smart Service by the end of the year. This is important because, in addition to Smart Service providing us with real time data on customer testing activity in support of our incentive programs for customers to run larger profiles per patient sample, this Internet connection between IDEXX and our customers enables us to monitor that instruments are performing optimally, which is a key requirement in support of Real-Time Care.
Instrument consumable sales of $63.3 million grew organically 7% or 8% when further normalized for changes in distributor inventories. This normalized growth is consistent with what we’ve been seeing this year, and is about double the normalized organic growth rate for last year.
Our third quarter Rapid Assay sales of $36.1 million showed flat organic growth with the prior year. When normalized for changes in distributor inventory levels and the estimated timing between quarters due to marketing initiatives revenues grew on par would be approximately 2% we have experienced during the first half of this year. This step up from the modestly negative growth rates we experienced in 2010 continues to be driven primarily by increased canine parasitic disease testing volumes, as well as the successful worldwide launch of our SNAP Feline pancreatitis test in the second quarter.
Offsetting these areas of strength, is the weakness we have been seeing for sometime in feline testing, reflective of year-over-year declines in patient visits for tests. US distributor inventories for instrument consumables and rapid assays averaged just under four weeks at the end of the third quarter, a level we consider normal and customary.
Our Reference Laboratory and Consulting Services business, with revenues of $94 million, achieved organic growth of 10% in the third quarter consistent with the first half of the year. Growth was strong across all regions, and the majority of the growth came from higher test volume, driven primarily from the addition of new customers. We continued to expand our worldwide laboratory footprint supporting the goal of strengthening our service levels. And we recently opened a new day lab at Houston and have expanded internationally through our new day lab in Seoul, South Korea.
During the quarter, we also consolidated two of our labs in South Africa, which brings the total global network to 52 labs across five continents. And we plan to open an additional lab in the fourth quarter of this year. In addition to the operating margin benefits, we derive from increase testing volumes, we continue with other operating initiatives to increase lab margins.
In the third quarter, our Canada labs in particular, showed strong year-over-year improvement as we benefited from structural changes and Lean processing initiatives. During the quarter, we expanded our core lab in Memphis adding significant capacity by tripling our labs square footage at that location. This facility expansion will allow us to further consolidate night testing in Memphis and take advantage of sale economies. At this facility, we also have plans to take advantage of automation, advance lab technologies and Lean processing to drive further efficiencies.
Our Practice Information Management and Digital Radiograph Systems, with revenues of $18.3 million, grew organically 11% year-to-year. As noted upfront, this performance was just a bit below our expectations in July leading us to now project full year organic growth in the low single digit. Order books are strong going into the fourth quarter, a reflection of the innovations we continued to introduce in both product lines. And John will explain us some of these in his comments.
Our Livestock and Poultry Diagnostic revenues grew organically 10% to $20.7 million in the third quarter. This growth was in line with our expectations and reflected a continuation of higher sales volumes from the eradication programs in Germany that we have discussed in earlier calls, as well as strong gains in smaller emerging markets such as Latin America and Eastern Europe. As anticipated, growth did moderate from the approximately 20% rate achieved in the first half due in part were declined in BSE testing as countries begin to adopt the new EU rules that increased the mandatory testing age for BSE from 48 months to 72 months which was effective July 1.
For the full year, we continue to expect organic growth of about 10% which implies relatively flat growth in the fourth quarter due to two factors. First, we expect sales growth associated with a bovine testing program in Germany to level up because the program ramped significantly in the fourth quarter of 2010; and second, we anticipate further price and volume declines for BSE test.
Our Water business hit sales of $21.6 million for the quarter or 4% organic growth which is reflecting gains in our core [colder] testing business in Latin America and Europe. Third quarter growth was in line with our thinking and consistent with our expectations for mid single digit full year organic growth.
Turning to the rest of the P&L, as mentioned upfront, the gross margin at 53% was slightly lower than anticipated in July as placements of in-clinic analyzers with relatively lower gross margins were a higher portion of our revenue mix.
Operating expenses at 34% or revenues were also somewhat below our thinking in July due in large part to the receipt of the pharma inventory payment, which I also mentioned earlier. In addition lower healthcare costs for which we are self-insured and lower discretionary stand were modest contributors.
Out effective tax rate of 30.8% was in line with our expectations and a bit below the previous two quarters due to the release of reserves in conjunction with the expiration of certain statutes of limitation. Share count was also largely in line with our expectations for the quarter.
Turning to the balance sheet and cash flow, we ended the quarter with $182 million of cash and $158 million of debt or a net cash position of $24 million. Our inventory balance of $137 million was approximately $3 million higher than the end of the second quarter as a result of chemistry consumable receipts. We except inventory level to come down $3 million to $4 million in the fourth quarter.
Day sales outstanding at 43 days remains in good shape and our free cash flow was $65 million or 168% of net income.
Looking forward we project all year revenues of approximately $1.215 billion. Our revenue guidance implies 10% reported revenue growth, which translates to organic growth of approximately 8%. Though organic growth is unchanged relative to the high end of our outlook in July, the components of this growth have changed slightly with somewhat higher revenues expected from instruments and consumable and somewhat lower revenue from our digital radiography and practice information management offerings.
We continue to project gross margin to be approximately 53% of revenues and operating expenses to be approximately 34% of revenues for the year. We are increasing our full year EPS projection to $2.71 to $2.74 compared to our July guidance of $2.68 to $2.73. The $0.01 increase in guidance at the high end of the range reflects the $0.01 of favorability related to the inventory payment in the third quarter. We believe that the business performance in the fourth quarter will be able to offset the anticipated $0.01 or expected unfavorability related to currency.
For little bit more detail on currency, the rates implicit in our guidance today are the Euro at $1.35, the pound at $1.55 and the Canadian dollar at $0.97. To remind, every 1% weakening of the US dollar these are the our basket of currencies increases revenue by slightly more than $4 million and operating profit by about $750,000 on an annual basis.
As we look the 2012, we project revenues to be $1.295 billion to $1.315 billion, a year-to-year increase are 6% to 8% reported growth or 7% to 9% organic growth, and earnings per share of $3 to $3.10, a reported growth up 10 to 15%.
With regard to currency, our 2012 guidance assumes that currencies remain at the rates implicit in our latest 2011 guidance. As these rates reflect a relatively stronger US dollar versus the average for 2011, currency is expected to reduce our 2012 reported revenue growth by about 1% as just noted.
Similar to 2011, every 1% change in the US dollar versus our basket of currencies changes revenues by slightly more than $4 million on an annual basis. Because we have not fully hedged our 2012 exposure at this time, the impact of 1% change in the US dollar verses our basket of currencies has a larger $1.2 million impact on operating profit. Our customary practice is to layer in hedges over the course of the year for the following year.
Our projected revenue growth assumes only a very minimal and gradual improvement in the economy. We expect our organic growth to be largely driven by continued successful execution of our strategies to bring to our principal market innovative diagnostic products, services, and information technologies that provide valuable insights to our customers and help them operate more efficiently, and to more effectively communicate the value of their services to their customers.
We anticipate operating margin expansion in 2012 led by focused initiatives, many already underway in our two largest businesses, IDEXX VetLabs and Reference Laboratories. The impact of these initiatives will manifest primarily in the gross margin line and we will also continue to make targeted investments to drive healthy top-line growth beyond 2012.
Our share repurchase program will generate earnings per share growth above operating profit growth. As we are still in the midst of our internal planning process, we will provide more details on the components of our P&L, balance sheet, and cash flow, at the time of our fourth quarter call in January.
However, I will note that today's guidance for 2012 does not incorporate any benefit from the federal R&D tax credit, which is said to expire at the end of 2011. The credit has provided us with three to four pennies of earnings per share benefit in each of the last couple of years.
Thanks. And now I would like turn it over to Jon for some further comments on the business.
Thanks Merilee. We see nice momentum in our business both in terms of our products and services on the market and our new product pipeline. The strategy of our Companion Animal Group, which as investors know contributes 82% of the company's revenue, is coming into sharper focus this quarter. Our customers, veterinary practices, can achieve growth in the current economy if they work to build their relevance and bond with their clients, pet owners. We see this clearly in the practice growth there.
First, our veterinary customers that use our Cornerstone practice management software, usually combined with some or all the elements on a diagnostics products and services, are growing the revenues from 2% to as much as 4% faster than other practices in the US.
Second, the practice-by-practice variation is wide. 27% of our sample set, this is of 400 plus Cornerstone practices, are growing at 5% or more year-to-date, and 12% of the samples are growing 10% or more. This is not generally explained by geography. Instead, it appears to be a function of the effectiveness of the local practice in generating growth in the intensity of care provided per pet served.
Our IDEXX products and services are designed to support practice growth and efficiency. One element of driving practice growth is the adoption of IDEXX tools that allows the practice to communicate to the pet owner the value of the medicine practice. Somewhat unique to veterinary medicine, the pet on our page cash for their pet healthcare services and thus makes some economic decision in the level of that care. When the practice effectively communicates the value, the pet owner generally responds in accordance with the strengths of bond with their pets, which is generally quiet strong. And this world, in this new world of consumerism, this communication becomes critical the practice success.
One of our strategies is that allows the vet to communicate clear values what we call Real-Time Care are the ability to provide immediately the diagnostic results during exam, be they blood work or radiograph. The Real-Time Care experience gets a wow reaction from pet owners and helps the practice stay highly welded in this new more challenged consumer economy.
A great anecdotal example of this is an article recently published in Health Care Communications News entitled “My dog has better medical records than my daughter.” It turns out that the author had a wow experienced at a practice that was fully integrated with IDEXX diagnostics and Cornerstone software, was provided blood work results during the visit and had made and their practice had made the move to (inaudible) products that’s in given in the report card end of that visit. Unlike most of human medicines, in the veterinary world, the electronic medical record that a practice compiles during the course of exam can also serve as the pet visit report provided to the pet owner at the end of the exam before the bill is presented. This is the type of communication that inspires pet owners in this new world to make the wise investment in the health and well-being of their beloved four legged companion.
In this way, we have achieved a number of objectives in Q3 in our Companion Animal Group. First, we were extremely pleased for the increased in the rate of instrument placement. Obviously, we used of our advanced instruments like Catalyst and ProCyte allows the practice to effectively and easily deliver Real-Time Care. A nearly 40% increase in Catalyst placements and the 38% increase in combined ProCyte and LaserCyte hematology instrument placements year over year has accelerated the growth in the base of customers who will benefit from the ability to provide comprehensive real-time blood work results.
So, why the big jumping Q3? As I indicated in the July call, we have refined our positioning and redesigned our costumer discount and incentive programs on new customer instrument sales, including the use of the Real-Time Care Protocol framework. Our sales organization moved down the learning group and how to execute this more medically based sales. So if a customer upgrades a patient's blood work from Chemistry only panel to a larger complete panel that includes electrolyte chemistry as well the complete hematology run, a combined 45 parameters in all, then they can earn a rebate from IDEXX, once they bought the new equipment. This idea providing increasing the attractive pricing as additional tests are added to the blood sample has been prevalent in the outside labs for a long time. So it’s very familiar to veterinarians. But some of the rebate that customer can earn as they move to the larger profiles can offset the new monthly lease and maintenance cost of the IDEXX equipment. When a pet gets a complete diagnostic profile, the pet owner wins, the practice realizes a higher standard of care and a rebate, and IDEXX obviously wins as you can see by the placement of success.
Also early returns suggest that the customers that are using the (inaudible) increase the number of patient’s samples run on their new IDEXX in-house lab by as much as 10% to 20% versus other customers. Even the Reference Lab wins as we consistently find that test results discussed with the pet owners in person lead the higher complaints with recommendations for follow-on care, all types of follow-on care, but including tests that would be essentially outside lab. In this way, testing begets more testing.
With this instrument's marketing strategy note that we are leveraging three unique capabilities in the IDEXX VetLab suite and the innovations we have brought to the market, namely first, the ability to run a complete chemistry up to 22 parameters and a complete hematology profile with less technician hands on time that it would take to prepare that sample to send to the outside lab.
Second, the ability to easily and efficiently provide real time results real time during the pet owner exam. Our instrument turn around time or cycle time is unique IDEXX’s system design. And third, the ability to monitor and track the number of test runs across multiple and treating instruments on a single patient. We do this through our Real-Time Smart Service connection with in-house lab, again the capability unique to IDEXX.
Tracking is a prerequisite tool, for awarding the rebate so as to identify the specific type of number of consumables used with the patient samples. Our success with this approach to marketing instruments is obvious with our Q3 placement numbers in North America. We are very comfortable with our overall equipment placement goals for the full year 2011, as laid out by Merilee, 4000 Chemistry systems including both Catalyst and VetTest, and please note that we have not even had a meaningful Catalyst placement growth contribution from Japan. We do expect that Japan will ramp in Q4 as we begin to take advantage of the preparation and limited launch accomplishments of over the last six months.
Our Digital business has launched a really exciting capability that supports Real-Time Care and the communication of medical value to the pet owner during exams with the introduction of the I-Vision Mobile App for I-Pad and Android Tablets. We started telling this new Mobile chief ability at the beginning of the month to much customer claim. The App allows the veterinarian to access digital radio graphs generated seconds ago on their IDEXX system, real time within the practice on their Mobile tablet. Interestingly, the form factor of the tablet is uniquely suited to facilitating a one on one medical conversation between the veterinarian or technician and the pet owner. With the right integrated app on a tablet, a powerful conversation can be achieved regarding the health of the pet and the recommendations for follow and care.
A picture tells a thousand words and a radiographic picture of a pet that can be zoomed or otherwise manipulated on a tablet is an effective device for showing the medical value of the sophisticated measurements that has been practiced.
In addition, the staffs can order additional images right from the patent AP as well as e-mail the images, a capability that leverages our internally developed digital packed software and it’s full integration with the practice management software. We are the first to market with this digital iPad and tablet capability.
Speaking of radiography, one of our businesses within CAG is IDEXX Telemedicine Consultants. Our service that has a team of Board certified radiologists ready to interpret imaging studies on behalf of primary care veterinarians. We are the leader in this fragmented and small but growing market. And in the third quarter we furthered our leadership with the acquisition of another Telemedicine service offering called BBM Insight. That’s a great little acquisition that will accelerate the already impressive growth of this line of business and extends the comprehensive nature of our diagnostic product and service offering.
Our global reference labs in consulting business again achieved 10% organic growth. During the quarter, we introduced the first molecular diagnostic test that provides a medically relevant quantitative result used for the diagnosis of canine distemper. This is a great example of continuing innovation with new, unique, and value-added diagnostic testing capabilities.
We have further innovations in the pipeline and expect to introduce new menu on our existing instrument suite on our SNAP platform and also in the reference labs in 2012.
Finally, we are excited about the continued momentum of our flagship practice management software Cornerstone. Placement volume has grown at mid-teens rate year-to-date; and [their] orders are up further year-over-year. We also just completed the highly successful Cornerstone Users Conference with over 500 Cornerstone customers in attendance, up 33% from last year’s conference, and over a 100% from two years ago. At the conference, we highlighted the exciting new features of our just released Cornerstone 8.2, features which help better communicate medical value to the pet owner while increasing practice productivity and efficiency.
So with these introductory comments, Cynthia, we are happy to open it up to Q and A.
Thank you. (Operator Instructions) And our first question will come from the line of Ryan Daniels with William Blair. Please go ahead.
Ryan Daniels - William Blair
Yeah, good morning everyone, and thanks for taking my question. Jon, I want to go back to some of the commentary you provided on the strength in the instrument placements and some of the normal marketing initiatives that appear very effective. So is it fair to say that the marketing pitch today is if you got an upgrade equipment and do enough testing that you’re rebase will effectively offset the lease cost. So the practice will generate more practice level sales and margins but in effect pay for the new equipment?
Yeah, and the one addition I would add is when you said we’re going test I would say expand the profiles that they’re running. So obviously you see a bigger, you would see an increase in utilization per pet if you will and per pet sample. And then you would earn enough rebates to maybe for the new cost, monthly cost that you would incur associated with leasing the instrument and maintenance cost.
Ryan Daniels - William Blair
Okay, very helpful. And then I guess my, I got a follow-up, I just want to talk a little bit more about some of the R&D investments, you obviously had some good announcements in the Cornerstone and in digital radiography with the Cloud and Mobile Solutions. And I’m curious if you’ve begun to invest in any clinical decision support tools that might help that more effectively practice real time care protocols or perhaps ID high risk patients for more diagnostic work et cetera is kind of the next level of driving more intensity of services, if you will?
Yes. I’d say the -- we aren’t generally investing in that area and that the digital application I think is the first of a whole area. I would say where we see the real value is not just medical decision support but communication support in that conversation. Because medicine that can be practiced but that can’t be communicated to the pet owner and where the pet owner therefore doesn’t appreciate it and doesn’t do it, then isn’t medicine as practice. So, it’s all up to the pet owners to decide yeah I want to do this and I think what pets are appreciating is that they’re, in some ways they’re under attacked. They are under attacked by the Internet in all sorts of different ways, Internet pharmacies, looking on the Internet, Internets are dying self diagnosed pets, they are under attack by retail, and they got to stay relevant, but they can’t stay relevant. Because they have a relationship that one on one relationship, we can give them the tools to really deepen that relationship that increases their relevance and as we’ve seen from the data they can, they can grow effectively. There is plenty of demand by pet owners for care, for their pet, if they appreciate the value, that’s really not the constraint here; the constraint is the appreciation of their value.
Thank you. Our next question comes from the line of David Clair with Piper Jaffray. Your line is open.
David Clair - Piper Jaffray
Hi, good morning everybody. Thanks for taking my questions. Just the first one here from me, it’s just of kind of going back to the rebate and the incentives that you talked about. What percent of your customers are seeing the targeted levels that you’re offering here and then where do you see this method going in coming quarters and is there something that you’re offering to all your customers or just new accounts?
Is that we’ve -- this has evolved overtime and these are generally new account placement strategies. Although we have another form of rebate that’s had some similarities to this that we had converted our customer base to in 2011 from a prior rebate structure that we had run for a number of years. And so there is really a lot of different flavors. And -- but we see, we’re very excited by how this really inspires customers to advance the standard of the care they can provide by really using the instruments that they were designed to be used. They can now run complete profiles, full 22 chemistries. That’s a good complete profile and a CBC that is really not different that they will get from the reference labs. And this has been the hallmark of IDEXX’s hematology strategy for many years and certainly augmented by the pro-sight and so what this does it sort of a final step here to move them to -- moving to in-house for standard first line diagnostic testing.
David Clair - Piper Jaffray
Okay. And then just a quick one on the 2011 guidance. Specifically we see like 4% or more sequential revenue increase from the third quarter to the fourth quarter and your guidance implies less than 1%. Just wondering if there is something going on there or I guess how should we look at that?
David, I think that the driver here in a step-down is we’re going from pretty high growth in livestock and poultry to pretty flat growth in the fourth quarter as I indicated. I think if you were to look at our Companion Animal lines of business, you would see very consistent organic growth.
Thank you. Our next question comes from the line of Miroslava Minkova from Leerink Swann. Your line is open.
Miroslava Minkova - Leerink Swann
Let me start with the economy. And I thought your comments were interesting that you are seeing minimal and gradual improvement in the economy and at least being curious, I’m pretty volatile economic data here at least from what we see. I was just curious may be if you could tell us anecdotally what you’re hearing from the vets and what you’re hearing from the customers and how they feel about their patients coming in, and patient traffic? And what’s driving your optimism that things are not going to get any worse out there?
Miroslava, thanks for the question. Let me start with the last one first. I guess what’s driving our optimism is, like you said, there was a tremendous amount of economic volatility in the third quarter, stock market and other things, and yet our trends held and were every so slightly improved over the first two quarters. So they seemed to be somewhat robust to the noise that we make here.
We’re hearing, its all over the math and in terms of what we hear from practices, but what we’re hearing more and more is okay I get it, it’s not going to improve that much, we’re not going to wait for turnarounds, what can I do in my practice to be more successful? What can I do to take control over my own destiny because the market is not going to help me? And then they’re inspired when they see their colleagues who are effectively growing with those strategies and so we see a slow and broader adoption of this chain.
The veterinary profession historically never really had to worry about in inspiring pet owners because they just came in and they just asked for everything. And now they got a move to, it has become more of an economic necessity in the current environment where the consumers get tickled about everything to communicate the value of the rather sophisticated medicine that they’re able to practice. But of course they’re finding it, if they do so that the pet owner response. And so, there is, obviously there is practices in all stages of change that are going on, and we see it as incumbent upon us and of course we’re working with the industry partners too to do that because the veterinary profession is our channel to the ultimate market, which is healthcare demand.
Miroslava Minkova - Leerink Swann
Thanks for these comments. And then the strong VetLab placement that we saw this quarter, I appreciate there is a marketing programs which clearly are working for them, but what does this mean for the fourth quarter Jon? I mean obviously, they were extremely strong but was there any demand that perhaps will fold into the third quarter that might have otherwise occurred into the fourth quarter? And then finally, my final question is any updates on the FTC investigation when would you hope to get this behind?
Okay. So we gave our guidance for the full year, which of course implies for fourth quarter. No, we didn’t pull anything in from the fourth quarter to the third quarter with instruments, we usually get a placement back, if anything we had a little bit ever so stronger backlog going into the fourth quarter although it’s relatively small. We’re very confident of both fourth quarter and the full year placements based on the momentum that we have and then I did mention that what did not yet really kick in, in the third quarter was Japan for catalyst, over launch catalyst in Japan we had a limited launch to ensure really, really good customer experience. Japanese customers are the most discerning in the world on quality and it was a great limited launch and we’ll ramp it up in Q4. So we’ll get a little benefit from that. So we’re very confident of our full year numbers.
With regard to the FTC, I’ve a couple of comments. First, we did receive a request for additional information in August from the FTC; we provided a response to that request. We have no reason to believe that the focus of the investigation has changed from really where it was than the whole time. Prior to this court request, we believe the FTC was getting fairly close to deciding on a resolution to the investigation. But at this time we believe the FTC has not made any decision and is still considering all the information that it has received over the last 18 months. I think it’s fair to say that there is no particular process here. We can’t really predict how long the investigation will continue or how it will be resolved.
As we said before, we think we have many reasons, we have a strong legal position including the two federal court decisions in our favor on the same issue, as well as the obvious intense competition that we see in the marketplace, which benefits our customers and tends to indicate that our distribution contracts do not foreclose competition. I think there are many ways to access the bargain and people are being quite successful, our competitors are being quite successful and I’ll tell you it’s a very intense competition. Our strategy is to continue to innovate and as a result of the innovation provide a new value to veterinarians to handle the economy and to move the practice medicine forward.
Thank you. Our next question comes from the line of Jonathan Block with SunTrust. Your line is open.
Jonathan Block - SunTrust
Thanks and good morning guys. Just may be this is the first question on the 2012 guidance Jon and Merilee. The 79% organic growth looks real solid but the $3.05 midpoint just back of the envelope implies about 50 or so bps of op margin expansion versus prior years when you’ve done a 100 or north of a 100. So maybe can you speak to a little bit on why that’s the case because also when I think to ‘12 you should have some of the big insurance placements that you’ve been experiencing in ’11 elevate and you would think consumable would really drive the top-line which is higher margin. So maybe if you can speak to the dynamic and then I’ll just also layer into that question, Merilee, does that ‘12 guidance also reflect the share, the accelerated share repurchase that you announced this morning?
Let me start with the last question first, yes we did announce that the Board had, our Board of Directors had increased our share authorization by 4 million shares. This is something that we do, kind of typically as we find ourselves, working through our repurchase program. So it’s not really, we’re not indicating with this that we’re looking at any sort of acceleration in the program but more I’d say a continuation of our program that’s been quite consistent over a long period of time now with repurchase that reduces our weighted average share count by 2% to 3% per annum. So I think that what we’re looking at here as we talk about 2012.
I guess one thing that I would say about the guidance just to reiterate because I know there were a lot of members that were mentioned but we do not have in this guidance three or four kinds of benefit from Federal R&D tax credit that of course we’re experiencing in 2011. So that’s just something to keep in mind, but it’s well I think if we -- well we haven’t given all the line item detail for 2012, yes for our P&L, I think that what we’re -- what we continue to target here, as we’ve said in the past is, something that on an annual basis should see 50 to 100 basis points of operating margin expansion over the next few years and it will vary a bit from year-to-year but that’s about what we’re targeting. And that balances the initiatives that we’re getting out of our two major businesses our in-clinic instruments, VetLab business and as well our Reference Labs. This is going to show up in the gross margin line, but we’re going to continue to make investments, they’re going to be in product innovation, they’re going to be in our commercial activities and things and we’re going to see those show up in OpEx. So I think between the balance of those two, we do expect that we’re going to see some margin expansion and we will fine tune all that and share that with you more explicitly in January.
Yeah just a follow-on, we really, the opportunity kind of it is on as exciting as ever, and of course what that does is drive long-term growth and shareholder value creation and we balance that with the need to generate good returns on the investments we’ve made historically as you would expect and you would see margin expansion in our two big businesses.
The other thing John I’d say is I don’t know, think and it’s a surprise to anyone I mean we’re in a world of pretty big uncertainty. There is of course the economic uncertainty around the world, there is currency uncertainty, you have the currency assumptions that Merilee gave that implicit in our 2012 guidance. There is policy uncertainty. So we’re in a period of uncertainty and we think the guidance is appropriate given the all the factors that we’ve just discussed.
Jonathan Block - SunTrust
Okay, very helpful. And I guess just one other question, I guess, one of the other elements of uncertainty is the FTC and I appreciate the update. Just to tie that back to maybe some of the rebates that you’re offering, I guess the first question is Merilee, can you just layout or tell how you’re accounting for that, is it netted out of the top-line or how that’s literally flowing through the P&L? And the second one, Jon, is there anything to the fact that you sort of accelerate this rebate program ahead of an FTC decision and clearly if you get the instrumentation into a practice that’s going to likely make them a lot more sticky even if this decision goes against you or am I just looking a little bit too far into it? Thanks guys.
All right. I will handle the accounting first. Yes the discounts they do get recorded in the top-line. Its -- we allocate those discounts across both the instruments and the consumables. So there is a reduction in the stated sales price of both the instruments and then the consumables as they’re sold off.
And that’s been our consistent practice. We’ve always had marketing incentive programs I think, as long as I can remember over the last decade, across our equipment and rapid assay business and they’re netted against revenues. The -- our marketing strategy has really had absolutely nothing to do with the FTC. I mean they’re just the right things to do from a innovation point of view, there is absolutely no connection. We are, as I said, we’re very confident and quite frankly it’s possible to think it could resolve in our favor sooner rather than later, but I think the other scenario if it doesn’t resolve for a long time I don’t, I think, but we’re not, we’re operating in an environment where we’re focused on competition, we’re focused on innovation and we’re focused on commitment to our distributors, that’s been consistent with our strategy over a couple of decades.
Thank you. Our next question comes from the line of Nicholas Jansen with Raymond James & Associates. Your line is open.
Nicholas Jansen - Raymond James & Associates
Hey, good morning guys. Just a quick question on practice information management system segment, certainly, a little less in your expectations for the quarter and in the first half of the year was a little sluggish as well. I’m just trying to get a sense of what you’re doing there to kind of reintegrate the top-line growth heading into 2012? Thanks.
Yeah. The -- those are really two related businesses, one practice software business and the other one is the digital radiography business. I think the weaknesses has been more in the digital radiography business. The practice management software business has performed very well. As I mentioned, the mid-teens growth in the Cornerstone placement revenue, although there are other elements of the Cornerstone, of the practice management software, the other components of the revenue that’s the most strategic one because placements generate all the follow-on relationship.
But on the digital side, I think we’re very excited about the new innovation that we brought in the mobile app and that really get people excited. And it’s something that we can do uniquely, because we’ve developed our own digital packs of software, that’s veterinary specific. We didn’t license the third-party software, we developed our own, we have fully control over that code, and it allows us to move in it’s own on current technology code all Java based, and it allows us to move very quickly on software innovations that are not just on the surface but fully integrated in the practice.
I think what’s important here is that you can do things quickly on the surface, but they don’t really work very well on the practice, if they’re not fully integrated into the medical record and into the billing system more and more that is the standard and we’ve been the leader in that area, and allows us to introduce these new things like the digital labs that are, continue to add the benefit of that full integration.
Nicholas Jansen - Raymond James & Associates
Great. And then just maybe on the international front, at the Analyst Day you talk a lot about kind of the opportunities received, just is there any areas of strength right now that you’re seeing on the placement side? And then, corollaries, or any areas of kind of the economic uncertainty over there kind of causing weakness? Thanks.
Well, I think we’re very pleased and impressed with our performance of our colleagues in Europe. It has the highest growth rate region, which is at odds to what you may hear in the news. I think it’s because we’re bringing innovations up in our primary businesses of the in-house and the reference labs to Europe. And just seems like there is a lot of growth opportunity irrespective of economy. And as I think the other thing I would reinforce is despite the fact that Japan has had a tough economy, a Catalyst is very, very perfectly suited to the Japanese market and so we’re excited that we’re going to be ramping the Catalyst placements after a very successful limit launch period starting in the fourth quarter.
Thank you. Our next question will come from the line of Ross Taylor with C.L. King. Your line is open.
Ross Taylor - C.L. King & Associates
Hi. My question relates to that your 10% to 20% increase in your panels that you see customers learn with some of those new marketing initiatives you have. And I just want to get a little bit of clarification around that. Number one, I think you said that those placements are really to new customers. So I was curious as to exactly what you’re comparing against. Is that on average for your installed base of Catalyst or something else, did I understand that correctly?
Yeah, we’ve had a variation of these types of protocol incentives with new product placements for the last three or four quarters. And so, but not every instrument is placed, we definitely we have a lot of different ways that we’ll place an instrument. So we compare instruments that are placed with those like a real time care protocol versus an instrument that was placed without that, with some other marketing program. And so we do compare it to a control group as best we can. I mean we’re scientists here as well as business people, so we take a scientific approach analyzing our financial data. And so it is -- it’s a 10% to 20% more profile is being run. So we’re talking about more samples being run, let alone the intensity of the number of tests that are run on that sample. Of course the intensity is partially offset by the rebate. But let me say that the intensity certainly makes up for the rebate.
I will say that these are early returns and we’re tracking this. It’s better to have more numbers rather than less, and have risk of parsing the data too finely. It does appear that they’re improving, these returns are. I mean that the growth and the impact and the change are getting better to the extent that it’s able to pass that data. I think it’s generally consistent. We step back from all of this. This is what’s driving and a lot of moving parts in our consumable growth. There is domestic, there is international, there is visiting customers, there are new customers. Do they have a ProCyte? Do they have a LaserCyte? Have they added a ProCyte to an account that previously had a LaserCyte? That is we’re going to keep them pass that gives 5% to 10% increase in the supply sales when they add a faster hematology analyzer, the ProCyte replacing a LaserCyte.
These are all the different factors that goes in and goes out, which I think gives us confidence to accelerating consumable growth, really under the umbrella of the value of point of care testing and real time care testing.
And as I said in the script, I really don’t believe this actually takes away from the lab, I actually think it actually helps, certainly helps the practice. We’ve seen many, many individual cases where other areas of the practice have grown as a result of doing more testing right at the point of care including lab services, including supply sales, including treatments. And I think it’s because practice are learning that this helps them with, they’ve always focused on the pet and now they’re focusing well on the pet owner too.
Ross Taylor - C.L. King & Associates
Okay. And I think I maybe just a follow-up related to that, I mean how much of your installed base you’re currently is able to take advantage of some of these marketing programs, where they really get an incentive to expand the number of panels they run to expand the number of consumables. I know you answered that in part to a prior question, but I just wanted a little more clarity?
I would say, if you look at kind of consumable volume generally and in North America, generally, over half of the consumables -- of the customers that generally, over half of the consumable volume are taking advantage of some kind of incentives, a protocol based incentive program. And that’s because we moved and there are lot of different flavors depending on, I think we’ve really refined in the third quarter of new instrument placements. But they’re lot different flavors and that’s because we move from a prior incentive program that was kind of not as effective it was sort of frequent flyer program type thing, the more IDEXX stuff you bought the more discount you got to ones that are really based on specific protocols that they run and we’re able to do that, because of the, as Merilee mentioned, the ability to move our installed base to Smart Service. So Smart Service happens to be a huge enabler to us being able to move to this different, more medically relevant incentive program.
Thank you. And looks like we’ve time for one final question and that will be from the line of Anne Wilson with Bank of America. Your line is open.
Anne Wilson - Bank of America
Hi, thanks for saving some time for my questions. Most of them have been answered, but I know you don’t give specific product pipeline. But if you could talk about maybe where your focus is, is it all on IT now or basically where should we be expecting new drivers in the form of I guess new products near-term?
It’s not all on IT, although we think IT is a very exciting area and certainly was the base for the lot of things I talked about the call Anne and so thank you for the question, and the opportunity to say it’s beyond IT. If we see opportunity for additional tests, whether they be run on our existing equipment, which is a very nice thing when you expand the menu on the equipment, you expand utilization, you expand the differentiation of that equipment and you didn’t have to place the equipment, you already have a ready installed base you can adopt it.
We have some exciting developments in the area of our SNAP platform in the pipeline and we’re continuing to develop medically relevant specialized tests for the Reference Labs. So the whole area of the diagnostic technology is I think is just as an attractive pipeline as IT what I would, the reason why I focus on some of the technology IT areas is because it’s been becoming more important to us, but it doesn’t reduce the importance of the diagnostic innovation.
Anne Wilson - Bank of America
Okay. And I understand that you can’t -- you don’t really have too much visibility on FTC and other than there formal disclosure, how will there be some sort of filing when you do get some sort of decision with potential ramifications?
Yeah, it’s really hard to -- will let investors know as we know things, it’s because there is no particular set process, it’s not like going through the USDA or the new product approval. It’s really hard to speculate exactly how things might unfold. But as we’ve done I think from the very beginning, we discussed this from the very moment that we received an inquire from the FTC before it was ever moved into a formal investigation with the subpoena, we kept investors informed, we’ll actually be coming up on two years on this investigation soon.
Thank you. And with that I would like to turn it back over to you Mr. Ayers.
I want to thank everybody for joining the call and we look forward to discussing our full year results in January. Also I want to congratulate all the employees at IDEXX on continuing to deal, innovate, and grow, in what is I think otherwise somewhat stagnant economy. Thank you very much.
Thank you, and ladies and gentlemen today’s conference call will be available for replay after 11 a.m. today until midnight October 28. You may access the AT&T teleconference replay system by dialing 800-475-6701 and entering the access code of 220384. International participants dial 320-365-3844. Once again those numbers 800-475-6701 or 320-365-3844 and enter the access code of 220384.
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