愛德士 (IDXX) 2017 Q1 法說會逐字稿

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 measure 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. (Operator Instructions)

I would now like to turn the call over to Brian McKeon.

Thank you, and good morning, everyone. IDEXX' 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 of foreign exchange rates, which improved since our last call, this results in a reported revenue range of $1,925,000,000, to $1,950,000,000 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 a 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 a 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 reflect a continued strong premium instrument placements and 12% organic growth in CAG diagnostic 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 diagnostic recurring pricing gains in the 2% to 3% range in the U.S., augmenting strong volume trends.

IDEXX' 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 2-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 diagnostic 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 continue to see double -- 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 a stronger gains across CAG diagnostic 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 level, 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% are 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 in our sales composition approach, we also saw excellent results in the placements of SediVue and SNAP Pros in North America. Strong customer response to our new PreRead capabilities 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 continued to drive very strong recurring CAG diagnostic revenue growth. In Q1, global CAG diagnostic 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 consumer 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 trends 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 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 work -- 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 P&L, operating profit in Q1 was $92 million, up 25% as reported, or 28% on a constant-currency basis, with results driven by strong profit gains in our CAG business. Operating margins were 20%, up 260 basis points on a constant-currency basis, reflected 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 margin's increased 150 basis points, reflecting solid CAG net price gains and volume leverage from strong consumable in 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, reflected timing of select headcount 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 a significant recent appreciation of our stock price, Q1 vesting of stock option and restricted stock grants and higher levels of activity in 2017 related to the expiration of specific stock compensation grants.

For the full year, we now expect benefits from the adoption of a 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 a 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, support 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 $1,268,000,000 in debt outstanding, $400 million in cash and investment balances, and $178 million of borrowing capacity available under our revolving credit facility. Our leverage ratios as a multiple of adjusted EBITDA were 2.7x gross and 1.8x net of cash and investment balances.

We anticipate maintaining gross leverage ratios in the 2.5x to 3.0x range in 2017, with continued deployment of excess cash flow towards 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 the 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 our 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 is at the high end of our long-term annual operating margin improvement goals. We'll be delivering a 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 a 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 from 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 a 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're 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're 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 to 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 preliminary guidance for 2018.

Our outlook for share count in 2017 is for reduction in average shares outstanding from continued stock repurchases of 1% to 1.5%, net of 0.5% accounting impact. As noted, we expect to maintain our gross leverage ratios at 2.5x to 3x 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 equivalent 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're indeed off to a great start to the year. I note the 14% constant currency growth of our CAG diagnostic recurring revenues in Q1, which make up 72% of IDEXX' 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 of 2016, which itself was the highest growth quarter of 2016. And we had a strong compare of Q1 of 2016 in the U.S., if investors recall. We had strength in all global geographies and double-digit growth in all 3 modalities that contribute to these diagnostic recurring revenues, that is reference labs, instruments, consumables and rapid assay tests. So a solid start to the year with good momentum, giving us confidence to increase IDEXX' 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 on chemistry analyzer in all geographies, generating 20% international VetLab consumables. 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 of North America has grown cumulatively to over 11,000 instruments and customers, and yet we believe the potential number of additional customers is roughly 5x that amount, and the number of Companion Animal practices is growing every year. So many growth -- 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 launched 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 multiyear time frame, which recognizes not only the IDEXX instrument placement, but the recurring revenues that comes from each type of placement and the profitability of those revenues. I'm 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 instrument placed in Q1 of 2017 versus the implied economic value in Q1 of 2016 and adjusting appropriately up 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 a new software functionality in Q1 that automatically interprets the SNAP. Customers that are actively using their SNAP Pros or the 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 continued to drive strong double-digit growth in reference labs, growing the market in 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 3 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 had a high ROI. Our recent investments had 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 a more advanced SediVue algorithmic interpretation software to our install base of customers courtesy of the fact that all connect it 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 send to us via SmartService over the 9 months in 2016 that the product had been in the field. Neural Network 2.0 makes great strides in the instrument's capability, but we're never done. We continually upgrade our instruments with new software, new capability and occasional 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 test 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 determining a pet's health status, since pets can't tell you what's wrong. Our strategy is to work hard to fill the GAAP between current practice and this potential. But 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 upfront 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 up to Q&A.

(Operator Instructions) And our first question will come from the line of Ryan Daniels with William Blair.

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 in 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?

Yes, I saw a wonderful situation, Ryan, because we really see attractive markets, of course, in the U.S., which is, by the way, 2/3 of global market today, as silly as it 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're led by just the exceptional opportunity we have for Catalyst placements. And there -- it's a high growth, and I think we feel comfortable with the growth in the 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 are chemistry panel, just a chemistry panel in front, only 7%. And yet, best practice -- evidence-based medicine would suggest that preventative care, including routine wellness testing, is really appropriate given the fine 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 volume, that 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 to you, this is an investment that's based on an opportunity and a return from the opportunity; it's not a reaction to other dynamics. This is -- 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.

Yes. And 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 doing them. But there are just not that many to do. So all types of investments we're making are organic and -- but we think that has the best ROI.

Okay. That's helpful. And then one more follow-up. Can you talk a little bit more about instrument placements in the competitive accounts you've made over the last 1 to 2 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've displaced over the last year or 2?

Yes, 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 quarter one; last quarter was a little better than the quarter before. And so we're pleased with that. And...

Yes. 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. and reference lab, consumables, rapid assay, and it's one of the things that's helping our underlying growth. It's also helping improve our other underlying net price realization. It's a very positive trend and goes back to some of the comments we were making about this -- the network effort, as we're bringing together different instrument solutions through integrated systems architecture and have invested well above $100 million plus ahead of the industry in 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.

The other things, Ryan, we're seeing is we 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 30s, 36% or 38%, depending on what year you pick. 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.

Our next question comes from the line of Erin Wright with Credit Suisse.

You mentioned some underlying or better underlying margin improvement and your updated guidance net of the incremental investments that you're making. 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?

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 investments 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 diagnostic 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 similar to 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 you, 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 -- it's a -- that's a good business, in the growth in the recurring revenues of VetLab consumables. Both of those augmented by couple of percent price realization and effective management of cost 2 of -- I think between the 2 of those, it's easily over 60% of IDEXX' total revenues.

Excellent. And you mentioned the 45 new reps, I think you said in some of the 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?

Yes, thank you. Those -- we go through a systematic process of looking at our account coverage around the country, and it's a pretty complicated process, because when you -- you have to kind of redraw the lines. But -- 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 they -- because that's what rose the revenues. And some of it is covering some of what we call the whitespace, which is the kind of roughly 5% or 6% of the country that we don't have a 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, 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. It's 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 they have full presence and supporting our distributors. These are generally more emerging markets or places where it just doesn't make sense to have a direct presence. So I think we're going to, obviously, be continuing to grow appropriately our fee 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.

Our next question will come from the line of Derik De Bruin with Bank of America Merrill Lynch.

So I actually wanted to piggy back on Erin's question on the gross margin. I mean, certainly, a 150 basis point improvement is much better than we had thought in the quarter. Just can you talk about pacing of the gross margin for the rest of the year, and I guess, full year expectations for where you think it will end up?

Yes, 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 in Q2, the net of that will be relatively flat, and that is, we will have some ramp in the OpEx. Some of the lab capacity investments are impacting gross margin, but those, of course, will pay off. 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 the gross margin line and we're reinvesting that in OpEx, just given the growth opportunity we see.

I guess, still staying on it, if you look at sort of the out-year expectations on the business, I know you've guided to the 50 to 100 basis points for the longer-term model. Is there an opportunity to sort of have a bigger step change in that on a recurring basis? And can that growth 50 basis points higher over time? Is that -- would you need to see a better mix shift in that or you just see more adoption products? I'm just simply saying is that it gives you an opportunity on the margin to see it sustainably go up another 50-or-so basis points on annual basis?

I think we will continue to drive gross margin improvement. That's a key part of our goals, and I think if we're successful following the way we think we can on the occurring CAG said, 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 tried 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, I think, is very much aligned with how we think about managing the business, Derik. 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 market, it 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 -- 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 margin. 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, if that's -- what's interesting is it's gotten better and better over the last 5 years with -- 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, on the information technology side. And so we're really -- all supported by the fact that people love their pets and are underserved by the veterinary profession today, meaning that if -- 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.

Our next question comes from the line of Jon Block with Stifel.

Brian, I'll meet you up offline on how your OpEx leverages isn't better than 50 to 100 bps. So I'll focus on 2 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?

Just on the performance, I'll turn it over to Jon, but we said it was 13% organic growth. It's 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 competitors. So we agree that it was an excellent performance on lab front, both USA and internationally.

Yes. The growth in reference lab is really 3 factors. One is that we're getting some price realization. Of course, everybody said, "Why did you offer SDMA no incremental charge?" Well, we did offer 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 lab is a contributor to that, all U.S. CAG recurring diagnostics. 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're 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 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 3 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. Okay. Helpful color. And then the other one, Jon, is just on the sales force, if I get it. I mean, you're putting up tremendous top line growth in 3 or 6 months. It is an incredibly quick return for Rapid. Where do you see that number leveling off? In other words, I think you and I talked on the call maybe 9 or 12 months ago, you opted 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 it 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 is a finite number of points here where you think you'd have to be fully -- a full sales force out there specific to the U.S.?

Yes. Well, I think what we saw is we have seen a 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 services and veterinarians. They do not include people on the phone, that or sales or support. They do not include managers. They're just field, field on the street. It's a very clean -- 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 2 years ago, why can't we have more SNAP Pro placements? Well, we've got more SNAP Pro placements now. And look at our -- look at the competitive Catalyst, the 18% year-over-year growth in competitive and Greenfield Catalyst placements. And look at the 14% EVI productivity, part of that's 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 on how to expand -- expand the test again. And because now they are -- 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 able to do it and expand our constant currency operating margin target.

Our next question will come from the line of Nicholas Jansen with Raymond James & Associates.

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 dropped down from an incremental test perspective. So if I run the math, 1/3 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. It'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.

Yes, 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, which is supporting kind of the long-term growth of the annuity. And on balance, we think that yields the outcome. But 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. 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 where the company has been run 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.

Yes. 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 to -- that will be leverageable over time. And it takes a while to roll those out in our different geographies, and we will get very good returns on that. But primary goal here with the reference lab is to be able to serve the customer consistently and with quality. That is the #1 thing that customers care about. They care about that before they care about an advanced test. So that's stable state. 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's 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, that to execute that well, our #1 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 any one particular year, but has a long runway associated with it.

And 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 this 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 2 or 3 years of pretty rapid growth off of the lows?

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've 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 2-year stacked growth, it was 6.8%. So...

6.9%.

6.9%. Yes. So I think that you take the 2 years, add them together and divide by 2. So I think it's 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 versus 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.

Our next question will come from the line of Mark Massaro with Canaccord Genuity.

The first one is a 2-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 whitespace versus going to 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?

Yes. It's mostly greater coverage in existing territories, and a small part of it is whitespace 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 can you just speak to maybe how many placements were in North America versus international in the first quarter?

There were only 47 placements international. So the bulk of that was North America placements. And just for clarity, Mark, we vary 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 new North American product, a more sophisticated market as such. But the opportunity we have internationally is, I think it's all SediVue, I think it's all 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 you're -- 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 an international opportunity.

And our final question will come from the line of David Westenberg with CL King.

I'm going to stay away from the margins for you guys, and then just wanted to talk real quickly about capital deployment strategy, you've been buying back shares a lot more after couple of years. Is that still a primary focus in your capital deployment strategy?

Yes. We're comfortable -- we've been -- had a very successful program. We 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. 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 much below quarter there. Can you talk about how volumes correlate from -- on a quarter-to-quarter basis with your consumable and reference lab businesses?

As you could tell, it's not that great a correlation, I think, 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 typically 15% of the total and are growing in 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.

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% above that when you add in practice formation and the fact that diagnostics are growing quicker. And of course, we're growing faster than market. So I think those are the dynamics that contribute to the differences.

Thank you. I think that, that concludes the call. We appreciate all the questions, and 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 wellbeing of our pets, the people who love them and livestock. Thank you very much. That closes the call.

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