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

Ryan S. Daniels - William Blair & Co. LLC Erin Wilson Wright - Credit Suisse 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 First Quarter 2017 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 statements.

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 measures is provided in our earnings release, which can be found on our website, idexx.com.

In reviewing our first quarter 2017 results, please note all references to growth and organic growth refer to growth compared to the equivalent period in 2016, unless otherwise noted. In order to allow broad participation in the Q&A, we ask that each participant limit his or her questions to one, with one follow-up if necessary.

We appreciate you may have additional questions, 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..

Thank you and good morning everyone. IDEXX's strong business momentum continued in Q1, driving excellent financial results. In terms of highlights, Q1 revenues were $462 million, reflecting organic growth of 11%, at the high-end of our expectations, supported by very strong 14% organic gains in CAG recurring diagnostic revenues.

CAG recurring revenue gains reflected strong global growth across major modalities, including 15% consumable growth, 13% lab gains and 11% organic growth in rapid assay. We also delivered another strong quarter in terms of expanding our instrument base, with 2,340 premium analyzers placed globally, up 18% from prior year levels.

Strong top line growth, better than expected operating margin performance, and $0.12 per share in benefit from the adoption of new accounting guidance related to tax benefits from share-based compensation, supported Q1 EPS of $0.77 per share or an increase of 53% on a constant dollar basis.

Further adjusting for the impact of the new share-based compensation accounting guidance, comparable constant currency EPS growth was 29%. Reflecting our continued strong business trends, we're raising our full-year organic growth guidance by 0.5%, to 9.5% to 11%.

Along with updated estimates for foreign exchange rates, which improved since our last call, this results in a reported revenue range of $1.925 billion to $1.950 billion for 2017, an increase of $15 million compared to our original guidance.

We're increasing our EPS range by $0.10, to $2.95 to $3.11 per share, reflecting higher estimates for 2017 benefits associated with adoption of accounting guidance related to tax benefits from share-based compensation. Operating profit upside from our higher revenue outlook will be offset by incremental planned investments in our U.S.

commercial capability, U.S. lab capacity and R&D, aligned with the significant opportunity we see to build on strong CAG growth trends and continue to deliver against our long-term goals for 10% plus overall annual organic revenue growth.

We'll manage these investments while delivering a targeted 75 to 100 basis point improvement in constant currency operating margins, at the higher end of our long-term goals.

These operating profit benefits will be offset by a $0.05 per share headwind related to expectations for relatively higher average effective tax rate, excluding share compensation accounting impacts, driven by strong profit growth in the U.S. We'll review our updated 2017 outlook later in my comments.

Let's begin with a review of our Q1 performance by segment and region. We achieved continued strong organic growth in both U.S. and international regions in the first quarter, driven by our CAG business. U.S. revenues were $289 million in the quarter, up 11% organically.

Gains reflected continued strong premium instrument placements and 12% organic growth in CAG Diagnostics recurring revenues. U.S. recurring revenue gains were supported by strong double-digit growth in consumables and reference labs, as well as a very solid quarter for rapid assay sales, driven by our growing 4Dx franchise. U.S.

recurring gains continue to be primarily volume driven, supported by ongoing improvement in customer retention trends across modalities. We also achieved a relatively stronger 3% level of average net price improvement in Q1 benefiting from timing and year-on-year comparisons of promotional programs.

For the full year 2017, we're maintaining an outlook for solid average CAG Diagnostics recurring pricing gains in the 2% to 3% range in the U.S., augmenting strong volume trends. IDEXX's performance continued to significantly outpace solid U.S. veterinary practice market growth in Q1, reflected in our data set from about 5,000 clinics.

In Q1 on a same store basis, patient visits increased 0.7% and clinic revenues increased 4.6% compared to very strong prior year Q1 clinic revenue gains of 9% or a two year average of 6.8%, very much in line with recent trends. International revenues in Q1 were $173 million, up 11% organically.

International results were driven by 17% organic gains in CAG Diagnostics recurring revenues reflecting continued very strong consumable revenue gains supported by our expanding Catalyst instrument base and significant gains in average testing utilization.

We also continued to see solid double-digit organic lab revenue gains in our international markets supported by very positive customer response to SDMA, as well as double-digit growth in rapid assay sales.

Overall international revenue gains were moderated by year-on-year declines in our international LPD business, impacted by lower levels of herd health screening for Asia cattle exports.

Turning to segment performance, our Q1 results were supported by strong global gains across CAG Diagnostics testing modalities and continued momentum in expanding our premium instrument base. Global instrument revenues for IDEXX were $26 million, up 17% organically, supported by 18% growth in premium Instrument placements.

Strong year-on-year instrument revenue growth was driven by SediVue, including benefits from our SediVue international launch in select markets. Globally, we placed 1,131 Catalysts, 822 premium hematology analyzers, and 387 SediVues in the first quarter.

Global Catalyst placements were in line with very strong prior year Q1 levels supported by ongoing international momentum and high levels of competitive Catalyst placements in North America. Placement momentum supported continued global expansion of our Catalyst base which is driving accelerated consumable growth.

Globally, our installed Catalyst instrument base increased 22% year-on-year in Q1 reflecting 11% year-on-year growth in the U.S. and 36% year-on-year gains in international markets. In North America, we placed 388 Catalysts in Q1 with 304 or 78%, at competitive or greenfield accounts.

Overall North America Catalyst placements in the prior year first quarter included 131 second Catalyst placements as part of our successful customer retention program compared to 59 second Catalyst placements in Q1 of 2017.

Adjusting for second Catalysts, year-on-year Catalyst placements grew solidly in North America, supported by 18% gains in competitive placements. Consistent with our economic value focus and our sales compensation approach, we also saw excellent results in the placement of SediVue and SNAP Pros in North America.

Strong customer response to our new ProRead capability supported the placement of 1,041 SNAP Pros in North America in Q1, our strongest quarterly performance since the SNAP Pro launch in 2014.

The combined impact of accelerating customer penetration and the beneficial network effect of integration across our offerings sets the stage for continued strong recurring revenue growth and very high customer retention.

Benefits from IDEXX innovation and enhanced commercial capability continue to drive very strong recurring CAG Diagnostics revenue growth. In Q1, global CAG Diagnostics recurring revenues were $347 million, up 14% organically.

Reference laboratory and consulting services, with revenues of $159 million, grew 13% organically in the first quarter supported by double-digit organic gains in both U.S. and international markets compared to very strong 15% organic growth in Q1 of 2016.

Please note that our organic growth metrics do not include adjustments for the number of equivalent days in the quarter. Instrument consumable revenues of $124 million in Q1 grew 15% organically supported by continued 20% organic gains in international markets and strong double-digit growth in the U.S.

including building benefits from the expansion of SediVue. Overall, SediVue contributed 1.6% to global consumable gains in the quarter.

Rapid assay revenues increased 11% organically in Q1 to $48 million supported by continued solid volume gains in SNAP 4Dx Plus, strong growth in specialty rapid assays, stabilized volume trend in first generation products as well as solid net price improvement, including favorable year-on-year comparisons in Q1 related to U.S.

promotional programs which supported both higher price and volume realization in Q1. We're targeting mid-single digit organic growth in rapid assay revenues for the balance of 2017. Please note that these results do not include revenues from SNAP Pro placements which are captured in instrument revenues.

Veterinary software, services and diagnostic imaging system revenues were $30 million in the quarter, up 4% organically. Solid VSS gains were driven by continued penetration of recurring services in our Cornerstone installed base, moderated by lower instrument placement revenue as we transition to a recurring cloud-based service model.

Diagnostic imaging system revenues also increased solidly supported by growth in digital radiography placements and recurring services, including growth in our Web PACS platform. Livestock, poultry and dairy revenues of $29 million declined 5% organically in Q1.

Results were pressured by lower levels of herd health screening of Australian and New Zealand dairy cattle for export to China. This is a relatively small business for us, which can be subject to more volatility based on local market conditions.

Excluding herd health screening impacts, LPD revenues were flat year-on-year in Q1, as solid gains in recurring core products and double-digit gains in pregnancy testing were offset by pressure on our dairy business, in part related to lower milk pricing globally.

As noted on our Q4 call, for 2017, we're targeting flat to modest growth in LPD overall, as we continue to work through pressures from year-on-year comparisons for select product lines. Our water business revenues grew 7% organically in Q1 to $25 million, up against a strong 11% growth comparison in Q1 of 2016.

Performance was supported by continued progress in developing our core U.S. and European markets and strong growth in Asia Pacific. We continue to be on-track to sustain high-single-digit organic growth in this highly profitable business.

Turning to the P&L, operating profit in Q1 was $92 million, up 25% as reported or 28% on a constant currency basis, with the results driven by strong profit gains in our CAG business. Operating margins were 20%, up 260 basis points on a constant currency basis, reflecting solid gross margin improvement and significant operating expense leverage.

Excellent Q1 performance puts us on track to deliver constant currency operating margin improvement this year at the higher end of our long-term goal of 50 to 100-basis point annual gains, while we advance investments to sustain our strong organic revenue growth trajectory. Gross profit was $258 million in Q1, up 13% on a reported basis.

Adjusted for foreign exchange impacts, gross margins increased 150 basis points, reflecting solid CAG net price gains and volume leverage from strong consumable and reference lab growth. Foreign exchange hedge gains, which benefit gross profit, were about $1 million in Q1.

Operating expenses in Q1 were up 8%, driven primarily by investments in sales and marketing resources and enabling information technology capability. Q1 expense growth was lower than projected, reflecting timing of select head count additions.

We expect higher levels of operating expense growth for the balance of the year as we advance incremental investments in U.S. commercial capability and towards R&D initiatives which we'll discuss as part of our updated 2017 financial outlook.

EPS in Q1 was $0.77 per share, including $0.12 per share in benefit from adoption of new accounting guidance related to share-based compensation.

Tax benefits from share-based compensation were high in Q1 reflecting a combination of factors, including the significant recent appreciation of our stock price, Q1 vesting of stock option and restricted stock grants, and higher levels of activity in 2017 relating to the expiration of specific stock compensation grants.

For the full-year, we now expect benefits from the adoption of the new accounting guidance in the range of $0.22 to $0.26 per share or $0.10 per share higher than our original estimates.

Please note that we do not estimate that this higher level of activity will flow through to future periods as we believe that a range of $0.12 to $0.16 per share of annual benefit reflects a reasonable estimate for 2018 and beyond based on our current visibility and analysis, assuming current stock price levels.

Aside from the benefits from the new accounting adoption, Q1 EPS results were supported by continued benefits from share repurchases, which lowered year-on-year shares outstanding by 0.9%, net of a 0.5% negative impact, related to the adoption of the new share-based compensation accounting guidance.

Our effective tax rate was 18.5% in Q1, including 13.2% of tax rate benefit from share-based compensation accounting adoption. Foreign exchange net of hedge impacts in Q1 2016 and 2017 lowered operating profit by $2 million and EPS by $0.01 per share in the quarter. Free cash flow was $8 million for 2017 in Q1, reflecting normal quarterly seasonality.

We continue to maintain a full year outlook for free cash flow of about 95% of net income, aligned with projected full year capital spending of $90 million. Our outlook for continued strong free cash flow generation aligned with our very strong business momentum, supports allocation of capital to share repurchases.

In Q1 we repurchased 400,000 shares in the open market at an average price of $130 per share, or a deployment of $51 million in cash flow. We ended Q1 with $1.268 billion in debt outstanding, $400 million in cash and investment balances and $178 million in borrowing capacity available under our revolving credit facility.

Our leverage ratios as a multiple of adjusted EBITDA were 2.7 times gross and 1.8 times net of cash and investment balances. We anticipate maintaining gross leverage ratios in the 2.5 times to 3.0 times range in 2017, with continued deployment of excess cash flow toward share repurchases.

Turning to our 2017 outlook, as noted, we're increasing our full-year revenue and EPS guidance range.

We are raising our reported revenue guidance by $15 million to $1.925 billion to $1.950 billion, reflecting a higher expectation for organic revenue growth of 9.5% to 11% as well as about $5 million of revenue benefits from relatively more favorable FX rate changes.

At the updated FX rates noted in our press release, we're now projecting that our reported revenue growth will be reduced by about 1% in 2017 related to year-on-year strengthening of the U.S. dollar.

FX changes are projected to reduce 2017 operating profit by about $6 million and EPS by $0.05 a share at the assumed rates net of a projected $6 million or $0.05 per share benefit from previously established hedge positions.

In terms of our operating margin outlook, we're projecting annual improvement on a reported basis of 60 to 85 basis points, which equates to 75 to 100 annual basis point improvement on a constant currency basis.

This constant currency outlook is relatively higher than our original guidance and it's at the high end of our long-term annual operating margin improvement goals.

We'll be delivering this strong performance while advancing about $10 million in incremental investment related to expanding our regional customer-facing capability in the U.S., adding capacity to support continued strong U.S. laboratory services growth and advancing our R&D agenda. Jon will talk more about these initiatives in his comments.

We see these as very high-return investments aligned with the very strong organic growth potential that we see for our business. As noted, we're raising our 2017 EPS outlook to $2.95 to $3.11 per share, an increase of $0.10 per share, to reflect benefits from updated estimates for the adoption of the new accounting guidance.

While we're expecting $0.03 per share in EPS upsides from flow-through of stronger organic growth expectations, while covering planned incremental investments and $0.02 per share in benefits for an improved FX outlook, these upsides will be offset by the $0.05 per share negative impact related to increase in our underlying effective tax rate.

Regarding the adoption of the new accounting guidance related to share-based compensation, on our Q4 call, we had estimated that our effective tax rate for 2017 would be about 30.5% to 31% prior to these impacts, similar to prior year levels.

Given very strong profit growth trends in the U.S., which carry a higher effective tax rate, we are now increasing this estimate for 2017 to 32.0%.

In terms of benefits from reflecting the tax deductibility of share-based compensation in our P&L under the new accounting guidance, we are raising our expected tax rate benefits on this front in 2017 by 2%, to 5.5% to 6.5%. This results in an updated estimate for 2017 full year effective tax rate of 25.5% to 26.5%.

As noted, a portion of this tax rate benefit in 2017 is related to specific factors, including the timing of the exercise of options, which are not expected to carry over into future periods.

At this stage, we believe an estimate for an effective tax rate of 27.5% to 28.5% is reasonable for years post 2017, based on our analysis of future vesting schedules and historical activity. This assumes no change in U.S. corporate tax policy.

We'll provide updated estimates on this front later in the year as we share our preliminary guidance for 2018. Our outlook for share count in 2017 is for a reduction in average shares outstanding from continued stock repurchases of 1% to 1.5%, net of a 0.5% accounting impact.

As noted, we expect to maintain our gross leverage ratios at 2.5 to 3 times adjusted EBITDA in 2017, resulting in net interest expense of $32 million to $33 million.

In terms of our second quarter outlook in 2017, we expect Q2 revenue – reported revenue growth in the 7% to 8% range reflecting organic gains of 9% to 10%, offset by about 2% of FX headwind. Keep in mind that we'll be facing some tougher growth comparisons related to the U.S.

SediVue instrument launch which will moderate reported instrument revenue gains as well as favorable Easter timing last year. Year-on-year operating margin improvement in Q2 is expected to be flat on a reported basis as we ramp the incremental U.S. commercial investment including impacts from some upfront costs.

And looking ahead to Q3 and Q4, please also keep in mind that we will have about 1% of revenue headwind due to year-on-year comparisons in the number of equipment business days. This impact is factored into our updated full-year guidance. That concludes the financial review. Let me now turn the call over to Jon for his comments..

Thank you, Brian. We are indeed off to a great start to the year. I note the 14% constant currency growth of our CAG Diagnostics recurring revenues in Q1 which make up 72% of IDEXXs total revenues and is the core driver of not just revenue but profitability to IDEXX.

This growth metric exceeded the 13% we achieved in Q4 2016, which itself was the highest growth quarter of 2016 and we had a strong compare in Q1 of 2016 in the U.S. if investors recall.

We had strength in all global geographies and double-digit growth in all three modalities that contribute to these diagnostic recurring revenues; that is reference labs, instrument consumables, and rapid assay tests.

So, a solid start to the year with good momentum, giving us confidence to increase IDEXX's 2017 organic growth guidance by 0.5%, to 9.5% to 11%. Let me turn to a few operational highlights in the quarter.

Our international teams around the world continue to make huge progress placing our franchise Catalyst One chemistry analyzer in all geographies, generating 20% international VetLab consumable growth. This novel chemistry analyzer is high function and low cost. We believe there exists a long runway for instrument placements internationally.

At the end of Q1, our active installed base of Catalysts outside North America has grown cumulatively to over 11,000 instruments and customers. And yet, we believe the potential number of additional customers is roughly five times that amount. And the number of companion animal practices is growing every year, so, many years of growth ahead for us.

In addition, we are seeing very nice double-digit growth in our reference labs in our core markets of Europe, Australia and Japan. In many international markets, SDMA adoption and appreciation has been even quicker than the North American markets.

While this is driving reference lab growth, it also bodes well for when we launch SDMA on the Catalyst analyzer in the form of a slide, currently targeted for the end of this year. Our Companion Animal Group North American sales organization also had a great quarter.

During the quarter, our North American team moved to a new compensation approach to reward for instrument placements where we give our sales professionals credit for the economic value of a placement to IDEXX over a multi-year timeframe, which recognizes not only the value of the instrument placement but the recurring revenues that comes from each type of placement and the profitability of those revenues.

I am very pleased that our teams made a nice transition to the new approach.

And we saw a 14% jump in field productivity and instrument placement value in Q1 when viewed on an apples-to-apples basis, i.e., based on the economic value of instruments placed in Q1 2017 versus the implied economic value in Q1 of 2016 and adjusting appropriately for SediVue, where last year, we generated orders in Q1 but did not start placements until Q2.

It's great to see this productivity jump as it was the driver of 18% growth in competitive Catalyst placements and very strong placement level for over 1,000 SNAP Pro devices. SNAP Pro placements also benefited from the new software functionality in Q1 that automatically interprets the SNAP.

Customers that are actively using their SNAP Pros for their SNAP devices are very loyal to our family of rapid assay tests and these placements are growing that cohort of loyal customers. While our U.S.

commercial teams in the field and those supporting them did a great job with instrument placements, they also continue to drive strong double-digit growth in reference labs growing the market and convincing new accounts to join the IDEXX SDMA revolution. Indeed, our fully direct presence in the U.S.

has been so successful that we've made a decision to further augment our field presence. We are expanding our field commercial organization in the second quarter, adding three new regions and a total of over 45 new field-based professionals, growing our field presence by 12% from roughly 390 professionals to over 435.

We're also growing our reference lab capacity to better serve our customers as well as slightly augmenting our R&D investments. Collectively, this $10 million additional investment in 2017 is something we can do and still expand our constant currency operating margins above prior guidance, courtesy of strong accelerated revenue growth.

We know the investments in customer presence, customer experience and innovation in the core U.S. companion animal market has a high ROI. Our recent investments have a clear and proven track record of return in the form of profitable augmented growth in recurring diagnostic revenue.

On the technology front, we've now completed our rollout of the more advanced SediVue algorithmic interpretation software to our installed base of customers, courtesy of the fact they're all connected via SmartService and we've gotten tremendous customer feedback.

The software update that we call Neural Network 2.0 takes a machine learning approach that incorporates over 14 million images that our customers have generated and sent to us via SmartService over the nine months in 2016 that the product had been in the field. Neural Network 2.0 makes great strides in the instrument's capability but were never done.

We continually upgrade our instruments with new software, new capability and occasionally new menu. And SediVue is no exception. There will be even more to come. The reception of SediVue, now with Neural Network 2.0 gives us confidence in our target of over 2,000 SediVue placements globally in 2017.

As I mentioned, we remain on track to launch SDMA on a Catalyst slide by the end of the year which will be huge. And our new SNAP fecal test in mid-2018, which we view as another long-term blockbuster. No question that our pipeline of novel diagnostic tests, systems and software remains robust. Our strategy is about enduring, profitable growth.

People love their pets the world over and want to take care of them. And yet, veterinary services are vastly underutilized, including the all-important diagnostics category, which after all is essential to determining a pet's health status, since pets can't tell you what's wrong.

Our strategy is to work hard to fill the gap between current practice and this potential. This is going to take a long time, years if not decades. The trends are both huge, somewhat tectonic in pace and long-term in nature, driving both long-term secular growth well above the growth of the general economy and profitability for IDEXX.

IDEXX is at the tip of the spear in driving this growth with our technology and software solutions and the great teams in markets around the world.

I want to conclude the up-front comments with just a huge thanks to our IDEXX employees across the company and around the world who delivered such a great quarter, and to our customers for their continued confidence in partnering with IDEXX to support their clients with the important bonds we all have with our pets.

So, at this point, we'll open it up to Q&A..

Thank you. And our first question will come from the line of Ryan Daniels with William Blair. Your line is open..

Yeah. Good morning, guys. Thanks for taking the question. Jon, one for you. Given the significant OUS opportunities, specifically with instruments that you discussed, can you talk a little bit more about the balance between investing more of the upside into the U.S.

customer-facing organization and spending those dollars outside of the U.S.? And then, number two, I'm just curious if any of this is due to competitive actions in the U.S.

market, or if it's more just the expected return on investment versus any externalities you're seeing?.

Yeah. It's a wonderful situation, Ryan, because we really see attractive markets, of course, in the U.S. which is, by the way, two-thirds of global market today, as silly as that seems, for Companion Animal Diagnostics, and great opportunities really around the world.

As you know, in international geographies, over the last several years, we have moved to more and more of a fully direct presence in many countries and roughly 70% of our Companion Animal revenues outside the U.S. are now sold through direct organizations and 30% through hybrid or distribution.

We think at this point we're about at the right mix, but those have been some very significant investments. And now we're seeing the return on those investments. And they're led by – outside the U.S.

They are led by just the exceptional opportunity we have for Catalyst placements and they're – it's a high growth, and I think we feel comfortable with the growth and investments we're making there. In the U.S. market, we're just seeing a tremendous response to our innovation portfolio. The U.S. market is a more sophisticated market.

But it's shocking, Ryan. We estimate that only 7% of clinical visits, a chemistry panel, just a chemistry panel is run. Only 7%, and yet best practice, evidence-based medicine would suggest that preventive care, including routine wellness testing is really appropriate given we find things.

So, that 7% is just a small fraction of where we think it could be. And the responses we're seeing to things like SDMA or SediVue, or now the incredible response to the SNAP Pro, which is primarily a U.S. market because, of course, it leverages the rapid assay behind, means that the constraint here is more customer presence.

And so, based on the momentum we have in the U.S., we think that augmenting our investments here is going to help us support our 10%-plus organic growth of the company as a whole into future years..

Ryan, I'd just reinforce too. This is an investment that's based on an opportunity and a return from the opportunity. It's not a reaction to other dynamics. As you know, this is our core business. We know it well.

And this is what we love to invest in, and when we see the opportunity for incremental growth and incremental return, we very much would like to invest towards that for – on an ongoing basis..

Yeah. It's just – kind of building on that comment, Ryan. We're not a company that makes a lot of acquisitions. I mean, we make acquisitions when they fit into our core strategy. We're very interested in it, but there's just not that many to do. So, our types of investments we're making are – they're more organic, but we think that has the best ROI..

Okay. That's helpful. And then one more follow-up. Could you talk a little bit more about instrument placements into competitive accounts you've made over the last one to two years. I know some of your competitors have talked about those opportunities reopening for them.

So, I'm curious if you have data on retention for some of the accounts that you have displaced over the last year or two? Thank you..

Yeah. We measure the retention trends for our instrument customer base as a whole. And we've seen an improving trend in those retention levels for the consumables that come from our instrument customers and we're around – and that's improving every quarter, at low rates at this point. But we're at 98% retention.

So, that's – and this quarter is a little better than last and last quarter is a little better than the quarter before. And so, we're pleased with that and....

Yeah. I'd expand beyond that to say it's not just instruments, it's across modalities. We're seeing improving retention trends in the U.S. in reference lab, consumables, rapid assay. And it's one of the things that's helping our underlying growth. It's also helping improve our underlying net price realization.

It's a very positive trend and goes back to some of the comments we were making about the network effect that, as we're bringing together different instrument solutions through integrated systems architecture and have invested well above $100 million plus ahead of the industry on these types of initiatives over time, we're seeing the benefits of that.

And, I think, that aids retention and will continue to aid retention going forward..

Yeah. The other thing, Ryan, we're seeing is we've shared this metric from time to time, the percentage of our customers that we believe are loyal customers or significant customers for both our in-house and reference lab. And, I think, several years ago, we said that was in the high-30%s, 36% to 38%, depending on what year you picked.

We're now at 47% of our customers who are loyal in one or the other or both of the in-house instrument and reference lab, are loyal in both. It's an interesting number because it has grown, but it's still below 50%, which just shows how much runway we have ahead to continue to build a complete diagnostic experience with our customers..

Great. Well, thank you for that. That's helpful color..

Thanks..

Thank you. Our next question comes from the line of Erin Wright with Credit Suisse. Your line is open..

Great. Thanks so much. You mentioned some underlying or better underlying margin improvement in your updated guidance net of the incremental investments that you're making.

And is that just a function of the improved organic growth profile or is there other initiatives going on? And as we think about the longer term drivers of profit improvement, where do you see some of the more meaningful opportunities near-term? Thanks..

Yeah. Erin, in simple terms, I think we had obviously a great start to the year in the first quarter. And looking ahead, we do see some incremental benefit from the stronger organic growth profile that we've highlighted, which is offset by the $10 million of incremental investment that we're advancing.

And the net of that is it's a bit better than where we were in our original guidance, and it's at the high-end of our long-term goals. I think our long-term goals are consistent with where we've been, which is we see the opportunity to sustain 50 to 100 basis points of annual margin improvement.

We think the gross margin will be a key driver of that, aided by strong growth in recurring revenues, CAG Diagnostics revenues, as well as productivity in areas like our lab business, ongoing improvement there.

And we think that we can also get operating expense leverage as we continue to invest against the long-term potential of this highly profitable and durable annuity that is at the core of our economic model.

So, a similar long-term outlook and we're tracking really well this year as we position ourselves for that 10% plus organic revenue growth goal that we're hoping to continue to achieve..

And Erin, from a modality point of view, obviously, we've got volume leverage and productivity initiatives in our core reference lab networks around the world, the benefit from the double-digit growth we're seeing in the lab business.

And on the VetLab side, obviously, the growth in the – that's a good business and the growth in the recurring revenues of VetLab consumables, both of those augmented by a couple percent price realization and effective management of costs are two of the big – I think between the two of those, it's easily over 60% of IDEXX's total revenues..

Excellent. Thanks. And you mentioned the 45 new reps, I think, you said and some new regions as well. What regions are you adding and how quickly should these reps fully ramp up based on the experience you've seen so far? And just that hybrid versus direct model in your other countries, are you expanding the direct effort elsewhere as well? Thanks..

Yes. Thank you. We go through a systematic process of looking at our account coverage around the country. And it's a pretty complicated process because you have to kind of redraw the lines. So, we see where we see the highest ROI.

And some of that is in having fewer accounts per rep, so that reps can call on those accounts because that's what grows the revenues. And some of it is covering some of what we call the white space which is the – I don't know, roughly 5% or 6% of the country that we don't have direct account coverage because it's highly rural.

We cover by phone, but now we're adding some account coverage. So, this is really the highest ROI places to make those investments. Those 45 reps are, of course, both sales and our field support organization, both of which are highly appreciated by the customers and help drive growth.

It generally takes a quarter for them to get trained and get into those territories. I think they start generating a return after that quarter. So, we're really timing this so we're going to be in great shape for the fourth quarter of 2017, always an important instrument placement quarter. But they grow in productivity over time.

You can just see what's happened, we did the expansion in the beginning of 2015, and we're still seeing productivity growth from that expansion in the first quarter of 2017. So, it's a – you get growth in productivity of those reps.

With regard to your comments of international, we think we're about – right now in terms of the 70% direct and 30%, now 30%, many of those, we do have a strong in-country presence, but we also work with distribution. Sometimes they provide logistics or collections or sometimes there's a full presence.

And supporting our distributors is – these are generally more emerging markets and – or places where it's just not – doesn't make sense to have a direct presence. So, I think we're going to, obviously, be continuing to grow appropriately our feet on the street internationally consistent with the revenue growth.

But I don't see – I think we've made the shifts we want to make in fully direct now for all intents and purposes. I think we have the right mix right now..

Great. Thanks. Appreciate the color..

Thank you. Our next question will come from the line of Derik de Bruin with Bank of America Merrill Lynch. Your line is open..

Hi. Good morning..

Good morning..

Good morning..

So, I actually wanted to piggyback on Erin's question on the gross margin. I mean, certainly 150 basis points improvement, much better than we had thought in the quarter.

Just kind of talk about pacings of the gross margin for the rest of the year and I guess full year expectations for where you think it'll end up?.

Yeah. I think we are targeting continued gross margin improvement. I think that the investments that we're talking about will be relatively more in the OpEx line in terms of how they're going to flow through the year.

So, I mentioned Q2, the net of that will be relatively flat and that is we will have some ramp in the OpEx and some of the lab capacity investments are impacting gross margin, but those, of course, will pay off for us, it's basically they will ramp.

But I think you should expect a profile moving forward in the near term that is margin gains driven by on the gross margin line and where we're reinvesting that in OpEx just given the growth opportunity we see..

I guess, still, staying on – I guess, if you look at sort of the out year expectations on the business. I know you've guided to 50 to 100 basis points for the longer term model.

Is there an opportunity to sort of have a bigger step change than that on a recurring basis? I mean can that go 50 basis points higher over time? Is that – would you need to see a better mix shift in that or just see more adoption of product? I'm just simply saying like is there an opportunity on the margin to see it sustainably go up another 50 or so basis points on an annual basis?.

I think we will continue to drive gross margin improvement. That is a key part of our goals, and I think if we're successful growing the way we think we can on the recurring CAG side. That will aid that dynamic. I think we always have the choice to govern the pace of the investment that we're investing back in the business.

And just building on Jon's earlier comments, I think we want to build this annuity as large as we can make it, and so I think we try to calibrate that expectation to invest in things like the international opportunity and growing the U.S.

market where it makes sense and on balance we still think that 50 to 100 basis points is a – I think it's very much aligned with how we think about managing the business, Derik..

Yeah..

I think we can always change that dynamic over time, but I think given the growth opportunities that we see, the broad range of innovation we're bringing to the market that requires support, not just from commercial resources but from enabling information technology, we think that's a reasonable balance and outlook for the business.

This is clearly a very powerful business model that has a lot of profit potential and – but we think we're balancing that in the right kind of ways..

It's a – building on Brian's comment, it's a virtual cycle, and we can really see that in play in our revised guidance in 2017.

As Brian said, we raised the constant-currency operating margin expansion guidance for the year to the high end of our long term of 75 to 100 basis points, and yet that's with augmented investments which we think will help us with longer term growth of that very profitable recurring revenue, which itself will help us with margins..

Yeah..

So, it's a virtual cycle, and it's driven by an incredible technology portfolio that we have, that quite frankly just gets better and better. I mean, that's what's interesting is, it's gotten better and better over the last five years.

Starting with the launch of really back to launch of ProCyte and then Catalyst One and SDMA and SediVue and there's a whole lot going on in the information technology side, and so, we're really in a – all supported by the fact that people love their pets and are underserved by the veterinary profession today, and meaning that as vets get better at communicating the value of the services that they provide, pet owners respond and that's a lot of what's behind our technology and our commercial investment.

So, it's a virtual cycle and we have long-term goals, and we manage that year-by-year within those long-term goals..

Thank you very much..

Thank you. Our next question comes from the line of Jon Block with Stifel. Your line is open..

Great. Thanks, guys. Good morning. Brian, I'll beat you up offline on how the out-year OpEx leverage isn't better than 50 to 100 bps. I'll focus on two other questions. Maybe the first one, on the reference lab, growth was really solid. The growth rate accelerated.

I think the stacked growth was actually the strongest that I can see in my model looking back 10 years. So, Brian, can you revisit the international versus U.S. lab commentary? And then, Jon, if you can speak to the long-term opportunity within U.S.

reference lab and if you see some opportunities for accelerated market share gains sort of in light of the recent acquisition of Antech by Banfield..

Yeah. Just on the performance, then I'll turn over to Jon, but we said it was 13% organic growth. It was actually a little bit higher than that, and it was comparable growth in U.S. and international markets. And to your point, Jon, I think we were up against some really strong compares.

So, we agree that it was an excellent performance on the lab front, both U.S. and internationally..

Yeah. The growth in reference lab is really three factors. One is that we're getting some price realization. Of course, everybody said, well, why did you offer SDMA at no incremental charge? Well, we did offer it at no incremental charge, but now the chemistry panel that all customers are getting is much higher value.

And that allows us to realize price and realize some of that value in price. The second – and that's not a big number, as Brian said it was, I think, 3% in the quarter, 2% to 3% for the year. That's for all-U.S., but reference labs is a contributor to that, all-U.S. CAG recurring diagnostics. And second is that we are growing our customers that we have.

They're growing. And sometimes, the customers don't give us all their lab business, but they're shifting more of their lab business to us. It's kind of hard for us to measure that. But we are growing our existing customers. Part of it is because they're adopting more testing.

Maybe they're running more chemistry because it's a better case for preventative care. Maybe they are picking up a molecular diagnostics or fecal antigen that they previously were not – they were doing manually or just not doing at all. I mean, they're expanding their standard of care.

And then the third is that we are adding customers and adding more customers at the same time that we're seeing improved retention rates with our existing customer base. Of course, all of that takes field presence to make that happen. It doesn't just happen.

It happens because of our extraordinarily professional sales, professional service vets and the field support representatives that we have in the field that are the face of IDEXX to veterinary practices. And so, we think the opportunity is there on all three of those dimensions to continue to grow.

What is actually – it's interesting, the reference lab is the largest diagnostic modality, largest contributor to our CAG Diagnostics recurring revenue growth..

Got it. Got it. Okay. Helpful color. And then, the other one, Jon, is just on the sales force. I get it, I mean, you're putting up tremendous top line growth, and three or six months is an incredibly quick return for a rep.

But where do you see that number leveling off? In other words, I think you and I talked on the call, maybe nine or 12 months ago, you upped it and you thought you were where you needed to be, and here you're taking another 10% higher, 25,000 vet practices and over 400 reps.

I know they're all not out in the field but that's a big number when your arguably next biggest competitor from a direct basis might be 60 or 70 reps.

So, maybe just looking out, is this something where, hey, you can always add 5% or 10% to sort of continue to augment the top line or should we think about a number out there as a finite number to point to where you think you'd have a fully – a full sales force out there, specific to the U.S.? Thanks, guys..

Yeah. Well, I think what we saw is we have seen the tremendous response to our innovation in the field and yet we believe that the constraint here is time with customers. The more we call on customers the faster they grow. And so, it's a tough call. Okay.

It's a tough call about when or where or what rate to make incremental investments but obviously we're able to do it and expand our operating margin target for the year which is good. I mean, we feel good about both of those. Where will that go going forward? It's a tough call.

The other thing we have going on is we're continuing to see growth in productivity of our field professionals. I just want to correct you on one thing, the 435, those are only the people in the field calling on customers.

They include sales reps, they include our field support representatives are highly valued and they include our professional service and veterinarians. They do not include people on the phone that are sales or support. They do not include managers. They're just field feet on the street. It's a very, very clean metric. And so, we think it's the right call.

Given the incredible response we're seeing, I mean, the over 1,000 SNAP Pros and the momentum in that business, we actually ended the quarter with a backlog, that's just the number that we installed.

That's just – I remember you asking me about SNAP Pros two years ago, why can't we have more SNAP Pro placements? Well, we got more SNAP Pro placements now. And look at the competitive Catalyst, 18% year-over-year growth in competitive and greenfield Catalyst placements. And look at the 14% EVI productivity.

Part of that is coming from the maturation of the sales organization, and part of that's coming from enabling support. We're actually fully moved to a new CRM. We're leveraging the salesforce.com platform, fully implemented now in the U.S.

field organization and highly leveraged by the incredible data that we have that helps the rep support the customer. I mean, they have incredible data at their fingertips now, real-time, that helps them engage in very substantive conversations with customers where they can act like true diagnostic consultants how to expand the testing.

And because now they have these relationships because they have enough customers, they can call on the average customer 10 times over the course of the year. And that's what we achieved in 2016. We see nice – that combined with professionalism and the data that they have at their disposal on our innovation portfolio, we see nice returns on that.

So, it's an art, but we're pleased to be able to do it and expand our constant currency operating margin target..

Okay. Great. Thanks for your time, guys..

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

Hey. Congrats on another excellent quarter. I just wanted to talk a little bit more about the gross margin and particularly with the reference lab.

The strength that you guys have noted in terms of kind of accelerating revenue growth there, I would assume that that has your – one of your highest incremental gross margins dropdown from an incremental test perspective.

So, if I run the math, if one-third of your total revenue is coming from this highly incrementally profitable business, you can get to your 50 to 100 basis points of kind of margin target expansion just in that business alone almost.

And so, I'm just trying to reconcile how we should be thinking about the rest of the business that's also growing double-digits, that's good margin, when we think about the long-term opportunity to expand beyond the 50 to 100 basis points that was reiterated today. Thanks..

Yeah. I do think we see good potential that flows from the incremental growth, as you point out. I think that the – that is offset to a degree by some of the investments that we're talking about and – which is supporting the long-term growth of the annuity.

And on balance, we think that yields the outcome – the outlook for 75 to 100 bps is – of improvement this year is very reasonable in that context. And that's how we look at it kind of in an integrated way.

So, I think we're acknowledging that there is good gross profit improvement potential, particularly for growing the recurring CAG modalities at a good rate. And we anticipate continuing to improve on the lab front as we grow. And so, I think we're aligned with that.

It's just, it really comes back to, I think, fundamentally, how we are choosing to manage the business in the context of the growth potential that we see for the company.

And we are going to balance margin improvement with reinvesting towards the long-term growth potential, and we think that's the way the company has been running for a long time very successfully.

And we continue to see, particularly with the innovation pipeline that we have and the global market opportunity that continues to grow, a lot of opportunity to continue on that path. So, that's how we're choosing to manage the margin equation..

Yeah. Let me comment a little more about the lab. The lab is a very, very operationally intensive, hour-by-hour type of business, very different than our other businesses. And we are good, and we have the opportunity to get a lot better. And we are making systems and other types of investments that will be leverage-able over time.

And it takes a while to roll those out in our different geographies. And we will get very good returns on that. Our primary goal here with the reference lab is to be able to serve the customer consistently and with quality. That is the number one thing that customers care about. They care about that before they care about an advanced test.

So, that's table stakes. And so, we want to make sure that we are world-class in that capability. So, I would say with regard to the reference lab, we see long-term, very significant gross margin expansion in the reference lab, but it happens over time as we both get the leverage but also prioritize the customer experience..

I think Jon is making a very important point, just to give you a sense of maybe the tone of the business right now and how we're managing things. We're growing very, very quickly.

So, to have the kind of consistent double-digit organic growth in our reference labs, to execute that well, our number one priority is to make sure that we have flawless turnaround times and the capacity to do everything that we need to do to support our customers.

And it's not to say that we're not trying to improve as we grow, but that's our first priority and that's certainly where the business context is now. So, on balance, I think we've got a reasonable outlook and we'll continue to try to perform well and deliver against that..

And what it means is there's a lot of long-term runway. It means that the runway is there for many years to come. And it comes back to the enduring opportunity we see not only on the top-line growth but on the margin expansion. It's an enduring number.

It may not be as much as you want in any one particular year but it has a long runway associated with it..

Thanks for the color. And then just quickly on the market stats. I know the industry faced a very challenging first quarter comparison, but the data you presented and certainly one of your largest peer also presented kind of a decel.

And I'm just trying to – how do we think about, is this just a comp issue, or is there something perhaps a little bit going on in the end market after two or three years of pretty rapid growth off of the lows? Thanks..

I really appreciate that question, too, and we measure this with every data source that we can get our hands on, some of which are proprietary to our own systems, and some of which are external validations of all different kinds. And the net of that is we really do not see a change. We don't see a deceleration, we don't see an acceleration.

We see the trends that we have seen over the last several years are intact, the same rate. I think the so called deceleration that you saw in Q1 was really a comp issue because, as Brian said, you take the average two year stack growth, it was 6.8%. So....

6.9%, actually..

6.9%. Yeah. So, I think that you take the two years, add them together, and divide by two.

So, yeah, I think everything that tells us this is kind of steady as you go, 5.5% to 6.5% same-store sales growth market at the practice level – of course there's a little bit of net practice formation that adds to that, diagnostics is growing faster, all those things, but really kind of a steady – as far as we can tell, it's steady..

Thanks. Congrats again..

Thank you. Our next question will come from the line of Mark Massaro with Canaccord Genuity. Your line is open..

Hey, guys. Nice quarter and thanks for the questions. The first one is a two-parter, just to clarify on the investments you're making. The extra 45 people in the field, how many of those are going to the so-called white space versus going into an existing territory? And then the second part of that is on the lab capacity.

How much of that is going to service existing products versus scaling for the future?.

It's mostly greater coverage in existing territories, and a small part of it is white space expansion. And the capacity is really to support the core lab, the existing products..

Great. That's helpful. And then, my second question is on the international launch of SediVue. Can you just speak to some of the opportunities and challenges? The number dipped a bit sequentially. My guess is that might be a timing issue because you have reiterated your goal for 2,000 for the full year.

So, could you just speak to maybe how many placements were in North America versus international in the first quarter?.

There were only 47 placements in international. So the bulk of that was North America placements. And just for clarity, Mark, we very consistently – if you go back over time and look at our premium instrument placements, Q1 is typically less than 20% of the full year number.

And so that, it's very much aligned with our outlook for 2,000-plus placements. We feel we're right on track and it's very consistent seasonality that we've seen in our business for a number of years..

And what I would say about – we think in the near term, SediVue is mostly a North American product, a more sophisticated market and such, but the opportunity we have internationally is they could sell a SediVue or they could sell a Catalyst and get much higher consumables.

So, our teams are still very focused on Catalyst placements, and that's higher economic value or ROI for them.

So, SediVues are typically in the more sophisticated markets that are add-ons to existing customers, but I think you're going to – and we haven't completely rolled out SediVue internationally – it's going to occur over the course of the year.

And so – but I think you're going to see it being mostly in the next couple of years, mostly a North American opportunity whereas Catalyst One is the international opportunity..

Great. Thank you..

Thank you..

Thank you. And our final question will come from the line of David Westenberg with C.L. King. Your line is open..

All right. Hey. Thank you for squeezing me in, and happy Friday..

Thank you. Appreciate it..

So, I'm going to stay away from the margin for you guys, and then just want to talk real quickly about capital deployment strategy. You've been buying back shares a lot in the last year, couple years.

Is that still a primary focus in your capital deployment strategy?.

Yes, we're comfortable. We've had a very successful program. We've bought back $3.2 billion worth of stock at an average price of $27 a share over time. So, this has been a long-term strategy that's had very good outcomes. We look at this on an ongoing basis.

We try to understand our business strategy and the intrinsic value we see in the company, and to the degree that we have cash flow beyond the investments in the core business that we're generating, if we think there's value in share repurchases, we'll continue to allocate capital that way.

That's been our past practice and we continue to have that level of confidence and that's what we were signaling today..

Got you. All right. And then can you talk about, it looks like a little bit of a low volume quarter in terms of veterinary practice volumes, but reference lab and consumables were pretty – you had pretty much a blowout quarter there.

Can you talk about how volumes correlate on a quarter-to-quarter basis with your consumable and reference lab businesses?.

Well, as you can tell, it's not that great a correlation. I think, it's because we're expanding the diagnostic category; whereas, the clinic revenue is the entire revenue of the clinic of all customers, whether they are customers or not. Diagnostics is typically 15% of the total and a growing percent.

So, there are going to be some disconnects between our innovation-based market expansion strategy in the diagnostics and software categories versus the entire practice revenue growth..

Yeah. When we report the market numbers, that's a same-store number for all sales in the clinic, and we believe diagnostics, itself, in the market is growing 1.5 to 2.5 points above that when you add in practice formation and our – the fact that diagnostics is growing quicker. And, of course, we're growing faster than market.

So, I think those are the dynamics that contribute to the differences..

Okay. Perfect. Have a good weekend..

Great. Thanks..

Okay. Thank you. I think that concludes the call. We appreciate all the questions.

Again, I just want to thank everybody who dialed in And, again, congratulate our IDEXXers around the country and around the world for a great quarter and pursuit of the purpose to be a great company, that creates exceptional long-term value for our customers, employees and shareholders by enhancing the health and well-being of our pets, the people who love them, and livestock.

Thank you very much. That closes the call..

Thank you. Ladies and gentlemen, that does conclude you conference call for today. Thank you for your participation and for using AT&T Executive TeleConference Service. You may now disconnect..