• 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.
• 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 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. The significant accounting policies used in preparation of these condensed consolidated financial statements for the six months ended June 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 and 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 six months ended June 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 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 six months ended June 30, 2008 were $5.5 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 unanticipated increases or decreases in share-based compensation expense from period to period.

• Results of Operations Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007 Revenue Total Company. Revenue increased $43.5 million, or 18%, to $280.6 million for the three months ended June 30, 2008 from $237.0 million for the same period of the prior year. The favorable impact of currency exchange rates contributed 5% to revenue growth. The following table presents revenue by operating segment:

                                                   For the Three Months Ended June 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                      $ 230,752     $ 194,025     $ 36,727            18.9 %             4.0 %                  0.4 %              14.5 %
Water                       20,150        17,105        3,045            17.8 %             4.2 %                    -                13.6 %
PAS                         21,489        18,683        2,806            15.0 %            11.4 %                    -                 3.6 %
Other                        8,179         7,233          946            13.1 %             5.1 %                    -                 8.0 %

Total                    $ 280,570     $ 237,046     $ 43,524            18.4 %             4.7 %                  0.3 %              13.4 %

(1) Represents the percentage change in revenue attributed to the effect of changes in currency rates from the three months ended June 30, 2007 to the three months ended June 30, 2008.

(2) Represents the percentage change in revenue attributed to incremental revenues during the three months ended June 30, 2008 compared to the three months ended June 30, 2007 from businesses acquired subsequent to April 1, 2007.

Companion Animal Group. Revenue for CAG increased $36.7 million, or 19%, to $230.8 million for the three months ended June 30, 2008 from $194.0 million for the same period of the prior year. Incremental sales from veterinary reference laboratory businesses acquired subsequent to April 1, 2007 contributed just under one-half of a percent to CAG revenue growth. The favorable impact of currency exchange rates contributed 4% to the increase in CAG revenue. The following table presents revenue by product and service category for CAG:

                                                            For the Three Months Ended June 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                   $  80,777       $  71,490       $  9,287               13.0 %               4.7 %                      -                   8.3 %
Rapid assay products             41,265          36,588          4,677               12.8 %               1.9 %                      -                  10.9 %
Laboratory and consulting
services                         79,341          68,548         10,793               15.7 %               5.2 %                    1.2 %                 9.3 %
Practice information
management systems and
digital radiography              14,015          11,697          2,318               19.8 %               1.7 %                      -                  18.1 %
Pharmaceutical products          15,354           5,702          9,652              169.3 %                 -                        -                 169.3 %

Net CAG revenue               $ 230,752       $ 194,025       $ 36,727               18.9 %               4.0 %                    0.4 %                14.5 %

(1) Represents the percentage change in revenue attributed to the effect of changes in currency rates from the three months ended June 30, 2007 to the three months ended June 30, 2008.

(2) Represents the percentage change in revenue attributed to incremental revenues during the three months ended June 30, 2008 compared to the three months ended June 30, 2007 from businesses acquired subsequent to April 1, 2007.

The following revenue analysis reflects the results of operations net of the impact of currency exchange rates on sales outside the U.S. and net of incremental sales from veterinary reference laboratory businesses acquired subsequent to April 1, 2007.
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.
The increase in sales of instruments and consumables was due to higher unit sales volume across all instrument and consumables product categories and net higher average unit sales prices. Higher consumables sales volumes were due primarily to higher worldwide practice-level sales of chemistry slides, consumables used with our Coag Dx™ blood coagulation analyzers and tubes used with our hematology analyzers. Higher instrument sales volumes were due primarily to increased sales of Coag Dx™ analyzers and LaserCyte® hematology analyzers. Higher instrument service revenue was due to higher volume of service contracts sold resulting from increased number of units placed. Instruments and consumables sales were also favorably impacted by higher average unit sales prices for slides that are sold for use in our chemistry analyzers, partly offset by lower average unit prices on sales of our VetTest® chemistry and LaserCyte®hematology analyzers, due primarily to increased promotional discounting. Sales volumes of consumables in the U.S. and Canada in the second quarter of 2007 benefited from temporary additional diagnostic testing volume related to the recall of certain pet foods in March 2007. We believe that the recall resulted in a higher than usual number of pet visits to veterinary clinics in North America in the first and second quarters of 2007. We estimate that this event negatively impacted year-over-year second quarter growth in sales of consumables used in our IDEXX VetLab® suite of analyzers by approximately 2%, and negatively impacted growth in sales of total instruments and consumables by approximately 1%. Changes in U.S. distributors' inventory levels increased reported instruments and consumables revenue growth by 1%. The increase in sales of rapid assay products was due to higher sales volumes and higher average unit sales prices. Increased volume was due primarily to increased U.S. practice-level sales of canine combination test products, such as SNAP® 4Dx®, favorable changes in U.S. distributor inventory levels of feline combination test products and, to a lesser extent, the July 2007 launch of SNAP® cPL™, our test for pancreatitis in dogs, partly offset by unfavorable volume in Japan resulting from the timing of orders placed by our distributor. Higher average unit sales prices were due, in part, to higher relative sales of canine combination test products and less promotional discounting in connection with our SNAP®up the Savings™ and other customer programs. We expect that the rate of end users' conversion from canine heartworm-only tests to combination test products will slow in future periods, which will decelerate the rate of increase in average unit sales prices. The impact from changes in distributors' inventory levels decreased reported rapid assay revenue growth by 1%.
The increase in sales of laboratory and consulting services resulted primarily from the impact of price increases, higher testing volume and, to a lesser extent, acquisitions. Higher testing volume was attributable to incremental sales to new customers, increased testing volume from existing customers and the impact of new test offerings. As discussed above, the second quarter of 2007 benefited from temporary additional diagnostic testing volume resulting from the March 2007 pet food recall. We estimate that this event negatively impacted year-over-year second quarter laboratory and consulting services revenue growth by approximately 2%. Acquisitions of veterinary reference laboratories in the United States and Europe contributed 1% to reported laboratory and consulting services revenue growth.

The increase in sales of practice information management systems and digital radiography resulted primarily from higher sales volumes of companion animal radiography systems and the favorable impact of changes to the customer support pricing structure for our Cornerstone® practice information management systems, partly offset by lower sales of practice information management systems and lower average unit prices for companion animal digital radiography systems due to increased competition.
The increase in sales of pharmaceutical products resulted primarily from higher sales volume of PZI VET®, our insulin product for the treatment of diabetic cats. In the second quarter of 2008, we informed customers that we would be discontinuing the PZI VET®product since the raw material used in the product is no longer commercially available. Consequently, sales of PZI VET® were unusually high in the second quarter and we will have no sales of PZI VET® beyond the second quarter. The incremental impact in the second quarter related to timing of PZI VET® sales was approximately $10 million.
Water. Revenue for Water increased $3.0 million, or 18%, to $20.2 million for the three months ended June 30, 2008 from $17.1 million for the same period of the prior year. The increase resulted primarily from higher sales volume, partly offset by lower average unit sales prices due to higher relative sales in geographies where products are sold at lower average unit sales prices. Higher sales volumes were attributable to the commencement in September 2007 of distribution of certain water testing kits manufactured by Invitrogen Corporation ("Invitrogen"), which increased reported Water revenue growth by 8%, as well as higher sales of our Colilert® products, used to detect total coliforms and E. coli in water. The favorable impact of currency exchange rates contributed 4% to the increase in Water revenue.
Production Animal Segment. Revenue for PAS increased $2.8 million, or 15%, to $21.5 million for the three months ended June 30, 2008 from $18.7 million for the same period of the prior year. The favorable impact of currency exchange rates contributed 11% to the increase in PAS revenue. The remaining increase resulted primarily from higher livestock diagnostics sales volume, partly offset by lower average unit sales prices for our post-mortem test for bovine spongiform encephalopathy ("BSE"), due to greater price competition, and for our test for mycobacterium paratuberculosis ("M. pt").
Other. Revenue for Other operating units increased $0.9 million, or 13%, to $8.2 million for the three months ended June 30, 2008 from $7.2 million for the same period of the prior year due primarily to higher sales volume of our OPTI Medical products.
Gross Profit
Total Company. The following table presents gross profit and gross profit percentage by operating segment:

                                     For the Three Months Ended June 30,
Gross Profit                           Percent of                    Percent of       Dollar       Percentage
(dollars in thousands)     2008          Revenue         2007          Revenue        Change         Change

CAG                      $ 120,800            52.4 %   $  89,049            45.9 %   $ 31,751             35.7 %
Water                       12,433            61.7 %      10,809            63.2 %      1,624             15.0 %
PAS                         14,430            67.2 %      11,302            60.5 %      3,128             27.7 %
Other                        3,501            42.8 %       2,931            40.5 %        570             19.4 %
Unallocated amounts             96             N/A           130             N/A          (34 )          (26.2 %)

Total Company            $ 151,260            53.9 %   $ 114,221            48.2 %   $ 37,039             32.4 %

Companion Animal Group. Gross profit for CAG increased $31.8 million, or 36%, to $120.8 million for the three months ended June 30, 2008 from $89.0 million for the same period of the prior year due to increased revenue across the CAG product and service lines and to an increase in gross profit percentage to 52% from 46%. The increase in the gross profit percentage was due primarily to the absence in 2008 of the second quarter 2007 inventory and prepaid royalty license write-off related to our Navigator® product, discussed below, that resulted in an unfavorable impact of 5% of CAG revenue for the second quarter of 2007 and, to a lesser extent, higher average unit sales prices on laboratory and consulting services and canine combination test products, including SNAP®4Dx®; higher relative sales of our relatively higher margin pharmaceutical product, PZI VET®, as discussed above; and the favorable impact of foreign currency rates on sales denominated in those currencies, net of foreign exchange hedge contract losses and foreign currency denominated expenses. These favorable items were partly offset by higher manufacturing costs of our instruments, including our Catalyst Dx™ chemistry analyzer where we have not yet achieved economies of scale; higher costs of service in the laboratory and consulting services business; and higher relative sales of lower margin laboratory and consulting services.

During the three months ended June 30, 2007 we recognized a write-down of nitazoxanide raw materials inventory of $9.1 million and a write-off of a prepaid royalty license of $1.0 million associated with Navigator® paste. We wrote down these assets because the third-party contract manufacturer of finished goods notified us that it would discontinue manufacturing the product in 2009. Additionally, product sales were lower than projected. We believed that we would not be able to enter into a replacement manufacturing arrangement on economically feasible terms and that we would not be able to obtain the product after termination of the existing manufacturing arrangement because the estimated production volume was low. Accordingly, we evaluated our associated inventory for obsolescence based on our changed estimates of product availability and estimated future demand and market conditions. Additionally, because of lower sales volume estimates and the reduced product life, we determined that we would not realize our related investment in prepaid royalties and, therefore, fully expensed this asset.
Water. Gross profit for Water increased $1.6 million, or 15%, to $12.4 million for the three months ended June 30, 2008 from $10.8 million for the same period of the prior year due to higher revenue, partly offset by a decrease in the gross profit percentage to 62% from 63%. The decrease in the gross profit percentage was due primarily to greater relative sales of lower margin products, consisting primarily of water testing kits manufactured by Invitrogen, and higher relative sales in geographies where products are sold at lower unit prices. These unfavorable impacts were partly offset by lower overall costs of manufacturing and the impact of foreign currency rates on sales denominated in those currencies, net of foreign exchange hedge contract losses and foreign currency denominated expenses.
Production Animal Segment. Gross profit for PAS increased $3.1 million, or 28%, to $14.4 million for the three months ended June 30, 2008 from $11.3 million for the same period of the prior year due to increased sales volume and an increase in the gross profit percentage to 67% from 60%. The gross profit percentage in 2007 was depressed by 1.5% as a result of purchase accounting for inventory acquired with the Pourquier business. In an acquisition the finished goods inventory is assigned a fair value that exceeds replacement cost, which results in a low gross margin on the sale of those finished goods. Additional improvements in the 2008 gross profit percentage resulted from the impact of foreign currency rates on sales denominated in those currencies, net of foreign exchange hedge contract losses and foreign currency denominated expenses, partly offset by the impact of lower average unit sales prices.
Other. Gross profit for Other operating units increased $0.6 million, or 19%, to $3.5 million for the three months ended June 30, 2008 from $2.9 million for the same period of the prior year due primarily to increased sales volume and to an increase in the gross profit percentage to 43% from 41%. The gross profit percentage was favorably impacted by foreign currency rates on sales denominated in those currencies, net of foreign exchange hedge contract losses and foreign currency denominated expenses and comparatively lower costs of production, partly offset by the impact of lower average unit sales prices due to higher relative sales in geographies where products are sold at lower unit prices.

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

                                     For the Three Months Ended June 30,
Operating Expenses                    Percent of                   Percent of       Dollar      Percentage
(dollars in thousands)     2008         Revenue         2007         Revenue        Change        Change

CAG                      $ 72,993            31.6 %   $ 65,870            33.9 %   $  7,123            10.8 %
Water                       4,131            20.5 %      3,653            21.4 %        478            13.1 %
. . .