Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10‑K.

We have included certain terms and abbreviations used throughout this Annual Report on Form 10-K in the "Glossary of Terms and Selected Abbreviations.”

Description of Business Segments. We operate primarily through three business segments: diagnostic and information technology-based products and services for the veterinary market, which we refer to as the Companion Animal Group (“CAG”); water quality products (“Water”); and diagnostic products and services for livestock and poultry health and to ensure the quality and safety of milk and food, which we refer to as Livestock, Poultry and Dairy (“LPD”). Our Other operating segment combines and presents products for the human point-of-care medical diagnostics market (“OPTI Medical”) with our pharmaceutical product line and our out-licensing arrangements because they do not meet the quantitative or qualitative thresholds for reportable segments. See Note 15 to the consolidated financial statements for the year ended December 31, 2017, included in this Annual Report on Form 10-K for financial information about our segments, including our product and service categories, and our geographic areas.

Certain costs are not allocated to our operating segments and are instead reported under the caption “Unallocated Amounts”. These costs include costs that do not align with one of our existing operating segments or are cost prohibitive to allocate, which primarily consist of our R&D function, regional or country expenses, certain foreign currency revaluation gains and losses on monetary balances in currencies other than our subsidiaries’ functional currency and unusual items. Corporate support function costs (such as information technology, facilities, human resources, finance and legal), health benefits and incentive compensation are charged to our business segments at pre-determined budgeted amounts or rates. Differences from these pre-determined budgeted amounts or rates are captured within Unallocated Amounts.

The following is a discussion of the strategic and operating factors that we believe have the most significant effect on the performance of our business.

Companion Animal Group

Our strategy is to provide veterinarians with both the highest quality diagnostic information to support more advanced medical care and information management solutions that help demonstrate the value of diagnostics to pet owners and enable efficient practice management. By doing so, we are able to build a mutually successful relationship with our veterinarian customers based on healthy pets, loyal customers and expanding practice revenues.

CAG Diagnostics. We provide diagnostic capabilities that meet veterinarians’ diverse needs through a variety of modalities including in-clinic diagnostic solutions and outside reference laboratory services. Veterinarians that utilize our full line of diagnostic modalities obtain a single view of a patient’s diagnostic results, which allows them to track and evaluate trends and achieve greater medical insight.

The breadth and complementary nature of our diagnostic solutions also provides us scale in sales and distribution. To further increase our customer reach, effective January 1, 2015, we transitioned to an all-direct sales strategy in the U.S. and did not renew our annual contracts with our U.S. distribution partners. Under this approach, we take orders, ship product, invoice and receive payment for all rapid assay test kits and IDEXX VetLab consumables in the U.S., aligning with our direct model for instruments, reference laboratory services, and other CAG products and services. We believe these changes will continue to strengthen customer loyalty and help support growth of our diagnostic revenues in North America.

Our diagnostic capabilities generate both recurring and non-recurring revenues. Revenues related to capital placements of our in-clinic IDEXX VetLab suite of instruments and our SNAP Pro Mobile Device are non-recurring in nature in that they are sold to a particular customer only once. Revenues from the associated proprietary IDEXX VetLab consumables, SNAP rapid assay test kits, reference laboratory and consulting services, and extended maintenance agreements and accessories related to our IDEXX VetLab instruments and our SNAP Pro Mobile Device are recurring in nature, in that they are regularly purchased by our customers, typically as they perform diagnostic testing as part of ongoing veterinary care services. Our recurring revenues, most prominently IDEXX VetLab consumables and rapid assay test kits, have significantly higher gross margins than those provided by our instrument sales. Therefore, the mix of recurring and non-recurring revenues in a particular period will impact our gross margins.

Diagnostic Capital Revenue. Revenues related to the placement of the IDEXX VetLab suite of instruments are non-recurring in nature, in that the customer will buy an instrument once over its respective product life cycle, but will purchase consumables for that instrument on a recurring basis as they use that instrument for testing purposes. During the early stage of an instrument’s life cycle, we derive relatively greater revenues from instrument placements, while consumable sales become relatively more significant in later stages as the installed base of instruments increases and instrument placement revenues begin to decline. In the early stage of an instrument’s life cycle, placements are made primarily through sales transactions. As the market for the product matures, an increasing percentage of placements are made in transactions, sometimes referred to as “reagent rentals,” in which instruments are placed at customer sites at little or no cost in exchange for a multi-year customer commitment to purchase instrument consumables.

Prior to the Catalyst One instrument launch during November 2014, we pre-sold the instrument under a customer marketing program through which customers preordering a Catalyst One were initially provided with the right to use a Catalyst Dx instrument. Under this marketing program, we deferred $7 million of instrument revenue in 2014, which was fully recognized in 2015 upon delivery of the Catalyst One instruments or customer election to keep the Catalyst Dx was received.

We place our Catalyst chemistry analyzers through sales, leases, rental and other programs. In addition, we continue to place VetTest instruments through sales, lease, rental and other programs, with substantially all of our revenues from that product line currently derived from consumable sales. As of December 31, 2017, these three chemistry analyzers provided for a combined active installed base of approximately 47,000 units globally, as compared to 43,000 units globally in 2016. Approximately 54 percent of 2017 Catalyst analyzer placements were to customers that are new to IDEXX, including customers who had been using instruments from one of our competitors, sometimes referred to as competitive accounts. Generally, placement of an instrument with a new or competitive account is more attractive as the entire consumable stream associated with that placement represents incremental recurring revenue, whereas the consumable stream associated with a Catalyst placement at a VetTest customer substitutes a Catalyst consumable stream for a VetTest consumable stream. We have found that the consumables revenues increase when a customer upgrades from a VetTest analyzer to a Catalyst analyzer due to the superior test menu capability, flexibility, and ease of use of the Catalyst analyzers, which leads to additional testing by the customer.

As we continue to experience growth in placements of Catalyst analyzers and in sales of related consumables, we expect this growth to be partly offset by a decline in placements of VetTest analyzers and in sales of related consumables.

The Procyte Dx analyzer is our latest generation hematology analyzer. In addition, we sell the LaserCyte Dx and VetAutoread analyzers. As of December 31, 2017, these hematology analyzers provided for a combined active installed base of approximately 33,400 units, as compared to 31,000 units in 2016 and 29,000 units in 2015. A substantial portion of ProCyte Dx analyzer placements continue to be made at veterinary clinics that elect to upgrade from their LaserCyte Dx analyzer to a ProCyte Dx analyzer. In 2017, approximately 60 percent of ProCyte placements were made at competitive accounts. We also continue to place a substantial number of LaserCyte Dx instruments, both new and recertified, as trade-ups from the VetAutoread analyzer and at new and competitive accounts. As we continue to experience growth in placements of ProCyte Dx analyzers and in sales of related consumables, we expect this growth to be partly offset by a decline in placements of LaserCyte Dx and VetAutoread analyzers and a decrease in the associated recurring revenue stream.

Our SediVue Dx instrument was launched in North America early in 2016 and in the U.K. and Australia in the fourth quarter of 2016. During 2017, we continued to launch Sedivue Dx internationally. Sedivue Dx is the first veterinary in-clinic analyzer to provide urine sediment analysis. This instrument and single-use consumable system provides a highly accurate way to automate the in-house process of examining urine under a microscope. We provide customers with SediVue Dx consumables that are charged upon utilization, which we refer to as pay-per-run, as compared to other instruments where we charge upon shipment of consumables.

We seek to enhance the attractiveness and customer loyalty of our SNAP rapid assay tests, by providing the SNAP Pro Mobile Device, which activates SNAP tests, properly times the run, captures, and saves images of the results and, in conjunction with IVLS, records invoice charges in the patient record. Beginning in January of 2017, with our ProRead software, the SNAP Pro Mobile Device interprets results. These features promote practice efficiency by eliminating manual entry of test results in patient records and also helps ensure that the services are recorded and accurately invoiced. In addition, SNAP Pro Mobile Device results can be shared with pet owners on the SNAP Pro screen or, in conjunction with IVLS, via VetConnect PLUS. We also sell the SNAPshot Dx, which automatically reads certain SNAP test results and, in conjunction with IVLS, records those results in the electronic medical record. We continue to work on enhancing the functionality of our analyzers to read the results of additional tests from our canine and feline family of rapid assay products.

Our long-term success in the continuing growth of our CAG recurring diagnostic product and services is dependent upon new customer acquisition, customer loyalty and retention of their recurring revenues, our ability to realize price increases based on our differentiated products and customer utilization of existing and new assays introduced for use on our analyzers. We continuously seek opportunities to enhance the care that veterinary professionals give to their patients and clients through supporting the implementation of real-time care testing work flows, which is performing tests and sharing test results with the client at the time of the patient visit. Our latest generation of chemistry and hematology instruments demonstrates this commitment by offering enhanced ease of use, faster time to results, broader test menu and connectivity to various information technology platforms that enhance the value of the diagnostic information generated by the instruments. In addition, we provide marketing tools and customer support that help drive efficiencies in veterinary practice processes and allow practices to increase the number of clients they see on a daily basis.

With all of our instrument product lines, we seek to differentiate our products from our competitors’ products based on time-to-result, ease-of-use, throughput, breadth of diagnostic menu, flexibility of menu selection, accuracy, reliability, ability to handle compromised samples, analytical capability of software, integration with the IDEXX VetLab Station and VetConnect PLUS, client communications capabilities, education and training, and superior sales and customer service. Our success depends, in part, on our ability to differentiate our products in a way that justifies a premium price.

Recurring Diagnostic Revenue. Revenues from our proprietary IDEXX VetLab consumable products, our SNAP rapid assay test kits, outside reference laboratory and consulting services, and extended maintenance agreements and accessories related to our CAG Diagnostics instruments are considered recurring in nature. For the year ended December 31, 2017, recurring diagnostic revenue, which is both highly durable and profitable, accounted for approximately 74 percent of our consolidated revenue.

Our in-clinic diagnostic solutions, consisting of our IDEXX VetLab consumable products and SNAP rapid assay test kits, provide real-time reference lab quality diagnostic results for a variety of companion animal diseases and health conditions. Our outside reference laboratories provide veterinarians with the benefits of a more comprehensive list of diagnostic tests and access to consultations with board-certified veterinary specialists and pathologists, combined with the benefit of same-day or next-day turnaround times.

We derive substantial revenues and margins from the sale of consumables that are used in IDEXX VetLab instruments and the multi-year consumable revenue stream is significantly more valuable than the placement of the instrument. Our strategy is to increase diagnostic testing within veterinary practices by placing IDEXX VetLab instruments and increasing instrument utilization of consumables. Utilization can increase due to a greater number of patient samples being run or to an increase in the number of tests being run per patient sample. Our strategy is to increase both drivers. To increase utilization, we seek to educate veterinarians about best medical practices that emphasize the importance of chemistry, hematology and urinalysis testing for a variety of diagnostic purposes, as well as by introducing new testing capabilities that were previously not available to veterinarians. Additionally, we

have found that veterinarian adoption of VetConnect PLUS drives utilization by spurring testing across all IDEXX diagnostic modalities. In connection with the purchase of instruments, we also offer protocol-based rebate incentives when customers utilize the broad testing functionality of our analyzers.

Our in-clinic diagnostic solutions also include SNAP rapid assay tests that address important medical needs for particular diseases prevalent in the companion animal population. We seek to differentiate these tests from those of other in-clinic test providers and reference laboratory diagnostic service providers based on critically important sensitivity and specificity, as well as overall superior performance and ease of use by providing our customers with combination tests that test a single sample for up to six diseases at once, including the ability to utilize our SNAP Pro mobile device. We further augment our product development and customer service efforts with sales and marketing programs that enhance medical awareness and understanding regarding certain diseases and the importance of diagnostic testing.

The expiration of a third party’s U.S. lateral flow patent in early 2015 enabled competitors to launch single use tests that competed with several of our early generation SNAP rapid assay products, including Heartworm RT, FIV/FeLV Combo Test, Feline Triple, Parvo, and Giardia. These companies partnered with several of our former national distributors to gain market share by competing primarily on price. In the second half of 2015, we stabilized our market share on these products in part by communicating the significant superiority in test sensitivity for both our Canine and Feline lines over competing tests using the lateral flow platform, and in part with more effective marketing and promotion programs. Our higher sensitivity in the detection of infectious diseases is due in part to our SNAP platform, which is unique in using enzyme-linked immunosorbent assays (“ELISA”) technology. Test accuracy through specificity and sensitivity is a primary factor that customers value with these in-house tests, given the importance of detecting the presence of serious infectious diseases in the practice.

We believe approximately half of all diagnostic testing by U.S. veterinarians is provided by outside reference laboratories such as IDEXX Reference Laboratories. In several markets outside the U.S., in-clinic testing is less prevalent and an even greater percentage of diagnostic testing is done in reference laboratories. We attempt to differentiate our reference laboratory testing services from those of competitive reference laboratories and competitive in-clinic offerings primarily on the basis of a unique and proprietary test menu, technology employed, quality, turnaround time, customer service and tools such as VetConnect PLUS that demonstrate the complementary manner in which our laboratory services work with our in-clinic offerings.

Profitability in our lab business is supported, in part, by our expanding business scale globally. Profit improvements also reflect benefits from price increases and our ability to achieve efficiencies. When possible, we utilize core reference laboratories to service samples from other states or countries, expanding our customer reach without an associated expansion in our reference laboratory footprint. New laboratories that we open typically will operate at a loss until testing volumes achieve sufficient scale. Acquired laboratories frequently operate less profitably than our existing laboratories and acquired laboratories may not achieve the profitability of our existing laboratory network for several years until we complete the implementation of operating improvements and efficiencies. Therefore, in the short term, new and acquired reference laboratories generally will have a negative effect on our operating margin. Recurring reference lab revenue growth is achieved both through increased sales to existing customers and through the acquisition of new customers. We believe the increased number of customer visits by our sales professionals as a result of the implementation of our all-direct sales strategy in the U.S. and the subsequent growth in our field sales organization has led to increased reference laboratory opportunities with customers who already use one of our in-clinic diagnostic modalities. In recent years, recurring reference laboratory diagnostic and consulting revenues have also been increased through reference laboratory acquisitions, customer list acquisitions, the opening of new reference laboratories, including laboratories that are co-located with large practice customers, and as a result of our up-front customer loyalty programs. Our up-front customer loyalty programs associated with customer acquisitions and retention provide incentives to customers in the form of cash payments or IDEXX Points upon entering multi-year agreements to purchase annual minimum amounts of products or services, including reference laboratory services.

Health Monitoring and Biological Materials Testing. We believe the acquisition of the research and diagnostic laboratory business of the College of Veterinary Medicine from the University of Missouri has allowed us to leverage our expertise in veterinary diagnostics and expand our integrated offering of reference laboratory diagnostic and consulting services and in-clinic testing solutions in the adjacent bioresearch market.

Veterinary Software, Services and Diagnostic Imaging Systems. Our portfolio of practice management offerings is designed to serve the full range of customers within the North American, Australian, and European markets. Cornerstone, DVMAX, Animana and IDEXX Neo practice management systems provide superior integrated information solutions, backed by exceptional customer support and education. These practice management systems allow the veterinarian to practice better medicine and achieve the practice’s business objectives, including a quality client experience, staff efficiency and practice profitability. We market Cornerstone, DVMAX and IDEXX Neo practice management systems to customers primarily in North America and Australia. We market our Animana offering to customers primarily throughout Europe.

Animana and IDEXX Neo practice management systems are subscription-based SaaS offerings designed to provide flexible pricing and a durable, recurring revenue stream, while utilizing cloud technology instead of a client server platform. While we continue to develop, sell, and support our licensed-based Cornerstone and DVMAX software, we are growing our installed base of subscription-based practice management offerings for new customers of IDEXX practice management systems. We believe that once established, this subscription-based model will provide higher profitability as compared to the historical license-based placements. Our Cornerstone and DVMAX customer base continues to be an important driver of growth through enhanced diagnostic integrations and high value add-on subscription services, such as Pet Health Network Pro, Petly Plans, and credit card processing, and we continue to make investments to enhance the customer experience of all of our license-based software offerings. We also offer rVetLink, a comprehensive referral management solution for specialty care hospitals that streamlines the referral process between primary care and specialty care veterinarians. rVetLink’s cloud technology integrates with major specialty hospital management systems, including Cornerstone Software and DVMAX Software.

We differentiate our practice management systems through enhanced functionality, ease of use and connectivity with in-clinic IDEXX VetLab instruments and outside reference laboratory test results. Our client communication services create more meaningful pet owner experiences through personalized communication. Pet Health Network Pro online client communication and education service complements the entire IDEXX product offering by educating pet owners and building loyalty through engaging the pet owner before, during and after the visit, thereby building client loyalty and driving more patient visits.

Our diagnostic imaging systems offer a convenient radiographic solution that provides superior image quality and the ability to share images with clients virtually anywhere. IDEXX imaging software enables enhanced diagnostic features and streamlined integration with our other products and services. Our newest digital radiography systems, the ImageVue DR50 Digital Imaging System enables low-dose radiation image capture without sacrificing clear, high-quality diagnostic images, reducing the risk posed by excess radiation exposure for veterinary professionals. Placements of imaging systems are important to the growth of revenue streams that are recurring in nature, including extended maintenance agreements and IDEXX Web PACS, which is our cloud-based SaaS offering for viewing, accessing, storing, and sharing multi-modality diagnostic images. We derive relatively higher margins from our subscription-based products. IDEXX Web PACS is integrated with Cornerstone, IDEXX Neo and IDEXX VetConnect PLUS to provide centralized access to diagnostic imaging results alongside patient diagnostic results from any internet connected device.

Water

Our strategy in the water testing business is to develop, manufacture, market and sell proprietary products that test primarily for the presence of microbial contamination in water matrices, including drinking water supplies, with superior performance, supported by exceptional customer service. Our customers primarily consist of water utilities, government laboratories and private certified laboratories that highly value strong relationships and customer support. We expect that future growth in this business will be significantly dependent on our ability to increase international sales. Growth also will be dependent on our ability to enhance and broaden our product line. Most water microbiological testing is driven by regulation, and, in many countries, a test may not be used for compliance testing unless it has been approved by the applicable regulatory body and integrated into customers’ testing protocols. As a result, we maintain an active regulatory program that involves applying for a growing number of regulatory approvals in a number of countries, primarily in Europe. Further, we seek to receive regulatory approvals from governing agencies as a means to differentiate our products from the competition.

Livestock, Poultry and Dairy

We develop, manufacture, market and sell a broad range of tests and perform services for various livestock diseases and conditions, and have active research and development and in-licensing programs in this area. Our strategy is to offer proprietary tests with superior performance characteristics for use in government programs to control or eradicate disease and disease outbreaks and in livestock and poultry producers’ disease, reproductive, and herd health and production management programs. Disease outbreaks are episodic and unpredictable, and certain diseases that are prevalent at one time may be substantially contained or eradicated at a later time. In response to outbreaks, testing initiatives may lead to exceptional demand for certain products in certain periods. Conversely, successful eradication programs may result in significantly decreased demand for certain products. In addition, increases in government funding may lead to increased demand for certain products and budgetary constraints may lead to decreased demand for certain products. As result, the performance in certain sectors of this business can fluctuate.

Our strategy in the dairy testing business is to develop, manufacture and sell antibiotic residue and contaminant testing products that satisfy applicable regulatory requirements or dairy processor standards for testing of milk and provide reliable field performance. The manufacture of these testing products leverages the SNAP platform and production assets that also support our rapid assay business, which also leverages the SNAP platform. The dairy SNAP products, incorporate customized reagents for antibiotic and contaminant detection. To successfully increase sales of dairy testing products, we believe that we need to increase penetration in dairy processors and develop product line enhancements and extensions. Our Rapid Visual Pregnancy Test for cattle can detect pregnancy 28 days after breeding. This test provides a quick and accurate identifier using whole blood samples.

The performance of the business is particularly subject to the various risks that are associated with doing business internationally. See “Part I, Item 1A. Risk Factors.”

Other

OPTI Medical. Our strategy in the OPTI Medical business for the human market is to develop, manufacture, and sell electrolyte and blood gas analyzers and related consumable products for the medical point-of-care diagnostics market worldwide, with a focus on small to mid-sized hospitals. We seek to differentiate our products based on ease of use, convenience, international distribution and service and instrument reliability. Similar to our veterinary instruments and consumables strategy, a substantial portion of the revenues from this product line is derived from the sale of consumables for use on the installed base of electrolyte and blood gas analyzers. During the early stage of an instrument’s life cycle, relatively greater revenues are derived from instrument placements, while consumable sales become relatively more significant in later stages as the installed base of instruments increases and instrument placement revenues begin to decline. Our long-term success in this area of our business is dependent upon new customer acquisition, customer retention and increased customer utilization of existing and new assays introduced on these instruments.

Our facility in Roswell, Georgia develops and manufactures the OPTI product lines using the same or similar technology to support the electrolyte needs of the veterinary market. We leverage this facility’s know-how, intellectual property, and manufacturing capability to continue to expand the menu and instrument capability of the VetStat and Catalyst platforms for veterinary applications while reducing our cost of consumables by leveraging experience and economies of scale.

During the first half of 2016, management reviewed the OPTI Medical product offerings. As a result of this review, in March 2016 we discontinued certain development activities in the human point-of-care medical diagnostics market that were devoted to a new platform and focused our efforts on supporting our current generation OPTI CCA-TS2 Blood Gas and Electrolyte analyzer.

The performance of the business is particularly subject to the various risks that are associated with doing business internationally. See “Part I, Item 1A. Risk Factors.”

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Note 2 to the consolidated financial statements included in this Annual Report on Form 10-K describes the significant accounting policies used in preparation of these consolidated financial statements.

We believe the following critical accounting estimates and assumptions may have a material impact on reported financial condition and operating performance and involve significant levels of judgment to account for highly uncertain matters or are susceptible to significant change.

Revenue Recognition

We recognize revenue when four criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the sales price is fixed or determinable; and (iv) collectability is reasonably assured. See Note 2(j) to the consolidated financial statements for the year ended December 31, 2017, included in this Annual Report on Form 10-K for additional information about our revenue recognition policy and criteria for recognizing revenue.

Multiple Element Arrangements (“MEAs”). Arrangements to sell products to customers frequently include multiple deliverables. Our most significant MEAs include the sale of one or more of the instruments from the IDEXX VetLab suite of analyzers, diagnostic imaging systems or practice management software, combined with one or more of the following products: extended maintenance agreements (“EMAs”), consumables, rapid assay kits and reference laboratory diagnostic and consulting services. Practice management software is frequently sold with post-contract customer support and implementation services. Delivery of the various products or performance of services within the arrangement may or may not coincide. Delivery of our IDEXX VetLab instruments, diagnostic imaging systems and practice management software generally occurs at the onset of the arrangement. EMAs, consumables, rapid assay kits, and reference laboratory diagnostic and consulting services typically are delivered over future periods, generally one to six years. In certain arrangements, revenue recognized is limited to the amount invoiced or received that is not contingent on the delivery of products and services in the future.

We allocate revenue to each element based on the relative selling price and recognize revenue when the elements have standalone value and the four criteria for revenue recognition, as discussed above, have been met for each element. If available, we establish the selling price of each element based on vendor-specific objective evidence (“VSOE”), which represents the price charged for a deliverable when it is sold separately. We use third-party evidence (“TPE”) if VSOE is not available, or best estimate of selling price if neither VSOE nor TPE is available. When these arrangements include a separately-priced EMA, we recognize revenue related to the EMA at the stated contractual price on a straight-line basis over the life of the agreement to the extent the separately stated price is substantive. If there is no stated contractual price for an EMA, or the separately stated price is not substantive, we allocate revenue to each element based on the relative selling price and recognize revenue when the elements have standalone value and the four criteria for revenue recognition, as discussed above, have been met for each element.

When arrangements within the scope of software revenue recognition guidance include multiple elements, we allocate revenue to each element based on relative fair value, when VSOE exists for all elements, or by using the residual method when there is VSOE for the undelivered elements but no such evidence for the delivered elements. Under the residual method, the fair value of the undelivered elements is deferred and the residual revenue is allocated to the delivered elements. Revenue is recognized on any delivered elements when the four criteria for revenue recognition have been met for each element. If VSOE does not exist for the undelivered element, all revenue from the arrangement is deferred until the earlier of the point at which such sufficient VSOE does exist or all elements of the arrangement have been delivered. We determine fair value based on amounts charged separately for the delivered and undelivered elements to similar customers in standalone sales of the specific elements.

Certain arrangements with customers include discounts on future sales of products and services. We apply judgment in determining whether future discounts are significant and incremental. When the future discount offered is not considered significant and incremental, we do not account for the discount as an element of the original arrangement. If the future discount is significant and incremental, we recognize that discount as an element of the original arrangement and allocate the discount to the other elements of the arrangement based on relative selling price. To determine whether a discount is significant and incremental, we look to the discount provided in comparison to standalone sales of the same product or service to similar customers, the level of discount provided on other elements in the arrangement and the significance of the discount to the overall arrangement. If the discount in the MEA approximates the discount typically provided in standalone sales, that discount is not considered incremental.

Customer Programs. We record reductions to revenue related to customer marketing and incentive programs, which include end-user rebates and other volume-based incentives. Incentives may be provided in the form of IDEXX Points, credits or cash and are earned by end users upon achieving defined volume purchases or utilization levels or upon entering an agreement to purchase products or services in future periods. The summary of revenue reductions presented in the tables below reflects all revenue reductions recorded for the year for each particular program. These amounts are presented on a net basis when applicable, which accounts for any differences between estimates and actual incentives earned for the relevant customer marketing or incentive program. These differences have been insignificant in all quarterly or annual periods. Our most significant customer programs are categorized as follows:

Customer Loyalty Programs. Our customer loyalty programs offer customers the opportunity to earn incentives on a variety of IDEXX products and services as those products and services are purchased and utilized. Revenue reductions related to customer loyalty programs are recorded based on the actual issuance of incentives, incentives earned but not yet issued and estimates of incentives to be earned in the future.

Up-Front Customer Loyalty Programs. Our up-front loyalty programs provide incentives to customers in the form of cash payments or IDEXX Points upon entering multi-year agreements to purchase annual minimum amounts of future products or services. We predominately offer up-front loyalty incentives in response to competitive offerings. If a customer breaches its agreement, they are required to refund all or a portion of the up-front cash or IDEXX Points, or make other repayments, remedial actions, or both. These incentives are considered to be customer acquisition costs and are capitalized within other current assets and other long-term assets and are subsequently recognized as a reduction to revenue over the term of the customer agreement. If these up-front incentives are subsequently utilized to purchase IDEXX VetLab instruments, diagnostic imaging systems or Cornerstone practice management systems, product revenue and cost is deferred and recognized over the term of the customer agreement as products and services are provided to the customer. We monitor customer purchases over the term of their agreement to assess the realizability of our capitalized customer acquisition costs. For the years ended December 31, 2017, 2016 and 2015, impairments of customer acquisition costs were immaterial.

IDEXX Instrument Marketing Programs. Our instrument marketing programs require the customer to enroll at the time of instrument purchase and offer customers the opportunity to earn incentives in future periods based on the volume of the products they purchase and utilize over the term of the program. These arrangements are considered MEAs in accordance with our revenue recognition policy stated above. Revenue reductions related to instrument marketing programs are recorded based on an estimate of customer purchase and utilization levels and the incentive the customer will earn over the term of the program. Our estimates are based on historical experience and the specific terms and conditions of the marketing program, requiring us to apply judgment to estimate future product purchases and utilization. Differences between our estimates and actual incentives earned are accounted for as a change in estimate. These differences were not material for the years ended December 31, 2017, 2016 and 2015. At December 31, 2017, a 5 percent change in our estimate of future customer utilization would increase or reduce revenue by approximately $0.4 million.

Reagent Rental Programs. Our reagent rental programs provide customers the right to use our instruments in consideration for multi-year agreements to purchase annual minimum amounts of consumables. No instrument revenue is recognized at the time of instrument installation. We recognize a portion of the revenue allocated to the instrument concurrent with the future sale of consumables. We determine the amount of revenue allocated from the consumable to the instrument based on relative selling prices and determine the rate of instrument revenue recognition in proportion to the customer’s minimum volume commitment. The cost of the instrument is capitalized within property and equipment or deferred within other assets, and is charged to the cost of product revenue on a straight-line basis over the term of the minimum purchase agreement.

IDEXX Points are considered the same as cash and may be applied against the purchase price of IDEXX products and services or applied to trade receivables due to us. IDEXX Points that have not yet been used by customers are classified as a liability until use or expiration occurs. We estimate the amount of IDEXX Points expected to expire, or breakage, based on historical expirations and we recognize the estimated benefit of breakage in proportion to actual redemptions of IDEXX Points by customers. On November 30 of each year, unused IDEXX Points earned before January 1 of the prior year generally expire and any variance from the breakage estimate is accounted for as a change in estimate. This variance was not material for the years ended December 31, 2017, 2016 and 2015.

Future market conditions and changes in product offerings may cause us to change marketing strategies to increase or decrease customer incentive offerings, possibly resulting in incremental reductions of revenue in future periods as compared to reductions in the current or prior periods. Additionally, certain customer programs require us to estimate, based on historical experience, and apply judgment to predict the number of customers who will actually redeem the incentive. In determining estimated revenue reductions, we utilize data collected directly from end users, which includes the volume of qualifying products purchased and the number of qualifying tests run as reported to us by end users via IDEXX SmartService. Differences between estimated and actual customer participation in programs may impact the amount and timing of revenue recognition.

Following is a summary of revenue reductions, net recorded in connection with our customer programs for the years ended December 31, 2017, 2016 and 2015 (in thousands):

	For the Years Ended December 31,
		2017			2016			2015
Revenue Reductions Recorded, Net
Customer Loyalty Programs, Net (1)	$	22,106		$	18,226		$	16,742
Up-Front Customer Loyalty Programs		28,881			24,595			19,972
IDEXX Instrument Marketing Programs, Net (1)		43,939			37,012			31,112
Other Customer Programs, Net (1)		384			417			664
Total revenue reductions, Net	$	95,310		$	80,250		$	68,490

	(1)		Revenue reduction is provided on a net basis, which accounts for any differences between estimates and actual incentives earned.

Accrued customer programs are included within accrued liabilities and other long-term liabilities, depending on the anticipated settlement date, in the consolidated balance sheets included in this Annual Report on Form 10-K. Following is a summary of changes in the accrual for estimated revenue reductions attributable to customer programs and the ending accrued customer programs balance for the years ended December 31, 2017 and 2016 (in thousands):

	For the Years Ended December 31,
		2017			2016
Accrued Customer Programs:
Balance, beginning of the year	$	59,432		$	55,133
Revenue reductions for Customer Loyalty Programs, Net (1)		22,106			18,227
Up-Front Customer Loyalty Program Awards issued as IDEXX Points		50,902			31,407
Revenue reductions for IDEXX Instrument Marketing Programs, Net (1)		43,939			37,011
Revenue reductions for Other Customer Programs, Net (1)		384			417
IDEXX Points redeemed and credits issued		(107,867)			(81,733)
Breakage		(471)			(722)
Exchange impact on balances denominated in foreign currency		1,186			(308)
Balance, end of the year	$	69,611		$	59,432

	(1)		Revenue reduction is provided on a net basis, which accounts for any differences between estimates and actual incentives earned.

New Revenue Standard. We will adopt ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (the “New Revenue Standard”) in the first quarter of 2018 on a modified-retrospective basis. ASU 2014-09 will replace most of the existing revenue recognition guidance within U.S. GAAP. See Note 2(x) to the consolidated financial statements for the year ended December 31, 2017, included in this Annual Report on Form 10-K for additional information about ASU 2014-09. While ASU 2014-09 will not impact the overall economics of our products and services sold under customer marketing and incentive programs, we expect the New Revenue Standard will require us to accelerate revenue recognition related to certain of our customer programs and to delay revenue recognition for certain other customer programs. We expect to accelerate revenue recognition on instruments and systems placed through programs where customers are committed to purchase future goods and services, including our up-front customer loyalty and volume commitment programs. This change is the result of the New Revenue Standard no longer limiting revenue recognition to the amount of customer consideration received upon placement. Conversely, we expect to defer an increased portion of revenue related to instrument placements under programs that provide rebate incentives on future purchases, including certain of our IDEXX instrument marketing programs. Under the New Revenue Standard, future purchases that are optional and not subject to a customer commitment, are not considered part of the customer arrangement, resulting in the instrument absorbing a higher relative allocation of rebate incentives. We expect this change to result in lower instrument revenue upon placement and higher recurring revenues over the term of the rebate incentive program. We believe these will be the most significant impacts related to our adoption of the New Revenue Standard and we estimate a net increase in revenue of approximately $10 million for the year ending December 31, 2018, in connection with such adoption. The estimated net increase in revenue is the result of anticipated earlier recognition on 2018 activity, which is expected to be partially offset by the net impact of the modified-retrospective cumulative adjustments on 2018. These impacts are expected to increase CAG Diagnostics recurring revenues related to the modified-retrospective cumulative adjustments, which is expected to be partially offset by a net decrease in both CAG Diagnostics capital instrument revenue and Veterinary software, services and imaging systems revenue. This assessment is based on the anticipated volume, mix and

design of our customer marketing and incentive programs, which may change in response to future customer and competitive demands. Furthermore, the New Revenue Standard requires the deferral of incremental costs to obtain a customer contract over the term of the customer arrangement, such as sales commissions. Based on the current design of our sales commission plans, the impact of implementing this element of the New Revenue Standard is not expected to be material to our results for the year ending December 31, 2018.

Inventory Valuation

We write down the carrying value of inventory for estimated obsolescence by an amount equal to the difference between the cost of inventory and the estimated market value when warranted based on assumptions of future demand, market conditions, remaining shelf life or product functionality. If actual market conditions or results of estimated functionality are less favorable than those we estimated, additional inventory write-downs may be required, which would have a negative effect on results of operations.

Valuation of Goodwill and Other Intangible Assets

A significant portion of the purchase price for acquired businesses is generally assigned to intangible assets. Intangible assets other than goodwill are initially valued at fair value. If a quoted price in an active market for the identical asset is not readily available at the measurement date, the fair value of the intangible asset is estimated based on discounted cash flows using market participant assumptions, which are assumptions that are not specific to IDEXX. The selection of appropriate valuation methodologies and the estimation of discounted cash flows require significant assumptions about the timing and amounts of future cash flows, risks, appropriate discount rates, and the useful lives of intangible assets. When material, we utilize independent valuation experts to advise and assist us in determining the fair values of the identified intangible assets acquired in connection with a business acquisition and in determining appropriate amortization methods and periods for those intangible assets. Goodwill is initially valued based on the excess of the purchase price of a business combination over the fair value of acquired net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized.

We assess goodwill for impairment annually, at the reporting unit level, in the fourth quarter and whenever events or circumstances indicate impairment may exist. An impairment charge is recorded for the amount, if any, by which the carrying amount of goodwill exceeds its implied fair value. Our reporting units are the individual product and service categories that comprise our CAG operating segment, our Water and LPD operating segments and goodwill remaining from the restructuring of our pharmaceutical business in the fourth quarter of 2008. A substantial portion of the goodwill remaining from the pharmaceutical business, included in our “Other Segment”, is associated with intellectual property that has been, or that we expect to be, licensed to third parties. Realization of this goodwill is dependent upon the success of those third parties in developing and commercializing products, which will result in our receipt of royalties and other payments.

In evaluating goodwill for impairment, we have the option to first assess the qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The more likely than not threshold is defined as having a likelihood of more than 50 percent. If, after assessing the totality of events or circumstances, we determine that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we would then perform step one of the two-step impairment test; otherwise, no further impairment test would be required. In contrast, we can opt to bypass the qualitative assessment for any reporting unit in any period and proceed directly to step one of the two-step impairment test. Doing so does not preclude us from performing the qualitative assessment in any subsequent period.

As part of our goodwill testing process, we evaluate factors specific to a reporting unit as well as industry and macroeconomic factors that are reasonably likely to have a material impact on the fair value of a reporting unit. Examples of the factors considered in assessing the fair value of a reporting unit include: the results of the most recent impairment test, the competitive environment, the regulatory environment, anticipated changes in product or labor costs, revenue growth trends, the consistency of operating margins and cash flows and current and long-range financial forecasts. The long-range financial forecasts of the reporting units, which are based upon management’s long-term view of our markets, are used by senior management and the Board of Directors to evaluate operating performance.

In the fourth quarters of 2017 and 2016, we elected to bypass the qualitative approach and instead proceeded directly to step one of the two-step impairment test to assess the fair value of all of our reporting units.

As part of step one of the two-step impairment test, we estimate the fair values of applicable reporting units using an income approach based on discounted forecasted cash flows. We make significant assumptions about the extent and timing of future cash flows, growth rates and discount rates. Model assumptions are based on our projections and best estimates, using appropriate and customary market participant assumptions. In addition, we make certain assumptions in allocating shared assets and liabilities to individual reporting units in determining the carrying value of each reporting unit. To validate the reasonableness of our reporting units' estimated fair values, we reconcile the aggregate fair values of our reporting units to our total market capitalization. Valuation assumptions reflect our projections and best estimates, based on significant assumptions about the extent and timing of future cash flows, growth rates and discount rates.

We maintain approximately $6.5 million of goodwill associated with our remaining pharmaceutical intellectual property, out-licensing arrangements, and certain retained drug delivery technologies (collectively “Pharmaceutical Activities”) that we seek to commercialize through arrangements with third parties. Currently, our primary support for the carrying value of this goodwill is royalty revenue associated with the commercialization of certain intellectual property. There is no guarantee that we will be able to maintain or increase revenues from our remaining Pharmaceutical Activities. The results of our goodwill impairment test for these Pharmaceutical Activities indicate an excess of estimated fair value over the carrying amount of this reporting unit by approximately $3.1 million and 47 percent of the reporting unit’s carrying value. Excluding these Pharmaceutical Activities, the results of our goodwill impairment test indicate an excess of estimated fair value over the carrying amount for each of our reporting units with a minimum of 150 percent and an average of approximately 550 percent.

While we believe that the assumptions used to determine the estimated fair values of each of our reporting units are reasonable, a change in assumptions underlying these estimates could result in a material negative effect on the estimated fair value of the reporting units. Our fair value estimate assumes the achievement of future financial results contemplated in our forecasted cash flows, and there can be no assurance that we will realize that value. We use forecasts to estimate future cash flows and include an estimate of long-term future growth rates based on our most recent views of the long-term outlooks for our reporting units. Actual results may differ from those assumed in our forecasts. The discount rate is based on a weighted average cost of capital derived from industry peers. Changes in market conditions, interest rates, growth rates, tax rates, costs, pricing, or the discount rate would affect the estimated fair values of our reporting units and could result in a goodwill impairment charge in a future period. No goodwill impairments were identified during the years ended December 31, 2017, 2016 or 2015.

A prolonged economic downturn in the U.S. or internationally resulting in lower long-term growth rates and reduced long-term profitability may reduce the fair value of our reporting units. Industry specific events or circumstances could have a negative impact on our reporting units and may also reduce the fair value of our reporting units. Should such events occur and it becomes more likely than not that a reporting unit’s fair value has fallen below its carrying value, we will perform an interim goodwill impairment test, in addition to the annual impairment test. Future impairment tests may result in an impairment of goodwill, depending on the outcome of future impairment tests. An impairment of goodwill would be reported as a non-cash charge to earnings.

We assess the realizability of intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If an impairment review is triggered, we evaluate the carrying value of intangible assets based on estimated undiscounted future cash flows over the remaining useful life of the primary asset of the asset group and compare that value to the carrying value of the asset group. The cash flows that are used contain our best estimates, using appropriate and customary assumptions and projections at the time. If the net carrying value of an intangible asset exceeds the related estimated undiscounted future cash flows, an impairment to adjust the intangible asset to its fair value would be reported as a non-cash charge to earnings. If necessary, we would calculate the fair value of an intangible asset using the present value of the estimated future cash flows to be generated by the intangible asset and applying a risk-adjusted discount rate.

We had no impairments of our intangible assets during the year ended December 31, 2017. During the first half of 2016, management reviewed our OPTI Medical product offering, which resulted in the discontinuance of our instrument development activities in the human point-of-care medical diagnostics market and a decision to focus our commercial and development efforts to support our latest generation OPTI CCA-TS2 Blood Gas and Electrolyte analyzer. Management identified unfavorable trends in our OPTI Medical business resulting from this change in strategy. We revised our forecasts downward, causing us to assess the realizability of the related tangible and intangible assets and determined the expected future cash flows were less than the carrying value of the OPTI Medical asset group. Non-cash intangible asset impairments of $2.2 million were recognized during the six months ended June 30, 2016. The intangibles associated with our OPTI Medical human point-of-care medical diagnostics market are fully written off. Intangible assets impairments during the years ended December 31, 2015 were not material.

Our business combinations regularly include contingent consideration arrangements that require additional consideration to be paid based on the achievement of established objectives, most commonly related to the retention or growth of the customer base during the post-combination period. We assess contingent consideration to determine if it is part of the business combination or if it should be accounted for separately from the business combination in the post-combination period. Contingent consideration is recognized at its fair value on the acquisition date. A liability resulting from contingent consideration is remeasured to fair value at each reporting date until the contingency is resolved, with changes in fair value recognized in earnings. Changes in fair value of contingent consideration and differences arising upon settlement were not material during the years ended December 31, 2017, 2016 and 2015. See Note 3 to the consolidated financial statements included in this Annual Report on Form 10-K for additional information regarding contingent consideration arising from business acquisitions.

Share-Based Compensation

Effective January 1, 2017, we adopted the FASB Accounting Standard Update (“ASU”) 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting which simplifies several aspects of the accounting for share-based payment transactions, including income tax consequences, recognition of stock compensation award forfeitures, classification of awards as either equity or liabilities, the calculation of diluted shares outstanding and classification on the statement of cash flows. The tax benefits related to share-based payments reduced income tax expense by approximately $28 million for the year ended December 31, 2017, primarily through a reduction in our effective income tax rate. We do not estimate that the level of share-based payment activity in 2017 will continue in future periods. We believe that the historical range of $11 million to $14 million of annual tax benefits reflects a reasonable estimate for 2018, based on current settlement trends and stock price levels. These impacts may vary significantly based on the timing of actual settlement activity. For more information regarding the adoption of the new share-based compensation guidance, ASU 2016-09, see Note 2 to the consolidated financial statements included in this Annual Report on Form 10-K.

Our share-based compensation programs provide for grants of stock options, restricted stock units and deferred stock units, along with the issuance of employee stock purchase rights. The total fair value of future awards may vary significantly from past awards based on a number of factors, including our share-based award practices. Therefore, share-based compensation expense is likely to fluctuate, possibly significantly, from year to year.

We use the Black-Scholes-Merton option-pricing model to determine the fair value of options granted. Option-pricing models require the input of highly subjective assumptions, particularly for the expected stock price volatility and the expected term of options. The risk-free interest rate is based on the U.S. Treasury yield for a duration similar to the expected term at the date of grant. We have never paid any cash dividends on our common stock and we have no intention to pay a dividend at this time; therefore, we assume that no dividends will be paid over the expected terms of option awards. We determine the assumptions to be used in the valuation of option grants as of the date of grant. As such, we use different assumptions during the year if we grant options at different dates. Substantially all our options granted during the years ended December 31, 2017, 2016 and 2015 were granted in the first quarter of each year. The weighted average of each of the valuation assumptions used to determine the fair value of each option grant during each of the previous three years is as follows:

		For the Years Ended December 31,
		2017			2016			2015
Expected stock price volatility		26	%		25	%		23	%
Expected term, in years (1)		5.8			5.7			5.6
Risk-free interest rate		2.0	%		1.2	%		1.5	%

	(1)		Options granted have a contractual term of ten years.

Changes in these subjective assumptions, particularly for the expected stock price volatility and the expected term of options, can materially affect the fair value estimate. Our expected stock price volatility assumption is based on the historical volatility of our stock over a period similar to the expected term and other relevant factors. Higher estimated volatility increases the fair value of a stock option, while lower estimated volatility has the opposite effect. The total fair value of stock options granted during the year ended December 31, 2017, was $15.7 million. If the weighted average of the stock price volatility assumption was increased or decreased by 1 percent, the total fair value of stock options awarded during the year ended December 31, 2017, would have increased or decreased by approximately $0.5 million and the total expense recognized for the year ended December 31, 2017, for options awarded during the same period would have increased or decreased by less than $0.1 million.

We derive the expected term assumption for stock options based on historical experience and other relevant factors concerning expected behavior with regard to option exercises. The expected term is determined using a consistent method at each grant date. A longer expected term assumption increases the fair value of stock option awards, while a shorter expected term assumption has the opposite effect. If the weighted average of the expected term was increased or decreased by one year, the total fair value of stock options awarded during the year ended December 31, 2017, would have increased or decreased by approximately $1.5 million, and the total expense recognized for the year ended December 31, 2017, for options awarded during 2017 would have increased or decreased by approximately $0.3 million.

For a significant majority of our awards, share-based compensation expense is recognized on a straight-line basis over the requisite service period, which ranges from one to five years, depending on the award. Share-based compensation expense is recognized on a grade-vesting methodology for performance-based restricted stock units. Share-based compensation expense is based on the number of awards expected to vest and is, therefore, reduced for an estimate of the number of awards that are expected to be forfeited. The forfeiture estimates are based on historical data and other factors; share-based compensation expense is adjusted annually for actual results. Total share-based compensation expense for the year ended December 31, 2017, was $23.5 million, which is net of a reduction of approximately $2.2 million for actual and estimated forfeitures. Fluctuations in our overall employee turnover rate may result in changes in estimated forfeiture rates and differences between estimated forfeiture rates and actual experience and, therefore could have a significant unanticipated impact on share-based compensation expense.

Modifications of the terms of outstanding awards may result in significant increases or decreases in share-based compensation. There were no material modifications to the terms of outstanding options, restricted stock units or deferred stock units during 2017, 2016 or 2015.

The fair value of stock options, restricted stock units, deferred stock units and employee stock purchase rights issued totaled $31.4 million for the year ended December 31, 2017, $27.0 million for the year ended December 31, 2016, and $25.6 million for the year ended December 31, 2015. The total unrecognized compensation expense, net of estimated forfeitures, for unvested share-based compensation awards outstanding at December 31, 2017, was $45.2 million, which will be recognized over a weighted average period of approximately 1.6 years.



Income Taxes

The Tax Act was enacted on December 22, 2017, and includes significant changes to the U.S. corporate tax system. Effective January 1, 2018, the Tax Act reduced the U.S. federal corporate tax rate from 35 percent to 21 percent, and transitioned from a worldwide tax system to a territorial tax system, and eliminated or reduced certain domestic deductions among other changes. The Tax Act introduced new provisions including the Global Intangible Low-Taxed Income (“GILTI”), Foreign Derived Intangible Income (“FDII”), Base Erosion Anti-Abuse Tax (“BEAT’), expanded bonus depreciation and changed deductions for executive compensation and interest expense. We continue to assess the impact of the new provisions which become effective beginning in 2018. See Note 12 – Income Taxes, in the accompanying Notes to the consolidated financial statements for more information regarding the impact of the Tax Act.

We estimate our future effective tax rate will be reduced as a result of the corporate tax rate reduction and the new provisions provided in the Tax Act. The outlook for our 2018 effective tax rate is 20 - 21 percent, which includes the estimated impact of the Tax Act.

The provision for income taxes is determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the estimated future tax effects of temporary differences between book and tax treatment of assets and liabilities and carryforwards to the extent they are realizable.

On a quarterly basis, we assess our current and projected earnings by jurisdiction to determine whether or not our earnings during the periods when the temporary differences become deductible will be sufficient to realize the related future tax benefits. Should we determine that we would not be able to realize all or part of our net deferred tax asset in a particular jurisdiction in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. A reduction of net income before taxes in each subsidiary equal to 5 percent of revenue, compared to the corresponding reported amounts for the year ended December 31, 2017, would not result in the recognition of material incremental valuation allowances.

For those jurisdictions where tax carryforwards are likely to expire unused or the projected operating results indicate that realization is not more likely than not, a valuation allowance is recorded to offset the deferred tax asset within that jurisdiction. In assessing the need for a valuation allowance, we consider future taxable income and ongoing prudent and feasible tax planning strategies. In the event that we determine that we would be able to realize our deferred tax assets in the future in excess of the net recorded amount, a reduction of the valuation allowance would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, a reduction to the deferred tax asset would be charged to income in the period such determination was made.

Our net taxable temporary differences and tax carryforwards are recorded using the enacted tax rates expected to apply to taxable income in the periods in which the deferred tax liability or asset is expected to be settled or realized. Should the expected applicable tax rates change in the future, an adjustment to our deferred taxes would be credited or charged, as appropriate, to income in the period such determination was made. To illustrate the impact, the reduction in the U.S. federal income tax rate from 35 percent to 21 percent from the passage of the Tax Act resulted in a reduction to our net deferred tax liability of approximately $17 million. This decrease in the deferred tax liability increased our net income in the fourth quarter of 2017.

We periodically assess our exposures related to our worldwide provision for income taxes and believe that we have appropriately accrued taxes for contingencies. Any reduction of these contingent liabilities or additional assessment would increase or decrease income, respectively, in the period such determination was made.

As a result of the Tax Act we are no longer asserting indefinite reversal under ASC 740-30-25 for undistributed earnings of non-U.S. subsidiaries earned prior to December 31, 2017. We have recorded a provisional amount of $48.8 million for the deemed repatriation tax liability related to these earnings. For operating earnings generated after December 31, 2017, we are still analyzing the effects of the change in position as allowed under U.S. GAAP.

We record a liability for uncertain tax positions that do not meet the more likely than not standard as prescribed by the authoritative guidance for income tax accounting. We record tax benefits for only those positions that we believe will more likely than not be sustained. For positions that we believe that it is more likely than not that we will prevail, we record a benefit considering the amounts and probabilities that could be realized upon ultimate settlement. If our judgment as to the likely resolution of the uncertainty changes, if the uncertainty is ultimately settled or if the statute of limitation related to the uncertainty expires, the effects of the change would be recognized in the period in which the change, resolution or expiration occurs. Our net liability for uncertain tax positions was $21.8 million as of December 31, 2017, and $18.8 million as of December 31, 2016, which includes estimated interest expense and penalties. See Note 12 – Income Taxes, in the accompanying Notes to the consolidated financial statements for more information.

RECENT ACCOUNTING PRONOUNCEMENTS

In addition to the impacts from new accounting pronouncements included above, see Note 2(w) and (x) to the consolidated financial statements for the year ended December 31, 2017, included in this Annual Report on Form 10-K for a complete discussion of recent accounting pronouncement adopted and not adopted.

RESULTS OF OPERATIONS AND TRENDS

Effects of Certain Factors on Results of Operations

Distributor Purchasing and Inventories. When selling our products through distributors, changes in distributors’ inventory levels can impact our reported sales, and these changes may be affected by many factors, which may not be directly related to underlying demand for our products by veterinary practices, which are the end users. Therefore, we believe it is important to track sales to end users in the relevant periods by our significant distributors in order to distinguish between the impact of end-user demand and the impact of distributor purchasing dynamics on our reported revenue in those periods. In addition, where growth rates are affected by changes in end-user demand, we refer to this as the impact of practice-level sales on growth. Where growth rates are affected by distributor purchasing dynamics, we refer to this as the impact of changes in distributors’ inventories on growth. If during the current year, distributors’ inventories grew by less than those inventories grew in the comparable period of the prior year, then changes in distributors’ inventories would have an unfavorable impact on our reported sales growth in the current period. Conversely, if during the current year, distributors’ inventories grew by more than those inventories grew in the comparable period of the prior year, then changes in distributors’ inventories would have a favorable impact on our reported sales growth in the current period.

In the U.S., effective January 1, 2015, we fully transitioned to an all-direct sales strategy. Under this approach, we take orders, ship product, invoice and receive payment for all rapid assay test kits and VetLab consumables, instruments, reference laboratory services, and other CAG products and services. While changes in prior year U.S. distributors’ inventory levels impacted 2015 reported growth results, distributor inventory levels had an immaterial impact on our reported U.S. sales and growth results in later years. In certain other countries, we continue to sell our products through third-party distributors. Although we are unable to obtain data for sales to end users from certain less significant non-U.S. third party distributors, we do not believe the impact of changes in these distributors’ inventories had or would have a material impact on our growth rates in the relevant periods.

Currency Impact. For the year ended December 31, 2017, approximately 21 percent of our consolidated revenue was derived from products manufactured or sourced in U.S. dollars and sold internationally in local currencies, as compared to 21 percent for the year ended December 31, 2016, and 20 percent for the year ended December 31, 2015. Strengthening of the rate of exchange for the U.S. dollar relative to other currencies has a negative impact on our revenues derived in currencies other than the U.S. dollar and on profits of products manufactured or purchased in U.S. dollars and sold internationally, and a weakening of the U.S. dollar has the opposite effect. Similarly, to the extent that the U.S. dollar is stronger in current or future periods relative to the exchange rates in effect in the corresponding prior periods, our growth rate will be negatively affected. The impact of foreign currency denominated operating expenses and foreign currency denominated supply contracts partly offsets this exposure. Additionally, our designated hedges of intercompany inventory purchases and sales help delay the impact of certain exchange rate fluctuations on non-U.S. denominated revenues. See “Part II, Item 7A. Quantitative and Qualitative Disclosure About Market Risks” included in this Annual Report on Form 10-K for additional information regarding currency impact. Our future income tax expense could also be affected by changes in the mix of earnings, including as a result of changes in the rate of exchange for the U.S. dollar relative to currencies in countries with differing statutory tax rates. See “Part I, Item 1A. Risk Factors” included in this Annual Report on Form 10-K for additional information regarding tax impacts.

Effects of Economic Conditions. Demand for our products and services is vulnerable to changes in the economic environment, including slow economic growth, high unemployment, and credit availability. Negative or cautious consumer sentiment can lead to reduced or delayed consumer spending, resulting in a decreased number of patient visits to veterinary clinics. Unfavorable economic conditions can impact sales of instruments, diagnostic imaging, and practice management systems, which are larger capital purchases for veterinarians. Additionally, economic turmoil can cause our customers to remain sensitive to the pricing of our products and services. In the U.S., we monitor patient visits and clinic revenue data provided by a subset of our CAG customers. Although this data is a limited sample and susceptible to short-term impacts such as weather, which may affect the number of patient visits in a given period, we believe that this data provides a fair and meaningful long-term representation of the trend in patient visit activity in the U.S., providing us insight regarding demand for our products and services.

Economic conditions can also affect the purchasing decisions of our Water and LPD business customers. Water testing volumes may be susceptible to declines in discretionary testing for existing home and commercial sales and in mandated testing as a result of decreases in home and commercial construction. Testing volumes may also be impacted by severe weather conditions such as drought. In addition, fiscal difficulties can also reduce government funding for water and herd health screening services.

We believe that the diversity of our products and services and the geographic diversity of our markets partially mitigate the potential effects of the economic environment and negative consumer sentiment on our revenue growth rates.

Effects of Patent Expiration. Although we have several patents and licenses of patents and technologies from third parties that expired during 2017, and several that are expected to expire in 2018 and beyond, the expiration of these patents or licenses, individually or in the aggregate, is not expected to have a material effect on our financial position or future operations due to a range of factors as described in Item 1. “Business - Patents and Licenses”.

Non-GAAP Financial Measures. The following revenue analysis and discussion focuses on organic revenue growth, and references in this analysis and discussion to “revenue,” “revenues” or “revenue growth” are references to “organic revenue growth.” Organic revenue growth is a non-GAAP financial measure and represents the percentage change in revenue during the current year, as compared to the same period for the prior year, net of the effect of changes in foreign currency exchange rates, business acquisitions, and divestitures. Organic revenue growth should be considered in addition to, and not as a replacement for, or as a superior measure to, revenues reported in accordance with U.S. GAAP, and may not be comparable to similarly titled measures reported by other companies. Management believes that reporting organic revenue growth provides useful information to investors by facilitating easier comparisons of our revenue performance with prior and future periods and to the performance of our peers.

We exclude from organic revenue growth the effect of changes in foreign currency exchange rates because changes in foreign currency exchange rates are not under management’s control, are subject to volatility and can obscure underlying business trends. We calculate the impact on revenue resulting from changes in foreign currency exchange rates by applying the difference between the weighted average exchange rates during the current year period and the comparable prior year period to foreign currency denominated revenues for the prior year period.

We also exclude from organic revenue growth the effect of business acquisitions and divestitures because the nature, size and number of these transactions can vary dramatically from period to period, require or generate cash as an inherent consequence of the transaction, and therefore can also obscure underlying business and operating trends.

We also use Adjusted EBITDA, gross debt, net debt, gross debt to Adjusted EBITDA ratio and net debt to Adjusted EBITDA ratio, all of which are non-GAAP financial measures that should be considered in addition to, and not as a replacement for, financial measures presented according to U.S. GAAP. Management believes that reporting these non-GAAP financial measures provides supplemental analysis to help investors further evaluate our business performance and available borrowing capacity under our Credit Facility.

Comparisons to Prior Periods. Our fiscal years end on December 31. Unless otherwise stated, the analysis and discussion of our financial condition, results of operations and liquidity, including references to growth and organic growth and increases and decreases, are being compared to the equivalent prior year period.

Twelve Months Ended December 31, 2017, Compared to Twelve Months Ended December 31, 2016

Total Company

The following table presents revenue by operating segment by U.S. markets and non-U.S., or international markets:

		For the Year			For the Year
		Ended			Ended									Percentage			Percentage			Organic
Net Revenue		December 31,			December 31,			Dollar			Percentage			Change from			Change from			Revenue
(dollars in thousands)		2017			2016			Change			Change			Currency			Acquisitions			Growth (1)
CAG		$	1,703,377		$	1,522,689		$	180,688		11.9%			0.3%			0.2%			11.4%
United States			1,125,364			1,017,065			108,299		10.6%			-			0.2%			10.5%
International			578,013			505,624			72,389		14.3%			0.8%			0.4%			13.2%
Water			114,395			103,579			10,816		10.4%			0.3%			-			10.2%
United States			55,482			52,852			2,630		5.0%			-			-			5.0%
International			58,913			50,727			8,186		16.1%			0.6%			-			15.6%
LPD			128,481			126,491			1,990		1.6%			1.1%			-			0.5%
United States			14,108			13,253			855		6.5%			-			-			6.5%
International			114,373			113,238			1,135		1.0%			1.2%			-			(0.2%)
Other			22,805			22,664			141		0.6%			0.1%			-			0.5%
Total Company		$	1,969,058		$	1,775,423		$	193,635		10.9%			0.3%			0.2%			10.4%
United States			1,203,547			1,089,595			113,952		10.5%			-			0.2%			10.3%
International			765,511			685,828			79,683		11.6%			0.8%			0.3%			10.5%

	(1)		Amounts presented may not recalculate to organic revenue growth rates due to rounding.

U.S. and international organic revenue growth both reflect strong volume gains in CAG Diagnostics recurring revenue, supported by our differentiated diagnostic technologies that are driving increased volumes from new and existing customers in our reference laboratory business, and continued strong growth in CAG Diagnostics instrument installed base, including growth in our SediVue analyzer installed base. International organic growth was strong in Europe and Asia Pacific, reflecting the aforementioned CAG Diagnostics recurring volume-driven growth. Our Water business also contributed to our international growth, primarily from higher sales volumes of our Colilert test products and related accessories in Europe, the Asia-Pacific region, and increases from our go-direct initiative in Brazil.

The following table presents our total Company results of operations:

			For the Year Ended December 31,									Change
Total Company - Results of Operations					Percent of					Percent of
(dollars in thousands)		2017			Revenue		2016			Revenue			Amount			Percentage
Revenues		$	1,969,058				$	1,775,423				$	193,635			10.9%
Cost of revenue			871,676					799,987					71,689			9.0%
Gross profit			1,097,382		55.7%			975,436		54.9%			121,946			12.5%
Operating Expenses:
Sales and marketing			354,294		18.0%			317,058		17.9%			37,236			11.7%
General and administrative			220,878		11.2%			207,017		11.7%			13,861			6.7%
Research and development			109,182		5.5%			101,122		5.7%			8,060			8.0%
Total operating expenses			684,354		34.8%			625,197		35.2%			59,157			9.5%
Income from operations		$	413,028		21.0%		$	350,239		19.7%		$	62,789			17.9%

Total Company gross profit increase was due to higher sales volumes and an 80 basis point increase in the gross profit percentage. The increase in the gross profit percentage was supported by the net benefit of price increases in our CAG Diagnostics recurring revenue portfolio, the favorable impact of lower product and manufacturing costs, and favorable mix benefits from high growth CAG Diagnostic recurring revenues. These favorable impacts were slightly offset by a reduction of approximately 20 basis points from currency movements, including the combined impact of comparisons to hedge gains in the prior year and hedge losses in the current year.

The increase in total Company sales and marketing expense was due primarily to increases in personnel-related costs as we continued to invest in and grow our global commercial infrastructure. The increase in general and administrative expense resulted primarily from information technology investments, including ongoing depreciation and maintenance associated with prior year projects and higher personnel-related costs, offset by a prior year non-cash intangible asset impairment within our OPTI Medical business. Research and development expense increased primarily due to higher personnel-related and consultant costs.

Companion Animal Group

The following table presents revenue by product and service category for CAG:

		For the Year			For the Year
		Ended			Ended									Percentage			Percentage			Organic
Net Revenue		December 31,			December 31,			Dollar			Percentage			Change from			Change from			Revenue
(dollars in thousands)		2017			2016			Change			Change			Currency			Acquisitions			Growth (1)
CAG Diagnostics recurring revenue:		$	1,451,701		$	1,281,262		$	170,439		13.3%			0.2%			0.3%			12.8%
IDEXX VetLab consumables			518,774			451,456			67,318		14.9%			0.3%			-			14.6%
Rapid assay products			205,309			189,122			16,187		8.6%			0.1%			-			8.5%
Reference laboratory diagnostic and consulting services			660,142			581,067			79,075		13.6%			0.2%			0.6%			12.8%
CAG Diagnostics service and accessories			67,476			59,617			7,859		13.2%			0.3%			-			12.9%
CAG Diagnostics capital - instruments			119,963			121,191			(1,228)		(1.0%)			0.6%			-			(1.6%)
Veterinary software, services and diagnostic imaging systems			131,713			120,236			11,477		9.5%			0.2%			0.5%			8.9%
Net CAG revenue		$	1,703,377		$	1,522,689		$	180,688		11.9%			0.3%			0.2%			11.4%

	(1)		Amounts presented may not recalculate to organic revenue growth rates due to rounding.

CAG Diagnostics Recurring Revenue. The increase in CAG Diagnostics recurring revenue was due primarily to increased volumes in reference laboratory diagnostic services and IDEXX VetLab consumables and, to a lesser extent, higher realized prices.

IDEXX VetLab consumables revenue growth was due primarily to higher sales volumes in the U.S., Europe, and the Asia-Pacific region from our Catalyst consumables and, to a lesser extent, ProCyte Dx consumables and Sedivue Dx analyzer pay-per-run sales, resulting from growth in testing by existing and new customers, and an expanded menu of available tests, as well as higher average unit sales prices.

The increase in rapid assay revenue resulted from higher sales volumes and average unit price of canine SNAP 4Dx Plus tests and higher sales volumes of single analyte SNAP products.

The increase in reference laboratory diagnostic and consulting services revenue was primarily due to the impact of higher testing volumes throughout our worldwide network of laboratories, most prominently in the U.S., resulting from increased testing from existing customers, supported by our differentiated diagnostic technologies, such as IDEXX SDMA and fecal antigen testing. Additionally, the increase in revenue was the result of higher average unit sales prices.

CAG Diagnostic services and accessories revenue growth was primarily a result of the increase in our active installed base of instruments.

CAG Diagnostics Capital – Instruments Revenue. The decrease in CAG Diagnostics capital instruments revenue reflects our shift to focus sales incentives on the long-term economic value of instrument placements during 2017, partially offset by our sales of SediVue Dx, introduced in the second quarter of 2016. Our focus on long-term economic value continues to drive new and competitive Catalyst placements, which are the highest economic value placements due to the incremental CAG Diagnostic recurring revenue. As part of this focus, we continue to see declines in the lower relative long-term economic value second Catalyst placements, as well as growth of our customer commitment programs, including up-front customer loyalty programs in the U.S. and reagent rental programs internationally. These customer commitment programs result in lower up-front instrument revenue recognized at the time of placement, and instead the recognition of revenue for these programs occurs over the term of the customer agreement.

Veterinary Software, Services, and Diagnostic Imaging Systems Revenue. The increase in customer information management and diagnostic imaging systems revenue was primarily due to increasing veterinary subscription service revenue, growth in diagnostic imaging placements, and higher support revenue resulting from an increase in our installed base. These favorable factors were partially offset by lower relative diagnostic imaging system prices.

The following table presents the CAG segment results of operations:

			For the Year Ended December 31,									Change
Results of Operations					Percent of					Percent of
(dollars in thousands)		2017			Revenue		2016			Revenue			Amount			Percentage
Revenues		$	1,703,377				$	1,522,689				$	180,688			11.9%
Cost of revenue			766,579					702,367					64,212			9.1%
Gross profit			936,798		55.0%			820,322		53.9%			116,476			14.2%
Operating Expenses:
Sales and marketing			312,497		18.3%			277,377		18.2%			35,120			12.7%
General and administrative			180,907		10.6%			168,637		11.1%			12,270			7.3%
Research and development			79,837		4.7%			72,966		4.8%			6,871			9.4%
Total operating expenses			573,241		33.7%			518,980		34.1%			54,261			10.5%
Income from operations		$	363,557		21.3%		$	301,342		19.8%		$	62,215			20.6%

CAG Gross Profit. Gross profit for CAG increased due to higher sales volumes, along with a 110 basis point increase in the gross profit percentage. The unfavorable impact of currency reduced the gross profit percentage by approximately 20 basis points, resulting primarily from lower hedging gains in 2017. Excluding currency impacts, the increase in gross margins was supported by the net benefit of price increases in our CAG Diagnostic recurring portfolio, the favorable impact of lower product and manufacturing costs, and favorable mix benefits from high growth in IDEXX VetLab consumables and rapid assay revenues, offset by incremental investments in reference laboratory capacity and relatively lower IDEXX VetLab instrument prices reflecting strong international growth.

CAG Operating Expenses. The increase in sales and marketing expense was due primarily to increased personnel-related costs as we continue to invest in and grow our global commercial infrastructure. The increase in general and administrative expense resulted primarily from information technology investments, including ongoing depreciation and maintenance associated with prior year projects and higher personnel-related costs. The increase in research and development expense was primarily due to increased personnel-related costs.

Water

The following table presents the Water segment results of operations:

			For the Year Ended December 31,									Change
Results of Operations					Percent of					Percent of
(dollars in thousands)		2017			Revenue		2016			Revenue			Amount			Percentage
Revenues		$	114,395				$	103,579				$	10,816			10.4%
Cost of revenue			35,030					31,701					3,329			10.5%
Gross profit			79,365		69.4%			71,878		69.4%			7,487			10.4%
Operating Expenses:
Sales and marketing			14,482		12.7%			13,201		12.7%			1,281			9.7%
General and administrative			11,803		10.3%			10,426		10.1%			1,377			13.2%
Research and development			2,464		2.2%			2,549		2.5%			(85)			(3.3%)
Total operating expenses			28,749		25.1%			26,176		25.3%			2,573			9.8%
Income from operations		$	50,616		44.2%		$	45,702		44.1%		$	4,914			10.8%

Revenue. The increase in Water revenue was attributable to higher sales volumes of our Colilert test products and related accessories, used in coliform and E. coli testing in the Asia-Pacific region and North America, and the benefits of price increases in Latin America. Revenue growth in Latin America was driven by our go-direct initiative in Brazil, which contributed approximately 4 percent to revenue growth, including the impact of reductions in distributor inventories in 2016 and the benefits of price increases in 2017. The favorable impact of currency increased revenue by approximately 30 basis points.

Gross Profit. Gross profit for Water increased due to higher sale volumes. The gross profit percentage was flat, year over year, primarily due to the net benefit of price increases, which were largely driven by our go-direct initiative in Brazil, offset by higher manufacturing and distribution costs, and the overall change in currency exchange rates which decreased the gross profit percentage by approximately 70 basis points. The change in exchange rates was primarily due to lower relative hedge gains in 2017.

Operating Expenses. The increase in sales and marketing expense was primarily due to higher personnel-related costs related to increased head count. The increase in general and administrative expense resulted primarily from investments in Brazil and higher personnel-related costs. Research and development expense was lower primarily due to allocation of project costs and certain higher project costs that were incurred in 2016, partially offset by increases in personnel-related costs due to increased headcount.

Livestock, Poultry and Dairy

The following table presents the LPD segment results of operations:

			For the Year Ended December 31,									Change
Results of Operations					Percent of					Percent of
(dollars in thousands)		2017			Revenue		2016			Revenue			Amount			Percentage
Revenues		$	128,481				$	126,491				$	1,990			1.6%
Cost of revenue			56,341					52,690					3,651			6.9%
Gross profit			72,140		56.1%			73,801		58.3%			(1,661)			(2.3%)
Operating Expenses:
Sales and marketing			24,801		19.3%			22,723		18.0%			2,078			9.1%
General and administrative			18,723		14.6%			20,193		16.0%			(1,470)			(7.3%)
Research and development			12,152		9.5%			11,971		9.5%			181			1.5%
Total operating expenses			55,676		43.3%			54,887		43.4%			789			1.4%
Income from operations		$	16,464		12.8%		$	18,914		15.0%		$	(2,450)			(13.0%)

Revenue. The increase in LPD revenue resulted from an increase in swine testing, primarily in China, expanded pregnancy testing primarily in Europe and North America, and moderate growth in European bovine program revenues. These increases were partially offset by lower dairy producer demand for diagnostic testing particularly in China and Brazil, and lower herd health screening, primarily driven by lower global milk prices. The favorable impact of currency increased revenue 110 basis points.

Gross Profit. The decrease in LPD gross profit was due to higher sales volume offset by a 220 basis point reduction in the gross profit percentage reflecting higher product costs. The overall change in currency exchange rates had no impact on the gross profit percentage, primarily due to increased hedge losses in the current year compared to the prior year.

Operating Expenses. Overall, LPD operating expenses increased by less than 2 percent. Sales and marketing expenses were higher due to increases in commercial infrastructure investments in emerging markets. General and administrative expenses were lower due to a lower LPD allocation of overall overhead costs reflecting the higher relative growth in our CAG business as compared to LPD. Research and development expenses were relatively consistent.

Other

The following table presents the Other results of operations:

			For the Year Ended December 31,									Change
Results of Operations					Percent of					Percent of
(dollars in thousands)		2017			Revenue		2016			Revenue			Amount			Percentage
Revenues		$	22,805				$	22,664				$	141			0.6%
Cost of revenue			11,417					11,103					314			2.8%
Gross profit			11,388		49.9%			11,561		51.0%			(173)			(1.5%)
Operating Expenses:
Sales and marketing			2,093		9.2%			2,870		12.7%			(777)			(27.1%)
General and administrative			3,359		14.7%			4,908		21.7%			(1,549)			(31.6%)
Research and development			1,099		4.8%			2,899		12.8%			(1,800)			(62.1%)
Total operating expenses			6,551		28.7%			10,677		47.1%			(4,126)			(38.6%)
Income from operations		$	4,837		21.2%		$	884		3.9%		$	3,953			447.2%

Revenue. The increase in Other was primarily due to higher realized prices on our OPTI Medical products and services, partially offset by lower sales volumes of our OPTI Medical blood gas analyzers and related consumables as a result of temporary product availability constraints during the first half of 2017.

Gross Profit. Gross profit for Other decreased due to a 110 basis point decrease in the gross profit percentage as a result of higher manufacturing costs, partially offset by higher realized pricing on overall OPTI Medical products and services. The overall change in currency exchange rates resulted in a decrease in the gross profit percentage of less than 10 basis points.

Operating Expenses. The decrease in operating expense was due primarily to an intangible asset impairment within our OPTI Medical business during the first half of 2016 and lower personnel cost in research and development as a result of discontinuing certain product development activities in the human point-of-care medical diagnostics market.

During the first half of 2016, management reviewed our OPTI Medical product offering, which resulted in the discontinuance of our instrument development activities in the human point-of-care medical diagnostics market and a decision to focus our commercial and development efforts to support our latest generation OPTI CCA-TS2 Blood Gas and Electrolyte analyzer. Management identified unfavorable trends in our OPTI Medical business resulting from this change in strategy. We revised our forecasts downward, causing us to assess the realizability of the related tangible and intangible assets and determined the expected future cash flows were less than the carrying value of the OPTI Medical asset group. Non-cash intangible asset impairments of $2.2 million were recognized during the six months ended June 30, 2016.

Unallocated Amounts

We estimate certain personnel-related costs and allocate these budgeted expenses to the operating segments. This allocation differs from actual expense and consequently yields a difference that is reported under the caption “Unallocated Amounts.”

The following table presents the Unallocated Amounts results of operations:

			For the Year Ended December 31,									Change
Results of Operations
(dollars in thousands)		2017					2016						Amount			Percentage
Revenues		$	-				$	-				$	-			N/A
Cost of revenue			2,309					2,126					183			8.6%
Gross profit			(2,309)					(2,126)					(183)			8.6%
Operating Expenses:
Sales and marketing			421					887					(466)			(52.5%)
General and administrative			6,086					2,853					3,233			113.3%
Research and development			13,630					10,737					2,893			26.9%
Total operating expenses			20,137					14,477					5,660			39.1%
Income from operations		$	(22,446)				$	(16,603)				$	(5,843)			35.2%

Gross Profit. Costs of revenues that were not allocated to segments were relatively consistent.

Operating Expenses. The increase in operating expenses was primarily due to higher than budgeted corporate function spending in research and development, information technology, facilities management, human resources, and higher than budgeted employee incentive costs. The overall increase in operating expenses was partially offset by favorable foreign exchange gains on monetary assets, as compared to losses in the prior year, as well as increased benefits from customer interest payments on overdue accounts.

Non-Operating Items

Interest Income. Interest income was $5.3 million for the year ended December 31, 2017, as compared to $3.7 million for the same period in the prior year. The increase in interest income was due primarily to a larger relative portfolio of marketable securities during the year ended December 31, 2017, and, to a lesser extent, higher interest rates, as compared to the prior year.

Interest Expense. Interest expense was $37.2 million for the year ended December 31, 2017, as compared to $32.0 million for the prior year. The increase in interest expense was due to higher outstanding balances and higher floating interest rates on our Credit Facility. See Note 11 to the consolidated financial statements included in this Annual Report on Form 10-K for additional information regarding our senior notes and Credit Facility.

Provisions for Income Taxes. Our effective income tax rate was 30.9 percent for the year ended December 31, 2017, and 31.0 percent for the year ended December 31, 2016. Our effective income tax rate for the year ended December 31, 2017, was lower as a result of the adoption of ASU 2016-09 related to share-based compensation, which decreased our effective tax rate by approximately 7 percent (see Note 2 to the consolidated financial statements included in this Annual Report on Form 10-K for more information regarding the adoption of ASU 2016-09) and the utilization of foreign tax credits, which reduced our effective tax rate by approximately 1 percent. These decreases were offset by the following non-recurring items: A deemed repatriation tax, net of the remeasurement of our deferred tax assets and liabilities resulting from the Tax Act and a tax benefit related to state tax credit carryforwards, which combined, increased our tax rate by approximately 8 percent.

Twelve Months Ended December 31, 2016, Compared to Twelve Months Ended December 31, 2015

Total Company

The following table presents revenue by operating segment, by U.S. markets and non-U.S., or international markets:

		For the Year			For the Year
		Ended			Ended									Percentage			Percentage			Organic
Net Revenue		December 31,			December 31,			Dollar			Percentage			Change from			Change from			Revenue
(dollars in thousands)		2016			2015			Change			Change			Currency			Acquisitions			Growth (1)
CAG		$	1,522,689		$	1,356,287		$	166,402		12.3%			(0.6%)			0.3%			12.6%
United States			1,017,065			912,822			104,243		11.4%			-			0.2%			11.2%
International			505,624			443,465			62,159		14.0%			(2.0%)			0.5%			15.5%
Water			103,579			96,884			6,695		6.9%			(1.8%)			-			8.7%
United States			52,852			48,677			4,175		8.6%			-			-			8.6%
International			50,727			48,207			2,520		5.2%			(3.7%)			-			8.9%
LPD			126,491			127,143			(652)		(0.5%)			(1.6%)			-			1.1%
United States			13,253			14,041			(788)		(5.6%)			-			-			(5.6%)
International			113,238			113,102			136		0.1%			(1.8%)			-			1.9%
Other			22,664			21,578			1,086		5.0%			(0.1%)			-			5.1%
Total Company		$	1,775,423		$	1,601,892		$	173,531		10.8%			(0.8%)			0.2%			11.4%
United States			1,089,595			980,321			109,274		11.1%			0.1%			0.2%			10.8%
International			685,828			621,571			64,257		10.3%			(2.1%)			0.4%			12.0%

	(1)		Amounts presented may not recalculate to organic revenue growth rates due to rounding.

U.S. and international organic revenue growth both reflect very strong volume gains in CAG Diagnostics recurring revenue, supported by our differentiated diagnostic technologies that are driving increased volumes from new and existing customers in our reference laboratory business, and continued strong growth in CAG Diagnostics capital instrument placements that are driving IDEXX VetLab consumable volume growth. International organic growth across Europe, Asia Pacific and Latin America outpaced U.S. growth, reflecting the aforementioned CAG Diagnostics recurring volume driven growth, continued growth of Colilert testing products in our Water business and LPD emerging market growth, offset by declines in LPD bovine disease eradication testing in Europe. To a lesser extent, U.S. and international LPD organic growth also reflects pressure on our dairy testing business due to a decline in worldwide milk prices.

The following table presents the total Company results of operations:

			For the Year Ended December 31,									Change
Total Company - Results of Operations					Percent of					Percent of
(dollars in thousands)		2016			Revenue		2015			Revenue			Amount			Percentage
Revenues		$	1,775,423				$	1,601,892				$	173,531			10.8%
Cost of revenue			799,987					711,622					88,365			12.4%
Gross profit			975,436		54.9%			890,270		55.6%			85,166			9.6%
Operating Expenses:
Sales and marketing			317,058		17.9%			299,955		18.7%			17,103			5.7%
General and administrative			207,017		11.7%			182,510		11.4%			24,507			13.4%
Research and development			101,122		5.7%			99,681		6.2%			1,441			1.4%
Impairment charge			-		0.0%			8,212		0.5%			(8,212)			N/A
Total operating expenses			625,197		35.2%			590,358		36.9%			34,839			5.9%
Income from operations		$	350,239		19.7%		$	299,912		18.7%		$	50,327			16.8%

Total Company gross profit increased due to higher sales volumes, partly offset by a 70 basis point reduction in the gross profit percentage during the year ended December 31, 2016. Excluding currency impacts of approximately 118 basis points, gross margins increased moderately, supported by improvements in our CAG business.

During the year ended December 31, 2015, we recorded an $8.2 million impairment charge related to internally-developed software not yet placed into service within Unallocated Amounts as a result of a strategic shift to refocus our development efforts within our information management business. For the year ended December 31, 2015, adjusted operating income, which is total Company operating income adjusted for the aforementioned software impairment charge was approximately $308.1 million and 19.2 percent of revenue. Adjusted operating income increased by $42.1 million or 13.7 percent for the year ended December 31, 2016. Adjusted operating income is a non-GAAP financial measure and should be considered in addition to, and not as a replacement for or as a superior measure to, operating income reported in accordance with U.S. GAAP. Management believes that reporting adjusted operating income provides useful information to investors by facilitating easier comparisons of our operating income performance with prior and future periods and to the performance of our peers.

Companion Animal Group

The following table presents revenue by product and service category for CAG:

		For the Year			For the Year
		Ended			Ended									Percentage			Percentage			Organic
Net Revenue		December 31,			December 31,			Dollar			Percentage			Change from			Change from			Revenue
(dollars in thousands)		2016			2015			Change			Change			Currency			Acquisitions			Growth (1)
CAG Diagnostics recurring revenue:		$	1,281,262		$	1,147,026		$	134,236		11.7%			(0.7%)			0.4%			12.0%
IDEXX VetLab consumables			451,456			396,526			54,930		13.9%			(0.8%)			-			14.7%
Rapid assay products			189,122			182,670			6,452		3.5%			-			-			3.5%
Reference laboratory diagnostic and consulting services			581,067			512,155			68,912		13.5%			(0.9%)			0.8%			13.6%
CAG Diagnostics service and accessories			59,617			55,675			3,942		7.1%			(0.3%)			-			7.4%
CAG Diagnostics capital instruments			121,191			98,502			22,689		23.0%			(0.7%)			-			23.7%
Veterinary software, services and diagnostic imaging systems			120,236			110,759			9,477		8.6%			(0.2%)			-			8.8%
Net CAG revenue		$	1,522,689		$	1,356,287		$	166,402		12.3%			(0.6%)			0.3%			12.6%

	(1)		Amounts presented may not recalculate to organic revenue growth rates due to rounding.

CAG Diagnostics Recurring Revenue. The increase in CAG Diagnostics recurring revenue was due primarily to higher sales of our IDEXX VetLab consumables and reference laboratory diagnostic and consulting services resulting from increased volumes and, to a lesser extent, higher realized prices.

IDEXX VetLab consumables revenue growth was due primarily to higher sales volumes in the U.S., Europe, and the Asia-Pacific region from our Catalyst consumables and, to a lesser extent, ProCyte DX consumables, resulting from growth in testing by existing customers, the acquisition of new customers and an expanded menu of available tests. These favorable impacts were partly offset by lower consumables volumes from our VetTest chemistry instrument due to customer upgrades from our previous generation VetTest to our Catalyst analyzers. IDEXX VetLab consumables revenue also benefited from higher average unit sales prices.

The increase in rapid assay revenue resulted from higher average unit price and sales volumes of SNAP 4Dx and higher sales volumes of single analyte SNAP products. These favorable factors were partly offset by the unfavorable impact of lower average unit sales prices in the U.S. for certain earlier generation rapid assay products.

The increase in reference laboratory diagnostic and consulting services revenue was due primarily to the impact of higher testing volumes throughout our worldwide network of laboratories, most prominently in the U.S., resulting from increased testing from existing customers and the net acquisition of new customers, supported by our differentiated diagnostic technologies, such as the IDEXX SDMA test. Also, revenue increased, to a lesser extent, from higher average unit sales prices due to price increases. Testing volumes benefited slightly from favorable weather trends experienced during the first quarter of 2016.

CAG Diagnostic services and accessories revenue growth was primarily a result of the increase in our active installed base of instruments.

CAG Diagnostics Capital – Instruments Revenue. The increase in CAG Diagnostics capital instruments revenue resulted from the launch of our SediVue Dx analyzer in the second quarter of 2016, which contributed approximately 23 percent to reported and organic instrument revenue growth, and higher ProCyte Dx revenues, partly offset by lower Catalyst revenues resulting from a shift in placements from our Catalyst Dx

analyzer to our lower priced Catalyst One analyzer and the prior year benefit of recognizing previously deferred revenues associated with pre-orders of our Catalyst One analyzer in the U.S. in 2014.

Veterinary Software, Services and Diagnostic Imaging Systems Revenue. The increase in veterinary software, services and diagnostic imaging systems revenue was due primarily to increasing diagnostic imaging systems revenue, higher veterinary subscription service revenue, including increases in our Pet Health Network Pro subscriber base and higher support revenue resulting from an increase in our active installed base of diagnostic imaging and practice management systems. Revenues from diagnostic imaging systems were higher due to the timing of revenue recognized from fewer deferred revenue placements under up-front customer loyalty programs, and the recognition of previously deferred revenues. These favorable factors were partially offset by fewer licensed-based Cornerstone placements as we evolve to a subscription-based model for new practice management customer acquisitions, as well as lower average unit sale prices on diagnostic imaging system placements.

The following table presents the CAG segment results of operations:

			For the Year Ended December 31,									Change
Results of Operations					Percent of					Percent of
(dollars in thousands)		2016			Revenue		2015			Revenue			Amount			Percentage
Revenues		$	1,522,689				$	1,356,287				$	166,402			12.3%
Cost of revenue			702,367					626,984					75,383			12.0%
Gross profit			820,322		53.9%			729,303		53.8%			91,019			12.5%
Operating Expenses:
Sales and marketing			277,377		18.2%			263,907		19.5%			13,470			5.1%
General and administrative			168,637		11.1%			159,851		11.8%			8,786			5.5%
Research and development			72,966		4.8%			72,226		5.3%			740			1.0%
Total operating expenses			518,980		34.1%			495,984		36.6%			22,996			4.6%
Income from operations		$	301,342		19.8%		$	233,319		17.2%		$	68,023			29.2%

CAG Gross Profit. Gross profit for CAG increased due to higher sales volumes, along with a 10 basis point increase in the gross profit percentage. The unfavorable impact of currency reduced the gross profit percentage by approximately 90 basis points, resulting primarily from lower hedging gains. Excluding currency impacts, gross margins increased moderately, supported by the net benefit of price increases for our reference laboratory diagnostic services and IDEXX VetLab consumables and profitability improvements from higher relative revenue of our expanded subscription service offerings, and within our worldwide network of reference laboratories.

CAG Operating Expenses. The increase in sales and marketing expense was due primarily to increased personnel-related costs, including investments in our global commercial infrastructure and sales performance incentives, partly offset by the favorable impact of changes in foreign currency exchange rates. The increase in general and administrative expense resulted primarily from information technology investments, including ongoing depreciation and maintenance associated with prior year projects, and higher personnel-related costs. These increases were partly offset by the favorable impact of changes in foreign currency exchange rates. Research and development expense was generally consistent.

Water

The following table presents the Water segment results of operations:

			For the Year Ended December 31,									Change
Results of Operations					Percent of					Percent of
(dollars in thousands)		2016			Revenue		2015			Revenue			Amount			Percentage
Revenues		$	103,579				$	96,884				$	6,695			6.9%
Cost of revenue			31,701					27,931					3,770			13.5%
Gross profit			71,878		69.4%			68,953		71.2%			2,925			4.2%
Operating Expenses:
Sales and marketing			13,201		12.7%			12,204		12.6%			997			8.2%
General and administrative			10,426		10.1%			9,058		9.3%			1,368			15.1%
Research and development			2,549		2.5%			2,939		3.0%			(390)			(13.3%)
Total operating expenses			26,176		25.3%			24,201		25.0%			1,975			8.2%
Income from operations		$	45,702		44.1%		$	44,752		46.2%		$	950			2.1%

Revenue. The increase in Water revenue was attributable to all regions in which we operate, most notably from strong performance in North America, Europe, and the Asia-Pacific region. Higher revenues resulted primarily from increased sales volumes and price increases of our Colilert test products and related accessories used in coliform and E. coli testing, placements of our Quanti-Tray Sealer PLUS instrument, which we launched in June 2015, several large project orders during the first half of 2016, and to a lesser extent, from higher sales volumes of our products designed to detect cryptosporidium related to an outbreak in the United Kingdom beginning in mid-2015 through the first half of 2016. Testing volumes also benefited slightly from favorable weather trends experienced during the first quarter of 2016.

Gross Profit. Gross profit for Water increased due to higher sales volumes, offset by a 180 basis point reduction in the gross profit percentage. The unfavorable impact of currency reduced the gross profit percentage by approximately 210 basis points, resulting from lower hedging gains and changes in foreign currency exchange rates. Excluding currency impacts, the gross profit percentage increased slightly due to the net benefit of price increases on our Colilert testing products and related accessories.

Operating Expenses. The increase in sales and marketing was due primarily to higher personnel-related costs and increased advertising and marketing materials. The increase in general and administrative expense was due primarily to higher personnel-related costs. The decrease in research and development expense was a result of lower product development costs during the year ended December 31, 2016.

Livestock, Poultry and Dairy

The following table presents the LPD segment results of operations:

			For the Year Ended December 31,									Change
Results of Operations					Percent of					Percent of
(dollars in thousands)		2016			Revenue		2015			Revenue			Amount			Percentage
Revenues		$	126,491				$	127,143				$	(652)			(0.5%)
Cost of revenue			52,690					47,156					5,534			11.7%
Gross profit			73,801		58.3%			79,987		62.9%			(6,186)			(7.7%)
Operating Expenses:
Sales and marketing			22,723		18.0%			22,307		17.5%			416			1.9%
General and administrative			20,193		16.0%			18,655		14.7%			1,538			8.2%
Research and development			11,971		9.5%			11,868		9.3%			103			0.9%
Total operating expenses			54,887		43.4%			52,830		41.6%			2,057			3.9%
Income from operations		$	18,914		15.0%		$	27,157		21.4%		$	(8,243)			(30.4%)

Revenue. The overall change in exchange rates reduced revenue growth by approximately 160 basis points. The increase in LPD organic revenue resulted from strong performance in emerging markets, most notably resulting from higher sales volumes of swine, poultry and bovine pregnancy products and services in various regions. This increase was partially offset by a decrease in sales volumes of bovine testing products within Western Europe in large part due to the success of certain disease eradication programs in the region, as well as pressure on our dairy testing business due to a decline in worldwide milk prices.

Gross Profit. Gross profit for LPD decreased due to a reduction in the gross profit percentage of 460 basis points. The decrease in the gross profit percentage resulted primarily from approximately 360 basis points of unfavorable currency impact, primarily due to lower relative hedging gains. Additionally, higher overall manufacturing costs, which were partially offset by the expiration of royalties on certain of our swine testing products, resulted in an overall lower gross profit.

Operating Expenses. The increase in sales and marketing expense for the year ended December 31, 2016, was due to higher commercial infrastructure investments within emerging markets. The increase in general and administrative expense resulted primarily from higher investments in emerging markets including Brazil. The increase in research and development expense resulted primarily from higher external product development and material costs. All the increases above were partially offset by the favorable impact of changes in foreign currency exchange rates.

Other

The following table presents the Other results of operations:

			For the Year Ended December 31,									Change
Results of Operations					Percent of					Percent of
(dollars in thousands)		2016			Revenue		2015			Revenue			Amount			Percentage
Revenues		$	22,664				$	21,578				$	1,086			5.0%
Cost of revenue			11,103					11,297					(194)			(1.7%)
Gross profit			11,561		51.0%			10,281		47.6%			1,280			12.5%
Operating Expenses:
Sales and marketing			2,870		12.7%			3,466		16.1%			(596)			(17.2%)
General and administrative			4,908		21.7%			3,326		15.4%			1,582			47.6%
Research and development			2,899		12.8%			3,626		16.8%			(727)			(20.0%)
Total operating expenses			10,677		47.1%			10,418		48.3%			259			2.5%
Income from operations		$	884		3.9%		$	(137)		(0.6%)		$	1,021			(745.3%)

Revenue. The increase in Other revenue was due primarily to royalty revenue associated with the commercialization of certain intellectual property related to our former pharmaceutical product line, partially offset by lower sales volumes of our OPTI Medical blood gas analyzers and related consumables.

Gross Profit. Gross profit for Other increased due to higher sales and an increase in the gross profit percentage of 340 basis points. The increase in the gross profit percentage resulted primarily from higher relative royalty revenue associated with the commercialization of certain intellectual property related to our former pharmaceutical product line, partly offset by an increase in overall OPTI Medical product costs.

Operating Expenses. Operating expenses for Other, which totaled $10.7 million for the year ended December 31, 2016, increased $0.3 million, due primarily to intangible impairments within our OPTI Medical business, partly offset by lower amortization expense on the aforementioned intangible assets and a reduction in personnel-related costs.

During the first half of 2016, management reviewed the OPTI Medical product offerings. As a result of this review, we discontinued our product development activities in the human point-of-care medical diagnostics market during March 2016 and focused our commercial efforts in this market on supporting our latest generation OPTI CCA-TS2 Blood Gas and Electrolyte analyzer. Management identified unfavorable trends in our OPTI Medical line of business resulting from this change in strategy. We revised our forecasts downward, causing us to assess the realizability of the related tangible and intangible assets and determined the expected future cash flows were less than the carrying value of the OPTI Medical asset group. Non-cash intangible asset impairments of $2.2 million were recorded during the year ended December 31, 2016.

Unallocated Amounts

We estimate certain personnel-related costs and allocate these budgeted expenses to the operating segments. This allocation differs from actual expense and consequently yields a difference that is reported under the caption “Unallocated Amounts.”

The following table presents the Unallocated Amounts results of operations:

			For the Year Ended December 31,									Change
Results of Operations
(dollars in thousands)		2016					2015						Amount			Percentage
Revenues		$	-				$	-				$	-			N/A
Cost of revenue			2,126					(1,746)					3,872			(221.8%)
Gross profit			(2,126)					1,746					(3,872)			(221.8%)
Operating Expenses:
Sales and marketing			887					(1,929)					2,816			(146.0%)
General and administrative			2,853					(8,380)					11,233			(134.0%)
Research and development			10,737					9,022					1,715			19.0%
Impairment charge			-					8,212					(8,212)			N/A
Total operating expenses			14,477					6,925					7,552			109.1%
Income from operations		$	(16,603)				$	(5,179)				$	(11,424)			220.6%

Gross Profit. Gross profit for Unallocated Amounts decreased due primarily to higher personnel-related costs as compared to budget. The increase in personnel-related costs was due primarily to higher self-insured healthcare costs and higher than budgeted employee incentives reported within Unallocated Amounts during the year ended December 31, 2016.

Operating Expenses. Operating expenses that are not allocated to our operating segments increased $7.6 million to $14.5 million for the year ended December 31, 2016, due primarily to higher personnel-related costs as compared to budget, reflecting increased employee incentives and higher self-insured health claim expenses, as well as certain foreign exchange losses on monetary assets due to strengthening of the U.S. dollar. This compares to prior period cost control initiatives that resulted in lower than budgeted costs. Partially offsetting these increases was the aforementioned $8.2 million impairment charge recorded in 2015, related to internally-developed software not yet placed into service as a result of a strategic shift to refocus our development efforts within our veterinary software and services business.

Non-Operating Items

Interest Income. Interest income was $3.7 million for the year ended December 31, 2016, as compared to $2.5 million for the prior year. The increase in interest income was due primarily to a larger relative portfolio of marketable securities during the year ended December 31, 2016, and, to a lesser extent, higher interest rates.

Interest Expense. Interest expense was $32.0 million for the year ended December 31, 2016, as compared to $29.2 million for the prior year. The increase in interest expense resulted from higher relative interest incurred in 2016 as a result of approximately $250 million in senior notes that we issued and sold through private placements during the first half of 2015, for which fixed interest rates range from 1.785 percent to 3.72 percent. Additionally, the increase in interest expense was due to higher relative interest rates on our Credit Facility. See Note 11 to the consolidated financial statements included in this Annual Report on Form 10-K for additional information regarding our senior notes and Credit Facility.

Provision for Income Taxes. Our effective income tax rate was 31.0 percent for the year ended December 31, 2016, as compared to 29.7 percent for the year ended December 31, 2015. The increase in our effective tax rate for the year ended December 31, 2016, as compared to the year ended December 31, 2015, was primarily related to a change in earnings mix in 2016, with relatively higher earnings subject to domestic tax rates as opposed to lower international tax rates including the impact of foreign currency exchange rates.

LIQUIDITY AND CAPITAL RESOURCES

We fund the capital needs of our business through cash on hand, funds generated from operations, and amounts available under our Credit Facility. In addition, we issued $150 million of senior notes in February 2015 and €88.9 million of euro-denominated senior notes in June 2015. During the twelve months ended December 31, 2015, we purchased marketable debt securities using a portion of our cash balances. We generate cash primarily through the payments made by customers for our diagnostic products and services, consumables, consulting services, and other various systems and services provided to the animal veterinary, livestock, poultry, dairy, and water testing markets. Our cash disbursements are primarily related to compensation and benefits for our employees, inventory and supplies, taxes, research and development, capital expenditures, rents, occupancy-related charges, interest expense, and acquisitions. At December 31, 2017, we had $471.9 million of cash, cash equivalents and marketable securities, as compared to $391.8 million on December 31, 2016, and $342.6 million on December 31, 2015. Working capital, including our Credit Facility, totaled negative $32.6 million at December 31, 2017, as compared to negative $89.0 million at December 31, 2016, and negative $35.1 million at December 31, 2015. Additionally, at December 31, 2017, we had remaining borrowing availability of $194.0 million under our $850 million Credit Facility. We believe that, if necessary, we could obtain additional borrowings at similar rates to our existing borrowings to fund our growth objectives. We further believe that current cash and cash equivalents, our portfolio of short-duration marketable securities, funds generated from operations, and committed borrowing availability will be sufficient to fund our operations, capital purchase requirements, and anticipated growth needs for the next twelve months. We believe that these resources, coupled with our ability, as needed, to obtain additional financing on favorable terms will also be sufficient for the foreseeable future to fund our business as currently conducted.

The Tax Act was enacted on December 22, 2017, and includes significant changes to the U.S. corporate tax system. The Tax Act reduced the U.S. federal corporate tax rate from 35 percent to 21 percent, effective as of January 1, 2018, and transitioned the U.S. federal tax system from a worldwide tax system to a territorial tax system. In converting to the new territorial tax system, a deemed repatriation tax on previously tax-deferred earnings of certain foreign subsidiaries was required to be recognized as of December 31, 2017, and will be payable over eight years.

As a result of the Tax Act, we are no longer asserting indefinite investment for undistributed earnings of non-U.S. subsidiaries earned prior to December 31, 2017. We have recorded a provisional amount of $48.8 million for the deemed repatriation tax liability related to these earnings which will be paid over eight years.

The following table presents cash, cash equivalents and marketable securities held domestically, and by our foreign subsidiaries:

Cash, cash equivalents and marketable securities		For the Years Ended December 31,
(dollars in millions)		2017			2016			2015
U.S.		$	5.9		$	4.8		$	1.4
Foreign			466.0			387.0			341.2
Total		$	471.9		$	391.8		$	342.6
Total cash, cash equivalents and marketable securities held in U.S. dollars		$	334.3		$	285.8		$	239.2
Percentage of total cash, cash equivalents and marketable securities held in U.S. dollars			70.8%			72.9%			69.8%

During 2018, in connection with the passage of the Tax Act in the fourth quarter of 2017, we intend to liquidate our marketable securities and use the cash to partially pay down our Credit Facility. We held marketable securities with effective maturities of two years or less that had an average AA- credit rating as of December 31, 2017.

The following table presents marketable securities at fair value for the years ended December 31, 2017 and 2016:

		For the Year						For the Year
		Ended						Ended
Marketable securities		December 31,			Percent of			December 31,			Percent of
(dollars in millions)		2017			Total			2016			Total
Corporate bonds		$	140.9		49.6%			$	130.8		55.2%
Certificates of deposit			58.5			20.6%			40.4			17.1%
Commercial paper			29.2			10.3%			20.2			8.5%
Asset backed securities			22.2			7.8%			27.3			11.5%
U.S. government bonds			15.6			5.5%			12.2			5.1%
Agency bonds			10.9			3.8%			4.6			1.9%
Treasury bills			7.0			2.5%			-			0.0%
All other			-		0.0%				1.4		0.6%
Total marketable securities		$	284.3					$	236.9

Of the $187.7 million of cash and cash equivalents held as of December 31, 2017, approximately 82 percent was held as bank deposits, approximately 18 percent was invested in money market funds restricted to U.S. government and agency securities, and the remainder consisted of commercial paper and other securities with original maturities of less than ninety days. Of the $154.9 million of cash and cash equivalents held as of December 31, 2016, 76 percent was held as bank deposits, 22 percent was invested in money market funds restricted to U.S. government and agency securities, and the remainder consisted of commercial paper and other securities with original maturities of less than ninety days.

Should we require more capital than is generated by our operations, for example to fund significant discretionary activities, we could raise capital through debt or equity issuances. These alternatives could result in increased interest expense and dilution of our earnings. We have borrowed funds domestically and continue to have the ability to borrow funds domestically at reasonable interest rates.

The following table presents additional key information concerning working capital:

		For the Three Months Ended
		December 31,			September 30,			June 30,			March 31,			December 31,
			2017			2017			2017			2017			2016
Days sales outstanding (1)			41.7			43.4			41.7			42.4			42.1
Inventory turns (2)			2.2			1.9			2.0			1.9			2.0

(1) Days sales outstanding represents the average of the accounts receivable balances at the beginning and end of each quarter divided by revenue for that quarter, the result of which is then multiplied by 91.25 days.

(2) Inventory turns represent inventory-related cost of product revenue for the 12 months preceding each quarter-end divided by the inventory balance at the end of the quarter.

Sources and Uses of Cash

The following table presents cash provided (used):

		For the Years Ended December 31,
(dollars in thousands)		2017			2016			2015
Net cash provided by operating activities		$	373,276		$	338,943		$	221,802
Net cash used by investing activities			(138,688)			(90,786)			(308,406)
Net cash used by financing activities			(208,016)			(222,196)			(100,990)
Net effect of changes in exchange rates on cash			6,202			(54)			(5,948)
Net increase (decrease) in cash and cash equivalents		$	32,774		$	25,907		$	(193,542)

Operating Activities. The increase in cash provided by operating activities of $34.3 million during 2017 as compared to 2016 was primarily due to an increase in net income, including the impact of adopting the new accounting guidance for share-based compensation. The increase in cash provided by operating activities of $117.1 million during 2016 as compared to 2015 was due primarily to changes in operating assets and liabilities, as well as an increase in net income including increases in non-cash charges.

The following table presents cash flows from changes in operating assets and liabilities and the tax benefit from share-based compensation arrangements for the years ended December 31, 2017, 2016 and 2015:

		For the Years Ended December 31,
(dollars in thousands)		2017			2016			2015
Accounts receivable		$	(24,918)		$	(22,554)		$	(50,142)
Inventories			(19,062)			7,648			(34,969)
Accounts payable			1,391			2,117			(2,468)
Deferred revenue			3,551			7,672			(319)
Other assets and liabilities			47,418			12,491			23,525
Tax benefit from share-based compensation arrangements			-			(14,702)			(11,315)
Total change in cash due to changes in operating assets and liabilities and the tax benefit from share-based compensation arrangements		$	8,380		$	(7,328)		$	(75,688)

The cash used by accounts receivable during 2017 as compared to 2016 was relatively consistent with revenue growth. The reduction in cash used by accounts receivable during 2016 as compared to 2015 was primarily due to the absence of the impacts related to our change in U.S. commercial strategy impacting the first quarter of 2015. The incremental cash used by accounts receivable for the year ended December 31, 2015, was primarily due to our transition to an all-direct strategy in the U.S., including the establishment of accounts receivable directly with our U.S. end-users that previously purchased from our U.S. distribution partners, which take a longer elapsed time to collect. Additionally, accounts receivable was impacted by revenue growth for the years ended December 31, 2016 and 2015, relative to the respective prior periods, including the margin capture associated with the aforementioned all-direct strategy.

The net incremental cash used by inventories during 2017 as compared to cash provided by inventories in 2016 was primarily due to our operational initiatives to optimize inventory levels that were implemented in the first

half of 2016, which followed a period of inventory growth to support new products and increasing demand. Cash used by inventories for 2015 was primarily due to growth in our volume commitment rental programs in international markets and relatively higher inventory levels to support new instrument and diagnostic test launches.

The decrease in cash provided by deferred revenue during 2017 as compared to 2016 was primarily due to customer program mix. The increase in cash provided by deferred revenue during 2016 as compared to cash used by deferred revenue for 2015 was primarily due to the recognition in 2015 of deferred revenues related to our 2014 Catalyst One introductory offer, where we pre-sold the instrument and provided customers with temporary use of a Catalyst Dx instrument.

The increase in cash provided by other assets and liabilities during 2017 as compared to cash provided by assets and liabilities during 2016 was primarily due to the deemed repatriation tax on foreign profits from the enactment of the Tax Act, which was recorded in the fourth quarter of 2017 and is payable over eight years, as well as higher relative employee incentive compensation payments. The decrease in cash provided by other assets and liabilities during 2016 as compared to 2015 was the result of higher taxable income in 2015. Income tax payments were lower during 2015 resulting from one-time impacts of implementing our U.S. all-direct strategy and the benefit from the Tax Increase Prevention Act enactment late in the fourth quarter of 2014. The net incremental cash provided by other assets and liabilities for 2015 was also due to the recognition of previously deferred Catalyst instrument costs under the Catalyst One introductory offer during 2015.

We have historically experienced proportionally lower net cash flows from operating activities during the first quarter and proportionally higher cash flows from operating activities for the remainder of the year and for the annual period driven primarily by payments related to annual employee incentive programs in the first quarter following the year for which the bonuses were earned and the seasonality of vector-borne disease testing, which has historically resulted in significant increases in accounts receivable balances during the first quarter of the year.

Investing Activities. Cash used by investing activities was $138.7 million during 2017 as compared to $90.8 million used during 2016, and $308.4 million used during 2015. The increase in cash used by investing activities during 2017 as compared to 2016 was primarily due to the increase in net purchases of marketable securities, as well as increases in acquisitions of businesses and intangible assets and capital spending. The decrease in cash used by investing activities during 2016 as compared to 2015 was due primarily to the initial purchase of marketable securities that began in 2015. During 2018, in connection with the passage of the Tax Act in the fourth quarter of 2017, we intend to liquidate our marketable securities and use the cash to partially pay down our Credit Facility.

Our total capital expenditure plan for 2018 is estimated to be approximately $140 million, which includes the expansion of our headquarters, the relocation and expansion of our German core reference laboratory, other capital investments in manufacturing and reference laboratory equipment, investments in internal use software and information technology infrastructure, and the renovation and expansion of our facilities and reference laboratories.

Financing Activities. Cash used by financing activities was $208.0 million during 2017 as compared to $222.2 million used during 2016, and $101.0 million used during 2015. The decrease in cash used by financing activities during 2017 as compared to 2016 was primarily due to fewer repurchases of our common stock. The increase in cash used by financing activities during 2016 as compared to 2015 was due to the issuance of senior notes in 2015, as well as a decrease in cash used to repurchase our common stock.

In June 2015, we entered into an Amended and Restated Multi-Currency Note Purchase and Private Shelf Agreement (the “2015 Amended Agreement”), among the Company, Prudential Investment Management, Inc. (“Prudential”) and the accredited institutional purchasers named therein, which amends and restates the Note Purchase and Private Shelf Agreement dated July 21, 2014. Pursuant to the 2015 Amended Agreement, we issued and sold through a private placement a principal amount of €88.9 million of 1.785% Series C Senior Notes due June 18, 2025 (the “2025 Series C Notes”). We used the net proceeds from this issuance and sale of the 2025 Series C Notes for general corporate purposes, including repaying amounts outstanding under our Credit Facility.

In December 2014, we entered into a Multi-Currency Note Purchase and Private Shelf Agreement (the “MetLife Agreement”) with accredited institutional purchasers named therein pursuant to which we agreed to issue and sell $75 million of 3.25% Series A Senior Notes having a seven-year term (the “2022 Notes”) and $75 million

of 3.72% Series B Senior Notes having a twelve-year term (the “2027 Notes”). In February 2015, we issued and sold the 2022 Notes and the 2027 Notes pursuant to the MetLife Agreement. We used the net proceeds from these issuance and sales for general corporate purposes, including repaying amounts outstanding under our Credit Facility.

Cash used to repurchase shares of our common stock decreased by $21.5 million during the year ended December 31, 2017, as compared to 2016. Cash used to repurchase shares of our common stock decreased by $97.9 million during the year ended December 31, 2016, as compared to 2015. From the inception of our share repurchase program in August 1999 to December 31, 2017, we have repurchased 63.0 million shares. During the year ended December 31, 2017, we purchased 1.75 million shares for an aggregate cost of $270.3 million, as compared to purchases of 3.1 million shares for an aggregate cost of $313.1 million during 2016 and purchases of 5.7 million shares for an aggregate cost of $406.4 million during 2015. We believe that the repurchase of our common stock is a favorable means of returning value to our shareholders and we also repurchase our stock to offset the dilutive effect of our share-based compensation programs. Repurchases of our common stock may vary depending upon the level of other investing activities and the share price. See Note 18 to the consolidated financial statements included in this Annual Report on Form 10-K for additional information about our share repurchases.

As noted above, we refinanced our existing $700 million Credit Facility during December 2015, increasing the principal amount thereunder to $850 million. The Credit Facility matures on December 4, 2020 and requires no scheduled prepayments before that date. Although the Credit Facility does not mature until December 2020, all amounts borrowed under the terms of the Credit Facility are reflected in the current liabilities section in the accompanying consolidated balance sheets because the Credit Facility contains a subjective material adverse event clause, which allows the debt holders to call the loans under the Credit Facility if we fail to notify the syndicate of such an event. Applicable interest rates on borrowings under the Credit Facility generally range from 1.250 to 1.375 percentage points above the London interbank offered rate or the Canadian dollar-denominated bankers’ acceptance rate, based on our leverage ratio, or the prevailing prime rate plus a maximum spread of up to 0.375 percent, based on our leverage ratio.

Net borrowing and repayment activity under the Credit Facility resulted in more cash provided of $6.0 million during the year ended December 31, 2017, as compared to 2016. At December 31, 2017, we had $655.0 million outstanding under the Credit Facility. Net borrowing and repayment activity under the Credit Facility resulted in more cash provided of $14.0 million during the year ended December 31, 2016, compared to 2015. At December 31, 2016, we had $611.0 million outstanding under the Credit Facility. The general availability of funds under the Credit Facility was further reduced by $1.0 million for a letter of credit that was issued in connection with claims under our workers’ compensation policy. The Credit Facility contains affirmative, negative, and financial covenants customary for financings of this type. The negative covenants include restrictions on liens, indebtedness of subsidiaries of the Company, fundamental changes, investments, transactions with affiliates, and certain restrictive agreements and violations of laws and regulations. The financial covenant is a consolidated leverage ratio test that requires our ratio of debt to earnings before interest, taxes, depreciation, amortization, and share-based compensation not to exceed 3.5-to-1. At December 31, 2017, we were in compliance with the covenants of the Credit Facility. The obligations under the Credit Facility may be accelerated upon the occurrence of an event of default under the Credit Facility, which includes customary events of default including payment defaults, defaults in the performance of the affirmative, negative and financial covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, defaults relating to judgments, certain events related to employee pension benefit plans under the Employee Retirement Income Security Act of 1974, the failure to pay specified indebtedness, cross-acceleration to specified indebtedness and a change of control default.

Since December 2013, we have issued and sold through private placements senior notes having an aggregate principal amount of approximately $600 million pursuant to certain note purchase agreements (collectively, the “Senior Note Agreements”). The Senior Note Agreements contain affirmative, negative, and financial covenants customary for agreements of this type. The negative covenants include restrictions on liens, indebtedness of our subsidiaries, priority indebtedness, fundamental changes, investments, transactions with affiliates, certain restrictive agreements and violations of laws and regulations. See Note 11 to the consolidated financial statements included in this Annual Report on Form 10-K for additional information regarding our senior notes.

Should we elect to prepay the Senior Notes, such aggregate prepayment will include the applicable make-whole amount(s), as defined within the applicable Senior Note Agreements. Additionally, in the event of a change in

control of the Company, or upon the disposition of certain assets of the Company the proceeds of which are not reinvested (as defined in the Senior Note Agreements), we may be required to prepay all or a portion of the Senior Notes. The obligations under the Senior Notes may be accelerated upon the occurrence of an event of default under the applicable Senior Note Agreement, each of which includes customary events of default including payment defaults, defaults in the performance of the affirmative, negative and financial covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, defaults relating to judgments, certain events related to employee pension benefit plans under the Employee Retirement Income Security Act of 1974, the failure to pay specified indebtedness and cross-acceleration to specified indebtedness.

Effect of currency translation on cash. The net effect of changes in foreign currency exchange rates are related to changes in exchange rates between the U.S. dollar and the functional currencies of our foreign subsidiaries. These changes will fluctuate each year as the value of the U.S. dollar relative to the value of the foreign currencies change. A currency’s value depends on many factors, including interest rates, the country’s debt levels and strength of economy.

Off Balance Sheet Arrangements. We have no off-balance sheet arrangements or variable interest entities except for letters of credit and third party guarantees, as reflected in Note 11 and Note 14 to the consolidated financial statements for the year ended December 31, 2017, included in this Annual Report on Form 10-K, respectively.

Financial Covenant. The financial covenant is a consolidated leverage ratio test that requires our ratio of debt to earnings before interest, taxes, depreciation, amortization, and share-based compensation, as defined in the Senior Note Agreements, not to exceed 3.5-to-1. At December 31, 2017, we were in compliance with the covenants of the Senior Note Agreements. The following details our consolidated leverage ratio calculation as of December 31, 2017 (in thousands):

		December
Trailing 12 Months Adjusted EBITDA:			2017
Net income attributable to stockholders		$	263,144
Interest expense			37,225
Provision for income taxes			117,788
Depreciation and amortization			83,140
Share-based compensation expense			23,517
Adjusted EBITDA		$	524,814
		December
Debt to Adjusted EBITDA Ratio:			2017
Line of credit		$	655,000
Long-term debt			606,075
Total debt			1,261,075
Acquisition-related consideration payable			3,537
Capitalized leases			419
U.S. GAAP change - deferred financing costs			492
Gross debt			1,265,523
Gross debt to Adjusted EBITDA ratio			2.41
Cash and cash equivalents			(187,675)
Marketable securities			(284,255)
Net debt		$	793,593
Net debt to Adjusted EBITDA ratio			1.51

Other Commitments, Contingencies and Guarantees

Under our workers’ compensation insurance policies for U.S. employees, we have retained the first $0.3 million for the years ended December 31, 2017, 2016 and 2015, in claim liability per incident with aggregate maximum claim liabilities per year of $2.5 million, $2.6 million, and $3.5 million for the years ended December 31, 2017, 2016 and 2015, respectively. Workers’ compensation expense recognized during the years ended December 31, 2017, 2016 and 2015 and our respective liability for such claims as of December 31, 2017, 2016 and 2015 was not material. Claims incurred during the years ended December 31, 2017 and 2016, are relatively undeveloped as of December 31, 2017. Therefore, it is possible that we could incur additional healthcare and wage indemnification costs beyond those previously recognized up to our aggregate liability for each of the respective claim years. For the years ended on or prior to December 31, 2015, based on our retained claim liability per incident and our aggregate claim liability per year, our maximum liability in excess of the amounts deemed probable and previously recognized, is not material as of December 31, 2017. As of December 31, 2017, we had outstanding letters of credit totaling $1.0 million to the insurance companies as security for these claims in connection with these policies.

Under our current employee healthcare insurance policy for U.S. employees, we retained claims liability risk per incident up to $1 million per year in 2017, $0.45 million per year in 2016 and $0.43 million per year in 2015. We recognized employee healthcare claim expense of $47.2 million during the year ended December 31, 2017, $40.4 million during the year ended December 31, 2016, and $34.6 million during the year ended December 31, 2015, which represents actual claims paid and an estimate of our liability for the uninsured portion of employee healthcare obligations that have been incurred but not paid. Should employee health insurance claims exceed our estimated liability, we would have further obligations. Our estimated liability for healthcare claims that have been incurred but not paid were $4.2 million as of December 31, 2017, $4.0 million as of December 31, 2016, and $4.8 million as of December 31, 2015.

We have total acquisition-related contingent consideration liabilities outstanding primarily related to the achievement of certain revenue milestones of $3.0 million at December 31, 2017, as compared to $0.9 million at December 31, 2016, and $5.9 million at December 31, 2015. These contractual obligations are not reflected in the table below.

We are contractually obligated to make the following payments in the years below:

Contractual obligations (in thousands)		Total				Less than 1 year				1-3 years				3-5 years					More than 5 years
Long-term debt obligations (1)		$	747,461			$	20,385			$	40,769			$	161,387				$		524,920
Operating leases			95,929				19,233				27,661				16,600						32,435
Purchase obligations (2)			214,539				184,564				24,003				3,872						2,100
Minimum royalty payments			1,736				528				439				187						582
U.S. deemed repatriation tax			48,783				3,903				7,805				7,805						29,270
Total contractual cash obligations		$	1,108,448			$	228,613			$	100,677			$	189,851				$		589,307

	(1)		Long-term debt amounts include interest payments associated with long-term debt.

	(2)		Purchase obligations include agreements and purchase orders to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including fixed or minimum quantities, pricing, and approximate timing of purchase transactions.

These commitments do not reflect unrecognized tax benefits of $21.4 million and $2.2 million of deferred compensation liabilities as of December 31, 2017, as the timing of recognition is uncertain. See Note 12 to the consolidated financial statements included in this Annual Report on Form 10-K for additional discussion of unrecognized tax benefits.

Not reflected in the contractual obligation table above are agreements with third parties that we have entered into in the ordinary course of business under which we are obligated to indemnify such third parties for and against various risks and losses. The precise terms of such indemnities vary with the nature of the agreement. In many cases, we limit the maximum amount of our indemnification obligations, but in some cases those obligations may be theoretically unlimited. We have not incurred material expenses in discharging any of these indemnification obligations, and based on our analysis of the nature of the risks involved, we believe that the fair value of these agreements is minimal. Accordingly, we did not record any liabilities for these obligations at December 31, 2017 and 2016, and do not anticipate any future payments for these guarantees.