Danaher Corporation (DHR) Earnings Call Transcript & Summary

Good morning. Dan Brennan here from Cowen. Pleased to be here on the second day of the 42nd Annual Healthcare Conference. Joined with me on the virtual podium with the executive management team from Danaher. We have Rainer Blair, Chief Executive Officer; and Matthew McGrew, Chief Financial Officer. I recently joined Cowen, thrilled to be here, and this is a great way to kick off day 2 with this management team. So first off, I just want to say, Rainer and Matt, welcome.

Thanks, Dan, for having us.

You got it. So Rainer, I thought I'd start off with a couple of big picture questions and then we dig into a bunch of the drivers of your business here. Certainly, in the years leading up to assuming the role of executive of CFO back in September of 2020, the company increased its focus on the life sciences via spinning Fortive and Envista and acquiring GE. And under your leadership, we're certainly quite constructive on the outlook that the company has been progressing towards, particularly with the increased focus on biologics and biopharma, and your actions clearly signal strong focus and leadership here. It would be great to learn about kind of, in your words, the strategic direction you're fostering as CEO of the company and to gain insight into your leadership style before we dig into a lot of the drivers.

Sounds great. Thanks, Dan, for having us, again. And it's just great to be here to talk about our story. And it's best probably to take a step back and talk about this really significant portfolio transformation that has really changed us into the global science and technology leader that we're today. And as we step back, there's really 3 elements to that transformation. So the first one, of course, is these world-class and leading growth franchises that have helped re-rate our gross profile. And I'll talk about that in more detail, but we have enhanced our growth profile quite significantly here versus where we were just even in 2015, 2016. At the same time, sure, great growth franchises, but we've also repositioned ourselves into really outstanding end markets that are underwritten by very strong long-term secular growth drivers. You mentioned one of them, the growth of biologic therapies. And then, of course, the third part here is our enhanced earnings profile, which has also significantly enhanced our free cash flow. So if we unpack that a little bit and we look at that transformation, and you mentioned some of that in your question, we really took that first big step with Paul that really enhanced our biologics end market exposure and got us into bioprocessing at scale. And that was quickly followed then by Cepheid, where, once again, we stepped into molecular diagnostics and an exciting field with plenty of runway, and we had the leading franchise there. And then we opened up another front, if you will, which we call genomic medicines with the acquisition of IDT and Aldevron, which really give us great beachheads into this exciting new field, which we expect to be seeing growth from for decades, while at the same time, creating 2 New York Stock Exchange traded companies, Fortive and Envista, that had different growth and earnings profiles. And then all -- if that wasn't enough, we enhanced our organic capability significantly, investing through the Danaher business system into innovation, expanding our science and technology capabilities. So as you think about Danaher, well, yes, we're a lot larger than we were even just a couple of years ago, but we're also much stronger. And you see that biopharma end market exposure, genomic medicine, molecular diagnostics so topical today, water quality and environmental safety. Our portfolio is nicely positioned in these end markets. And then last, if you took the dimension of what kind of business models do you like? Well, we have skewing towards razor/razorblade business models for some time. Sometimes that's related to an instrument or a piece of manufacturing equipment, which pulls through specked in or very specific consumables to drive 75% recurring revenue. And other times, it's a raw material that is so critical that, in and of itself, it is spec-ed in. So we really like that stickiness. And then lastly, if you bring all that together, what does that mean then? Well, our core growth from 2015, when we were in the low single digits, well, 2019 to '21 was actually in the low-teens. And in the long term, we've talked about, take the pandemic out, sort of mid-single-digit plus growth. But our operating margins are over 800 basis points higher. So imagine the compounding effect that this higher growth has with these higher margins that really brings us into a different territory, generating cash flows twice as high as they've been, over $7 billion of cash flow and $10 million of EBITDA. So as you think about our setup here, we feel very well positioned, our balance sheet is in great shape and this portfolio transformation and strengthening Danaher, not just to be bigger but to be better, it's going to continue under my leadership as well.

That's great, Rainer. So maybe jumping off on the balance sheet being in great shape. So the company is pretty unique in allocating all free cash towards M&A rather than returning to shareholders via buybacks. And you've historically talked about being opportunistic clearly in periods of dislocation. And certainly, right now, it appears that we're in one. So I'd be interested to get your viewpoint on the deal pipeline today. Is it richer than it's been given some of the -- given the sell-off in the market? And in particular, just kind of give us a flavor of kind of appetite for kind of size of deals, kind of what you're seeing in the pipeline? And I'd be interested, connected to your bioproduction business, whether or not the CMO industry or the CRO industry, I believe, 2 industries that you historically haven't maybe necessarily been interested from maybe given the recurring nature of the business or the capital intensity. I'm just wondering, is there any new viewpoint maybe given the complementary of some of those businesses?

Great. Well, let's start at the top maybe with how we think about the current environment. And I agree with you, we're in a period of dislocation for so many reasons. We were also in a period of dislocation here in the past 18, 24 months. In fact, even in 2021, we closed 14 deals and deployed over $11 billion of capital. So our funnels are very active. We can say that almost independent of the kind of environment that they're in, and they continue to be very active today. So this is a time certainly of opportunity. We always seem to find opportunity. And this time of dislocation today, it's still early days. We're in the early part of that dislocation. And so we'll see how that plays out. But we feel strongly not only about the quality of our funnels and the amount of deal activity that is in there but also our balance sheet positioning, 2x net debt to EBITDA here at the end of '21. I mentioned the $7 billion-plus free cash flow. So we feel like we're well positioned here to take advantage of the current volatility. And we'll see what happens with that. Now you're coming back to sort of the CRO, CMO question. And our portfolio, the way we're set up today is outstanding. I went on at length about it just a minute ago. But if you look at the fact that we have these business models that are razor-razorblade, we have 75% recurring revenue where this proximity to our customers informs our innovation funnels. We really like that kind of business, the margin profiles, the stickiness of it. That's really where we feel very comfortable. And we also see a lot of opportunity there. Now having said that, one of our core values is customers talk and we listen. We're in constant dialogue with our customers. And should they feel that they want us to be a part and play here to help them, of course, that's something we would consider, but recognize our preference is the scope that we have.

Got it. Okay. That makes sense, Rainer. So maybe back to comment you brought up in your introductory comments about the growth profile of the company. You basically characterized the long-term growth profile as kind of mid-single-digit-plus. One interpretation could be your '22 guidance of high single-digit organic, when you strip away the 2- to 3-point drag from COVID, which maybe that reflects the long-term growth profile. So just trying to understand a little bit, like is the mid-single-digit plus possibly more towards that 7% plus? Is that the right way to think about it? And maybe any color you could provide, what kind of underpins from a segment basis, kind of your long-term growth profile?

Sure. Well, first of all, let's level set on '22 and how we think about that. First of all, there, we're talking about our base business, so non-COVID testing -- or let me say it this way, COVID testing not included, growing high single digits. And that the COVID headwind represents about 200 to 300 basis points. So we're stepping down from the 60 million tests in 2021 to 50 million tests here in 2022. And that gives you a mid-single-digit growth. And quite frankly, we think that, that mid-single-digit growth in 2022 shows pretty well versus our peers and shows the strength of our business models and the strength of our base business. Now as you unpack that then, we see bioprocessing as a part of that base business in the high single-digit, low-double digit with strong activity levels. Yes, there's therapeutics and vaccines related to COVID. But as importantly or if not more so, the size of the monoclonal antibody market, which continues to grow, the number of projects there going through the pipeline is 50% higher than it was just 5 years ago. Cell and gene therapy projects that are making their way through the clinic and ultimately being commercialized, there is a huge amount of leverage in that funnel. And we feel that, that really is the most important aspect here to take away. So bioprocessing, high single digits, low double digits. And we've talked about that being a high single-digit business for the long term, exceeding our expectations when we originally acquired the business from GE, where we thought this might be a 6%, 7% kind of growth. Now the rest of the base business, if you look at that, here, we continue to see strong underlying customer activity. We have invested in innovation significantly, and we would expect to take share there as well. And then lastly, I talked about the testing headwind here, stepping down from 60 million to 50 million tests here in 2022. So if you look at that, you look at our fall through that is re-rated higher from a historical 30% to 35% to now 35% to 40%, we think we're really very well positioned here for the near term and the long term. And if you think of the very long-term, call it, the world in which COVID is endemic, we see ourselves there as a top mid-single-digit-plus player driving that double-digit-plus EPS growth on the basis of our cash conversion and our ability, and you mentioned this, to deploy capital to M&A with a focus and leverage that is really unique to us, all of which then is then buttressed by the Danaher business system, which shows that we can execute nearly in any environment.

Great. Maybe another one more high-level question. Inflation, obviously, in the wake of Russia's -- this awful situation that's unfolding overseas. Commodity prices have gone higher. The company has been constructive about the ability to kind of offset inflation vis-a-vis pricing, which I believe you talked about pricing up 150 basis points in the most recent quarter. And the guide for '22, I believe assumes the same, which is, I think you've talked about double historical pricing. So the question is, a, is there a need to even go higher on pricing? And do you have opportunity to do that if need be, given where commodity prices are? And then b, if you could comment just directly maybe what your exposure is to the affected regions with Russia and Ukraine? And directly or indirectly, is there any demand issues that are maybe unfolding maybe as customers are pausing, just given this global calamity?

Well, let me start with the back end of your question there, which is we are astonished and incredibly disappointed in what is going on in the Ukraine and the surrounding areas. What we're watching there is humanitarian crisis unfolding before our eyes. And really, and I say this in all sincerity, our hearts and prayers are out there with all of those people. And of course, we have been and continue to be in direct contact with our own associates in Ukraine and elsewhere to ensure that they're safe and, beyond that, have taken on humanitarian efforts. We have both as a company and together with our associates, contribute at this point and this continues to grow well over $1 million in order to help with the humanitarian crisis that is unfolding there. Huge tragedy and I'm sure all of you have your perspective on all of that as well. So we're doing what we can for our associates, which is the #1 priority. And then if we get to the business aspect of that, Dan, our exposure to the region, Ukraine, Belarus and Russia, it's right around 1% of what we do as a company and, as such, is not something that we're as focused on because we feel we have the ability to drive business elsewhere in order to offset that sort of thing. So for us, right now, the focus here is in taking care of our people and making sure that they're going to be all right here. Now to your related question on inflation because, of course, there's the impact, and we believe there will be already is an inflationary impact, particularly through energy pricing in -- from a macroeconomic perspective as it relates to this crisis. And we also believe that we can continue to responsibly offset costs driving the Danaher Business System on the one hand and, on the other hand, responsibly increase prices or surcharges where those are necessary in order to offset that. And so what we've said is, look, we did 150 basis points the last quarters here on price, and we would expect to do at least that here for the near term as well.

Great. Let's shift over to some of the businesses, in particular, bioproduction, where I've got a number of questions that are kind of consistent with kind of the layout that I had put on my own question. So I guess the first one is, when we think about the outlook for this $2 billion in COVID-related vaccine therapeutic revenues, which you've outlined for '22, which is consistent with what you did in '21. You've talked about that number being sustainable in the 23%, partly from -- directly from COVID. And also from any kind of slowing from COVID volumes would be made up by the fungibility of that capacity towards your base demand ex COVID. So I guess the first question is, can you comment on the $2 billion outlook? We've gotten a couple of questions here this morning just in light of one of your competitors in Europe last week, Merck. They kind of modestly lowered their outlook for EUR 900 million to something approaching EUR 900 million. I think they talked about this is in response to customer conversations that they've had. So I guess is it $2 billion value? Have you seen anything from customers in terms of slowing their COVID orders?

We have not. I mean we continue to believe that our backlog and our numbers are solid to be able to reach that and support that expectation that we put out there. And we continue to see orders coming in here for existing programs that have been very successful and new programs that are trying to address the complexities of the latest variants, whether that's from a vaccine or a therapeutic perspective. So we feel good about what that represents. But most importantly, we have seen that our non-COVID bioprocessing business is well into the low double digits in terms of growth as it has been in the last quarters. We continue to see that, that business is strong, continues to grow. And we've said that our COVID therapeutic vaccine business will be flattish year-over-year here. And I think that's still the right way to think about it so much so that we put that business into the base now and talk about bioprocessing, all in high single digits, low double digits for the year 2022. And that's the best way to think about it because it's just another modality of so many modalities in that business. And that team manages that fluidly and is able to deploy those capacities accordingly. So we feel really strongly that we're very well positioned there. Look, it's the widest and deepest bioprocessing portfolio in the world. We have more scientists, more salespeople, more of any sort of capability around the world than any other player here. So we feel well positioned.

Terrific. Rainer, that was helpful. And maybe just one follow-up, if you don't mind. Just as we look beyond '22, and that's where you've guided, but even into '23, just the question comes up, well, '23 could represent a further step-down in terms of COVID, but at the same time, as you mentioned, the base business and the backlog and the demand and the expanding modalities are very strong. Is there any reason to think at this point the high single digit for your overall bioproduction business isn't the right way we should be expecting the growth rate to unfold in '23?

No. I mean we -- I don't think anybody knows what COVID does with variants in 2023 and what new vaccines and therapeutics might be in development for them. But what we do see is the incredible strength that we see on the monoclonal antibody, cell and gene therapy, bispecifics and many other types of modalities in the biologic framework, if you will. And we see those really as the long-term drivers of the growth. And COVID is going to do what it does, but our team is going to continue to deliver that high single digits kind of growth here for the long term.

Got it. Got it, right. For the whole portfolio, with COVID, the whole piece, right, high single digit?

All up all in, all up all in.

Great. Great. Makes sense. Maybe just talking about the -- all the pieces that you have now in bioproduction. When you first did the GE deal, I don't think you've really baked in any revenue synergies back at the time, but our diligence suggested that there should be opportunities given the broader franchise that you have. And now you have Aldevron wrapped in. So I'm just wondering, can you discuss to what extent you are seeing cross-sell synergies and kind of help frame what this opportunity looks like for Danaher?

Well, first of all, let me start with -- we could not be more pleased with how these businesses have come on and transitioned into Danaher, whether that is Pall back in the day, Cytiva more recently, which you know was a triple carve-out out of GE and done in a pandemic. And this team is firing on all cylinders. And then the same goes for Aldevron, which in Q4 grew over 30%, and we still feel good about $500 million of revenue for them here in 2022 as well. So there, for sure, are cross-selling opportunities with Pall and Cytiva and where customers are looking for that, that's where that occurs, and that happens fluidly between those teams there. So we have processes in place that when a customer, in fact, wants to work across the entire value stream as opposed to solving a point opportunity, which either the one or the other could solve independently, they work together seamlessly to deliver a seamless value proposition. And we believe that we're taking share there in that area where that's required as well as in the individual modalities, right? Now as you think about Aldevron, there, the cross-selling is less of a factor because Aldevron, if you will, is an input to the process as opposed to a process equipment where you have consumables that help that process along. Of course, long term, we understand a great deal about plasmid manufacturing and for plasmid manufacturing with the capabilities we have in all and Cytiva can and do develop proprietary solutions, which make us stronger there and ultimately give our customers faster time to market with higher yields, for instance, in their viral vector manufacturing needs.

Great. Maybe just shifting over to diagnostics here. Cepheid, you have over 40,000 systems placed up from, I think, 20,000 prepandemic. So you've got the opportunity to capture a larger sale of the global -- larger share, excuse me, of the global market. What's the right way to think about like the durable growth rate for Cepheid within the long-term guide? I guess it would be the question.

Yes. Well, let's start off with the 40,000-plus systems that have been placed gives us, by far, the largest installed base out there in the world. And we have placed those systems strategically with the end in mind to help our customers beyond COVID so that they don't just have an asset there, which wanes and utility as COVID goes endemic, but that they have been available to them the largest testing menu both inside the U.S. with 20-plus tests and outside the U.S. with 30-plus tests. So this is a uniquely differentiated positioning. Now to date, of course, a lot of that capacity, if not most of it, is being issued for COVID testing. But we're already starting to see the green shoots of that COVID testing starting to wane and our customers starting to use some of that menu. But early days, really. So as you think about our positioning there for the long term, I'd frame it up this way. You heard me over press, I was in another session, just talk about how we think about what the endemic market looks like. So prior to COVID, the respiratory market was about $1 billion market, Dan. And it went to, let's call it, $25 billion-plus here during what we hope has been the peak of the pandemic. And our share went from 25% pre-pandemic to less than 10% during the pandemic. And as we now think forward and we've talked to a lot of experts bottom-up from our customers, they're framing that endemic market to be about $5 billion. So not the $25 billion plus, but $5 billion, but -- which is still 5x what it was prior to the pandemic. And we would expect our share to continue to be at that 25% level there in an endemic world. So that's how we see the COVID aspect of Cepheid. And then you have, of course, this large menu, which we are continuing to drive. So as you think about the long-term growth rate, how you think about Cepheid, we would expect them to return back to their low double-digit growth rate, albeit on a much larger base because you have a much larger respiratory business. Still, the market is 5x what it was before. And you have Cepheid representing not less than 5% of Danaher's portfolio, but 10% or so.

Great. Maybe one for yourself or for Matt, just on margins. You talked about the higher level of drop through, 35% to 40% versus, I think, pre-COVID, you were at 30%, 35%. So just give us a sense of what that translates into in terms of an absolute operating margin outlook for this year? And then as we think through that, if that higher level is sustainable, what does that imply for like annual margin expansion from the operating basis?

That's great. Matt, did you want to take that one?

Yes, I certainly can. I mean I think, Dan, like you said, we've sort of talked about kind of the re-rating of the growth profile from 30% to 35% -- sorry, re-rating of the growth profile, but we've also had a re-rating of the margin profile. And historically, I think we were sort of 30%, 35% kind of fall through. And given the fact that we've brought in the Cytivas of the world, the Aldevrons of the world. I think Rainer mentioned earlier that we sort of have a growth or a margin re-rating as well. And so I think now going forward, like you said, probably more 35% to 40% from a fall-through perspective. And I think if we think about what that looks like, I think it's probably that same 50 to 75 basis points core margin expansion, which is kind of on an EBIT basis. And the way I would think about it as well, Dan, that should help us to drive kind of, call it, double-digit OP dollar growth, which in turn is going to kind of feed through and drive that double-digit-plus EPS growth. So I guess I kind of -- I'd say that the re-rated growth -- got a re-rated margin profile to it that helps us drive whether it be kind of actual margin expansion or at least with the higher volume that we're going to see that higher OP dollar growth, which will also sort of really drive the earnings perspective as well.

Terrific. Well, I think with that, guys, we're at the 9:40 mark. So I really appreciate both Rainer and Matt and Danaher for being here. I hope you guys have a great rest of the conference and everyone on the video as well.

Thanks, Dan. Great job. Thanks for having us.

Take care. Bye-bye.

Bye.