Revvity Inc

NYSE:RVTY

Earnings Call Transcript 2017-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the Q4 2017 PerkinElmer Earnings Conference Call. [Operator Instructions] As a reminder, today's conference may be recorded.

I would now like to turn the call over to Tommy Thomas, Vice President of Investor Relations. Sir, you may begin.

[Tommy Thomas, executive]

Thank you, Chelsea. Good afternoon, and welcome to the PerkinElmer Fourth Quarter and Full Year 2017 Earnings Conference Call. With me on the call are Rob Friel, Chairman and Chief Executive Officer; and Andy Wilson, Senior Vice President and Chief Financial Officer.

If you have not received a copy of our earnings press release, you may get one from the Investors section of our website at www.perkinelmer.com. Please note, this call is being webcast live and will be archived on our website until February 8, 2018.

Before we begin, we need to remind everyone of the safe harbor statements that we have outlined in our earnings press release issued earlier this afternoon and also those in our SEC filings. Any forward-looking statements made today represent our views only as of today. We disclaim any obligation to update forward-looking statements in the future even if our estimates change. So you should not rely on any of today's forward-looking statements as representing our views as of any date after today.

During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures we plan to use during this call to the most directly comparable GAAP measure is available as an attachment to our earnings press release. To the extent we use non-GAAP financial measures during this call that are not reconciled to GAAP in that attachment, we will provide reconciliations promptly.

I'm now pleased to introduce the Chairman and Chief Executive Officer of PerkinElmer, Rob Friel. Rob?

[Robert Friel, executive]

Thanks, Tommy. Good afternoon, and thank you for joining us today. I'm pleased to report that PerkinElmer had a very strong finish to 2017, delivering significant revenue growth and beating both the top and bottom line of our previous guidance.

Our revenue for the quarter was $642 million, representing reported growth of 13%, and organic growth, excluding the impact of EUROIMMUN, of 6%, which was well balanced across both our diagnostics and Discovery & Analytical Solutions, or DAS business. On the bottom line, our adjusted earnings per share was $0.97. However, on a diluted share basis, which is the more appropriate comparison, our adjusted EPS was $0.96, representing growth of 16% compared to the fourth quarter of 2016.

The EUROIMMUN acquisition, which we completed on December 19, contributed $13 million or approximately 2% to our fourth quarter revenue. However, the operating income generated by EUROIMMUN during this stub period was offset by an increase in incentive compensation related to the closing of the transaction. This increased compensation charge negatively impacted our adjusted operating margins by about 60 basis points, resulting in a modest fourth quarter increase in our adjusted operating margins to 21.4%. Excluding this charge, operating margins would have expanded by about 70 basis points.

Looking at our full year financial performance, we grew reported revenue by 7% and organic revenue by 4%. Adjusted earnings per share increased by 12% to $2.90, and our adjusted operating margins expanded by 30 basis points to 18.9%. Reflecting on last year, I am very pleased not only with our financial performance but also our success in expanding the scale and the scope of the company, further positioning us to accelerate long-term growth while making an even greater impact on global health. While Andy will discuss our fourth quarter financial results and 2018 guidance in more detail, I want to mention some of the progress we have made recently in improving the growth and competitive strength of our portfolio.

Starting first with Diagnostics. During 2017, we expanded the extent and reach of our capabilities to enable earlier treatments and better outcomes both in terms of number of disease states covered and geographies served. The sale of our Medical Imaging business and the acquisition of EUROIMMUN have increased our reagent mix, expanded our technical capabilities and positioned us in more attractive markets. We couldn't be more enthusiastic about our combined future with EUROIMMUN, which adds autoimmune and allergy testing to our portfolio as well as additional infectious disease testing capabilities. The company has extensive expertise and skill across immunology, cell biology, histology, biochemistry and molecular biology and is a terrific strategic fit for PerkinElmer, bringing synergistic end markets in core technologies and commercial capabilities. This combination enables expansion into nearby adjacencies within several of our markets while increasing PerkinElmer's ability to continue to enhance our already extensive menu and develop more complete solutions for our customers.

EUROIMMUN's technologies and platforms will fill gaps in our existing product lines, broaden our offerings and drive synergies and also expand PerkinElmer's geographic reach. The addition of EUROIMMUN and tools diagnostics in the last year has increased our headcount in diagnostics by more than 3,000 employees, significantly bolstering our R&D, sales and clinical capabilities. More specifically, our presence in the emerging markets of China and India has more than doubled.

Projected population growth rates currently estimate that over 40% of the world population will soon be in China and India. However, out of the $65 billion global market for diagnostic testing today, China and India collectively represent less than 10%. We therefore believe we have a significant opportunity as these countries invest in the necessary infrastructure to support their growing, aging and increasing health populations as our Chinese and Indian diagnostics capabilities provide terrific assets to leverage and benefit from this important trend.

In reproductive health, during 2017, we increased our screening menu; launched the QSight, our triple quad mass spec instrument; expanded into newborn confirmatory testing through the establishment of our genetic testing business; and we will soon be entering the non-invasive prenatal screening market with our Vanadis offering.

With Vanadis, PerkinElmer uses proprietary molecular technology that eliminates the need for expensive sequencing and PCR and instead relies on high-precision digital quantification. The Vanadis solution is cost effective and simple to use and delivers high sensitivity, resulting in a solution that we believe will make NIPT available to all women and, ultimately, a standard of care. During 2017, Vanadis product development progressed as planned and research units were placed with external institutions to support regulatory submissions. We continue to expect the system will be ready for commercialization in the second quarter of this year.

In the area of genomics, we launched our whole genome sequencing service business, focused on inherited and rare diseases, which will include a unique comprehensive end-to-end solution offering comprised of sample collection, assay development, biochemical and sequencing testing services. Additionally, a laboratory in-house suite of products, giving us a competitive advantage. As the first lab to launch whole genome sequencing with a complementary biochemical test, we expect collaborations both on the newborn screening side and within rare disease testing to ramp up quickly.

Turning to our DAS business. 2017 was focused on finalizing the organizational changes associated with the combination of our environmental and life science businesses and harmonizing operating and governance practices across all functions and new geographies. In addition, as part of a strategic review of the DAS portfolio of businesses, we identified 4 key areas of focus, these being: food analysis; life sciences imaging to facilitate the discovery and development of more effective therapeutics; addressing environmental issues; and improving productivity in our customers' labs through the deployment of our enterprise service and software.

In addition to being strategically placed in these areas or well strategically placed and having differentiated capabilities, these market opportunities should provide strong growth as they are fueled by overarching macro trends. With regard to food analysis, over the last couple of years, we have built strong capabilities around the 3 key tenets of food analysis which are chemical and biological aspects of safety as well as food quality.

During 2017, we continued to add capabilities by acquiring a small food company and introduced our previously mentioned QSight triple quad mass spec, which targets the identification of pesticides. These added capabilities further strengthen our offerings to large food testing laboratories which require diverse method analysis.

In the area of service, the pharmaceutical industry is currently spending well in excess of $100 billion a year on R&D. Developing drugs and introducing new medicines is becoming even more difficult as the industry continues to undergo changes in technology and competitive pressures mount. As the pace of life science research accelerates, laboratories face heavy demands to produce timely, accurate results with efficiency and cost savings. The solution is the digital transformation of the lab, which has been shown to enable 20% savings in R&D costs.

During 2017, we continued to build out our capabilities in service and software as our customers in the pharma and biotech markets continued to seek service and software platforms to improve the efficiencies of their scientific workflows while supporting a flexible and secure collaboration environment. We also continue to win large enterprise programs as we are uniquely positioned to address their needs due to the strength of our service capabilities as well as our informatics and data analysis competencies. By utilizing our informatics capability to more closely integrate workflow solutions and high-value scientific applications, we can increase the overall productivity of not only our instruments, but also of scientists and entire laboratories. And as we control more of the workflow of the lab, we can better tailor our instruments to optimize how their functionality works within each customer's lab.

Finally, in the environmental analysis area, by refreshing our inorganic product offerings last year, we expanded the breadth and performance of our detection capabilities. And when combined with our extensive application knowledge, we are now in an excellent position to benefit from the increasing investment required to help ensure the global safety of drinking water. Particularly important in emerging markets is cost and functionality, and our new NexION 1000 is a good example of a product designed specifically for these markets. Another important component of our strategy is to introduce innovative new products into the market, further helping our customers solve some of their most difficult problems.

In that regard, I was pleased with our progress in 2017 as we delivered $66 million of incremental revenue from new products, exceeding our goal of $50 million and creating strong momentum heading into this year. Furthermore, with the addition of EUROIMMUN, the total amount we'll be spending in R&D will increase 30% in 2018 over 2017 and will represent 8.7% of our product revenue. I am optimistic that in addition to providing the enhanced scientific and technical skills I mentioned previously, the EUROIMMUN culture of introducing successful innovation rapidly into the market will help improve our processes and capabilities in this important area.

While we focus on accelerating the top line, we are also continuously improving operational execution, as it not only underpins our ability to gain share and win new business, but also contributes to profitability. Last year, for example, we adopted Lean methods across more of our operations and geographically aligned several sites with the locations of our customers. Through initiatives like these, we can continue to strengthen our operational foundation which will benefit our margins over the next several years. We expect over the next 3 years we will see significant gross margin expansion and remain on track to achieve operating margins of 22% by the year 2020.

So let me wrap up 2017 by summarizing it as the year in which we elevated PerkinElmer's technological, operational and organizational capabilities. We have entered 2018 with an improved portfolio, wider reach and even more capable organization. And combined with the macroeconomic environment that is quite favorable across both geographic and commercial end markets, we are confident in forecasting an acceleration of both our top and bottom line growth rates for 2018.

Looking ahead to our financial guidance for 2018, we are forecasting reported revenue growth of approximately 20% to a range of $2.72 billion to $2.74 billion. This is comprised of our base business growing organically at 4% to 5% and EUROIMMUN revenue of approximately $360 million, representing growth of 13% to 15%, which should add approximately an additional 100 basis points to PerkinElmer's organic growth. We anticipate expanding operating margins by 70 to 90 basis points this year, which would produce adjusted earnings per share of approximately $3.50, representing a 21% increase over 2017.

I would now like to turn the call over to Andy.

[Frank Wilson, executive]

Thanks, Rob, and good afternoon, everyone. Consistent with previous quarters, I'll provide some additional color on our end markets, a financial summary of our fourth quarter 2017 results as well as details around our guidance for the first quarter and full year of 2018.

To start off, we were pleased with the strong finish to 2017 as adjusted revenues grew 13% to $642 million. Foreign exchange represented a tailwind of approximately 300 basis points, with acquisitions adding approximately 400 basis points, resulting in organic growth of 6%, which excludes any impact of organic growth from the EUROIMMUN stub period.

By business segment. Diagnostics represented approximately 30% of total revenues with organic growth, excluding EUROIMMUN, of approximately 6% for the fourth quarter, driven by solid demand for our reproductive health and applied genomics offerings. Discovery & Analytical Solutions represented 70% of total sales and grew approximately 6.5% organically in the fourth quarter, highlighted by a year of successful new product introductions and an improving macro environment. I'll provide some additional color on both businesses in a moment.

We experienced healthy growth across all major geographies with low teens organic revenue growth in Europe, high single-digit organic revenue growth in Asia and low single-digit organic revenue growth in the Americas. In the BRIC regions, we continued to experience strong and broad-based organic revenue growth, driven by solid recovery in Brazil and continued double-digit organic revenue growth in China.

Looking at our operating results for the period. The fourth quarter was particularly complex given the impact of tax reform, the upcoming change in accounting for pension income as well as the consolidation of the EUROIMMUN financials, among others. I'll attempt to clarify the impact of these changes in my prepared remarks, but should you have additional questions, Tom and I will be available after today to provide any further details you might need. In addition, there are reconciliation schedules on our website that may be helpful in that regard.

As Rob discussed earlier, fourth quarter adjusted operating margins were 21.4%, driven by continued leverage from G&A, but were partially offset by incremental expenses related to the EUROIMMUN transaction. Excluding this charge, operating margins would have expanded by approximately 70 basis points. Adjusted basic earnings per share for the fourth quarter of 2017 was $0.97, while adjusted earnings per share using fully diluted shares outstanding was $0.96. As a reminder, the GAAP loss created by the Tax Cuts and Jobs Act, which resulted in the charge of approximately $106 million in the fourth quarter, require the use of basic share count in the adjusted earnings per share calculation. Fourth quarter 2017 adjusted earnings per share increased approximately 17% in spite of a 15% increase in R&D investments in the quarter, which we believe will support an acceleration of new product introductions in 2018 and beyond.

Looking further on the key drivers within our business segments for the fourth quarter, let's start with diagnostics. Revenue results were in line with our expectations, driven by strength in our reproductive health franchise, specifically newborn and prenatal screening, principally in Europe and Asia. Tulip, our Indian diagnostics business, had a very successful year under PerkinElmer ownership with revenue growth in the fourth quarter of 2017 growing double digits driven by rapid test for communicable diseases and profitability exceeding both our forecast and the deal model. We continue to be encouraged by the opportunities within the Indian in-vitro diagnostics market, and we believe we are well positioned to further penetrate the region with our Made in India, For India strategy, collaborating with EUROIMMUN in 2018 and beyond.

As Rob mentioned, we have ramped R&D spending in 2016 and 2017 in the diagnostics business to bring Vanadis Smart NIPT and our triple quad mass spec instrument to the market. We successfully launched this new mass spec at the recent Association for Public Health Labs (sic) [ Association of Public Health Labs ] conference and we now look forward to the Vanadis commercial launch in 2018. We are pleased to report that this novel screening tool for newborns has been well received, as evidenced by a number of early adopters. In addition, Vanadis baby units have been installed at early launch sites with training, clinical sample validation and data collection for CE mark submission activities remaining on track. As you may recall, we closed our EUROIMMUN transaction on December 19, which resulted in the recognition of approximately $13 million of revenues for the stub period, driven by robust demand in Asia.

Switching to our Discovery & Analytical Solutions business. Fourth quarter results exceeded expectations, driven by very strong demand for our environmental and food offerings as well as stronger-than-forecasted pharma/biotech products and services. Industrial organic revenues grew low single digit, and academic end market revenues declined low single-digits, primarily on a tough comparison in the prior period, but both are expected to improve with our new imaging product introductions slated for the first half of 2018.

Looking at key drivers of growth. Our new ICP-OES and our ICP-MS instrumentation targeting food and environmental applications, high content screening, cellular analysis and our OneSource services franchise focused on pharma/biotech were the primary contributors to our performance in the quarter.

Switching to below the line items. Adjusted net interest and other expense for the fourth quarter was approximately $10 million, and our full year adjusted tax rate was approximately 17%, slightly below our January guidance.

Turning to the balance sheet. As announced, we closed the EUROIMMUN transaction late in the fourth quarter and finished the year with approximately $2 billion of debt and $202 million of cash. On a reported basis, we exited the quarter with a net debt-to-adjusted EBITDA ratio of approximately 3.7x.

Turning to our cash flow performance. Full year operating cash flow from continuing operations was approximately $292 million, which included $17 million of EUROIMMUN deal-related costs and prepaid royalties. Working capital needs were higher than initially forecasted, but as we look ahead, we continue to believe that we will efficiently manage our working capital requirements and drive strong operating capital cash flow in 2018.

To wrap up 2017, we're pleased with our performance, as evidenced by the successful launch of a number of new products during the year, resulting in solid organic revenue growth, good traction on our Lean initiatives and a successful year of M&A, including the divestiture of the Medical Imaging business and the closing of the EUROIMMUN transaction, all of this leading to adjusted earnings per share growth from continuing operations of approximately 12%.

Looking ahead to 2018, we believe that we are better positioned to deliver on our corporate mission while accelerating organic revenue growth and providing strong financial results for our shareholders. For the full year 2018, we expect reported revenue to be in the range of $2.72 billion to $2.74 billion, representing 5% to 6% organic revenue growth on a pro forma basis, which includes approximately $25 million in foreign exchange tailwinds and approximately $360 million reported revenue from EUROIMMUN. Organic growth for the base business is expected to be 4% to 5%, and as Rob mentioned, the impact of EUROIMMUN adding just north of 100 basis points.

Our organic revenue growth guidance assumes 9% organic revenue growth in diagnostics and 4% revenue growth in DAS, driven by stable pharma/biotech, improved academic and industrial, with food and environmental end market accelerating on strong 2017 comparison. Geographically, we expect mid-single-digit organic revenue growth in the Americas and Europe, with high -- mid- to high single-digit organic revenue growth in Asia.

Full year adjusted earnings per share is expected to be $3.50, which represents approximately 21% adjusted earnings per share growth and includes approximately $0.28 to $0.30 in accretion from EUROIMMUN, which is consistent with our initial expectations. Implicit in this guidance range is adjusted gross margin expansion of approximately 150 basis points, an increase in G&A of approximately 30 basis points, and an increase in R&D of approximately 40 basis points. Note that a driver of higher gross margin and operating expenses are the result of the initiation of EUROIMMUN. As a result, our guidance assumes adjusted operating margin expansion of approximately 70 to 90 basis points. Our full year guidance assumes net interest expense and other of approximately $60 million, which incorporates the financing costs related to the EUROIMMUN transaction of approximately $25 million. The EUROIMMUN financing assumptions are currently comprised of approximately $820 million of borrowing from our bank revolver.

Weighted average share count is expected to be approximately 111 million shares. And in terms of our tax rate, we are forecasting our full year effective tax rate to be approximately 18.5%. Our current assumptions of the Tax Cuts and Jobs Act all-in will modestly increase our effective U.S. tax rate by approximately 50 basis points, and we expect our overall effective rate to be further impacted by the mix of profits and higher tax jurisdictions, principally driven by the addition of EUROIMMUN.

For the first quarter of 2018, we're forecasting reported revenues to be approximately $615 million, which represents mid-single-digit organic revenue growth. Note that EUROIMMUN's first quarter is seasonally the lowest quarter of the year for both revenue and profit. So in terms of adjusted earnings per share guidance, we will see no impact from EUROIMMUN in the first quarter due to this seasonality as well as the impact of incremental interest expense related to the deal. As a result, we're forecasting adjusted earnings per share for the first quarter to be in the range of $0.59 to $0.61.

This concludes my prepared remarks. Chelsea, at this time, we would like to open up the call to questions.

[Operator]

[Operator Instructions] And our first question comes from the line of Dan Arias with Citigroup.

[Daniel Arias, analyst]

Rob, nice step up for DAS this quarter. How should we think about 2018 growth in that segment in the context of just the 4Q number, but also some of the organizational disruptions that seem like they're behind you at this point? Do you feel like DAS can be above 4% this year just given the upward trend and the state of the end markets?

[Robert Friel, executive]

Yes, we're forecasting 4%, as I sort of mentioned previously, or Andy mentioned too. Is there a possibility we can do better than that? I think so. We're seeing good trends in pharma, as you pointed out. We continue to get good traction in our service business, and food was very strong for us. So I think the key for fourth quarter and will be for 2018, the businesses that have been sort of our growth business that we focused on have continued to do well and are growing sort of high single, low double. The challenge in the first couple of quarters of the year was that the core -- our core businesses were sort of flat to up low single digits. What we saw on the fourth quarter was that the core businesses actually recovered in sort of mid-single digits. If we can continue to see that in 2018 time frame, I think DAS will do better than 4%.

[Daniel Arias, analyst]

Okay. And then maybe on EUROIMMUN, what was the revenue growth there for the quarter? And then on the margin, you guys have talked about the ability to get that business to the DX average. So I guess, how long before you think that business starts to give some loft to the overall corporate margin? I mean, I guess, what are the investment needs that you see at this point? And then when should we look for profitability there to start contributing?

[Robert Friel, executive]

So EUROIMMUN continued to see strong growth in the fourth quarter as it did the entire year of 2017, as we sort of commented before. They continue to grow at sort of the high teens growth rate, and it's fairly broad based among the 3 businesses. So whether it's autoimmune, allergy, infectious disease, they're all seeing -- they all experienced good growth. So we're excited to see that. With regard to the operating margins of EUROIMMUN, I think our approach right now is as we continue to see the volume ramp, we expect the margins to go up there. But for the immediate time frame, or at least for the short term, I think we'll see that ramp maybe 100 basis points a year or something like that. So I don't know that we've got huge expectations, at least, for the next couple of years to see significant ramping up of the EUROIMMUN margins.

[Operator]

And our next question comes from the line of Steve Beuchaw with Morgan Stanley.

[Steve Beuchaw, analyst]

Rob, exiting the year, you're understandably really happy with some of the changes that you've made in terms of business divestitures and additions. I'm wondering if you could give us an update for your thinking on any future changes to the business mix. At times, it seems like we've picked up a sense that you were looking to make further changes, maybe not as big as imaging or EUROIMMUN. How's the thinking there evolving?

[Robert Friel, executive]

I would say, first of all, when we look at diagnostics, the focus there has been sort of expanding our impact there. So I think I wouldn't expect to see much on a divestiture side there on the diagnostics business. We just look continue to sort of add our ability to impact by geographic region and disease state, and I alluded to that in my comment. I think the DAS business again, the majority of our focus is on how do we invest more in the growth areas because I think that's really how ultimately we make that a better business. Having said that, during the year, could we see some product lines being shed? I think we could. But I wouldn't say they're significant dollar amounts. But again, I would say the majority of the focus on DAS is how do we make that business execute better. And then the second thing is focus on the areas where we have the most significant growth opportunity. But you should -- you could see some, but I wouldn't say it's a significant number.

[Steve Beuchaw, analyst]

Okay, I appreciate that. And then just a couple of follow-ups for clarification. One, Andy, on gross margins, any timing items in the COGS line in the quarter that we should think about that might have impacted the progression there? And then Rob, on EUROIMMUN, really strong year for EUROIMMUN in 2017 relative to the guidance for EUROIMMUN growth in 2018. I wonder if you could just give us a sense for what takes the growth from the '17 rate to the '18 rate? And then I'll drop.

[Robert Friel, executive]

I'll answer that, and then Andy can handle the gross margin one. I think it's -- we think it's prudent given the amount of potential disruption of a business that has been privately run for over 30 years that -- and we talked about before, our goal was going to be to do as little disruption as possible. We just think, at this point, as we sort of better understand the business, that to take it down from, call it, 18% to something in the sort of 13% to 15% is prudent. Having said that, I don't know that there's anything either market or competitive-wise that would suggest we're necessarily going to see a deceleration in growth. But we just think for purposes of forecasting '18, that we should lower the growth rate by a couple hundred basis points, again, just to be prudent.

[Frank Wilson, executive]

And Steve, to answer your question on gross margin, there wasn't really anything similar in the period. What we have seen throughout 2017 was a bit of a mix shift into services, which obviously has a dampening effect on gross margins. And in the mix, we saw strong growth within DAS, which has lower margins than diagnostics. And that also contributed to the margin performance. Although, as I mentioned in my prepared remarks, we think that as we move into 2018, we should be able to expand those gross margins at least 150 basis points. So I think we feel like we're very well situated going into 2018.

[Operator]

And our next question comes from the line of Tycho Peterson with JPMorgan.

[Tycho Peterson, analyst]

Just wondering, on the channel side if you can talk a little bit about the U.S. commercial side for EUROIMMUN, where you are in that build out.

[Robert Friel, executive]

So we've been working with them. We actually had a meeting earlier this week between the U.S. sales force and EUROIMMUN and the PerkinElmer sales force. I think we've got a very good plan mapped out from the standpoint of educating both sales forces on each other's products. I think we've got a good plan with regard to the specific customers that we'll target. We've actually got incentive plans in place for each company to sort of provide leads on -- for each other's products. And we start to put in the regulatory resources required to accelerate -- hopefully accelerate EUROIMMUN's regulatory approval of some of their products. So I think we've got a very good path to hopefully accelerate the growth rate of EUROIMMUN in the U.S. over the next couple months or quarters.

[Tycho Peterson, analyst]

And then, I guess, if we think about the longer-term guidance you gave back at the conference in January or updated, to get diagnostics into the double-digit territory, are there kind of leverage you can point to? I mean, obviously, you're getting to 9% here in the near term, so not that far off, but...

[Robert Friel, executive]

Well, I think if we get EUROIMMUN, like -- as we talked about the previous discussion is, we've got that it's sort of 13% to 15% this year. That continues to get up in the high teens, that would do that. As we start to get some of the traction with Vanadis, particularly as we get into '19 and '20. We've seen initial good response on the genetic testing business. And of course, what we're finding is increasing synergies between EUROIMMUN and Tulip as we look to penetrate some of the emerging areas. I think there's a number of levers that we feel like we should be able to get up into the double digits on the diagnostics business.

[Operator]

And our next question comes from the line of Patrick Donnelly with Goldman Sachs.

[Patrick Donnelly, analyst]

I appreciate the color on Vanadis and the launch timing there in 2Q. Just curious, I know you guys always kind of include a new product bucket in terms of revenue for the year ahead. What kind of revenue expectations are baked in for Vanadis, specifically for 2018?

[Robert Friel, executive]

It's fairly low, I would say, because of the timing of the tenders. Our expectations for Vanadis for 2018, at least in our plan, is less than $10 million.

[Patrick Donnelly, analyst]

Okay, that's helpful. And then on the genetic testing business, I know it's early days there, but can you maybe just give us an update on expectations on revenue opportunity there? And then also, I know you talked about partnerships in newborn screening and rare disease testing. How should we expect those to be restructured and the news flow on that as well?

[Robert Friel, executive]

So I think in genetic testing, we'll sort of see to that ramp probably again $5 million to $10 million business in 2018. And then by 2020, we've been saying that we think we can get that up to close to a $50 million business, particularly as we start to branch that out globally. Up to this point, it's largely been a U.S. business, but our intentions are to move this out into India and China and some other areas as well. So call it maybe $10 million next year but $50 million by 2020.

[Operator]

And our next question comes from the line of Ross Muken with Evercore ISI.

[Ross Muken, analyst]

So maybe can we talk China for a moment? Obviously, an increasingly important part of your business. So help us understand how you're thinking both on the industrial and environmental side, the cadence and the comps through next year? You continue to show strong double-digit growth there. And then as you've gotten now to better understand sort of the diagnostic market, how well that kind of business correlates overall with the economy versus just the secular trend there in terms of some of the places where EUROIMMUN obviously has great strength.

[Robert Friel, executive]

So first of all, China continued to be strong for us in the fourth quarter. I think it was sort of mid-teens, give or take. And I think as we think about going into 2018 right now, I would say we're forecasting in the high single, low double digit. And again, in the context of being a little prudent here, particularly on the EUROIMMUN side. EUROIMMUN has continued to see very strong growth in China. I would say when you look at our businesses, the diagnostics business has also done well, particularly on the newborn and prenatal side. The one area where we've seen a little bit of a challenge has been in some of the tenders, the local content is becoming increasingly more important. And in fact, there were some tenders on the newborn side where we haven't been able to bid on. And so probably it's been 18 months now we've been aggressively moving our manufacturing of some of our assays, some of our instruments into China on the diagnostics side. And of course, some of that requires regulatory approval. So I would say I continue to be fairly bullish on the diagnostics side within China. But we've got to be able to make sure that our businesses, and this is mostly on the reproductive health side, are able to meet the local content requirement. When I go to the sort of non-diagnostics, the DAS side, I think we continue to be enthused with the opportunities there, whether it's the environmental, whether it's the pharmaceutical side. And I think we've seen some recovery on the industrial markets as you alluded to. So and I think some of the benefits we're seeing is that we're trying to increasingly make sure that our products are designed and manufactured for those markets specifically. So whether it's the functionality or whether it's the cost position, and I think we're seeing good traction there.

[Ross Muken, analyst]

That's helpful. And maybe Andy, just 2 clarifications. So one, on the diagnostic core growth for next year, 9%, I just want to understand the component of that coming from EUROIMMUN. It seems like, I guess, you're counting the incremental core growth in that business in that calc. Just want to be sure of that. And then secondarily, in terms of the Q1 seasonality, it implies pretty good revenue shift from what you would think the normal quarterly cadence is. So is it to assume that, that sort of balanced back to the fourth quarter? Or how exactly is that sort of seasonality, I guess, going to play out?

[Frank Wilson, executive]

The anomaly -- I'll answer the second question first, and then I'll answer your first question second. The anomaly is really just the first quarter. So you'll see -- and we've talked about the growth for the year, and the first quarter, as we said, is seasonally low. Qs 2, 3 and 4 are fairly consistent, with the fourth quarter being slightly higher than the second and third. So that's the way it's at least been historically and that's the way we're planning for it in 2018. The split within the 9% is about 2.5 percentage points related to EUROIMMUN, and then the core business is growing at about 6.5%.

[Robert Friel, executive]

Yes, so Ross, maybe said a little differently, the way to think, the growth rate by quarter doesn't necessarily vary much. So our assumption is the 13% to 15% is fairly consistent through the 4 quarters. The difference is the absolute number historically is low in the first quarter.

[Operator]

And our next question comes from the line of Steve Willoughby with Cleveland Research.

[Steve Willoughby, analyst]

One, just on new products. Rob, I think, you said new products contributed 56 -- or sorry, $66 million this year. I believe the last quarter you said it was $56 million, implying only about $10 million in revenue from new products here in the fourth quarter. Just wondering if there's anything to that. And then just, Andy, on the incentive comp charge, with the headwind to your margins, since it was related to an acquisition, why wasn't that called out as a onetime item here?

[Robert Friel, executive]

So I'll take the first one. So yes, $66 million is the total for the year, and we were -- I think, through the first 3 quarters, you're right, we were sort of tracking to the low 50s. It just was a mix of revenue that we saw in the fourth quarter. It was less attributable to the new products. And then I would say going into '18, although you didn't ask, we think $50 million is probably a good number as well. Now that would exclude EUROIMMUN. I would say at this point, I don't know that we've got good visibility in the split in the revenue growth between new products and sort of existing products. But we think we can do at least another $50 million next year as well.

[Frank Wilson, executive]

And then as far as your question related to the compensation, we typically do not break out compensation. This is a part of our longer-term compensation plan which you can find in our proxy. So it's something that's been around, and we felt like that it was really a part of the operating results and really didn't need to be broken out and put it in a box.

[Operator]

And our next question comes from the line of Doug Schenkel with Cowen.

[Doug Schenkel, analyst]

My first question is on capital deployment. Now that you've closed EUROIMMUN, can you give us an update on your capital deployment plans, I guess, near term and long term? Specifically, I'm curious about your ability to go out there and do more M&A. I'm curious about how you're thinking about potentially changing your thoughts on share repurchases. And I'm also curious about whether you have the portfolio you need to have in place as we sit here today to achieve high single-digit organic revenue growth in 2020, consistent with the recent comments you've made, Rob.

[Robert Friel, executive]

So I would say, first of all, I don't know that the strategy behind our capital deployment has changed because of the EUROIMMUN acquisition. I think the preference was still the first acquisition, the bolt-on acquisitions, in particular, that sort of add capabilities, either technological or others. Then probably the second area would be share repurchase. And then probably third would be to continue to sort of reduce our debt to a level below, let's say, 2x EBITDA. If you look at the leverage we took on relative to the EUROIMMUN acquisition, we believe with the combination of EBITDA growth and the cash we generate, that we could delever relatively quickly. So the answer to your question relative to acquisitions, we continue to have a fairly robust pipeline. We continue to sort of look at a lot of potential opportunities to buy things. I would say the only differences is probably in the short term, I would say, doing a large deal that I would say sort of north of $1 billion is unlikely. Not impossible, but unlikely. But I think we feel we can continue to do $100 million, $200 million, $300 million deals given the cash flow we generate. And like I said, we believe we have the ability to delever relatively quickly. With regard to the second part of the question is, do we have the portfolio currently to get to high single digits for PerkinElmer? I think so. As we continue to migrate the portfolio organically. And I think as you look out a couple of years, diagnostics will be a bigger component. I think the service component of DAS will be bigger. I think the food component of DAS will be bigger. And as I mentioned before, maybe we'll get out of a couple of product lines. But if we could add, let's say, a couple of hundred million dollars of incremental profits in high-growth areas, I think that will be helpful. But I don't feel like we need to do a major transformational deal between now and 2020 to get to high single digits. As we've spiked that in the past, we talk about 50% of our businesses historically have been growing close to 10%. So the idea is continue to invest in those areas, make them bigger, and we can get to high single-digit growth organically.

[Doug Schenkel, analyst]

Okay. And one other thing I wanted to cover was just FX, foreign exchange, in the context of guidance. I guess, Andy, what rates are you using in your -- for FX in your guidance calculations? And then more specifically, to EUROIMMUN, I believe EUROIMMUN has a pretty significant cost base in euros. How are you accounting for the weakening dollar in the context of guidance?

[Frank Wilson, executive]

Where we -- this has been our consistent approach for as long as I've been here, but we use the ending rate from the previous quarter. And so going into this year, we used a $1.18 rate, which obviously, the euro has strengthened dramatically. We'll obviously provide an update each quarter as we true that up. But we typically use that rate at the end of the previous quarter to establish our guidance for the next quarter.

[Operator]

And our next question comes from the line of Jack Meehan with Barclays.

[Jack Meehan, analyst]

I was hoping you could provide a little -- could you provide a little greater granularity just on the performance within DAS? I caught low singles in industrial and a decline client academic, but how did OneSource and the other end markets do within there?

[Robert Friel, executive]

And is that with regard to Q4?

[Jack Meehan, analyst]

Correct. Yes.

[Robert Friel, executive]

Yes, okay. So if you look at pharma and the biotech areas, that was sort of a low double, actually, for us. So it was a nice step up. We were very pleased to see that. Food was high single. Environmental was actually sort of low double digits as well. Industrial was up high single. And the only one we saw a little bit of decline on was academic and government, which again, isn't a big business for us, was down low single digits.

[Frank Wilson, executive]

And Jack, on pharma and bio, the nice thing we saw here, it's typically been driven a lot by service, but we did see some pick up in product in the fourth quarter, which was encouraging.

[Robert Friel, executive]

Yes. It was more evenly balanced between product and service than historically we've seen.

[Jack Meehan, analyst]

Great. And maybe just on industrial itself, we continue to see a really rosy macroeconomic picture. I'm curious what you're seeing and what the outlook for 2018 is there, too.

[Robert Friel, executive]

Yes, I would say, for us, when we look at the fourth quarter on our industrial side, we saw pretty good growth in the Americas and Europe. APAC was a little challenged. But I think, to a large extent, that was a difficult comparison year-over-year. So I think we support the view that the industrial market continue to be constructive. And I think as we project it into 2018, that's the view that we continue to believe is the appropriate one.

[Operator]

And our next question comes from the line of Paul Knight with Janney Montgomery Scott.

[Paul Knight, analyst]

Rob, could you frame up the size of China, specifically, percent of revenue? And then my read is that this is a pretty big platform. Do you think you can get half of your incremental growth out of that market? Could you kind of frame up your thoughts on the platform and the opportunities you have there?

[Robert Friel, executive]

So China, actually, with EUROIMMUN right now, will take us through to over $600 million in revenue for PerkinElmer. So against a 2018 forecast of $2.7 billion, it's almost between 20% and 25% of our revenue. So it's increasingly becoming a more important part of it. To some extent, as I alluded to on the diagnostics discussion earlier, I mean, that was sort of part of our strategy. When you look at 40% of the population between China and India and 10% of the diagnostics spending, we do think that's an area where you're going to see disproportionate spending, so we sort of like that aspect of it. Clearly, when you look at sort of environmental and food, even on the pharmaceutical side, I think those are other areas that have been identified as key areas of investment by the government. So we continue to feel very good. We continue to invest there, whether it's in people, whether it's in manufacturing capability, whether it's increasing our R&D. But -- so we continue to be fairly bullish on the Chinese area now. I sort of alluded to before that probably relative to the growth we've seen historically, that may come down a little bit. But I think to some extent, that we're just getting such a large business there that I think we're planning in the sort of low double-digit growth in China, but I think that's the realistic and prudent approach.

[Paul Knight, analyst]

And then lastly, Rob, on DAS, what do you want to do by 2020? Where do you want to go today on reagents and service in the future? What are your thoughts on -- can you -- will you do something to move the cyclicality down a bit in DAS?

[Robert Friel, executive]

Yes, absolutely. I mean, I think that's an important part of the strategy in DAS is to continue to expand our consumable portion of the business, and then also continuing to use service to hopefully pull through more product. But the other aspect of service is continue to expand the types of services we provide. And then we also believe, when we get to maybe the 2020 time frame, again as our customers look to change the way they deploy technology that we make it into a situation where increasing more and more customers are looking to technology partners to provide measurements and outcomes as compared to product. And I think we'll be in a very good position to do that. But the answer to your question is yes, absolutely. We want to try and improve the service software and consumable portion of the business that not only reduces or dampens down the cyclicality, as you point out, but also should translate into higher margins.

[Operator]

And our next question comes from the line of Derik De Bruin with Bank of America.

[Derik De Bruin, analyst]

So 2 questions. One is a tax question. So you've had some pretty good benefit from the stock-based comp changes this year. I guess, could you talk about what was the fourth quarter benefit and sort of like the headwind that creates for 2018? I'm also just curious on your comments on tax reforming up. I thought you would've been flattish. It sounds like it's going up a little bit. Could you sort of walk through the moving parts on that one? And then the follow-up's going to be, could you talk about any real budget flush in the fourth quarter?

[Frank Wilson, executive]

All right, I'll start. We haven't seen a real significant impact on our tax rate from the comp piece. As we went into the year and started looking in 2018, we went through and determined that, as I mentioned on my -- in my prepared remarks, we think that the changes coming up next year will be a modest headwind, and the real impact to our tax rate from 2017 to 2018 will be the mix in domicile profits which is primarily due to EUROIMMUN. So we said 18.5%, and that's really -- what the majority of that is a slight headwind on the Tax Act and a bigger headwind on the domicile profits.

[Robert Friel, executive]

Derik, maybe to sort of help clarify that is we have, call it 35%, 40% of our revenue in the U.S. We have less than 15% of our profit in the U.S. And part of that was purposeful, right. So if you go back and think about 35% tax rate in the U.S. was -- has been sort of publicized quite often as one of the highest in the developed world is you purposefully want to put a lot of your expenses there. So we had, like I said, less than 15% of our income in the U.S., at least from a tax perspective. And so therefore, the rate-down from 35% to 21% did not have that significant of an impact. And then some of the other provisions that are in the tax law are sort of slightly offsetting the impact of the lower rate.

[Derik De Bruin, analyst]

Okay, that's really helpful. And budget flush?

[Robert Friel, executive]

I think when you look at pharma product, again, up high single digits. The sense was there probably was some. It's hard for us to tell right now. I would tell you that while we saw strong bookings in the end of the fourth quarter, they've continued, to some extent, in January. But it did appear, at least, when we look at the numbers, that clearly, we saw a ramp-up in orders and sales in the December time frame. So my sense is there was some budget flush.

[Operator]

And our next question comes from the line of Brandon Couillard with Jefferies.

[S. Brandon Couillard, analyst]

Just one cash flow question for you. In the fourth quarter, were there any one-timers related to the EUROIMMUN closing that depressed operating cash flow in the fourth quarter? And then what are you penciling in for free cash flow conversion in the...

[Frank Wilson, executive]

Yes, that's true. We had about $10 million of expenses related to the deal cost on the EUROIMMUN transaction, which hit -- all hit in the fourth quarter that were accrued and paid. In addition, as we go into -- I'm sorry, one other thing is we also have prepaid royalties that come up every so often, and there was about a $7 million prepaid royalty that we made in December as well. So both of those, obviously, had a dampening effect on the cash flow. As we go into 2018, we continue to try to target onetime adjusted net income for our free cash flow target. If you look at '17, we had a working capital use of about $20 million, and we hope to see that as a source going into next year. So we feel like we have a real opportunity on receivables and the inventory to drive that. And we're still kind of calculating what we think the impact of cash flow is at EUROIMMUN. But we still are going to shoot for that, between 95% and 100% of adjusted net income.

[Operator]

And our next question comes from the line of Bill Quirk with Piper Jaffray.

[William Quirk, analyst]

A couple of questions. Rob, first off, can you just remind us of the Vanadis menu? Will this cover anything beyond the 3 principal trisomies like microdeletions or anything like that?

[Robert Friel, executive]

So initially, we're going to come out particularly focused on, I would say, a limited menu from the standpoint of the trisomies and then the sex chromosomes. So 13, 18, 21 and X and Y. Now we do think down the road we might be able to sort of expand upon that, but initially, that's the focus.

[William Quirk, analyst]

Okay, got it. And then just a follow-up to that, are there any big clinical studies that we should be watching for over the course of '18? And then somewhat unrelated follow-up is just anything in China blood screening. We haven't heard anything about that in a little while.

[Robert Friel, executive]

So with regard to the studies that we want to be sort of focused on was there's a couple that are ongoing right now that are generating clinical data, and we would hope to see something like that maybe in the second quarter. With regard to blood screening, I think as we mentioned before, we had strong placement of instrument in the sort of -- or particularly in the first half of 2016 that was causing some difficult comps earlier in the year. We continue to see good growth from the reagent side of things. So it generates a fair amount of profitability, but you'll don't see the impact on the revenue until we sort of cycle through the instrument placements that occurred in '17 -- or in '16. So I think as we go into '18, we expect to see some better growth from the blood screening business.

[Operator]

And our next question comes from the line of Dan Leonard with Deutsche Bank.

[Daniel Leonard, analyst]

So just trying to better understand the operating margin expansion of 70 to 90 bps in the forecast for 2018. How much of that would be core operating margin expansion versus the lift you're going to get from the addition of EUROIMMUN as a higher-margin business?

[Frank Wilson, executive]

Well, on an operating margin basis, EUROIMMUN is similar to PerkinElmer, maybe slightly higher. But the vast majority of the margin expansion is coming from core PerkinElmer.

[Daniel Leonard, analyst]

And Andy, can you talk about how much of that margin expansion comes through mix within corporate PerkinElmer? Because you're expecting diagnostics, like core, to grow a lot faster than DAS. So how much of that would be mix versus self-help and Lean and some of the other things you're doing?

[Frank Wilson, executive]

Yes, I think it's probably half and half, Dan.

[Operator]

And our next question comes from the line of Catherine Schulte with Baird.

[Catherine Ramsey, analyst]

Now that we're about a quarter away from the Vanadis launch, can you just give any updates on pricing? And then do you guys have any visibility into the timing of any upcoming tenders over the course of the year?

[Robert Friel, executive]

So with regard to pricing, we will probably come out with the pricing when we release the product commercially, so after CE mark. And with regard to tender, yes, we have a very good sort of perspective on which tenders, which countries, when they come out, and we're focused on a couple more significant tenders that start sort of early second half. But yes, we have some fairly specific targets in mind. And so the hope would be, we'd get the CE mark out in sort of the latter half of Q2 and to be able to place. I think the goal is probably 8 to 10 instruments in the back half of the year. And we'll start to generate some reagents, but as I sort of alluded to before, I think the significant growth will probably be in the earlier part of '19.

[Catherine Ramsey, analyst]

Okay. And then just for your EPS guidance, I know you gave EUROIMMUN impact, but can you just give us a bridge versus 2017? So what's coming from the core business versus tax reform versus FX?

[Frank Wilson, executive]

Well, tax reform is actually going to be a bit of a headwind for us. And as I mentioned, EUROIMMUN has a higher tax rate as well, so that's a little bit of a headwind. We said the amount coming from EUROIMMUN is 28% to 30%. So core is really growing at about 11%, and then the addition of the EUROIMMUN acquisition makes up the rest, so.

[Operator]

And our next question comes from the line of Tim Evans with Wells Fargo Securities.

[Timothy Evans, analyst]

Would you be willing to tell us how big the entire service and software component of DAS was in dollar terms in 2017? And then about how fast that business grew?

[Robert Friel, executive]

So it's about $700 million. It's about 40% of our revenue. And the growth rate of that in total, I don't know if -- we don't necessarily cut it all together, but probably about 6 -- in the year or the quarter?

[Timothy Evans, analyst]

In the year, yes.

[Robert Friel, executive]

Yes. I would say -- I don't know the number off the top of my head. Probably mid-single, probably that type of rage, maybe 6, if I had to guess.

[Operator]

And I'm showing no further questions at this time. I would now like to turn the call back to Rob Friel for closing remarks.

[Robert Friel, executive]

Well, Chelsea, thank you, and thank all of you for your questions and interest in PerkinElmer. Looking ahead, I continue to be energized by our employees and the many opportunities we see to continue to drive our mission of innovating for a healthier world. I have no doubt this year we will once again successfully deliver on our commitments to our customers and shareholders. We feel very good about our plans moving ahead and look forward to updating you on our progress next quarter. Thanks, again, and have a terrific evening.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.