Interest income was $2.3 million for the nine months ended September 30, 2006 and September 30, 2005. The decrease in interest income due to lower invested cash balances was substantially offset by higher effective interest rates.
Interest expense was $0.3 million for the nine months ended September 30, 2006 compared to less than $0.1 million for the nine months ended September 30, 2005. The increase in interest expense was primarily due to interest expense incurred on the mortgage assumed in connection with the Westbrook, Maine facility purchase in May 2006.
Our effective tax rate was 31.4% for the nine months ended September 30, 2006, compared with 33.7% for the nine months ended September 30, 2005. The decrease in our effective tax rate was due, in part, to a reduction in previously accrued taxes resulting from the expiration of various statutes of limitations. These rate-reducing adjustments were partly offset by the nonrecognition, in the current period, of tax benefits on compensation expense for incentive stock options and employee stock purchase rights that were recognized in accordance with SFAS No. 123(R) effective January 1, 2006; a reduction of previously recorded international deferred tax liabilities as a result of obtaining certain tax incentives; the release of a valuation allowance on international deferred tax assets as a result of a subsidiary demonstrating consistent sustained profitability; and the December 31, 2005 expiration of U.S. tax benefits related to research and development expense.
A discussion of recent accounting pronouncements is included in Note 2(p) to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2005 and in Note 1 to the condensed consolidated financial statements included in this Form 10-Q.
We fund the capital needs of our business through cash generated from operations. At September 30, 2006 and December 31, 2005, we had $94.6 million and $132.7 million of cash and cash equivalents and short-term investments, respectively, and working capital of $175.2 million and $192.7 million, respectively.
We consider the operating earnings of non-United States subsidiaries to be indefinitely invested outside the U.S. Changes to this policy could have adverse tax consequences. Subject to this policy, we manage our worldwide cash requirements considering available funds among all of our subsidiaries. Foreign cash balances are generally available without legal restrictions to fund ordinary business operations outside the U.S.
We believe that current cash and cash equivalents, short-term investments and funds generated from operations will be sufficient to fund our operations, capital purchase requirements, and strategic organic growth needs.
Sources and Uses of Cash
Cash provided by operating activities was $71.4 million for the nine months ended September 30, 2006, compared to $76.5 million for the same period in 2005. The total of net income and net noncash charges was $86.5 million for the nine months ended September 30, 2006, compared to $80.2 million for the same period of the prior year. Reported cash flows from operations were negatively impacted by a change in accounting for the tax benefits from exercises of stock options and disqualifying dispositions of shares acquired in connection with our adoption of SFAS No. 123(R) on January 1, 2006, which reduced reported cash flows from operations by $8.7 million for the nine months ended September 30, 2006. For the nine months ended September 30, 2006, the tax benefit on exercises of stock options and disqualifying dispositions of shares was classified as a cash flow from financing activities, whereas the benefit was classified as a cash flow from operating activities in prior years.
During the nine months ended September 30, 2006, cash decreased $15.1 million due to changes in operating assets and liabilities, compared to a decrease of $3.7 million for the same period in 2005, resulting in a year-to-year change of $11.4 million. The increase in cash used by changes in operating assets and liabilities, compared to the same period in 2005, was primarily attributable to $19.8 million of incremental cash used to purchase inventory, partly offset by $10.3 million of additional cash provided by an increase in accrued liabilities during the nine months ended September 30, 2006. The greater incremental increase in inventories was largely due to the timing of VetTest® slide purchases in the first quarter of 2006. Our supplier deferred certain shipments to us of VetTest® slides from the fourth quarter of 2005 to the first quarter of 2006. In addition, we increased instruments and consumables inventory levels during the third quarter of 2006 in preparation for a supplier’s production facility transition and for anticipated sales volume increases, as well as to ensure adequate supply of a component that is being discontinued by the manufacturer. The reported increase in cash provided by changes in accrued liabilities, compared to the same period in 2005, was primarily attributable to the change in the presentation of tax benefits, noted above, of $8.7 million from exercises of stock options and disqualifying dispositions of shares acquired.
Cash of $21.7 million was used by investing activities for the nine months ended September 30, 2006, compared to cash provided of $12.2 million during the same period in 2005. The decrease in cash provided by investing activities for 2006, compared to the same period in 2005, was primarily due to lower net proceeds from net sales and maturities of short- and long-term investments of $14.1 million and to the cash payment of $11.5 million for the purchase of land and buildings in 2006. Additionally, during the nine months ended September 30, 2006, we incurred incremental payments of $3.0 million to acquire intangible assets and businesses and $5.0 million to purchase property and equipment, compared to the same period of 2005.
We paid cash of $11.5 million to purchase our Westbrook, Maine headquarters facility, $21.5 million to purchase other fixed assets and $1.4 million to acquire rental instruments sold under recourse during the nine months ended September 30, 2006. We anticipate total capital expenditures in 2006 of $55 to $60 million, including capital expenditures associated with the purchase of our Westbrook, Maine facility. We are considering plans to utilize the portion of the Westbrook, Maine facility that we did not previously occupy and to renovate our existing headquarters space. We preliminarily project capital spending of approximately $50 million during 2007 through 2008 to accomplish this facility project.
The board of directors has authorized the repurchase of up to 16,000,000 shares of our common stock in the open market or in negotiated transactions. At September 30, 2006, we had 857,000 shares remaining under our share repurchase authorization. See Note 11 to the condensed consolidated statements included in this Form 10-Q for additional information about our share repurchases.
Other Commitments, Contingencies and Guarantees
Significant commitments, contingencies and guarantees at September 30, 2006 are consistent with those discussed in our Annual Report on Form 10-K for the year ended December 31, 2005 in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations— Liquidity and Capital Resources,” and in Note 11 to the consolidated financial statements, except as described below.
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In connection with our acquisition of our Westbrook, Maine facility in May 2006, we assumed a mortgage that is payable in equal monthly installments of approximately $0.1 million through May 1, 2015. Annual mortgage principal payments as of September 30, 2006, based on the fair market value of the mortgage at the assumption date, are as follows(in thousands):
Years Ending December 31,
| Amount
| |
|---|
| 2006 | | | $ | 109 | |
| 2007 | | | | 675 | |
| 2008 | | | | 717 | |
| 2009 | | | | 762 | |
| 2010 | | | | 809 | |
| Thereafter | | | | 4,218 | |
|
| |
| | | | $ | 7,290 | |
|
| |
The purchase of our Westbrook, Maine facility relieved us from associated future lease commitments. This transaction, partly offset by other transactions whereby we entered into facility lease agreements in the normal course of business, resulted in net reductions to the minimum annual rental obligations disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005 in Note 11 to the consolidated financial statements of approximately $0.5 million in 2007 and in 2008, $0.6 million in 2009, and $1.4 million in 2010.
In connection with the acquisitions of certain businesses and intangible assets, we have commitments outstanding at September 30, 2006 to make additional purchase price payments of up to $4.6 million, of which $2.6 million is contingent on the achievement by certain acquired businesses and sellers of specified milestones. In connection with the acquisitions of certain businesses and intangible assets during the nine months ended September 30, 2006, we also assumed other long-term liabilities of $1.6 million.
We previously had a 40% equity interest in a joint venture to market production animal diagnostic products in China. In April 2006, we paid $0.6 million to acquire an additional 55% equity interest in the joint venture from our partner. We also committed to pay an additional $0.2 million over two years in consideration for the additional equity. In addition, the joint venture entered into a contract with the joint venture partner where the partner will provide promotional and agency services and will receive sales commissions at rates escalating from 2.5% to 8.5% annually based on sales volume.
During the nine months ended September 30, 2006, we incurred additional commitments to a supplier to purchase approximately $20 million of products through 2009. Should we fail to meet these purchase obligations, we are subject to penalties of ten percent of the sales value of the unpurchased quantities of products that would be required to satisfy the minimum volume commitments.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our financial market risk consists primarily of foreign currency exchange rate risk. We operate subsidiaries in 16 foreign countries and transact business in local currencies. We attempt to hedge the majority of our cash flow on intercompany sales to minimize foreign currency exposure.
The primary purpose of our foreign currency hedging activities is to protect against the volatility associated with foreign currency transactions. Corporate policy prescribes the range of allowable hedging activity. We primarily utilize forward exchange contracts with durations of less than 18 months. Gains and losses related to qualifying hedges of foreign currency from commitments or anticipated transactions are deferred in prepaid expenses or accruals, as appropriate, and are included in the basis of the underlying transaction. Our hedging strategy is consistent with prior periods. Our hedging strategy 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 following year. Accordingly, our risk with respect to foreign currency exchange rate fluctuations may vary throughout each annual cycle. At September 30, 2006, we had $0.9 million in net unrealized losses on foreign exchange contracts designated as hedges recorded in other comprehensive income, which is net of $0.5 million in taxes.
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Item 4. Controls and Procedures
Disclosure Controls and Procedures
Our management is responsible for establishing and maintaining disclosure controls and procedures, as defined by the Securities and Exchange Commission in its Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Our chief executive officer and chief financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective to achieve their stated purpose.
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 September 30, 2006 that materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.
PART II — OTHER INFORMATION
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.
| | IDEXX’s Future Growth and Profitability Depend on Several Factors |
The future success of our business depends upon our ability to successfully implement various strategies, including:
| • | Developing, manufacturing and marketing new products with new features and capabilities, including pharmaceutical products; a new clinical chemistry instrument; and rapid assay, water testing and production animal diagnostic products, as well as improving and enhancing existing products; |
| • | Developing and implementing new technology and licensing strategies; and identifying, completing and integrating acquisitions that enhance our existing businesses or create new business areas for us; |
| • | Increasing the value to our customers of our companion animal products and services by enhancing the connectivity of these products, including the connectivity among the IDEXX VetLab® instrument suite, Cornerstone® practice information management system, the IDEXX-PACS™ software and IDEXX Reference Laboratories; |
| • | Expanding our market by expanding the installed base of our instrumentation through customer acquisition and retention and increasing use of our products by our customers; |
| • | Strengthening our sales and marketing activities both within the U.S. and in geographies outside of the U.S.; and |
| • | Reducing the costs of manufacturing our products and providing services through operating efficiencies and increased focus on quality. |
However, we may not be able to successfully implement some or all of these strategies and increase or sustain our rate of growth or profitability.
| | Our Products and Services Are Subject to Various Government Regulations |
In the U.S., the manufacture and sale of our products are regulated by agencies such as the U.S. Department of Agriculture (“USDA”), U.S. Food and Drug Administration (“FDA”) and the U.S. Environmental Protection Agency (“EPA”). Most diagnostic tests for animal health applications, including our canine, feline, poultry and livestock tests, must be approved by the USDA prior to sale. 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 pharmaceutical and dairy testing products require approval by the FDA. The manufacture and sale of our products are subject to similar 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 removals of our products from the market, which could have a material adverse effect on our results of operations.
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We have entered into an agreement with the FDA under which we have agreed, among other things, to perform selected specified lot release and stability testing of our SNAP® beta-lactam dairy-testing products and to provide related data to the FDA. If the FDA were to determine that one or more lots of product failed to meet applicable criteria for product performance or stability, the FDA could take various actions, including requiring us to recall products or restricting our ability to sell these products.
Commercialization of animal health pharmaceuticals in the U.S. requires prior approval by the FDA. To obtain such approvals, we are required to submit substantial clinical, manufacturing and other data to the FDA. Regulatory approval for products submitted to the FDA may take several years and, following approval, the FDA continues to regulate all aspects of the manufacture, labeling, storage, record keeping and promotion of pharmaceutical products. Failure to obtain, or delays in obtaining, FDA approval for new pharmaceutical products could have a negative impact on our future growth.
| | We Purchase Materials for Our Products from a Limited Number of Sources |
We currently purchase many products and materials from single sources or a limited number of sources. Some of the products that we purchase from these sources are proprietary, and, therefore, cannot be readily replaced by alternative sources. These products include our VetTest® Chemistry, VetAutoread™ Hematology, VetLyte® Electrolyte, and VetStat™ Electrolyte and Blood Gas Analyzers and related consumables; certain digital radiography system components, specifically image capture plates and readers; active ingredients for pharmaceutical products; and certain components of our SNAP®rapid assay devices, water testing products and LaserCyte® Hematology Analyzers. If we are unable to obtain adequate quantities of these products in the future, we could face cost increases, reductions, delays or discontinuations in product shipments, which could have a material adverse effect on our results of operations.
We currently purchase the slides sold for use in our VetTest® Chemistry Analyzers; our electrolyte instruments, components and consumables; our VetAutoread™ Hematology Analyzers, components and consumables; and certain rapid assay products sold outside the U.S. under agreements with suppliers under which we have minimum purchase obligations. If demand for any of the products purchased under these agreements is insufficient to support our minimum purchase obligations for those products, we could incur losses related to those obligations. In addition, because we purchase the products at predetermined prices, our profits on sales of these products could decline if we are unable to maintain current pricing levels for such products.
| | Our Biologic Products Are Complex and Difficult to Manufacture |
Many of our rapid assay and production animal diagnostic products are biologics, which are products that are comprised of materials from living organisms, such as antibodies, cells and sera. Manufacturing biologic products is highly complex. Unlike products that rely on chemicals for efficacy (such as most pharmaceuticals), biologics are difficult to characterize due to the inherent variability of biological input materials. Difficulty in characterizing biological materials or their interactions creates greater risk in the manufacturing process. We attempt to mitigate risk associated with the manufacture of biologics by continuing to improve the characterization of all of our input materials, utilizing multiple vendors, manufacturing some of these materials ourselves and maintaining substantial inventories of materials that have demonstrated the appropriate characteristics. However, there can be no assurance that we will be able to maintain adequate sources of biological materials or that biological materials that we maintain in inventory will yield finished products that satisfy applicable product release criteria. Our inability to obtain necessary biological materials or to successfully manufacture biologic products that incorporate such materials could have a material adverse effect on our results of operations.
| | 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 develop substantially equivalent technologies that compete with us.
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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 adverse result could have a material adverse effect on our results of operations.
| | Our Sales Are Dependent on Distributor Purchasing Patterns |
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 distributors may generally be terminated by the distributors for any reason on 60 days notice. Because significant product sales are made to a limited number of distributors, the 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. Our financial performance, therefore, is subject to an unexpected downturn in product demand and may be unpredictable.
Distributors of veterinary products have entered into business combinations resulting in fewer distribution companies. Consolidation within distribution channels would increase our customer concentration level, which could increase the risks described in the preceding paragraph.
| | Our Markets Are Competitive and Subject to Rapid and Substantial Technological Change |
We face intense competition within the markets in which we sell our products and services. We expect that future competition will become even more intense, and that we will have to compete with changing and improving technologies. Some of our competitors and potential competitors, including large pharmaceutical and diagnostic companies, have substantially greater capital, manufacturing, marketing, and research and development resources than we do.
| | Changes in Diagnostic Testing Could Negatively Affect Our Operating Results |
The market for diagnostic tests could be negatively impacted by the introduction or broad market acceptance of vaccines or preventatives for the diseases and conditions for which we sell diagnostic tests and services. Eradication or substantial declines in the prevalence of certain diseases also could lead to a decline in diagnostic testing for such diseases. Our production animal services business in particular is subject to fluctuations resulting from changes in disease prevalence and government-mandated testing programs. Such declines in diagnostic testing could have a material adverse effect on our results of operations.
| | International Revenue Accounts for a Significant Portion of Our Total Revenue |
Some of our revenue is attributable to sales of products and services to customers outside the U.S. Various risks associated with foreign operations may impact our international sales. Possible risks include fluctuations in the value of foreign currencies, 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 quotas, and unexpected regulatory, economic or political changes in foreign markets. 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. As a result, the mix of domestic and international sales in a particular period could have a material impact on our results for that period. In addition, many of the products for which our selling price may be denominated in foreign currencies are manufactured, sourced, or both, in the U.S. and our costs are incurred in U.S. dollars. We utilize nonspeculative forward currency exchange contracts to mitigate foreign currency exposure. However, an appreciation of the U.S. dollar relative to the foreign currencies in which we sell these products would reduce our operating margins.
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| | The Loss of Our President, Chief Executive Officer and Chairman Could Adversely Affect Our Business |
We rely on the management and leadership of Jonathan W. Ayers, our President, Chief Executive Officer and Chairman. We do not maintain key man life insurance coverage for Mr. Ayers. The loss of Mr. Ayers could have a material impact on our business.
| | We Could Be Subject to Class Action Litigation Due to Stock Price Volatility, which, if Occurs, Could Result inSubstantial 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. In the past, 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 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, research and development expenditures, litigation and claim-related expenditures; changes in competitors’ product offerings; and other matters. Similarly, our future operating results may vary significantly from quarter to quarter 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 Materially Affected By the Resolution of Various Uncertain Tax Positions and Adversely Affected 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 and our income tax filings are regularly under audit by tax authorities. We believe that we have adequately accrued for all potential tax liabilities and, although we believe our tax estimates are reasonable, 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, our inability to use these benefits could have a material negative effect on future earnings.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the three months ended September 30, 2006, we purchased treasury shares as described below:
Period
| Total Number of
Shares Purchased
(a)
| | Average
Price Paid
per Share
(b)
| | Total Number of
Shares Purchased
as Part of
Publicly
Announced Plans
or Programs
(c)
| | Maximum Number of
Shares that May Yet
Be Purchased Under
the Plans or
Programs
(d)
| |
|---|
| July 1, 2006 to July 31, 2006 | | | | 110,000 | | $ | 74.46 | | | 110,000 | | | 862,930 | |
| August 1, 2006 to August 31, 2006 | | | | 5,500 | | | 75.27 | | | 5,500 | | | 857,430 | |
| September 1, 2006 to September 30, 2006 | | | | 47 | | | 92.34 | | | -- | | | 857,430 | |
|
| | |
| | |
| Total | | | | 115,547 | | $ | 74.51 | | | 115,500 | | | 857,430 | |
|
| | |
| | |
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Our Board of Directors has approved the repurchase of up to 16,000,000 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, July 21, 2000, October 20, 2003, October 12, 2004, and October 12, 2005, and does not have a specified expiration date. There were no other repurchase plans outstanding during the nine months ended September 30, 2006, and no repurchase plans expired during the period. Repurchases of 1,194,900 shares were made during the nine months ended September 30, 2006 in open market transactions.
During the three and nine months ended September 30, 2006, we received 47 and 227 shares of our common stock, respectively, 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).
Item 6. Exhibits
| | 10.1 | Amendment No. 1 to Director Deferred Compensation Plan, as amended. |
| | 31.1 | Certification by Chief Executive Officer. |
| | 31.2 | Certification by Vice President, Chief Financial Officer and Treasurer. |
| | 32.1 | Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | 32.2 | Certification by Vice President, Chief Financial Officer and Treasurer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements 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.
| |
|---|
| | |
| | IDEXX LABORATORIES, INC. |
| | |
| /s/Merilee Raines
|
| Date: November 1, 2006 | Merilee Raines
Vice President, Chief Financial Officer and Treasurer
(Principal Financial Officer) |
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Exhibit Index
| | 10.1 | Amendment No. 1 to Director Deferred Compensation Plan, as amended. |
| | 31.1 | Certification by Chief Executive Officer. |
| | 31.2 | Certification by Vice President, Chief Financial Officer and Treasurer. |
| | 32.1 | Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | 32.2 | Certification by Vice President, Chief Financial Officer and Treasurer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
