Danaher Corp

NYSE:DHR

Earnings Call Transcript 2017-Q4

[Operator]

Please stand by, we're about to begin. My name is Tracey, and I will be your conference facilitator this morning. At this time, I would like to welcome everyone to the Danaher Corporation's Fourth Quarter 2017 Earnings Results Conference Call. All lines have been muted to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]

I will now turn the call over to Mr. Matt Gugino, Vice President of Investor Relations. Mr. Gugino, you may begin your conference.

[Matt Gugino, VP, IR]

Thank you, Tracey. Good morning everyone, and thanks for joining us on the call. With us today are Tom Joyce, our President and Chief Executive Officer; and Dan Comas, our Executive Vice President and Chief Financial Officer.

I'd like to point out that our earnings release, the slide presentation supplementing today's call, and the reconciliations and other information required by SEC Regulation G relating to any non-GAAP financial measures provided during the call are all available on the Investors section of our website, www.danaher.com, under the heading Quarterly Earnings.

The audio portion of this call will be archived on the Investors section of our website later today, under the heading Events & Presentations, and will remain archived until our next quarterly call. A replay of this call will also be available until February 04, 2018.

During the presentation, we will describe certain of the more significant factors that impacted year-over-year performance. The supplemental materials describe additional factors that impacted year-over-year performance. Unless otherwise noted, all references in these remarks and supplemental materials to company-specific financial metrics relate to the continuing operations of the company and the fourth quarter of 2017, and all references to period-to-period increases or decreases in financial metrics are year-over-year. We may also describe certain products and devices, which have applications submitted and pending for certain regulatory approvals.

During the call, we will make forward-looking statements within the meaning of the Federal Securities Laws, including statements regarding events or developments that we believe or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings, and actual results might differ materially from any forward-looking statements that we make today. These forward-looking statements speak only as of the date that they are made, and we do not assume any obligation to update any forward-looking statements, except as required by law.

With that, I'd like to turn the call over to Tom.

[Tom Joyce, President and CEO]

Thank you, Matt, and good morning, everyone. Before we get in to the details of the quarter, I’d like to touch briefly on the announcement we made this morning regarding our CFO transition plan. As I’m sure many of you saw, we announced that Matt McGrew, our current Group CFO of our diagnostics and dental platforms will succeed Dan Comas as Chief Financial Officer of Danaher on January 1 of 2019.

Dan will continue on as an Executive Vice President and a member of the office of the Chief Executive post January 1, 2019, as he begins a gradual transition to retirement. Dan, it goes without saying that it has been and will continue to be a privilege working with you.

For the past 27 years, all of us at Danaher have valued your outstanding financial stewardship, thoughtful guidance and longtime friendship. Danaher would not be where it is today without your leadership, strategic vision, and humility. We are also very pleased that you’ll continue to work with us post-2018 to ensure a seamless CFO transition and provide a strategic counsel we value so highly.

Many of you know Matt McGrew from his time as Vice President of Investor Relations. But Matt has had a number of important roles during his past 14 years with Danaher. Matt is uniquely qualified to take on the positon of CFO, as he will be able to leverage his extensive Danaher experience in internal audit, M&A, investor relations and as Group CFO with operational experience across four of our five platforms.

Throughout his tenure with Danaher, Matt has consistently demonstrated superior leadership and played an integral role in the company’s growth both organically and inorganically. We look forward to helping Matt transition to this important role with Dan’s guidance and strategic counsel.

With that lets’ get to our results. We are very pleased with our strong fourth quarter performance, as the team delivered 5.5% core revenue growth, solid margin expansion and double-digit adjusted earnings per share growth. These results capped a solid year for Danaher and we’re very encouraged by the momentum we built throughout 2017.

2017 was a great example of how we run the Danaher playbook. We improved gross margins to nearly 56%, lowered G&A, increased our investments in sales and marketing and R&D to drive accelerating core growth, all while delivering 70 basis points of core operating margin expansion. This operating model continues to demonstrate how we build a better, stronger Danaher.

For the full year, our differentiated portfolio, organic growth investments and good commercial execution helped drive 3.5% core revenue growth, including mid-single digit growth in three out of our four reporting segments. Our total annual revenues are now nearly $18.5 billion. We generated $2.9 billion of free cash flow in 2017, resulting in mid-teens growth year-on-year that helps position us for more significant capital deployment in 2018.

Our free cash-to-net income conversion ratio was 117%, and 2017 represents the 26th consecutive year in which our free cash flow has exceeded net income. From an M&A perspective, we deployed nearly $400 million of capital in 2017 on 10 strategic bolt-on acquisitions, each of which will help enhance their respective platforms. We also remain encouraged by the great performance at our most recently acquired larger businesses, Cepheid, Phenomenex, PALL and Nobel Biocare.

Turning now to the fourth quarter, sales grew 11% to $5.1 billion, as the impact of currency translation increased revenue by 3% and acquisitions increased revenues by 2.5%. Core revenue increased 5.5%, led by four of our five platforms that grew between 5.5% and 7.5%.

Geographically high growth markets grew high single digits with China and India continuing to lead the way. In developed markets, we saw acceleration as both the US and Western Europe were up mid-single digits.

Gross margin for the fourth quarter was 55.8%, an increase of 130 basis points, while core operating margin expanded 105 basis points led by our life sciences and diagnostics platforms. These margin results are a testament to our teams’ consistent execution using the tools of the Danaher business system. Fourth quarter adjusted diluted net EPS was $1.19, bringing full year adjusted EPS to $4.03 both representing double digit growth year-on-year.

Now let’s take a more detailed look at fourth quarter results across the portfolio. In life sciences, reported revenue was up 12% and core revenue grew 7.5%, which marks the platforms highest quarterly core growth rate in over four years. Life sciences operating profit margin was 20%, with both core and reported operating margins increasing over 300 basis points. This increase was broad based across the platform driven primarily by outstanding DBS execution, new product innovations and better than expected topline performance.

Beckman Life Sciences delivered high single digit core revenue growth for the second consecutive quarter, led by ongoing strong performance in our Flow Cytometry and particle counting businesses. We believe the Beckman team continues to take market share driven by improved commercial execution and new product innovations.

Over the past three years, Beckman has refreshed its portfolio launching approximately 20 new products. Several of these new products address higher growth areas such as biologic and genomic work flows, setting the business up well for continued strong performance.

Leica Microsystem’s core revenue was up low single digits, led by growth in Western Europe and China, primarily in the medical and research end markets. Core revenue at Sciex increased at a mid-single digit rate, led by continued strength in the food, environmental and pharmaceutical end markets. In addition, Phenomenex had a very good quarter, growing core revenue high single digits as both Sciex and Phenomenex are starting to leverage each other’s go-to-market capabilities.

At Pall, core revenue grew nearly 10%, its best quarterly growth rate since we acquired the business as our microelectronics and single use technologies businesses continued to perform very well. In addition, biopharma and process and industrial finished the year on a strong note, as these businesses rebounded nicely from the hurricane disruptions that impacted third quarter results.

In October, our life sciences platform successfully closed the acquisition of IDBS, a software informatics leader in the life science space. IDBS’s software provides a data management platform enabling its research customers to better capture, manage and report on scientific insights. This platform in combination with our life sciences instrumentation will enable researches to accelerate their innovation efforts helping to make better and faster scientific decisions.

Moving now to diagnostics, reported revenues increased 13.5% and core revenue increased 6%. Core operating margin grew by 105 basis points and reported operating margin increased 690 basis points to 19.5%. At Beckman Coulter, core revenue grew at low single digit rate led by solid growth in our immunoassay, urinalysis and clinical chemistry product lines. Regionally the growth was driven by China and Latin America.

At Radiometer, core revenue increased mid-single digits in the quarter, as both our blood gas and AQT product lines continued to perform well. Leica Biosystems delivered high single digit core revenue growth, led by increased demand in both our advanced staining and core histology product lines. Growth was broad based across most regions, with particular strength in North America and Western Europe.

Turning to Cepheid, the team had an outstanding quarter. Core revenue increased greater than 25% driven by growth in all major product lines and geographies. For the full year 2017, Cepheid’s core revenue grew approximately 20%, which is almost double the expected rate from when we announced the acquisition. This outperformance was driven by a combination of strong commercial execution, test menu expansion and an ever increasing installed base of instruments.

Overall it was a tremendous first year at Cepheid, with DBS helping to deliver improvements across the company. Since we acquired the business last November, Cepheid has achieved 400 basis points of gross margin expansion, increased operating margins from just above breakeven in to the mid-teens and improved on-time delivery by over 1500 basis points.

The team has also meaningfully embraced two key commercial DBS growth tools, transformative marketing and funnel management. These tools have helped Cepheid expand its market visibility, generate more potential leads and increase the number of new customers they are serving. As a result, we believe Cepheid continues to expand its leading market position and gain market share.

Turning to our dental segment, reported revenue increased 2.5% and core revenue was down slightly. Dental operating profit margin was 13.1% as both core and reported operating margins declined. By product line, performance was in line with our expectations. Growth in our specialty consumables businesses, implants and orthodontics was offset by declines in equipment and traditional consumables.

As expected the declines in traditional consumable growth rate has started to moderate, however, our equipment business was negatively impacted by the recent realignment of certain distributor and manufacture relationships. We anticipate these difficult market conditions to persist through the first half of 2018.

We continue to be pleased with the performance in our specialty consumables businesses. Nobel Biocare in particular had a great quarter, growing core revenue high single digits driven by North America and China. December marked the three-year anniversary of the Nobel acquisition, and they’ve made tremendous progress.

Not only has the team meaningfully improved operating margins, but has also increased R&D spend by approximately 20%, launched more than 25 new products and increased their sales force by 15% over the past two years. These growth initiatives along with the execution of DBS tools to streamline sales from our proxies and increase new customer starts has helped Nobel pose mid-single digit core growth in each of the last two years.

Moving now to our environmental and applied solutions segment, reported revenue grew 12.5% with core revenue up 6%. Core operating margin declined by 50 basis points and reported operating margin decreased to 23.1%, driven primarily by increased productivity initiatives and a deafening spend within our water quality platform.

In product identification, core revenue increased at a mid-single digit rate, led by strong demand from marking and coating equipment and related consumables. The out-growth in our packaging and color solutions offerings was attributed to increased demand in North America and Western Europe. Videojet core revenue increased high single digits in the quarter, with broad based growth across most major product lines and geographies. The fourth quarter capped off another great year for Videojet as the business continued to compound returns and gain market share.

Over the past five years, Videojet has averaged mid-single digit core revenue growth, continued to expand margins and also completed a number of strategic Bolton acquisitions. One of those acquisitions Laetus had its best quarter of core revenue growth since we acquired the business in 2015. As a reminder Laetus is a leading supplier of track and trade inspection systems for pharmaceutical packaging plants.

With the help of DBS tools Laetus has generated greater market awareness and demand within the pharmaceutical tracking vertical and we believe is well positioned for growth going forward. In our packaging and color solutions businesses, core revenue at Esko was up mid-single digits, while X-Rite was up low-single digits.

Finally, turning to our quality, core revenue growth for the platform at a mid-single digit rate. Hach had its best quarter of the year, with core revenue growing mid-single digits. This growth was drive by solid performance across our core municipal and industrial end markets, with strength in Western Europe and China.

Hach also continued its healthy cadence of Bolton acquisitions, closing two deals in the quarter, AppliTek and Kipp & Zonen. AppliTek is a leading provider of wet chemistry process analyzers and integrated systems that will help Hach offer a broader suite of parameters to its core industrial and municipal customers. Kipp & Zonen specializes in making instrumentation that’s relied upon by meteorologist through applications such as climate research, water resource management and materials testing.

Kipp & Zonen will join Hach’s environmental business and nicely complement our existing offerings, providing us an opportunity to deliver enhanced customer solutions. We are excited to welcome both teams to Danaher.

At Chemtreat, core revenue grew at a low single digit rate, driven by increases in the food, steel and oil and gas end markets, primarily in North America. It’s worth noting that 2017 marks Chemtreat’s 50th consecutive year of revenue growth, a tremendous accomplishment and a testament to the team’s commitment to continue its improvement and their best-in-class commercial execution.

Lastly, Trojan had a great quarter delivering double digit core growth, driven by healthy demand and increased bidding activity in the North American municipal market. Trojan continues to execute very well significantly improving customer win rates to help drive share gains relative to its markets.

So to wrap up, we’re very pleased with our fourth quarter results, capping off a good year for Danaher and helping to build momentum as we start 2018. In 2017, the team delivered double digit adjusted EPS growth; meaningful margin improvement and cash flow generation and saw core revenue growth accelerate through the year.

We also executed on a number of strategic Bolton acquisitions, continued to focus on integration of our recent larger deals and we now have a balance sheet that positions us well for a more significant capital deployment in 2018.

As we look ahead, we believe that the strength of our portfolio, combined with the power of the Danaher business system provide us with the foundation to achieve long term shareholder value creation. We are initiating first quarter adjusted diluted net EPS guidance between $0.90 and $0.93, which assumer core growth of 3.5% to 4%.

We continue to expect full year 2018 core revenue growth of 3.5% to 4% and adjusted diluted net EPS to be in the range of $4.25 and $4.35.

[Matt Gugino, VP, IR]

Thanks Tom. That concludes our formal comments. Tracey, we are now ready for questions.

[Operator]

[Operator Instructions] And we’ll go first to Scott Davis with Melius Research.

[Scott Davis, Melius Research]

Let’s step back just a bit, the step up in core growth was pretty exceptional really, but can you walk us around the world, I wasn’t clear where the positive surprises came from globally. By business it was clear, but let’s clear globally.

[Tom Joyce, President and CEO]

Scott it was really very positive on a global basis. Of course I think we all know from a macro perspective we’re in a unique time, right, we’re in a time of globally synchronous economic expansion. And I think in many respects our businesses are well positioned to take advantage of that growth rate on a global basis across all the many markets in which we participate.

What we saw in the fourth quarter was continued good performance in the high growth markets, with exceptional growth in China, in India, as we’d seen consistently throughout the course of the year, some improving performance in places like Latin America and Russia, and frankly still some softness in places like the Middle East.

But I think what was maybe a bit more noteworthy than the continued good performance in the high growth markets was the incremental strength that we saw in the developed markets. In the US and in Europe both of those markets up mid-single digits is I think where the real difference is on a global basis.

Now clearly our businesses were well positioned to take advantage of opportunities in each of those markets. We saw obviously particular strength in our life science businesses and our diagnostic businesses, up north of 7% and 6% respectively, improved performance sequentially in our water quality business which we expected, and consistent performance in product identification.

So I think overall pretty well in line with what’s happening in the macro from a geographic perspective, but I think clearly four to five platforms incredibly well positioned relative to those macro drivers.

[Scott Davis, Melius Research]

So that just begs the natural question of when you think about your guidance 3.5% to 4%. That first half of the year you’ve got reasonably easy comps and you made positive comments about the global macro. Is there something you’ve seen January that leads to be a little bit more conservative or is this just the standard Danaher, it’s still early in the year, let’s wait and see before we raise that guidance.

[Tom Joyce, President and CEO]

I wouldn’t say it’s anything in particular that we’ve seen on a near-term basis Scott. I think it’s much more to the latter point you made, which is it’s very early in the year. We are encouraged by obviously the finish we saw. What little we’ve seen of January to this point gives us encouragement as well. And I think it’s just early at this point and obviously we’ll be updating throughout the course of the year. But I think for now we feel very good about the guidance that we have and we’ll watch carefully as this quarter unfolds.

[Operator]

And we’ll go next to Tycho Peterson with JPMorgan.

[Tycho Peterson, JPMorgan]

Question on in terms of the delta relative to our model life science certainly stood out. You called out Beckman life science, Phenomenex. Can you quantify what Pall life sciences was up and then was there any catchup affect from 3Q there that you can quantify and any budget flush dynamic that you’re willing to call out.

[Tom Joyce, President and CEO]

So our best stance was the life science was up 7.5%, there was probably about a point benefit, kind of a hurricane recovery, so call it ex hurricane recovery more like 6.5%. That was also followed through with very strong orders. We were I think as we went into the beginning in January slightly worried that there were some budget flush, but our January orders have remained very strong. That’s not only life science but more broadly.

[Tycho Peterson, JPMorgan]

And then a question on Cepheid, obviously this has done incredibly well. I’m just wondering if you can provide a little bit more color on how much of this is coming from new cartridge launches versus flu trends versus [HVDC][ph] and some of these other markets.

[Tom Joyce, President and CEO]

We saw a really broad based strong performance from Cepheid. There were a number of factors that I think contributed to that. Not the least of which certainly was enhanced commercial execution. One of the things we tracked at Cepheid is our installed base and our new customer addition, and since we’ve acquired the business, new customer additions are plus 15% since we acquired the business.

I think menu is certainly a contributor with Xpress flu, with Flu/RSV, with strep test all introduced in 2017, all making a difference. Yes, continued strength in the hybrid in developing countries but very good strength in the developed markets as well. Clearly we are in the midst of at least certainly from a patient perspective a very challenging flu season.

And yes that does drive growth at Cepheid. But I think if you step back and you look at the performance in the fourth quarter, that performance is driven far beyond the early strength of the flu season and really represents I think a number of both commercial execution enhancement and menu expansions that have driven growth in the installed base.

[Operator]

And we’ll go next to Ross Muken with Evercore ISI.

[Ross Muken, Evercore ISI]

Maybe on dental right, some of the underlying trends particularly in the recently acquired business and Nobel seems better, but obviously some of the noise still exist with the channel and maybe on sort of basic consumables. I guess based on what you’ve seen kind of closing the year to start of the year. I mean in terms of cadence and in terms of your thoughts on how some of the changes you’ve made over time are starting to playout and the pieces where you’ve been able to influence it versus maybe some of the market factors you don’t have control on. And what’s your sort of updated thoughts on how that’s gone and in terms of maybe some of the small wins it seems like you’re getting in pieces like Nobel.

[Tom Joyce, President and CEO]

The fourth quarter played out pretty much in line with what we expected. I think we all know that 2017 was clearly a difficult year in the industry. But there are a number of things that actually are quite encouraging for us. Starting with especially consumables business, I mentioned in my comments earlier the terrific performance that we’ve seen in Nobel. We’ve seen very consistent and good performance from Ormco as well.

And those two businesses especially consumables businesses represent half our dental segment. Mid-single digit growth across that group of businesses combined in the fourth quarter with Nobel being high single digits, and there’s no question I think those are some pretty attractive markets to participate in.

Could the strength there be taken a little bit of wallet share from some of the more traditional consumables, maybe a little bit tough to pinpoint on that, but in general that half of our segment we were quite encouraged by? High growth markets have continued to perform very well, high single digit growth in the fourth quarter and throughout 2017.

And then operational execution, you know we’ve talked in the past and I think we’ve just finished up our second year of talking about our dental platform, approaching the dental platform as a new acquisition. And we’ve done a number of things to right size the cost structure while we invest in over the last couple of years.

We consolidated operating companies from 10 down to four, reduced the manufacturing and back office sites by over nearly a third. Gross margins are up a 100 basis points as a result of a number of those changes and yet we’re still reinvesting. R&D up a 100 basis points as a percent of sales, up 20% in 2017 year-on-year, a whole bunch of new products, 25 new products as I mentioned in Nobel.

So this is a $3 billion platform we have today and admittedly that doesn’t represent an enormous percentage of Danaher and clearly where we’ve seen the weakness in about half of that platform isn’t even a smaller percentage of the overall platform. But these are strong brands and great franchises. Good secular trends around digital dentistry and so on and over all we feel good about the operational improvements and the progress we’re making and we continue to drive to create long term value out of that platform.

[Ross Muken, Evercore ISI]

That’s super helpful and maybe just on the capital allocation front. So you guys free cash continues to be a really tremendous 100% plus of net income. I guess as you’re staring out over the balance of the year, it looks like the leverage levels are going to get back because of manageable place. How are you balancing kind of your balance sheet capacity versus public market multiples, looks like you were a little bit busy on the tuck-in side in the last quarter or two. So help us just think through kind of how that environment looks like for you right now?

[Tom Joyce, President and CEO]

We feel very good about where we sit today Ross. The 10 acquisitions that we did in the past year were strategic enhancements to a number of our platforms, and the spend that we executed during the course of the year was certainly within the range of the spend that we anticipated during the course of the year, particularly in light of the capital deployment that had preceded that over the couple of years of ’15 and ’16.

As we enter 2018, as I mentioned, I think the balance sheet’s in great shape. It positions us now to take advantage of opportunities as they come along. Optimally we would deploy that capital at or above our free cash flow and for deals that really are strategically important to anyone of our platforms today, we’d be willing to stretch that a bit.

So we feel great about how we enter the year. We’ve seen activity pick up a little bit. Second half of the year you saw a little bit more activity in those boltons in the first half of the year, and I think that bodes well for how things might open up here with people feeling good about their own valuations clearly as sellers.

But I think it’s also probably worth noting that now the tax reform has been determined, if you will. That pays a level of uncertainty out of the market, and anytime you eliminate uncertainty, confidence grows and that may help things out as well.

[Operator]

We’ll take our next question from Steven Winoker with UBS.

[Steven Winoker, UBS]

Dan could you maybe give a little more color on the puts and takes around the gross margin, 130 basis points. Obviously you guys are less sensitive in your cost structure to material inflation than a lot of other companies. But maybe just talk about the price productivity mix impact versus other headwinds.

[Dan Comas, EVP and CFO]

You’re right. I mean all up a big part of the driver is the continued expansion of gross margins at Pall. It’s obviously been a multi-year effort. The big step-up, the 400 basis points step up in gross margin at Cepheid is year-on-year are probably the two biggest drivers. We had a 55% gross margin; we just don’t have that much impact from sort of commodities and direct labor inflation. It’s a little bit of a headwind right now, but at t hose levels it’s relatively modest. And clearly when you’re putting together 5.5% core growth, you get very good fall through including on the gross margin side.

[Steven Winoker, UBS]

And so you expect that to continue?

[Dan Comas, EVP and CFO]

Yes, probably not at the – we’re not going to get another 400 basis points step up at Cepheid next year in gross margin, but I think we’re very well positioned from gross margin. And I think as we saw on the operating margin side, as many of you’ll remember, we had negative OMX, core OMX in the first quarter of this year and we still ended up at the high end of our range of 50 to 75 basis points of core margin expansion. I feel very good about how we are set up in terms of core margin falling in to ’18 including some of the actions we took in the latter part of ’17.

[Steven Winoker, UBS]

And then maybe just talk through a little more of the margin dynamics gotten it down 50 basis points at Environmental & Applied Solutions.

[Dan Comas, EVP and CFO]

Sure, that was primarily a couple of different factors, Trojan being very strong, a little bit of a negative mix. But the water business particularly Hach came to us kind of early in the fourth quarter with some opportunities both on the growth side and on the cost side to take some actions. It was clear we were having a very good quarter. We let them execute upon those actions both top and bottom line. You did see their growth accelerate. I just saw it for January they had a very strong start to the year. So I think some of their growth investments are still paying off pretty quickly here.

So I’m not concerned. A fair amount of it was kind of orchestrated through the course, given the strength we had. And again we’re not going to have the uplift we have in that segment that we will continue to have in diagnostics and dental. But I think you’ll see more normalized margin improvement across those businesses.

And [PID] had a very good quarter in terms of year, in terms of margins. And I think you’ll see water sort of back on track here starting earlier this year.

[Operator]

And we’ll next go to Jeff Sprague with Vertical Research.

[Jeff Sprague, Vertical Research]

Just a couple of things, just back to tax reform, you guys obviously do a fair amount of boltons and just looking at this provision on deals that are structured as asset deals where you can get immediate expensing of the fixed assets of the target company. I just wondered if you could give us a little context from a Danaher standpoint. On a lot of your bolton deals, typically asset deals and you have the ability to structure them that way, and kind of change the economic lunge you’re looking through when you look at these properties.

[Tom Joyce, President and CEO]

Jeff there’s always been an advantage to acquire the assets as oppose to the stock of an entity, perhaps even more so now. I would say that we’re sort of incrementally encouraged versus where we were two months ago generally wrapped around tax reform. We said in December we thought our rate would be 21%. I think it will be probably close to 20% to 21% this year.

We talked about a toll tax being probably in the magnitude of 100 million a year for the next five years. We now think it’s going to be more like 50 million to 60 million. So it’s still like sort of incrementally, and finally to your point, as often been the case, often with acquisitions particularly asset acquisitions there is an opportunity to do even more tax work to potentially lower that ETR even more overtime.

[Jeff Sprague, Vertical Research]

And then on the investment spend in Environmental and Applied, just wondering is that kind of traditional or restructuring or you’re doing something further drive growth. Obviously the tempo when the business seems like its quite strong, I guess there’s always some belt tightening to do around the edges. But is this more growth oriented or is it more restructuring oriented?

[Tom Joyce, President and CEO]

It’s little bit of both, more growth oriented, Hach adding both on the R&D side and the feet on the street side. We’re seeing very good numbers on the municipal and the industrial side, they actually got better through the year and we gave some latitude to ramp it up even more in Q4.

[Jeff Sprague, Vertical Research]

And then finally just on the distributor realignment in dental. Are we just now kind of working through the comparisons associated with the growth realignment that happened in the last several months or so, six months or so, maybe it’s longer than that? And so we’re just kind of working through the annualization of these dynamics or is there still somethings shifting around in the business?

[Tom Joyce, President and CEO]

Jeff those relationships changed in a formal way at the beginning last year. So we’re about four or five months in two what is a shift in largely exclusive arrangements that involved our relationship with Henry Schein and Dentsply Sirona’s relationship with Patterson. Essentially changing places in terms of a number of equipment related product line particularly around imaging.

When that sort of thing happens, there’s a series of adjustments that need to be made. Some of that comes in the form of inventory, some of that comes in the form of actually sell-out that is associated with sales team, learnings new products, shifting incentives etcetera which can further, along with the inventory adjustment have an impact on sell-in.

So it’s a series of factors that come together that does take a number of months to work its way through the system. At the end of the day the market becomes a little more of a level playing field when you have less exclusive arrangements between manufacturers and distributors. We believe that it will still take better part of the first half of this year for those adjustments to work their way through the system.

In the meantime, we are encouraged by seeing the traditional consumable side, which has been challenged as well moderate a bit in the fourth quarter. We take that altogether and we still think our dental business is likely to be flattish in the first half of this year with the specially tool of business is continuing to perform quite well, the high growth markets continue to perform quite well and much of the operational improvement that we’re putting in place continuing to improve profitability.

[Operator]

We’ll take our next question from Derik De Bruin with Bank of America Merrill Lynch.

[Derik De Bruin, Bank of America Merrill Lynch]

Just got a couple, one quick one and then one follow-up. So net interest expense, interest expense, so what’s the guide for ’18 could you remind me?

[Dan Comas, EVP and CFO]

145 million.

[Derik De Bruin, Bank of America Merrill Lynch]

And could you talk a little bit about pharma demand. I mean we’re starting to see some big companies talking about increasing their capital allocations and spending. Could you sort of talk about what you sort of see in the pharma space and sort of order pick-ups in that area on the equipment side or what’s on the bio process side? I’m wondering if some of the stuff you’re seeing directly weighted to some of the commentary that we’re hearing on them stepping up on those spend.

[Tom Joyce, President and CEO]

We feel good about the overall pharma market today, not just in bio-processing, in biologic demand pharma demand, but across more molecules as well. And we would point to the continued good performance in our equipment businesses at Sciex, at Beckman Life Science, at Phenomenex, at Leica Microsystem. Each of those businesses on the equipment side continuing to perform very well, and not all of those businesses have a significant exposure to the biologic side of life science or certainly pharma as we do say at Pall, where by the way we saw some improved performance clearly in the fourth quarter, obviously not all a function of the recovery from the third quarter hurricane disruptions but in fact we saw good order rate trends around biologic and small molecules, good order rate trend around our single use technologies as well. So on balance I would say, the overall pharma market, biologics and small molecules combined continues to be in pretty good shape.

[Derik De Bruin, Bank of America Merrill Lynch]

And the diagnostics side, any possible CapEx or any PAMA blow back?

[Tom Joyce, President and CEO]

Not really. Derik, again early relative to PAMA those rates as you know are just going in to place. As I mentioned previously, our exposure there is relatively modest with 60%of our volume outside the United States, this being only a US impact and limited to Medicare reimbursements for outpatient spending which again further mitigates the impact on us.

It’s certainly reasonable to think that customers will leverage the reduction and reimbursement associated with PAMA more broadly, but then again, I don’t think that’s necessarily anything new. I think anytime there are competitive dynamics in a market like the diagnostics market certainly in the central lab there’s going to be some pricing pressure, PAMA will create a little bit of an additional rationale for that. But on a fact basis the exposure there, again US only hospital outpatient and Medicare reimbursement would suggest it’s relatively modest.

[Operator]

And we’ll go next to Steve Beuchaw with Morgan Stanley.

[Steve Beuchaw, Morgan Stanley]

First question is a geographic focused question, because you talked a fair amount here on this call about the developed markets. I wonder if you could spend just a minute or two on China as it didn’t get as much attention on the call. Where in China do you think that we have a particularly good ’18; how are things evolving there; where in China, given some of the liquidity news items out there should we maybe budget in, something that is a little bit moderate relative to ’17.

[Tom Joyce, President and CEO]

Steve, China has been an important growth driver for us for a number of years. Today we do, I think in excess of $2 billion of revenue in China. We’ve strong positions across each of the platforms and there are extraordinary secular market drivers in China that support our water quality platform with the environmental concerns in China. Product ID even with the growth of the middle class and consumer package goods, diagnostics and life science both receiving significant amount of investment from the Chinese government. And as I’ve mentioned a number of times, our dental business continues to grow high single digits and in certain quarters double digits pretty consistently in China.

So I think if you step back, it’s a boy this is a portfolio that really lines up well with a number of key growth drivers in the Chinese market. In terms of any changes, you have the impact of a relatively new five year plan in China. Again I think that’s going to be supportive broadly across most of our platforms, I don’t think there’s much of a change there.

So in general we feel pretty good about continuing contributions from the Chinese market in each one of the platforms.

[Dan Comas, EVP and CFO]

One of the things that was encouraging in China was we were up double digit for the year and we were basically 10%-11% every quarter through 2017. So it feels like we have pretty good momentum. It’s a bigger base now for that kick down a point or two share, but things are still feeling pretty good over there.

[Steve Beuchaw, Morgan Stanley]

Good to hear. One more of a big picture question for Tom, it’s hard not to look at the improvement of organic growth to your core growth in the last couple of quarter, and here the really encouraging commentary on new product flow and execution across the businesses and think, hey vow these guys are seeing some step up in R&D, step up in commercial investment, really pay-off.

It will be helpful just to hear what you’ve learned and how this success, the way I perceive it as a success downstream of an investment effort. How is that changing your thinking if at all about the medium or long term, appropriate level of spend on R&D and sales and marketing in the organization.

[Tom Joyce, President and CEO]

Well clearly this has been an evolution for us. Part of that evolution Steve is the evolution of the portfolio. Many of the changes that we’ve made in the portfolio over quite a number of years not just in the last two years or so, but really over the last probably better than five years has set up a portfolio that is really aligned to markets that have a great growth drivers.

I think secondly, we’ve seen an evolution in the Danaher business system, as the tools of DBS have evolved beyond lean in to leadership and most importantly in to growth, and we see the tools of DBS which by the way continued to evolve. Even in 2017, we developed incremental growth tools that are having an impact on each of our businesses from a commercial execution perspective, but also in terms of driving higher rates of innovation.

And I think finally on innovation, I think it has and will continue to play an increasingly important role in our growth rates. And those investments in R&D have paid off and we can point to a number of those examples in our businesses where we see new products from incrementing their growth rates. I point specifically for example the Videojet whose got probably the most robust new product pipeline in its history today with the 1860 fully censored and wired to the internet through greater levels of customer services, Hach’s launch of the [Claro] system leveraging the internet of things as well.

So I think the portfolio evolution, the evolution of the tools on the Danaher business system, continued investment in R&D to drive higher rates of innovation, and then finally inorganically obviously the deals we’ve done over the last couple of years have been incremental to our growth rates. You clearly look at the impact of Cepheid and Phenomenex our most recent acquisitions, but certainly Pall and Nobel having an impact. And those 10 strategic Bolton acquisitions, each of those have strategic impacts on our businesses and the ability to drive incremental growth over time through what at times is kind of early stage investment that can drive long term innovation related growth.

So it’s really a combination of things, having learned a lot in the process. Certainly we have, but I think that learning has come really as a function of executing a plan.

[Operator]

And we’ll next to Richard Eastman with Baird.

[Richard Eastman, Robert W. Baird]

Could we just circle back if you will to the life sciences up margin here in the quarter, and maybe just speak a little bit to Pall, the strength that Pall and the impact of mix on that up margin. I’m curious, Dan you flagged Pall’s gross margin improvement as a big factor in overall margin improvement and expansion. But could you maybe just give us a sense to Pall’s gross margin improvement during and for the full year in calendar ’17.

[Dan Comas, EVP and CFO]

As you know Rick when we purchased the business it was a high-teens [OP][ph] business and we’re up a 1000 basis points since the time of the acquisition, and a big chunk of that has been [indiscernible] in the gross margin. I would say that, but one thing that was encouraging in the quarter, was the gross margin improvement in life science is pretty broad based. And none of the businesses grew mid-single digits. Beck life sciences improved their gross margin and then turned their operating margins; we’re seeing the same thing as Sciex good margin expansion.

Though I noted Pall the big driver of the life science improvement. It was this broad based particularly to put up that sort of number as I’ve seen it, and clearly the better core growth helps. Though all those businesses are doing a good job expanding the growth margins, leveraging G&A, they are off stepping up their R&D in sales and marketing. So we’re getting those margins step up. Back to Tom’s point about investing and grow while stepping up our growth investment.

[Richard Eastman, Robert W. Baird]

Again when you look at the out margin here, for the fourth quarter assuming Pall, both Pall life sciences as well as PI were stepped up and rebounded, how do you look at the gross margin in the fourth quarter here is maybe a new structural level here to grow off and leverage off with core growth going forward for life sciences?

[Dan Comas, EVP and CFO]

Rick I’d have to look at them more carefully. As you know there’s some seasonal benefit in the fourth quarter in life science with equipment sales, which were very strong. But I believe we’ve made a lot of structural changes in the cost profile across life science. And I have to look at it specifically kind of going to the next couple of quarters, but this step up is real.

[Richard Eastman, Robert W. Baird]

And then just last question follow-up on dental, if we look at the dental, I think Tom you had suggested maybe first half of ’18 would see flattish revenue. So perhaps a little bit of growth in the back half. But I’m curious when you look at the margin expectation around dental for ’18, do we have enough restructuring, do we have enough growth investment without a great deal of topline to drive 50 to 100 basis points of margin improvement in ’18. What does the plan look like given the sales outlook for [dental]?

[Tom Joyce, President and CEO]

I think we’ve balanced that pretty well over the last couple of years and we’ll continue to do that in 2018. We’ve applied restructuring dollars to drive enhanced productivity in a number of different areas, but at the same time we’ve invested in R&D and we’ve invested in sales and marketing and I’ve cited a number of those numbers as you may recall.

And so I think it’s a balance, and I think we shook that balance pretty well in ’16 and ’17 and I don’t anticipate that we will approach any differently in 2018.

[Operator]

We’ll take our final question today from Doug Schenkel with Cowen & Company.

[Doug Schenkel, Cowen & Company]

I’m going to start on Pall; you guys had a solid quarter even normalized for hurricane effect. Your comments earlier on order trends is encouraging. Specific to bio production is it safe to say that you’ve seen an improvement in demands or at least normalization subsequent to some of the customer inventory rebalancing dynamics you mentioned earlier in 2017.

[Tom Joyce, President and CEO]

Doug it is safe to say that. It was a solid performance even normalized, the order trends are good and those order trends do point to an improvement in the demand profile, because I think you and others know, we saw a number of customers in that market adjust levels in a couple of cases slow down production during the course of 2017, and I think in the late third quarter and in to certainly the fourth quarter, we saw order trends improve. So we’re encouraged by that.

[Doug Schenkel, Cowen & Company]

And maybe just to close out by going back to something we covered at length earlier in the discussion the topic of 2018 guidance rationale. You were clear in saying that based on what you saw in January you don’t think there was any pull forward of revenue from Q1 in to Q4. And we know you have a history of tending to be prudently conservative with guidance especially earlier in the year.

And that said, I just want to confirm two other things, one, that current FX rates would seemingly cut out as much as $0.10 to full year EPS relative to on the original guidance at least based on our math that those are not fully reflected in current guidance. And second, that you’ve not fully adjusted guidance for the lower tax rate dynamic that you mentioned in response to an earlier question.

[Tom Joyce, President and CEO]

Doug let me try to answer that. We have a – it’s been in the 12, 13, 14 years we’ve sort of avoided adjusted December guidance when we get to January. Just feels too early, too quick. I also recognized that January call next year will be Matt McGrew’s first call. So I’m not suddenly looking to sort of change things up here. But you’re right there are some tailwinds out there, whether a Q4 demand, December demand, January numbers, they all point to good numbers.

We are benefitting from the further weakness of the dollar and we are a little more optimistic on the tax rate. Yes, probably a few offsets there, probably a higher share count, but that offsets are modest. So net-net we are feeling pretty good about where we are, and if those good things continue, we’ll have plenty of opportunities to update you through the year.

[Operator]

This does conclude today’s question-and-answer session. At this time, I would like to turn the call back to Mr. Gugino for any additional or closing remarks.

[Matt Gugino, VP, IR]

Thanks Tracey and thanks everyone for joining us. We’re around all day for questions.

[Operator]

This does conclude todays’ conference. We thank you for your participation. You may now disconnect.