IDEXX LABORATORIES INC /DE - Annual Report: 2012 (Form 10-K)

 

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each className of each exchange on which registered

Common Stock, $0.10 par value per shareNASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes x No o 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

Based on the closing sale price on June 30, 2012 of the registrant’s Common Stock as reported by the NASDAQ Global Market, the aggregate market value of the voting stock held by non-affiliates of the registrant was $5,216,189,814. For these purposes, the registrant considers its directors and executive officers to be its only affiliates.

The number of shares outstanding of the registrant’s Common Stock was 54,579,344 on February 8, 2013.

DOCUMENTS INCORPORATED BY REFERENCE

Part III—Specifically identified portions of the Company’s definitive proxy statement to be filed in connection with the Company’s 2013 Annual Meeting, to be held on May 8, 2013, are incorporated herein by reference.

 

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IDEXX LABORATORIES, INC.

Annual Report on Form 10-K

Table of Contents

 

 

 

 

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

 

This Annual Report on Form 10-K for the year ended December 31, 2012 contains statements which, to the extent they are not statements of historical fact, constitute “forward-looking statements.” Such forward-looking statements about our business and expectations within the meaning of the Private Securities Litigation Reform Act of 1995,  Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), include statements relating to future revenue growth rates, earnings and other measures of financial performance; the effect of economic downturns on our business performance; demand for our products; realizability of assets; future cash flow and uses of cash; future repurchases of common stock; future levels of indebtedness and capital spending; interest expense; warranty expense; share-based compensation expense; and competition. 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. These forward-looking statements are intended to provide our current expectations or forecasts of future events; are based on current estimates, projections, beliefs, and assumptions; and are not guarantees of future performance. Actual events or results may differ materially from those described in the forward-looking statements. These forward-looking statements involve a number of risks and uncertainties as more fully described under the heading “Part I, Item 1A. Risk Factors” in this Annual Report on Form 10-K. The risks and uncertainties discussed herein do not reflect the potential impact of any mergers, acquisitions or dispositions. In addition, any forward-looking statements represent our estimates only as of the day this Annual Report on Form 10-K was first filed with the Securities and Exchange Commission (“SEC”) and should not be relied upon as representing our estimates as of any subsequent date. From time to time, oral or written forward-looking statements may also be included in other materials released to the public. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates or expectations change.

 

PART I

 

ITEM 1. BUSINESS

 

We develop, manufacture and distribute products and provide services primarily for the companion animal veterinary, livestock and poultry, water testing and dairy markets. We also sell a line of portable electrolytes and blood gas analyzers for the human point-of-care medical diagnostics market. Our primary products and services are:

 

 

We are a Delaware corporation and were incorporated in 1983. Our principal executive offices are located at One IDEXX Drive, Westbrook, Maine 04092, our telephone number is 207-556-0300, and our Internet address is www.idexx.com. References herein to “we,” “us,” the “Company,” or “IDEXX” include our wholly-owned subsidiaries and majority-owned subsidiaries unless the context otherwise requires. References to our Web site are inactive textual references only and the content of our Web site should not be deemed incorporated by reference into this Form 10-K for any purpose.

 

 

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We make available free of charge on our Web site our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we file such information with, or furnish it to, the SEC. In addition, copies of our reports filed electronically with the SEC may be accessed on the SEC’s Web site at www.sec.gov. The public may also read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

 

DESCRIPTION OF BUSINESS BY SEGMENT

 

During 2012, we operated primarily through three business segments: diagnostic and information technology-based products and services for the veterinary and bioresearch markets, which we refer to as the Companion Animal Group (“CAG”), water quality products (“Water”) and products for livestock and poultry health, which we refer to as Livestock and Poultry Diagnostics (“LPD”). Prior to the second quarter of 2010, we referred to our LPD segment as our Production Animal Segment. We also operate two smaller operating segments that comprise products for milk quality and safety (“Dairy”) and products for the human point-of-care medical diagnostics market (“OPTI Medical”).  Financial information about the Dairy and OPTI Medical operating segments is combined and presented with one of our remaining pharmaceutical product lines and our out-licensing arrangements in an “Other” category because they do not meet the quantitative or qualitative thresholds for reportable segments. See Note 15 to the consolidated financial statements for the year ended December 31, 2012 included in this Annual Report on Form 10-K for financial information about our segments, including geographic information, and our product and service categories.

 

COMPANION ANIMAL GROUP

 

CAG offers a set of discrete products and services as described below.  The breadth and complementary nature of our products and services permit us to offer integrated disease-management diagnostic solutions that leverage the advantages of both point-of-care and outside laboratory testing, facilitate the flow of medical and business information in the veterinary practice and between the veterinary practice and its clients, and provide us with scale in sales and distribution. Our objective is to provide veterinarians with the tools and services to enhance the pet owner experience with veterinary medical care, while also growing veterinary practice revenues and improving staff efficiencies.

 

VetConnect^® PLUS. In the third quarter of 2012, we launched VetConnect^® PLUS,  a cloud-based technology that enables veterinarians to access and analyze patients’ diagnostic data from both IDEXX in-house analyzers, Rapid Assays and IDEXX Reference Laboratories in one place. VetConnect^® PLUS combines all results that have been run on a patient with IDEXX VetLab^® Station and Reference Laboratories, and thus allows the veterinarian to easily see and trend patient-specific diagnostic results, enabling greater medical insight. In addition, VetConnect^® PLUS provides instant mobile or Internet access to results, whether run at IDEXX Reference Labs or on in-house equipment. Results can easily be printed or emailed from VetConnect^® PLUS to pet owners or other veterinarians. In this way, VetConnect^® PLUS can aid the veterinarian and the practice staff in engaging the pet owner in the patient’s care, which can support greater compliance to care recommendations or preventive care protocols.  

 

Instruments and Consumables

 

We currently market an integrated suite of in-house laboratory analyzers for use in providing reference laboratory quality diagnostic results in companion animal veterinary practices that we refer to as the IDEXX VetLab^® suite of analyzers. The IDEXX VetLab^® suite includes several instrument systems, as well as associated proprietary consumable products, all of which are described below:

 

 

 

 

 

 

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Blood and Urine Chemistry. We sell two chemistry analyzers,  the Catalyst Dx^®  Chemistry Analyzer and the VetTest^® Chemistry Analyzer, that are used by veterinarians to measure levels of certain enzymes and other substances in blood or urine for monitoring health status and assistance in diagnosing physiologic conditions. Both instruments use consumables manufactured for IDEXX by Ortho-Clinical Diagnostics, Inc. (“Ortho”), a subsidiary of Johnson & Johnson, based on Ortho’s dry slide technology (“Catalyst Dx^® slides,” “VetTest^® slides” or “slides”). In addition, the Catalyst Dx^® analyzer also uses dry slide electrolyte consumables manufactured by IDEXX at OPTI Medical Systems, one of our wholly-owned subsidiaries. Blood tests commonly run on these analyzers include glucose, alkaline phosphatase, ALT (alanine aminotransferase), albumin, calcium, creatinine, blood urea nitrogen (“BUN”), and total protein. Tests are sold individually and in prepackaged panels. Both analyzers also run a urine test called urine protein:creatinine ratio, which assists in the detection of early renal disease.

 

The Catalyst Dx^® analyzer is our latest generation chemistry analyzer, which was launched in 2008. The Catalyst Dx^® analyzer provides significantly improved throughput, ease of use and menu relative to the VetTest^® analyzer, including the ability to run electrolytes. Key ease-of-use features include the ability to run a  whole blood sample using an on-board centrifuge, the ability to run pre-packaged, multi-slide clips in addition to single chemistry slides, and an automated metering system. The Catalyst Dx^® analyzer also enables automated dilutions, which is an ease-of-use feature both for certain blood chemistries and the test for urine protein:creatinine ratio. The Catalyst Dx^® analyzer allows a veterinarian to run multiple patient samples simultaneously; to run different sample types including whole blood, plasma, serum and urine; to perform 28 different chemistry and electrolyte tests; and to automatically calculate other parameters and ratios important to blood chemistry analysis. In addition, the Catalyst Dx^® analyzer runs a test to measure phenobarbital levels in blood, allowing veterinarians to adjust anticonvulsant medication more quickly and efficiently.

 

Our VetLyte^® Electrolyte Analyzer measures three electrolytes—sodium, potassium and chloride—to aid in evaluating acid-base and electrolyte balances and assessing plasma hydration.

 

Our VetStat^® Electrolyte and Blood Gas Analyzer measures electrolytes, blood gases, glucose and ionized calcium, and calculates other parameters, such as base excess and anion gap. These measurements aid veterinarians in diagnosing various disease states, evaluating fluid therapy choices and measuring respiratory function. The VetStat^® analyzer runs single-use disposable cassettes that contain various configurations of analytes. The VetStat^® analyzer and its cassettes are manufactured by OPTI Medical Systems.

 

Sales of consumables for use in our installed base of chemistry analyzers provide the majority of consumables volumes and revenues generated from our installed base of IDEXX VetLab^® equipment.

 

Hematology. We sell four hematology analyzers that assess the cellular components of blood, including red blood cells, white blood cells and platelets (also called a complete blood count (“CBC”)). These analyzers include the ProCyte Dx^®  Hematology Analyzer, which uses laser-flow cytometry, optical fluorescence and laminar-flow impedance in its analysis; the LaserCyte^® Hematology Analyzer and the newly launched LaserCyte^® Dx Hematology Analyzer, which both use laser-flow cytometry technology in their analysis; and the IDEXX VetAutoread^™ Hematology Analyzer. In addition, the ProCyte Dx^®  Hematology Analyzer, the LaserCyte^® Dx Hematology Analyzer and the LaserCyte^® Hematology Analyzer each have the ability to analyze the components of certain body fluids. We also sell the Coag Dx^™ Analyzer, which permits the detection and diagnosis of blood clotting disorders. 

 

The ProCyte Dx^®  analyzer is our premier hematology analyzer, which we launched in 2010. The ProCyte Dx^® analyzer provides significantly improved throughput, accuracy and more complete medical information relative to the LaserCyte^® and VetAutoread^™ hematology analyzers. The ProCyte Dx^® analyzer provides up to 24 different blood parameters including the ability to detect band neutrophils and nucleated red blood cells for a more complete picture of a patient’s health. The ProCyte Dx^® is validated for nine companion animal species (canine, feline, equine, bovine, ferret, rabbit, gerbil, pig and mini pig) with research and development efforts focused on validating results for additional species. In January 2013, we launched the LaserCyte^® Dx Hematology Analyzer, which combines the advanced capabilities of the original LaserCyte^® Hematology Analyzer with several features of our ProCyte Dx^® analyzer. 

 

 

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Quantitative Immunoassay Testing. With multiple-patient testing functionality, the SNAPshot Dx^® analyzer provides quantitative measurements of total thyroxine (“T₄”), cortisol and bile acids to assist in the evaluation of thyroid, adrenal and liver function, respectively. The SNAPshot Dx^® analyzer also reads, interprets and records the results of many IDEXX rapid assay SNAP^® tests, including our canine SNAP^® 4Dx^®  and SNAP^® 4Dx^® Plus tests, feline SNAP^® FIV/FeLV Combo test, canine SNAP^®  cPL^™ test, feline SNAP^®  fPL^™ test, SNAP^® Feline Triple^® test and canine SNAP^®  Heartworm RT test.

 

Urinalysis. The IDEXX VetLab^® UA^™ Analyzer provides rapid, semi-quantitative chemical urinalysis and is validated specifically for veterinary use.

 

IDEXX VetLab^® Station. The IDEXX VetLab^® Station (“IVLS”) connects and integrates the diagnostic information from all the IDEXX VetLab^® equipment and thus provides reference laboratory information management system capability. We sell the IVLS as an integral component of the Catalyst Dx^®, LaserCyte^®, LaserCyte^® Dx and ProCyte Dx^®  analyzers and also as a standalone hardware platform. The IVLS includes a user interface to simplify laboratory work flow, connect with a practice management system and send information to run the individual analyzers. IVLS also generates one integrated patient report incorporating all of the lab work generated by the IDEXX VetLab^® suite; stores, retrieves and analyzes historical patient diagnostics data, including SNAP^® test results; and sends and receives information from practice management systems, including the IDEXX Cornerstone^® system, as well as a wide variety of third-party systems. IVLS also connects back to IDEXX through SmartService^TM Solutions, a secure Internet link that enables us to provide diagnostic service, software updates and support for certain IDEXX VetLab^® instruments through remote access.

 

Rapid Assays

 

We sell a broad range of single-use, handheld test kits under the SNAP^® name that provide quick, accurate and convenient diagnostic test results for a variety of companion animal diseases and health conditions. These kits work without the use of instrumentation, although many kits may also be read automatically by the SNAPshot Dx^® analyzer as discussed above.  

 

Principal single-use canine tests are:

 

Principal single-use feline tests are:

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Sales of canine vector-borne disease tests,  including SNAP^® 4Dx^® Plus, SNAP^® 4Dx^®,  SNAP^® 3Dx^® and SNAP^® Heartworm RT, are greater in the first half of our fiscal year due to seasonality of disease testing in the veterinary practice.

 

In addition to our single-use tests, we sell a line of microwell-based test kits under the PetChek^® name for canine heartworm, FIV and FeLV. Larger clinics and laboratories use these kits to test multiple samples and provide ease-of-use and cost advantages to high-volume customers.

 

Reference Laboratory Diagnostic and Consulting Services

 

Reference Laboratory Diagnostic Services. We offer commercial reference laboratory diagnostic and consulting services to veterinarians worldwide, including customers in the U.S., Europe, Canada, Australia, Japan, South Africa, China and South Korea. Customers use our services by submitting samples by courier or overnight delivery to one of our facilities. Most test results have same-day or next-day turnaround times. Our laboratories offer a large selection of tests and diagnostic panels to detect a number of disease states and other conditions in animals, including virtually all tests that can be run in-clinic at the veterinary practice with our instruments or rapid assays. This menu of tests also includes a number of specialized and proprietary tests that we have developed that allow practitioners to diagnose increasingly relevant conditions in dogs and cats, including heart disease, allergies, pancreatitis and infectious diseases. Canine vector-borne disease testing volumes are greater in the first half of our fiscal year due to seasonality of disease testing in the veterinary practice.

 

Health Monitoring and Biological Materials Testing. In November 2011, we acquired the research and diagnostic laboratory (“RADIL”) business of the College of Veterinary Medicine from the University of Missouri. RADIL provides health monitoring and diagnostic testing services to bioresearch customers in North America, Europe and Asia. The financial results of RADIL are reflected in the financial results of our reference laboratory diagnostic and consulting services business.

 

Consulting Services. Additionally, we provide specialized veterinary consultation, telemedicine and advisory services, including radiology, cardiology, internal medicine and ultrasound consulting. These services enable veterinarians to obtain readings and interpretations of test results transmitted by telephone and over the Internet.

 

Practice Management and Digital Imaging Systems and Services

 

            Practice Management Systems and Services. We develop, market and sell practice management systems, including hardware and software, and services that run key functions of veterinary clinics, including managing patient electronic health records, scheduling (including boarding and grooming), client communication, billing and inventory management. Our principal practice management system is Cornerstone^®. We also support several legacy practice management systems installed with our customers, including IDEXX Better Choice^®, IDEXX VPM^™ and IDEXX VetLINK^®.  In December 2012, we acquired the assets of Sneakers Software, Inc., which sold DVMAX^® Veterinary Practice Management Software and such acquisition did not have a material effect on our results of operation in 2012 and is not expected to have a material effect on our results of operation in 2013.

 

Our practice management services include Cornerstone^® Coaching, Practice Profile™, IDEXX Reminder Service, VetVault^® Backup Solution, PetDetect^® Pet Identification System and Pet Health Network^® Pro. Pet Health Network^® Pro, beta launched in the third quarter of 2012, is a subscription-based service that permits veterinarians to provide online communication and education to pet owners before, during and after each patient visit. We anticipate a full commercial launch of Pet Health Network^® Pro during the first quarter of 2013. Certain of our services are compatible with non-IDEXX practice management systems.

 

Digital Imaging Systems and Services. Our digital radiography systems capture radiographic images in digital form, replacing traditional x-ray film and the film development process, which generally requires the use of hazardous chemicals and darkrooms. We market and sell two digital radiography systems for use in the small animal veterinary hospital:  the IDEXX I-Vision CR^®, our latest generation computed radiography system, which we launched in September 2011 and the IDEXX-DR™ 1417 system. We also market and sell the IDEXX EquiView^® DR system for use as a portable unit in ambulatory veterinary practices, such as equine practices. 

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Our digital radiography systems use picture archiving and communication system (“PACS”) software, IDEXX-PACS^™ and IDEXX EquiView PACS^®, for the viewing, manipulation, management, storage and retrieval of the digital images generated by the digital capture plate. The PACS software also permits images from our digital radiography systems to be integrated into patients’ medical records in the Cornerstone^® system, as well as transferred to other practice management systems. In September 2011, we launched IDEXX I-Vision Mobile^™, an application that allows veterinarians with the IDEXX-DR™ 1417 and IDEXX I-Vision CR™  systems, as well as  our legacy digital radiography systems, to request, view and send images using an iPad^® or an Android™ mobile tablet. This application integrates with our IDEXX-PACS^™ software.

 

WATER 

 

We offer a range of products used in the detection and quantification of various microbiological parameters in water.

 

Our principal products are the Colilert^®, Colilert^®-18 and Colisure^® tests, which simultaneously detect the presence of total coliforms and E. coli in water. These organisms are broadly used as microbial indicators for potential fecal contamination in water. These products utilize nutrient-indicators that produce a change in color or fluorescence when metabolized by target microbes in the sample. Our water tests are used by government laboratories, water utilities and private certified laboratories to test drinking water in compliance with regulatory standards, including U.S. Environmental Protection Agency (“EPA”) standards. The tests also are used in evaluating water used in production processes (for example, in beverage and pharmaceutical applications) and in evaluating bottled water, recreational water, waste water and water from private wells.

 

Our Enterolert^® products detect the presence of enterococci in drinking, waste and recreational waters. Enterococci,  bacteria normally found in human and animal waste, are organisms broadly used as microbial indicators for potential fecal contamination in water. Our Pseudalert^® products detect the presence of Pseudomonas aeruginosa  in pool, spa and bottled water. Pseudomonas aeruginosa is a pathogen that can cause “hot-tub rash,” “swimmer’s ear” and potentially fatal infections in immunocompromised individuals.  Our Filta-Max^® and Filta-Max xpress^® products are used in the detection of Cryptosporidium and Giardia in water. Cryptosporidium and Giardia are parasites that can cause potentially fatal gastrointestinal illness if ingested. We also distribute certain water testing kits manufactured by Life Technologies Corporation that complement our Cryptosporidium and Giardia testing products.

 

Our Quanti-Tray^® products, when used in conjunction with our Colilert^®, Colilert^®-18, Colisure^®, Enterolert^®, Pseudalert™ or Heterotrophic Plate Count (HPC) products, provide users quantitative measurements of microbial contamination, rather than a presence/absence indication. Our SimPlate for HPC product detects the total number of the most common bacteria in a water sample.

 

We also sell consumables, parts and accessories to be used with many of our water testing products.

 

LIVESTOCK AND POULTRY DIAGNOSTICS

 

We sell diagnostic tests and related instrumentation that are used to detect a wide range of diseases and to monitor health status in livestock and poultry. Our livestock and poultry diagnostic products are purchased by government and private laboratories that provide testing services to cattle, swine and poultry veterinarians and producers. Our principal products include tests for Bovine Viral Diarrhea Virus (“BVDV”) and Porcine Reproductive and Respiratory Syndrome (“PRRS”). BVDV is a common and contagious viral infection that suppresses the immune system, making the animal susceptible to a host of other infections, impacting beef and dairy production yields as a result. PRRS is a contagious virus causing reproductive problems and respiratory diseases. In the fourth quarter of 2012, we launched a milk-based pregnancy test for detecting pregnancy in dairy cattle, which provides a means to optimize reproductive efficiency. Since 2009, changes in testing regulations pertaining to Bovine Spongiform Encephalopathy (“BSE” or “mad cow disease”) have led to a decline in revenues from sales of our BSE test products. Revenue from BSE testing products was less than $10 million during the twelve months ended December 31, 2012. BSE is a fatal neurodegenerative disease in cattle that causes a spongy degeneration in the brain and spinal cord.

 

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OTHER

 

Dairy

 

The principal products in our Dairy business are our SNAP^® tests used to detect antibiotic drug residue in milk. Dairy producers and processors worldwide use our tests for quality and safety assurance of raw milk. Our primary product line for detecting antibiotic residue in milk is SNAP^® Beta-Lactam, which detects penicillin, amoxicillin, ceftiofur and cephapirin residues, followed by SNAPduo^® Beta-Tetra, which detects certain tetracycline antibiotic residues in addition to those detected by the SNAP^® Beta Lactam test kits. We also sell SNAP^®  tests for the detection of certain other contaminants in milk, such as chemical melamine and Aflatoxin M1.  

 

OPTI Medical Systems

 

We sell OPTI^® point-of-care analyzers and related consumables for use in human medical hospitals and clinics to measure electrolytes, blood gases, acid-base balance, glucose, lactate, BUN and ionized calcium, and to calculate other parameters such as base excess and anion gap. These analyzers are used primarily in emergency rooms, operating rooms, cardiac monitoring areas and other locations where time-critical diagnostic testing is performed within the hospital setting. The OPTI^® CCA and OPTI^® Touch Electrolyte and Blood Gas Analyzers run single-use disposable cassettes that contain various configurations of analytes; the OPTI^® R Analyzer runs reusable cassettes in various analyte configurations; and the OPTI^® LION™ Stat Electrolyte Analyzer runs single-use electrolyte cassettes. OPTI Medical Systems also manufactures our VetStat^® analyzer, an instrument and consumable system that is a member of the IDEXX VetLab^® suite for the veterinary market. In addition, OPTI Medical Systems provides the electrolyte module and dry slide reagents that make up the electrolyte testing functionality of the Catalyst Dx^® analyzer.

 

Other Activities

 

In the fourth quarter of 2008, we sold our Acarexx^® and SURPASS^® veterinary pharmaceutical products and a feline insulin product under development. Upon completion of this transaction we restructured the remaining pharmaceutical division and realigned two of our pharmaceutical product lines to the Rapid Assay line of business, which is part of CAG, and realigned the remainder of the products, which comprised of one product line and two out-licensing arrangements in effect at the time of the realignment, to the Other segment. We retained certain drug delivery technologies that we have continued to seek to commercialize through agreements with third parties, such as pharmaceutical companies, that we also include in the Other segment. We earned milestone payments of $3.5 million, $3.0 million and $3.0 million in 2012, 2011 and 2010, respectively, in connection with the achievement of certain sales milestones by the acquirer following commercialization of the feline insulin product. See Note 22 to the consolidated financial statements for the year ended December 31, 2012 included in this Annual Report on Form 10-K for additional information regarding the restructuring of our pharmaceutical business. Since realignment to the Rapid Assay line of business, we have discontinued the production and sale of one of the remaining pharmaceutical product lines. Neither this product line nor the second remaining product line is or was a significant contributor to revenue in the Rapid Assay line of business.

 

MARKETING AND DISTRIBUTION

 

We market, sell and service our products worldwide through our marketing, sales and technical service groups, as well as through independent distributors and other resellers. We maintain sales offices outside the U.S. in Australia, Canada, China, France, Germany, Italy, Japan, the Netherlands, Spain, Switzerland, Taiwan, the United Kingdom, South Africa, Poland and South Korea. Sales and marketing expense was $217.0 million, $204.9 million and $179.6 million for the twelve months ended December 31, 2012, 2011 and 2010, respectively, or 16.8% of consolidated revenue in each of 2012 and 2011 and 16.3% of consolidated revenue in 2010.

 

 

 

 

 

 

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Generally, we select the appropriate distribution channel for our products based on the type of product, technical service requirements, number and concentration of customers, regulatory requirements and other factors. We market our companion animal diagnostic products to veterinarians both directly and through independent veterinary distributors in the U.S., with most instruments sold directly by IDEXX sales personnel and rapid assay test kits and instrument consumables supplied primarily by distributors. Outside the U.S., we sell our companion animal diagnostic products through our direct sales force and, in certain countries, through distributors and other resellers. We sell our veterinary reference laboratory diagnostic and consulting services worldwide through our direct sales force. We market our software and digital radiography products through our direct sales force and through distributors primarily in the U.S. and Canada. We market our water, livestock and poultry and dairy products primarily through our direct sales force in the U.S. and Canada. Outside the U.S. and Canada, we market these products through selected independent distributors and, in certain countries, through our direct sales force. We sell our OPTI^® electrolyte and blood gas analyzers both directly and through independent human medical product distributors in the U.S. and we sell most of the related consumables through the distribution channel. Outside the U.S., we sell our OPTI^® products primarily through distributors and other resellers.

 

Our largest customers are our U.S. distributors of our products in the CAG segment. One of our CAG distributors, Butler Schein Animal Health Supply, LLC (“Butler”), accounted for 9% of our consolidated revenue in each of 2012, 2011 and 2010.

 

RESEARCH AND DEVELOPMENT

 

Our business includes the development and introduction of new products and services and may involve entry into new business areas. We maintain active research and development programs in each of our business areas. Our research and development expenses, which consist of salaries, employee benefits, materials and external consulting and development costs, were $82.0 million, $76.0 million and $68.6 million for the twelve months ended December 31, 2012, 2011 and 2010, respectively, or 6.3% of revenue in 2012 and 6.2% of revenue in each of 2011 and 2010.

 

PATENTS AND LICENSES

 

We actively seek to obtain patent protection in the U.S. and other countries for inventions covering our products and technologies. We also license patents and technologies from third parties.

 

Important patents and licenses include:

 

To the extent some of our products may now, or in the future, embody technologies protected by patents, copyrights or trade secrets of others, we may be required to obtain licenses to such technologies in order to continue to sell our products. These licenses may not be available on commercially reasonable terms or at all. Our failure to obtain any such licenses may delay or prevent the sale of certain new or existing products. See “Part I, Item 1A. Risk Factors.”

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PRODUCTION AND SUPPLY

 

Many of the instruments that we sell are manufactured by third parties and we rely on third parties to supply us with certain important components, raw materials and consumables used in or with our products. In some cases these third parties are sole or single source suppliers.

 

Instruments and consumables. Significant products supplied by sole and single source providers include VetTest^®  analyzers and consumables, Catalyst Dx^® consumables (other than electrolyte consumables), LaserCyte^® and LaserCyte^® Dx consumables and VetAutoread^TM, VetLyte^®, and ProCyte Dx^® analyzers and consumables.

 

VetTest^® and Catalyst Dx^® chemistry slides are supplied by Ortho under supply agreements that are currently set to expire at the end of 2028. We are required to purchase all of our requirements for our current menu of VetTest^®  and Catalyst Dx^® chemistry slides from Ortho to the extent Ortho is able to supply those requirements. The agreements provide for pricing based on purchase volumes and a fixed annual inflationary adjustment. The agreements also prohibit Ortho from promoting and selling these chemistry slides in the veterinary market other than to IDEXX. 

 

We purchase other analyzers and consumables under supply agreements with terms extending through 2032, which in some cases may be extended at our option. We have minimum purchase obligations under some of these agreements, and our failure to satisfy these obligations may result in loss of some or all of our rights under these agreements. See “Part I, Item 1A. Risk Factors.”

 

Other components. We purchase certain other products, raw materials and components from sole and single source suppliers. These products include certain digital radiography systems and certain components used in our SNAP^® rapid assay and dairy devices, livestock and poultry testing kits and water testing products.

 

Certain components incorporated into our SNAP^® products and certain livestock and poultry testing kits are supplied by Moss, Inc. (“Moss”) under a supply agreement that either party may terminate with 24 months prior written notice. We are required annually to purchase a minimum amount from Moss equal to our average purchase volumes in 2004, 2005 and 2006. Annual price increases are capped at 3%. Pursuant to the terms of the supply agreement, Moss has escrowed its manufacturing information relating to the components, which may be released to us upon certain triggering events that would render Moss incapable of supplying the components to us. If such a triggering event occurs, we will make royalty payments to Moss for the use of such information until Moss is able to again begin manufacturing.

 

We have been successful in ensuring an uninterrupted supply of products purchased from sole and single source suppliers. However, there can be no assurance that uninterrupted supply can be maintained if these agreements terminate for any reason or our suppliers otherwise are unable to satisfy our requirements for products. See “Part I, Item 1A. Risk Factors.”

 

BACKLOG

 

We do not generally maintain significant backlog and believe that our backlog at any particular date historically has not been indicative of future sales.

 

 

COMPETITION

 

We face intense competition within the markets in which we sell our products and services. This competition is intensifying and increasing, as new competitors have entered our markets and some of our competitors have expanded the range of products and services offered to the companion animal veterinary market and expanded the geographic scope of their operations. In addition, we have to compete with changing technologies, which could affect the marketability of our products and services. Our competitive position will depend on our ability to develop proprietary or highly differentiated products and services, integrate our products, develop and maintain effective sales channels, attract and retain qualified scientific and other personnel, develop and implement production and marketing plans, obtain or license patent rights, and obtain adequate capital resources.

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We compete with many companies ranging from large human pharmaceutical and medical diagnostics companies to small businesses focused on animal health. Our companion animal veterinary diagnostic products and services compete with both reference laboratory service and in-clinic product providers. Our competitors vary in our different markets. In some markets, academic institutions, governmental agencies and other public and private research organizations conduct research activities and may commercialize products or services, which could compete with our products, on their own or through joint ventures. Several of our direct and indirect competitors have substantially greater capital, manufacturing, marketing, and research and development resources than we do.

 

Competitive factors in our different business areas are detailed below:

 

 

GOVERNMENT REGULATION

 

Many of our products are subject to comprehensive regulation by U.S. and foreign regulatory agencies that relate to, among other things, product approvals, manufacturing, distribution, marketing and promotion, labeling, recordkeeping, testing, quality, storage, and product disposal. The following is a description of the principal regulations affecting our businesses.

 

 

 

 

 

 

 

 

 

 

 

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Veterinary diagnostic products. Diagnostic tests for animal health infectious diseases, including most of our livestock and poultry products and our rapid assay products, are regulated in the U.S. by the Center for Veterinary Biologics within the United States Department of Agriculture (“USDA”) Animal and Plant Health Inspection Service (“APHIS”). These products must be approved by APHIS before they may be sold in the U.S. The APHIS regulatory approval process involves the submission of product performance data and manufacturing documentation. Following regulatory approval to market a product, APHIS requires that each lot of product be submitted for review before release to customers. In addition, APHIS requires special approval to market products where test results are used in part for government-mandated disease management programs. A number of foreign governments accept APHIS approval as part of their separate regulatory approvals. However, compliance with an extensive regulatory process is required in connection with marketing diagnostic products in Japan, Germany, the Netherlands and many other countries. We also are required to have a facility license from APHIS to manufacture USDA-licensed products. We have a facility license for our manufacturing facility in Westbrook, Maine and our distribution center in Memphis, Tennessee. Our manufacturing facility in Montpellier, France has been approved by APHIS and we have a permit to import products manufactured in Montpellier, France to the U.S. for distribution.

 

Our veterinary diagnostic instrument systems are veterinary medical devices regulated by the U.S. Food and Drug Administration (“FDA”) under the Food, Drug and Cosmetics Act (the “FDC Act”). While the sale of these products does not require premarket approval by the FDA and does not subject us to the FDA’s current Good Manufacturing Practices regulations (“cGMP”), these products must not be adulterated, mislabeled or misbranded under the FDC Act.

 

These instrument systems also are subject to the European Medical Device Directives, which create a single set of medical device regulations for all European Union (“EU”) member countries and require companies that wish to manufacture and distribute medical devices in EU member countries to obtain European Conformity (“CE”) marking for their products.

 

Water testing products. Our water tests are not subject to formal premarket regulatory approval. However, before a test can be used as part of a water quality monitoring program in the U.S. that is regulated by the EPA, the test must first be approved by the EPA. The EPA approval process involves submission of extensive product performance data in accordance with an EPA-approved protocol, evaluation of the data by the EPA and publication for public comment of any proposed approval in the Federal Register before final approval. Our Colilert^®, Colilert^®-18, Colisure^®, Quanti-Tray^®, Filta-Max xpress^®,  Enterolert^®, and SimPlate^® for heterotropic plate counts products have been approved by the EPA for use under various regulatory programs.  Water testing products are subject to similarly extensive regulatory processes in other countries around the world.

 

Dairy testing products. Dairy products used in National Conference on Interstate Milk Shipments (“NCIMS”) milk-monitoring programs are regulated by the FDA as veterinary medical devices. However, before products requiring FDA approval can be sold in the U.S., performance data must be submitted in accordance with an FDA approved protocol administered by an independent body, such as the Association of Analytical Communities Research Institute (“AOAC RI”). Following approval of a product by the FDA, the product must also be approved by NCIMS, an oversight body that includes state, federal and industry representatives. Our SNAP^® Beta-Lactam antibiotic residue test product has been approved by the FDA, NCIMS and AOAC RI for sale in the U.S. While some foreign countries accept AOAC RI approval as part of their regulatory approval process, many countries have separate regulatory processes.

 

Human point-of-care electrolyte and blood gas analyzers. Our OPTI^® instrument systems are classified as Class II medical devices, and their design, manufacture and marketing are regulated by the FDA. Accordingly, we must comply with cGMP in the manufacture of our OPTI^® products. The FDA’s Quality System regulations further set forth standards for product design and manufacturing processes, require the maintenance of certain records and provide for inspections of our facilities by the FDA. New OPTI^® products fall into FDA classifications that require notification of and review by the FDA before marketing, and which are submitted as a 510(k) application.

 

OPTI^® Medical products are also subject to the European Medical Device Directives and regulations governing the manufacture and marketing of medical devices in other countries in which they are sold.

 

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Any acquisitions of new products and technologies may subject us to additional areas of government regulation. These may involve food, medical device and water-quality regulations of the FDA, the EPA and the USDA, as well as state, local and foreign governments. See “Part I, Item 1A. Risk Factors.”

 

EMPLOYEES

 

            At February 8, 2013, we had approximately  5,400 employees.

 

ITEM 1A.            RISK FACTORS

 

Our future operating results involve a number of risks and uncertainties. Actual events or results may differ materially from those discussed in this report. Factors that could cause or contribute to such differences include, but are not limited to, the factors discussed below, as well as those discussed elsewhere in this report.

 

Our Failure to Successfully Execute Certain Strategies Could Have a Negative Impact on Our Growth and Profitability 

 

The companion animal healthcare industry is highly competitive and we anticipate increasing levels of competition from both existing competitors and new market entrants. Our ability to maintain or enhance our growth rates and our profitability depends on our successful execution of many elements of our strategy, which include: 

 

 

If we are unsuccessful in implementing and executing on some or all of these strategies, our rate of growth or profitability may be negatively impacted. 

 

 

 

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Our Dependence on a Limited Number of Suppliers Could Limit Our Ability to Sell Certain Products or Reduce Our Profitability  

 

We currently purchase many products and materials from sole or single sources. Some of the products that we purchase from these sources are proprietary and, therefore, cannot be readily or easily replaced by alternative sources. These products include our Catalyst Dx^® and VetTest^® consumables; ProCyte Dx^® hematology, IDEXX VetAutoread^™ hematology, VetLyte^®  electrolyte, IDEXX VetLab^® UA^™ urinalysis, VetTest^® chemistry, and Coag Dx^™ blood coagulation analyzers and related consumables and accessories; image capture plates used in our digital radiography systems; and certain components and raw materials used in our SNAP^® rapid assay devices, water testing products, livestock and poultry diagnostic tests, dairy testing products and LaserCyte^® and LaserCyte^® Dx hematology analyzers. To mitigate risks associated with sole and single source suppliers, we seek when possible to enter into long-term contracts that ensure an uninterrupted supply of products at predictable prices. However, some suppliers decline to enter into long-term contracts and we are required to purchase products on a purchase order basis. There can be no assurance that suppliers with which we do not have contracts will continue to supply our requirements for products, that suppliers with which we do have contracts will always fulfill their obligations under these contracts, or that any of our suppliers will not experience disruptions in their ability to supply our requirements for products. In cases where we purchase sole and single source products or components under purchase orders, we are more susceptible to unanticipated cost increases or changes in other terms of supply. In addition, under some contracts with suppliers we have minimum purchase obligations and our failure to satisfy those obligations may result in loss of some or all of our rights under these contracts or require us to compensate the supplier. If we are unable to obtain adequate quantities of products in the future from sole and single source suppliers, we may be unable to supply the market, which could have a material adverse effect on our results of operations. 

 

Our Biologic Products Are Complex and Difficult to Manufacture, Which Could Negatively Affect Our Ability to Supply the Market 

 

Many of our rapid assay, livestock and poultry diagnostic, water and dairy products are biologic products, which are products that include materials from living organisms, such as antibodies, cells and sera. Manufacturing biologic products is highly complex due to the inherent variability of biological input materials and to the difficulty of controlling the interactions of these materials with other components of the products, with samples and with the environment. There can be no assurance that we will be able to maintain adequate sources of biological materials or that we will be able to consistently manufacture biologic products that satisfy applicable product release criteria. Further, products that meet release criteria at the time of manufacture may fall out of specification while in customer inventory, which could necessitate field actions that would require us to incur expenses associated with recalling products and providing customers with new products, and could damage customer relations. Our inability to produce or obtain necessary biological materials or to successfully manufacture biologic products that incorporate such materials could result in our inability to supply the market with these products, which could have a material adverse effect on our results of operations.

 

A Weak Economy Could Result in Reduced Demand for Our Products and Services or Increased Customer Credit Risk 

 

A substantial percentage of our sales are made worldwide to the companion animal veterinary market. Demand for our companion animal diagnostic products and services is driven in part by the number of patient visits with their respective owners to veterinary hospitals and the practices of veterinarians with respect to the recommendations for diagnostic testing, as well as the pet owner compliance with these recommendations. Economic weakness in our significant markets in recent years has caused and could continue to cause pet owners to skip or defer visits to veterinary hospitals or could affect their willingness to approve certain diagnostic tests, comply with a treatment plan or, even more fundamentally, continue to own a pet. In addition, concerns about the financial resources of pet owners could cause veterinarians to be less likely to recommend certain diagnostic tests and concerns about the economy may cause veterinarians to defer purchasing capital items such as our instruments and systems. A decline in patient visits to the hospital, in the willingness of pet owners to treat certain health conditions or approve certain tests, in pet ownership in general, or in the inclination of veterinarians to recommend certain tests or make capital purchases could result in a decrease in sales of diagnostic products and services, which could have a material adverse effect on our results of operations.  

 

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Demand for our water products is driven in part by the availability of funds at the government laboratories, water utilities and private certified laboratories that utilize our products. Availability of funds also affects demand by the government laboratories and cattle, swine and poultry producers that utilize our livestock and poultry diagnostic products, and by users of our human point-of-care diagnostic instruments. Economic weakness in our markets has caused and could continue to cause our customers to reduce their investment in such testing, which could have a material adverse effect on our results of operations. 

 

In all of our markets, a weak economy may also cause deterioration in the financial condition of our distributors and customers, which could inhibit their ability to pay us amounts owed for products delivered or services provided in a timely fashion or at all. 

 

Strengthening of the Rate of Exchange for the U.S. Dollar Has a Negative Effect on Our Business

 

Any strengthening of the rate of exchange for the U.S. dollar against non-U.S. currencies, and in particular the Euro, British pound, Canadian dollar, Japanese yen and Australian dollar, adversely affects our results, as it reduces the dollar value of sales that are made in those currencies and reduces the profits on products manufactured or sourced in U.S. dollars and exported to international markets.  For the years ended December 31, 2012, 2011 and 2010, approximately 26%, 26% and 25%, respectively, of our consolidated revenue was derived from products manufactured in the U.S. and sold internationally in local currencies. To mitigate such foreign currency exposure, we utilize non-speculative forward currency exchange contracts. A strengthening U.S. dollar could also negatively impact the ability of customers outside the U.S. to pay for purchases denominated in U.S. dollars. 

 

Various Government Regulations Could Limit or Delay Our Ability to Market and Sell Our Products 

 

In the U.S., the manufacture and sale of our products are regulated by agencies such as the United States Department of Agriculture (“USDA”), the U.S. Food and Drug Administration (“FDA”) and the U.S. Environmental Protection Agency (“EPA”). Our infectious disease diagnostic tests for animal health applications, including most rapid assay canine and feline SNAP^® tests and livestock and poultry diagnostic tests, must be approved by the USDA prior to sale in the U.S. Our water testing products must be approved by the EPA before they can be used by customers in the U.S. as a part of a water quality monitoring program required by the EPA. Our dairy testing products require approval by the FDA prior to sale in the U.S. The manufacture and sale of our OPTI^® line of human point-of-care electrolytes and blood gas analyzers are regulated by the FDA and these products require approval by the FDA before they may be sold commercially in the U.S. The manufacture and sale of our products are subject to similar and sometimes more stringent laws in many foreign countries. Any failure to comply with legal and regulatory requirements relating to the manufacture and sale of our products in the U.S. or in other countries could result in fines and sanctions against us or suspensions or discontinuations of our ability to manufacture or sell our products, which could have a material adverse effect on our results of operations. In addition, delays in obtaining regulatory approvals for new products or product upgrades could have a negative impact on our growth and profitability.

 

The Impact of One of Our Distributors Becoming Non-exclusive on Our Results of Operations is Uncertain 

 

On February 11, 2013, the Commissioners of the U.S. Federal Trade Commission (“FTC”) granted final approval of the Agreement Containing Consent Order to Cease and Desist (“Consent Agreement”) previously reached with the FTC staff to resolve the investigation into whether IDEXX had engaged in unfair methods of competition in violation of Section 5 of the Federal Trade Commission Act. Details about the FTC investigation and the resulting Consent Agreement are described in “Part I, Item 3. Legal Proceedings.”

 

 

 

 

 

 

 

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On September 28, 2012, we entered into a modified agreement with MWI Veterinary Supply, Inc. (“MWI”) that became effective January 1, 2013.  Under this modified agreement, MWI is permitted to carry any competitive products without restriction or potential negative consequence. This agreement satisfies the requirements of the Consent Agreement, that we may have exclusive distribution agreements with only two of the three largest U.S. distributors of companion animal veterinary products.  The modification of our agreement with MWI will result in one or more of our competitors selling products through MWI, which we expect will increase the field sales resources of MWI used by those competitors to sell their products. Under the modified agreement with MWI, we will provide lower compensation to MWI on sales of our products since we will no longer receive the benefits of MWI’s exclusive focus on our products. We expect to reinvest savings from this lower rate of compensation in other sales and marketing resources and the selling efforts of our other distributors. We believe that the reallocation of these sales resources will help mitigate the potential effects of the loss of exclusive focus of MWI and the additional field sales resources used by our competitors.  However, there can be no assurances that we will be able to fully mitigate the competitive effects of the changes in the nature of our agreement with MWI. Any reduction in the relative effectiveness of our overall selling efforts could have an adverse effect on our results of operations, which we do not believe would be material. 

 

Our Success Is Heavily Dependent Upon Our Proprietary Technologies  

 

We rely on a combination of patent, trade secret, trademark and copyright laws to protect our proprietary rights. If we do not have adequate protection of our proprietary rights, our business may be affected by competitors who utilize substantially equivalent technologies that compete with us. 

 

We cannot ensure that we will obtain issued patents, that any patents issued or licensed to us will remain valid, or that any patents owned or licensed by us will provide protection against competitors with similar technologies. Even if our patents cover products sold by our competitors, the time and expense of litigating to enforce our patent rights could be substantial, and could have a material adverse effect on our results of operations. In addition, expiration of patent rights could result in substantial new competition in the markets for products previously covered by those patent rights. 

 

In the past, we have received notices claiming that our products infringe third-party patents and we may receive such notices in the future. Patent litigation is complex and expensive, and the outcome of patent litigation can be difficult to predict. We cannot ensure that we will win a patent litigation case or negotiate an acceptable resolution of such a case. If we lose, we may be stopped from selling certain products and/or we may be required to pay damages and/or ongoing royalties as a result of the lawsuit. Any such result could have a material adverse effect on our results of operations. 

 

Distributor Purchasing Patterns Could Negatively Affect Our Operating Results 

 

We sell many of our products, including substantially all of the rapid assays and instrument consumables sold in the U.S., through distributors. Distributor purchasing patterns can be unpredictable and may be influenced by factors unrelated to the end-user demand for our products. In addition, our agreements with U.S. distributors may generally be terminated by the distributors for any reason on 60 days prior written notice. Because significant product sales are made to a limited number of distributors, the unanticipated loss of a distributor or unanticipated changes in the frequency, timing or size of distributor purchases, could have a negative effect on our results of operations.  

 

Distributors of veterinary products have entered into business combinations resulting in fewer distribution companies. Consolidation within distribution channels increases our customer concentration level, which could increase the risks described in the preceding paragraph.

 

 

 

 

 

 

 

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Increased Competition and Technological Advances by Our Competitors Could Negatively Affect Our Operating Results 

 

We face intense competition within the markets in which we sell our products and services and we expect that future competition may become even more intense. Competition could negatively affect our sales and profitability in a number of ways. New competitors may enter our markets and new or existing competitors may introduce new and competitive products and services, which could be superior to our products and services. Some of our competitors and potential competitors may choose to differentiate themselves by offering similar products and services to ours at lower sales prices, which could have a material adverse effect on our results of operations through loss of market share or a decision to lower our own sales prices to remain competitive. In addition, multiple competitors could bundle product and service offerings through co-marketing or other arrangements, which could enhance their ability to compete with our broad product and service offering. Some of our competitors and potential competitors, including large diagnostic and pharmaceutical companies, have substantially greater financial resources than us, and greater experience in manufacturing, marketing, research and development and obtaining regulatory approvals than we do. 

 

Changes in Testing Patterns Could Negatively Affect Our Operating Results 

 

The market for our companion animal and livestock and poultry diagnostic tests and our dairy and water testing products could be negatively impacted by a number of factors impacting testing practices. The introduction or broad market acceptance of vaccines or preventatives for the diseases and conditions for which we sell diagnostic tests and services could result in a decline in testing. Changes in accepted medical protocols regarding the diagnosis of certain diseases and conditions could have a similar effect. Eradication or substantial declines in the prevalence of certain diseases also could lead to a decline in diagnostic testing for such diseases. Our livestock and poultry products business in particular is subject to fluctuations resulting from changes in disease prevalence. In addition, changes in government regulations or in the availability of government funds available for monitoring programs could negatively affect sales of our products that are driven by compliance testing, such as our livestock and poultry, dairy and water products. Declines in testing for any of the reasons described, along with lost opportunities associated with a reduction in veterinary visits, could have a material adverse effect on our results of operations. 

 

Effective January 1, 2009, the age at which healthy cattle to be slaughtered are required to be tested for bovine spongiform encephalopathy (“BSE” or “mad cow disease”) in the European Union was increased from 30 months to 48 months, which reduced the population of cattle tested by approximately 30%. In February 2011, the European Union’s Standing Committee on the Food Chain and Animal Health (“SCFCAH”) agreed to allow its member states to further raise the recommended testing age to 72 months, effective July 1, 2011, which further reduced the population of cattle tested. In December 2012, the SCFCAH agreed to allow European Union member states the option to eliminate BSE testing of healthy cattle at slaughter effective March 2013. The demand for our BSE testing products has been negatively impacted as a result of these regulatory changes and could be further impacted by further changes that could be made in the future. Revenue from BSE testing products was less than $10 million during the twelve months ended December 31, 2012.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Increase in Corporate Hospital Ownership and Prevalence of Buying Consortiums Could Negatively Affect Our Business 

 

An increasing percentage of veterinary hospitals in the U.S. is owned by corporations that are in the business of acquiring veterinary hospitals and/or opening new veterinary hospitals nationally or regionally. Major corporate hospital owners in the U.S. include VCA Antech, Inc., National Veterinary Associates and Banfield Pet Hospital, each of which is currently a customer of IDEXX. A similar trend exists in the U.K. and may in the future also develop in other countries. Furthermore, an increasing percentage of individually owned veterinary hospitals in the U.S. are participating in buying consortiums. Corporate owners of veterinary hospitals and buying consortiums often seek to improve profitability by leveraging the buying power they derive from their scale to obtain favorable pricing from suppliers, which could have a negative impact on our results of operations. While we have strong supplier relationships with several corporate hospital groups and buying consortiums that we believe are positive for our business, decisions by larger corporate owners and buying consortiums, in particular Banfield Pet Hospital, to shift their purchasing of products and services away from us and to a competitor would have a negative impact on our results of operations, which could be material. In addition, certain corporate owners, most notably VCA Antech Inc., our primary competitor in the U.S. and Canadian markets for veterinary reference laboratory diagnostic services, also operate reference laboratories that serve both their hospitals and unaffiliated hospitals. Any hospitals acquired by these companies generally use their reference laboratory services almost exclusively and shift a large portion of their testing from in-clinic testing to their reference laboratories. Furthermore, because these companies compete with us in the reference laboratory services marketplace, hospitals acquired by these companies may cease to be customers or potential customers of our other companion animal products and services, which would cause our sales of these products and services to decline.  

 

Our Limited Experience and Small Scale in the Human Point-of-Care Market Could Inhibit Our Success in this Market 

 

We have limited experience in the human point-of-care medical diagnostics market and we operate at a small scale in this market. This market differs in many respects from the veterinary diagnostic market. Significant differences include the impact of third party reimbursement on diagnostic testing, more extensive regulation, greater product liability risks, larger competitors, a more segmented customer base and more rapid technological innovation. Our limited experience and small scale in the human point-of-care medical diagnostics market could negatively affect our ability to successfully manage the risks and features of this market that differ from the veterinary diagnostic market. There can be no assurance that we will be successful in achieving growth and profitability in the human point-of-care medical diagnostics market comparable to the results we have achieved in the veterinary diagnostic market. 

 

            Risks Associated with Doing Business Internationally Could Negatively Affect Our Operating Results

 

For the year ended December 31, 2012, approximately 41% of our revenue was attributable to sales of products and services to customers outside the U.S., compared to 43% and 41% for the years ended December 31, 2011 and 2010, respectively. Various possible risks associated with foreign operations may impact our international sales, including disruptions in transportation of our products, the differing product and service needs of foreign customers, difficulties in building and managing foreign operations, import/export duties and licensing requirements, natural disasters and unexpected regulatory and economic or political changes in foreign markets. Further, prices that we charge to foreign customers may be different than the prices we charge for the same products in the U.S. due to competitive, market or other factors. Our results of operations are also susceptible to changes in foreign currency exchange rates. As a result, the mix of domestic and international sales in a particular period could have a material impact on our results of operations for that period.  

 

Our Operations are Vulnerable to Interruption as a Result of Natural and Man-Made Disasters or System Failures  

 

The operation of all of our facilities may be vulnerable to interruption as a result of natural and man-made disasters, interruptions in power supply or other system failures. While we maintain plans to continue business under such circumstances, there can be no assurance that such plans will be successful in fully or partially mitigating the effects of such events. 

 

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We manufacture many of our significant companion animal products, including our rapid assay devices and certain instruments, many of our water testing products and certain of our livestock and poultry testing products, at a single facility in Westbrook, Maine. Certain of our companion animal products, as well as our human point-of-care products, are manufactured in Roswell, Georgia. We also manufacture certain of our livestock and poultry testing products in Bern, Switzerland and Montpellier, France. In addition, we maintain major distribution facilities in North America and in the Netherlands and major reference laboratories in Memphis, Tennessee; Leipzig, Germany; Ludwigsburg, Germany; Sacramento, California; Elmhurst, Illinois; North Grafton, Massachusetts; East Brisbane, Australia; Markham, Ontario; and Wetherby, the United Kingdom. Therefore, interruption of operations at any of these facilities could have a material adverse effect on our results of operations. 

 

            We rely on several information systems throughout our company to keep financial records, process customer orders, manage inventory, process shipments to customers and operate other critical functions. If we were to experience a system disruption that impacts any of our critical functions, it could result in the loss of sales and customers, financial misstatement and significant incremental costs, which could adversely affect our business. 

 

We maintain property and business interruption insurance to insure against the financial impact of certain events of this nature. However, this insurance may be insufficient to compensate us for the full amount of any losses that we may incur. In addition, such insurance will not compensate us for the long-term competitive effects of being out of the market for the period of any interruption in operations. 

 

We Could Be Subject to Class Action Litigation Due to Stock Price Volatility, which, if it Occurs, Could Result in Substantial Costs or Large Judgments Against Us 

 

            The market for our common stock may experience extreme price and volume fluctuations, which may be unrelated or disproportionate to our operating performance or prospects. Securities class action litigation has often been brought against companies following periods of volatility in the market prices of their securities. We may be the target of similar litigation in the future. Securities litigation could result in substantial costs and divert our management’s attention and resources, which could have a negative effect on our business, operating results and financial condition. 

 

If Our Quarterly or Annual Results of Operations Fluctuate, This Fluctuation May Cause Our Stock Price to Decline, Resulting in Losses to You 

 

Our prior operating results have fluctuated due to a number of factors, including seasonality of certain product lines; changes in our accounting estimates; the impact of acquisitions; timing of distributor purchases, product launches, operating expenditures, marketing programs, changes in foreign currency exchange rates, and litigation and claim-related expenditures; changes in competitors’ product offerings; changes in the economy affecting consumer spending; and other matters. Similarly, our future operating results may vary significantly from quarter to quarter or year to year due to these and other factors, many of which are beyond our control. If our operating results or projections of future operating results do not meet the expectations of market analysts or investors in future periods, our stock price may fall. 

 

Future Operating Results Could Be Negatively Affected by the Resolution of Various Uncertain Tax Positions and by Potential Changes to Tax Incentives 

 

In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Significant judgment is required in determining our worldwide provision for income taxes. We periodically assess our exposures related to our worldwide provision for income taxes and believe that we have appropriately accrued taxes for contingencies. Any reduction of these contingent liabilities or additional assessments would increase or decrease income, respectively, in the period such determination was made. Our income tax filings are regularly under audit by tax authorities and the final determination of tax audits could be materially different than that which is reflected in historical income tax provisions and accruals. Additionally, we benefit from certain tax incentives offered by various jurisdictions. If we are unable to meet the requirements of such incentives, or if they expire or are renewed at less favorable terms, our inability to realize these benefits could have a material negative effect on future earnings.  

 

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Restrictions in Our Credit Facility or Our Inability to Obtain Financing on Favorable Terms May Limit Our Activities

 

Our ability to satisfy our obligations under our unsecured revolving credit facility (“Credit Facility”) depends on our future operating performance and on economic, financial, competitive and other factors beyond our control. Our business may not generate sufficient cash flows to meet these obligations or generate sufficient levels of earnings to satisfy the applicable affirmative, negative and financial covenants. Our failure to comply with these covenants and the other terms of the Credit Facility could result in an event of default and acceleration of our obligations under the Credit Facility, which may require us to seek additional financing or restructure existing debt and possibly on terms not deemed favorable. 

 

            We fund our operations, capital purchase requirements and strategic growth needs through cash on hand, funds generated from operations and amounts available under our Credit Facility. If we were unable to obtain financing on favorable terms, we could face restrictions that would limit our ability to execute certain strategies, which could have an adverse effect on our revenue growth and profitability. 

 

ITEM 1B.            UNRESOLVED STAFF COMMENTS

 

            Not applicable.

 

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ITEM 2.            PROPERTIES

 

            Our worldwide headquarters is located on a company-owned, 65-acre site in Westbrook, Maine where we occupy a 555,900 square foot building utilized for manufacturing, research and development, marketing, sales and general and administrative support functions. In 2011, we began the construction of a new 107,000 square foot administrative building adjacent to our primary facility in Westbrook, Maine, which we expect will be substantially complete in late 2013.

 

            Additional property ownership and leasing arrangements with approximate square footage, purpose and location are as follows:

 

            Additional Properties Owned:

 

 

            Additional Properties Leased:

 

 

            We believe that our owned and leased properties are generally in good condition, are well-maintained, and are generally suitable and adequate to carry on our business.

 

ITEM 3.            LEGAL PROCEEDINGS

 

In January 2010, we received a letter from the U.S. Federal Trade Commission (“FTC”), stating that it was conducting an investigation to determine whether IDEXX or others had engaged in unfair methods of competition in violation of Section 5 of the Federal Trade Commission Act (“FTC Act”), through pricing or marketing policies for companion animal veterinary products and services, including but not limited to exclusive dealing or tying arrangements with distributors or end-users of those products or services (the “Investigation”).

 

On December 5, 2012, we entered into an Agreement Containing Consent Order to Cease and Desist (“Consent Agreement”) with the FTC staff to resolve the Investigation.   The Consent Agreement, which is ten years in duration, specifies that IDEXX may have exclusive distribution agreements with two of the following three distributors: MWI Veterinary Supply, Inc. (“MWI”), Butler Schein Animal Health, and Webster Veterinary. The FTC Commissioners granted final approval of the Consent Agreement on February 11, 2013 resulting in the final resolution of the Investigation.

 

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We continue to believe that our marketing and sales practices for companion animal veterinary products and services do not violate applicable antitrust laws. We have chosen to enter into the Consent Agreement because we believe this course will help us avoid long and costly litigation and that our business will not be materially adversely affected. 

 

               From time to time, we are subject to other legal proceedings and claims, which arise in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our results of operations, financial condition or cash flows.

 

ITEM 4.            MINE SAFETY DISCLOSURES

 

            Not applicable.

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EXECUTIVE OFFICERS OF THE COMPANY

 

            Our executive officers as of February 19, 2013 were as follows:

 

Mr. Ayers has been Chairman of the Board, Chief Executive Officer and President of IDEXX since January 2002. Prior to joining IDEXX, from 1999 to 2001, Mr. Ayers was President of Carrier Corporation, the then-largest business unit of United Technologies Corporation, a provider of high-technology products and support services to customers in the aerospace and building industries worldwide, and from 1997 to 1999, he was President of Carrier’s Asia Pacific Operations. From 1995 to 1997, Mr. Ayers was Vice President, Strategic Planning at United Technologies. Before joining United Technologies, from 1986 to 1995, Mr. Ayers held various positions at Morgan Stanley & Co. in mergers and acquisitions and corporate finance. Prior to Morgan Stanley, Mr. Ayers was a strategy consultant for Bain & Company, a global management consulting firm, from 1983 to 1986, and was in the field sales organization of IBM’s Data Processing Division from 1978 to 1981. Mr. Ayers holds an undergraduate degree in molecular biophysics and biochemistry from Yale University and graduated from Harvard Business School in 1983.

 

Dr. Brown has been Executive Vice President, overseeing Research and Development, of the Company since July 2012. In December 2008, he joined IDEXX as Corporate Vice President, and was promoted to Chief Scientific Officer of the Company in March 2010. Prior to joining IDEXX, from 1982 to 2007, Dr. Brown held various positions at Abbott Laboratories, Inc., a broad-based healthcare company that manufactures and markets pharmaceuticals, medical products, and diagnostics, most recently as Corporate Officer and Divisional Vice President of R&D, Assays and Instrument Systems for the Diagnostic Division.

 

 Mr. Mazelsky joined IDEXX in August 2012 as Executive Vice President. He oversees the Companion Animal Group Customer Facing Organization in North America; the IDEXX VetLab^® in-house diagnostics, Digital Radiography and Computer Systems lines of business; the Pet Health Network^® Pro offering and the VetConnect^® PLUS and Integrated Practice strategies. Prior to joining the Company, Mr. Mazelsky was a Senior Vice President and General Manager from 2010 to 2012 of Computed Tomography, Nuclear Medicine and Radiation Therapy Planning at Philips Healthcare (“Philips”), a subsidiary of Royal Philips Electronics, the Netherlands, a healthcare, lifestyle and lighting technologies company. Previously he held a series of other leadership roles with increasing responsibilities during his tenure at Philips beginning in 2001. Prior to joining Philips, Mr. Mazelsky was at Agilent Technologies Inc., a technology company, where he was an Executive in Charge from 2000 to 2002 of leading the integration of Agilent’s Healthcare Group into Philips. He also served as a General Manager of the Medical Consumables Business Unit from 1997 to 2000 at Agilent Technologies. From 1988 to 1996, he was in a number of roles at Hewlett Packard Corporation, a technology company, in finance, marketing and business planning.

 

 

 

 

 

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Dr. Powers became Executive Vice President of IDEXX in July 2012, overseeing IDEXX Reference Laboratories, Telemedicine, Rapid Assay, Bioresearch and Worldwide Operations. He joined IDEXX as Corporate Vice President in February 2009 leading the Company’s worldwide reference laboratories business. Prior to joining the Company, Dr. Powers was Vice President responsible for the Cancer Diagnostics business of Becton, Dickinson and Company, a medical technology company, from 2007 to 2008. Dr. Powers joined Becton, Dickinson and Company as a result of its acquisition in 2006 of TriPath Imaging Inc., a molecular diagnostics-based cancer diagnostics company, where he held various positions from 2001 to 2007, including Vice President of Worldwide Operations and most recently served as President of the TriPath Oncology business unit. From 1996 to 2001, Dr. Powers was employed by Ventana Medical Systems, Inc., a tissue-based cancer diagnostics company, where he held various positions, including Vice President and General Manager of the Anatomical Pathology business and Vice President and General Manager of Worldwide Operations. From 1989 to 1996, Dr. Powers was employed by Organon Teknika Corporation, a medical diagnostics company, in various technical management roles.

 

Ms. Raines has been Executive Vice President of the Company since July 2012, and Chief Financial Officer of the Company since October 2003. Ms. Raines served as Corporate Vice President, Finance, from May 1995 to July 2012, Vice President, Finance, from March 1995 to May 1995, Director of Finance from 1988 to March 1995 and Controller from 1985 to 1988. Since February 2011, Ms. Raines has also served as a member of the board of directors of Watts Water Technologies, Inc., a publicly-traded manufacturer of products to control the efficiency, safety and quality of water within residential, commercial and institutional applications.

 

Dr. Williams has been Executive Vice President of IDEXX since July 2012, and oversees the Company’s international operations, and the Livestock and Poultry Diagnostics, Dairy, Water and OPTI Medical Systems lines of business.  He was Corporate Vice President, IDEXX VetLab^® in-house diagnostics, of the Company from September 2006 to July 2012 and General Manager of the IDEXX VetLab^® in-house diagnostics line of business from 2004 to 2012.  Dr. Williams has also overseen the OPTI Medical Systems business since its acquisition in January 2007. Dr. Williams was Vice President and General Manager of the Company’s chemistry instruments and consumables business from 2003 to 2004. Prior to joining the Company in 2003, Dr. Williams was a healthcare strategy consultant at McKinsey & Company, a management consulting firm, from 1995 to 2002, and a senior research associate at the Scripps Research Institute, a non-profit research organization, from 1992 to 1995.

 

Mr. Deady has been Corporate Vice President and General Counsel of the Company since 1999 and has been leading the Company’s business development activities since April 2005 and its regulatory function since October 2008. Mr. Deady was Deputy General Counsel of the Company from 1997 to 1999. Before joining the Company in 1997, Mr. Deady was Deputy General Counsel of Thermo Electron Corporation (now Thermo Fisher Scientific Inc.), a provider of analytical and laboratory products and services. Previously, Mr. Deady was a partner at Hale and Dorr LLP (now Wilmer Cutler Pickering Hale and Dorr LLP).

 

Mr. Fennell joined IDEXX in June 2011 as a Corporate Vice President of the Company, and leads the Companion Animal Group Customer Facing Organization in North America. Mr. Fennell came to IDEXX from Pfizer Animal Health, a division of Pfizer Inc., the world’s largest research-based pharmaceutical company, where in April 2003 he began as head of marketing for the companion animal business. He then served as vice president of the U.S. Companion Animal Division from 2005 through 2010, and from January 2011, was Vice President, Pfizer Animal Genetics, Diagnostics and Aquaculture. Before his tenure at Pfizer, he held a series of sales, marketing and operational roles in the crop sciences business for American Cyanamid and BASF, diversified chemical companies.

 

Mr. Meyaard joined IDEXX as Corporate Vice President in September 2009 and leads the Company’s worldwide operations function, including supply chain management, instrument and reagent manufacturing, quality assurance, facilities and operational excellence. Prior to joining the Company, from 1980 to 2009, Mr. Meyaard held various positions at multiple divisions of Siemens Healthcare Diagnostics, a clinical diagnostics company, and its predecessors, most recently as Vice President of Global Instrument Manufacturing for Siemens Medical Solutions Diagnostics.

 

 

 

 

 

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Dr. Naqui has been Corporate Vice President of the Company since January 2006, when he assumed oversight of IDEXX’s Asia Pacific and Latin America operations. Since July 2012, he has also led the Water line of business, which he previously led from 1997 to 2007. From 2007 to 2012, Dr. Naqui also oversaw the Company’s Europe, Middle East and Africa commercial operations. He was General Manager of the Water business from September 1997 to January 2000, and Director of Research and Development from February 1993 to September 1997. Dr. Naqui joined the Company in 1993 as a result of the Company’s acquisition of Environetics, the original manufacturer of the Colilert^® water testing product line, where he was the Director of Research and Development. Prior to joining Environetics, he was a research and development manager with Becton, Dickinson and Company, a medical technology company.

 

 Mr. Polewaczyk joined IDEXX as Corporate Vice President in February 2007 and since July 2012 has led the Company’s CAG Reference Laboratories and Telemedicine lines of business. From 2007 to 2012, Mr. Polewaczyk led the Company’s Rapid Assay, Digital Imaging and Telemedicine lines of business. Before joining IDEXX, Mr. Polewaczyk was employed from 2001 to 2006 at Philips Medical Systems, a subsidiary of Royal Philips Electronics, the Netherlands, a healthcare, lifestyle and lighting technologies company, as General Manager of their Medical Consumables and Sensors Business. Prior to that, Mr. Polewaczyk spent 15 years at Hewlett-Packard Corporation, a technology company, in a variety of senior marketing and medical technology product development roles.

  

Mr. Twigge became a Corporate Vice President of the Company in August 2010 and leads worldwide human resources. Before joining IDEXX, from 1999 to 2010, Mr. Twigge held various human resources leadership positions at Abbott Laboratories, Inc., a broad-based healthcare company that manufactures and markets pharmaceuticals, medical products, and diagnostics. Most recently Mr. Twigge was Divisional Vice President, HR, for Abbott Diagnostics. Prior to that, he served as Divisional Vice President, HR, for Abbott Nutrition International and as Regional HR Director for a number of international operations including those in Europe, Latin America/Canada and the Middle East.

 

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PART II

 

ITEM 5.         MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

 

Market Information

 

Our common stock is quoted on the NASDAQ Global Market under the symbol IDXX. The following table shows the quarterly range of high and low sale prices per share of our common stock as reported on the NASDAQ Global Market for the years 2012 and 2011.

 

 

Holders of Common Stock

 

As of February 8, 2013, there were 645 holders of record of our common stock.

 

Purchases of Equity Securities by the Issuer

 

During the three months ended December 31, 2012, we repurchased shares of common stock as described below:

 

 

As of December 31, 2012, our board of directors had approved the repurchase of up to 48,000,000 shares of our common stock in the open market or in negotiated transactions. The plan was approved and announced on August 13, 1999, and subsequently amended on October 4, 1999, November 16, 1999, July 21, 2000, October 20, 2003, October 12, 2004, October 12, 2005, February 14, 2007, February 13, 2008, February 10, 2010 and October 12, 2011 and does not have a specified expiration date. There were no other repurchase plans outstanding during the three months ended December 31, 2012, and no repurchase plans expired during the period. Repurchases of 436,306 shares were made during the three months ended December 31, 2012 in transactions made pursuant to our repurchase plan.

 

During the three months ended December 31, 2012, we received 1,788 shares of our common stock that were surrendered by employees in payment for the minimum required withholding taxes due on the vesting of restricted stock units and settlement of deferred stock units. In the above table, these shares are included in columns (a) and (b), but excluded from columns (c) and (d). These shares do not reduce the number of shares that may yet be purchased under the repurchase plan.

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During the year ended December 31, 2012, we repurchased 1,474,187 shares of our common stock in transactions made pursuant to our repurchase plan and received 53,272 shares of common stock that were surrendered by employees in payment for the minimum required withholding taxes due on the vesting of restricted stock units and settlement of deferred stock units. See Note 18 to the consolidated financial statements for the year ended December 31, 2012 included in this Annual Report on Form 10-K for further information.

 

Dividends

 

We have never paid any cash dividends on our common stock. From time to time our board of directors may consider the declaration of a dividend. However, we have no present intention to pay a dividend.

 

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Stock Performance

 

This graph compares our total stockholder returns, the Standard & Poor’s (“S&P”) MidCap 400 Index, the S&P MidCap 400 Health Care Index and the Total Return Index for the NASDAQ Stock Market (U.S. Companies) prepared by the Center for Research in Security Prices (the “NASDAQ Index”). This graph assumes the investment of $100 on December 31, 2007 in IDEXX’s common stock, the S&P MidCap 400 Index, the S&P MidCap 400 Health Care Index and the NASDAQ Index and assumes dividends, if any, are reinvested. Measurement points are the last trading days of the years ended December 2008, 2009, 2010, 2011 and 2012.  

 

¹ The Center for Research in Security Prices Total Return Indexes for the NASDAQ Stock Market are calculated each month and may incorporate historical edits to the data which changes values calculated in previous months.

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ITEM 6.            SELECTED FINANCIAL DATA

 

The following table sets forth selected consolidated financial data of the Company for each of the last five fiscal years of the Company. The selected consolidated financial data presented below has been derived from the Company’s consolidated financial statements. These financial data should be read in conjunction with the consolidated financial statements, related notes and other financial information appearing elsewhere in this Annual Report on Form 10-K.

 

 

 

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ITEM 7.         MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Description of Segments. During 2012, we operated primarily through three business segments: diagnostic and information technology-based products and services for the veterinary and bioresearch markets, which we refer to as the Companion Animal Group (“CAG”), water quality products (“Water”) and products for livestock and poultry health, which we refer to as Livestock and Poultry Diagnostics (“LPD”). Prior to the second quarter of 2010, we referred to our LPD segment as our Production Animal Segment. We also operate two smaller segments that comprise products for milk quality and safety (“Dairy”) and products for the human point-of-care medical diagnostic market (“OPTI Medical”). Financial information about the Dairy and OPTI Medical operating segments and about a product line and out-licensing arrangements remaining from our pharmaceutical business is combined and presented in an “Other” category because they do not meet the quantitative or qualitative thresholds for reportable segments. See Note 15 to the consolidated financial statements for the year ended December 31, 2012 included in this Annual Report on Form 10-K for financial information about our segments, including geographic information, and about our product and service categories.

 

Items that are not allocated to our operating segments are as follows: a portion of corporate support function and personnel-related expenses; certain manufacturing costs; corporate research and development expenses that do not align with one of our existing business or service categories; the difference between estimated and actual share-based compensation expense; and certain foreign currency exchange gains and losses. In our segment disclosure, these amounts are shown under the caption “Unallocated Amounts.”

 

The following is a discussion of the strategic and operating factors that we believe have the most significant effect on the performance of our business.

 

Companion Animal Group

 

CAG offers a set of discrete products and services as described below. However, our strategy is to provide these products and services as integrated diagnostic and information management solutions to veterinary practices that collectively create more value for the customer than the value derived from individual products and services, and that provide strong incentives for the customer to adopt full IDEXX solutions and to remain long-term users of our products and services. The breadth and complementary nature of our products and services permit us to offer integrated disease-management diagnostic solutions that leverage the advantages of both point-of-care and outside laboratory testing, facilitate the flow of medical and business information in the veterinary practice and between the veterinary practice and its clients, and provide us with scale in sales and distribution. Our objective is to provide veterinarians with the tools and services to enhance the pet owner experience with veterinary medical care, while also growing veterinary practice revenues and improving staff efficiencies.

 

Instruments and Consumables. Within the IDEXX VetLab^® instrument line of business, we seek to provide veterinarians with an integrated set of instruments that, individually and together, provide superior diagnostic information and performance features, enabling veterinarians to practice better medicine and improve practice efficiency and, in doing so, achieve their practice economic objectives, including growth and profitability. We derive substantial revenues and margins from the sale of consumables that are used in these instruments and the multi-year consumable revenue stream is significantly more valuable than the placement of the instrument. Additionally, we offer extended maintenance agreements in connection with the sale of our instruments.

 

During the early stage of an instrument’s life cycle, we derive relatively greater revenues from instrument placements, while consumable sales become relatively more significant in later stages as the installed base of instruments increases and instrument placement revenues begin to decline. Instrument sales have significantly lower gross margins than sales of consumables, and therefore the mix of instrument and consumable sales in a particular period will impact our gross margins in this line of business. In the early stage of an instrument’s life cycle, placements are made primarily through sales transactions.  As the market for the product matures, an increasing percentage of placements are made in transactions, sometimes referred to as “reagent rentals”, in which instruments are placed at customer sites at little or no cost in exchange for a long-term customer commitment to purchase instrument consumables.

 

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Our Catalyst Dx^® analyzer is our latest generation chemistry analyzer, which was launched in 2008. We place our Catalyst Dx^® analyzer through sales, leases, rental and other programs. In addition, we continue to place VetTest^®  instruments through sales, lease, rental and other programs, with substantially all of our revenues from that product line currently derived from consumable sales. As of December 31, 2012, these two chemistry analyzers provided for a combined active installed base of approximately 33,000 units.

 

A substantial portion of 2012 Catalyst Dx^® analyzer placements were to customers who had been using instruments from one of our competitors, sometimes referred to as competitive accounts. Generally, placement of an instrument with a competitive account is more attractive as the entire consumable stream associated with that placement represents incremental revenue, whereas the consumable stream associated with a Catalyst Dx^® placement at a VetTest^® customer substitutes a Catalyst Dx^® consumable stream for a VetTest^® consumable stream.  Nonetheless, we have found that the consumables revenues increase when a customer upgrades from a VetTest^® analyzer to a Catalyst Dx^® analyzer due to the superior capability and flexibility of the Catalyst Dx^®, which leads to additional testing by the customer.   

 

The ProCyte Dx^®  analyzer is our latest generation hematology analyzer, which we launched in the third quarter of 2010. In addition we sell the LaserCyte^® analyzer and VetAutoread^™ analyzer. As of December 31, 2012 these three hematology analyzers provided for a combined active installed base of approximately 24,000 units. A substantial portion of ProCyte Dx^® analyzer placements continue to be made at veterinary clinics that elect to upgrade from their LaserCyte^® analyzer to a ProCyte Dx^® analyzer. However, an increasing number of placements have been made at competitive accounts since the launch of this instrument in 2010. While customers continue to upgrade from their LaserCyte^® analyzer to a ProCyte Dx^® analyzer, we continue to place a substantial number of LaserCyte^® instruments, both new and refurbished, as trade-ups from the VetAutoread^™ analyzer and at new and competitive accounts. In 2012, a significant number of LaserCyte^® instruments that were placed were refurbished instruments that had been received in trade in the sale of a ProCyte Dx^® analyzer. As we continue to experience growth in placements of ProCyte Dx^®  analyzers and in sales of related consumables, we expect this growth to be partly offset by a decline in placements of LaserCyte^® and VetAutoread^™ analyzers and in sales of related consumables.

 

Our long-term success in this area of our business is dependent upon new customer acquisition, customer loyalty and retention and customer utilization of existing and new assays introduced for use on our analyzers. We continuously seek opportunities to enhance the care that veterinary professionals give to their patients and clients through supporting the implementation of real-time care testing workflows, which is performing tests and sharing test results with the client at the time of the patient visit. Our latest generation of chemistry and hematology instruments demonstrates this commitment by offering enhanced ease of use, faster time to results, greater sample throughput, broader test menu and connectivity to various information technology platforms that enhance the value of the diagnostic information generated by the instruments. Utilization can increase due to a greater number of patient samples being run or to an increase in the number of tests being run per patient sample. Our strategy is to increase both drivers. To increase utilization, we seek to educate veterinarians about best medical practices that emphasize the importance of chemistry and hematology testing at the point-of-care for a variety of diagnostic purposes. In connection with the purchase of instruments, we also offer protocol-based rebate incentives when customers utilize the broad testing functionality of our analyzers.  In addition, we provide marketing tools and consultative services that help drive efficiencies in veterinary practice processes and allow practices to increase the number of clients they see on a daily basis.

 

With all of our instrument product lines, we seek to differentiate our products from our competitors’ products based on time-to-result, ease-of-use, throughput, breadth of diagnostic menu, flexibility of menu selection, accuracy, reliability, ability to handle compromised samples, analytical capability of software, integration with the IDEXX VetLab^® Station, client communications capabilities, education and training, and superior sales and customer service. Our success depends, in part, on our ability to differentiate our products in a way that justifies a premium price.

 

 

 

 

 

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Rapid Assay Products. Our rapid assay strategy is to develop, manufacture, market and sell proprietary tests that address important medical needs for particular diseases prevalent in the companion animal population. We seek to differentiate our tests from those of other in-clinic test providers and reference laboratory diagnostic service providers through ease-of-use and superior performance, including by providing our customers with combination tests that test a single sample for multiple analytes. We further augment our product development and customer service efforts with sales and marketing programs that enhance medical awareness and understanding regarding certain diseases and the importance of diagnostic testing.

 

We also seek to enhance the attractiveness of our tests by providing the SNAPshot Dx^® analyzer, which automatically reads certain SNAP^® test results, and records those results in the electronic medical record. This promotes practice efficiency by eliminating manual entry of test results in patient records and also helps ensure that the services are recorded and accurately invoiced. We continue to work on enhancing the functionality of the SNAPshot Dx^® analyzer to read the results of additional tests from our canine and feline family of rapid assay products.

 

Reference Laboratory Diagnostic and Consulting Services. We believe that more than half of all diagnostic testing by U.S. veterinarians is provided by outside reference laboratories such as our IDEXX Reference Laboratories. In many markets outside the U.S., in-clinic testing is less prevalent and an even greater percentage of diagnostic testing is done in reference laboratories. We attempt to differentiate our reference laboratory testing services from those of our competitive reference laboratories and competitive in-clinic offerings primarily on the basis of test menu, technology employed, quality, customer service and tools such as VetConnect^® PLUS that demonstrate the complementary manner in which our laboratory services work with our point-of-care offerings.

 

Revenue growth in this line of business is achieved both through increased sales to existing customers and through the acquisition of new customers, including through reference laboratory acquisitions, customer list acquisitions and the opening of new reference laboratories, including laboratories that are co-located with large practice customers. Our up-front loyalty programs have been a source of revenue growth in 2012, 2011 and 2010. Under these arrangements, we provide incentives to customers in the form of cash payments or IDEXX Points upon entering multi-year agreements to purchase annual minimum amounts of products or services in the future. 

 

In November 2011, we acquired the research and diagnostic laboratory (“RADIL”) business of the College of Veterinary Medicine from the University of Missouri. RADIL provides health monitoring and diagnostic testing services to bioresearch customers. We believe the acquisition of RADIL allows us to leverage our expertise in veterinary diagnostics and expand our integrated offering of reference laboratory diagnostic and consulting services and in-clinic testing solutions in an adjacent market. In 2012, we began to place ProCyte Dx^®  Analyzers containing a more advanced and research focused user interface with customers in the bioresearch market.

 

Profitability of our reference laboratory diagnostic and consulting services business is largely the result of our ability to achieve efficiencies from both volume and operational improvements. Start-up laboratories that we open typically will operate at a loss until testing volumes achieve sufficient scale. Acquired laboratories frequently operate less profitably than our existing laboratories and acquired laboratories may not achieve the profitability of our existing laboratory network for several years until we complete the implementation of operating improvements and efficiencies. Therefore, in the short term, new and acquired reference laboratories generally will have a negative effect on the operating margin of the reference laboratory diagnostic and consulting services line of business.

 

            Practice Management and Digital Imaging Systems and Services. Our strategy in the practice management systems line of business is to provide superior integrated information solutions, backed by superior customer support and education, to allow the veterinarian to practice better medicine and achieve the practice’s business objectives, including superior client experience, staff efficiency and practice profitability. We differentiate our practice management systems through enhanced functionality, ease of use and connectivity with in-house and reference laboratory test results. Pet Health Network Pro on-line client communication tools and services complement the entire IDEXX product offering by educating pet owners and building loyalty through engaging the pet owner before, during and after the visit thereby driving more patient visits. Our strategy in digital radiography is to offer a convenient system that provides superior image quality and software capability that enables sharing of these images with clients virtually anywhere and enhanced diagnostic features and customer workflow, backed by the same customer support provided for our other products and services in CAG.

 

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Water

 

Our strategy in the water testing business is to develop, manufacture, market and sell proprietary products with superior performance, supported by exceptional customer service. Our customers primarily consist of water utilities, government laboratories and private certified laboratories that highly value strong relationships and customer support. Sales of water testing products outside of the U.S. represented 51% of total water product sales in 2012, and we expect that future growth in this business will be significantly dependent on our ability to increase international sales. Growth also will be dependent on our ability to enhance and broaden our product line. Most water microbiological testing is driven by regulation, and, in many countries, a test may not be used for compliance testing unless it has been approved by the applicable regulatory body. As a result, we maintain an active regulatory program that involves applying for regulatory approvals in a number of countries, primarily in Europe. 

 

Livestock and Poultry Diagnostics

 

We develop, manufacture, market and sell a broad range of tests for various cattle, swine and poultry diseases and conditions, and have active research and development and in-licensing programs in this area. Our strategy is to offer proprietary tests with superior performance characteristics, with demand for tests primarily created by government programs to control or eradicate disease and disease outbreaks, and to a lesser degree disease and reproductive management programs initiated by livestock and poultry producers. Disease outbreaks are episodic and unpredictable, and certain diseases that are prevalent at one time may be substantially contained or eradicated at a later time. In response to outbreaks, testing initiatives may lead to exceptional demand for certain products in certain periods. Conversely, successful eradication programs may result in significantly decreased demand for certain products. In addition, increases in government funding may lead to increased demand for certain products and budgetary constraints may lead to decreased demand for certain products. The performance of this business, therefore, can fluctuate. In 2012, LPD revenues declined approximately 4%, resulting primarily from lower sales of bovine test products due to the changes in European Union testing requirements and declines in certain government programs. In 2012, approximately 88% of our sales in this business were from markets outside of the U.S., most notably Europe. The performance of the business is particularly subject to the various risks that are associated with doing business internationally. See “Part I, Item 1A. Risk Factors.”

 

Other

 

            Dairy. Our strategy in the dairy testing business is to develop, manufacture and sell antibiotic residue and contaminant testing products that satisfy applicable regulatory requirements for testing of milk by processors and producers and provide reliable field performance. The manufacture of these testing products leverages, almost exclusively, the SNAP^® platform as well as the production equipment of our rapid assay business, incorporating customized reagents for antibiotic and contaminant detection. The majority of our sales in this business are international. To successfully increase sales of dairy testing products, we believe that we need to increase penetration in the processor and producer segments of the dairy market, and to develop product line enhancements and extensions. In 2012, approximately 86% of our sales in this business were from markets outside of the U.S., most notably China and Europe. The performance of the business is particularly subject to the various risks that are associated with doing business internationally. See “Part I, Item 1A. Risk Factors.”

 

OPTI Medical Systems. Our strategy in the OPTI Medical Systems business for the human market is to develop, manufacture, and sell electrolyte and blood gas analyzers and related consumable products for the medical point-of-care diagnostics market worldwide, with a focus on small to mid-sized hospitals. We seek to differentiate our products based on ease of use, convenience, international distribution and service, and instrument reliability. Similar to our veterinary instruments and consumables strategy, a substantial portion of the revenues from this product line is derived from the sale of consumables for use on the installed base of electrolyte and blood gas analyzers. During the early stage of an instrument’s life cycle, relatively greater revenues are derived from instrument placements, while consumable sales become relatively more significant in later stages as the installed base of instruments increases and instrument placement revenues begin to decline. Our long-term success in this area of our business is dependent upon new customer acquisition, customer retention and increased customer utilization of existing and new assays introduced on these instruments.

 

 

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Our strategy in the OPTI Medical Systems business for the veterinary market is to utilize this unit’s know-how, intellectual property and manufacturing capability to continue to expand the menu and instrument capability of the VetStat^® and Catalyst Dx^® platforms for veterinary applications while reducing our cost of consumables by leveraging experience and economies of scale.

 

In 2012, approximately 81% of our sales in the OPTI Medical Systems business were from markets outside of the U.S., most notably Europe, the Middle-East and Asia. The performance of the business is particularly subject to the various risks that are associated with doing business internationally. See “Part I, Item 1A. Risk Factors.”

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Note 2 to the consolidated financial statements included in this Annual Report on Form 10-K describes the significant accounting policies used in preparation of these consolidated financial statements.

 

We believe the following critical accounting estimates and assumptions may have a material impact on reported financial condition and operating performance and involve significant levels of judgment to account for highly uncertain matters or are susceptible to significant change.

 

Revenue Recognition

 

We recognize revenue when four criteria are met: (i) persuasive evidence that an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the sales price is fixed or determinable; and (iv) collectability is reasonably assured. See Note 2(i) to the consolidated financial statements for the year ended December 31, 2012 included in this Annual Report on Form 10-K for additional information about our revenue recognition policy and criteria for recognizing revenue.

 

Multiple element arrangements (“MEAs”). Arrangements to sell products to customers frequently include multiple deliverables. Our most significant MEAs include the sale of one or more of the instruments from the IDEXX VetLab^® suite of analyzers, digital radiography systems or practice management software, combined with one or more of the following products: extended maintenance agreements (“EMAs”), consumables and reference laboratory diagnostic and consulting services. Practice management software is frequently sold with post-contract customer support and implementation services. Delivery of the various products or performance of services within the arrangement may or may not coincide. Delivery of our IDEXX VetLab^® instruments, digital radiography systems, and practice management software generally occurs at the onset of the arrangement. EMAs, consumables, and reference laboratory diagnostic and consulting services typically are delivered over future periods, generally one to six years. In certain arrangements, revenue recognized is limited to the amount invoiced or received that is not contingent on the delivery of products and services in the future.

 

We allocate revenue to each element based on the relative selling price and recognize revenue when the elements have standalone value and the four criteria for revenue recognition, as discussed above, have been met for each element. If available, we establish the selling price of each element based on vendor-specific objective evidence (“VSOE”), which represents the price charged for a deliverable when it is sold separately. We use third-party evidence (“TPE”) if VSOE is not available or best estimate of selling price (“BESP”) if neither VSOE nor TPE is available. We generally determine selling price based on amounts charged separately for the delivered and undelivered elements to similar customers in standalone sales of the specific elements. When these arrangements include a separately-priced EMA, we recognize revenue related to the EMA at the stated contractual price on a straight-line basis over the life of the agreement to the extent the separately stated price is substantive. If there is no stated contractual price for an EMA, or the separately stated price is not substantive, we recognize revenue according to the MEA policy stated above.

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 When arrangements within the scope of software revenue recognition guidance include multiple elements, we allocate revenue to each element based on relative fair value, when VSOE exists for all elements, or by using the residual method when there is VSOE for the undelivered elements but no such evidence for the delivered elements. Under the residual method, the fair value of the undelivered elements is deferred and the residual revenue is allocated to the delivered elements. Revenue is recognized on any delivered elements when the four criteria for revenue recognition have been met for each element. If VSOE does not exist for the undelivered element, all revenue from the arrangement is deferred until the earlier of the point at which such sufficient VSOE does exist or all elements of the arrangement have been delivered. We determine fair value based on amounts charged separately for the delivered and undelivered elements to similar customers in standalone sales of the specific elements.

 

Certain arrangements with customers include discounts on future sales of products and services. We apply judgment in determining whether future discounts are significant and incremental. When the future discount offered is not considered significant and incremental, we do not account for the discount as an element of the original arrangement. If the future discount is significant and incremental, we recognize that discount as an element of the original arrangement and allocate the discount to the other elements of the arrangement based on relative selling price. To determine whether a discount is significant and incremental, we look to the discount provided in comparison to standalone sales of the same product or service to similar customers, the level of discount provided on other elements in the arrangement and the significance of the discount to the overall arrangement. If the discount in the MEA approximates the discount typically provided in standalone sales, that discount is not considered incremental.

 

Customer programs. We record reductions to revenue related to customer marketing and incentive programs, which include end-user rebates and other volume-based incentives.  Incentives may be provided in the form of IDEXX Points, credits or cash and are earned by end-users upon achieving defined volume purchases or utilization levels or upon entering an agreement to purchase products or services in future periods. Our most significant customer programs are categorized as follows:

 

Customer Loyalty Programs. Our customer loyalty programs offer customers the opportunity to earn incentives on a variety of IDEXX products and services as those products and services are purchased and utilized. Revenue reductions related to customer loyalty programs are recorded based on the actual issuance of incentives, incentives earned but not yet issued and estimates of incentives to be earned in the future based on applicable product inventories held by distributors at the end of the period.

 

Up-Front Customer Loyalty Programs. Our up-front loyalty programs provide incentives to customers in the form of cash payments or IDEXX Points upon entering multi-year agreements to purchase annual minimum amounts of future products or services. If a customer breaches its agreement, it is required to refund a prorated portion of the up-front cash or IDEXX Points. These incentives are considered to be customer acquisition costs and are capitalized and recognized as a reduction to revenue over the term of the customer agreement. If these up-front incentives are subsequently utilized to purchase IDEXX VetLab^® instruments, digital radiography systems or Cornerstone^® practice management systems, product revenue and cost is deferred and recognized over the term of the customer agreement as products and services are provided to the customer. We monitor customer purchases over the term of their agreement to assess the realizability of our capitalized customer acquisition costs. For the years ended December 31, 2012, 2011 and 2010, impairments of customer acquisition costs were immaterial.

 

IDEXX VetLab^® Instrument Marketing Programs. Our instrument marketing programs require the customer to enroll at the time of instrument purchase and offer customers the opportunity to earn incentives in future periods based on the volume of the products they purchase and utilize over the term of the program. These arrangements are considered MEAs in accordance with our revenue recognition policy stated above. Revenue reductions related to instrument marketing programs are recorded based on an estimate of customer purchase and utilization levels and the incentive the customer will earn over the term of the program. Our estimates are based on historical experience and the specific terms and conditions of the marketing program and require us to apply judgment to approximate future product purchases and utilization. Differences between our estimates and actual incentives earned are accounted for as a change in estimate. These differences were not material for the years ended December 31, 2012, 2011 and 2010. At

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December 31, 2012, a 5% change in our estimate of future customer utilization would increase or reduce revenue by approximately $0.3 million.

 

Reagent Rental Programs. Our reagent rental programs provide our customers the right to use our instruments in consideration for multi-year agreements to purchase annual minimum amounts of consumables. No instrument revenue is recognized at the time of instrument installation. We recognize a portion of the revenue allocated to the instrument concurrent with the future sale of consumables. We determine the amount of revenue allocated from the consumable to the instrument based on VSOE and determine the rate of instrument revenue recognition in proportion to the customer’s minimum volume commitment. The cost of the instrument is reclassified from inventory to equipment and charged to cost of product revenue on a straight-line basis over the term of the rental agreement.

 

IDEXX Points may be applied against the purchase price of IDEXX products and services purchased in the future or applied to trade receivables due to us. IDEXX Points that have not yet been used by customers are classified as a liability until use or expiration occurs. We estimate the amount of IDEXX Points expected to expire, or breakage, based on historical expirations and we recognize the estimated benefit of breakage as IDEXX Points are issued to customers. On November 30 of each year, unused IDEXX Points earned before January 1 of the prior year generally expire and any variance from the breakage estimate is accounted for as a change in estimate. This variance was not material for the years ended December 31, 2012, 2011 and 2010.

 

            Future market conditions and changes in product offerings may cause us to change marketing strategies to increase or decrease customer incentive offerings, possibly resulting in incremental reductions of revenue in future periods as compared to reductions in the current or prior periods. Additionally, certain customer programs require us to estimate, based on historical experience, and apply judgment to approximate the number of customers who will actually redeem the incentive. In determining estimated revenue reductions we utilize data supplied from distributors and collected directly from end-users, which includes the volume of qualifying products purchased and the number of qualifying tests run as reported to us by end-users via IDEXX SmartService^TM, a secure Internet link that enables us to extract data and provide diagnostic service and support for certain IDEXX VetLab^® instruments through remote access. Differences between estimated and actual customer participation in programs may impact the amount and timing of revenue recognition. 

Following is a summary of revenue reductions, net recorded in connection with our customer programs for the years ended December 31, 2012, 2011 and 2010 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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At December 31, 2012, 2011 and 2010, the total accrued revenue reductions were $36.6 million, $37.8 million and $23.3 million, respectively. Accrued customer programs are included within accrued liabilities and other long-term liabilities, depending on the anticipated settlement date, in the consolidated balance sheets included in this Annual Report on Form 10-K. Following is a summary of changes in the accrual for estimated revenue reductions attributable to customer marketing and incentive programs and the ending accrued customer programs balance for the years ended December 31, 2012, 2011 and 2010 (in thousands):

 

 

Inventory Valuation

 

We write down the carrying value of inventory for estimated obsolescence by an amount equal to the difference between the cost of inventory and the estimated market value when warranted based on assumptions of future demand, market conditions, remaining shelf life, or product functionality. If actual market conditions or results of estimated functionality are less favorable than those we estimated, additional inventory write-downs may be required, which would have a negative effect on results of operations.

 

Valuation of Goodwill and Other Intangible Assets

 

A significant portion of the purchase price for acquired businesses is generally assigned to intangible assets. Intangible assets other than goodwill are initially valued at fair value. If a quoted price in an active market for the identical asset is not readily available at the measurement date, the fair value of the intangible asset is estimated based on discounted cash flows using market participant assumptions, which are assumptions that are not specific to IDEXX. The selection of appropriate valuation methodologies and the estimation of discounted cash flows require significant assumptions about the timing and amounts of future cash flows, risks, appropriate discount rates, and the useful lives of intangible assets. When material, we utilize independent valuation experts to advise and assist us in allocating the purchase prices for acquired businesses to the fair values of the identified intangible assets and in determining appropriate amortization methods and periods for those intangible assets. Goodwill is initially valued based on the excess of the purchase price of a business combination over the fair values of acquired net assets, including intangible assets. Contingent consideration is included within the acquisition cost and is recognized at its fair value on acquisition date. A liability resulting from contingent consideration is remeasured to fair value at each reporting date until the contingency is resolved. Changes in fair value of contingent consideration are recognized in earnings. 

 

 

 

 

 

 

 

 

 

 

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We assess goodwill for impairment annually, at the reporting unit level, in the fourth quarter and whenever events or circumstances indicate impairment may exist. An impairment charge is recorded for the amount, if any, by which the carrying amount of goodwill exceeds its implied fair value. Our reporting units are the individual product and service categories that comprise our CAG operating segment, our Water and LPD operating segments and goodwill remaining from the restructuring of our pharmaceutical business in the fourth quarter of 2008, referred to herein as the Technology reporting unit. A substantial portion of the goodwill remaining from the pharmaceutical business, included in our “Other Segment”, is associated with products that have been, or that we expect to be, licensed to third parties. Realization of this goodwill is dependent upon the success of those third parties in developing and commercializing products, which will result in our receipt of royalties and other payments. Our Dairy and OPTI Medical businesses, for which there is no goodwill associated, are also presented in our “Other” segment.

 

On January 1, 2012, we adopted an amendment to the accounting guidance for goodwill which simplified how companies test goodwill for impairment. The amendment provides an entity the option to first assess the qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If, after assessing the totality of events or circumstances, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, it would then perform the two-step impairment test; otherwise, no further impairment test would be required.

 

As part of our goodwill qualitative testing process, we evaluate factors specific to a reporting unit as well as industry and macroeconomic factors that are reasonably likely to have a material impact on the fair value of a reporting unit. Examples of the qualitative factors considered in assessing the fair value of a reporting unit include: the results of the most recent impairment test, the competitive environment, anticipated changes in product or labor costs, revenue growth trends, the consistency of operating margins and cash flows, and current and long-range financial forecasts. The long-range financial forecasts of the reporting units, which are based upon management’s long-term view of our markets, are used by senior management and the Board of Directors to evaluate operating performance.

 

In the fourth quarter of 2012, we elected to assess the qualitative factors discussed above and determined that it was more likely than not that the fair value of the reporting units comprising our CAG, Water, and LPD operating segments exceeded the respective carrying amounts. Therefore, we did not perform the two-step impairment test for these reporting units. A prolonged economic downturn resulting in lower long-term growth rates and reduced long-term profitability may reduce the fair value of our reporting units. Industry specific events or circumstances could have a negative impact on our reporting units and may also reduce the fair value of our reporting units. Should such events occur and it becomes more likely than not that a reporting unit’s fair value has fallen below its carrying value, we will perform an interim goodwill impairment test(s), in addition to the annual impairment test. Future impairment tests may result in an impairment of goodwill, depending on the outcome of a qualitative assessment and, if necessary, the two-step impairment test. An impairment of goodwill would be reported as a non-cash charge to earnings.

 

We did not elect to use the simplified qualitative approach to assess goodwill in our Technology reporting unit due to the nature of these products that are dependent on the success of third parties to develop and commercialize.  Therefore, we performed the first step of the two-step goodwill impairment test, using an income approach based on discounted forecasted cash flows to estimate the fair value of the Technology reporting unit. Valuation assumptions reflect our projections and best estimates, based on significant assumptions about the extent and timing of future cash flows, growth rates and discount rates. The results of the Technology reporting unit goodwill impairment test indicated the estimated fair value of the reporting unit was in excess of its carrying value of $7 million by approximately 160%.

 

 

 

 

 

 

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While we believe that the assumptions used to determine the estimated fair value of our Technology reporting unit are reasonable, a change in assumptions underlying these estimates or the inability of third parties to successfully develop or commercialize these products could result in a material negative effect on the estimated fair value of the reporting unit. Our fair value estimate assumes the achievement of future financial results contemplated in our forecasted cash flows, and there can be no assurance that we will realize that value. We use forecasts to estimate future cash flows and include an estimate of long-term future growth rates based on our most recent views of the long-term outlook for this reporting unit. Actual results may differ from those assumed in our forecasts. The discount rate is based on a weighted average cost of capital (“WACC”) derived from industry peers. Changes in market conditions, interest rates, growth rates, tax rates, costs, pricing, or the discount rate would affect the estimated fair values of a reporting unit and could result in a goodwill impairment charge in a future period. No goodwill impairments were identified during the years ended December 31, 2012, 2011 or 2010.

 

We assess the realizability of intangible assets other than goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If an impairment review is triggered, we evaluate the carrying value of intangible assets based on estimated undiscounted future cash flows over the remaining useful life of the primary asset of the asset group and compare that value to the carrying value of the asset group. The cash flows that are used contain our best estimates, using appropriate and customary assumptions and projections at the time. If the net carrying value of an intangible asset exceeds the related estimated undiscounted future cash flows, an impairment to write the intangible asset to its fair value would be reported as a non-cash charge to earnings. If necessary, we would calculate the fair value of an intangible asset using the present value of the estimated future cash flows to be generated by the intangible asset, using a risk-adjusted discount rate.

As a result of recent operating losses incurred by our OPTI Medical Systems business in the human market, we tested the related asset group, including intangible assets, for impairment in the third quarter of 2012. Simultaneously, we also reviewed the estimated useful lives of these intangible assets and determined that based on investments in our next generation OPTI analyzer it is likely we will experience a reduction in revenues from the existing products based on the acquired technologies sooner than previously estimated. As a result, we reduced the estimated useful lives for certain OPTI Medical Systems intangible assets resulting in increased amortization in the fourth quarter of 2012 and future periods. The impact of this change in estimated useful lives is not expected to have a material impact on our future financial results.   

 

We determined the future net undiscounted cash flow for our OPTI Medical Systems business in the human market, which is comprised of those cash flows that are directly associated with and that are expected to arise as a direct result of the use of the asset group, exceeded the $17 million carrying value of the related asset group, including intangible assets of $5 million, by approximately 60%.

 

Inherent in our development of cash flow projections are assumptions and estimates derived from a review of our operating results, approved business plans, expected growth rates, and tax rates. Many of the factors used in assessing future cash flows are outside the control of management and changes in the assumptions or estimates could materially affect the future cash flows of an asset group, and therefore could affect the amount of potential future impairment of the asset. In addition, the performance of the business is subject to the various risks described above that are associated with our limited experience and small scale in the human point-of-care market. See “Part I, Item 1A. Risk Factors.” No impairments of intangible assets were identified during the years ended December 31, 2012, 2011 and 2010.

 

Share-Based Compensation

 

Our share-based compensation programs provide for grants of stock options, restricted stock units and deferred stock units, along with the issuance of employee stock purchase rights. The total fair value of future awards may vary significantly from past awards based on a number of factors, including our share-based award practices. Therefore, share-based compensation expense is likely to fluctuate, possibly significantly, from year to year.

 

 

 

 

 

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We use the Black-Scholes-Merton option-pricing model to determine the fair value of options granted. Option-pricing models require the input of highly subjective assumptions, particularly for the expected stock price volatility and the expected term of options. The risk-free interest rate is based on the U.S. Treasury yield for a duration similar to the expected term at the date of grant. We have never paid any cash dividends on our common stock and we have no present intention to pay a dividend; therefore, we assume that no dividends will be paid over the expected terms of option awards. We determine the assumptions to be used in the valuation of option grants as of the date of grant. As such, we use different assumptions during the year if we grant options at different dates. However, substantially all of our options granted during the years ended December 31, 2012, 2011 and 2010 were granted in the first quarter of each year. The weighted average of each of the valuation assumptions used to determine the fair value of each option grant during each of the previous three years is as follows:

 

            

 

Changes in the subjective input assumptions, particularly for the expected stock price volatility and the expected term of options, can materially affect the fair value estimate. Our expected stock price volatility assumption is based on the historical volatility of our stock over a period similar to the expected term and other relevant factors. Lower estimated volatility reduces the fair value of a stock option, while higher estimated volatility has the opposite effect. The total fair value of stock options granted during the year ended December 31, 2012 was $8.0 million. If the weighted average of the stock price volatility assumption was increased or decreased by 1%, the total fair value of stock options awarded during the year ended December 31, 2012 would have increased or decreased by approximately 3% and the total expense recognized for the year ended December 31, 2012 for options awarded during the same period would have increased or decreased by less than $0.1 million.

 

We derive the expected term assumption for stock options based on historical experience and other relevant factors concerning expected behavior with regard to option exercises. The expected term is determined using a consistent method at each grant date. A longer expected term assumption increases the fair value of stock option awards, while a shorter expected term assumption has the opposite effect. If the weighted average of the expected term was increased or decreased by one year, the total fair value of stock options awarded during the year ended December 31, 2012 would have increased by 10% or decreased by 11%, respectively, and the total expense recognized for the year ended December 31, 2012 for options awarded during 2012 would have increased or decreased by $0.2 million.

 

Share-based compensation expense is recognized on a straight-line basis over the requisite service period, which ranges from one to five years, depending on the award. Share-based compensation expense is based on the number of awards ultimately expected to vest and is, therefore, reduced for an estimate of the number of awards that are expected to be forfeited. The forfeiture estimates are based on historical data and other factors, and compensation expense is adjusted for actual results. Total share-based compensation expense for the year ended December 31, 2012 was $15.9 million, which is net of a reduction of $2.9 million for actual and estimated forfeitures. Changes in estimated forfeiture rates and differences between estimated forfeiture rates and actual experience may result in significant, unanticipated increases or decreases in share-based compensation expense from period to period. The termination of employment of certain employees who hold large numbers of share-based compensation instruments may also have a significant, unanticipated impact on forfeiture experience and, therefore, on share-based compensation expense. Modifications of the terms of outstanding options may result in significant increases or decreases in share-based compensation. There were no modifications to the terms of outstanding options, restricted stock units or deferred stock units during 2012, 2011 or 2010.

 

The fair value of stock options, restricted stock units, deferred stock units, and employee stock purchase rights issued during the years ended December 31, 2012, 2011 and 2010 totaled $18.2 million, $25.5 million and $16.3 million, respectively. The total unrecognized compensation expense, net of estimated forfeitures, for unvested share-based compensation awards outstanding at December 31, 2012 was $33.3 million, which will be recognized over a weighted average period of approximately 1.6 years.

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Income Taxes

 

We recognize a current tax liability or asset for current taxes payable or refundable, respectively, and a deferred tax liability or asset, as the case may be, for the estimated future tax effects of temporary differences between book and tax treatment of assets and liabilities and carryforwards to the extent they are realizable.

 

The future tax benefit arising from net deductible temporary differences and tax carryforwards, net of valuation allowances, was $4.3 million and $0.5 million at December 31, 2012 and 2011, respectively. On a quarterly basis, we assess our current and projected earnings by jurisdiction to determine whether or not our earnings during the periods when the temporary differences become deductible will be sufficient to realize the related future tax benefits. Should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. A reduction of net income before taxes in each subsidiary equal to 5% of revenue, compared to the corresponding reported amounts for the year ended December 31, 2012, would not result in the recognition of incremental valuation allowances.

 

For those jurisdictions where tax carryforwards are likely to expire unused or the projected operating results indicate that realization is not more likely than not, a valuation allowance is recorded to offset the deferred tax asset within that jurisdiction. In assessing the need for a valuation allowance, we consider future taxable income and ongoing prudent and feasible tax planning strategies. Alternatively, in the event that we were to determine that we would be able to realize our deferred tax assets in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made.

 

Our net deductible temporary differences and tax carryforwards are recorded using the enacted tax rates expected to apply to taxable income in the periods in which the deferred tax liability or asset is expected to be settled or realized. Should the expected applicable tax rates change in the future, an adjustment to the net deferred tax asset would be credited or charged, as appropriate, to income in the period such determination was made. For example, an increase of one percentage point in our anticipated U.S. state income tax rate would cause us to increase our net deferred tax asset balance by $0.3 million. This increase in the net deferred asset would increase net income in the period that our rate was adjusted. Likewise, a decrease of one percentage point to our anticipated U.S. state income tax rate would have the opposite effect.

 

We periodically assess our exposures related to our worldwide provision for income taxes and believe that we have appropriately accrued taxes for contingencies. Any reduction of these contingent liabilities or additional assessment would increase or decrease income, respectively, in the period such determination was made.

 

We consider the majority of the operating earnings of non-United States subsidiaries to be indefinitely invested outside the U.S. The cumulative earnings of these subsidiaries were $314.5 million at December 31, 2012, of which approximately $222.4 million was held in cash and cash equivalents as of December 31, 2012. No provision has been made for U.S. federal and state, or international taxes that may result from future remittances of these undistributed earnings of non-United States subsidiaries. Should we repatriate these earnings in the future, we would have to adjust the income tax provision in the period in which the decision to repatriate earnings is made. A determination of related tax liability that would be paid on these undistributed earnings if eventually repatriated is not practicable.  For the operating earnings not considered to be indefinitely invested outside the United States we have accounted for the tax impact on a current basis.

 

We record a liability for uncertain tax positions that do not meet the more likely than not standard as prescribed by the authoritative guidance for income tax accounting. We record tax benefits for only those positions that we believe will more likely than not be sustained. For positions that we believe that it is more likely than not that we will prevail, we record a benefit considering the amounts and probabilities that could be realized upon ultimate settlement. If our judgment as to the likely resolution of the uncertainty changes, if the uncertainty is ultimately settled or if the statute of limitation related to the uncertainty expires, the effects of the change would be recognized in the period in which the change, resolution or expiration occurs. Our net liability for uncertain tax positions was $6.3 million and $5.6 million as of December 31, 2012 and 2011, respectively, which includes estimated interest expense and penalties.

 

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RESULTS OF OPERATIONS AND TRENDS

 

Effects of Certain Factors on Results of Operations

 

Distributor Purchasing and Inventories. The instrument consumables and rapid assay products in our CAG segment are sold in the U.S. and certain other geographies by third party distributors, who purchase products from us and sell them to veterinary practices, which are the end users. As a result, distributor purchasing dynamics have an impact on our reported sales of these products. Distributor purchasing dynamics may be affected by many factors and in a given period may not be directly related to underlying end-user demand for our products. Consequently, reported results may reflect fluctuations in inventory levels held at distributors and not necessarily reflect changes in underlying end-user demand. Therefore, we believe it is important to track distributor sales to end users and to distinguish between the impact of end-user demand and the impact of distributor purchasing dynamics on reported revenue.  

 

Where growth rates are affected by changes in end-user demand, we refer to this as the impact of practice-level sales on growth. Where growth rates are affected by distributor purchasing dynamics, we refer to this as the impact of changes in distributors’ inventories on growth. If during the current year, distributors’ inventories grew by less than those inventories grew in the comparable period of the prior year, then changes in distributors’ inventories have an unfavorable impact on our reported sales growth in the current period. Conversely, if during the current year, distributors’ inventories grew by more than those inventories grew in the comparable period of the prior year, then changes in distributors’ inventories have a favorable impact on our reported sales growth in the current period. 

 

At the end of a quarter, we believe that our U.S. CAG distributors typically hold inventory equivalent to approximately four weeks of the anticipated end-user demand for instrument consumables and rapid assay products.

 

Currency Impact.  For the years ended December 31, 2012, 2011 and 2010, approximately 26%, 26%  and 25%, respectively, of IDEXX consolidated revenues were derived from products manufactured in the U.S. and sold internationally in local currencies.  Strengthening of the rate of exchange for the U.S. dollar relative to other currencies has a negative impact on our revenues derived in currencies other than the U.S. dollar and on profits of products manufactured in the U.S. and sold internationally, and a weakening of the U.S. dollar has the opposite effect. Similarly, to the extent that the U.S. dollar is stronger in current or future periods relative to the exchange rates in effect in the corresponding prior periods, our growth rate will be negatively affected. The impact of foreign currency denominated operating expenses and foreign currency denominated supply contracts partly offset this exposure.  

The impact on revenue resulting from changes in foreign currency exchange rates is not a measure defined by U.S. GAAP, otherwise referred to herein as a non-U.S. GAAP measure. We calculate the impact on revenue resulting from changes in foreign currency exchange rates by applying the difference between the weighted average exchange rates during the current year period and the comparable previous year period to foreign currency denominated revenues for the current year period. 

 

During the twelve months ended December 31, 2012, compared to the twelve months ended December 31, 2011, changes in foreign currency exchange rates reduced total company revenue by approximately $19.0 million, due primarily to the strengthening of the U.S. dollar against the Euro.

 

During the twelve months ended December 31, 2011, compared to the twelve months ended December 31, 2010, changes in foreign currency exchange rates increased total company revenue by approximately $27.1 million, due primarily to the weakening of the U.S. dollar against the Euro and, to a lesser extent, the Australian dollar, Japanese yen, Canadian dollar, British pound and Swiss franc.

 

 

 

 

 

 

 

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Effects of Economic Conditions. Demand for many of our products and services has been negatively affected by economic conditions since mid-2008. In our CAG segment, we believe that low economic growth and relatively high unemployment have led to negative or cautious consumer sentiment, which has affected the number of patient visits to veterinary clinics. Based on data provided by a subset of our customers that use our practice management systems, we observed patient visits were flat to slightly down beginning in 2009, with a slight improvement in the growth of patient visits beginning in the fourth quarter of 2011 and further improvement during 2012 over the previous year periods, although the rate of improvement has not been steady. We believe that this data, though limited, provides a fair and meaningful representation of the trend in patient visit activity in the U.S. that is consistent with trends in the U.S. economic environment and consumer sentiment. In contrast, economic conditions in certain European countries remain challenging, which continues to negatively impact our CAG segment in particular.  

 

We believe that the overall trend in patient visits since the beginning of the economic downturn has had a slightly negative impact on the growth rate of sales of rapid assay tests, instrument consumables and reference laboratory diagnostic and consulting services. In addition, we believe the rate of growth of sales of our instruments and digital radiography systems, which are larger capital purchases for veterinarians, has also been affected by continued caution among veterinarians regarding economic conditions. Weaker economic conditions since mid-2008 have also caused our customers to remain sensitive to the pricing of our products and services resulting in lower revenue growth due to limited price increases for certain products.  

 

We also believe that current economic conditions have affected purchasing decisions of our Water and LPD business customers. Lower water testing volumes have resulted from a decline in discretionary testing and a decline in mandated testing as a result of lower home and commercial construction. Fiscal difficulties in certain European countries have also reduced government funding for some water and livestock testing programs.  

 

We believe that the diversity of our products and services and the geographic diversity of our markets have partially mitigated the effects of the economic environment and negative consumer sentiment on our revenue growth rates. Looking forward, we are cautiously optimistic that the improvements we began to see in the U.S. commencing in the fourth quarter of 2011 and continuing in 2012 are reflective of a gradual improvement in the macroeconomic environment that over time will further reduce these effects.  

 

Twelve Months Ended December 31, 2012 Compared to Twelve Months Ended December 31, 2011

 

Revenue

 

The following revenue analysis and discussion reports on organic revenue growth. Organic revenue growth should be considered in addition to, and not as a replacement for or as a superior measure to, revenues reported in accordance with U.S. GAAP, and may not be comparable to similarly titled measures reported by other companies. Management believes that reporting organic revenue growth provides useful information to investors by facilitating easier comparisons of our revenue performance with prior and future periods and to our peers. We exclude the effect of changes in foreign currency exchange rates because changes in foreign currency exchange rates are not under management’s control, are subject to volatility and can obscure underlying business trends. We exclude the effect of acquisitions because the nature, size and number of acquisitions can vary dramatically from period to period and therefore can also obscure underlying business trends. 

 

            Organic revenue growth and the percentage changes in revenue from currency and acquisitions are non-U.S. GAAP measures. See the subsection above titled “Effects of Certain Factors on Results of Operations” for a description of the calculation of the percentage change in revenue resulting from changes in foreign currency exchange rates. The percentage change in revenue resulting from acquisitions represents incremental revenues attributable to acquisitions that have occurred since the beginning of the prior year period.  

 

 

 

 

 

 

 

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Total Company. The following table presents revenue by operating segment:

 

 

Companion Animal Group. The following table presents revenue by product and service category for CAG. The VetLab^® instruments and consumables product and service category has been disaggregated into its three VetLab^® components:

 

 

The decrease in VetLab^® instruments revenue was due primarily to lower sales of our Catalyst Dx^® and LaserCyte^® instruments, partly offset by increased sales of our ProCyte Dx^® instrument. Lower sales of our Catalyst Dx^® instrument were due primarily to lower average unit sales prices, a decrease in volumes during the year ended December 31, 2012 as compared to the prior year as result of the initial launch of a Catalyst Dx^® instrument marketing program in North America during the third quarter of 2011 and the impact of fourth quarter placements in 2012 under the reagent rental customer program where instrument revenue is recognized over the term of the rental agreement. VetLab^®  service and accessories revenue growth was primarily a result of the increase in our active installed base of instruments. 

 

VetLab^® consumables revenue growth was due primarily to higher sales volumes of consumables used with our Catalyst Dx^® instrument, partly offset by lower sales of consumables used with our VetTest^® chemistry instrument. The increase in consumables used with our Catalyst Dx^® instrument resulted primarily from growth of our install base as a result of customer acquisitions, as well as an increase in testing for customers who upgrade from our VetTest^® to our Catalyst Dx^® instrument. Higher sales volumes of consumables used with our ProCyte Dx^® instrument also contributed to the increase in consumables revenue. The impact of changes in distributors’ inventory levels contributed 1% to reported consumables growth. 

 

The increase in rapid assay revenue was due primarily to higher sales of our canine combination test products driven primarily by higher average unit sales prices. The impact of changes in distributors’ inventory levels was not significant to rapid assay revenue growth.

 

The increase in reference laboratory diagnostic and consulting services revenue resulted primarily from the impact of higher testing volumes and, to a lesser extent, price increases. Higher testing volumes were driven by the acquisition of new customers due, in part, to geographic expansion and our customer loyalty programs in which customers are provided incentives in exchange for agreements to purchase services in future periods. 

 

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The increase in practice management and digital imaging systems and services revenue resulted primarily from an increase in placements of our practice management systems, an increase in support and service revenue and incremental revenue recognized under customer loyalty programs where revenue had been deferred at the time of systems placement.

 

Water. The increase in Water revenue resulted primarily from higher Colilert^® product sales volumes due to new account acquisitions. 

 

Livestock and Poultry Diagnostics. The decrease in LPD revenue resulted primarily from lower bovine test sales resulting from the changes in European Union testing requirements and declines in certain government programs. Effective July 1, 2011, the age at which healthy cattle to be slaughtered are required to be tested for Bovine Spongiform Encephalopathy (“BSE” or “mad cow disease”) in the European Union was increased from 48 months to 72 months, which is reducing the population of cattle tested for this disease. Effective March 2013, European Union (“EU”) member states will have the option to eliminate BSE testing of healthy cattle at slaughter. Instead of eliminating testing, certain EU governments have elected to further increase the age at which healthy cattle are to be tested in 2013. Revenue from BSE testing products was less than $10 million during the twelve months ended December 31, 2012.

 

Other. The increase in Other revenue was due primarily to higher sales volumes of our Dairy SNAP^®  tests used for the detection of antibiotic residue and the contaminant Aflatoxin M1 in milk. Higher sales of our OPTI Medical instruments and related consumables also contributed to the increase in revenue. In 2013, we anticipate reduced sales of Dairy SNAP^®  tests used for the detection of the contaminant Aflatoxin M1 in milk due to lower testing volumes in China compared to testing that was performed in 2012 in response to an outbreak.

 

Gross Profit

 

Total Company. The following table presents gross profit and gross profit percentages by operating segment:

 

Companion Animal Group. Gross profit for CAG increased due to higher sales and an increase in the gross profit percentage. The increase in the gross profit percentage was due primarily higher average unit sales prices of our canine combination rapid assay tests, lower unit costs for consumables used in our VetLab^® instruments and the favorable impact of currency. The net effect of currency was positive because the net unfavorable impact of changes in foreign currency exchange rates was more than offset by hedging gains during the year ended December 31, 2012 compared to hedging losses during the same period of the prior year.

 

Water. Gross profit for Water increased due to higher sales and an increase in the gross profit percentage to 66% from 63%. The increase in the gross profit percentage was due primarily to lower overall manufacturing costs during the year ended December 31, 2012, the timing of certain manufacturing costs during the year ended December 31, 2011 and the favorable impact of currency. The net effect of currency was positive because the net unfavorable impact of changes in foreign currency exchange rates was more than offset by hedging gains during the year ended December 31, 2012 compared to hedging losses during the same period of the prior year. 

 

 

 

 

 

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Livestock and Poultry Diagnostics. Gross profit for LPD decreased due to lower sales and a decrease in the gross profit percentage to 66% from 68%. The decrease in the gross profit percentage was due primarily to higher overall manufacturing costs driven by lower production volumes, partly offset by the favorable impact of currency. The net effect of currency was positive because the net unfavorable impact of changes in foreign currency exchange rates was more than offset by hedging gains during the year ended December 31, 2012 compared to hedging losses during the same period of the prior year.  

 

Other. Gross profit for Other increased due to higher sales, partly offset by a decrease in the gross profit percentage to 39% from 40%. The decrease in the gross profit percentage was due primarily to lower average unit sales prices in our OPTI Medical line of business and higher freight and distribution costs in our Dairy line of business. These unfavorable factors were partly offset by lower overall manufacturing costs in our Dairy line of business driven by increased production volumes of our SNAP^®  tests.

 

Unallocated Amounts. Gross profit for Unallocated Amounts increased due primarily to a decrease in certain manufacturing costs. The manufacturing costs reported in our operating segments include our standard cost for products sold and any variances from standard cost for products purchased or manufactured within the period. We capitalize these variances for inventory on hand at the end of the period to record inventory in accordance with U.S. GAAP. We then record these variances as cost of product revenue as that inventory is sold. The impact to cost of product revenue resulting from this variance capitalization and subsequent recognition is reported within the caption “Unallocated Amounts.” The decrease in certain manufacturing costs is due primarily to the recognition of previously favorable production volume variances incurred in our LPD business.

 

Operating Expenses and Operating Income

 

Total Company. The following tables present operating expenses and operating income by operating segment:

 

 

 

 

 

 

 

 

 

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Companion Animal Group. The following table presents CAG operating expenses by functional area:

 

 

The increase in sales and marketing expense resulted primarily from higher personnel-related costs, partly offset by the favorable impact from changes in foreign currency exchange rates. The increase in general and administrative expense was due primarily to higher personnel-related costs, higher amortization expense of our intangible assets and an increase in costs attributable to investments in information technology. These unfavorable impacts were partly offset by the favorable impact of changes in foreign currency exchange rates. The increase in research and development expense resulted primarily from higher personnel-related costs and increased external consulting and development costs.

 

Water. The following table presents Water expenses by functional area:

 

 

The increase in sales and marketing expense resulted primarily from higher personnel-related costs, partly offset by the favorable impact of changes in foreign currency exchange rates. General and administrative expense was generally consistent with the same period of the prior year. The increase in research and development expense resulted primarily from higher personnel-related costs.

 

Livestock and Poultry Diagnostics. The following table presents LPD operating expenses by functional area:

 

 

The decrease in sales and marketing expense resulted primarily from the favorable impact of changes in foreign currency exchange rates and lower personnel-related costs. General and administrative expense was generally consistent with the same period of the prior year. The decrease in research and development expense was due primarily to lower personnel-related costs and the favorable impact of changes in foreign currency exchange rates. 

 

 

 

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Other. Operating expenses for Other, which totaled $14.8 million for the year ended December 31, 2012, were generally consistent with the same period of the prior year as higher personnel-related costs in our OPTI Medical line of business were offset by a final $3.5 million milestone payment earned related to the 2008 sale of product rights previously included in our pharmaceutical product line earned during the year ended December 31, 2012 that was incremental to a similar $3.0 million milestone payment earned during the year ended December 31, 2011. 

 

Unallocated Amounts. Operating expenses that are not allocated to our operating segments decreased $5.0 million to $7.2 million for the year months ended December 31, 2012 due primarily to lower personnel-related costs, lower legal and other professional fees incurred in connection with the U.S. Federal Trade Commission (“FTC”) investigation and the absence of legal and other fees incurred in connection with the U.K. Office of Fair Trading (“OFT”) investigation, which concluded in November 2011. These favorable factors were partly offset by the absence of a payment related to the sale of certain raw material inventory in connection with the restructuring of our pharmaceutical business in 2008 that was recognized during the year ended December 31, 2011. We estimate certain personnel-related costs and allocate the estimated expense to the operating segments. This allocation differs from the actual expense and consequently yields a difference that is reported under the caption “Unallocated Amounts.” The FTC investigation is discussed in more detail under the heading “Part I. Item 1A. Risk Factors” in this Annual Report on Form 10-K. 

 

Interest Income and Interest Expense

 

            Interest income of $1.9 million for the twelve months ended December 31, 2012 was generally consistent with interest income of $1.7 million for the same period of the prior year.

 

            Interest expense was $3.8 million for the twelve months ended December 31, 2012 compared to $3.5 million for the same period of the prior year. The increase in interest expense was due primarily to higher average balances outstanding on our unsecured revolving credit facility, partly offset by lower effective interest rates.

 

Provision for Income Taxes

 

Our effective income tax rate was 31.6% for the year ended December 31, 2012 and 31.0% for the year ended December 31, 2011. The increase in the tax rate is primarily due to federal research and development tax credits that were not available during 2012 but were available during 2011, partly offset by higher relative earnings subject to international tax rates that are lower than domestic tax rates.

 

On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law which retroactively reinstated and extended the federal research and development (R&D) tax credit from January 1, 2012 to December 31, 2013. As a result, the Company expects its income tax provision for the first quarter of 2013 will reflect the entire benefit of the R&D tax credit attributable to 2012. We expect the federal R&D tax credit reinstatement to contribute approximately a 2% reduction in our effective income tax rate for 2013, as compared to our effective tax rate for the year ended December 31, 2012.

 

In 2013, it is reasonably possible that we could recognize up to $1.1 million of income tax benefits that have not been recognized at December 31, 2012. The income tax benefits are primarily due to the lapse in the statutes of limitations for various U.S. and international tax jurisdictions.

 

Twelve Months Ended December 31, 2011 Compared to Twelve Months Ended December 31, 2010

 

The following revenue analysis and discussion reports on organic revenue growth. Organic revenue growth should be considered in addition to, and not as a replacement for or as a superior measure to, revenues reported in accordance with U.S. GAAP, and may not be comparable to similarly titled measures reported by other companies. Management believes that reporting organic revenue growth provides useful information to investors by facilitating easier comparisons of our revenue performance with prior and future periods and to our peers. We exclude the effect of changes in foreign currency exchange rates because changes in foreign currency exchange rates are not under management’s control, are subject to volatility and can obscure underlying business trends. We exclude the effect of acquisitions because the nature, size and number of acquisitions can vary dramatically from period to period and therefore can also obscure underlying business trends. 

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            Organic revenue growth and the percentage changes in revenue from currency and acquisitions are non-U.S. GAAP measures. See the subsection above titled “Effects of Certain Factors on Results of Operations” for a description of the calculation of the percentage change in revenue resulting from changes in foreign currency exchange rates. The percentage change in revenue resulting from acquisitions represents incremental revenues attributable to acquisitions that have occurred since the beginning of the prior year period.  

 

Revenue

 

Total Company. The following table presents revenue by operating segment:

 

 

Companion Animal Group. The following table presents revenue by product and service category for CAG. The VetLab^® instruments and consumables product and service category has been disaggregated into its three VetLab^® components:

 

 

VetLab^®  instruments revenue growth was due primarily to sales of ProCyte Dx^®, the hematology analyzer that we began shipping during the third quarter of 2010, and higher sales volumes of our Catalyst Dx^® instrument. These favorable impacts were partly offset by lower average unit sales prices driven primarily by discounts associated with our IDEXX VetLab^® instrument marketing programs. VetLab^® service and accessories revenue growth was primarily a result of the increase in our active installed base of instruments.

 

VetLab^®  consumables revenue growth was due primarily to higher sales of consumables used with our Catalyst Dx^®  instrument, partly offset by lower sales of consumables used with our VetTest^® chemistry instrument as customers continue to upgrade from our VetTest^® instrument to our Catalyst Dx^® instrument. Higher sales of consumables used with our ProCyte Dx^® instrument also contributed to the increase in consumables revenue. The impact of changes in distributors’ inventory levels contributed 1% to reported consumables growth. 

 

 

 

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The increase in rapid assay revenue was due primarily to an increase in U.S. practice-level sales of our canine combination test products and, to a lesser extent, sales of our feline pancreatitis test products, which we began shipping during the second quarter of 2011. The impact of changes in distributors’ inventory levels was not significant to rapid assay revenue growth.

 

The increase in reference laboratory diagnostic and consulting services revenue resulted primarily from the impact of higher testing volumes and, to a lesser extent, price increases. Higher testing volumes were driven by the acquisition of new customers due, in part, to geographic expansion and our customer loyalty programs in which customers are provided incentives in the form of IDEXX Points or cash in exchange for agreements to purchase services in future periods.

  

The increase in practice management and digital imaging systems and services revenue resulted primarily from an increase in service and support revenue and an increase in sales volumes of our practice management systems. The increase in service and support revenue was due primarily to an increase in our active installed base of digital radiography systems and, to a lesser extent, practice management systems. Higher sales volumes of our digital radiography systems also contributed to the overall increase in revenue. These favorable factors were partly offset by an increase in placements of digital radiography systems and practice management systems under our customer loyalty programs for which the related revenue is recognized in future periods.

 

Water. The increase in Water revenue resulted primarily from higher sales volumes of Colilert^® test products, partly offset by the unfavorable impact of higher relative sales of Colilert^® test products in geographies where these products are sold at lower average unit sales prices.

 

Livestock and Poultry Diagnostics. The increase in LPD revenue resulted primarily from higher sales volumes of certain bovine tests and, to a lesser extent, higher sales volumes of certain swine and poultry tests. The increased sales volume of certain bovine tests was driven primarily by sales in Germany where we have won several government tenders for testing in connection with a country-wide eradication program for a virus impacting beef and dairy production yields.

 

Other. The increase in Other revenue was primarily attributable to higher sales volumes of our OPTI Medical consumables and, to a lesser extent, instruments, partly offset by lower sales volumes of our Dairy SNAP^®  tests used for the detection of antibiotic residue in milk and lower average unit sales prices in our OPTI Medical line of business due, in part, to higher relative sales in geographies where products are sold at lower average unit sales prices.

 

Gross Profit

 

Total Company. The following table presents gross profit and gross profit percentages by operating segment:

 

 

 

 

 

 

 

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Companion Animal Group. Gross profit for CAG increased due to higher sales and an increase in the gross profit percentage to 52% from 51%. The increase in the gross profit percentage was due primarily to improvements in costs to manufacture our IDEXX VetLab^® instruments, higher relative sales of products that yield higher margins and an overall increase in average unit sales prices, driven by our reference laboratory diagnostic and consulting services line of business. These favorable impacts were partly offset by the unfavorable impact of currency as the net favorable impact of changes in foreign currency exchange rates was more than offset by the impact of increased hedging losses during the year ended December 31, 2011 compared to the year ended December 31, 2010.

 

Water. Gross profit for Water increased as higher sales were partly offset by a slight decrease in the gross profit percentage. The decrease in the gross profit percentage was due primarily to lower average unit sales prices of our Colilert^® products and higher freight costs as a result of rising fuel surcharges. These unfavorable impacts were partly offset by higher relative sales of our Colilert^® products that yield higher margins and lower manufacturing costs driven by cost improvement initiatives.

 

Livestock and Poultry Diagnostics. Gross profit for LPD increased as higher sales were partly offset by a slight decrease in the gross profit percentage. The decrease in the gross profit percentage was due primarily to the net unfavorable impact of currency as the net favorable impact of changes in foreign currency exchange rates was more than offset by hedging losses during the year ended December 31, 2011 compared to hedging gains during the year ended December 31, 2010. This unfavorable impact was partly offset by lower manufacturing costs and higher relative sales of products that yield higher margins. Lower manufacturing costs were driven largely by benefits achieved from economies of scale as a result of the increase in production volume.

 

Other. Gross profit for Other decreased as higher sales were more than offset by a decrease in the gross profit percentage to 40% from 44%. The decrease in the gross profit percentage was due primarily to lower average unit sales prices in our OPTI Medical line of business and higher freight costs in our Dairy line of business that were due, in part, to rising fuel surcharges.

 

Unallocated Amounts. Gross profit for Unallocated Amounts decreased due primarily to the unfavorable impact of certain manufacturing costs that we do not expect to continue at this level, partly offset by a decrease in certain personnel-related costs. With respect to manufacturing costs, the costs reported in our operating segments include our standard cost for products sold and any variances from standard cost for products purchased or manufactured within the period. We capitalize these variances for inventory on hand at the end of the period to record inventory in accordance with U.S. GAAP. We then record these costs as cost of product revenue as that inventory is sold. The impact to cost of product revenue resulting from this variance capitalization and subsequent expense recognition is reported within the caption “Unallocated Amounts.” With respect to personnel-related costs, we estimate certain personnel-related costs and allocate the estimated expenses to the operating segments. This allocation differs from actual expense and consequently yields a difference that is reported under the caption “Unallocated Amounts.” The decrease in certain personnel-related costs for Unallocated Amounts is due primarily to lower self-insured healthcare costs during the year ended December 31, 2011 compared to the same period of the prior year.

 

Operating Expenses and Operating Income

 

Total Company. The following tables present operating expenses and operating income by operating segment:

 

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Companion Animal Group. The following table presents CAG operating expenses by functional area:

 

 

The increase in sales and marketing expense resulted primarily from an increase in personnel-related costs, the unfavorable impact of changes in foreign currency exchange rates and higher sales commission expenses attributable to the increase in sales volume. The increase in general and administrative expense resulted primarily from higher personnel-related costs, the unfavorable impact of changes in foreign currency exchange rates and an increase in costs attributable to investments in information technology. These increases were partly offset by a certain bad debt expense in 2010 that was absent in 2011 and payments that were earned during 2011 pursuant to certain product development arrangements and a license agreement. The bad debt expense in 2010 was in connection with the bankruptcy of one of our U.S. distributors, Professional Veterinary Products, Inc. The increase in research and development expense was due primarily to increased personnel-related costs and higher external consulting and development costs.

 

Water. The following table presents Water expenses by functional area:

 

 

The increase in sales and marketing expense resulted primarily from increased personnel-related costs and the unfavorable impact of changes in foreign currency exchange rates. The increase in general and administrative expense resulted primarily from the unfavorable impact of changes in foreign currency exchange rates, partly offset by a decrease in personnel-related costs. The slight decrease in research and development expense resulted primarily from lower personnel-related costs.

 

 

 

 

 

 

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Livestock and Poultry Diagnostics. The following table presents LPD operating expenses by functional area:

 

 

The increase in sales and marketing expense resulted primarily from higher personnel-related costs and the unfavorable impact of changes in foreign currency exchange rates. The increase in personnel-related costs was due primarily to an increase in sales personnel to support growth in developing markets. The slight increase in general and administrative expense resulted primarily from the unfavorable impact of changes in foreign currency exchange rates, partly offset by a decrease in personnel-related costs. The increase in research and development expense was due primarily to an increase in personnel-related costs and, to a lesser extent, the unfavorable impact of changes in foreign currency exchange rates.

 

Other. Operating expenses for Other increased $1.1 million to $14.7 million for the year ended December 31, 2011. This increase was due primarily to increased research and development costs in our OPTI Medical line of business driven, in part, by higher personnel-related costs and increased consulting and external development costs.

 

Unallocated Amounts. Operating expenses that are not allocated to our operating segments decreased $3.5 million to $12.2 million for the year ended December 31, 2011 due primarily to a decrease in certain personnel-related costs, receipt of a payment related to the sale of certain raw material inventory in connection with the restructuring of our pharmaceutical business in the fourth quarter of 2008, an impairment charge in 2010 that was absent in 2011, a decrease in legal and other professional fees incurred in connection with the FTC and OFT investigations and decreased foreign exchange losses during the year ended December 31, 2011 compared to the year ended December 31, 2010. The FTC investigation is discussed in more detail under the heading “Part I. Item 1A. Risk Factors”. We estimate certain personnel-related costs and allocate the estimated expenses to the operating segments. This allocation differs from actual expense and consequently yields a difference that is reported under the caption “Unallocated Amounts.” The decrease in certain personnel-related costs for Unallocated Amounts is due primarily to lower self-insured healthcare costs during the year ended December 31, 2011 compared to the same period of the prior year. The payment related to the sale of certain raw material inventory was not recorded in our results of operation until received due to uncertain collectability. The impairment charge in 2010 was to write off certain design costs related to a facilities project that had changed in scope.

Interest Income and Interest Expense

 

Interest income was $1.7 million for the twelve months ended December 31, 2011 compared to $0.7 million for the same period of the prior year. The increase in interest income was due primarily to interest earned on a note issued in connection with a November 2010 strategic investment in a company that owns and operates veterinary hospitals and, to a lesser extent, from higher cash balances.

 

 

 

 

 

 

 

 

 

 

 

 

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Interest expense was $3.5 million for the twelve months ended December 31, 2011 compared to $2.4 million for the same period of the prior year. In July 2011, we refinanced our existing $200 million unsecured revolving credit facility by entering into an amended and restated credit agreement relating to a five-year unsecured revolving credit facility in the principal amount of $300 million with a syndicate of multinational banks, which matures on July 25, 2016 (the new credit facility and the previous credit facility are referred to collectively as the “Credit Facility”) and requires no scheduled prepayments before that date. The increase in interest expense during the year ended December 31, 2011 in comparison to the same period of the prior year was due primarily to higher debt balances outstanding on our Credit Facility and higher effective interest rates on borrowings under our Credit Facility. As a result of the refinancing event in July 2011, applicable interest rates on borrowings under the Credit Facility generally range from 0.875 to 1.25 percentage points (the range of applicable interest rates on borrowing under the new credit facility and the previous credit facility are referred to collectively as the “Credit Spread”) above the London interbank rate (“LIBOR”) or the Canadian Dollar-denominated bankers’ acceptance rate (“CDOR”) as opposed to a Credit Spread of 0.375 to 0.875 under the pre-existing Credit Facility. Because the Credit Spread increased as a result of the refinancing event, interest expense during the year ended December 31, 2011 increased in comparison to the same period of the prior year.

 

Provision for Income Taxes

 

Our effective income tax rate was 31.0% for the year ended December 31, 2011 and 30.1% for the year ended December 31, 2010. The increase in the tax rate is primarily due to lower tax benefits recognized related to the federal research and development tax credits, lower benefits recognized in connection with the expiration of certain statutes of limitations and increased state tax.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

A discussion of recent accounting pronouncements is included in Note 2 to the consolidated financial statements for the year ended December 31, 2012 included in this Annual Report on Form 10-K.

 

LIQUIDITY AND CAPITAL RESOURCES

 

We fund the capital needs of our business through cash on hand, funds generated from operations, and amounts available under our Credit Facility. At December 31, 2012 and December 31, 2011, we had $224.0 million and $183.9 million, respectively, of cash and cash equivalents, and working capital of $163.2 million and $87.3 million, respectively. Additionally, at December 31, 2012, we had remaining borrowing availability of $87 million under our $300 million Credit Facility. We believe that, if necessary, we could obtain additional borrowings at prevailing market interest rates to fund our growth objectives. We further believe that current cash and cash equivalents, funds generated from operations, and available borrowings will be sufficient to fund our operations, capital purchase requirements, and strategic growth needs for the next twelve months, and that these resources will be sufficient in the long term to fund our business as currently conducted.

 

We consider the majority of the operating earnings of certain non-U.S. subsidiaries to be indefinitely invested outside the U.S. Changes to this position could have adverse tax consequences. We manage our worldwide cash requirements considering available funds among all of our subsidiaries. Our foreign cash balances are generally available without restrictions to fund ordinary business operations outside the U.S. Of our total cash and cash equivalents at December 31, 2012, approximately $222.4 million was held by our foreign subsidiaries and was subject to material repatriation tax effects. The amount of cash and cash equivalents held by foreign subsidiaries subject to other restrictions on the free flow of funds (primarily securing various obligations) was approximately $1.6 million. As of December 31, 2012, 36% of the cash and cash equivalents held by our foreign subsidiaries was invested in money market funds restricted to U.S. government and agency securities, 42% was held as bank deposits, 21% was invested in money market funds having investments in highly liquid investment-grade fixed-income securities. As of December 31, 2012, approximately 61% of the cash and cash equivalents held by our foreign subsidiaries was held in U.S. dollars. 

 

 

 

 

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Should we require more capital in the U.S. than is generated by our operations domestically, for example to fund significant discretionary activities, we could elect to repatriate future earnings from foreign jurisdictions or raise capital in the U.S. through debt or equity issuances. These alternatives could result in higher effective tax rates, increased interest expense, or other dilution of our earnings. We have borrowed funds domestically and continue to have the ability to borrow funds domestically at reasonable interest rates. 

 

The following table presents additional key information concerning working capital:

 

 

Sources and Uses of Cash

 

The following table presents cash provided (used):

 

 

Operating Activities. Cash provided by operating activities was $230.3 million for the year ended December 31, 2012 compared to $220.7 million for the same period in 2011. The total of net income and net non-cash charges, excluding the impact of reclassifying the tax benefit from share-based compensation arrangements to a financing activity, was $242.7 million for the year ended December 31, 2012 compared to $230.4 million for the same period in 2011, resulting in incremental operating cash flows of $12.3 million driven primarily by the increase in net income. The total of changes in operating assets and liabilities and the tax benefit from share-based compensation arrangements decreased cash by $12.4 million and $9.7 million for the years ended December 31, 2012 and 2011, respectively, resulting in an incremental decrease in cash of $2.7 million.

 

The following table presents cash flows from changes in operating assets and liabilities and the tax benefit from share-based compensation arrangements:

 

 

 

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Incremental cash used by accounts payable and accrued liabilities was due primarily to the timing of vendor and income tax payments during the year ended December 31, 2012 compared to the prior year. The increase in inventories during the year ended December 31, 2012 was more than the increase during the year ended December 31, 2011 due primarily to the timing of inventory receipts, most significantly of slides used with our chemistry instruments. The amount and timing of revenues and customer payments was the primary driver of the cash used by accounts receivable during the year ended December 31, 2011. 

 

We historically have experienced proportionally lower net cash flows from operating activities during the first quarter and proportionally higher cash flows from operating activities for the remainder of the year and for the annual period driven primarily by the payment of annual bonuses in connection with employee incentive programs in the first quarter following the year for which the bonuses were earned and the seasonality of vector-borne disease testing, which has historically resulted in significant increases in accounts receivable balances during the first quarter of the year.

 

Investing Activities. Cash used by investing activities was $66.0 million for the year ended December 31, 2012 compared to $97.0 million for the same period of the prior year. The decrease in cash used by investing activities was due primarily to lower cash payments to acquire businesses during the year ended December 31, 2012 compared to the prior year and the substantial completion in 2011 of investments in our Memphis, Tennessee facility, partly offset by increased investments in information technology and incremental investments during the year ended December 31, 2012 to expand our headquarters facility in Westbrook, Maine. Investments in information technology consisted of incremental costs to develop Pet Health Network^® Pro and increased purchases of computer hardware during the year ended December 31, 2012 as compared to the prior year.  During the year December 31, 2012, we paid an aggregate of $2.7 million in cash to acquire three businesses, compared to $46.8 million paid in cash to acquire three businesses during the prior year. We accounted for all of the businesses acquired in 2012 and 2011 as business combinations.

 

Our total capital expenditure plan for 2013 is estimated to be approximately $75 million, which includes approximately $21 million for the expansion of our headquarters facility in Westbrook, Maine, $16 million of investments in internal use software and information technology infrastructure, $12 million of capital investments in manufacturing equipment and $10 million for investments in our reference laboratory equipment and facilities.

 

Financing Activities. Cash used by financing activities was $125.3 million for the year ended December 31, 2012 compared to cash used of $97.7 million for the same period in 2011. The increase in cash used by financing activities was due primarily to net payments under the Credit Facility for the year ended December 31, 2012 compared to net borrowing for the same period of the prior year and a decrease in cash received from the exercise of stock options and employee stock purchase plans and the related tax benefit, partly offset by a decrease in cash used to repurchase common stock.

 

Cash used to repurchase shares of our common stock decreased by $123.2 million during the year ended December 31, 2012 compared to the prior year. From the inception of our share repurchase program in August 1999 to December 31, 2012, we have repurchased 45.1 million shares. During the year ended December 31, 2012, we purchased 1.5 million shares for an aggregate cost of $132.3 million compared to purchases of 3.4 million shares for an aggregate cost of $255.5 million during 2011. We believe that the repurchase of our common stock is a favorable investment and we also repurchase to offset the dilutive effect of our share-based compensation programs. Repurchases of our common stock may vary depending upon the level of other investing activities and the share price. See Note 18 to the consolidated financial statements included in this Annual Report on Form 10-K for additional information about our share repurchases.

 

Cash proceeds from the exercise of stock options and share purchases under employee stock purchase plans and the related tax benefits decreased by $6.0 million during the year ended December 31, 2012 compared to the prior year due primarily to a decrease in the number of stock options exercised.   

 

 

 

 

 

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Net borrowing and repayment activity under our Credit Facility resulted in incremental cash used of $144.9 million during the year ended December 31, 2012 compared to the prior year. At December 31, 2012, we had $212.0 million outstanding under the Credit Facility. The general availability of funds under the Credit Facility was further reduced by $1.0 million for a letter of credit issued related to our worker’s compensation policy covering claims for the years ending 2009 through 2012. The obligations under the Credit Facility may be accelerated upon the occurrence of an event of default under the Credit Facility, which includes customary events of default including, without limitation, payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, defaults relating to judgments, certain events related to employee pension benefit plans under the Employee Retirement Income Security Act of 1974, the failure to pay specified indebtedness, and a change of control default. The Credit Facility contains affirmative, negative and financial covenants customary for financings of this type. The negative covenants include restrictions on liens, indebtedness of subsidiaries of the Company, fundamental changes, investments, transactions with affiliates and certain restrictive agreements. The financial covenant is a consolidated leverage ratio test that requires our ratio of debt to earnings before interest, taxes, depreciation and amortization, defined as the consolidated leverage ratio under the terms of the Credit Facility, not to exceed 3-to-1. At December 31, 2012, we were in compliance with the covenants of the Credit Facility. 

 

Other Commitments, Contingencies and Guarantees

 

Under our worker’s compensation insurance policies for U.S. employees since January 1, 2003, we have retained the first $250,000 in claim liability per incident with aggregate maximum claim liabilities per year of $2.0 million in 2012 and 2011 and $2.9 million in 2010. The insurance company provides for insurance claims above the individual occurrence and aggregate limits. We have recognized cumulative expenses of $0.7 million, $0.4 million, and $0.8 million for claims incurred during the years ended December 31, 2012, 2011 and 2010, respectively. Our estimated liability for worker’s compensation as of December 31, 2012 and 2011 was $1.2 million and $0.7 million, respectively. Claims incurred during the years ended December 31, 2012 and 2011 are relatively undeveloped as of December 31, 2012. Therefore, it is possible that we could incur additional healthcare and wage indemnification costs beyond those previously recognized up to our aggregate liability for each of the respective claim years. For the eight years ended on or prior to December 31, 2010, based on our retained claim liability per incident and our aggregate claim liability per year, our maximum liability at December 31, 2012 in excess of the amounts deemed probable and previously recognized is not material. In connection with these policies, we have outstanding letters of credit totaling $1.3 million to the insurance companies as security for these claims.

 

We have contingent commitments outstanding of up to $7.5 million related primarily to the acquisition of an intangible asset in 2008 and due to the seller upon our achievement of certain revenue and other milestones. We have not accrued for the commitments related to this intangible asset acquisition as we do not deem them to be probable of occurring as of December 31, 2012. The remaining commitments are not material.

 

We are contractually obligated to make the following payments in the years below:

 

 

            

 

These commitments do not reflect unrecognized tax benefits of $5.9 million and deferred compensation liabilities of $2.3 million as of December 31, 2012 as the timing of recognition is uncertain. Refer to Note 12 of the consolidated financial statements for the year ended December 31, 2012 included in this Annual Report on Form 10-K for additional discussion of unrecognized tax benefits.

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ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

Our financial market risk consists primarily of foreign currency exchange risk and interest rate risk. Our functional currency is the U.S. dollar and our primary manufacturing operations are in the U.S., but we distribute our products worldwide both through direct export and through our foreign subsidiaries. Our primary foreign currency transaction risk consists of intercompany purchases and sales of products and we attempt to mitigate this risk through our hedging program described below. For the years ended December 31, 2012, 2011 and 2010, approximately 26%, 26%  and 25%, respectively, of IDEXX consolidated revenues were derived from products manufactured in the U.S. and sold internationally in local currencies.  The functional currency of most of our subsidiaries is their local currency. For one of our subsidiaries located in the Netherlands, the functional currency is the U.S. dollar. 

 

The primary purpose of our foreign currency hedging activities is to protect against the volatility associated with foreign currency transactions. We also utilize natural hedges to mitigate our transaction and commitment exposures. Our corporate policy prescribes the range of allowable hedging activity. We enter into foreign currency exchange contracts with large multinational financial institutions and we do not hold or engage in transactions involving derivative instruments for purposes other than risk management. Our accounting policies for these contracts are based on our designation of such instruments as hedging transactions. Changes in the fair value of our derivative instruments are either recognized in earnings or deferred in other comprehensive income (“OCI”), net of tax, and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.  We primarily utilize foreign currency exchange contracts with durations of less than 24 months.

 

Our subsidiaries enter into foreign currency exchange contracts to manage the exchange risk associated with their forecasted intercompany inventory purchases and sales for the next year. From time to time, we may also enter into foreign currency exchange contracts to minimize the impact of foreign currency fluctuations associated with specific, significant transactions. As of December 31, 2012 and 2011, we were not hedging any specific, significant transactions.

 

Our foreign currency hedging strategy is consistent with prior periods and there were no material changes in our market risk exposure during the year ended December 31, 2012. We enter into foreign currency exchange contracts designated as cash flow hedges for amounts that are less than the full value of forecasted intercompany purchases and sales and for amounts that are equivalent to, or less than, other significant transactions, thus no significant ineffectiveness has resulted or been recorded through the statements of operations. Our hedging strategy related to intercompany inventory purchases and sales provides that we employ the full amount of our hedges for the succeeding year at the conclusion of our budgeting process for that year, which is complete by the end of the preceding year. Quarterly, we enter into contracts to hedge incremental portions of anticipated foreign currency transactions for the current and following year that are in excess of amounts previously hedged. Accordingly, our risk with respect to foreign currency exchange rate fluctuations may vary throughout each annual cycle.

 

We enter into hedge agreements where we believe we have meaningful exposure to foreign currency exchange risk. The notional amount of foreign currency exchange contracts to hedge forecasted intercompany purchase and sales outstanding at December 31, 2012 and 2011 was $157.0 million and $161.8 million, respectively. At December 31, 2012, we had $0.4 million in net unrealized losses on foreign currency exchange contracts designated as hedging instruments recorded in other comprehensive income, which is net of less than $0.1 million in taxes.

 

Our foreign currency exchange risk is comprised of three components: 1) local currency revenues and expenses; 2) the impact of settled hedge contracts; and 3) intercompany and monetary balances for our subsidiaries that are denominated in a currency that is different from the functional currency used by each subsidiary. Based on projected revenues and expenses for 2013, excluding the impact of intercompany and trade balances denominated in currencies other than the functional subsidiary currencies, a 10% strengthening of the U.S. dollar would reduce operating income by approximately $8 million. The impact of the intercompany and monetary balances referred to in the third component above have been excluded, as they are transacted at multiple times during the year and we are not able to reliably forecast the impact that changes in exchange rates would have.

 

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In 2011, we refinanced our existing $200 million unsecured revolving credit facility by entering into an amended and restated credit agreement relating to a five-year unsecured revolving credit facility in the principal amount of $300 million with a syndicate of multinational banks, which matures on July 25, 2016 (the new credit facility is referred to as the “Credit Facility”). We are subject to interest rate risk based on the terms of our Credit Facility to the extent that the London interbank rate (“LIBOR”) or the Canadian Dollar-denominated bankers’ acceptance rate (“CDOR”) increases. Borrowings under our Credit Facility bear interest in the range from 0.875 to 1.25 percentage points (“Credit Spread”) above the LIBOR or the CDOR, dependent on our consolidated leverage ratio, and the interest period terms for the outstanding borrowings, which range from one to six months. As discussed below, we have entered into forward fixed interest rate swaps to mitigate interest rate risk in future periods. Borrowings outstanding under the Credit Facility at December 31, 2012 were $212 million at a weighted-average effective interest rate of 1.3%. Based on amounts outstanding and our interest rate swap effective at December 31, 2012, an increase in the LIBOR or the CDOR of 1% would increase interest expense by approximately $1.7 million on an annualized basis.

 

             In 2009, we entered into two forward fixed interest rate swap agreements to manage the economic effect of variable interest obligations. Under these agreements, beginning on March 31, 2010 the variable interest rate associated with $80 million of borrowings outstanding under the Credit Facility became effectively fixed at 2% plus the Credit Spread through March 30, 2012. In August 2011, we entered into two additional forward fixed interest rate swap agreements for the same purpose. Under these agreements, beginning on March 30, 2012, the variable interest rate associated with $40 million of borrowings outstanding under the Credit Facility will become effectively fixed at 1.36% plus the Credit Spread through June 30, 2016 and beginning on March 28, 2013, the variable interest rate associated with an additional $40 million of borrowings outstanding under the Credit Facility will become effectively fixed at 1.64% plus the Credit Spread through June 30, 2016. We have designated these swaps as qualifying instruments to be accounted for as cash flow hedges.  See Note 17 to the consolidated financial statements included in this Annual Report on Form 10-K for a discussion of our derivative instruments and hedging activities.

 

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The response to this item is submitted as a separate section of this report commencing on page F-1.

 

ITEM 9.         CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

            Not applicable.

 

 

 

 

 

 

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ITEM 9A.CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Our management is responsible for establishing and maintaining disclosure controls and procedures, as defined by the SEC in its Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as amended (the “Exchange Act”). The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures at December 31, 2012, our chief executive officer and chief financial officer have concluded that, as of such date, the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

 

Report of Management on Internal Control Over Financial Reporting

 

We are responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America and includes those policies and procedures that:

 

 

 

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions and that the degree of compliance with the policies and procedures may deteriorate.

 

We conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, we conclude that, at December 31, 2012, our internal control over financial reporting was effective.

 

The effectiveness of the Company's internal control over financial reporting at December 31, 2012 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

 

 

 

 

 

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Changes in Internal Control Over Financial Reporting

 

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the three months ended December 31, 2012 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Certifications

 

The certifications with respect to disclosure controls and procedures and internal control over financial reporting of the Company’s chief executive officer and chief financial officer are attached as Exhibits 31.1 and 31.2 to this Annual Report on Form 10-K.

 

ITEM 9B.            OTHER INFORMATION

 

Not applicable.

 

PART III

 

ITEM 10.            DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

The information required by this Item with respect to Directors, Section 16(a) compliance and corporate governance is omitted from this Annual Report on Form 10-K and, pursuant to Regulation 14A of the Exchange Act, is incorporated herein by reference from the sections entitled “Corporate Governance – Committees of the Board of Directors – Audit Committee,”  “Corporate Governance – Corporate Governance Guidelines and Code of Ethics,” “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive proxy statement with respect to its 2013 Annual Meeting of Stockholders, which proxy statement will be filed with the SEC within 120 days after the end of the fiscal year covered by this report. For information required by this Item regarding Executive Officers with respect to Item 401 of Regulation S-K, see the section titled “Executive Officers of the Company” under “Part I.”

 

ITEM 11.            EXECUTIVE COMPENSATION

 

The information required by this Item is omitted from this Annual Report on Form 10-K and, pursuant to Regulation 14A of the Exchange Act, is incorporated herein by reference from the sections entitled “Executive Compensation,” “Corporate Governance – Committees of the Board – Compensation Committee – Analysis of Risks Associated with Compensation Practices,” “Corporate Governance – Committees of the Board – Compensation Committee – Compensation Committee Interlocks and Insider Participation,” and “Executive Compensation - Compensation Committee Report” in the Company’s definitive proxy statement with respect to its 2013 Annual Meeting of Stockholders, which proxy statement will be filed with the SEC within 120 days after the end of the fiscal year covered by this report.

 

ITEM 12.       SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The information required by this Item with respect to Item 201(d) of Regulation S-K is omitted from this Annual Report on Form 10-K and, pursuant to Regulation 14A of the Exchange Act, is incorporated herein by reference from the section entitled “Amendments to IDEXX Laboratories, Inc. 2009 Stock Incentive Plan (Proposal Three) – Equity Compensation Plan Information.” The information required by this Item with respect to Item 403 of Regulation S-K is omitted from this Annual Report on Form 10-K and, pursuant to Regulation 14A of the Exchange Act, is incorporated herein by reference from the sections entitled “Ownership of Common Stock by Directors and Officers” and “Ownership of More Than Five Percent of Our Common Stock” in the Company’s definitive proxy statement with respect to its 2013 Annual Meeting of Stockholders, which proxy statement will be filed with the SEC within 120 days after the end of the fiscal year covered by this report.

 

 

 

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ITEM 13.       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

The information required by this Item is omitted from this Annual Report on Form 10-K and, pursuant to Regulation 14A of the Exchange Act, is incorporated herein by reference from the sections entitled “Corporate Governance – Related Party Transactions” and “Corporate Governance – Director Independence” in the Company’s definitive proxy statement with respect to its 2013 Annual Meeting of Stockholders, which proxy statement will be filed with the SEC within 120 days after the end of the fiscal year covered by this report.

 

ITEM 14.            PRINCIPAL ACCOUNTANT FEES AND SERVICES

            The information required by this Item is omitted from this Annual Report on Form 10-K and, pursuant to Regulation 14A of the Exchange Act, is incorporated herein by reference from the sections entitled “Ratification of Appointment of Independent Registered Public Accounting Firm – Independent Auditors’ Fees” and “Ratification of Appointment of Independent Registered Public Accounting Firm – Audit Committee Pre-Approval Policy” in the Company’s definitive proxy statement with respect to its 2013 Annual Meeting of Stockholders, which proxy statement will be filed with the SEC within 120 days after the end of the fiscal year covered by this report.

 

PART IV

 

ITEM 15.            EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

 

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: