Danaher Corporation — Q2 2016 Form 10-Q
Reporting period: Three and six months ended July 1, 2016; comparisons are with periods ended July 3, 2015. Financial statements are unaudited. Unless otherwise indicated, amounts are in U.S. dollars.
Business context and reporting period
Danaher reported five segments during the quarter. On July 2, 2016, it completed the spin-off of Fortive, comprising Test & Measurement, most of Industrial Technologies, and the retail/commercial petroleum business. Fortive will be presented as a discontinued operation beginning in Q3 2016; Danaher will then report four continuing-operation segments. The July 1 balance sheet still includes Fortive’s debt and assets and liabilities transferred in the separation.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Sales | $5.785 billion | $4.960 billion | $11.172 billion | $9.655 billion |
| Gross profit margin | 54.4% | 53.3% | 53.8% | 52.9% |
| Operating profit | $1.035 billion | $934 million | $1.917 billion | $1.690 billion |
| Operating profit margin | 17.9% | 18.8% | 17.2% | 17.5% |
| Net earnings from continuing operations | $657 million | $716 million | $1.415 billion | $1.274 billion |
| Diluted EPS from continuing operations | $0.94 | $0.99 | $2.03 | $1.77 |
| Effective tax rate | 32.2% | 21.2% | 29.7% | 22.1% |
Q2 sales increased 16.5%: existing businesses contributed 2.0% growth, acquisitions 15.0%, and currency translation reduced reported sales by 0.5%. First-half sales rose 15.5%, with 1.5% growth from existing businesses, 15.5% from acquisitions, and a 1.5% currency headwind. Q2 continuing-operations earnings and diluted EPS declined despite higher sales and operating profit, principally amid a higher tax rate and increased interest expense.
For the first half, operating cash flow from continuing operations was $2.055 billion, versus $1.631 billion. Investing activities used $166 million, including $335 million of capital expenditures and $105 million for acquisitions; financing activities provided $1.474 billion. Cash and equivalents were $4.098 billion at July 1, versus $791 million at year-end 2015.
At July 1, total debt was $14.652 billion, including $3.372 billion of Fortive debt; $2.645 billion was classified as current and $12.008 billion as long-term. Danaher’s balance sheet therefore reflected pre-separation consolidation. Total debt less cash was approximately $10.555 billion on that date, before the subsequent separation accounting. Danaher reported compliance with debt covenants and no borrowings under its revolving credit facilities.
Material changes and unusual items
- Life Sciences & Diagnostics sales grew 41.5% in Q2, largely reflecting acquisitions, including Pall; existing-business growth was 2.5%. Environmental sales increased 7.5%, Dental 4.0%, while Test & Measurement declined 3.5% and Industrial Technologies 0.5%.
- Q2 operating margin fell 90 basis points year over year. Management attributed the decline to acquired-business dilution, separation charges, growth investments, and currency effects, partly offset by volume and productivity savings. First-half margin declined 30 basis points.
- Danaher recorded a $223 million pretax gain ($140 million after tax, or $0.20 per diluted share) on the sale of marketable equity securities. This nonrecurring gain contributed to first-half earnings and cash proceeds of $265 million.
- Separation-related costs were $17 million in Q2 and $26 million for the first half. Danaher expected approximately $25 million of additional separation costs after July 1.
- Danaher received approximately $3.0 billion in net cash distributions from Fortive, funded by Fortive’s approximately $3.4 billion debt issuance. Danaher had repaid $500 million of notes due June 2016 and planned to redeem $1.85 billion principal amount of notes on August 15, 2016. It estimated a roughly $190 million Q3 make-whole charge, subject to interest-rate changes, and expected annual interest expense to decline by about $92 million following debt redemptions.
Outlook, management commentary, and risks
Management expected overall sales growth to continue but cited macroeconomic and geopolitical uncertainty. If July 1 exchange rates persisted, currency was expected to reduce full-year 2016 sales by approximately 0.5% year over year. Expected 2016 capital spending was approximately $600 million, excluding businesses transferred to Fortive. Following the separation, Danaher expected an effective tax rate of approximately 22% for the balance of 2016, subject to earnings mix and discrete tax items. No specific full-year revenue or EPS guidance is provided in the filing text.
Management cited expected annual Pall cost savings of approximately $300 million as integration progresses. Key risks include the uncertain Danish tax dispute: existing assessments were approximately $197 million, with potential additional assessments of approximately $116 million for later years if the tax authority’s claims succeed. The company disputes the claims. Danaher also warned that the Fortive distribution could be taxable if relevant representations or conditions are not met, and that separation-related indemnification obligations could be material. The filing also highlights uncertainty following the U.K. vote to leave the EU, foreign-exchange exposure, acquisition and integration risks, and other regulatory, litigation, market, and debt risks.
Most important facts for investors to verify
- Q3 reporting treatment and the post-separation balance sheet, including removal of Fortive’s debt and transferred businesses.
- Completion and actual cost of the planned $1.85 billion debt redemptions, including the estimated make-whole expense and expected interest savings.
- Whether underlying sales growth, margins, and Pall integration savings meet management’s expectations, given acquisition-driven reported growth and softer results in some businesses.
- Resolution and financial exposure of the Danish tax assessments, and the tax-free status of the Fortive distribution.
- Actual tax rate and currency impact for the remainder of 2016 compared with management’s estimates.