June 6, 2007

 

Jim B. Rosenberg

Senior Assistant Chief Accountant

Division of Corporation Finance

United States Securities and Exchange Commission

 

 

Dear Mr. Rosenberg:

 

Please see our responses below to your letter dated May 22, 2007. Each of our responses is preceded by a reproduction of the corresponding numbered Staff comments.

 

In connection with responding to your comments, we acknowledge that:

 

Form 10-K December 31, 2006

 

Item 7. Management’s Discussion and Analyses of Financial Condition and Results of Operations, page 20

 

Comment:

 

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 2

 

variability that is reasonably likely to result from their application over time. Disclosures explaining the likelihood that any materially different amounts would be reported under different conditions, using different assumptions is consistent with the objective of Management’s Discussion and Analysis. See Release 33-8350.

 

Response:

 

We acknowledge the Commission guidance regarding the presentation of critical accounting policies. Below is a revised disclosure regarding our critical accounting policies as of December 31, 2006. We will include a similar expanded disclosure of our critical accounting policies in our periodic filings with the SEC for 2007, beginning with the Form 10-Q for the quarterly period ending June 30, 2007.

 

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 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 other 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 for the year ended December 31, 2006 included in our Annual Report on Form 10-K for the year ended December 31, 2006 describes the significant accounting policies used in preparation of these 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

 

Customer Programs. We record estimated reductions to revenue in connection with customer marketing programs and incentive offerings, which may give customers credits or award points. Award points may be applied to trade receivables owed to us and/or toward future purchases of our products or services. We establish accruals for estimated revenue reductions attributable to customer programs and incentive offerings for each program based on numerous factors, including:

 

 

Revenue reductions are recorded quarterly based on issuance of credits, points earned but not yet issued, and estimates of credits and points to be earned in the future based on current revenue. In our analysis, we utilize data supplied from distributors and collected in-house that details the volume of qualifying products purchased as well as price paid per clinic (“practice-level sales data”).

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 3

 

Our two most significant customer programs are Practice Developer^® and SNAP up the Savings^TM (“SUTS”). For the years ended December 31, 2006 and 2005 we recorded revenue reductions of $5.1 million and $4.8 million, respectively, related to our Practice Developer^® program and $4.9 million and $5.1 million, respectively, related to our SUTS program. As of December 31, 2006 and 2005 the accrued revenue reductions were $10.4 million and $7.1million, respectively, for the Practice Developer^®program and $1.4 million for both years for the SUTS program. The income statement impact of year-to-year changes in estimates related to these programs was not material in either year.

 

Our Practice Developer^® program is a Companion Animal Group awards program that permits customers to earn points by purchasing quarterly minimums in certain product and service categories, including IDEXX Reference Laboratories, VetTest^® slides, LaserCyte^® tubes, Feline SNAP^® tests and Canine SNAP^® tests. Points may then be applied against the purchase price for IDEXX products and services purchased in the future. SUTS is our volume incentive program for selected SNAP^® tests that provides customers with benefits in the form of (1) discounts off invoice at the time of purchase and (2) points under the Practice Developer^® program awarded at the end of the SUTS program year (August 30) based on total purchase volume of qualified products during the year.

 

For the Practice Developer program, we reduce revenue assuming all points granted will result in future credits because the historical forfeitures have been de minimis. The accrued revenue reduction is calculated each quarter based on sales to end users during the quarter by either us or our distributors and on our estimate of future points to be issued upon sale of applicable product inventories held by distributors at the quarter end. On November 30 of each year, unused points granted before January 1 of the prior year expire and are accounted for as a favorable change in estimate.

 

Under the SUTS program, the discount ultimately received by a customer will depend on the volume of products purchased by the customer, either from us or our distributors, over the entire program period. Because at any time during the period we cannot be certain what discount level each customer ultimately will be entitled to, at the beginning of the period we develop a program model that forecasts a per test discount for all tests sold over the program period based on program enrollee purchasing patterns, historical experience with similar programs, current sales trends, and marketing analysis. The per test discount is adjusted quarterly during the program year based on our experience with the program and finalized when the program year ends in August. The accrued revenue reduction is calculated each quarter by applying the applicable per test discount to sales to end users during the quarter by either us or our distributors. The accrued revenue reduction also includes our estimate of future points to be issued upon sale of applicable product inventories held by distributors at the quarter end.

 

If the per test factor used to determine the revenue reduction under the SUTS program were to increase or decrease by 10% per test, we would be required to further reduce revenue or increase revenue, as the case may be, by $0.2 million.

 

Doubtful Accounts. We recognize revenue only in those situations where collection from the customer is reasonably assured. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We base our estimates on detailed analysis of specific customer situations and a percentage of our accounts receivable by aging category. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances might be required. Account balances are charged off against the allowance when we believe it is probable the receivable will not be recovered. Write-offs of customer accounts for the years ended December 31, 2005 and 2006 were $0.4 million and $0.5 million, respectively.

 

Inventory Valuation

 

We write down inventory for estimated obsolescence when warranted by estimates of future demand and market conditions. If actual market conditions are less favorable than those we estimated,

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 4

 

additional inventory write-downs may be required, which would have a negative effect on results of operations. Certain major components of inventory for which we have made critical valuation judgments are discussed in more detail below.

 

LaserCyte^® Hematology Analyzer. At December 31, 2006, $1.7 million of inventory associated with our LaserCyte^® hematology instrument required rework before it could be used to manufacture finished goods, which was net of $0.9 million of write-downs for inventory estimated to be obsolete. We determined obsolescence based on our estimate of the costs to rework inventory and the probability of success, primarily based on historical experience. We expect to fully realize our net investment in inventory. However, if we are unsuccessful reworking this inventory, if we revise our judgment of our ability to successfully rework inventory due to new experience in reworking this inventory, or if we alter the design of this product, we may be required to write off some or all of the remaining associated inventory.

 

Nitazoxanide. At December 31, 2006, our inventories included $9.3 million of inventory associated with Navigator^®, our nitazoxanide product for the treatment of equine protozoal myeloencephalitis. This inventory consisted of $0.2 million of finished goods and $9.1 million of active ingredient and other raw materials. We have an agreement with our supplier of nitazoxanide under which the supplier agreed until 2017 to replace any expiring inventory of nitazoxanide with longer-dated material. We believe that this agreement has substantially mitigated the risk that we would be required to write down nitazoxanide inventory due to its anticipated expiration prior to sale. However, if actual market conditions or our market share through 2025 are less than we estimate, we may be required to write off some of the associated inventory. For example, if we sell approximately 50% fewer units through 2025 than we estimate, we would have approximately $5 million of excess inventory that we would be required to write off.

 

Valuation of Goodwill and Other Intangible Assets

 

A significant portion of the purchase prices for acquired businesses is assigned to intangible assets. Intangible assets other than goodwill are initially valued at the lesser of fair value or, if applicable, fair value proportionately reduced by the excess of the fair value of acquired net assets over the purchase price (collectively, “fair value”) of the acquired business. If a market value is not readily available, 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 deemed appropriate by management, 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.

 

We assess goodwill for impairment annually and whenever events or circumstances indicate an impairment may exist, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). For impairment testing, the fair values of the reporting units that include goodwill are estimated using a discounted cash flow approach. The cash flows used contain our best estimates, using appropriate and customary assumptions and projections at the time. No impairments were identified as a result of the annual or event-driven reviews during the years ended December 31, 2006, 2005 or 2004.

 

Changes in forecast cash flows or the discount rate would affect the estimated fair values of reporting units and could result in a goodwill impairment charge in a future period. However, a 25% decrease in the current estimated fair value of any of our reporting units would not result in a goodwill impairment charge for any of our reporting units that include goodwill. Because our pharmaceutical

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 5

 

business is still substantially in an investment stage, the determination of the fair value of this business unit requires significant assumptions about the timing and amounts of the unit’s future cash flows, including assumptions about the markets for our products and proprietary technologies, the future success of research and development activities, the attainment and timing of regulatory approvals to manufacture and sell new products, the introduction and success of competitive products by other market participants, and other business risks. We believe that the goodwill attributable to our pharmaceutical business of $13.7 million was not impaired at December 31, 2006. However, significant changes in our assumptions and estimates due to new information, or actual results that are below our expectations, could result in an impairment in the future of some or all of the goodwill attributable to our pharmaceutical products business.

 

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 in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”). 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 assets and comparing that value to the carrying value of the assets. The cash flows that are used contain our best estimates, using appropriate and customary assumptions and projections at the time. No impairments were identified during the years ended December 31, 2006, 2005 or 2004. At December 31, 2006, we had intangible assets other than goodwill of $1.4 million associated with our pharmaceutical products business. These intangible assets are related to specific pharmaceutical products and may or may not be impaired in the event of the impairment of goodwill associated with the pharmaceutical products business.

 

Share-based Compensation

 

We adopted the provisions of SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”) on January 1, 2006. Beginning in 2006, we modified our share-based employee compensation programs to shift from the grant of stock options and employee stock purchase rights only to the grant of a mix of restricted stock units and stock options, along with employee stock purchase rights. There were no modifications to the terms of outstanding options during 2006 or 2005.

 

In connection with the adoption of SFAS No. 123(R), we adopted the straight-line method to prospectively expense share-based awards granted subsequent to December 31, 2005. The graded-vesting, or accelerated, method has been used to calculate the expense for stock options granted prior to January 1, 2006. If the total fair value of share-based compensation awards, as well as other features that impact expense, including forfeitures and capitalization of costs, was consistent from year-to-year in each of the last five years and through 2010, this change in expense method from graded-vesting to straight-line expensing would yield decreasing annual expense through 2010 until awards granted prior to January 1, 2006 were fully expensed. However, 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.

 

The fair value of options, restricted stock units, deferred stock units with vesting conditions, and employee stock purchase rights awarded during the years ended December 31, 2006, 2005 and 2004 totaled $11.9 million, $15.7 million and $13.4 million, respectively. The total unrecognized compensation cost for unvested share-based compensation awards outstanding at December 31, 2006, net of estimated forfeitures, was $14.6 million. Approximately $6.3 million is expected to be recognized in the year ending December 31, 2007 for outstanding awards and decreasing amounts of the total expense are expected to be recognized over the subsequent five years, resulting in a weighted average remaining expense recognition period of approximately 1.5 years.

 

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

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 6

 

 

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. Changes in the subjective input assumptions can materially affect the fair value estimate. Our expected stock price volatility assumptions are based on the historical volatility of our stock over periods that are similar to the expected terms of grants, and other relevant factors. Lower estimated volatility reduces the fair value of an option. The total fair value of options awarded during the year ended December 31, 2006 ($4.4 million) would have increased or decreased by approximately 10% if the stock price volatility assumption were increased to 35% or decreased to 25%, respectively. The total cost recognized for options awarded during the year ended December 31, 2006 would have increased or decreased by less than $0.1 million if the stock price volatility assumption were increased to 35% or decreased to 25%, respectively.

 

To develop the expected term assumption for 2006 option awards, we 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. The application of the simplified method is allowable for options granted through December 31, 2007. We will transition to developing expected term assumptions for future awards based on historical experience and other relevant factors concerning expected employee behavior with regards to option exercise. Longer expected term assumptions increase the fair value of option awards, and therefore increase the expense recognized per award. The total fair value of options awarded during the year ended December 31, 2006 ($4.4 million) would have increased by approximately 10% or decreased by approximately 12% if the expected term assumption were increased or decreased by one year, respectively.

 

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. At December 31, 2006, we applied annual forfeiture rates ranging from 3% to 8% to estimate future forfeitures of previously granted options and restricted stock units that had vesting dates after December 31, 2006. Net share-based compensation costs for the year ended December 31, 2006 were $11.1 million, which is net of a reduction of $0.6 million for 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 by 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.

 

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 was $12.9 million at December 31, 2006 and $7.9 million at December 31, 2005. We believe that our

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 7

 

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, 2006, would not result in the recognition of incremental valuation allowances except in one subsidiary where a 5% reduction could result in our recording a valuation allowance of $0.4 million for that subsidiary.

 

For those jurisdictions where the expiration date of tax carryforwards or the projected operating results indicate that realization is not likely, 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. 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. Similarly, a determination that a higher valuation allowance is required would decrease 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 10% in our anticipated U.S. state income tax rate would cause us to increase our net deferred tax asset balance by $0.2 million. This increase in the net deferred asset would increase net income in the period that our rate was adjusted. Likewise, a decrease of 10% 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 operating earnings of non-United States subsidiaries, the cumulative amount of which was $111.4 million at December 31, 2006, to be indefinitely invested outside the United States. No provision has been made for United States federal and state, or international taxes that may result from future remittances of undistributed earnings of non-United States subsidiaries. Should we repatriate non-United States 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.

 

Estimates for Certain Contingencies

 

Under our workers’ compensation insurance policies for U.S. employees for the years ended December 31, 2006, 2005, 2004 and 2003, we retain the first $250,000 in claim liability per incident and $3.1 million, $2.8 million, $3.0 million and $1.4 million, respectively, in aggregate claim liability. We entered into a similar workers’ compensation insurance policy effective January 1, 2007. The insurance company provides insurance for claims above the individual occurrence and aggregate limits. We estimate claim liability based on claims incurred and the estimated ultimate cost to settle the claims. Based on this analysis, we have recognized cumulative expenses of $1.3 million, $0.6 million, $0.7 million and $0.8 million for claims incurred during the years ended December 31, 2006, 2005, 2004 and 2003, respectively. Claims incurred during the year ended December 31, 2006 are relatively new and significant additional healthcare and wage indemnification costs could arise from those claims. Our liability for claims incurred during the year ended December 31, 2006 could exceed our estimate and we could be liable for up to $1.8 million in excess of the expense we have recognized. For the three years ended on or prior to December 31, 2005, based on our retained claim liability per incident and our aggregate claim liability, our maximum

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 8

 

liability at December 31, 2006 is $1.5 million in excess of the amounts deemed probable and previously recognized.

 

Under our employee health care insurance policy, we retain claims liability risk up to $125,000 per incident and an aggregate claim limit based on the number of employees enrolled in the plan per month. We have insurance coverage of $1.0 million for claims above the aggregate limit. Should employee health insurance claims exceed this coverage, we would have further obligations for the amount in excess of such coverage. We estimate our liability for the uninsured portion of employee health care obligations that have been incurred but not reported based on individual and aggregate coverage, our claims experience, the number of employees enrolled in the program, and the average time from when a claim is incurred to the time it is paid. We recognized employee health care claim expense of $10.9 million during the twelve months ended December 31, 2006, which includes actual claims paid and an estimate for our liability for the uninsured portion of employee health care obligations that have been incurred but not paid. Should actual employee health care claims liability exceed estimates, we are liable for up to $1.5 million before reaching our aggregate limit at December 31, 2006. If our liability for the uninsured portion of employee health care obligations that have been incurred but not paid is 10% greater than our estimates at December 31, 2006, we would incur additional expense of $0.2 million.

 

Revenue Recognition, pages 24-25

 

Comment:

 

 

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 9

 

including the effect that changes in your estimates of these items had on your revenues and operations. Provide your response in a disclosure-type format.               

 

Response:

 

In future filings, we will expand our disclosures related to items that reduce gross revenue, such as customer credits, award points, trade-in rights and other discounts. Our expanded disclosure in future filings will address the additional factors and comments raised by the Staff in items (a) through (f) above. With regard to the nature of the accruals described in sub-paragraph (a) and other items suggested by the Staff in sub-paragraphs (b) through (d), please see our proposed revised critical accounting policy disclosure for revenue recognition as of December 31, 2006 in response to Staff comment (1) above. We will include a similar expanded disclosure of our critical accounting policies in our next periodic filing with the SEC, which will be the Form 10-Q for the quarterly period ending June 30, 2007. To assist Staff review, we have provided the following responses corresponding to each of sub-paragraphs (a), (e) and (f).

 

(a) The amount of each accrual for the years ended December 31, 2006 and 2005 was as follows (in thousands):

 

 

Regarding trade-in rights, these programs were more significant through the year ended December 31, 2004. As of December 31, 2005, accrued customer programs related to trade-in rights were not significant.

 

In future periodic filings with the SEC, beginning with our next periodic filing on Form 10-Q for the quarterly period ending June 30, 2007, we will classify “Accrued Marketing Expenses” in “Accrued Expenses” on the face of the balance sheet and the remaining components listed above will be captioned “Accrued Customer Programs” on the face of the balance sheet. In addition we will disclose the balance of our two most significant revenue-reducing accruals, Practice Developer^® and SNAP up the Savings^TM, as of each respective balance sheet date along with the income statement impact of these programs for the appropriate period in our critical accounting policies.

 

(e) The following is a roll forward of the liability for each estimate for the years ended December 31, 2006 and 2005 (in thousands):

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 10

 

 

 

 

 

(f) For the years ended December 31, 2006, 2005 and 2004, our absolute revenue reducing accruals for customer programs have grown primarily as a result of increased sales of eligible products covered in customer programs as well as increased customer participation, partly offset by reduced program incentives. Accordingly, reductions to revenue and corresponding increases to revenue reducing accruals have likewise increased. Revenue-reducing items as a percentage of Companion Animal Group product revenue in 2006, 2005, and 2004 were 2% in each year. These programs are concentrated in our rapid assay products category.

 

Below is a revised sample disclosure of the Companion Animal Group Results of Operations – Revenue for the twelve months ended December 31, 2006 compared to twelve months ended December 31, 2005 specifically related to rapid assay products revenues. We will include a similar expanded disclosure in future periodic filings with the SEC, beginning with our next periodic filing on Form 10-Q for the quarterly period ending June 30, 2007.

 

The increase in sales of rapid assay products from 2005 to 2006 was due primarily to increased sales volume of canine products, including sales of SNAP^® 4Dx^®, which was launched in the U.S. in September 2006. The impact from changes in distributors’ inventory levels increased reported rapid assay revenue growth by 3%. To a lesser extent, higher average unit sales prices of canine products, in part due to less promotional discounting in connection with our SNAP up the Savings^TM customer program and higher relative sales of combination test products, also contributed to rapid assay revenue growth. These increases were partly offset by lower average unit sales prices of feline products, partly due to greater promotional discounting in connection

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 11

 

with our SNAP up the Savings^TM customer program. Incremental sales of rapid assay products for which we acquired distribution rights in the second quarter of 2006 contributed 2% to rapid assay revenue growth.

 

 

Response:

 

We recognize revenue associated with extended maintenance agreements over the life of the contracts using the straight-line method, which approximates the expected timing in which applicable services are performed. We recognize revenue on certain instrument systems under rental programs over the life of the rental agreement using the straight-line method.

 

Liquidity and Capital Resources, page 39

 

Contractual Obligations Table, page 42

 

Comment:

 

 

Response:

 

We agree that interest on long-term debt should be included in the contractual obligations table. We have revised the table to include future payments of $0.4 million, $0.7 million, $0.5 million, and $0.4 million for the periods 2007, 2008-2009, 2010-2011 and after 2011, respectively. We will hereafter include interest on long-term debt in the contractual obligations tables that are in our future annual filings, beginning with our next annual report on Form 10-K for the year ending December 31, 2007. A sample revised disclosure as of December 31, 2006 is as follows:

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 12

 

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

 

 

 

 

Consolidated Financial Statements

 

Note 11. Commitments, Contingencies and Guarantees, page F-27

 

Comment:

 

 

Response:

 

We have not disclosed our litigation with Cyntegra, either in the footnotes to the Company’s financial statements or pursuant to Item 103 of Regulation S-K, because we believe that the chance of an adverse outcome is remote and that, even if an adverse outcome were to occur, any loss would be immaterial.

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 13

 

The essence of Cyntegra’s claims is that IDEXX’s agreements with its U.S. distributors of companion animal diagnostic products violate antitrust laws. Agreements of the kind that IDEXX has entered into with our distributors have been consistently upheld by courts in the Ninth Circuit, where this case has been filed. In addition, we previously defended against a similar suit in the Second Circuit. In that case, the District Court dismissed the case on summary judgment, and the Second Circuit Court of Appeals affirmed that judgment.

 

The only substantive ruling made to date by the District Court in the Cyntegra case was its denial in February 2007 of Cyntegra’s motion for preliminary injunction. In its order denying Cyntegra’s motion, the Court noted “the lack of evidentiary support for most of [Cyntegra’s] allegations” and stated that Cyntegra had “failed to show a likelihood of success on the merits.”

 

In its complaint filed June 30, 2006, Cyntegra claimed lost “sales” of $2,000,000. Seven months later, in its Initial Disclosure pursuant to Rule 26(a)(1) of the Federal Rules of Civil Procedure, Cyntegra claimed lost “profits” of $624,000,000 and treble damages of $1,872,000,000.

 

We believe that Cyntegra has no basis for claiming any damages from IDEXX. To our knowledge, Cyntegra has had no sales, no facilities, no commercial relationships, no proprietary technology, no products, and no other assets or resources of any kind that would indicate the means or the ability to enter the veterinary diagnostics market.

 

Cyntegra’s attempt to enter the veterinary diagnostics market appears to have consisted almost exclusively of contacting three of IDEXX’s distributors and, after those distributors declined to do business with Cyntegra, discontinuing its business and suing IDEXX. Likewise, we believe that Cyntegra’s preposterous damage claims were fabricated by Cyntegra’s counsel only to support her theory that IDEXX was violating securities laws by not disclosing the Cyntegra litigation in its periodic reports.

 

We previously discussed our position regarding disclosure of the Cyntegra litigation with Michael Reedich from the SEC’s Division of Corporation Finance on January 22, 2007. Since that time we have not had any further discussions or correspondence regarding this matter with the Division of Corporation Finance.

 

Although we continue to believe, for the reasons stated above, that the likelihood of an adverse outcome in the Cyntegra litigation is remote, we will add the following disclosure, updated to reflect any new developments, in our next periodic filing with the SEC, which will be our Form 10-Q for the quarterly period ending June 30, 2007, in Item 1 of Part II:

 

On June 30, 2006, Cyntegra, Inc. filed suit against IDEXX in the U.S. District Court for the Central District of California alleging that IDEXX had violated U.S. federal antitrust laws and California state unfair trade practices laws. The complaint alleged, among other things, that IDEXX was monopolizing the U.S. market for companion animal diagnostic products. In November 2006, Cyntegra filed a motion for preliminary injunction requesting, among other things, that the Court enjoin IDEXX from withdrawing or threatening to withdraw its products from distributors that wish to sell products that compete with IDEXX’s products. On February 5, 2007, the Court denied this motion and stated that

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 14

 

Cyntegra had failed to show a likelihood of success on the merits. IDEXX has filed a motion for summary judgment seeking judgment in its favor on all of Cyntegra’s claims. Oral arguments on the motion are currently scheduled to be held September 20, 2007. Although a favorable outcome for IDEXX cannot be assured, we believe that Cyntegra’s claims are without merit and we intend to continue to defend our positions vigorously.

 

Similarly, we will add the following disclosure to the footnotes of our financial statements in our next periodic filing with the SEC, which will be the Form 10-Q for the quarterly period ending June 30, 2007:

 

On June 30, 2006, Cyntegra, Inc. filed suit against IDEXX in the U.S. District Court for the Central District of California alleging that IDEXX had violated U.S. federal antitrust laws and California state unfair trade practices laws. The complaint alleged, among other things, that IDEXX was monopolizing the U.S. market for companion animal diagnostic products. In November 2006, Cyntegra filed a motion for preliminary injunction requesting, among other things, that the Court enjoin IDEXX from withdrawing or threatening to withdraw its products from distributors that wish to sell products that compete with IDEXX’s products. On February 5, 2007, the Court denied this motion and stated that Cyntegra had failed to show a likelihood of success on the merits. IDEXX has filed a motion for summary judgment seeking judgment in its favor on all of Cyntegra’s claims. Oral arguments on the motion are currently scheduled to be held September 20, 2007. Although a favorable outcome for IDEXX cannot be assured, we believe that Cyntegra’s claims are without merit and we intend to continue to defend our positions vigorously. We have not accrued a contingent litigation loss reserve in connection with this suit because we believe that the possibility of an adverse result is remote and that, even if an adverse outcome were to occur, any loss would not be material.

 

Note 16. Segment Reporting

 

Comment:

 

6. Long-lived assets by geographic areas should not include intangible assets. Refer to question 22 in the FASB Implementation Guide to FAS 131. Provide us revised disclosure. You may provide your current disclosure in addition to that required by the standard.

 

Response:

 

Below is a revised disclosure regarding long-lived assets by geographic areas as of December 31, 2006. We will include a similar disclosure of long-lived assets by geographic areas, which excludes intangible assets, in future annual filings, beginning with our next annual report on Form 10-K for the year ending December 31, 2007.

 

Net long-lived assets, consisting of net property and equipment, are subject to geographic risks because they are generally difficult to move and to effectively utilize in another geographic area in a reasonable time period and because they are relatively illiquid. Net long-lived assets by principal geographic areas were as follows (in thousands):

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 15

 

 

Exhibits 31.1 and 31.2

 

Comment:

 

 

Response:

 

Below are revised certifications. In future periodic filings with the SEC, beginning with our next periodic filing on Form 10-Q for the quarterly period ending June 30, 2007, we will ensure that the certifications’ language is exactly the same as required by Item 601 of regulation S-K.

 

Exhibit 31.1

 

CERTIFICATION

 

I, Jonathan W. Ayers, certify that:

 

 

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 16

 

 

 

 

 

 

 

 

 

 

 

Jonathan W. Ayers, Chairman,

President and Chief Executive Officer

 

 

---

Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 17

 

Exhibit 31.2

 

CERTIFICATION

 

I, Merilee Raines, certify that:

 

 

 

 

 

 

 

 

 

 

 

 

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 18

 

 

Merilee Raines

Corporate Vice President and

Chief Financial Officer

 

Form 10-Q March 31, 2007

 

Condensed Consolidated Financial Statements

 

Notes to Condensed Consolidated Financial Statements, page 6

 

Note 2. Business Acquisitions, page 6

 

Comment:

 

 

Response:

 

Regarding the disclosure of pro forma information about these acquisitions, we believe that our business acquisitions during the three months ended March 31, 2007 were not material, either individually or in the aggregate. The key factors that we considered in making this determination included:

 

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 19

 

judgment of a reasonable person relying upon the consolidated financial statements would have changed or been influenced by pro forma disclosures in our financial statements. Disclosures of our business acquisitions during the three months ended March 31, 2007 and during prior annual periods have not resulted in significant positive or negative market reactions based on the demonstrated volatility of the price of our common stock in comparison to the volatility of NASDAQ Composite and Standard & Poor’s 500 indices. The acquired businesses do not significantly change the nature of our overall business or of our individual reportable segments. Further, the acquired businesses do not significantly alter our anticipated business trends, contractual requirements, or significant risk factors that could cause or contribute to material impacts on our future operating results.

 

Based on our conclusion that the businesses acquired during the three months ended March 31, 2007 were not material individually or in the aggregate, pro forma information and disclosures were not required. However, we elected to disclose information that is consistent with certain of the annual FAS 141 disclosure requirements, including the disclosures described in paragraph 52 of FAS 141. These disclosures are located in our Form 10-Q for the quarterly period ended March 31, 2007 in Note 2, Business Acquisitions, and Note 4, Goodwill and Other Intangible Assets.

 

In response to your comment concerning the factors that contributed to the recognition of goodwill, we will include the following expanded disclosure in future periodic filings with the SEC, beginning with our next periodic filing on Form 10-Q for the quarterly period ending June 30, 2007.

 

We believe that the acquired businesses enhance our existing businesses by either expanding our geographic range of 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.

 

Regarding customer relationship assets in connection with businesses acquired during the three months ended March 31, 2007, we recorded customer-related intangible assets of $24.3 million (which is comprised solely of customer relationship assets), product rights other than patents of $9.9 million, and other intangible assets of $2.2 million. We disclosed the total of these intangible asset acquisitions, $36.3 million, in Note 2, Business Acquisitions in the Form 10-Q for the quarterly period ended March 31, 2007. We also disclosed changes in intangible assets, by type, due to business acquisitions and purchase accounting adjustments in Note 4, Goodwill and Other Intangible Assets in the Form 10-Q for the quarterly period ended March 31, 2007. We believe that the recognition and valuation of these intangible assets other than goodwill is appropriate and consistent with SFAS 141 and EITF 02-17.

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 20

 

 

Item 2. Management’s Discussion and Analyses of Financial Condition and Results of Operations, page 13

 

Liquidity and Capital Resources, page 20

 

Comment:

 

 

Response:

 

Below is a revised disclosure regarding cash used by operating activities for the three months ended March 31, 2007. We will include a similar expanded disclosure in future periodic filings with the SEC, beginning with our next periodic filing on Form 10-Q for the quarterly period ending June 30, 2007.

 

 Liquidity and Capital Resources

 

Sources and Uses of Cash

 

Cash used by operating activities was $1.4 million for the three months ended March 31, 2007, compared to $3.0 million for the same period in 2006. The total of net income and net non-cash charges was $27.8 million for the three months ended March 31, 2007, compared to $21.6 million for the same period in 2006. We have historically experienced proportionally lower or net negative cash flows from operating activities during the first quarter and net positive cash flows from operating activities for the remainder of the year and for the annual period. Several factors contribute to the seasonal fluctuations in cash flows generated by operating activities, including the following:

 

 

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Mr. Jim B. Rosenberg

United States Securities and Exchange Commission

June 6, 2007

Page 21

 

During the three months ended March 31, 2007, cash decreased by $29.2 million due to changes in operating assets and liabilities, compared to a decrease in the same period in 2006 of $24.7 million, resulting in a year-to-year change of $4.5 million. The increase in cash used by changes in operating assets and liabilities, compared to 2006, was primarily attributable to $7.6 million of incremental cash used by net decreases in accounts payable and accrued expenses and $6.3 million of incremental cash used by increases in accounts receivable, partly offset by a reduction of $8.6 million of cash used by increases in inventory. The incremental cash used by accounts payable and the reduction of cash used by inventory compared to the same period of 2006 was due, in part, to the deferral of receipts of VetTest^® slide inventory from our supplier from the fourth quarter of 2005 to the first quarter of 2006. This resulted in an unusually large increase in VetTest^® slide inventory during the three months ended March 31, 2006 and a delay in the timing of associated payments to the supplier. Incremental cash of $2.4 million was used by net decreases in accrued expenses due to an increase in annual employee incentive bonus payments. The increase in cash used by accounts receivable was due to higher sales during the three months ended March 31, 2007.

 

If you have any questions regarding the foregoing, please do not hesitate to contact me at (207) 556-4446.

 

Sincerely,

 

 

/s/ Merilee Raines

Merilee Raines

Corporate Vice President & Chief Financial Officer