Danaher Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter ended September 30, 2016; financial comparisons are against the quarter ended October 2, 2015. Unless noted, amounts are in U.S. dollars. The filing is unaudited.
Business context
Danaher completed the Fortive separation on July 2, 2016. Fortive’s businesses are presented as discontinued operations for all periods, so reported continuing-operations results reflect a smaller portfolio than in the prior-year comparison. Danaher now reports four segments: Life Sciences, Diagnostics, Dental, and Environmental & Applied Solutions. The 2015 Pall acquisition materially affects year-over-year comparisons, particularly in Life Sciences.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Sales | $4.132 billion | $3.512 billion | $12.298 billion | $10.111 billion |
| Gross profit margin | 55.3% | 53.9% | 55.6% | 54.5% |
| Operating profit | $699 million | $480 million | $2.022 billion | $1.511 billion |
| Operating profit margin | 16.9% | 13.7% | 16.4% | 14.9% |
| Net earnings from continuing operations | $403 million | $380 million | $1.406 billion | $1.226 billion |
| Diluted EPS from continuing operations | $0.57 | $0.54 | $2.01 | $1.72 |
Q3 sales increased 17.5%; existing businesses contributed 3.0% growth and acquisitions 14.5%, with currency having minimal effect. Nine-month sales increased 21.5%, comprising 2.5% growth from existing businesses, 20.0% from acquisitions, and a 1.0% currency headwind. Q3 net earnings including discontinued operations were $392 million versus $1.403 billion in the prior-year quarter, which included a large gain on the communications-business disposition. Nine-month net earnings were $1.807 billion versus $2.669 billion.
Cash flow and liquidity: Nine-month operating cash flow from continuing operations was $2.439 billion, up 29.1% from $1.889 billion. Capital expenditures were $422 million; management expected approximately $600 million for full-year 2016. Cash and equivalents were $971 million at September 30, 2016, versus $791 million at year-end 2015. Total debt was $8.312 billion, down from $12.870 billion; current debt was $809 million and long-term debt $7.503 billion. Danaher reported no borrowings under its $4.0 billion revolving credit facility and said it had approximately $2.5 billion of additional borrowing capacity under the facility and commercial-paper arrangements. It was in compliance with debt covenants.
Material changes and management commentary
- Q3 operating margin improved 320 basis points year over year. Management attributed the comparison to higher existing-business volume and productivity, absence of prior-year Pall acquisition costs and inventory fair-value charges, and a Q3 2016 gain on resolution of acquisition-related matters; acquired businesses’ net dilutive effect partly offset the improvement.
- Segment sales growth in Q3 was led by Life Sciences, which grew 64.5% (including 61.0% from acquisitions); Diagnostics grew 3.0%, Dental 3.5%, and Environmental & Applied Solutions 4.5%. Environmental & Applied Solutions’ nine-month operating margin fell to 23.4% from 25.2%.
- Danaher redeemed approximately $1.9 billion of notes in August and paid $188 million in make-whole premiums. It recorded a $179 million pretax extinguishment loss ($112 million after tax, or $0.16 per diluted share). The company expected annual interest expense to decline by approximately $92 million as a result of the debt repayments.
- A $223 million pretax gain on the sale of marketable equity securities ($140 million after tax, or $0.20 per diluted share) benefited nine-month results. The nine-month effective tax rate was 26.6%, versus 14.8% in 2015; $99 million of tax expense related to repatriation, legal-entity realignments associated with the separation, and other discrete items.
- Management said existing-business sales grew at a mid-single-digit rate in high-growth markets and low-single-digit in developed markets during Q3. It expected overall sales growth to continue, while noting macroeconomic and geopolitical uncertainty. The company estimated currency would reduce full-year 2016 sales by about 0.5% if September exchange rates persisted.
Outlook, transactions and risks
- Danaher agreed to acquire Cepheid for $53 per share in cash, at an enterprise value of approximately $4.0 billion, with closing expected by year-end 2016 subject to shareholder and regulatory approvals. It anticipated using cash and commercial paper. The company also disclosed approximately $4.8 billion of aggregate purchase-price commitments for acquisitions expected to close in Q4, including Cepheid.
- Management expected Cepheid to join Diagnostics and anticipated significant cost synergies. It also continued to target approximately $300 million in annual cost savings from integrating Pall; these are expectations, not achieved results.
- Management forecast a 21.0%–22.0% effective tax rate for continuing operations for the remainder of 2016, subject to earnings mix and discrete tax items. The filing did not provide a specific full-year sales or earnings forecast.
- A Danish tax dispute involved assessments of approximately $203 million, with a possible additional $120 million for 2010–2012 if the tax authority’s claims succeed. Danaher disputed the claims and said resolution could take years and materially affect results.
- Other risks include acquisition execution and integration, Fortive-related indemnities and separation tax treatment, foreign exchange, regulation, competition, debt and liquidity needs, and legal, product, cybersecurity, and pension exposures. Management reported no material change to previously disclosed risk factors.
Most important facts for investors to verify
- How much future revenue and profit growth is organic versus attributable to Pall and other acquisitions, and whether segment trends continue.
- Whether the Cepheid transaction closed on expected terms, how it was financed, and whether projected synergies materialize alongside the disclosed acquisition commitments.
- Underlying earnings after separating out the $179 million debt-extinguishment loss, $223 million securities gain, and separation-related items; also monitor the unusually variable tax rate.
- Whether cash generation, debt levels, and available credit remain sufficient to fund acquisitions, dividends, capital spending, and other obligations.
- Developments in the Danish tax assessments and other separation-related indemnity or tax contingencies.