UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     .

COMMISSION FILE NUMBER: 0-19271

IDEXX LABORATORIES, INC.

DELAWARE (State or other jurisdiction of incorporation or organization)		01-0393723 (IRS Employer Identification No.)
ONE IDEXX DRIVE, WESTBROOK, MAINE (Address of principal executive offices)		04092 (ZIP Code)

207-556-0300
(Registrant’s telephone number, including area code)

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 þ No 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.

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. The number of shares outstanding of the registrant’s Common Stock, $0.10 par value, was 59,559,969 on October 20, 2008.

 

 

IDEXX LABORATORIES, INC.
Quarterly Report on Form 10-Q
Table of Contents

Item No.		Page
PART I—FINANCIAL INFORMATION
Item 1.   Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007			3
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2008 and 2007			4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007			5
Notes to Condensed Consolidated Financial Statements			6
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3.   Quantitative and Qualitative Disclosures About Market Risk			33
Item 4.   Controls and Procedures			33
PART II—OTHER INFORMATION
Item 1.   Legal Proceedings			34
Item 1A.   Risk Factors			34
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds			39
Item 6.   Exhibits			40
Signatures			41
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

IDEXX LABORATORIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

		September 30,				December 31,
		2008				2007
ASSETS
Current Assets:
Cash and cash equivalents		$	84,586			$	60,360
Accounts receivable, less reserves of $2,949 in 2008 and $1,742 in 2007			112,053				108,384
Inventories			112,907				98,804
Deferred income tax assets			24,207				23,606
Other current assets			19,624				14,509
Total current assets			353,377				305,663
Property and equipment, net			178,655				141,852
Goodwill and other intangible assets, net			231,379				236,414
Other long-term assets, net			15,282				18,250
			246,661				254,664
TOTAL ASSETS		$	778,693			$	702,179
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	28,937			$	32,510
Accrued expenses			31,660				29,182
Accrued employee compensation and related expenses			41,754				44,753
Accrued taxes			12,432				18,206
Accrued customer programs			17,813				15,107
Short-term debt			163,942				72,236
Current portion of long-term debt			754				720
Deferred revenue			10,458				10,678
Total current liabilities			307,750				223,392
Long-term Liabilities:
Deferred tax liabilities			11,265				14,697
Long-term debt, net of current portion			5,157				5,727
Deferred revenue			5,667				6,210
Other long-term liabilities			11,527				13,830
Total long-term liabilities			33,616				40,464
Commitments and Contingencies (Notes 3 and 13)
Stockholders’ Equity:
Common stock, $0.10 par value: Authorized: 120,000 shares; Issued: 95,314 and 94,504 shares in 2008 and 2007, respectively			9,531				9,450
Additional paid-in capital			544,077				514,773
Deferred stock units: Outstanding: 100 and 82 units in 2008 and 2007, respectively			2,614				2,201
Retained earnings			678,476				585,862
Accumulated other comprehensive income			23,097				22,705
Treasury stock, at cost: 35,867 and 33,500 shares in 2008 and 2007, respectively			(820,468	)			(696,668	)
Total stockholders’ equity			437,327				438,323
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	778,693			$	702,179

The accompanying notes are an integral part of these condensed consolidated financial statements.

IDEXX LABORATORIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Revenue:
Product revenue		$	167,144			$	155,552			$	526,622			$	460,902
Service revenue			83,949				73,833				254,115				216,684
			251,093				229,385				780,737				677,586
Cost of Revenue:
Cost of product revenue			65,435				60,121				200,714				190,730
Cost of service revenue			57,509				50,786				170,778				145,578
			122,944				110,907				371,492				336,308
Gross profit			128,149				118,478				409,245				341,278
Expenses:
Sales and marketing			41,527				37,757				129,742				110,086
General and administrative			29,705				27,343				89,407				81,182
Research and development			17,920				17,281				53,489				50,569
Income from operations			38,997				36,097				136,607				99,441
Interest expense			(1,242	)			(1,202	)			(3,486	)			(3,290	)
Interest income			682				687				1,798				1,969
Income before provision for income taxes			38,437				35,582				134,919				98,120
Provision for income taxes			12,738				9,787				42,305				29,634
Net income		$	25,699			$	25,795			$	92,614			$	68,486
Earnings per Share:
Basic		$	0.43			$	0.42			$	1.54			$	1.11
Diluted		$	0.42			$	0.40			$	1.48			$	1.06
Weighted Average Shares Outstanding:
Basic			59,473				61,094				60,121				61,685
Diluted			61,865				63,916				62,603				64,449

The accompanying notes are an integral part of these condensed consolidated financial statements.

IDEXX LABORATORIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

		For the Nine Months Ended
		September 30,
		2008				2007
Cash Flows from Operating Activities:
Net income		$	92,614			$	68,486
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			36,170				29,538
Reduction (increase) in deferred compensation expense			(287	)			35
Navigator® inventory write-down and royalty license impairment			—				10,138
Provision for uncollectible accounts			1,709				376
Benefit of deferred income taxes			(926	)			(8,210	)
Share-based compensation expense			8,083				6,574
Tax benefit from exercises of stock options			(5,906	)			(7,544	)
Changes in assets and liabilities, net of acquisitions:
Accounts receivable			(5,000	)			(14,278	)
Inventories			(14,137	)			(2,722	)
Other assets			(1,751	)			(1,297	)
Accounts payable			(3,632	)			(4,748	)
Accrued liabilities			3,404				17,629
Deferred revenue			(527	)			773
Net cash provided by operating activities			109,814				94,750
Cash Flows from Investing Activities:
Sales and maturities of short-term investments			—				35,000
Purchases of property and equipment			(64,982	)			(41,723	)
Acquisitions of equipment leased to customers			(560	)			(740	)
Acquisitions of intangible assets and businesses, net of cash acquired			(8,649	)			(87,738	)
Net cash used by investing activities			(74,191	)			(95,201	)
Cash Flows from Financing Activities:
Borrowings on revolving credit facilities, net			92,099				71,031
Payment of other notes payable			(542	)			(2,212	)
Purchase of treasury stock			(122,429	)			(99,241	)
Proceeds from exercises of stock options			14,856				17,655
Tax benefit from exercises of stock options			5,906				7,544
Net cash used by financing activities			(10,110	)			(5,223	)
Net effect of exchange rates on cash			(1,287	)			2,515
Net increase (decrease) in cash and cash equivalents			24,226				(3,159	)
Cash and cash equivalents at beginning of period			60,360				61,666
Cash and cash equivalents at end of period		$	84,586			$	58,507
Supplemental Disclosures of Cash Flow Information:
Interest paid		$	3,615			$	2,710
Income taxes paid		$	43,234			$	30,846

The accompanying notes are an integral part of these condensed consolidated financial statements.

IDEXX LABORATORIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION

The accompanying unaudited, condensed consolidated financial statements of IDEXX Laboratories, Inc. (“IDEXX,” the “Company,” “we” or “our”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the requirements of Regulation S-X, Rule 10-01 for financial statements required to be filed as a part of Form 10-Q.

The accompanying unaudited, condensed consolidated financial statements include the accounts of IDEXX Laboratories, Inc. and our wholly-owned and majority-owned subsidiaries, and all other entities in which we have a variable interest and are determined to be the primary beneficiary. All material intercompany transactions and balances have been eliminated in consolidation.

The accompanying unaudited, condensed consolidated financial statements reflect, in the opinion of our management, all adjustments necessary for a fair statement of our financial position and results of operations. The condensed balance sheet data at December 31, 2007 was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. The results of operations for the nine months ended September 30, 2008 are not necessarily indicative of the results to be expected for the full year or any future period. These unaudited, condensed financial statements should be read in conjunction with this Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2008, and our Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission.

On October 25, 2007, our board of directors approved a two-for-one split of the outstanding shares of our common stock, to be effected in the form of a 100% stock dividend. Each holder of common stock of record at November 5, 2007 received one additional share of common stock for each share of common stock then held. The additional shares of common stock were distributed on November 26, 2007. As a result of the stock split, the number of outstanding common shares doubled to approximately 61 million shares.

All share and per share data (except par value) have been adjusted to reflect the effect of the stock split for all periods presented. In addition, the exercise of outstanding stock options and the vesting of other stock awards, as well as the number of shares of common stock reserved for issuance under our various employee benefit plans, were proportionately increased in accordance with the terms of those respective agreements and plans.

Certain reclassifications have been made to the prior year condensed consolidated financial statements to conform to the current year presentation. Reclassifications had no material impact on previously reported results of operations or financial position.

NOTE 2. ACCOUNTING POLICIES

Significant Accounting Policies

The significant accounting policies used in preparation of these condensed consolidated financial statements for the nine months ended September 30, 2008 are consistent with those discussed in Note 2 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2007, except as discussed below.

Share-Based Compensation

To develop the expected term assumption for option awards, we previously elected to use the simplified method described in the Securities and Exchange Commission Staff Accounting Bulletin No. 107, which is based on vesting and contractual terms. Beginning in January 2008, we derive the expected term assumption for options based on historical experience and other relevant factors concerning expected employee behavior with regard to option exercise. See Note 4 for additional information.

Recent Accounting Pronouncements

We adopted the provisions of Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”) on January 1, 2008. As permitted by FASB Staff Position (“FSP”) No. SFAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP No. SFAS 157-2”), we elected to defer the adoption of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until January 1, 2009. SFAS No. 157 establishes a framework for measuring fair value and expands financial statement disclosures about fair value measurements. There was no cumulative effect of adoption related to SFAS No. 157 and the adoption did not have an impact on our financial position, results of operations, or cash flows. We are studying SFAS No. 157 with respect to nonfinancial assets and nonfinancial liabilities falling under the scope of FSP No. SFAS 157-2 and have not yet determined the expected impact on our financial position, results of operations, or cash flows. See Note 16 for a discussion of our adoption of SFAS No. 157.

We adopted the provisions of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (“SFAS No. 159”) on January 1, 2008. SFAS No. 159 permits entities to choose, at specified election dates, to measure eligible items at fair value (the “fair value option”). Under this pronouncement, a business entity must report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting period. We have not elected the fair value option for any items on our balance sheet.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of SFAS No. 133” (“SFAS No. 161”). SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. This standard requires enhanced disclosures about how and why an entity uses derivative instruments, how instruments are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and how derivatives and hedging activities affect an entity’s financial position, financial performance and cash flows. This standard is effective for fiscal years beginning after November 15, 2008. We are evaluating the expected impact that the adoption of SFAS No. 161 will have on our consolidated financial statements.

In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends FASB Statement No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”) to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No 141, “Business Combinations” (“SFAS No. 141”) and other U.S. GAAP. This FSP is effective for fiscal years beginning after December 15, 2008. The guidance for determining the useful life of a recognized intangible asset is to be applied prospectively, therefore, the impact of the implementation of this pronouncement cannot be determined until the transactions occur.

NOTE 3. ACQUISITIONS OF BUSINESSES AND OTHER ASSETS

We paid $6.8 million in cash to acquire a business and, under separate transactions, to acquire certain intangible assets that did not comprise businesses during the nine months ended September 30, 2008 and recognized liabilities, including contingent liabilities associated with purchase accounting, of $0.3 million, of which $0.1 million was paid in the third quarter of 2008. In addition, we have agreed to pay up to $7.5 million in cash in the future upon achievement of certain revenue and other milestones. These payments will be accrued and recorded as additional intangible assets if and when we determine that it is probable that the milestones will be achieved.

More specifically, in January 2008, we acquired substantially all of the assets and assumed certain liabilities of VetLab Laboratorio Veterinario de Referencia, S.L. (“VetLab S.L.”). With operations in Barcelona, Spain, VetLab S.L. is a provider of reference laboratory testing services to veterinarians. We also acquired certain intellectual property and distribution rights associated with a diagnostic test product during the nine months ended September 30, 2008. In connection with these acquisitions, we recognized goodwill of $0.4 million and amortizable intangible assets of $6.4 million.

During the nine months ended September 30, 2008, we made purchase price payments of $1.7 million related to the achievement of milestones realized by certain businesses acquired in prior years, of which $1.5 million was previously accrued.

We believe that the acquired businesses enhance our existing businesses by either expanding the geographic range of our existing businesses or expanding our existing product lines. We determined the purchase price of each acquired business based on our assessment of estimated future cash flows attributable to the business enterprise taken as a whole, the strength of the business in the marketplace, the strategic importance of the acquisition to IDEXX, and the seller’s desire to be acquired by IDEXX versus perceived alternatives. We recognized goodwill based on the excess of the purchase price for each business over the fair values of the individual tangible and separately identified intangible assets acquired, which were valued in accordance with SFAS No. 141.

We have commitments outstanding at September 30, 2008 for additional purchase price payments of up to $7.8 million, of which $0.3 million has been accrued, in connection with acquisitions of businesses and intangible assets prior to September 30, 2008, all of which are contingent upon the achievement by certain acquired businesses of specified milestones.

The results of operations of the acquired businesses have been included since their respective acquisition dates. Pro forma information has not been presented because such information is not material to the financial statements taken as a whole.

NOTE 4. SHARE-BASED COMPENSATION

For the nine months ended September 30, 2008, share-based compensation expense included $7.5 million for options, restricted stock units and deferred stock units with vesting conditions and $0.4 million for employee stock purchase rights. Expense for deferred stock units without vesting conditions of $0.2 million has been excluded from share-based compensation in the table below for the nine months ended September 30, 2008 and 2007, as it relates to deferred stock units granted to directors in lieu of cash compensation. Share-based compensation expense has been included in our condensed consolidated statements of operations for the three and nine months ended September 30, 2008 and 2007 as follows (in thousands):

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Cost of revenue		$	371			$	224			$	819			$	495
Sales and marketing			331				317				1,136				812
General and administrative			1,230				1,350				4,409				3,848
Research and development			486				516				1,517				1,257
Total		$	2,418			$	2,407			$	7,881			$	6,412

The fair value of options, restricted stock units, deferred stock units with vesting conditions, and employee stock purchase rights awarded during the nine months ended September 30, 2008 and 2007 totaled $18.0 and $18.1 million, respectively. The total unrecognized compensation cost for unvested share-based compensation awards outstanding at September 30, 2008, before consideration of estimated forfeitures, was $33.3 million. We estimate that this cost will be reduced by approximately $2.2 million related to forfeitures. The weighted average remaining expense recognition period at September 30, 2008 was approximately 2.0 years.

Options

The weighted average valuation assumptions used to determine the fair value of each option grant on the date of grant were as follows:

		For the Nine Months Ended
		September 30,
		2008				2007
Expected stock price volatility			25	%			29	%
Expected term, in years			4.9				5.0
Risk-free interest rate			2.7	%			4.7	%

The total fair value of options that vested during the nine months ended September 30, 2008 and 2007 was $11.2 million and $12.6 million, respectively.

Restricted and Other Deferred Stock Units With Vesting Conditions

The combined weighted average fair value per unit of restricted stock units and deferred stock units with vesting conditions granted during the nine months ended September 30, 2008 and 2007 was $56.78 and $42.62, respectively.

NOTE 5. INVENTORIES

Inventories include material, labor and overhead, and are stated at the lower of cost (first-in, first-out) or market. The components of inventories were as follows (in thousands):

		September 30,				December 31,
		2008				2007
Raw materials		$	32,837			$	26,182
Work-in-process			17,964				16,425
Finished goods			62,106				56,197
		$	112,907			$	98,804

NOTE 6. PROPERTY AND EQUIPMENT

Property and equipment, net, consisted of the following (in thousands):

		September 30,				December 31,
		2008				2007
Land and improvements		$	7,602			$	7,754
Buildings and improvements			53,867				54,072
Leasehold improvements			17,901				16,737
Machinery and equipment			105,937				92,139
Office furniture and equipment			72,885				61,472
Construction in progress			53,612				23,002
			311,804				255,176
Less accumulated depreciation and amortization			133,149				113,324
Total property and equipment		$	178,655			$	141,852

Depreciation expense was $9.1 million and $26.5 million for the three and nine months ended September 30, 2008, respectively. Depreciation expense was $7.3 million and $21.0 million for the three and nine months ended September 30, 2007, respectively.

In 2007, we began the renovation and expansion of our primary facility in Westbrook, Maine. We have capitalized $29.0 million related to this project as construction in progress during the nine months ended September 30, 2008 and $41.4 million since the project’s inception.

Instruments placed with customers under certain minimum volume commitment programs are capitalized and depreciated over the shorter of the useful life of the instrument or the minimum volume commitment period.

NOTE 7. GOODWILL AND OTHER INTANGIBLE ASSETS

Intangible assets other than goodwill consisted of the following (in thousands):

		September 30, 2008								December 31, 2007
						Accumulated								Accumulated
		Cost				Amortization				Cost				Amortization
Patents		$	10,575			$	4,579			$	10,895			$	4,003
Product rights (1)			32,989				13,146				27,838				10,428
Customer-related intangible assets (2)			57,718				11,517				57,907				8,011
Other, primarily noncompete agreements			6,592				3,144				6,416				2,299
		$	107,874			$	32,386			$	103,056			$	24,741

Amortization expense of intangible assets was $2.7 million and $7.9 million for the three and nine months ended September 30, 2008, respectively. Amortization expense of intangible assets was $2.4 million and $6.6 million for the three and nine months ended September 30, 2007, respectively.

During the nine months ended September 30, 2008, we acquired customer-related intangible assets of $1.4 million, product rights of $4.8 million, and other intangible assets of $0.2 million, all of which were assigned to the Companion Animal Group (“CAG”) segment, with weighted amortization periods of 15 years, 10 years and 3 years, respectively. See Note 3 for additional information. The remaining changes in the cost of intangible assets other than goodwill during the nine months ended September 30, 2008 resulted from changes in foreign currency exchange rates.

Goodwill by segment consisted of the following (in thousands):

		September 30,				December 31,
		2008				2007
CAG segment		$	129,803			$	131,004
Water segment			16,222				17,566
Production animal segment			9,866				9,529
		$	155,891			$	158,099

During the nine months ended September 30, 2008, we recognized goodwill of $0.6 million (all of which is expected to be tax deductible) related to business acquisitions prior to September 30, 2008, which was assigned to the CAG segment. Of this amount, $0.2 million related to business acquisitions prior to 2008. See Note 3 for additional information. The remaining changes in goodwill during the nine months ended September 30, 2008 resulted from changes in foreign currency exchange rates.

NOTE 8. WARRANTY RESERVES

We provide for the estimated cost of instrument warranties in cost of product revenue at the time revenue is recognized based on the estimated cost to repair the instrument over its warranty period. Cost of revenue reflects not only estimated warranty expense for the systems sold in the current period, but also any changes in estimated warranty expense for the installed base that results from our quarterly evaluation of service experience. Our actual warranty obligation is affected by instrument performance in the customers’ environment and associated costs incurred in servicing instruments. Should actual service rates or costs differ from our estimates, which are based on historical data and projections of future costs, revisions to the estimated warranty liability would be required.

Following is a summary of changes in accrued warranty reserves during the three and nine months ended September 30, 2008 and 2007 (in thousands):

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Balance, beginning of period		$	1,579			$	1,751			$	1,667			$	1,978
Provision for warranty expense			1,096				784				2,154				1,566
Liability assumed in connection with business acquisition			—				—				—				86
Change in estimate, balance beginning of period			(167	)			48				(246	)			299
Settlement of warranty liability			(642	)			(852	)			(1,709	)			(2,198	)
Balance, end of period		$	1,866			$	1,731			$	1,866			$	1,731

NOTE 9. DEBT

In February 2008, we increased the aggregate principal amount available under our unsecured short-term revolving credit facility (“Credit Facility”) to $200.0 million from $125.0 million. At September 30, 2008 we had $163.9 million outstanding under the Credit Facility with a weighted average interest rate of 3.5%. Of the total amount outstanding at September 30, 2008, $3.9 million was borrowed by our Canadian subsidiary and denominated in Canadian dollars.

NOTE 10. INCOME TAXES

Our effective income tax rates for the three and nine months ended September 30, 2008 were 33.1% and 31.4%, respectively, compared with 27.5% and 30.2% for the three and nine months ended September 30, 2007, respectively.

The increase in our effective income tax rate for the three months ended September 30, 2008 compared to September 30, 2007 was due primarily to a federal research and experimentation tax credit that was not available for the three months ended September 30, 2008; the reduction of international deferred tax liabilities during the three months ended September 30, 2007, resulting from a decrease in statutory tax rates; and the recognition of certain state tax benefits, resulting from the completion of an audit during the three months ended September 30, 2007.

The increase in our effective income tax rate for the nine months ended September 30, 2008 compared to September 30, 2007 was due primarily to a federal research and experimentation tax credit that was not available for the nine months ended September 30, 2008. The tax benefits discussed above that were realized during the three months ended September 30, 2007 were offset by a reduction in international deferred tax liabilities due to a change in the statutory tax rates for a jurisdiction in which we operate in the three months ended March 31, 2008. This reduction of statutory rates was a non-recurring benefit of approximately $1.5 million, which reduced our effective income tax rate for the nine months ended September 30, 2008 by 1.1%.

NOTE 11. COMPREHENSIVE INCOME

The following is a summary of comprehensive income for the three and nine months ended September 30, 2008 and 2007 (in thousands):

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Net income		$	25,699			$	25,795			$	92,614			$	68,486
Other comprehensive income (loss):
Foreign currency translation adjustments			(13,921	)			6,305				(5,015	)			9,344
Change in fair value of foreign currency contracts classified as hedges, net of tax			6,230				(1,155	)			5,599				(1,684	)
Change in fair market value of investments, net of tax			(223	)			(95	)			(192	)			(40	)
Comprehensive income		$	17,785			$	30,850			$	93,006			$	76,106

NOTE 12. EARNINGS PER SHARE

Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock and vested deferred stock units outstanding during the period. Diluted earnings per common share is computed by dividing net income available to common shareholders by shares used for basic earnings per share increased by the dilutive impact using the treasury stock method of options, restricted stock units and unvested deferred stock units.

The following is a reconciliation of shares outstanding for basic and diluted earnings per share (in thousands):

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Shares Outstanding for Basic Earnings per Share:
Weighted average shares outstanding			59,374				61,013				60,025				61,607
Weighted average vested deferred stock units outstanding			99				81				96				78
			59,473				61,094				60,121				61,685
Shares Outstanding for Diluted Earnings per Share:
Shares outstanding for basic earnings per share			59,473				61,094				60,121				61,685
Dilutive effect of options issued to employees and directors			2,304				2,733				2,378				2,692
Dilutive effect of restricted stock units issued to employees			83				78				98				61
Dilutive effect of unvested deferred stock units issued to directors			5				11				6				11
			61,865				63,916				62,603				64,449

Vested deferred stock units outstanding are included in shares outstanding for basic and diluted earnings per share because the associated shares of our common stock are issuable for no cash consideration, the number of shares of our common stock to be issued is fixed, and issuance is not contingent.

Certain options to acquire shares and restricted stock units have been excluded from the calculation of shares outstanding for dilutive earnings per share because they were anti-dilutive. The following table presents information concerning those anti-dilutive options and restricted stock units (in thousands, except per share amounts):

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Weighted average number of shares underlying anti-dilutive options			653				502				610				561
Weighted average exercise price per underlying share of anti-dilutive options		$	53.67			$	45.15			$	52.98			$	43.66
Weighted average number of shares underlying anti-dilutive restricted stock units			3				4				2				1

The following table presents additional information concerning the exercise prices of vested and unvested options outstanding at the end of the period (in thousands, except per share amounts):

		September 30,
		2008				2007
Closing price per share of our common stock		$	54.80			$	54.79
Number of shares underlying options with exercise prices below the closing price			4,758				5,680
Number of shares underlying options with exercise prices equal to or above the closing price			403				—
Total number of shares underlying outstanding options			5,161				5,680

NOTE 13. COMMITMENTS, CONTINGENCIES AND GUARANTEES

Significant commitments, contingencies and guarantees at September 30, 2008 are consistent with those discussed in our Annual Report on Form 10-K for the year ended December 31, 2007 in Note 13 to the consolidated financial statements, except as described in Note 3.

NOTE 14. TREASURY STOCK

Our board of directors has authorized the repurchase of up to 40,000,000 shares of our common stock in the open market or in negotiated transactions. We believe that the repurchase of our common stock is a favorable investment and we also repurchase to offset the dilutive effect of our employee share-based compensation programs. Repurchases of our common stock may vary depending upon the level of other investing activities and the share price.

From the inception of the program in August 1999 to September 30, 2008, we repurchased 35,491,000 shares for $812.6 million. From the inception of the program to September 30, 2008, we also received 376,000 shares of stock with a market value of $7.9 million that were surrendered by employees in payment for the minimum required withholding taxes due on the exercise of stock options, the vesting of restricted stock units and the settlement of deferred stock units, and in payment for the exercise price of stock options.

Information about our treasury stock purchases and other receipts is presented in the table below (in thousands, except per share amounts):

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Shares acquired			392				140				2,367				2,269
Total cost of shares acquired		$	20,143			$	7,150			$	123,800			$	99,683
Average cost per share		$	51.44			$	50.93			$	52.30			$	43.93

NOTE 15. SEGMENT REPORTING

We are organized into business units by market and customer group. Our reportable segments include: products and services for the veterinary market, which we refer to as our Companion Animal Group (“CAG”), water quality products (“Water”), and products for production animal health, which we refer to as the Production Animal Segment (“PAS”). We also operate two smaller segments that comprise products for dairy quality, which we refer to as Dairy, and products for the human medical diagnostic market, which we refer to as OPTI Medical. Financial information about the Dairy and OPTI Medical operating segments are combined and presented in an “Other” category because they do not meet the quantitative or qualitative thresholds for reportable segments. CAG develops, designs, manufactures, and distributes products and performs services for veterinarians. Water develops, designs, manufactures, and distributes products to detect contaminants in water. PAS develops, designs, manufactures, and distributes products to detect disease in production animals. Dairy develops, designs, manufactures, and distributes products to detect contaminants in dairy products. OPTI Medical develops, designs, manufactures, and distributes point-of-care electrolyte and blood gas analyzers and related consumable products for the human medical diagnostics market.

Items that are not allocated to our operating segments comprise primarily corporate research and development expenses, a portion of share-based compensation expense, interest income and expense, and income taxes. We allocate most of our share-based compensation expense to the operating segments. This allocation differs from the actual expense and consequently yields a difference between the total allocated share-based compensation expense and the actual expense for the total company.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies in our Annual Report on Form 10-K for the year ended December 31, 2007 in Notes 2 and 17.

The following is the segment information (in thousands):

		For the Three Months Ended September 30,
																		Unallocated				Consolidated
		CAG				Water				PAS				Other				Amounts				Total
2008
Revenues		$	205,050			$	20,321			$	17,801			$	7,921			$	—			$	251,093
Income (loss) from operations		$	28,938			$	8,865			$	3,482			$	(11	)		$	(2,277	)		$	38,997
Interest expense, net																							560
Income before provision for income taxes																							38,437
Provision for income taxes																							12,738
Net income																						$	25,699
2007
Revenues		$	187,481			$	17,431			$	17,377			$	7,096			$	—			$	229,385
Income (loss) from operations		$	28,529			$	7,212			$	2,561			$	27			$	(2,232	)		$	36,097
Interest expense, net																							515
Income before provision for income taxes																							35,582
Provision for income taxes																							9,787
Net income																						$	25,795

		For the Nine Months Ended September 30,
																		Unallocated				Consolidated
		CAG				Water				PAS				Other				Amounts				Total
2008
Revenues		$	639,411			$	57,287			$	60,452			$	23,587			$	—			$	780,737
Income (loss) from operations		$	106,300			$	23,437			$	14,824			$	(254	)		$	(7,700	)		$	136,607
Interest expense, net																							1,688
Income before provision for income taxes																							134,919
Provision for income taxes																							42,305
Net income																						$	92,614
2007
Revenues		$	554,939			$	48,941			$	52,871			$	20,835			$	—			$	677,586
Income (loss) from operations		$	75,293			$	20,010			$	10,286			$	(487	)		$	(5,661	)		$	99,441
Interest expense, net																							1,321
Income before provision for income taxes																							98,120
Provision for income taxes																							29,634
Net income																						$	68,486

Revenue by product and service category was as follows (in thousands):

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
CAG segment revenue:
Instruments and consumables		$	80,587			$	71,443			$	236,974			$	209,889
Rapid assay products			36,212				33,639				115,699				101,464
Laboratory and consulting services			73,536				64,914				222,984				191,350
Practice information systems and digital radiography			13,333				12,197				42,373				36,419
Pharmaceutical products			1,382				5,288				21,381				15,817
CAG segment revenue			205,050				187,481				639,411				554,939
Water segment revenue			20,321				17,431				57,287				48,941
PAS segment revenue			17,801				17,377				60,452				52,871
Other segment revenue			7,921				7,096				23,587				20,835
Total revenue		$	251,093			$	229,385			$	780,737			$	677,586

NOTE 16. FAIR VALUE MEASUREMENTS

On January 1, 2008, we adopted the provisions of SFAS No. 157 for our financial assets and liabilities. As permitted by FSP No. SFAS 157-2, we elected to defer the adoption of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until January 1, 2009. SFAS No. 157 provides a framework for measuring fair value under U.S. GAAP and requires expanded disclosures regarding fair value measurements. SFAS No. 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS No. 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available, and minimize the use of unobservable inputs when measuring fair value.

SFAS No. 157 describes three levels of inputs that may be used to measure fair value:

Level 1		Quoted prices in active markets for identical assets or liabilities. Our Level 1 assets and liabilities include investments in money market funds and marketable securities related to a deferred compensation plan assumed in a business combination. The liabilities associated with this plan relate to deferred compensation, which is indexed to the performance of the underlying investments.
Level 2		Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Our Level 2 assets include unrealized gains on hedge contracts.
Level 3		Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. At September 30, 2008, we had no Level 3 assets or liabilities.

The following table sets forth our financial assets and liabilities that were measured at fair value on a recurring basis at September 30, 2008 by level within the fair value hierarchy. We did not have any nonfinancial assets or liabilities that were measured or disclosed at fair value on a recurring basis at September 30, 2008. As required by SFAS No. 157, assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability (in thousands):

		Quoted Prices				Significant
		in Active				Other				Significant
		Markets for				Observable				Unobservable				Balance at
		Identical Assets				Inputs				Inputs				September 30,
		(Level 1)				(Level 2)				(Level 3)				2008
Assets
Marketable securities (1)		$	1,762			$	—			$	—			$	1,762
Money market funds (2)			6,807				—				—				6,807
Derivatives (3)			—				6,229				—				6,229
Liabilities
Deferred compensation (4)			1,762				—				—				1,762

NOTE 17. SUBSEQUENT EVENTS

On October 17, 2008, we entered into an agreement to sell our ACAREXX and SURPASS pharmaceutical products and a product currently under development, which are a part of our CAG segment. We expect that this transaction will be completed in the fourth quarter of 2008, at which time we also intend to restructure the remaining pharmaceutical business. The impact of the sale and restructuring is not expected to have a material effect on the results of operations for the fourth quarter of 2008. Proceeds received from the sale of these assets are projected to be approximately $8 million. In addition, we may receive future consideration that is contingent upon the acquirer receiving approval to market and sell the product currently under development, in the U.S., and the subsequent achievement of specific product sales milestones. The impact of receiving this consideration will be recorded in our results of operations in the period that the milestones are achieved.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This Quarterly Report on Form 10-Q includes or incorporates forward-looking statements about our business and expectations within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements relating to future revenue growth rates, demand for our products, realizability of assets, warranty expense, share-based compensation expense, and competition. You can generally identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. Words such as “expects,” “may,” “anticipates,” “intends,” “would,” “will,” “plans,” “believes,” “estimates,” “should,” and similar words and expressions are intended to help you identify forward-looking statements. These statements give 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 II, Item 1A. Risk Factors” in this Quarterly Report on Form 10-Q. The risks and uncertainties discussed herein do not reflect the potential impact of future mergers, acquisitions or dispositions. In addition, any forward-looking statements represent our estimates only as of the day this Quarterly Report was first filed with the Securities and Exchange Commission and should not be relied upon as representing our estimates as of any subsequent date. 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.

• Business Overview

We operate primarily through three business segments: products and services for the veterinary market, which we refer to as our Companion Animal Group (“CAG”), water quality products (“Water”) and products for production animal health, which we refer to as the Production Animal Segment (“PAS”). We also operate two smaller segments that comprise products for dairy quality, which we refer to as Dairy, and products for the human medical diagnostic market, which we refer to as OPTI Medical. Financial information about the Dairy and OPTI Medical operating segments are combined and presented in an “Other” category because they do not meet the quantitative or qualitative thresholds for reportable segments.

CAG develops, designs, manufactures, and distributes products and performs services for veterinarians. Water develops, designs, manufactures, and distributes products to detect contaminants in water. PAS develops, designs, manufactures, and distributes products to detect diseases in production animals. Dairy develops, designs, manufactures, and distributes products to detect contaminants in dairy products. OPTI Medical develops, designs, manufactures, and distributes point-of-care electrolyte and blood gas analyzers and related consumable products for the human medical diagnostics market.

Items that are not allocated to our operating segments comprise primarily corporate research and development expenses, a portion of share-based compensation expense, interest income and expense, and income taxes. We allocate most of our share-based compensation expense to the operating segments. This allocation differs from the actual expense and consequently yields a difference between the total allocated share-based compensation expense and the actual expense for the total company.

Because our instrument consumables, rapid assay products, and pharmaceutical products are sold in the U.S. and certain other geographies by distributors, distributor purchasing dynamics have an impact on our reported sales of these products. Distributors purchase products from us and sell them to veterinary practices, who are the end users. Distributor purchasing dynamics may be affected by many factors and may be unrelated to underlying end-user demand for our products. As a result, fluctuations in distributors’ inventories may cause reported results in a period not to be representative of 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 growth.

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

We operate in 17 countries and, for the nine months ended September 30, 2008, 41% of our revenue was derived from sales outside of the U.S. Since August, 2008 the U.S. dollar has strengthened substantially in relation to other currencies in which our sales are denominated. Strengthening of the U.S. dollar relative to other currencies has a negative impact on our international revenues and on margins of products manufactured in the U.S. and sold internationally. In addition, to the extent that the U.S. dollar is stronger in future periods relative to the exchange rates in effect in the corresponding prior periods, our growth rate will be negatively affected. The related impact on foreign currency denominated operating expenses and the impact of foreign currency hedge contracts in place partially offset this exposure. See also the section captioned “Quantitative and Qualitative Disclosures About Market Risk.”

On October 17, 2008, we entered into an agreement to sell our ACAREXX and SURPASS pharmaceutical products and a product currently under development, which are a part of our CAG segment. We expect that this transaction will be completed in the fourth quarter of 2008, at which time we also intend to restructure the remaining pharmaceutical business. The impact of the sale and restructuring is not expected to have a material effect on the results of operations for the fourth quarter of 2008.

• Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. 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. The significant accounting policies used in preparation of these condensed consolidated financial statements for the nine months ended September 30, 2008 are consistent with those discussed in Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007, except as discussed in Note 2 to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. The critical accounting policies and the significant judgments and estimates used in the preparation of our condensed consolidated financial statements for the nine months ended September 30, 2008 are consistent with those discussed in our Annual Report on Form 10-K for the year ended December 31, 2007 in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates,” except as discussed below.

Share-Based Compensation

We grant share-based compensation to certain classes of employees annually in the first quarter of each year, including stock options. We have used subjective assumptions to value stock options, particularly for the expected stock price volatility and the expected term of the options that we believe are reasonable.

To develop the expected term assumption for option awards, we previously elected to use the simplified method described in the Securities and Exchange Commission Staff Accounting Bulletin No. 107, which is based on vesting and contractual terms. Beginning in January 2008, we derive the expected term assumption for options based on historical experience and other relevant factors concerning expected employee behavior with regard to option exercise. Expected term for future awards will be determined using a consistent method. Longer expected term assumptions increase the fair value of option awards and therefore increase the expense recognized per 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. Net share-based compensation costs for the nine months ended September 30, 2008 were $7.9 million, which is net of a reduction of $1.1 million for estimated forfeitures. Changes in estimated forfeiture rates and differences between estimated forfeiture rates and actual experience may result in unanticipated increases or decreases in share-based compensation expense from period to period.

• Results of Operations

Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007

Revenue

Total Company. Revenue increased $21.7 million, or 9%, to $251.1 million for the three months ended September 30, 2008 from $229.4 million for the same period of the prior year. The favorable impact of currency exchange rates contributed 2% to revenue growth. The following table presents revenue by operating segment:

For the Three Months Ended September 30,
																										Percentage
																										Change Net of
																		Percentage				Percentage				Acquisitions
Net Revenue										Dollar				Percentage				Change from				Change from				and Currency
(dollars in thousands)		2008				2007				Change				Change				Currency (1)				Acquisitions (2)				Effect
CAG		$	205,050			$	187,481			$	17,569				9.4	%			1.3	%			0.3	%			7.8	%
Water			20,321				17,431				2,890				16.6	%			1.2	%			—				15.4	%
PAS			17,801				17,377				424				2.4	%			5.6	%			—				(3.2	%)
Other			7,921				7,096				825				11.6	%			3.0	%			—				8.6	%
Total		$	251,093			$	229,385			$	21,708				9.5	%			1.8	%			0.2	%			7.5	%

Companion Animal Group. Revenue for CAG increased $17.6 million, or 9%, to $205.1 million for the three months ended September 30, 2008 from $187.5 million for the same period of the prior year. The favorable impact of currency exchange rates contributed 1% to the increase in CAG revenue. Incremental sales from veterinary reference laboratory businesses acquired subsequent to July 1, 2007 contributed less than one-half of a percent to CAG revenue growth. The following table presents revenue by product and service category for CAG:

For the Three Months Ended September 30,
																										Percentage
																										Change Net of
																		Percentage				Percentage				Acquisitions
Net Revenue										Dollar				Percentage				Change from				Change from				and Currency
(dollars in thousands)		2008				2007				Change				Change				Currency (1)				Acquisitions (2)				Effect
Instruments and consumables		$	80,587			$	71,443			$	9,144				12.8	%			1.2	%			—				11.6	%
Rapid assay products			36,212				33,639				2,573				7.6	%			0.7	%			—				6.9	%
Laboratory and consulting Services			73,536				64,914				8,622				13.3	%			2.0	%			0.8	%			10.5	%
Practice information management systems and digital radiography			13,333				12,197				1,136				9.3	%			0.3	%			—				9.0	%
Pharmaceutical products			1,382				5,288				(3,906	)			(73.9	%)			—				—				(73.9	%)
Net CAG revenue		$	205,050			$	187,481			$	17,569				9.4	%			1.3	%			0.3	%			7.8	%