Danaher Corporation

Good morning. My name is Christy, and I will be your conference facilitator this morning. At this time, I would like to welcome everyone to Danaher Corporation's fourth quarter 2018 earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. I will now turn the call over to Mr. Matt Gugino, Vice President of Investor Relations. Mr. Gugino, you may begin your conference.

Thanks, Christy, and good morning, everyone, and thanks for joining us on the call. With us today are Tom Joyce, our President and Chief Executive Officer, Matt McGrew, our Executive Vice President and Chief Financial Officer, and Dan Comis, our Executive Vice President. 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 investor section of our website, www.danagher.com, under the heading Quarterly Earnings. The audio portion of this call will be archived on the investor section of our website later today under the heading Events and Presentations and will remain archived until our next quarterly call. A replay of this call will also be available until February 5, 2019. 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 in the fourth quarter of 2018, 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 or are only available in certain markets. 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 FCC 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 statement except as required by law. With that, I'd like to turn the call over to Tom.

Thank you, Matt, and good morning, everyone. Our fourth quarter results round out a tremendous 2018 for Danaher. During the year, strong revenue growth and operating margin expansion delivered double-digit adjusted EPS and mid-teens free cash flow growth. We delivered 6% core revenue growth for the full year, which was a meaningful step up versus prior years, led primarily by the impact of new product innovation and commercial initiatives. The Danaher business system continued to serve as the driving force behind our execution and our ability to take share in many of our businesses. We generated $3.4 billion of free cash flow in 2018, resulting in 16.5% growth year-on-year that helps position us for significant capital deployment going forward. Our free cash flow to net income conversion ratio was 127%. representing the 27th consecutive year in which our free cash flow has exceeded net income. We deployed over $2 billion of capital during the year, including the acquisitions of IDT and Blue Software. IDT joined our life science platform, adding best-in-class genomics consumables capabilities, and Blue Software, now part of ESCO, enhances our offering across the packaging development and production workflow. We're excited to have both these businesses as part of Danaher. Turning now to the fourth quarter. Sales grew 5.5% to $5.4 billion as the impact of foreign currency translation decreased revenue by 2% while acquisitions increased revenues by 2%. Core revenue increased 5.5% with all five platforms delivering better than expected results. Geographically, high-growth markets grew high single digits, led by double-digit growth in both China and India. Across the developed markets, we saw high single-digit growth in the U.S., while Western Europe was up low single digits. Gross margins for the fourth quarter. Gross margin was 55.1%, and operating profit margin was 17.9%. Core operating margin declined 15 basis points, driven primarily by accelerated investment spend, foreign currency impact from a stronger U.S. dollar, and tariff-related costs. Full-year gross margin was a record high, 55.8 percent, and we increased our core operating margin by 70 basis points. This marks the fourth consecutive year that we increased our core operating margin by 70 basis points or more. Fourth quarter adjusted diluted net EPS was $1.28, bringing full year adjusted diluted net EPS to $4.52, our fifth straight year of double digit growth. Now let's take a more detailed look at our fourth quarter results across the portfolio. In Life Sciences, Reported revenue increased 10.5% and core revenue was up 7.5%. Operating profit margin declined 30 basis points to 19.7% as a result of foreign currency impact and accelerated growth investments. For the full year, Life Sciences delivered an outstanding 180 basis points of core operating margin expansion, a testament to the team's strong DBS execution. Turning to the individual operating companies, Beckman Life Sciences achieved high single-digit core revenue growth for the quarter. More than 20% growth in automation was driven by demand for new products like the Biomech i-Series, Beckman's sample preparation platform launched last year. We further enhanced our automation capabilities with our recent bolt-on acquisition of LabSight Corporation. LabSight brings complementary technology to the core Beckman offering with an acoustic dispensing method that is used for liquid handling in life science applications. The non-contact, low-volume dispensing technique eliminates cross-contamination risks and greatly reduces fluid loss, helping scientists around the world achieve better results. These organic and inorganic growth investments are helping us provide best-in-class solutions for our customers, and contributing to Beckman Life Sciences' above-market growth rate. Leica Microsystems' core revenue was up mid-single digits, with positive performance across most major end markets and regions, led by life science research in North America. Over the last few years, the Leica team has significantly improved their cadence of innovation through the use of DBS tools, Leica introduced three times the number of new products and technologies in 2018 versus the prior year, while improving their project on-time delivery by more than 2,000 basis points. The combination of better R&D processes, along with enhanced commercial execution, has contributed to a meaningful step up in Leica's core revenue growth over the past few years. Core revenue at SIEX was up high single digits Strong results in North America and China were broad-based, driven by demand across the clinical, food testing, and forensic end markets. Phenomenex, our separations consumables business, achieved high single-digit core revenue growth. It's been two years since we acquired Phenomenex, and the team has made tremendous progress with a number of DBS commercial initiatives, including funnel management and transformative marketing. Through these and other DBS-driven growth initiatives, Phenomenex has increased the size of their addressable market by 30%. At Paul, high single-digit core revenue growth was driven by similar results across both our life sciences and industrial businesses. Biotech was up double digits, led by strong performance in single-use technologies, where demand for new products like the Icelis bioreactor system continues to help drive share gains. IDT delivered mid-teens revenue growth with positive performance across all major regions and product lines. The team continued to build upon early progress with DBS, and the business has consistently exceeded our initial performance expectations. Moving to diagnostics, reported revenue increased 3.5%, and core revenue was up 6%. For the full year, diagnostics delivered 6.5% core revenue growth, a meaningful step up versus prior years, driven by both organic growth investments and the continued evolution of our diagnostics portfolio. Reported operating margin declined by 70 basis points to 18.8% in the fourth quarter, However, core operating margin expanded by 20 basis points. At Beckman Diagnostics, core revenue increased at a mid-single-digit rate, led by China, and improved results in North America. By product line, immunoassay led the way, and we saw good growth in automation as well, driven by early success in Europe with our recently launched DXA5000 automation system. In hematology, We're encouraged by early customer feedback on our new DXH900 high-volume analyzer and the DXH520 for low to mid-volume settings. These are two of the many new products that Beckman introduced this year that expanded our offering and improved our competitive position in the core lab. At Radiometer, high single-digit core revenue growth was driven by a strong quarter in North America, Western Europe, and China. Our blood gas and AQT product lines delivered outstanding results, and we believe Radiometer continued to take share in the acute care market. Like a biosystems, core revenue was up mid-single digits, with broad-based strength across most major regions and product lines, led by double-digit growth in advanced staining. And at Cepheid, double-digit core revenue growth was driven by North America and Western Europe, The business achieved a significant milestone in the fourth quarter, placing its 20,000th instrument globally, further expanding Cepheid's market-leading install base. Continued innovation around our test menu has also been a meaningful contributor to Cepheid's outstanding results. The team maintained their cadence of innovation with the recent CE-IBD marking of the expert HBV viral load test, a new rapid test for the quantitation of the hepatitis B virus that delivers results in less than an hour. With the addition of this test, Cepheid now offers a complete virology test menu, suitable for any laboratory setting, making high-quality testing and disease monitoring accessible to even more clinicians and patients. Turning now to our dental segment, reported revenue was flat and operating profit margin increased by 70 basis points to 13.8%. Core operating margins declined by 185 basis points, primarily as a result of ongoing investment spend focused on new product development. Dental core revenue was up 2.5%, one of our better quarters in some time. We remain encouraged by signs of end market stabilizations, particularly in our North American traditional consumables and equipment business, where we saw another quarter of positive sellout data. Our dental business in China, now over $200 million in annual revenue, saw double-digit growth again this quarter. Our approach as a more localized player, offering a comprehensive product suite, positions us well for continued growth in the region. Our specialty consumables business, was up low single digits versus a tough prior year comparison with solid performance across orthodontics and implants. Growth was led by performance in high-growth markets with particular strength in China and Eastern Europe. At the Greater New York Dental Show in November, we featured a number of new technologies from across the dental platform. These included the DEXIS titanium interoral sensor, and Nobel's X-Guide for computer-guided dental implant surgery, both important products that support the team's focus on providing customers with a best-in-class, fully integrated digital workflow. In addition, Ormco's full-scale clear aligner system, SPARC, continues to be very well received in Australia. And as a reminder, the team obtained FDA 510K clearance for SPARC earlier in the fourth quarter. This is obviously an important step as we continue our expansion of our clear aligner offering. Moving to our environmental and applied solutions segment. Reported revenue was up 4.5% and core revenue increased 5%. Reported operating margin decreased 40 basis points to 22.7% with modest core margin expansions. In product identification, core revenue increased at a mid-single-digit rate, led by demand for marking and coding equipment and related consumables. VideoJet core revenue was up high single digits, with positive performance across all major regions and markets and product lines. The team continued to expand VideoJet's powerful install base, which now includes more than 10,000 remotely connected printers. Using data analytics, we're able to help customers run their packaging processes and plans more efficiently and with fewer instances of disruptive downtime. VideoJet's industry-leading connectivity provides unique insights to help us serve customers more effectively, and this differentiated offering is a key contributor to VideoJet's above-market growth race. 2018 marked VideoJet's ninth consecutive year of mid-single-digit or better core growth. Our packaging business, which includes ESCO and X-Rite, was down low single digits, but we're encouraged by recent order trends and feel well-positioned for improved performance in 2019. Finally, turning to water quality, core revenue growth for the platform was up mid-single digits. Core revenue increased at Hawk at a high single-digit rate, off momentum in both municipal and industrial end markets. Geographically, the developed markets and China led the way. For the full year 2018, Hawk achieved 10% core revenue growth. The Hawk team has consistently combined outstanding commercial execution with innovative new products to deliver this market-leading growth. HACC develops a best-in-class digital marketing platform that we've now rolled out across our other water quality businesses. And the team has meaningfully expanded HACC's addressable market with new products like the CM-130 Chlorine Analyzer for dialysis applications and the CLEROS water intelligence software system. The team's commitment to continuous improvement has helped HACC differentiate its customer value proposition and further strengthen its competitive advantage. At Trojan, core revenue declined due to a tough prior comparison, but we saw healthy levels of project bidding activity during the quarter and were encouraged by the underlying momentum in the market. Lastly, Chemtreat's high single-digit core revenue growth was driven by strength across North America and Latin America, primarily in the food, chemical, and oil and gas end markets. The team's commitment to commercial excellence has helped Chemtreat sustain a remarkable track record, with 2018 marking their 51st consecutive year of core revenue growth. So to wrap up, 2018 was a tremendous year for Danaher, and we're well positioned as we begin 2019. Over the past several years, through a combination of organic and inorganic growth initiatives, We have transformed Danaher into a higher growth, higher margin, and higher recurring revenue company with strong footholds in attractive, fast-growing end markets. Our portfolio today, combined with the power of the Danaher business system, positions us well as we focus on delivering long-term shareholder value in 2019 and beyond. We are initiating first-quarter adjusted diluted net EPS guidance between $1 and $1.03, which assumes core growth of approximately 4%. We continue to expect full-year 2019 core revenue growth of approximately 4% and adjusted diluted net EPS to be in the range of $4.75 to $4.85.

Thanks, Tom. That concludes our formal comments. Christy, we're now ready for questions. Christy, we're now ready for questions.

Thank you. The floor is now open for questions. If you would like to ask a question, please press star, then the number 1 on your telephone keypad. To withdraw your question, press the pound key. We do ask that you please limit yourself to one question and one follow-up. Your first question is from Tycho Peterson of JP Morgan.

Good morning, Tycho.

Good morning. Maybe we want to start on margins. Obviously, a lot of moving pieces here between FX, tariffs, M&A, and then some of the dental investments. I know it's going to be maybe more of a back-end loaded year for margin expansion this year. Can you maybe just talk about when some of these acquisitions may turn margin accretive? And then can you also comment on diagnostic margins look like they've contracted quite a bit? Can you maybe just touch on that as well?

Sure, Taika. Well, you know, obviously we did a few things here in the fourth quarter to take advantage of what we saw was a pretty strong quarter evolving, particularly in the latter month of December. And so we did accelerate some investment, some spend in a couple of areas that impacted both the cost of good sales line and NSG&A. We accelerated some investment in life science, in particular in life science, in R&D and sales and marketing, and and also did a few things accelerating some cost actions in diagnostics and made some investments in new products around dental. So I think a few things that really made some good sense there, and to your point, clearly FX and tariffs were headwinds in the quarter and made a difference. I think if you put those aside, overall margins would have been up roughly about 50 basis points were it not for the FX and tariff impact. We do see margins continue to improve during the course of the year. Obviously, we've got a terrific track record here. In terms of acquisition-related impact on the margins, IDT turns core here in April, so we'll start to see those start to move through. It'll take a little bit of a while here before we see the impact of LabSight, obviously our newer acquisition, but IDT obviously will be a much more material contribution. So, we'll see that starting in April, which will be a help. On the DX side, as I mentioned, we did accelerate some cost actions and some investment there. We've got a terrific lineup of new products that are coming through. And so, continuing to invest in our automation products, hematology, some new products that are coming a little bit out in the future around immunoassay and clinical chemistry will, I think, certainly also are having an impact there. But we think those investments, you know, make tremendous sense. Obviously, we had a bit of a comp there with Cepheid coming off of the fourth quarter in 2017, where Cepheid's top line was up I think, north of 25% a year ago and was up, you know, low double digits in the fourth quarter here. So, you know, a little bit less, a little bit of a tough comp there that had some impact on margin. But again, specific to DX, just coming back very briefly to FX and tariffs, if you put those aside, DX would have been up about 50 basis points in the quarter.

Yeah, Tycho, maybe just kind of more color. If you think about kind of the first half headwind that we've got in FX, we're going to kind of see the margin ramp throughout the year. Q1, we're going to have, of the $400 million of revenue headwind, $200 is going to be in Q1. That's probably going to be five or six cents of EPS hit in Q1. So if we wouldn't have had that in Q1, I think we probably would have seen more like double-digit EPS growth at the high end. And, you know, the FX impact here in the first half is going to be greater than it will be in the second half, you know, heading into 2019.

Okay, that's helpful. And then just one quick follow-up on dental. Obviously, you know, nice recovery there. How much of this do you think is kind of broader end market strength versus some of the, you know, Danaher specific factors like the Nobel China strength and anything we should be thinking about in terms of the clear aligner launch here in the U.S. in terms of revenue contributions for this year?

Sure. Well, clearly, we've seen some stabilization in the end market, as I commented in my remarks, and that really is coming in the form of improved sellout in North America, and specifically in the areas that were more challenged in the past several months and quarters, which was on the traditional equipment and consumables side. So, end market stabilization, definitely a contributor, but our execution continues to improve as well, and a number of the steps that we've taken have over the last several quarters has continued to enhance the way we're executing in that market. From a clear aligner perspective, again, things are going extremely well in Australia, but we're trying to take a very thoughtful approach to the way we expand our geographic footprint, making sure that we are cultivating the right customer targets, as we did in Australia, the digitally savvy end customer dentists and orthodontists who has historically taken advantage of our insignia product line as an example. And so as we think about geographic expansion, you know, we'll be thoughtful about where those markets are well set up from our standpoint for commercial execution. And obviously we're in the process of ramping our own capacity. And so that will be an impact as well. I would not expect that we would be talking to material contributions to the dental platform for growth rate this year, but perhaps as we go into next year, we'll start to be looking at some numbers that are starting to make a difference.

Okay. Thanks, and congrats on the question.

Thanks, Tycho.

Thank you. Your next question is from Ross Mukin of Evercore.

Good morning, Ross.

Good morning, guys. So it seemed like you had sort of better execution in Beckman this quarter. The business had been doing reasonably well, but relative to your peers, you're a little underweight in amino acid, but it seemed like that had quite a good quarter. Just give me a little bit of a feel for how the execution at Beck and how you feel about sort of that growth step off into next year, given maybe some of the things you've also done in the portfolio there.

Sure. Ross, this was clearly, the fourth quarter was clearly one of Beckman Diagnostics' better quarters in some time. And that really comes to or is driven by improved commercial execution in a number of regions and new product innovation starting to drive some impact. And we saw mid-single-digit core revenue growth in the fourth quarter. That was really led by immunoassay and automation, and those are obviously key drivers here. 2018 is the first time that our immunoassay business has tipped over and become a bit larger than our clinical chemistry business. So you see the impact of our commercial execution there and some of the automation-related competitive advantages we have that are driving that immunoassay growth rate. And that growth rate has been very consistent in most cases with our competitive set. And so now we're mixing upward our core revenue growth by virtue of that performance. North America in particular saw some improvement in growth rates, and obviously that's a key battleground for us. And we're encouraged by what we're seeing in our competitive win rates and our customer retention rates. So I think a meaningful step up here into the kind of 3%-ish kind of growth rate, and what we're looking for is, Kind of another 40 to 50 basis points to step up going forward. And I think what we've seen historically over the last couple of years is that very thing. Automation is going well, as I mentioned in my remarks. Hematology, you know, that's been kind of a drag for us. We're seeing a much more competitive product line because of both the high volume and the low and mid volume offerings now. And I think with what's coming around low and mid-volume immunoassay and clinical chemistry, as well as some of what we're doing in terms of menu gaps, that we'll start to see continued or we will see continued performance improvement there. I think one thing to keep in mind is we, you know, I know we often talk about Beckman. It's obviously the biggest business in our diagnostic portfolio, but it's also important to remember that The DX platform grew 6.5% in 2018. And so, you know, as we do the comparisons appropriately to broad-based competitors in the market, we're feeling pretty good about how the portfolio is stacking up right now.

No, that's helpful, Tom. And maybe just, you know, I feel like you guys have consistently highlighted, given where the balance sheet is and how strong the cash flow is, sort of the, you know, M&A firepower opportunity. Obviously, though, it's sort of been a choppy or volatile situation. public equity market, which sometimes will make transactions more complicated. But I guess, how are you thinking about your ability to execute on something at least more sizable in the current environment? And how are you thinking about valuations as you look at them broadly, and whether or not you've seen sellers, given some of this volatility, get a bit more sensible around potential prices?

Sure. Well, in terms of our ability to execute, and we talked about this a fair amount when we were all together in December, we feel terrific about where we are. Some really good acquisitions this year, obviously. $2 billion or better executed this past year. IDT and Blue and a few other smaller deals are terrific additions to our portfolio. But the balance sheet today, it's in as good a position as almost we have ever been. You know, if you think about our leverage ratio today, you know, we're talking about being about two in terms of net debt to EBITDA. That's the lowest level since pre-Paul. And so in terms of our capacity, our ability to execute both from a balance sheet perspective and, of course, also from a talent perspective, we feel very good about where we are. In terms of the valuations in the market today, we all know that M&A can be episodic. We are nothing if not patient about looking for and cultivating the most strategic and financially attractive deals. The pipeline is good today. Our cultivation levels are as good as ever. You've heard us talk about The breadth of that cultivation, which is across all the platforms, probably with a little bit less emphasis, as you might imagine right now, in terms of large capital deployment, a little bit less emphasis perhaps on doing that in dental, but certainly the other four platforms are all at the front of the line. And with the capacity we have and the ability to deploy a significant amount of capital this year, you know, we're hoping that things break our way. You know, in terms of sensibility of valuations, well, of course, the sellers always think their valuations are sensible. This volatility helps, clearly. I think the shakeup in the latter part of last year may have gotten some folks thinking about what they might do. But, you know, things have sort of stabilized here. So it's early, a little tough to tell. But we're in great shape and are prepared to do things of consequence. Thanks, Tom. Thanks, Rod.

Thank you. Your next question is from Scott Davis of Mellius Research.

Hey, Scott. Good morning, guys.

Good morning.

It's overall a really strong quarter. I would love to have a little bit more color on what you're seeing out of China, just given the variability of results that we've seen across the board from both cyclical and non-cyclical companies have had – a range of outcomes that are pretty broad, but what are you guys seeing in China? What are your local guys telling you, and what kind of confidence do you have in 2019 and in the region?

Sure. Scott, I know there's a lot of interest in China right now, and there's been a lot written about what appears factually based to be a slowdown in the broadly defined Chinese market. We are not seeing anything specific that we could point to today that is impacting our businesses in China. I think you can start with the fact that we're really well positioned across our core markets. Diagnostics, life sciences, water quality, product identification, consumer packaged goods, and of course dental, which as you heard, again, growing double digits, are great markets to be in. So I'm not sure that what you're reading about today, which appears to be more of a consumer-driven slowdown in the Chinese market, would be as obvious in our businesses. Our business in China was up double-digit in the fourth quarter. That's the eighth consecutive quarter, or better said, the second straight year, of double-digit growth for us in China. And that was pretty broad-based, I mean, pretty much across the board. We can't really point to any particular slowdowns. Over the past three to four years, our China growth has been up high single-digit, low single-digit. So could we start to see a little bit of impact there? I think we could. I think these consumer-driven impacts can can start to move across into even the industrial markets' psychologies. And, you know, while we have very little industrial exposure left, broadly defined at Danaher, whether that's at Paul Industrial or Hawk Industrial or PID Industrial, you know, it's probably less than 10% of Danaher wide today, and therefore an even smaller portion of our China business. Those are things we'll watch carefully as indicators as to whether or not we're seeing a broader slowdown.

Yeah, makes sense. And just a little bit of a nuanced question here, but when I see companies take a step up in investments, discretionary investments, it always begs the question of are you catching up on spend or are you getting ahead of spend? And obviously the nuance there being if you're catching up, it's more of a new normal. If you're getting ahead, it's more pulled forward. So do you have a color in that?

Yeah. Sure. It's an interesting question, Scott, because I think it's probably – I think if you look across how broad our portfolio is and the number of operating companies, I'm sure we could find examples of both. But I think largely we try to get ahead. We try to look for those things where, you know, based on what we were anticipating in the quarter we thought we might not have room for, and some things where we can use some good discretion about investments that would have some impact on a relatively near-term basis. And so, you know, clearly I think there could always be a mix there, but the strategic intent is to look for those things that we knew were the right things to do, we're anticipating that we would do at some point, and we wanted to get ahead to try to continue to enhance the growth trajectory of the business.

I think that's a fair answer. So thanks, guys, and good luck to you this year. Thanks, Scott. Good to hear from you.

Thank you. Your next question is from Derek DeBruin of Bank of America, Merrill Lynch.

Hi, Derek. Hi, good morning. Good morning. A couple of questions. I guess the first one is any pull-forwards budget flushing of that, I just, you know, given the tariff issues and just concerns on spending, did you notice anything different about sort of like spending trends in the quarter?

Not that we can see, Derek. The order rates looked pretty solid. You know, we said when we spoke in December, said we had a pretty solid October and November That remained consistent in December. And I think in general, our businesses are probably a bit less exposed, if you will, to budget flush pull forwards given the 70% recurring revenue, which is obviously largely made up of consumables and in some part service. But when 70% of your revenue is driven by that recurring revenue, you're a bit less, whether it's exposed or vulnerable or however you might want to describe it, to a budget flush or a pull forward at year end. So, you know, I'm sure there could be a couple of circumstances, you know, whether it's a high-end Leica microscope or a couple things at Beck LS where somebody might do that. But in terms of materiality of it, it doesn't appear that that had much impact. In terms of tariffs, I'm not sure that had much impact, at least as we look at our China numbers throughout the course of the quarter. We're not, you know, a significant target. Right now, I wouldn't say in the crosshairs, at least if you measured that by virtue of the financial impact. We've talked already to about $12 to $13 million of impact per quarter or about $50 million annually. with about $30 million of incremental impact in 2019 versus 2018. So, you know, we're doing some things, obviously, to try to offset that. But in terms of the impact of that dynamic on orders or pull forwards, again, limited exposure, probably to some extent, a limited level of even the awareness level at the China end market level. So, Nothing to point to specifically at the moment in terms of the impact on orders or volume.

Great. And then just a follow-up question. Have you made any decisions in terms of how much debt you're going to put on the dental spin? And just a question of sort of like at the time of the spin, sort of what's the Remainco leverage ratio is going to be?

You know, I would say what we did back with Fortiv is probably a good proxy here. You know, our intention is to is to launch the dental business with a strong balance sheet, with an investment grade rating and an ability to use their free cash flow to add incrementally to their portfolio through some inorganic moves, some M&A moves. So I think that's, you know, our history is probably a good proxy for what we would do going forward. And I think we would do that in a way that also leaves us in terrific shape from a RemainCo perspective. I mean, obviously we... We start with a great position here in the beginning of 2019. It's hard to imagine being in a better shape, but I don't think that dental, given its scale, will ultimately impact us in terms of RemainCo being set up to win from a capital deployment perspective.

So, Derek, maybe the simple way to think about it is, you know, we're at two times, two turns today.

If we did the spin today, we'd likely do dental at two turns. Gotcha. Thank you. That's really helpful. Thanks, Derek.

Thank you. Your next question is from Steve Buchov, Morgan Stanley.

Hey, Steve. Hi. Good morning, and thanks for the time here. Actually, maybe we'll just jump off from the conversation there about dental and the spin with just a couple more questions around the assumptions there. I guess, first off, any change to the thought process on timing? I think we all remember with Fortiv, you guys were able to execute a little faster than initially planned and then as you think about the plan for dental for this year do you anticipate any impact of channel inventory fluctuations and then maybe last one on dental is you know as you think about the the trajectory of margins there you clearly put a lot of capital to work driving accelerated commercial investments how do you think about that line in 19. sure

Thanks, Steve. Good questions. So let's talk first about the spin. We've said all along we expected it to be in the second half of this year. That's still our expectation right now. I mean, I think if I had to peg it, I would probably say, you know, we did forward it kind of right at the midpoint. I think dental is more like probably I would call more mid to late in the second half. You know, as we said when we announced, we want to continue to see this market stability. We're encouraged by the fourth quarter performance clearly in the positive sellout data. But I'd like to see a bit more of that. And we need to obviously make absolutely certain that the business is ready to stand up on its own and continue to make good progress. And we're encouraged by all that. And that's not just in the last quarter. two quarters, we've really been at that for much longer than that. So we're making good progress. I mean, one thing that's clearly on our mind, and you guys have all read about it, is, you know, the federal government here in Washington has reopened, but the shutdown certainly didn't help timing for IPOs and spins. You know, you've probably read in the news the backlog of NSEC filings and tax rulings and so on and so forth are likely going to create some delays here. So I think you put all those things together, we'll continue to make progress here, but I think we need to be aware of some of those factors. In terms of the channel inventories and your question about that and being in flux, we worked really hard over the last couple of years to ensure that we built sustainable processes in partnership with our partners our channel customers, our channel partners, to ensure that we have great visibility and transparency around those channel inventories. You know, we've talked a lot about that over the last couple of years, and I think key to ensuring that we have those channel inventories in good shape for all of our, for both the benefit of our customers as well as ourselves, is to make sure that we have good transparency and visibility. And I think we've established that and a good dialogue month to month and quarter to quarter with our channel partners. So I feel good about the stability of those. There's obviously always some variability with sellout and category by category. But as a general rule, I think our processes are much better, as are the processes in the channels. Finally, in terms of margins and commercial execution, again, we've done a number of things here that we feel good about in terms of driving performance. First of all, the cost structure is in much better shape than it was three to four years ago. You've heard me talk about consolidating from 10 opcos to three and probably now north of 30% reduction in manufacturing in back office facilities. So the cost structure is in better shape. But we're continuing to invest significantly in new product innovation. That will normalize a bit as we go forward. And I think you combine that with the impact in terms of continued top-line improvement, and that leads us to really continuing to be very positive about our long-term growth and margin opportunities on the platform. So I think we expect to see some modest growth and core OMX here in the first quarter. But we also expect that to continue to improve throughout the course of the year.

Got it. Really helpful. And then just one quick follow-up. You've flagged a couple times, and it's very true, that the business has transformed significantly over the last couple years, faster growth, some changes inorganically that have been really helpful. And so I have to imagine you feel maybe better now than you did even a couple years ago about your ability to drive growth with targeted investments. When you think about 2019, maybe we'll set aside the inorganic, but think about where you can drive organic investments. What are your top priorities? And then I'll get back to you. Thank you.

Sure. Thanks, Steve. You know, I think we've got a number of priorities, but... Clearly, they would be consistent with where we've invested really over the last couple of years. We've invested significantly in our diagnostic platform organically. I've talked about new products that are now having an impact at places like Beckman Diagnostics. We've continued the investment rates at Cepheid, sustaining those double-digit growth rates, both in terms of investments and instrumentation. the evolution of the architecture, as well as the expansion of the menu. In life science as well, we continue to make investments, a number of organic investments, but, of course, inorganic has played a key role there. I think, you know, obviously we look back on those investments in businesses like Paul that have helped to transform the platform, but even as recently as this past year with the additions of IDT and LabSight, Those inorganic moves are obviously not to be overlooked in terms of their impact on improving the growth rates. But water quality and PID are making investments as well. Those new CIJ printers at VideoJet that are helping us to drive connectivity to and enhancing our service offering to customers is having an impact on sustaining that growth rate at PID and at VideoJet specifically. And water quality, investing in things like the CM-130, opening up a whole new market like dialysis testing where water plays a critical role, those are having an impact. Now, the investment may not be as material there as what might go on, say, in a new platform at Beckman, but But, boy, it has an impact when we roll those things out to the market. So it's broad-based, but I think within a given platform or an operating company, it's very specific relative to new product innovations that we think can have a material impact on growth rates.

Great to hear. Thanks a bunch.

Thanks, Steve.

Thank you. Our next question is from Julian Mitchell of Barclays.

Thanks. Good morning, and welcome to Matt in your new role. Thank you, Julian. Just a first question around environmental and applied, which I don't think has been touched on yet. Wondered if you could give any update on how you've seen the order patterns there, particularly in some of the more industrial-weighted businesses. And also, flipping over to Paul, What are your expectations for the microelectronics unit there, given that CapEx seems to be coming down?

Sure. Good morning, Julian. So, let's start with environmental applied just broadly. You know, a very good quarter, really driven by consistent performance at PID and terrific performance across water quality and specifically at HOC. So, I think those businesses are tracking quite well. They are, to your question, each of those businesses, including Paul, represent some of the limited industrial exposure that we have. I mentioned to, I think it was Scott, or an earlier questioner, that we're not necessarily a terrific proxy in terms of the industrial side, with about probably less than 10 percent of the portfolio being at Paul Industrial, Hock Industrial, and PID Industrial. And so, I mean, our sense is we could see some moderation there in 2019, but in general, the underlying trends remain pretty solid. So, I don't know that we're necessarily making any kind of macro call here, but, you know, given where we are in the cycle, it wouldn't be unheard of that we'd see those limited pockets of industrial exposure perhaps soften up a little bit. You know, so far, so good. Paul Industrial, for example, fourth quarter, we're up high single digits, and orders were in a similar range on a two-year stack. Hawk Industrial, pretty good numbers. PID numbers, pretty solid. So we'll continue to watch that carefully. Specific to your question about Paul and and the microelectronics market, you know, that has been a phenomenal market for Paul, uh, over the last few years since, since we've owned the business. And so, um, I think, uh, it still is pretty solid today as we look at those growth rates. But, um, again, I, I do not think it would be unusual, um, given some of what we've read about, um, in terms of the, let's just call it the consumer electronics market and some of the, what you've read about in, uh, in terms of the impacts in China, to see a little bit of moderation there. It's been tremendous so far, but we are not ignorant of the headlines.

And that's also a business, Julian, that micro-e-business is a business that's got a lot less consumables than some of our other businesses, kind of giving it a little bit more of that cyclicality as well.

Thank you. And then my second question around margins. One would be kind of a follow-up on the dental question in that should we expect the step-up in investment to step back down materially once the spin happens? So you'll see in the first 12 months of dental as a standalone company, maybe a decent margin tailwind from that. And then firm-wide, if we think about the core margins, as you said, they were down slightly in Q4. Do we expect those to rebound in the first quarter? Maybe as some of that investment spend firm-wide cools off.

Sure. Well, on the dental question, I do think that there would be a combination of factors that would impact continued growth. improvement in what you see in dental margins. Some of that would be some moderation in the investment spend around new products, because again, as I've mentioned, we've tried to be very focused on continuing to set that business up to grow, not only in terms of the investments we've made in our digital platforms, because of the importance of digital dentistry going forward, but certainly the investments that we're making in the clear aligner business. So Some of those may moderate slightly. In the cases of clear aligners, those actually would probably be sustained. So a bit of a mix there. But again, I think in general, in terms of the value creation opportunities of the dental platform, continued improvement in growth and profitability, we feel good about those trajectories. And then in terms of core margins more broadly, I think There's an impact here, as Matt mentioned earlier, around FX and tariffs here in the first quarter. As Matt mentioned, probably five to six cents. And so those will tail off. We'll see better margin performance the deeper we get into the year. But we start out in the most challenging part of the calendar for certain.

Great. Thank you.

Thanks, Julian.

Thank you. Your next question is from Doug Schenkel of Cowen.

Hi, Doug. Hi. Good morning. So first, a question on growth investments and gross margin. When I think of opportunistic growth investment and the impact on the income statement, I typically look to the R&D and SG&A lines. That said, it looks like there was some impact at the COGS line this quarter. Is that right? And if so, can you provide a little bit of detail on what you did and what you expect the returns to be this year? I'm just at a high level trying to get a better handle on how gross margin was impacted by these investments versus things like FX and tariffs. So that's another component of the question as well.

Yeah, sure, Doug. So I think some of the things that we kind of have done is, I mean, think about some kind of cost pull forwards, if you will, Specifically around maybe some supply chain related things etc like that I think we saw some of that probably most pronounced in diagnostics specifically at Beckman diagnostics And then you know also if you think about some of the new product ramps Kind of capacity if you will with spark at dental and some of our other kind of new product accelerations where you're kind of building up for that first time to the degree that we were able to kind of pull some of that forward here and from 2019 and get some of that work done a little bit earlier to kind of have a more impactful launch and timing some of that with the sales and marketing as well, right? So you're kind of holistically planning to pull forward and get a launch out a little quicker. So I think you'll see a little bit of both that R&D, sales and marketing, and those items that impact COGS too.

I think, Doug, also it's important to think about the situation in the fourth quarter where, again, as the quarter progressed, We were seeing the continued good performance on the top line. And so, you know, we look broadly at where there are those opportunities to take advantage of growth investments. And, you know, that is one of those fortunate circumstances. It doesn't happen every quarter, obviously. But, you know, you look to take advantage of those things because it benefits you both on the – hopefully on the short term and on the long term. basis, and we were clearly not holding back.

Okay, that's super helpful. And then just a couple of small but important quick follow-ups on China. I know this may not apply to you as much as some other folks, but I'm just curious if you've had any success passing along price to offset tariffs in China. And then at a higher level, I'm wondering if you'd be willing to share what the growth rate for China is that you've embedded into 2019 guidance. Thank you.

Sure, Doug. You know, I would say price broadly defined is achieved across our portfolio largely on the consumables side. It's a little bit more challenging on the – given the competitive sets in our businesses on the equipment side. So we generally get it on consumables, and that's both true probably broadly and in China. I would not necessarily associate what we're getting in terms of price, which has been pretty consistent, with an ability to pass those on specific to the tariffs. The tariffs obviously are coming in other commodities as than that which impacts our consumables business. So we're certainly not having a specific conversation with customers about that. But in general, we try to get price on a global basis and generally on the consumables side. And then in terms of growth rates, you've heard me mention already today about the consistency of our performance In China, in terms of what our expectations are for this year, we embedded an assumption that China would continue to be a high single-digit kind of growth rate and could very well be right up there at a double-digit growth rate. But I think high single is probably the right way to think about it.

Okay. Thank you again.

Thank you.

Thank you. We have reached our allotted time for questions. I want to turn the call back over to Matt Gugino for any additional or closing remarks.

Thanks, Christy, and thanks, everyone, for joining us. We're around for questions all day.

Thank you. This does conclude today's conference call. You may now disconnect.