Danaher Corporation (DHR) Earnings Call Transcript & Summary

Okay. We're going to go ahead and kick it off. I'm Tycho Peterson from the life science team at JPMorgan. Welcome to day 2 of the conference. I'm here to introduce Danaher. We'll do a breakout right after in the Georgian Room across the hall. With that, let me turn it over to Tom Joyce.

Thank you, Tycho, and thank you to the entire JPMorgan team for putting on what I know, again, will be a terrific conference. Thanks to all of you also for joining us, all of you who rose to the early bell this morning for the 8:00 session. We appreciate you all joining us. Here are our forward-looking statements. Obviously, I will let you read those at your leisure. Maybe before we dive in, I think many of you probably saw the announcement that we put out yesterday. An announcement around a preliminary look at our fourth quarter. And as you saw from that announcement, and I'll recap here, appears that we had a very good finish. 2019 has been a fantastic year. And as we've seen in the preliminary numbers in the fourth quarter, it looks like our core growth will be above the previously announced guidance. We were looking at roughly 4.5% core growth. We think we'll be certainly above that number, probably up 100 basis points or thereabouts. But those numbers are still preliminary at this time. We have looked at the individual segments, and I would say, Life Science and Diagnostics clearly represented some of the most significant strength, particularly at Pall and the biotech side of Pall look very good. And also at Cepheid, where we've seen some particular strength in the flu season, obviously that's good from a diagnostic standpoint and unfortunate for many who suffer from what is a challenging flu season. But overall, a very good finish, it looks like, from the top line perspective. The adjusted EPS will reflect what we think will be pretty solid fall-through and that should translate into an adjusted EPS number that's at the -- at or above the high end of our previously announced guidance range. So good finish, it appears. But I think as we look back on the fourth quarter, there was a lot more to look back on in a very positive way. And certainly, the continued progress that we've seen in the regulatory steps associated with the GE Biopharma acquisition was a big part of that. And as you may have seen, we received conditional clearance from the EU in December. For those of you not as well informed around the nuances of the regulatory environment, that's a pretty important milestone and represents very constructive dialogue and, I think, puts us in a very good position to continue to track towards the close of that transaction in the fourth -- in the first quarter of this year. In addition to that, as you know, we've been working on the launch of a new stand-alone independent public company in the form of our dental platform. And in December, we completed the exchange offer that followed the IPO that resulted in a split-off of that Dental business now into the business known as Envista, a new stand-alone public dental business that's off to a very good start. The combination of these 2 transactions, we believe, really represents another significant step in the transformation of Danaher into a better, stronger Danaher portfolio really built for the years to come. So an outstanding year. And I think we're well set up for 2020. So what you'll hear today as we get into the balance of my presentation, we'll begin with providing a perspective on the Danaher portfolio today, a different portfolio, a more focused portfolio, given those transaction that I just mentioned. We'll then spend some time on our Diagnostic business and talk about how we've built a best-in-class portfolio and how we've set that portfolio up to win in its market. And then we'll take a closer look at Cepheid. Cepheid, a great molecular diagnostic business, now 3 years in and delivering performance in excess of our expectations, and a fantastic team continuing to leverage the tools and the processes of DBS for market share gains and terrific operating performance across the board. So let's start with an updated frame of the Danaher portfolio today. What you see here now are 3 reporting segments and 4 platforms: Life Sciences, Diagnostics, water quality and product identification. Those 4 platforms represent roughly 20 operating companies, each of those sitting in #1 or #2 market positions in their respective industries. And each of those sharing a common business model, a common business model with characteristics that I'll talk about throughout the course of this presentation. There's a significant geographic spread of these businesses. And as you can see, over 30% of our geographic footprint is in high-growth markets today. As we've evolved the portfolio, we become an increasingly direct business, less reliant on third-party distribution, and that creates a level of customer intimacy that ultimately allows us to build even greater competitive advantage. And then finally, an important element of that common business model is the level of recurring revenue that we have in the portfolio. And as you can see in the lower right-hand corner, now that recurring revenue, up from just 45% 5-or-so years ago, now to roughly 70% of the portfolio. And I'll talk a little bit more about that as we move into thinking about how do we win in our markets and what are the characteristics of that common business model. Well, that model starts with an extensive installed base of instrumentation. Instrumentation that drives a steady stream of consumables and aftermarket service. But in particular, those consumables tend to be high-value, mission-critical consumables that are focused on applications that demand high-quality products and often are positioned to meet regulatory requirements. And so you could think of this broadly as a razor/razorblade model. And in many respects, I think we have examples where that is the case, where the consumables revenue might represent 2 to 5x that initial instrumentation sale. And you see some examples of those businesses in the logos to the upper right-hand corner, where that model is the case. But we also have situations where those consumables associated with that instrumentation are actually specified into a customer's processes, where they're both either FDA-approved or, in many cases, customer validated in such a way that makes them very sticky. And as a result of that stickiness, creates a steady consumable stream that's largely captive to that installed base. And finally, service. Service has become an increasingly important component of our commercial activities and creates a tremendous source of competitive advantage. And I think there's no better example of that than our Videojet business that has led the way with the largest service organization amongst its competitive set and continues to build competitive advantage as a function of that now increasingly, digitally driven service model. So this characteristics of that common business model provides a number of important benefits and opportunities. It reduces our revenue volatility. It creates that steady stream of consumables that we can count on day in and day out. That direct model, along with those consumables, creates a level of customer intimacy that's important for competitive advantage. And finally, of course, those consumables as well as the aftermarket service, represent a significant component of our margin opportunities and, thereby, enables us to continue to reinvest that profitability effectively in continuing to evolve our instrumentation platforms as well as our commercial activities. So we have great businesses today and they are in fantastic markets. But obviously, great markets and great companies are just a start, we have to execute well. And that's where the Danaher Business System comes in. The Danaher Business System has evolved over the last 30 years. That's a lot of reps. It's a lot of reps that are anchored in 5 core values that start, first and foremost, with the best team wins. Building the best team of talent focused on customers every day. And that team is challenged with the second of our core values, which is customers talk, we listen. We then leverage that voice of the customer back into our businesses with a focus on continuous improvement. And the third of our core values is continuous improvement or kaizen as our way of life. Fourthly, we understand that innovation defines our future, the fourth of our core values. Recognizing the customers' demands for improvements in their workflows everyday are continually increasing and we need to keep pace as we have done. And finally, the fifth of our core values, we compete for shareholders. We compete in our markets for the benefit of market share, but we compete in the interest of you, our shareholders, every day by continuing to drive our core growth trajectory as well as our operating margin enhancement. And we measure the impacts of the Danaher Business Systems, the tools and the processes that have evolved over the last 30 years, in growth, in lean and in leadership with 8 core value drivers, the 8 metrics that you see on the right-hand side here. And as we focus on shareholders, the 4 shareholder metrics you see, we do it in a balanced way. We do it by running what we call the Danaher playbook, which is focusing on, first, improving the cost structure of the businesses in which we run by driving gross margins up and holding SG&A tight. Thereby creating operating margin flexibility for us to reinvest in our businesses by moving those funds back into R&D and sales and marketing. Thereby accelerating our core growth, while at the same time ensuring that we're expanding operating margins and creating upper quartile EPS growth. So the combination of core growth, operating margin expansion, our prodigious free cash flow, which today in excess of $3 billion, with the addition of the GE transaction, will be substantially greater than that, will combine to allow us to continue to maintain our bias towards deploying all and more of our free cash flow towards acquisitions. And the combination of those -- that math essentially is how we are committing ourselves to top quartile EPS growth and compounding returns on a long-term basis. So let's turn now to our Diagnostic platform. A platform that we believe is a best-in-class portfolio that's anchored by 4 very strong and scaled operating businesses: Beckman Coulter Diagnostics, Cepheid, Leica Biosystems and Radiometer, in addition to a number of niche businesses that augment those positions and allow us to bring a broader suite of solutions to our customers. Each of those businesses benefits from a number of strong secular growth drivers, as all of our businesses do across Danaher. In the case of Diagnostics, it starts with the improving standards of care in high-growth markets. High-growth markets have continued to be a strong growth driver for us over a long period of time. China, in particular, has been a double-digit growth market for us on a sustainable basis. In addition, the diagnostic world today is challenged. It's challenged by a shortage of skilled labor and cost pressures that increasingly demand more automated solutions to leverage that precious skilled labor base and allow those facilities to then address cost pressures on a continuous basis. And finally, health care continues to decentralize. Some of the most expensive places to treat a patient today are increasingly shifting towards less-expensive points of care. And the architectures of diagnostic products and their associated workflows need to move with that. And we have done that. If you look at the architectures associated with Radiometer, Cepheid and now increasingly at Beckman Coulter, we are moving with that decentralization of the market and benefiting from that decentralization, particularly to the point-of-care and physician office labs. And so today, we have now built a 6.5 -- nearly $6.5 billion portfolio with terrific core revenue growth of, more recently, 7% and great adjusted EBITDA margins of over 25%. The platform's evolved. You have to go back to 2004 to see the beginnings of the platform, which were with the acquisition of Radiometer. And from Radiometer, we expanded the platform with the acquisitions of Leica Biosystems, which came from the Vision Biosystems business. Ultimately, to Beckman Coulter. Later to bolt-on acquisitions like Iris and HemoCue and Devicor and MicroScan. And more recently, the high-growth acquisition and tremendous business that I'll update you on here shortly of Cepheid. If you go back just 5 years, you'd see that half the portfolio was growing low single digits. Fast forward 5 years, 70% of the portfolio is now growing mid-single digits or better and half the portfolio is growing high single digits or better. So a tremendous evolution of the portfolio into a position where the growth trajectory now is sustained at or above market rates. And you see the margin improvement that has come as a function of that. So tremendous progress and, I think, a testament to the platform and the teams across those operating companies, adoption and use and sustaining the tools and the processes of the Danaher Business System in lean, in growth and in development of leadership. Part of what's helped us in the evolution of the platform as well has been indexing our positions in the platform into attractive subsegments of the diagnostic market. Molecular being a really important move with the addition of Cepheid to the portfolio, which now has, by far, the largest installed base and test menu in the molecular market segment and is continually demonstrating double-digit growth rates in excess of our expectations. And I'll get into more about Cepheid in just a few minutes. But we also have scaled niche positions. Businesses like Radiometer in acute care and Leica Biosystems in anatomical pathology are now each roughly billion-dollar businesses and are showing consistent high single-digit core growth. And finally at Beckman Coulter, the largest of the businesses, a $3 billion position in the core lab in hospitals today. That's a leading player where we've continued to improve its growth trajectory now over the last 4 quarters coming through the third quarter of this year as a mid-single-digit growth business. And we're continuing to invest there in hematology, in our commercial opportunities, in order to continue to leverage that growth rate. And we're excited about the portfolio of new products that are coming over the next couple of years. Our strategic focus has been consistent across the Diagnostic platform over the last number of years, consistent with looking for the most attractive subsegments of the diagnostic market. We focused on high-growth segments, particularly in the emerging markets. We have strong positions as well in the point of care as well as in a number of smaller markets where we see great potential over time. And we're making early stage bets to ensure that we're continuing to stay out ahead of the evolution of the technologies associated with the diagnostics of the future. Our architectures continue to focus on those challenges that our customers face every day. Those challenges I mentioned around skilled labor, particularly nursing labor, skilled lab technicians and are increasingly addressing the shortage of space in hospital facilities, where the architecture and the footprint of instrumentation is really at a premium. And finally, we've continued to invest in our commercial teams, ensuring that we have the best and the brightest, the most domain-savvy commercial leaders in the market today. The combination of all those investments in those highly attractive markets have now taken the portfolio from one that just a few years ago was really underperforming the overall market, to today, where we're consistently outperforming the average market growth across Diagnostics. So we're thrilled with the progress that we're making across the portfolio, and we are excited about the opportunities that lie ahead. Acquisitions have obviously played a really important role in the evolution of the portfolio. You saw the number of acquisitions from 2004 all the way through to today. And one of the most important of those, obviously, is Cepheid. Now every acquisition is different in the sense of what the opportunities are in a given acquisition. The opportunities at Radiometer 15 years ago versus the opportunities at Beckman just 7 or 8 years ago versus the opportunities at Cepheid are very different. And so we take a tailored approach to the deployment of the Danaher Business System in each acquisition. And we design our approach to target those opportunities that are uniquely focused on the improvement in those key metrics that I mentioned earlier. So in the case of Cepheid, that really involved commercial execution. Yes, a terrific growth business at the point of time when we acquired the business, but they had limited market visibility and there was not a structured and replicable sales and marketing process. By bringing the growth tools of the Danaher Business System to Cepheid, we've been able to exceed our expectations relative to growth and continue to grow market share. Today, now with over 20,000 instruments in its installed base, the largest menu today of any molecular player and a continued growth in market share that we're confident will continue. If you also remember, Cepheid had its challenges relative to driving that growth rate and translating it into operating margin expansion. And so we needed operational leverage. And we leveraged the tools of the Danaher Business System, particularly the lean tools, to focus on manufacturing efficiencies, to expand capacity while ensuring that we were doing that at lower cost, and by focusing on cost that heretofore had not been attended to. Indirect cost, procurement leverage that we could get across the portfolio at -- in Diagnostics as well as across Danaher. And we built global scale. We were -- Cepheid was underpenetrated in a number of markets, and today, we're seeing good growth in those markets. That wouldn't have happened where we not -- did we not have the teamwork, an extraordinary team of talent at Cepheid, and the deployment of Danaher skilled resources in the Danaher Business System as well. And so as you can see, we had a tremendous number of Danaher associates deployed to help address these challenges, and a great number of senior leaders at Cepheid have adopted the tools of Danaher Business System and helped to drive great results. And here are those results. I mentioned focusing on commercial execution. So we 3x-ed the market visibility that Cepheid had in terms of opportunities. That's the top of the funnel from a commercial perspective. By driving the top of the funnel, translating sales qualified leads into marketing qualified leads, we were able to 2x that sales funnel. By 2x-ing the sales funnel, we were able to drive new customer acquisitions up by 20% versus the situation that we had prior to the acquisition. Operational leverage came from the tools of the Danaher Business System, driving lean operating practices that also focus on ensuring that we deliver outstanding customer quality. And as a result of that, we've now seen increasing customer satisfaction and an increasing penetration in the market. And building global scale. I mentioned a level of underpenetration in a number of high-growth markets. And you see that, particularly in China, where we've been able to 5x the revenue in China. Again, still a relatively small base, but growing double digits. And we'll continue to expand the number of tests that we provide to that market that will continue to support our long-term growth. And so that $600 million business that we acquired today passed a huge milestone. In December, Cepheid shipped its first billion-dollar year. And that, obviously, was very exciting for that team. Great double-digit growth business. We've lifted the R&D spend to continue to support its growth over time. We've been able to translate that growth into operating margin expansion consistent with the balanced approach that I mentioned in using the Danaher playbook. And finally, you see the operating margin that now, today, is healthy and running roughly at 20%. And so to sum up, the portfolio has evolved in a significant way over time, particularly in the last 5 years. Today, we have a stronger, better, more resilient portfolio at Danaher built for the future. It's united by a common business model and supported by the tools and processes and strong execution by our team in the Danaher Business System. We have a great Diagnostic platform that's well positioned in attractive, fast-growing segments of the overall diagnostic market. And finally, just to highlight an exciting business in Cepheid, one that's poised to continue to support the platform's growth on a long-term basis. So with that, thanks for your attention today. I'd be happy to take your questions across the hall.