Brian P. McKeon - IDEXX Laboratories, Inc. Jonathan W. Ayers - IDEXX Laboratories, Inc..

Erin Wilson - Credit Suisse Securities (USA) LLC (Broker) Ryan S. Daniels - William Blair & Co. LLC Derik de Bruin - Bank of America Merrill Lynch Jonathan Block - Stifel, Nicolaus & Co., Inc. Nicholas M. Jansen - Raymond James & Associates, Inc. Mark Anthony Massaro - Canaccord Genuity, Inc. David Westenberg - C.L. King & Associates, Inc..

Good morning and welcome to the IDEXX Laboratories Third Quarter 2016 Earnings Conference Call. As a reminder, today's conference is being recorded. Participating in the call this morning are Jon Ayers, Chief Executive Officer; Brian McKeon, Chief Financial Officer; and Kerry Bennett, Vice President, Investor Relations.

IDEXX would like to preface the discussion today with a caution regarding forward-looking statements.

Listeners are reminded that statements that members of IDEXX management may make on this call regarding IDEXX's future expectations, plans and prospects constitute forward-looking statements for purposes of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements can be identified by the use of words such as expects, may, anticipates, intends, would, will, plans, believes, estimates, should, and similar words and expressions. Such statements include, but are not limited to, statements regarding management's expectations for financial results for future periods.

Investors should be aware that any forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the company's filings with the Securities and Exchange Commission.

Please refer to these filings for a more detailed discussion of forward-looking statements, and the risks and uncertainties of such statement.

All forward-looking statements are made as of today and, except as required by law, the company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Also during this call we will be discussing certain financial measures not prepared in accordance with generally accepted accounting principles, or GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure is provided on our earnings release, which can be found on our website, idexx.com.

In reviewing our third quarter 2016 results, please note all references to growth and organic growth refer to growth compared to the equivalent period in 2015, unless otherwise noted. In order to allow broad participation in the Q&A, we ask each participant limit his or her questions to one, with one follow-up as necessary.

We appreciate you may have additional questions, so please feel free to get back into the queue. And if time permits, we'll take your additional questions. I would now like to turn the call over to Brian McKeon..

Good morning and thanks everybody for joining us today in our call. I'll be taking you through our Q3 results and our outlook for the full year, and I'll also provide an overview of our preliminary guidance for 2017. Jon will follow with his comments.

We delivered 10% organic revenue growth in third quarter, driven by 12% organic growth in CAG recurring revenues and continued strong premium instrument placements, including benefits from the launch of SediVue, which contributed about 2% to overall revenue growth.

EPS was $0.62 per share, up 29% as reported and 22% on an adjusted constant currency basis, with prior year third quarter results adjusted to exclude impacts from a $0.06 per share software impairment charge. Our business performance continues to track very well.

Today we're updating our 2016 guidance to reflect projected performance at the high-end of our previous revenue growth and EPS ranges. We're now projecting full-year organic revenue growth of 10.5% to 11.5% and EPS of $2.35 to $2.39, or 15% to 17% reported EPS growth.

Our full-year EPS outlook reflects 21% to 23% adjusted constant currency growth, supported by solid constant currency operating margin improvement. We're also raising our free cash flow outlook to about 105% of net income for the full year, reflecting strong progress in reducing inventory levels and a relatively lower outlook for capital spending.

As has been our practice, we are sharing our preliminary P&L guidance for 2017 today, which reflects targeted revenue of $1.910 billion to $1.935 billion, and EPS of $2.77 to $2.93 per share. This outlook reflects expectations for 9% to 10.5% organic revenue growth overall, supported by strong organic gains in recurring CAG Diagnostics revenues.

Our 2017 EPS outlook includes $0.08 to $0.12 per share of projected P&L benefit from implementing new accounting guidance related to employee stock-based compensation.

Adjusting for this impact and currency changes, which will provide a $0.03 per share EPS headwind at assumed rates, our 2017 EPS outlook equates to 15% to 20% constant currency growth consistent with our long-term goals. We'll discuss our 2016 and preliminary 2017 outlook later in my comments.

Let's begin with the review of our Q3 performance by segment and region. Organic growth in Q3 continue to be driven by strong global CAG gains. Global CAG revenues were $385 million, up 12% organically, reflecting strong CAG recurring diagnostic revenue gains across U.S. and international regions, and continued high global growth in instrument sales.

Water revenues increased 9% organically to $28 million, driven by double-digit gains in international markets.

These gains offset relatively softer performance in our LPD business, as strong growth in China and Brazil were offset by lower levels of testing related to European bovine disease eradication programs and reduced health herd screening in Asia. Overall, Livestock, Poultry and Dairy revenues declined 2% organically in Q3 to $30 million. By region, U.S.

revenues were $277 million in the quarter, up 10%, supported by strong growth in premium instrument placements, including benefits from the launch of SediVue. U.S. CAG recurring diagnostic revenues grew 9% organically, net of about 1% of growth headwind related to pure equivalent days in the quarter. Strong U.S.

CAG recurring performance was supported by continued double-digit revenue growth in our U.S. lab business and accelerating consumable gains. Recurring CAG revenue growth continues to be primarily volume-driven, aided by solid net price gains. Average net price gains for U.S.

CAG recurring diagnostic revenues overall are tracking in the 2% to 3% range, supported by our significant product differentiation and enhanced commercial capability, which is resulting in relatively lower levels of discounting. Our U.S. performance continues to outpace solid U.S. market growth, as reflected in our dataset from about 5,200 clinics.

In Q3, patient visits per practice increased 2.3% and revenues per practice increased 5.8% overall, with relatively stronger performance in August and September. International revenues in the second quarter were $171 million, up 11% organically, driven by 17% organic gains in CAG Diagnostics recurring revenues.

The expansion of Catalyst platform globally drove international consumable revenue gains above 20% in Q3. In addition, similar to our experience in the U.S., we're seeing incremental benefits from SDMA that is supporting continued double-digit gains in lab revenues.

Global instrument revenues for IDEXX were $32 million, up 22% organically, supported by 18% growth in premium instrument placements. Globally, we placed 1,214 Catalysts, 814 premium hematology analyzers, and 562 SediVues in the third quarter. In North America, we've placed 490 Catalysts with 292 or 60% at competitive or greenfield accounts.

This represents a 9% year-over-year increase in competitive placements, supporting a 13% year-on-year increase in our U.S. Catalyst instrument base. Please note that in the third quarter of 2015, we benefited from placements of over 200 second Catalysts at U.S. customers, about 100 units more second Catalysts that we placed in Q3 of this year.

While comparisons to higher levels of second Catalyst placements last year constrained overall Catalyst placement growth in Q3, this initiative has been very helpful in supporting continued improvement in U.S. consumable revenue retention rates, which are now tracking at 98% annualized.

International instrument placement performance continues to be very strong as well, reflected in 1,211 premium instrument placements and 269 placements of VetTests. International premium instrument placements were up modestly versus very strong prior year levels, as we begin to lap the international Catalyst One launch expansion.

Strong instrument placement trends continue to support high growth in CAG Diagnostics recurring revenues. Global CAG Diagnostics recurring revenues were $324 million in Q3, up 12% organically. By modality, instrument revenues of $114 million grew 15% organically, supported by higher growth in both U.S. and international markets.

Reference laboratory and consulting services revenues were $147 million in Q3, up 13% organically. U.S. lab revenue gains continued at a strong pace, with 12% volume-driven organic gains supported by benefits from SDMA, which continues to drive strong growth in core chemistry panels.

International lab revenues also posted strong 13% organic growth, with solid performance across markets. Rapid assay revenues increased 2% organically in Q3 to $49 million. As expected, we saw some moderation in rapid assay growth related to the timing of prior year promotional programs, with overall growth supported by solid gains in 4Dx revenues.

Veterinary software, services and digital imaging system revenues were $29 million in the quarter, up 7% organically, reflecting solid growth at software, service and digital recurring revenues. Turning to the P&L, strong revenue growth and a flow-through drove excellent profit results in the quarter.

Please note that our Q3 2015 financial results included an $8 million software impairment charge. For purposes of the following commentary, we've excluded those impacts when we refer to adjusted comparisons for key metrics. Operating profit was $88 million, up 10% compared to adjusted prior year levels, supported primarily by gains in our CAG segment.

Reported operating profit gains were mitigated by the lapping of $5 million in prior year foreign exchange hedge gains. On a constant currency basis, operating margins of 19.7% were up about 100 basis points, reflecting benefits from gross margin gains and operating expense leverage. Gross profit was $247 million in Q3, up 10% on a reported basis.

Constant currency gross margin gains of 70 basis points reflected benefits from moderate price increases, favorable mix impacts from strong consumable growth, global volume leverage in reference labs, and continued improvements in our software services business. Mix impacts from higher instrument revenues partially moderated these gains.

For 2016, we had a $600,000 foreign exchange hedge gain in Q3 reported in gross profit, which partially offset impacts from the lapping of the $5 million 2015 hedge gain. Operating expenses increased 10% in Q3, slightly below revenue growth levels and relatively favorable to our prior Q3 outlook, reflecting timing of investments.

As noted, EPS was $0.62 per share, up 29% on a reported basis and 22% adjusting for currency impacts and the 2015 software impairment charge. The federal R&D tax credit, which benefited 2016, but not 2015 third quarter results, had a favorable 2% EPS growth impact.

EPS growth continues to benefit from share repurchases, albeit at a moderated pace, which reduced year-on-year share count by 1.9%. In Q3, we repurchased 142,000 shares for $15 million. Year-to-date, we repurchased over 1.1 million shares at an average price of $79 per share.

Given increases in our share price, which raises dilutive EPS impacts and moderation in share repurchases in Q2 and Q3, we expect year-on-year share count will be reduced by about 1% in Q4 and 2.5% to 3% for the full year 2016. As noted, our free cash flow is trending very well and is now projected to be about 105% of net income in 2016.

This performance is supported by lower inventory levels, improved receivable metrics, and an outlook for relatively lower levels of capital spending. Our current outlook for capital spending is $80 million for 2016, or about 4.5% of revenues. Strong cash flows have supported a moderate reduction in our leverage levels.

We ended Q3 with approximately $1.1 billion in debt outstanding, with an average interest rate of about 2.5%, reflecting a gross leverage ratio of 2.5 times adjusted EBITDA within our targeted 2.5 to 3 times leverage range. Cash investment balances were $391 million at quarter-end.

Looking ahead, we're adjusting our full year 2016 guidance to reflect solid Q3 performance and continued strong operating trends. We're adjusting our 2016 revenue guidance range to $1.763 billion to $1.773 billion.

We've updated our foreign exchange rate estimates used for guidance purposes, which resulted in a $2 million reduction in our 2016 reported revenue outlook, primarily related to erosion in the British pound.

This effect partially offset an increase of $10 million to the low end of our previous revenue guidance range, reflecting solid operating trends. Our updated outlook yields of reported full year revenue growth outlook of approximately 10% to 11% and organic revenue growth of 10.5% to 11.5%.

We're adjusting our 2016 EPS guidance to $2.35 to $2.39, which reflects expectations for constant currency margin gains of 21% to 23% adjusting for the 2015 software impairment.

We're on track to post operating margins slightly ahead of our prior 19% full year estimate, which will result in 100 basis points or more of year-on-year constant currency improvement compared to 2015 results adjusted for the software impairment charge.

As noted, we've updated our outlook for FX impacts with assumptions detailed in our press release.

At the updated exchange rates, we estimate that foreign exchange rate changes will reduce year-on-year revenue growth in 2016 by about 1% and 2016 EPS by $0.20 per share, including net impacts from the lapping of $21 million in 2015 hedge gains compared to projected hedge gains of about $4 million in 2016.

We continue to estimate our effective tax rate at 30.5% to 31% for the year. As we finish 2016, we're well positioned to deliver continued strong revenue and profit growth in 2017, consistent with our long-term goals.

Our preliminary outlook is for 2017 revenue of $1.910 billion to $1.935 million [sic] billion (16:06), reflecting 9% to 10.5% organic growth.

This outlook reflects expectations for continued strong gains in recurring CAG Diagnostics revenues, which will offset some moderating impacts as we lap very strong gains in instrument placements, and plan for relatively modest growth in LPD revenues, given current business trends.

Our reported revenue outlook incorporates a 1% growth headwind from foreign exchange at the rates noted in our press release. This will reduce 2017 operating profits by about $4 million and EPS by about $0.03 per share, and create a slight headwind to reported operating margins.

Our 2017 EPS outlook of $2.77 to $2.93 includes $0.08 to $0.12 per share of projected benefit from the implementation of new accounting guidance related to employee stock-based compensation.

Under the new guidance, tax benefits from the exercise of stock-based compensation, which have been reflected in cash flows, will be treated now – in the future as a reduction in reported income taxes in the P&L rather than as an equity adjustment.

In addition, we will no longer assume that the tax benefit is used to repurchase shares in our diluted EPS calculation.

Based on stock repurchase activity over the last two years, we estimate this will be – this will reduce IDEXX's 2017 effective tax rate by – based on share-based compensation activity over the last two years, we estimate this will reduce IDEXX's 2017 effective tax rate by 250 to 350 basis points, and lower our projected year-on-year reduction in shares outstanding from repurchases by about 50 basis points.

Incorporating this new accounting guidance, our preliminary outlook for our 2017 effective tax rate is 27% to 28.5%, and for a reduction in average shares outstanding from continued stock repurchases of 1% to 1.5%, net of the 0.5% accounting impact noted.

We're projecting continued annual share repurchases at a relatively consistent gross leverage level of 2.5 times EBITDA. Our outlook for share count reductions from stock repurchases next year is relatively lower than our long-term goals, primarily reflecting carryover impacts from moderate repurchase activities in 2016.

Adjusting for benefits from the new accounting guidance and foreign exchange impacts, our EPS outlook equates to 15% to 20% constant currency growth. This is consistent with our long-term goals and reflects a targeted 70 basis point year-on-year improvement in operating margins, net of modest headwinds associated with year-on-year FX changes.

We look forward to providing an updated and more detailed review of our 2017 guidance in our year-end conference call. That concludes our financial review. I'll now turn the discussion over to Jon for his comments..

Thank you, Brian, very, very comprehensive. Our strategy of bringing new innovations to our global markets through an enhanced commercial capability is solidly on track. Our strategy's continuing success along with solid continued market growth led to our achieving the 10% organic revenue growth for the company.

As a whole, and as Brian pointed out, the 12% organic growth of our global CAG Diagnostics recurring revenues, which year-to-date comprise about 73% of our total revenues and have some of the most enduring profit characteristics.

We are pleased as well that we are ahead of schedule in our progress this quarter on operating margin enhancement, as demonstrated by the 100 basis points of constant currency operating gains in Q3. Our commercial capabilities in the U.S. continued to gain momentum and we continue to make selective investments in our field-based U.S.

sales and support organization, with about 40 professionals added in the last six months, bringing the total to about 375 professionals. We are expanding the field staffing even as we achieve operating expense leverage, the benefit of even stronger organic revenue growth and productivity and other parts of the P&L.

We also achieved outstanding results internationally including, but not limited to, the important markets of Europe, where we saw a strong double-digit CAG Diagnostics recurring revenue growth, driven by the commercial investments we've made over the past few years.

A couple of key performance metrics illustrate the success that I'd like to highlight. Let's talk about our North American premium instrument installed base, which continues to grow solidly as a result of several factors.

First, we have achieved increasingly strong retention rates of our chemistry instrument customer base in the U.S., where we can now report that Q2 annualized retention was about 98% as measured by revenue, and our Q3 initial data indicates annualized retention is continuing at this 98% level.

This is within 0.5% of the levels that we were achieving just before we announced we were going fully direct in mid-2014. Secondly, in Q3 we placed over 1,400 premium instruments in North America, an all-time quarterly high.

As part of that, we continue to grow competitive and greenfield placements of Catalyst chemistry units in North America, up 9% year-over-year, as Brian mentioned. Finally, SediVue analyzer orders and placements continued to be strong.

SediVue analyzer Q3 revenues benefited both from the Q3 orders and placements against the backlog going into the quarter from the launch earlier in the year. And SediVue placements contribute to growth in recurring revenue. Our current estimates indicate that a SediVue placement generates between $3,000 and $4,500 in annual recurring revenue.

Continuing with the metrics, we reported exceptional global VetLab recurring revenue growth of 15% in Q3. U.S. continued to accelerate in Q3 over Q2.

While we laid plan for SediVue's launch internationally, with placements beginning in UK and Australia in Q4, our teams around the world continues to make exceptional progress growing chemistry and hematology instrument installed base, upgrading VetTest customers to Catalyst, and driving the recurring revenue of instrument consumables.

The exceptional international instrument consumable growth of greater than 20% is a consequence of strong placements over the past year of Catalyst One, combined with deep experienced talent in our country organizations around the world.

Globally, our reference labs and consulting services reported a strong quarter of 13% organic growth, while improving our lab gross margins in the process, a contributor to the company's overall gross margin gains. In our Q2 call with investors, we'll recall how we said that our new kidney function test, IDEXX SDMA was growing our U.S.

reference lab revenues through accelerated growth of requisitions that include chemistry panels. Now, with the experience of another quarter, we can see the same impact in each of our international lab markets tied with the launch of IDEXX SDMA as part of the routine chemistry panel in each market.

This validates that IDEXX SDMA is supporting overall lab revenue growth by offering a unique new value to the chemistry profile. Let me provide a quick update on our new product pipeline. We are on track to introduce our PROREAD software update for SNAP Pro in Q4 this year.

PROREAD will allow the device to automatically interpret results for all SNAP tests. We see increased loyalty to our rapid assay lines when customers adopt SNAP Pro into their workflow. Second, we are also on track to introduce the IDEXX SDMA test for Catalyst, for Catalyst on a Catalyst slide for in-house use in Q4 of 2017.

Excitement about SDMA at the point-of-care is running high. Finally, we're on track to launch a new SNAP using antigen technology to perform in-house fecal test, currently planned for the first half of 2018.

This standard preventative care test is run routinely in the practice today using microscopy, and the SNAP will be able to replace these time-consuming manual in-house methods.

In addition to these previously announced innovations, we are excited to announce another menu expansion for our Catalyst platform, this time for C-reactive protein, or CRP, an inflammatory marker. We plan to launch the CRP slide in Q1 of 2017, with a focus on certain international markets.

This new CRP slide highlights yet another proof point of the power of Catalyst as the platform that continues to grow in value, in part through continued market expansion, such as we've had with the additions of phenobarbital, fructosamine, the total T4 slide, and the upcoming SDMA slide.

In summary, our company is executing at a high level, in line with our growth strategy, in a market with enduring growth characteristics. The momentum in the business gives us confidence in the 2017 financial guidance, as provided by Brian. And with that, we'll open the call to questions..

Certainly. And we'll go to the line of Erin Wilson with Credit Suisse. Your line is open..

Hey. Thanks for taking my questions. Could you speak to the competitive dynamics across the reference laboratory business? At this point, what sort of share gains do you think are attributable to SDMA? And could you break out maybe the growth rates across the U.S.

reference laboratory business and international and how we should think about, I guess, that SDMA dynamic once it's offered in clinic? Thanks..

Thank you. Let me just take the last part of that question first. We're very excited – there is a lot of excitement with our customers that we will be offering SDMA on a slide for our Catalyst platform in about a year's time. Many customers run their full chemistry panels in-house and are waiting for the opportunity to add SDMA to that panel.

And so, we actually believe, as in many cases where testing begets more testing, that by offering it in-house, we're going to actually expand the awareness and the understanding of the clinic utility of SDMA. And, of course, there are many markets around the world where we don't have a ready reference lab option.

And so, this will, of course, be value to our over 20,000 Catalyst customers on a global basis. The competitive environment in the U.S. is always intense. It remains intense. We operate in an environment with a very, very capable competitor. We're pleased with our double-digit U.S. gains in the reference lab.

Some of that's coming from expanded utilization of our expanse of menu of tests with our existing customers. Some of it's coming from volume gains that are beyond that, and of course, we're getting some price realization..

And, Erin, we mentioned that the U.S. organic growth in labs was 12% and the international growth was 13%..

Great. Thanks. And a follow-up on fundamental demand trends. You mentioned strength in August and September being, I guess, a little bit stronger. What about quarter-to-date? And do you have, I guess, any view on the sustainability of the trends here? What is reflected in your 2017 guidance as it relates to fundamental demand? Thanks..

Yeah. We really see it is a steady market. I mean, we saw a nice 5.8% growth in clinic – in practice revenue that's measured by 5,200 data points, so it's a pretty good number of observations there. I think that was a pretty good number for Q3. And so, I think it's steady as she goes.

We really don't – your guess is as good as ours with regard to the general economy. But I think as we look at all the trends, we see a continuation of the fundamentals we've seen in this market for the past year or two, and that's what's embedded in our outlook for 2017..

Erin, I think, year-to-date the – that same metric Jon referenced is up 6.6%. We saw market growth north of 6% in August and September. It was a little bit softer in July, but I think to Jon's point, we're seeing – we've seen continued solid trends, and that's what we're assuming next year..

About a third of our Companion Animal Group revenues, of course, come from outside the U.S. And when we saw nice, strong double-digit recurring revenue growth in Europe – I think a market most people would say isn't the most exciting in the world – not that strong or different than the U.S.

market, but it really shows that I think we can grow this market through innovation. People are willing to spend money on their pets. That is an enduring trend. And it can happen in markets around the world, and Europe being the prime example..

And to your question on SDMA, as Jon noted, we saw a similar uplift in international markets to chemistry panel growth. Now that we've got the SDMA marker, we're kind of building traction and understanding within the market. So that we're seeing the same kind of supportive benefits to our lab growth.

And as a reminder, we had projected over longer term, we think, that SDMA can add about 2% to our lab growth rate..

Okay, great. Thank you so much..

Thank you. And our next question comes from the line of Ryan Daniels with William Blair. Your line is open..

Yeah. Thanks for taking the questions and the details thus far. I wanted to ask a few follow-ups on SediVue. Jon, you mentioned in your prepared comments, I believe you're seeing consumable streams annually run at $3,000 to $4,500.

I'm curious if you can remind us how that is trending, one, versus expectations, and number two, if there's any confounding factors there like the early adopters perhaps driving better growth of being bigger clinics..

Thank you. First of all, the market response to SediVue has been really quite impressive, combined with, I think, an extraordinarily capable commercial organization in North America.

And I think we're hitting a – we're addressing a pain point of manual urinalysis or the issues associated with sending out samples and seeing the decay in the clinical value of urine as it passes over time and analyzed at the reference lab. So we're very pleased with the placements.

What we're doing is we're giving you early indicators of what we believe to be the consumable growth per placement, and we are very excited about the long-term outlook for SediVue, given that we're selling SediVue into practices large, medium and small.

And so, the $3,000 to $4,500 is within the range that we provided before we'd launched SediVue and didn't have any field experience. And we wanted just to provide a little bit more refinement on that now that we've got four, five months of – really actually only four to five months of experience in the field..

Okay, great. And then I guess a follow-up on that.

Is SediVue opening up IDEXX to new accounts? Or maybe asked differently, are SediVue installs yet going to new customers, given the novelty of that product and some of the workflow benefits, or have you focused more with the sales on just meeting demand from your existing customers, and then the share gains could be in quarters to come?.

Thank you. I believe that SediVue was one of many contributors to the 9% growth in competitive Catalyst placements. But, of course, we have large number of IDEXX customers that want to adopt the newest technology, and so we want to serve them too.

So, a portion, less than 50% – well, less than 50%, a portion of those SediVues are going to accounts that do not have our other in-house equipment, and sometimes they add. The other in-house equipment is part of the placements.

Sometimes that equipment comes later, because, of course, once we place the SediVue into an account which doesn't have in-house equipment, they get the IDEXX VetLab Station -- comes with it, and they begin to see and appreciate that highly differentiated value of our integrated offering and things like VetConnect PLUS.

It really opens the conversation to differentiators. So, clearly, SediVue along with innovations such as SDMA is giving us access to accounts that want to learn about this technology, an access that we didn't previously have when we were talking about our more traditional in-house chemistry and hematology..

Okay, great. Thank you..

Thank you. Next we'll go to the line of Derik de Bruin with Bank of America. Your line is open..

Hi. Good morning..

Morning..

Hey.

Just on the tax adjustment, so my understanding is – and this is going to be something that's going to be recurring going forward, so we should think about the lower tax rate in 2018 and beyond?.

Yes, that's right. This is – to make it a little simpler to understand, in our cash flow statement you'll see the tax benefits that flow from when employees exercise their stock-based compensation. And going forward, this change has no impact on cash flow, but now – it used to flow through equity, now it will flow through the P&L.

There's a little bit of an offset, where in our diluted EPS calculation you would assume that cash flow will be used to repurchase shares, and that will no longer be the case going forward. So, that $0.01 per share benefit that we gave is the net of those two numbers. I would highlight this is going to – it's not easy to predict.

It's going to vary quarter by quarter. We're putting out a reasonable estimate based on the activity by quarter we've seen the last couple of years. We'll, obviously, talk and be transparent about that each quarter, but it is something that's going to be a little more volatile in terms of the metric..

And, Derik, just to highlight it. I think Brian is – every company is going to have this....

Yeah..

...a change in the accounting for taxes associated with the options, new guidance. We just want – given that we provide 2017 guidance at this point, we wanted to be very transparent as to what is the impact of this versus the fundamentals of the company. It's just consistent with the way we like to do business..

No, thanks. Appreciate the color on that. And if I can do one quick follow-up.

When you sort of look at your international, and particularly in the UK, are you embedding anything in terms of potential slowdown because of currency movements in the UK or just general consumer weakness in UK? And just sort of how do you think about the UK in 2017?.

Our UK business is on fire. I can't believe how strong. We have an unbelievable team there, and we are not seeing anything. I mean, the only thing we're seeing, of course, is the currency translation effect. But in terms of the impact, what's interesting about this business is the economy might affect it, but our growth rates are so strong.

We grew 5% organically in 2009, which was, of course, was a terrible year globally. And so, I think what's happening in the UK is a combination of all of our innovations with a very, very strong team is really coming together for us, from reference lab to in-house, the launch of SediVue at the London Vet Show. It's very exciting.

I mean, it's a great team and they really are clicking on all cylinders. And so we don't really see any – I don't think we really – I don't know if we could even tell if there was an economic impact, but we certainly haven't seen any in our numbers..

Thank you..

Thank you. And we'll go to the line of Jon Block with Stifel. Your line is open..

Great. Thanks, guys, and good morning..

Good morning, Jon..

First of all, Brian, maybe for you. If you can just talk to the normalized 70 bps and expected op margin expansion in 2017 versus, I think, you called out normalized of about 100 bps in 2016. Really just trying to figure out if maybe that's a sense of conservatism or why the op margin expansion would be slightly less than 2017.

Arguably, you're leveraging the direct sales force, and I also think you'll have a lower mix in instrument revs in 2017 versus 2016. Thanks..

Yeah, those are great points. The 70 bps is basically right at the midpoint of the range that we've been highlighting, the 50 to 100 basis points. There's a little bit of foreign exchange headwind that's taken it down slightly. This is our preliminary guidance. I think we feel good about trends in the business and we do have positive drivers.

As you've noted, we feel comfortable at this point with that outlook. I would highlight, Jon, that we've made significant progress this year reducing inventories, and there's a bit of an absorption headwind that goes along with that. It's a good news story from a cash flow and business management point of view.

It's just there's some temporal impacts on the margin side. We'll peel all of this apart more at year-end. But, I think we're comfortable that we're on track with our long-term goals and can build on the strong operating margin improvements that we had this year..

Yeah, Jon, I would also say that, reinforcing Brian's comments, we're very focused on things like gross margin improvement in our businesses, labs, and the VetLab business being the largest one, and some operating expense leverage, but we're also – the growth is a good thing.

Organic growth is a good thing, and so we don't want to constrain investments that are going to generate enduring organic revenue growth. So, when you take it all together, that's our first step for 2017..

Okay. Perfect, very helpful. And maybe, Jon, just to sort of follow-up on that. You mentioned I think the 40 professionals added over, I believe you said the last six months, sort of maybe a plus 12% count of the sales force in North America. I believe now it totals 375.

Can you just give some details where those reps were added as a broad base? Are they specialists? And then when we look forward, do you think that it really right-sizes where you need to be with the organization? Thanks, guys..

Yeah, thank you for that question. They were in two primary areas. One is we have an elite group of professional service veterinarians. We have literally hired the best across the industry, and we are now at a full complement of 23.

These are field-based professional service veterinarians that run dinner meetings, run CE, call on customers, talk about the benefit of things like SDMA and our clinical advantages, talk about the importance of adding urinalysis to the minimum database and supporting SediVue.

And we now have a full complement of one per region, which reduces their size of geography and allows them to be highly productive. We think it's a really important part of the fact that we're bringing new clinical differentiation to the industry. The other area is an amazing group of field of support representatives.

These are typically very highly capable, either lead technicians of very large practices or practice managers, and we have now moved to 89 of those in place and they are set-up to be one for every two VDC territory, so several per region. And this, of course, shrinks their territories and allows them to be more productive.

These are essential in things like our two-way integration and the integration of SNAP Pro, the adoption of VetConnect PLUS, but of course, they are involved in instrument installations and lab on-boarding. They're not commissioned.

They get great – rave reviews from our customers when they show up, because they provide a lot of value, and they're completely unique to the model of someone in our category of bringing value to the customer.

So, those were really the two areas that we filled out to get to a set that matches our regions and our veterinary diagnostic territory managed coverage..

And, Jon, to your question, I think we're heading towards a good place in terms of our staffing levels. There'll be some year-over-year carryover as we increase some of the levels this year. I would highlight that we do have some enabling investments going on.

As we're expanding the team, we've got an investment in a CRM system that we're putting in place, HRS system. So, it's all within our outlook for margin improvement, but we do have some enabling investments that we're advancing in parallel..

And then I might just finally add that, even with those investments, we've achieved nice leverage in our operating expense in Q3 in the U.S. CAG business..

Understood. Thanks for the color, guys..

Thank you. Our next question comes from the line of Nicholas Jansen with Raymond James & Associates. Your line is open..

Hey, guys. First one from me in terms of 2017 organic growth guidance. I know you'll provide more specifics on the segments, I believe, in January or February when you report full year. But I just wanted to get a better understanding of just some of the other segments, Water, LPD. Obviously, Water has been quite strong this year.

LPD moderated a bit in 3Q.

And I'm just trying to get a better understanding of, if we look at that organic growth guidance for the full year next year, is there any change in terms of CAG outside of just instrument dynamics that we should be aware of or is the – perhaps the slight deceleration year-over-year on organic growth more attributed to the other segments versus CAG? Thanks..

We, obviously, will get more into the color by modality on the year-end call. We did highlight a few things today just as color. One was, we are anticipating continued strong CAG recurring diagnostic growth, which is the key driver of our business. As you noted, we'll be up against some tougher compares on instruments..

SediVue launch..

Yeah, the SediVue launch post-Q1. And we did note that LPD is trending relatively softer. We're seeing good growth in expansion regions and in emerging markets.

But, I think the long awaited kind of slowdown in the disease eradication testing in Europe, we're seeing – quote – the numbers and there has been a lower level of health herd screening testing, which is into China primarily, and that is a small business, but a little more volatile relatively in the contrast of our overall.

So, those were just the factors we're highlighting. But net-net, I think it's much more of a consistent growth story..

Yeah, and I want to thank you for calling out our Water business. They had yet another great quarter. I think we have a very entrepreneurial team, very focused on our customers. They've done a great job this year. And we continue to see – there's a good market for our core products in Water in the U.S. and around the world.

And so, just an awesome business with – it's 95% recurring revenue, 99%-plus, 99.5%; 99.9% customer loyalty and retention and mid-40s operating margin. That's a great business for us..

Great. And then my second question would be on net price realization. It seems like you guys have made some real progress over the last couple of quarters as you've navigated through this commercial reorganization.

But I think that 2% to 3% has been the strongest and sometimes – I just wanted to get a little bit more – a better understanding on kind of sustainability. Obviously that has positive ramifications as you think about gross margin improvement longer term. Thanks..

I think there's two things that really are benefiting from the fact that customers are appreciating that IDEXX's offering and diagnostics is very unique. And it's unique because the innovations first and only innovations that we brought to the market that customers are adopting.

So, we see an improved customer retention that I mentioned, and the flip side of the coin is we see it in modest price realization. We offer SDMA at no incremental charge as part of the standard reference lab panel.

This allows us to get some modest price differentiation, because it's now highly differentiated offering and a major part of the reference lab offering. So, I think those two dynamics are two good things that are consequence of the adoption of the innovation by our customers..

Thank you. And we'll go to the line of Mark Massaro with Canaccord Genuity. Your line is open..

Hey, guys. Thanks for taking the questions. My first is on the rate of international growth that you have in your forecast for 2017. Obviously, you had a blowout Q2, 18% premium placement revenue growth in Q3.

Is it reasonable for us to model in double-digit instrument growth in 2017, or do you think you're more likely to come in a hair below that?.

Yeah, I don't really want to talk about – we're not just ready to talk about details of the different parts of the P&L in 2017. I think it's pretty amazing actually we give 2017 guidance. I don't think too many companies actually do that. But what I will say with regard to international is it'll benefit from the SediVue launch.

Most of the SediVue launches – two important countries, UK and Australia, are happening in Q4. Obviously, they'll really get rolling in 2017, but we'll be launching SediVue around the world over the course of 2017. So, that will be a nice contributing factor to international's performance..

We feel very good about the trends internationally. We'll, obviously, be up against some very strong numbers on the Catalyst placements this year. So just on a reported, we're looking to sustain strong performance, but I think the growth rates, that'll obviously be something we'll factor into the outlook..

And I'll also mention, as I mentioned earlier, that about a third of our Companion Animal Group revenues are outside the U.S. In terms of the SediVue opportunity, obviously, the big opportunity is the launch that we had in the U.S. or North America.

And so the opportunity for SediVue is going to be smaller international, just as the entire market opportunity is small..

Great. And then as a follow-up to SediVue, was wondering if you could comment about where you expect to launch beginning in 2017 beyond UK and Australia. I have to imagine it's probably across other European countries, where you're direct would be my guess and perhaps in maybe Brazil or other faster-growing territories.

Any color there would be helpful..

Yeah. Thank you. Obviously, we're going to be – what I'll make as a general comment, the countries where we have more experience, more – where we're direct, that are larger, these are the markets that we'll roll out first. UK and Australia, obviously, are characteristic of that. They're also, of course, English language countries.

And we'll be rolling – it rolls out over the course of 2017..

Great. Thank you..

Thank you..

Thank you. Next we'll go to the line of David Westenberg with C.L. King. Your line is open..

Hi, guys. Thanks for taking my question. So, most of my questions have already been asked, so I'll just do the one I have left on SediVue.

Can you talk about the way you're looking at utilization in existing in-house chemistry accounts? Sort of asked another way, do you have an initial revenue per Catalyst estimate that you're looking at with the increase of the SDMA slide?.

So, yeah. So, they are related. Okay? SediVue, we think the – the early data that we're showing is the $3,000 to $4,500 per analyzer placement. And on SDMA on a slide, we're still a year away from launch, and we will be charging, of course, for the slide. So, it will be a source of revenue. But we're still quite a ways from that.

It won't be a meaningful contributor to 2017 revenue, given the launch will be in the fourth quarter of the year.

But what I will tell you is it's bringing a tremendous amount of excitement to not only our existing Catalyst base, but to those customers who are considering upgrading to a Catalyst from their current analyzer, be it an IDEXX VetTest or competitive analyzer.

And many of those customers are using IDEXX reference labs already and getting the benefit of SDMA.

And then, to know that they could also use SDMA on their in-house lab if they upgraded to an IDEXX Catalyst is – and to know that that's going to happen in 2017, I think will be beneficial to our competitive Catalyst placements leading up to that launch date..

Great. And just a quick follow-up on that.

Do you think that you're going to see an increase in SDMA spend as we anticipate the SDMA launch?.

I'm sorry. Ask that question again..

Do you anticipate increasing your sales and marketing spend on SDMA in anticipation of the launch on the Catalyst?.

No. I don't think – I think we're – what we've talked about in terms of a great field force that we have today supplemented by the professional service veterinarians and the expansion that we've now completed was really an amazing group.

The best of the best in the industry have decided to come to IDEXX, because we're by far the most innovative company in the U.S. market, regardless of what product lines. There's more to talk about with IDEXX, and that's what is exciting, is actually changing the course of veterinary medicine.

And so, we're already, I think, well facilitated to launch the SDMA on a slide with the resources that we have in place today..

Great. Thank you, guys..

Thank you. We will go the line of Erin Wilson with Credit Suisse. Your line is open..

Can you speak to sort of the opportunity associated with that CRP launch that you mentioned that's going to launch in the first quarter? Are the contributions embedded in your long-term guidance or is this incremental? Thanks..

Yeah, thank you. CRP is a really interesting test, but the test is well understood and appreciated in certain international markets.

And, Erin, in the long term, we don't see any reason why it couldn't be appreciated in all markets, because after all dogs and cats are the same around the world in terms of inflammatory markets, but it's not as appreciated in the U.S. Our focus in the U.S.

is going to be on the assays that we already have in the market, things like SDMA and fecal antigen. But we're going to be offering the slide. A point is there are certain international markets where CRP has already been adopted.

And so, we're going to be launching it worldwide, but it is not going to be – we don't believe it to be a material at all, or a meaningful contributor to our recurring revenue. It will be an incremental value to the Catalyst in placements in these international markets that already see the value of CRP.

And in the long term, we have the opportunity of expanding the appreciation of CRP in other markets including the U.S..

Okay, great. And then one last one. How are your relationships with corporate teams progressing? Any updates on your relationship with Banfield, NVA or other chains out there? Thanks..

Thank you. I think we have – really we don't comment on individual customers, but we have outstanding relationships. It's interesting. The corporate accounts appreciate the value of our differentiators as much as the individual accounts on two dimensions. The first is these help them to grow their revenue.

And second of all, their doctors are seeing the changing standard of cares that we're bringing to the industry and they want to make their doctors happy. And so, we have a great corporate account team, which, by the way, isn't even included in the 375. It's another group of very experienced IDEXX field professionals.

And I think there's really no individual comment I would have. So I'd say, I think our corporate account team is executing very well. We are also doing that around the world. There are corporate accounts in markets around the world and we are attending to their needs..

Great. Thank you..

Thank you. And with that, I'd like to turn it over to the speakers for any closing comment..

Thank you very much. We appreciate everybody's addition to the – coming on to the call. As I said, our company is executing on all key dimensions.

And I just continue to be amazed by our employees' innovation and entrepreneurial spirit, and continue to believe that our unique IDEXX culture consists – that this entrepreneurial spirit is one of our most competitive advantages.

So, I want to thank all of our employees for yet another great quarter and for the work that we're doing to expand the standard of care and support veterinarians in their quest to support the health and well-being of the pets and the families that love them around the world. So with that, we're going to conclude the call. Thank you very much..

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