IDEXX Laboratories Inc

NASDAQ:IDXX

Earnings Call Transcript 2017-Q4

[Operator]

Good morning and welcome to the IDEXX Laboratories Fourth 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 our discussion during the call will include forward-looking that are subject to risks and uncertainties that could cause actual results to differ materially from those discussed today. Additional information regarding these risks and uncertainties is available under the forward-looking statements notice in our press release issued this morning as well as in our periodic filings with the Securities and Exchange Commission which can be obtained from the SEC or by visiting the investor relations section of our website idexx.com.

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 in our earnings release, which may also be found by visiting the investor relations section of our website. In reviewing our fourth quarter 2017 results, please note all references to growth, organic growth, constant currency growth, and comparable constant currency growth referred 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, 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.

[Brian P. McKeon, EVP, Treasurer, and CFO]

Thank you and good morning everyone. I am pleased to take you through our fourth quarter and full year 2017 results and provide an update on our financial outlook for 2018. We had excellent results in Q4 which concluded another year of outstanding financial performance for IDEXX. We achieved 12% organic revenue growth in the fourth quarter supported by 13% growth in CAG Diagnostic recurring revenues and 15% growth in premium instrument placements. Overall reported revenue increased 14%, aided by favorable year-on-year changes in FX rates.

Our strong finish to 2017 supported achievement of full year organic revenue growth of 10.4% consistent with our long-term financial goals. Results were driven by accelerated 13% organic gains and CAG Diagnostic recurring revenues reflecting strong double-digit growth in U.S. and international markets. Our full year EPS was $2.94 net of a non-recurring $0.34 per share charge related to the enactment of U.S. tax reform. Adjusted for this factor, full year EPS was $3.28, $0.02 per share above the high end of our guidance range. This performance reflected strong top line growth and achievement of full year operating margins of 21%, a 140 basis point improvement year-on-year on a constant currency basis. EPS grew 21% on a comparable constant currency basis in 2017 above our long-term financial goal range for the second consecutive year.

We're well positioned to build on these results in 2018 reflected in our updated outlook for 9.5% to 11.5% organic revenue growth which now includes an estimated $10 million year-on-year benefit from revenue accounting standard changes. We're also maintaining a consistent outlook for 75 to 125 basis points improvement in constant currency operating margins while investing 10 million in incremental operating expense leveraging benefits from U.S. tax reform. Overall strong operating trends, favorable FX rate changes, revenue upside from accounting changes, and significant projected benefits from U.S. tax reform support a $65 million increase to our 2018 preliminary revenue guidance to $2,205 million to $2,245 million and a $0.55 per share increase to the midpoint of our EPS guidance to $4.04 to $4.18 per share.

We'll provide an update on our 2018 guidance later in the call. Let's begin with a review of our fourth quarter and full year 2017 results beginning with an overview of performance by segment and region. Q4 performance was led by continued strong momentum in our Companion Animal Group. Global CAG revenues were 434 million up 12% organically supported by 13% organic gains in recurring CAG Diagnostic revenues and in our veterinary software services and diagnostic imaging businesses. For the full year, CAG revenues increased 11% organically to 1.7 billion driven by accelerated 13% organic gains in recurring CAG Diagnostic revenues.

Livestock, poultry, and dairy revenue of 37 million increased 8% organically in Q4 ahead of our expectations. Results reflected higher than projected year-end government program and distributor ordering and solid gains in recurring revenues supported by growth of our pregnancy platform. These gains were moderated by continued pressure on dairy and swine markets in China which have constrained emerging market gains. For the full year, our LPD revenues were 128 million reflecting relatively flat organic growth. For 2018, we're planning for flat to modest organic growth in LPD [ph] overall consistent with recent underlying growth trends.

Our water business revenues grew 16% organically in the fourth quarter to 29 million aided by favorable comparisons to prior year channel inventory adjustments in advance of our go-direct initiative in Brazil. Adjusted for these changes, we estimate Q4 water organic revenue growth was about 9%. For the full year, water business revenues increased to 114 million, up 10% organically including about 3 percentage points of growth benefit from go-direct initiatives. We're very pleased with our momentum in the water business and believe we're on track for continued high-single digit organic revenue gains in this highly profitable business in 2018.

By region, U.S. revenues were 298 million in the quarter, up 11% organically. Gains were driven by strong 12% organic growth in CAG Diagnostic recurring revenues, despite a 1% headwind from fewer equivalent days. U.S. recurring revenue gains were supported by continued strong double-digit growth in reference labs and consumables and high-single-digit growth in rapid assay sales. U.S. CAG recurring diagnostic price gains continued to trend in the 2% to 3% range with the bulk of our growth driven by volume.

IDEXX's performance continues to significantly outpace solid U.S. veterinary practice market growth reflected in our dataset from about 5,200 clinics. In Q4, patient visits increased 2.0% and clinic revenues increased 6.1% compared to the prior-year period. For the full year U.S. revenues reached 1,204 million up 10% organically driven primarily by our U.S. CAG business, which represents nearly 94% of total U.S. revenues. We achieved U.S. CAG organic growth of 10% in 2017, supported by accelerated 12% organic CAG Diagnostic recurring revenue gains.

International revenues in Q4 were 208 million up 13% organically. International results were driven by 14% organic gains in CAG Diagnostic recurring revenues, reflecting continued strong consumable gains supported by our expanding Catalyst instrument base. International revenues reached 766 million for the full year or 39% of total IDEXX revenues supported by organic gains of 11%. International CAG Diagnostic recurring revenues increased 14% organically for the full year, reflecting double-digit growth across Europe, Asia Pacific, and Latin American regions. Overall, international revenue gains were moderated by flat organic growth in our international LPD business.

In terms of segment performance, our Q4 results were supported by accelerating expansion of our premium instrument base and continued strong global gains across CAG Diagnostic testing modalities. Globally, we placed a record 3,650 premium analyzers in Q4, up 15% compared to prior year levels driven by a 25% year-on-year increase in Catalyst placements and record SediVue results. Q4 results included 1,863 Catalyst placements. This performance reflected 1,300 placements in international markets of 34% year-on-year and 433 placements to new and competitive counts in North America, a 25% increase over strong prior year levels. Consistent with our strategic focus, 77% of North American Catalyst placements were at new or competitive accounts in the quarter.

In the quarter, we also placed 1,040 premium hematology instruments globally, 747 SediVues and 1,630 SNAP Pros bringing year-to-date SediVue placements to 2,267 and year-to-date SNAP Pro placements to nearly 6000. Instrument revenues in Q4 were 37 million, up 2% organically as very strong placement gains offset deferred revenue impacts under 2017 GAAP accounting standards. Our EVI metric in the U.S. was up significantly in the quarter reflecting very strong gains in competitive Catalysts and SediVue placements consistent with our strategy.

For the full year IDEXX made substantial progress in growing our global premium install base. We now have 29,855 Catalysts installed globally, the growth of 22% year-on-year. These gains reflect 37% year-on-year installed base growth in international markets and 10% gains in North America driven by 1,369 placements in new and competitive accounts, a 14% year-on-year increase in North America. International Catalyst placements reached 3,839 this year up 19% and on track with our long-term expansion goals.

Growth in our instrument customer base supported by sustained high retention levels and augmented by continued seller utilization gains to grow continued strong momentum in consumable revenues. Instrument consumer revenues of 134 million grew 14% organically in Q4 supported by robust gains across U.S. and international markets. Our SediVue installed base continues to expand and contributed 2% to consumable growth in the quarter.

Reference laboratory and consulting services with revenue of 162 million also grew 12% organically in the fourth quarter net of the 1% equivalent day headwind. Continued high Reference Lab gains were supported by strong double-digit organic revenue growth in the U.S. reflecting double-digit organic volume gains with existing customers augmented by solid price realization and net customer additions. International Reference Lab gains were solid in the quarter with organic growth at high single-digit rates driven by consistent gains in Europe.

Rapid assay revenues continued to trend very well. Q4 revenues of 46 million grew 10% organically benefiting by about 1% net due to favorable international distributor inventory changes offset by fewer equivalent days. Rapid assay gains continued to reflect solid volume growth in 4Dx and specialty test and continued progress we're gaining share in first generation products in the U.S. Veterinary Software Services and Diagnostic Imaging System revenues were 37 million in the quarter up 13% organically driven by increased penetration of recurring services in our cornerstone installed base and very strong growth in digital radiography placements which were up 24% year-on-year in the quarter.

Turning to the P&L gross profit was 272 million in Q4 or 53.8% of revenues up 13% on a reported basis. Adjusting for foreign exchange impacts gross margins decreased 30 basis points. Continued solid net price and productivity gains were offset by stepped up investments in lab capacity in operations, approximately 1 million of IT related costs reclassifications from operating expense to cost of goods sold, relatively higher year-on-year LPD and water costs, and relatively lower average instrument margins reflecting strong international growth. Certainly these impacts were specific to the quarter and we're targeting continued solid gross margin expansion 2018. Foreign exchange hedge impacts reported gross profit reflected a $1 million loss in Q4 related to the weakening of the U.S. dollar limiting year-on-year net FX gains to about $0.02 per share in the quarter.

Operating profit in Q4 was 98 million up 17% as reported or 14% on a constant currency basis. Operating profit results benefited from strong revenue gains in operating expense leverage supporting a 40 basis point improvement in constant currency operating margins in the quarter. Operating expenses in Q4 were up 11% as reported or 10% on a constant currency basis driven by investments in sales and marketing resources and enabling information technology. For the full year operating profit was 413 million, this reflects an operating margin of 21% or an increase of 140 basis points on a constant currency basis in 2017. This outstanding full year result reflects about 100 basis points of constant currency gross margin gains and 40 basis points of benefits from operating expense leverage benefiting from our accelerated revenue growth.

EPS in Q4 was $0.43 per share including a 31 million or $0.34 per share non-recurring charge related to the implementation of U.S. tax reform, $0.06 per share in benefit from a share based compensation accounting adoption, and less than $0.01 in discrete tax benefit from the expected utilization of foreign tax credits. The $31 million tax reform related charges are current estimates and relates to the deemed repatriation of the company's foreign profits net of deferred tax remeasurement at lower corporate tax rates and other related adjustments. The charge came in below earlier estimates reflecting favorable clarification of specific factors related to deemed repatriation tax impacts for IDEXX.

For 2017 EPS was $2.94. Adjusted to exclude the onetime tax reform impact EPS was $3.28 per share. For the full year foreign exchange rate changes increased revenue growth by 0.3% and reduced EPS by $0.01 per share including FX hedge loss impacts of about $4 million. For the full year adoption of a share based compensation accounting guidance provided 28 million or $0.30 per share and benefit. Discrete tax benefits also contributed $0.04 per share benefit in 2017. Adjusting for these factors 2017 EPS growth was 21% on a comparable constant currency basis.

Free cash flow was 299 million for 2017, this represents free cash flow at 114% of net income or 102% adjusting for the U.S. tax reform charge that includes deemed repatriation taxes required to be paid over eight years. This performance was delivered while supporting 76 million in annual capital investment. Our strong cash flows and continued positive business momentum supported the allocation of 270 million in capital towards share repurchases for the full year including repurchases of 350,000 shares in Q4 for $55 million. This brought our 2017 repurchase levels to nearly 1.75 million shares at an average price of $155 per share.

Of note over the last five years we deployed just under $2 billion to repurchase 28 million shares or more than 25% of the shares outstanding at the beginning of the period for an average price of $70 per share significantly enhancing per share returns for IDEXX shareholders.

Our balance sheet is in a very strong position, we ended the year with 1,266 million in debt outstanding including 606 million in fixed rate term debt and 655 million outstanding under our $850 million revolving credit facility. At year-end we had 472 million in cash and investment balances of which 99% was held internationally. Our leverage ratios at year-end is a multiple of EBITDA where 2.4 times gross and 1.5 times net of cash investment balances.

Turning towards 2018 outlook our growth momentum and disciplined operating performance positions as well to deliver continued strong financial results in 2018 aided by substantial projected benefits from U.S. tax reform. As noted we're raising our 2018 organic revenue growth outlook to 9.5% to 11.5% gains incorporating an estimated $10 million or 0.5% growth benefit from revenue recognition accounting changes. Our outlook is supported by expectations for continued high levels of premium instrument placements and 12% to 14% organic growth in CAG Diagnostic recurring revenues including about 1% of growth benefit to CAG Diagnostics recurring revenues in 2018 for retroactive revenue accounting standards change impacts.

Overall we are raising our reported revenue outlook by 65 million at midpoint to 2,205 million to 2,245 million or reported growth of 12% to 14%. This increase reflects strong operating trends including the flow through of higher than expected 2017 performance. The projected 10 million accounting change benefit and about 35 million of additional benefit from updated rate assumptions for foreign exchange which are reflected in our press release. At the new FX rates we project that our reported revenue growth will be increased by 2% to 2.5% in 2018 related to year-on-year weakening of the U.S. dollar. We're raising our 2018 EPS outlook to $4.04 to $4.18, an increase of $0.55 per share reflecting about $0.06 in upside from strong operating trends, $0.10 of additional EPS related to our updated FX estimates, and an estimated $0.39 per share in net benefits related to U.S. tax reform.

The EPS outlook reflects consistent goals for year-on-year constant currency operating margin improvement of 75 to 125 basis points. We have maintained this outlook while incorporating 10 million of additional operating expense investment and about 5 million of incremental capital investment in 2018 leveraging benefits from U.S. tax reform. This outlook results in comparable constant currency EPS growth of 28% to 33% including an estimated 13% of net EPS growth benefit related to U.S. tax reform.

Our outlook for our effective tax rate in 2018 is now 20% to 21% including an estimated 11 million or 147 million, excuse me, including 11 million to 14 million or about 3% in projected tax rate benefit from exercise of stock based compensation. This outlook reflects projected recurring tax rate benefits to the newest -- the new U.S. corporate tax structure primarily driven by the reduction in the U.S. statutory rate from 35% to 21% net of certain offsets. Our updated outlook for share count in 2018 is for reduction in average shares outstanding from continued stock repurchases of 1% to 1.5% which assumes that we maintain net leverage at approximately 1.5 times EBITDA.

Under U.S. tax reform we will have increased flexibility related to global management of cash and debt balances. Our 2018 projections reflect an assumed optimization of our global net interest costs utilizing excess cash balances over time resulting in an outlook for net interest expense of 35 million to 36 million. Free cash flow was projected at 80% to 85% of net income for 2018 including approximately 15% of free cash flow impact driven by 50 million of combined incremental capital spending related to our Westbrook, Maine headquarters expansion and our German core lab relocation and expansion as well as about $5 million of incremental growth capital investment supported by additional cash flows associated with the U.S. tax reform. Incorporating these estimates our 2018 free cash flow outlook reflects projected capital spending of approximately 140 million.

Foreign exchange rates will be a positive factor impacting 2018 profit results at the updated exchange rates outlined in our press release. At these rates we estimate that foreign exchange rate changes will increase reported EPS by approximately $0.12 per share net of $7 million in currently projected hedge losses. In terms of our first quarter outlook in 2018 we expect Q1 reported revenue growth in the 13% to 14.5% range reflecting organic gains of 9.5% to 10.5% net of a 1% equivalent to a headwind. Reported Q1 revenue results will benefit by approximately 3.5% to 4% from favorable year-on-year FX impacts at the rates assumed in our press release.

Q1 operating margins are expected to be flat to modestly higher than prior year levels reflecting near-term moderating impacts from Reference Lab growth capacity investments and relatively higher levels of operating expense growth as we lap incremental commercial investment advance in the second half of 2017. We expect our effective tax rate in Q1 to be 15.5% to 16.5% including projected benefits from share based compensation, exercise activity which is typically higher in the first quarter. That concludes the financial overview, let me turn the call over to Jon for his comments on our business performance and our areas of focus heading into 2018.

[Jonathan W. Ayers, Chairman, President, and CEO]

Thank you, Brian. We had a very strong finish to the year across our businesses and around the globe. I'm very pleased with our team's success in 2017 in growing the market for IDEXX's innovative diagnostics and software solutions including for the companion animal market resulting in over 10% organic revenue growth and EPS gains at the high end of our long-term financial goals. Our North American commercial team saw accelerated successes at high value instrument placements, a key driver to the profitable recurring revenues of instrument consumables while at the same time growing both our Reference Lab Diagnostic modality, the largest contributor to North American recurring revenue and our Rapid assay line.

As investors recall we undertook a 12% expansion in our U.S. field organization fully in place in Q3 but still early in the learning curve. In Q4 we saw this expansion kick into gear. We also resumed the double-digit productivity in our EVI growth in instrument placements per rep that we achieved in the first half of the year and the combination of the expansion in the number of reps and the productivity per rep in North America grow our 25% growth in Catalyst placements to new and competitive accounts and 23% growth in SediVue placements. Along with these results we saw sustained high levels of customer retention which are world class levels. Our 98% retention of in-house chemistry accounts in U.S. compares favorably to any period since we announced our intention to go fully direct in 2014.

Our U.S. Reference Lab revenue growth in the fourth quarter sustained mid teen range even with a 1% headwind related to equivalent days. North American growth continues to benefit from strong same store sales growth as customers appreciate and adopt our unique offerings including fecal antigen, SDMA, molecular diagnostics, and we saw increasing customer retention levels reaching 97% from the Reference Lab modality. These results are driven by our deep sales coverage and strengthening customer relationships that come over time combined with an expanding diagnostic offering that is unique as well as new tools and technologies that help customers adopt and grow preventive care testing protocols. This volume led growth in our Reference Labs helps us assure our long-term margin expansion growth goals in the lab operation.

Our Companion Animal Group international operations completed a year with exceptional performance in placements of instruments led by Catalyst, our instrument platform with the strongest generation of recurring consumable revenues. Premium instrument placements growth of 24% to almost 25% in the high value Catalyst placements growth was 34% resulting in full year Catalyst placements of 3,839 and a 37% expansion in our international Catalyst installed base. Results were strong in virtually every country of every geography Europe, Japan, China, Australia, New Zealand, and Latin America. Our move to a direct sales structure in most countries in each of these regions over time has proven to be highly successful and our teams around the world are applying their entrepreneurial spirit to bringing Catalyst and the rest of the IDEXX lab offering to countries in a way that inspires veterinarians to adopt this advanced technology in accordance with local market needs.

I was also very pleased with the waters continued growth and profitability and the rebound in the growth of livestock, poultry, and dairy or LPD from Q3 levels. No water benefit this year from go-direct initiatives that set the stage for sustained long-term growth in this business. While LPD leveraged the benefits of new innovations like our pregnancy testing platform to offset broader market headwinds constraining overall growth gains in 2017. These are exceptional businesses represented by IDEXX professionals around the world that are committed to our purpose.

The key innovation accomplishment for Q4 was the on-time launch of Catalyst SDMA. In adding this remarkable assay to our in-house Catalyst solution we are greatly expanding access to SDMA and the availability of estimate providing expanded pet care. As Brian mentioned we have close to 30,000 Catalysts instruments in customers around the world and these Catalyst customers have been anxiously awaiting for the availability of this slide as evidenced by the over 3,500 unique practices in North America that have already bought the test since our pre-launch and 60 days ago and are beginning shipping just a couple weeks ago. Many of our Catalyst customers do not have access to our Reference Labs for a variety of reasons and others are committed to running their chemistry real-time in the practice. We call this real-time care or the practice of running the panel immediately on the in-house lab during the exam and providing care at that moment in time.

We're also looking to build a clinical appreciation of SDMA with veterinary schools which is facilitated by Catalysts SDMA since these institutions typically run lab work on their premise and now can do so with Catalyst. We find that the more customers gain experience with SDMA in a clinical setting where it can make the difference in the health of their patients, the faster they realize how essential this new parameter is in routine chemistry testing including a sick animal, disease monitoring, and preventive care protocols. Catalyst SDMA would celebrate this learning and market adoption and once customers conclude that SDMA is critically important then they become highly loyal to IDEXX for their diagnostic needs.

Our SediVue results were also amazing in Q4 bringing 2017 total placements to well over our 2000 of 2,267 units. This month we're rolling out our next generation algorithmic software to the entire customer base called Neural Network 3.0. This version has the benefit of images from a million patients and uses machine learning to add quantification to red and white blood cells, advance to detection of certain bacteria as you can imagine bacteria is an essential urine parameter, and also bring other enhancements to the image algorithm. The instruments growing capabilities that come from having over 3,800 systems in the field it's achievable through our 10 years of experience with smart service or the Internet things which means that the unique IDEXX innovation for in-house lab equipment. Every pet sample run on SediVue improves SediVue for all future patients and this is the impact of smart service and machine learning.

We also remain on track for the launch of SNAP Fecal Dx in the summer of 2018, our biggest SNAP launch in 15 years. SNAP Fecal will launch our ever growing installed base of SNAP Pro customers and our success with fecal antigen at the Reference Labs. As a result of the great success in SNAP Pro placements in 2017 we have an installed base of over 17,000 instruments in almost 10,000 practices in the U.S. alone with continued momentum in 2018. The volume of SNAP 4Dx in the U.S. market that comes from SNAP Pro customers easily exceeds 50% of our U.S. 4Dx volume up significantly from where we were when we went direct in early 2015.

SNAP Pro penetration combined with strong field presence, a powerful online marketing channel and demonstrated clinical accuracy of our SNAP technology sets the stage for continued solid expansion in our Rapid assay franchise. The strength of our business performance reflects the attractiveness of our recurring revenue business model around the world which achieved accelerated 13% organic growth in CAG recurring revenues in 2017. We have consistently focused on aggressively allocating capital to grow our businesses organically. The attractiveness of investing in growth in our franchise will be further enhanced by U.S. tax reform.

Simply put tax reform is huge for IDEXX as it is for our U.S. customers who are generally small businesses. And anything that helps our customers become more successful economically also helps IDEXX and tax reform gives our customers greater resources to invest in IDEXX's advance innovations be they diagnostic, digital radiography where we had a breakout in Q4, software or staff education. All these areas support practiced growth and the acceleration of their partnership with and utilization of IDEXX through the benefit of the owners and their pets. As a result of tax reform we are accelerating our investment in software, data, and related innovation. We are the innovative leader in veterinary software with nearly 39,000 VetConnect PLUS accounts, 22,000 of which we call active monthly users, 9,000 customers for our practice management solutions and over 5,000 customers for our cloud based apps that add value to the customers practice management software.

Our data capabilities have already generated groundbreaking insights in medicine using a data driven evidence based approach. And in 2018 we aim to use data to help our customers appreciate how to grow their protocols with the appropriate use of diagnostics to better meet the needs of today's pet owner. Importantly we will be able to show how any particular IDEXX customer benchmarks in relation to their peers and colleagues and other practice locations in diagnostic utilization. We're also using some of the benefits of U.S. tax reform to expand the company's financial math we provide the U.S. -- two U.S. employees who save for retirement using IDEXX 401K plan. This expansion to a dollar for dollar match of 5% of salary or up to 5% of salary will help our U.S. employees better provide for their retirement in a highly tax efficient fashion. Retirement planning is a societal challenge and we are further supporting our employees with this expanded benefit.

Tax reform supports investments towards our purpose and our long-term growth strategy. The return on investments that we've made in past years in the U.S. market starting with our sales force reconfiguration and then decision to go fully direct and then estimates we continue to make as we grow the topline will increase on an after tax basis. Prior to 2018 our pretax dollar of U.S. return generated $0.65 after federal tax and in 2018 this same dollar generated $0.79 after federal tax, a growth of 21% all other things being equal. This gives us confidence to continue to grow our investments in this incredibly attractive market. We are able to do that and still meet the company wide margin expansion goals that Brian reinforced earlier in the call driven in part by 2018 operational efficiencies resulting from our accomplishments in 2017 and prior years. All of us remained dedicated to our purpose, to create exceptional long-term value for our customers, employees, and shareholders by enhancing the health and well being of pets, people, and livestock. So with that we will open the call to questions.

[Operator]

[Operator Instructions]. We'll go to the line of Ryan Daniels with William Blair. Please go ahead.

[Nick Hiller, William Blair & Co]

Good morning, this Nick Hiller in for Ryan Daniels, thanks for taking my questions. I was just wondering if you could give a bit of an update on the SNAP Fecal Dx launch specifically when would produce of that product begin, and how much interest is there in that products specifically outside of the core IDEXX customer base especially given how prevalent fecal tests are and how unique the offering will be? And just a follow-up on assays, any thoughts on the potential competitive launch of a Rapid assay to compete against 4Dx? Thanks.

[Jonathan W. Ayers, Chairman, President, and CEO]

We're very excited about the SNAP Fecal launch which we expect in the summer of 2018. I think as you referenced fecal testing is a routine preventative care protocol for dogs, usually done with the annual or semiannual exam. The vast majority of those are run in-house today using manual methods in the microscope and so we see this as an opportunity to replace that in-house manual method with using biotechnology and ELISA method. So, our rough estimate is around 40 million fecal tests are run in North America annually. And a large majority of that is run in house although we're also very successful in driving fecal testing in the Reference Lab with our fecal antigen offering. And so, like anything the penetration and adoption of any product takes time, but we think this is going to be a long-term grower. I’ll just noted I was really excited about the rapid pick up with SDMA on slide with over 25% of catalyst customers buying in the first couple months. We think it is an amazing start up, but I think Fecal will be a major -- the in house fecal leveraging the Reference Lab fecal antigen technology will be a major franchise for us.

We remain excited about strong franchise we have with vector borne disease screening. We believe the announcement to which you refer validates that customers really need multiplexing a comprehensive disease screening, which has been our strategy from the beginning and what we've been doing in that business is turning it into a razorblade business model by adding a SNAP Pro which not only interprets the result but automatically runs a result, connects it to our ecosystem, captures the charge, and adds it to the medical record. And at this point, easily over 50% of our U.S. volume is running on SNAP Pro and that will continue to grow as we continue to replace SNAP Pro we placed over almost 6000 of them last year. We also have a really unique accuracy, sensitivity, and specificity that has been validated by third party technology and I think that is unique to our SNAP ELISA platform. And so I think we remain excited. This is a business though that is still under penetrated and not enough customers are running 4Dx or vector-borne disease screening as part of preventative care protocols on their dogs. And so while we had very strong high single-digit growth in 2017 and we've launched -- regionally launched actually vector-borne disease screening over 15 years ago, we see continued growth in this market in 2018 and beyond and that's a growth that we expect to continue to drive.

[Operator]

Thank you, we will go to the line of Derik De Bruin with Bank of America Merrill Lynch. Please go ahead.

[Michael Ryskin, Bank of America Merrill Lynch]

Hey thanks, it is actually Mike Ryskin on for Derik. Congrats on the quarter guys. Want to touch on a couple quick points, the instrument growth in the quarter, it's nice to see they have returned to positive growth but just want to confirm the difference between the instrument revenue growth and the placements, is that along the lines that we saw in previous quarters of the revenue recognition that we talked about in 3Q or is there something going on with pricing there? And then also I have a follow-up on the margins, saw that you reiterated that targets for 2018 of the constant currency op margin growth, but still saw some choppiness in gross margins this quarter, can you talk about some of the gives and takes there and what your expectations are on the gross margin line for 2018?

[Brian P. McKeon, EVP, Treasurer, and CFO]

Sure, why don’t I take those on instruments, that's correct. We did have some deferred revenue impacts, very, very strong growth as noted, and under current accounting we had deferrals which under the new accounting will be a new set of rules and we won't have that same dynamic. Moving forward, they will be different pieces moving forward, but net-net I think that's more reflective of the current GAAP standards and we work through that.

[Michael Ryskin, Bank of America Merrill Lynch]

And that's starting in 1Q?

[Brian P. McKeon, EVP, Treasurer, and CFO]

Yes, we'll break that out for you. It's going to be complicated, it will be very, very detailed disclosures because you have a restatement -- modified restatement of prior year balance sheet information and then obviously the new accounting, try to highlight that net we now estimate that overall that's going to be a plus 10 million impact for IDEXX. It will from a growth rate point of view which is actually going to help us on the recurring CAG and we highlighted that was about a point of growth rate impact and that's more related to the restatement of balance sheet the prior year aspect, and on the instruments well basically new accounting gets you to more upfront revenue recognition, but there again will be some restatement impact that will be a slight headwind, so we will clarify that all for you.

[Jonathan W. Ayers, Chairman, President, and CEO]

I think just to get back to your -- the fundamental essence of your question, these remain the pricing, it's not a factor. These are economically very successful placements and are really no different than prior quarters in that regard, and so I think the unit placement numbers particularly in the U.S. to new and competitive accounts and of course internationally we're placing to both new competitive and upgrading a VetTest which is a good -- which also contributes to recurring revenue growth. These are very high quality placements.

[Brian P. McKeon, EVP, Treasurer, and CFO]

And also of note, the EVI metric we noted was up significantly, that's a measure of value and we'll be rolling that out to international markets in 2018 to reinforce that. On your question of gross margins, a couple of themes here, our Reference Lab business in the U.S. is growing very quickly and with accelerating growth momentum and we made decisions to add routes basically, add capacity to support the growth that we see coming, make sure that we are fully staffed, we're doing a better job on retention of our lab employees. And the net of that is it is extremely healthy business. We actually delivered close to 100 basis points of constant currency margin improvements in our lab businesses here while supporting those investments, so in the near-term, that has some moderating impacts on gross margins but we will quickly grow into that.

[Michael Ryskin, Bank of America Merrill Lynch]

And then also knew this quarter was -- the fourth quarter was the reclassification of million…?

[Brian P. McKeon, EVP, Treasurer, and CFO]

Yeah included in that too was our laboratory information management systems. We're recording those costs that previously the amortization was recorded in the OPEX and we're moving that to cost of goods sold. So no net profit impact but it has a moderating impact from margins. We also had another factor that was more specific to the quarter in our LPD and water businesses. We were comparing to a prior year Q4 number that had favorability related to basically inventory dynamics, accelerated production growth and higher levels of absorption. That's not something we anticipate carrying forward so the outlook that we have for operating margin growth next year we reinforce the 75 to 125 basis point improvement that will be driven by gross margin gains. So we feel good about that and I'd also note that that covers the 10 million of incremental investment that Jon highlighted so the underlying growth is really about 50 bips stronger than that.

[Jonathan W. Ayers, Chairman, President, and CEO]

And that 75 to 125 basis point margin improvement is off of the higher revenue which as Brian referenced was FX related, was accounting related, and was flow through of the revenue over delivery so higher growth. But none of those things are changing our 75 to 125 basis point incremental margin on that higher level. So there are some fundamental goodness there.

[Michael Ryskin, Bank of America Merrill Lynch]

Got it, that's all really helpful, thanks guys.

[Operator]

We will go to the line of Erin Wright with Credit Suisse. Please go ahead.

[Erin Wright, Credit Suisse]

Hey, thanks. I notice there is a nice uplift in Rapid assay, I guess let's all try the amount [ph], I guess how much of it was price and it continues to be a competitive market there, do you think that growth rate is sustainable or what is your overall growth assumption assume for that segment thanks?

[Brian P. McKeon, EVP, Treasurer, and CFO]

Thank you, yeah, of course it is a global business. We had a good Rapid assay performance around the world. It is predominantly North American. We had good performance in North America that was more volume than it was price. I think our reps are pretty engaged in Rapid assay business it is combine with their -- the value that they are bringing with SNAP Pro, a placement so when they're placing SNAP Pro they are really talking about the entire Rapid assay family. Our 2018 guidance for recurring revenue growth incorporates the benefit of the second half year launch of SNAP Fecal. And so I think you know I think our overall Rapid assay growth if you will combined scope of what I would call reasonable assumptions for the Rapid assay business augmented by new revenues from a new product launch. Of course that will take time to be adopted so we're only talking about a partial launch and like everything we just like the ramp to be faster than it will be. But that will be new revenue from new innovation.

[Jonathan W. Ayers, Chairman, President, and CEO]

And it was price -- volume driven growth.

[Brian P. McKeon, EVP, Treasurer, and CFO]

Volume driven growth in the fourth quarter and in 20…

[Jonathan W. Ayers, Chairman, President, and CEO]

We always have a timing of -- year-over-year timing of programs that are underlying 2% to 3% recurring CAG price gains is pretty consistent across…

[Brian P. McKeon, EVP, Treasurer, and CFO]

Yes, we just -- we had just good performance in Rapid assay. We saw market share gains, continued market share gains in the first generation in 2017 and the vector-borne disease franchise just continues to grow in volume. And even though we're 15 or 16 years into that it just shows the long runways of growth that we have. In fact that was the best volume growth we've had in that franchise in a number of years. But every year it's grown so it's still amazing that we don't have as many dogs as we have that get annual screening for vector-borne diseases.

[Erin Wright, Credit Suisse]

Great and I'm curious on your thoughts on just the overall market as we stand here kind of, I felt that you saw strong 6% growth in practice revenues across your data set, I guess what does your guidance imply for 2018 in terms of the underlying demand trends across the CAG segment and where does it stand now, I guess how much room do we have to run, I know we've seen this massive improvements since the recession over in terms of overall veterinary demand trends but I guess what are some of the key metrics that you're tracking and looking at that give you kind of confidence in underlying demand, thanks?

[Jonathan W. Ayers, Chairman, President, and CEO]

Well we have as Brian reported the 6% growth in veterinary practices which really comes out of it. That's a measured number out of what 5000 or 6000 of practices that we saw in Q4 and really consistent with the growth over the course of the year. And that's overall practice revenue at our customer level. Our assumptions for 2018 are consistent with really what we saw in 2017. But the runway every time we look at this, the runway for growth is amazing because what's interesting is our customers are growing faster than the market. We can measure this okay, our customers are growing faster, they're growing their overall practice revenues faster, they're growing their diagnostic portion of their revenues faster. They are growing it faster because our reps are helping them adopt more and more diagnostics to meet the changing needs of today's pet owner. What's interesting is the best practices in doing this are 2-3 X times the size of the average practice and just in our portfolio practices who are themselves above the market averages. And so we see the opportunity to help customers appreciate that while they may be doing well they can actually be doing better because other practices that are very much like them are doing better. And so the diversity of practice -- of performances inspires us to inspire the practices, to continue to focus on advancing diagnostic utilization and protocols using IDEXX's expanded and unique menu of tools to bring value to pet health. And to do so meeting the needs of the pet owners that want this when they appreciate the value and of course some -- the best practices are doing a great job doing that. So we need to bring those best practices to the broad market and that's why we have very deep sales coverage with strong account relationships so we can grow not just adoption of IDEXX but adoption of diagnostics as part of the care equation.

[Operator]

And we go to the line of Jon Block with Stifel Nicolaus, please go ahead.

[Jonathan Block, Stifel, Nicolaus & Co]

Great, thanks, and good morning. Maybe two questions, first one what still needs to be done from a regulatory standpoint for SNAP Fecal antigen, is that sort of a gating factor between I don't know a June launch versus September? And part two sorry, that same first question is maybe you can just talk to us some of the moving parts of call it the low end of the organic guidance versus the high end, the 9.5 versus the 11.5 as you look at the year. Is it based on traction with new projects or limiting Rapid assay in roads from competitor, the overall market, would love to just get your thoughts and then I got a follow-up?

[Jonathan W. Ayers, Chairman, President, and CEO]

Very quickly on the first question a point of care test, that tests for infectious diseases is one of the few areas that requires a regulatory approval. So for instance our lab test, fecal antigen test does not require regulatory approval but the same technology on a stamp does and so that does -- that is a factor that will that we need to be successful with, the U.S.D.A. approval in order to launch the product. We're confident of the track record there that always adds a little bit of uncertainty as to exactly which month or when

[Brian P. McKeon, EVP, Treasurer, and CFO]

Yeah, and just in terms of revenue outlook the key driver of that of course is going to be the recurring CAG growth number Jon so that's the 12% to 14% if you adjust for the accounting change, its 11% to 13%. We finished this year just under 13%. I think it's a reasonable range. We're obviously growing very quickly. In terms of high growth rate we need to execute very well and we think that's a reasonable range at this time in the year. It's not projecting risks, it's more just reflecting that we're growing off a base at high rates and need to execute well and need to execute well against the new innovation launches and that's principally why we have that type of range this time of the year.

[Jonathan Block, Stifel, Nicolaus & Co]

Okay, got it.

[Jonathan W. Ayers, Chairman, President, and CEO]

One of the nice things is we over deliver in the fourth quarter on revenue so with the same growth rate that the absolute revenues in 2018 are -- they're growing off higher base. So, as Brian said we need to continue to do a great job executing and supporting our customers with great products, reliable products, and great sales coverage around the world.

[Jonathan Block, Stifel, Nicolaus & Co]

Got it and just the second question, you deemed across most of the CAG were occurring modalities but maybe the only one that I could sort of nitpick on was international lab. I think you mentioned up high single-digits for the second consecutive quarter, the U.S. has been up mid teens. It just seems like a relatively big delta and I think that's for the second or third quarter we've seen that delta. Arguably international should sort of be in that sweet spot of SDMA. And I know the competitive landscape is more fragmented O.U.S. So Jon any reason why that international rough lab is call it lagging some of the other diagnostic modalities that we see with the mid teen growth from some of your other areas? Thanks guys.

[Jonathan W. Ayers, Chairman, President, and CEO]

Yeah, I think that's a fair observation from my relative basis. Of course I wouldn't sneeze at high single-digit organic revenue growth in any business in the current market. But relative to the success of our other businesses a fair characterization. The fact of the matter is our international organizations are really prioritizing the highly profitable placements of Catalysts where we just have a unique instrument you know you saw those Catalysts placements up 37% year-over-year and then the retention on these Catalysts is like 100% and 99.95% or something. It's an amazing business, it's a -- these are profitable placements and then we also have a reference lab business. By the way the Reference Lab business is not as profitable as other lab business internationally whereas in the U.S. we've got a really good network effect taking place. We want to make sure that we have that network in fact in place and that when we grow the Reference Lab business and let's recognize a reference lab business internationally there is a lot of different labs in a lot of different regions. Our German lab for example is doing very well, it's very profitable business which is why we're investing in a world class lab. As part of the relocation of the core German lab. Other parts of the world are not as profitable as they need to be and so we're focused more on profitability there before growth with the -- again the primary sales growth being the placement of the analyzer. These analyzers that we're placing today are going to be there decades from now. I mean it's just it's just a great business.

[Operator]

And we will go to the line of Nicholas Jansen with Raymond James and Associates. Please go ahead.

[Nicholas Jansen, Raymond James & Associates]

Hey guys and congrats on a great quarter. Just following up on that point Jon, just looking at the Greenfield opportunities O.U.S. versus U.S. as you think about Catalyst. Certainly the U.S. opportunity is probably starting to diminish a bit. I mean where are we on the O.U.S. trajectory as a number of that test still outstanding that could be upgraded, areas where you're seeing competitive displacements, just maybe walk us through how we think about the sustainability of this global like Catalyst placement growth that we've seen over the last three years?

[Jonathan W. Ayers, Chairman, President, and CEO]

Yeah, I just do want to note the 25% year-over-year growth and Catalyst placements to new and competitive counts in North America I don't want to gloss over that a number. Our U.S. teams had an extraordinary quarter and we think there's a lot of runway ahead in the U.S. because of the result of the fabulous product line now supported by SDMA and great commercial teams but turning to the essence of your question on the international opportunity, it's wide open. And as you know we've shared the number of customers who we believe are targets for Catalyst placements internationally. Over 75,000 customers and that’s a growing number of course. And so we're upgrading that test but roughly half of those placements are to new and competitive accounts. So they're organic accounts, we're replacing really an aged install base of competitive analyzers that have really fallen behind and then of course once we put Catalyst in there it stays there which I've mentioned with a very, very high retention rates. We have markets like China where it's basically a Greenfield opportunity and then we have markets like Europe that's both a vet test and a very attractive Greenfield and new account and competitive account. We as Brian mentioned in a previous question we are moving -- international was now moving to the compensation approach which looks at the economic value index of an instrument placement. What this is going to do is put even more focus on new and competitive.

Well it turns out our vet test customers internationally are pretty loyal customers. I mean they're in the high 90's in terms of their loyalty and so it's not like we have to rush to upgrade them because they're already pretty loyal. Of course we will continue to do so but the highest value placement is to a newer competitive account and as we move to EVI we expect to see a jump in the productivity of the same sales efforts towards the highest value placement. So even with the phenomenal success we had in 2017 we would expect to see a productivity jump in 2018 in placements and yet we have very, very -- less than -- a little bit less than 4000 placements of Catalyst internationally and you put that in the context of the opportunity. We have a long runway of opportunity for filling out the world with a very attractive point of care technology to help veterinarians provide care for pets. And they're all going to have SDMA. And so we're running, we are rolling out SDMA internationally in the next couple of months on Catalyst and so that -- and the international markets have developed the market appreciation for SDMA. So they're just as excited as our North American teams were with the availability of SDMA now being able to be run on Catalyst.

[Brian P. McKeon, EVP, Treasurer, and CFO]

I will just reinforce the strap we talked about, the build to our five year growth and trying to achieve over the next five years 20,000 placements in international markets and we're right on track with that. So this year was right in that range and we're building each year the percentages coming out of new and competitive placements. So we're feeling very good about the execution on the international front.

[Nicholas Jansen, Raymond James & Associates]

That's very helpful and as we think about the recurring revenue associated with those O.U.S. Catalysts placements where we are on the utilization map on those relative to the U.S. and if you can maybe compare that to maybe three or five years ago are we seeing more and more utilization off of these boxes as these end markets become more like the U.S. or are we still very early in that transition?

[Jonathan W. Ayers, Chairman, President, and CEO]

So it's a great question, the bottom line is we're still very early, okay but we are seeing a same store sales growth and we're seeing it because they're adding menu. We saw it with P4 when we had P4 to a Catalyst install base. We're going to see it with SDMA and interesting parameter we don't talk that much about CRP. We've launched CRP now globally. There are markets outside the U.S. that already value CRP. We don't have to explain to them why that's an inflammatory market and they're adopting it that gross utilization. So, as we add menu to the analyzer we see growth in utilization of the installed base. Where we really haven't even begun the story outside of North America it's preventive care. And so that's kind of the next wave, it's not a 2018 wave, it's couple of years out as we grow the market, as we grow our intensity of sales coverage we can then really take the preventative care story around the world. But right now they're just working on sick animal testing and so it's just amazing how early we are in the whole story and yet we are we're getting utilization growth primarily from sick animal testing from this menu expansion which customers appreciate is helpful in helping rule in and rule out disease on a sick presentation.

[Operator]

And we go to the line, I am sorry go ahead.

[Jonathan W. Ayers, Chairman, President, and CEO]

We have time for one more question, I know we're up against the hour.

[Operator]

Absolutely, the last question will come from the line of Alex Nowak with Piper Jaffray. Please go ahead.

[Alexander Nowak, Piper Jaffray & Co]

Great, good morning everyone. I just had a two part question. Jon you mentioned this in your prepared comments but regarding tax reform to your customers is it fair to say that most of that customers will see some sort of tax rate because I believe the personal service corporations are going from a flat 35% rate to 21%? And then the second part of that is have you talked with any customers since the beginning of the year and have they signaled what they plan to do with the extra income such as reinvest into analyzers, is that place filled out or they just simply plan to park the extra cash?

[Jonathan W. Ayers, Chairman, President, and CEO]

Okay, very quickly we expect most to answer your question it's a little complicated because there's a couple of different moving parts but the bottom line is yes, our customers will see benefit. They're all small businesses, they are [indiscernible]. They will see a benefit to tax reform. I think they're just beginning to realize. I am seeing around the corner on this okay, I don't think our customers fully appreciate because they didn't take tax accounting in veterinary school. Okay, they ask their accountants and their accountants are still trying to figure it all out. So here we are February 1st, I would say it's still early days. So what I'm saying is as this starts to -- as they start to see the benefits I think their appreciation for the attractiveness of their business gives them some room to make incremental investments and of course we're going to be there inspiring them with IDEXX technology.

[Alexander Nowak, Piper Jaffray & Co]

Okay, that's helpful. And then you are only couple weeks into the SDMA launching Catalyst but are you seeing any cannibalization of SDMA in the reference web?

[Jonathan W. Ayers, Chairman, President, and CEO]

No, we -- absolutely not. This is all a testing begets testing. We in fact think the estimated option in our in house will actually grow the Reference Lab business because of the appreciation. We have seen this issue in launch after launch where we have something in Reference Lab and then we launch it in-house. It actually helps our Reference Lab. You can go back 15 years when we launched a five part white blood cell differential with absolute ridiculous sides with laser sight or by studying you are going to see Campbell's any reference lab and you've seen what's really happened to our reference lab over that period of time. So we actually think this augments Reference Lab growth over time because it accelerates the clinical appreciation of SDMA in the care of pets.

[Alexander Nowak, Piper Jaffray & Co]

Okay, that's helpful. Thank you.

[Operator]

And I'll turn the call back over to Mr. Ayers for closing remarks.

[Jonathan W. Ayers, Chairman, President, and CEO]

Yes, thank you very much. We had the little bit longer comments because of the end of the year and because the number of exciting things going on at IDEXX. So I appreciate we didn't get into all the questions and we'll try to do so afterwards. And we appreciate all the attention. I just really want to thank the IDEXX organization for fabulous 2017 and the excitement and momentum that we have I think will be evidenced at the BMX previously known as the North American veterinary conference show that's taking place this weekend. I know some of our investors will be there. Our sales teams will be there. We're very excited about the prospects for 2018 and I think that's reflected in our comments and in our financial guidance for 2018. This is a long-term enduring growth business. As we enhanced the health and wellbeing of pets, people, and livestock we see the long-term growth vectors ahead of us. So with that we will close the call and thank you very much for signing in.

[Operator]

Thank you and ladies and gentlemen that does conclude our conference for today. Thank you for your participation and for using AT&T Teleconference. You may now disconnect.