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Danaher (NYSE:DHR)

Q2 2010 Earnings Call

July 22, 2010 8:00 am ET

Executives

Matt McGrew - Vice President of Investor Relations

H. Culp - Chief Executive Officer, President, Director, Member of Finance Committee and Member of Executive Committee

Daniel Comas - Chief Financial Officer and Executive Vice President

Analysts

Wendy Caplan - SunTrust Robinson Humphrey Capital Markets

Richard Eastman - Robert W. Baird & Co. Incorporated

John Inch - BofA Merrill Lynch

Terry Darling - Goldman Sachs Group Inc.

Steven Winoker - Bernstein Research

C. Stephen Tusa - JP Morgan Chase & Co

Robert Cornell - Barclays Capital

Jeffrey Sprague - Citigroup

Julian Mitchell

Ajit Pai - Stifel, Nicolaus & Co., Inc.

Nigel Coe - Deutsche Bank AG

Operator

Good morning. My name is John, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the Danaher Corporation Second Quarter 2010 Earnings Results Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Matt McGrew, Vice President of Investor Relations. Mr. McGrew, you may begin your conference.

Matt McGrew

Good morning, everyone, and thanks for joining us. On the call today are Larry Culp, our President and Chief Executive Officer; and Dan Comas, our Executive Vice President and Chief Financial Officer.

I'd like to point out that our earnings release, a slide presentation supplementing today's call, our second quarter Form 10-Q and the reconciling and other information required by SEC Regulation G relating to any non-GAAP financial measures provided during the call are all available in the Investors section of our website, www.danaher.com, under the heading Earnings and will remain available following the call. The audio portion of this call will be archived on the Investors section of our website later today under the heading Investor Events and will remain archived until our next quarterly call. A replay of this call will also be available until July 27. The replay number is (888) 203-1112 in the U.S. and (719) 457-0820 internationally. The confirmation code is 6884014.

During the presentation, we will describe certain of the more significant factors that impacted year-over-year performance. Please refer to the accompanying slide presentation, our earnings release, our second quarter Form 10-Q and other related presentation materials supplementing today's call for additional factors that impacted year-over-year performance.

I'd also like to note that we'll be making some forward-looking statements during the call, 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 SEC filings. It is possible that actual results might differ materially from any forward-looking statements that we might 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 statements whether as a result of new information, future events and developments or otherwise.

With that, I would like to turn the call over to Larry.

H. Culp

Matt, thanks. Good morning, everyone. I'll begin this morning by giving some color around what we are seeing across our businesses and end markets to give you a framework for our solid second quarter results and our outlook for the balance of the year.

We continue to see encouraging signs across the global economy. We grew 14% in the second quarter on a core basis. Our core growth was broad-based with Professional Instrumentation growth of 19%, Industrial Tech growth of 15.5% and Med Tech coming in up 4.5%. Our enhanced commitment over the last several years to organic growth, both in the form of the expansion of the Danaher Business System, as well as increased investments in new product developments and sales and marketing initiatives is evident in this solid core growth performance.

As a result of these efforts, we continue to capture market share in many of our businesses. Leica, DEXIS, Hach Lange, ChemTreat, Gilbarco Veeder-Root and Radiometer are among the businesses where we believe we are taking market share.

Geographically, emerging markets were our best performers, up more than 25% in the quarter. Emerging markets now represent about 20% of total sales, up 16% from three years ago, representing a low teen compounded annual growth rate. The U.S. grew low double digits, and Europe was up high single digits. Given the recent headlines in Europe, we've been paying particular attention to that region. By and large, what we saw on the quarter suggested that our Western European business, which is largely dependent on Germany, France, the U.K. and the Nordics, is healthy. But we are again watching that space very carefully.

The quality of the core growth was evident in the outstanding margin performance in the quarter, with our core operating margin improving year-over-year by over 300 basis points, which, when combined with our sales growth, resulted in second quarter adjusted EPS up 40% over the prior year.

So with that as a backdrop, let me move to the details of the quarter. Today, we reported second quarter GAAP earnings per diluted share of $0.55, up 25% year-over-year. Adjusted net earnings per diluted share was $0.56, up 40% year-over-year. Our EPS performance reflects the 2-for-1 stock split, which took effect in June.

Revenues for the quarter increased 24% to a record $3.3 billion, with core revenues up 14%. The impact of currency translation decreased revenues by 1%, while acquisitions contributed 11% to sales growth. Year-over-year gross margin for the second quarter increased 230 basis points to 49.5%, largely due to higher sales volumes and the benefit of our 2009 restructuring initiatives.

Operating margin in the second quarter increased 320 basis points year-over-year to 16.1%, resulting from higher sales volumes and the benefit of our prior year's restructuring initiatives. Year-to-date, the operating cash flow was a record $932 million, a 16% increase year-over-year. Free cash was $839 million, and our free cash to net income conversion ratio was 125%. This outstanding cash flow performance is due principally to the quality of our growth and our team's solid execution on working capital.

During the quarter, we completed six bolt-on acquisitions with aggregate annual revenues of approximately $60 million, strengthening our Test & Measurement, Life Sciences & Diagnostics, Dental, and Sensors and Control businesses. We believe the M&A environment remains attractive, and we currently have more than $2 billion of additional M&A spending capacity to expand and strengthen our portfolio, and our obvious focus continues to be on our five growth platforms.

Now turning to our operating segments. Professional Instrumentation revenues increased 23% for the quarter, with core revenues up 19%. Operating margin for the second quarter increased 660 basis points to 21.7%, primarily due to higher sales volumes and the benefit of the prior-year restructuring initiatives.

Our core operating margin was up 440 basis points in the quarter. Our environmental platform revenues increased 18.5% in the quarter, with core revenues up 15.5%. Water Quality core revenues increased at a low double-digit rate in the quarter. The Hach Lange core revenues grew to low teens rate with solid industrial demand for our lab and process instrumentation and consumables and improved demand from customers in the electronics industry.

Sales were strong across all major geographies, with particularly robust results across the emerging markets, which now represent almost 30% of the overall business. Trojan core revenues were up modestly in the quarter as the difficult year-over-year comparison resulting from the New York City drinking water installation project obscured solid growth elsewhere in the business. Demand was robust for industrial and residential applications, and we are very encouraged by the recent municipal bookings activity.

We recently launched our solo UV green technology solution, which offers our customers a strong value proposition, high ultraviolet output for disaffection with energy efficiency to reduce power consumption and their carbon footprint.

At ChemTreat, second quarter core revenues were up low double digits, with broad-based growth across all major industries and particular strength in our cooling water applications. We believe we continue to capture market share as we accelerate our investment in ChemTreat's go-to-market model, and we've been pleased with the early results from our expansion into Canada and Latin America.

Gilbarco Veeder-Root's second quarter core revenues increased more than 20% year-over-year, with sales at Gilbarco up double digits across all major product categories, partially offset by a decline at Veeder-Root due to a difficult year-over-year comparison with our 2009 California Vapor Recovery Program.

Customers continue to invest in our Passport Point-of-Sale systems and outdoor payment solutions in North America, while dispenser demand has been robust globally.

Moving to Test & Measurement. Revenues increased 32% in the quarter, with core revenues up 23%. Fluke core revenues increased more than 20% in the quarter, with solid demand in all major geographies for our core industrial and thermography products, including our new TiS, a thermal imager in the Building Diagnostics segment available at a sub-$3,000 price point.

European demand increased significantly from the prior quarter, driven by sales of our new Ti32 thermographer and overall strength in distribution. We've been particularly pleased with our go-to-market efforts in Eastern Europe, with additional feet on the street and channel expansion initiatives driving greater than 30% growth during the quarter.

In June, Fluke acquired the Ruska and Pressure Measurements (sic) [Ruska and Pressurements] product lines of Druck Inc. Based in Houston, the businesses provide high-performance solutions for pressure test and calibration applications, complementing Fluke's existing calibration offerings.

Tektronix core revenues grew more than 30%, led by robust global sales of oscilloscopes and other bench top instruments. All major geographies were up at least 25%.

In June, Huawei, one of China's largest telecom companies, presented Tektronix with its Best Supplier Award, selected from more than 15 under suppliers. The award was voted on by all Huawei purchasing and R&D technical selection committee members and recognizes TEK's outstanding pre-sales, after-sales and technical support.

For those captivated by the World Cup television coverage for the past month, you have Tektronix to thank for the quality of your viewing experience. Over $1.5 million of Tektronix waveform monitors and other video testers were used throughout the games by broadcasters and systems integrators to support the quality of programming and enhanced the viewer experience.

Tektronix augmented its R&D efforts with two important product line acquisition in the quarter. SyntheSys Research, based in Menlo Park, California, is a leading developer of bit error rate testing scopes, otherwise known as birth scopes, which perform high-speed signal integrity Test & Measurement analysis and largely sell into TEK's existing customer base.

Mixed Signals is a leading technology provider in the digital video and audio monitoring for digital television operators and media providers. This acquisition expands our presence in the attractive IP Internet protocol video Test & Measurement market, which continues to grow with the expansion of broadcast services requiring greater bandwidth and monitoring.

Core revenues for our Fluke Networks and TEK Communications businesses collectively grew to mid-single-digit rate in the quarter, with mid-teens growth of core enterprise solutions at Fluke Networks, partially offset by the timing of large mobile carrier network management installations at TEK Communications compared to the prior year. The rollout of our new GeoProbe G10 platform to address high-bandwidth interfaces, and data center applications continues to be well received by mobile operators and is expected to help drive growth for the remainder of this year.

Moving to Medical Technologies. Revenues for the quarter increased 31.5% compared to the prior-year period, with core revenues up 4.5%. Med Tech core operating margin for the second quarter increased 100 basis points on a year-over-year basis as a result of higher sales volumes and the benefit of restructuring initiatives implemented in 2009.

Our overall operating margin was down due to the adverse impact of AB SCIEX acquisition-related costs. Our dental platform revenues increased 10.5% in the quarter, with core revenues up 2%. Cable revenues increased at a low double-digit rate in the quarter, with particularly healthy demand for our imaging products, including 3D and our new intra-oral sensors.

Sales expanded in most major geographies, led by the U.S. and Europe. I'm very pleased with our year-to-date improvements in both sales and margins at cable. We expect this good top line performance to continue in the second half, largely due to new product introductions and improving end-user demand.

Sybron core sales were down mid-single digits in the quarter, with strong sales of our orthodontia solutions more than offset by soft sales of general consumables due to inventory destocking in our U.S. distribution channels. However, sellout of our general consumables continues to be positive, and we expect a sequential improvement in the third quarter and a return to historical growth rates in the fourth quarter.

Moving to Life Sciences & Diagnostics. Revenues increased 55% in the quarter, with core revenues up 7.5%. Leica Microsystems core revenues grew at a low single digit rate in the quarter, driven by sales of compound and stereo microscopes in the U.S. and Europe.

We are pleased to report that our SCN400 Slide Scanner and SL801 Autoloader recently received industry awards for the Best Scan Speed and Best-Focused Images, respectively, during the European Scanner Contest held at the International Conference on Virtual Microscopy in Berlin. This recognition is particularly meaningful for Leica as they just recently entered the digital pathology scanning market.

Leica Biosystems core revenues increased at a low teens rate in the quarter, with robust demand for our advanced staining systems and consumables. We saw double-digit growth across all major geographies. We continue to see excellent customer response to our BOND-III advanced staining system that was introduced in the fourth quarter of last year. Our Advanced Staining Consumables business should continue to benefit from the growing BOND-III installed base.

Radiometers core revenues grew at a low double-digit rate for the quarter, driven by solid demand for our blood gas diagnostic instruments and consumables across most major geographies, with particular strength in Asia and Europe. Demand for our ABL90 FLEX, which we launched last quarter, is quite strong. The rollout of AQT in Europe is progressing well with a key customer win at Berlin, Charité, the largest university hospital in Europe.

During the quarter, we launched the Troponin T parameter for AQT, which can be used to test several different heart disorders, including acute myocardial infarction. Product approval is still pending for all of these new products in the U.S.

We are very encouraged with the ongoing integration efforts at both AB SCIEX and Molecular Devices. One of our first major success stories at AB SCIEX has been the introduction of the new TripleTOF 5600 mass spectrometer. We launched this system in May at the Annual ASMS Conference, and early customer feedback has been great. The 5600 is the fastest and most sensitive high-resolution mass spectrometer for high-performance qualitative and quantitative analysis on a single platform. AB SCIEX's commitment to innovation and developing cutting-edge technology is clearly evident in the 5600. We look forward to sharing more successes like this with you in the future.

Molecular Devices has been active as well. It recently completed its first bolt-on acquisition with the PARADIGM and DTX Microplate Reader platforms from Beckman Coulter, which address both the Modular and Standard Multimode Reader segments and complement Molecular Devices' current product portfolio.

Moving to our Industrial Technologies segment. Revenues increased 18.5% for the quarter, with core revenues up 15.5%. Operating margin for the second quarter was 20.4%, a 470 basis point increase compared to the same period last year due to the benefit of restructuring and cost initiatives implemented in 2009, as well as the higher sales volumes in the segment. Our core operating margin increased 330 basis points in the quarter.

Product Identification revenues were up 22.5% in the quarter, with core revenues increasing 15.5% with strength in both our marketing encoding systems and the related consumables. Emerging markets led the way with 20% growth, and we also saw a sequential improvement in both the U.S. and Europe.

Motion core revenues were up 34% in the quarter, with significant year-over-year and sequential growth in all major geographies and business units, with particular strength in industrial automation, electronic assembly and elevator end markets.

During the quarter, our Thomson business captured significant new opportunities in Eastern Europe, in each case replacing local or low-cost region suppliers.

During the quarter, our Sensors and Controls business acquired IRIS Power. IRIS, headquartered in Toronto, manufactures online and offline condition monitoring products for large generators and motors, complementing our Qualitrol product offering.

And finally, moving to Tools and Components. Revenues for the quarter increased 19%, with core revenues up 20%. Operating margin for the quarter was 15.2%, an increase of 70 basis points from the prior year.

Mechanics' Hand Tool core revenues grew 13.5% in the second quarter, with solid sales to both the retail and professional channels across all major geographies. Sales of our domestic China tool brand, Sata, grew at a double-digit rate, and our Niche Tool business has also performed well in the quarter.

Subsequent to quarter end, we completed the strategic joint venture with Cooper Industries to combine our Tool businesses. This new company, called Apex Tool Group, offers industrial, commercial and do-it-yourself customers an unparalleled selection of over 30 leading brands. We look forward to going with Kirk [Kirk S. Hachigian] and the Cooper team to help drive the long-term value creation we both envision for our shareholders, customers and associates. Beginning here in the third quarter, we will deconsolidate the financial results of the businesses contributed to Apex and record them based on the equity method of accounting.

So to wrap up, we are very pleased with our execution in the quarter. With the Danaher Business System, we believe we are well positioned here in 2010 for continued outperformance. We are initiating third quarter 2010 adjusted earnings per share guidance this morning of $0.50 to $0.55, which, at the midpoint, represents an 18% increase year-over-year.

For the full year 2010, we are increasing our adjusted earnings per share guidance from the prior range of $2.12 to $2.20 to a new range of $2.16 to $2.23. The new full year range includes approximately $0.04 of dilution resulting from the Tools joint venture, but excludes the gain that we'll recognize in the third quarter.

Matt McGrew

Thanks, Larry. That concludes the formal comments. John, we are now ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We will take our first question from Bob Cornell with Barclays Capital.

Robert Cornell - Barclays Capital

So the 14% organic growth, Larry, could you go back and talk a little bit about how that developed? Did they accelerate through the quarter? I heard some of the comments, maybe just expand on that a bit, please.

H. Culp

I think as the quarter played out, it was solid all the way through. We saw double-digit comps year-on-year up, and that was encouraging to see. Obviously in June, we finished strong. If we did a little bit better in some places than others than we had anticipated, certainly, in Professional Instrumentation, we saw both TEK and Fluke do well. TEK clearly leading the way there, had just a very strong, very strong quarter, and I would also point out in Industrial Tech, what we saw both at Product Identification and frankly, Motion was a bit better than expected and very solid through the course of the quarter. I think that as we mentioned, we are very encouraged with what we've seen at cable, both from a top line and bottom line performance. But if you just look at top line performance in the second quarter, they were particularly strong through the quarter. I think, in the prepared remarks, we mentioned the imaging products, particularly 3D and intra-oral, I think we're seeing docs come back in the market investing in technology, investing in their practices and given the line up there that we have, both here and frankly, Europe, we couldn't be better positioned to take advantage of some of that additional investment on their part.

Robert Cornell - Barclays Capital

Yesterday, The Financial Times ran an article about Danaher potentially divesting the Aerospace & Defense business. Any comment on that? And what will be the reason for selling that, if that's correct at this point?

H. Culp

Bob, as you well know, we tend not to comment on rumors, printed or otherwise, and I think we're going to stay to that. But you're asking about our A&D businesses, those are very good businesses for us. As you know, they've been strong contributors really ever since we began to put that group together a decade ago. I think we're seeing an uptick in their performance as well, particularly at Pak side here of late. So I think they're in position to have an improved second half, and we're looking forward to that performance.

Operator

We'll take our next question from Steve Winoker with Sanford Bernstein.

Steven Winoker - Bernstein Research

So a first question, just around the organic growth number, so that was down 15% last year and up 14% this year. I'm trying to get a sense particularly in light of your comment around dental destocking, about how much of this is sort of your estimate of restocking versus other factors, however split between share gain, et cetera. I know some other CEOs are always trying to get at this number. How do you guys look at that right now? Do you feel like there's any tailwind in this at all?

H. Culp

Well, I think if you're asking, Steve, specifically about the destocking that we have seen in dental, particularly at dental consumables, which is where the channel inventory topic I think is more relevant. I think what we've seen through the first six months, and this is not something that has happened to us, we've been working this with our channel partners, is we've been trying to be smarter about where our inventories are. We do that every time we work with distributor partners, and while we do that, we're trying to make sure we drive sell-through with them very effectively. So as I mentioned, when we look at Sybron, clearly, we would have liked to turn in a better number. I think what I focused on through the quarter was the sell-through, which was particularly good on the specialty side, particularly in ortho. The consumables sell-through was positive, but we were taking inventory down. So that hit us in the second quarter. That will moderate but continue in the third quarter. I think by the fourth quarter, Steve, you'll hear us talking about consumable Sybron at large being back to more normal growth rates, in part because the destocking will have run its course, but also in part, frankly, with how we're ramping on some of the new products. Stain and clear for example, really, is just turning onto the next phase of its ramp here in 2010. So I think we're well positioned, really, nothing there that is unexpected or of concern to me at this point.

Daniel Comas

And, Steve, we don't try to calculate how much of the 14% was share gain. Larry and I were out with most of our businesses this past quarter, and we're pretty confident that both Hach Lange and ChemTreat continue to take share. That's also true of Radiometer. I would add both Kollmorgen and Thomson to that and that may be a more recent phenomenon in the last six months. I'm very pleased with how they're doing, and based on the numbers they have in their comps, we believe we're taking some share as well. Double-digit number at cable, I think these new products are helping us. We may be back in position to taking share there as well, but we don't try to calculate how much of the 14% was share gain.

Steven Winoker - Bernstein Research

Well, I'm more interested in how much of that 14% was restocking. I mean, do you have an idea of that?

Daniel Comas

Steve, we think it's modest. I mean, maybe it's a point or two.

Steven Winoker - Bernstein Research

And then the second point there, you mentioned municipal bookings being up in environmental. Is that stimulus-driven? Are you seeing that sort of working its way through the municipalities from federal funds, are you -- what is that? Or driving that?

H. Culp

Steve, we really don't think that we've seen any positive effect in our Water business from any federal stimulus, either here in the U.S. or frankly, throughout Asia. By the same token, we haven't really seen any negative impact from any of the austerity concerns in Europe. That business has demonstrated a level of stability and predictability that we've come to count on and thus far, no benefit and no negative impact.

Steven Winoker - Bernstein Research

Just two more. One is you have no unusual restructuring beyond that $10 million-ish per quarter that you normally do. Many of your peer companies are continuing to press restructuring agendas very hard to drive future earnings growth, and how do you guys think about that? I mean, you're really sort of kind of delaying it. Is it because you're still kind of processing everything that's happened to date? Or from an investor standpoint, how should we think about that going forward this year?

H. Culp

Well, Steve, I think we're always in restructuring mode. Obviously, given the activity that we initiated in 2008 and pushed through hard in 2009, we got a lot accomplished. I think you'll see the benefit of that in our year-over-year and incremental margins here. But we continue to do some things, and I think as we look at the second half, there's some larger projects as well that are certainly under review. But again, in the spirit of Kaizen, we're always doing that whether we are talking about it in the way that we did last year. Obviously, we don't want to be in that position with frequency. But don't, for a moment, think that we're ever done in that regard.

Steven Winoker - Bernstein Research

And then just a quick technical question here. On the payable side and when you break out the working capital, it just look to me like payables are up and driving part of that benefit. Anything going on with suppliers there that we should be aware of?

Daniel Comas

Nothing of note. Just the higher purchases versus where we were a year ago.

Operator

We'll take our next question from Jeff Sprague with Vertical Research Partners.

Jeffrey Sprague - Citigroup

Just a couple of things. First, just on -- back to dental for a moment, Larry. There's been a little bit of noise that perhaps there's a channel shift towards private label on consumables. Is that part of the equation on what's going on here at all?

H. Culp

Not in my opinion, Jeff.

Jeffrey Sprague - Citigroup

And then you talked about a return to historical growth in Q4. I guess there's a little bit of question on really what is the historical norm for that business. What do you view as kind of the historical kind of normalized growth rate for that business?

H. Culp

Jeff, I didn't mean to be unclear on that point. I think Sybron, in a typical period, is going to be a mid-single digit grower with obviously a lot of our efforts around new products, around international expansion aimed at lifting that number. But we're not talking about that moderation in the third and return to normal growth in the fourth. I'm really suggesting we should be back at least in the mid-single digit range by year end.

Jeffrey Sprague - Citigroup

Just thinking about the forward guidance, can you give us some indication of what your view of back-half organic growth is embedded in the EPS guidance?

H. Culp

Sure. Well, I think when we look at the full year, at this point, we really think we're going to be at a high single digit level in terms of core. What that probably means, Jeff, by quarter, in the third, I suspect we're up high singles, we could hit 10% but I'd band it like that. I think as we look at the third, it will play out by and large, not unlike the second quarter. I think we'll see T&M, I think, lead the way here again. I think Motion and PID and Industrial Tech should be up low to mid-teen. Environmental should be solid as well, probably up mid-singles, and I think Med Tech, in part because of that moderation I referred to a moment ago, should be up mid-single digits. Obviously, the comps get a little tougher as we go through the second half. I think in the fourth quarter, I probably would call it mid-singles at this point. We're not seeing any of the negative headline or some of the market in our order books, in our conversations with customers just yet. But I think everybody's probably a little cautious the further out we get. But right now, call it high singles for the year with the quarters breaking out like that.

Jeffrey Sprague - Citigroup

And also just on Motion, that deal you did in the quarter was probably quite small, but I can't recall a deal in the last couple of years in Motion. There's been some questions about just the kind of strategic importance of Motion overall, perhaps this Pak size speculation has caused some confusion on where you're heading with that business. But can you comment on Motion in general and kind of the strategic imperative for that business, and where that might be heading over time?

H. Culp

Jeff, just to be clear, I think the acquisition that you're referencing, the IRIS Power acquisition, is really within our Sensors and Controls group, one of our niche businesses. Probably the best business we have there is our Power Quality business, Qualitrol. And from time to time, Qualitrol has actually been a silent but savvy acquirer building out on their instrumentation position, primarily, in T&D. And IRIS gives them some online and online capability, which is quite synergistic with what they're doing, so no real change there. From time to time, we do some things with them and we get nice bumps and growth, and frankly, very nice returns. With respect to your question about Motion, as we've talked before, that's a very strong business. I think Dan and the group have done an excellent job driving margin expansion. You see that again here in the second quarter. I think we really are seeing the fruits of the teams' investments and their labors here the last couple of years, and being just more effective in driving design wins, and in turn, share gains, particularly as the market picks up here. So both at Kollmorgen and Thomson, we're very pleased with that performance and continue to, I think, have high expectations for those businesses going forward.

Jeffrey Sprague - Citigroup

AB SCIEX pro forma organic, how is that growing?

H. Culp

Well, I think as we get the new 5600 out, when we've launched that product, Jeff, we have not shipped it yet. We'll begin shipments later this year. We would expect to see SCIEX up here for the year in the mid-single digit range. So all in all, I think we're pretty much where we thought we would be at SCIEX. It's an important launch for us. We're ready to get that product out. Customer evals are underway and knock wood here, the feedback continues to be net positive.

Operator

[Operator Instructions] Our next question will come from John Inch with Merrill Lynch.

John Inch - BofA Merrill Lynch

Could you just remind us how big the collective of your Aero and Defense businesses are? And roughly, is the profitability at the corporate level are above or below?

Daniel Comas

It's about $700 million in revenues and pretty much in line with the overall company profitability.

John Inch - BofA Merrill Lynch

Last quarter, Larry, you did actually talk about, I think, some of what you were seeing in Greece and some of the non-Northern European countries. Could you remind us -- or maybe, Dan, you have these numbers? Like, how big are Danaher's revenues in non-Northern Europe, and say, non-Eastern Europe? And has there been any kind of change there from the first quarter that you would call out?

Daniel Comas

John, I don't know the exact number of Southern Europe, but it's a small percentage of our European business. It's obviously a small percentage of the overall European economy, and we're particularly heavy in the north. We really haven't seen a lot across the businesses. Europe remained strong throughout the quarter. We actually had very strong June throughout Europe. We're watching it carefully, but we are not seeing much.

John Inch - BofA Merrill Lynch

In your guidance, has there been any, kind of, an update with respect to electronic supply lines? I'm thinking, perhaps, does it affect some of your medical products? You see any kind of a softening associated with that, from kind of, what you saw before? Or are you sort of been able to manage the situation? What's going on there?

Daniel Comas

We're clearly having supply chain issues across a number of our businesses, not just Med Tech. Anything with an electrical component, electronic component, whether it's PID or Gilbarco or Test & Measurement, it hasn't turned out to be a big issue within a quarter, and maybe with month-to-month, we've had some challenges. But we've been able to manage it, at least, on a quarterly basis, but we're clearly having to buy ahead a little bit more, wait in line for some products. So I don't think it's any worse in the last six months ago, but it continues to be a, probably, our biggest kind of operating challenge right now.

John Inch - BofA Merrill Lynch

But your guide, Dan, does not assume some, sort of, demand hold-back because of product constraints associated with the supply chain incrementally, does it?

Daniel Comas

No.

John Inch - BofA Merrill Lynch

Dan, I think you had talked before, given how robust your results have been about some incremental spending on R&D, feet on the street. Could you just -- obviously, there's a lot of macroeconomic uncertainty. What's your latest thinking there? I mean, and how would you maybe -- are you able to even quantify some of these spending headwinds, if you want to call them that, heading into the second half but may be embedded in your guidance?

H. Culp

John, maybe I can take that. I see that opportunity, not headwind. And I think what we try to do with the updated guidance here is obviously suggest, as I referenced in my response to Jeff's question, we'll see a moderation in our core growth in large part because of the comps. We think that still gives us plenty of opportunity to increase our growth investments, increase them versus what we had budgeted, increase, frankly, versus what we had done in terms of taking those numbers up earlier in the year. I think you'll see part of that in the moderation of the incremental margins through the second half. We'll still be up, call it 35%, 40% year-on-year as that restructuring and that volume course through the P&L. But we're going to take every opportunity to continue to step up, where we see good potential, both in technology and innovation and on the go-to-market side to drive growth for '11 and '12 because we're going to be here. And I think that it's just the way we're going to manage the business.

John Inch - BofA Merrill Lynch

And do those pay [ph] equally in the third quarter and fourth quarter? Or does it ramp through to the fourth quarter?

Daniel Comas

Whole [ph] ramps. If you look at our, kind of -- maybe the best way to think about the fall through, which was about almost 50% in the first quarter, it was slightly over 40% in the second quarter. And this is stripping out acquisitions and FX. And we think it'll be in the 35% to 40% range in the back half, so maybe closer to 40% in the third quarter, and maybe closer to 35% in the fourth quarter.

Operator

We'll take our next question from Steve Tusa with JPMorgan.

C. Stephen Tusa - JP Morgan Chase & Co

The Med Tech result was pretty weak, and I think you've gone through a little of this, but it's kind of tough for us with an ongoing facelift there, as you integrate acquisitions. Is there any way for you guys to, maybe, give us a little more granularity around what, maybe, over the next 18 months these margins can move to, so that we have a target to be able to better model this business? And maybe, what are the leverages? Is it really just the consumables on dental that get you there, or is there more heavy lifting on the cost side you need to do?

H. Culp

Steve, I think that with respect to the second quarter, I was actually very pleased with the margin performance in Med Tech. Let me just break that down, so we're all on the same page. On a core basis, if we start there, we were up 100 basis points in the second quarter, just as we were in the first quarter. And as I mentioned, I mean, cable was, I think, quite strong. They were up 300 basis points year-over-year. And as we look at the second half, again, on a core basis, we think we drive better operating margin expansion through the second half. And I just think that's the execution and the volume coming together to drive that. Now obviously on the print, what you get is the M&A impact and keep in mind, it's not the M&A impact just from SCIEX and molecular devices. We've also had two bolt-ons in that space with Genetix and Exogen, which come in. You've got the non-cash acquisition charges diluting that margin. Clearly, there's been some restructuring activity in there as well, headcount reductions and the like. And third, I'd just call out the one-time transition expenses at SCIEX. You'll recall this is a fairly complicated decoupling from two parents, so you've got IT systems that are being transitioned. You've got other one-time expenses, like leases that are being broken to stitch this business together to create the growth powerhouse that we think SCIEX can be. I think as we look out, which I think is important to your question, in the third quarter, I think you'll see us up sequentially, probably somewhere in the order of 250 basis points or more. So that should take the out margin up to the 10%, 10.5% plus range. I think you'll see incremental sequential performance improvement in the fourth quarter. On top of that, probably the same tune, we'll call it 250 bps plus, which I think puts us at a position at the end of the year where those businesses are back to a trajectory, very much in line with expectation. And I say that just back to prior conversation, all the while, I suspect we will sequentially be stepping up some of our growth investments all the while. So hopefully, that provides a little bit of clarity, but again, I think from the execution level, very strong second quarter, and I think a good outlook here in the second half for Med Tech.

C. Stephen Tusa - JP Morgan Chase & Co

With regards to the acquisition pipeline, anything -- has the flavor changed at all over the last couple of months with the recent financial market volatility, whether it's regards to number of properties, size of properties, how do you characterize that for the back half of the year?

Daniel Comas

Steve, there's still a lot out there to look at. A lot of discussions going on. The volatility in recent months has probably helped on the margin. I think the concern about higher tax rates in 2011 is helping as well, so we're looking at it a lot right now.

Operator

We'll take our next question from Nigel Coe with Deutsche Bank.

Nigel Coe - Deutsche Bank AG

Just wanted to follow-up on the Med Tech margins. The 2.7 points of M&A dilution, which I understand doesn't include restructuring and all the non-cash, it's a bit heavier. And it suggests that the contribution from AB SCIEX from Molecular Devices and the two bolt-ons was virtually zero. Is that correct? And how does that change at the back half of the year?

Daniel Comas

Nigel, they were positive, but not meaningfully so. As Larry pointed out, there's a lot of restructuring going on, which we're not calling out separately. There's a fair amount of, kind of, one-time transition expense, which will continue through the balance of the year at SCIEX, but we took a big chunk of that in the second quarter. So this step-up of 250-plus basis points in Q3 and another 250 in Q4 reflects both operational improvement in those businesses, as well as, kind of, much incrementally less restructuring and one-time transition expense.

Nigel Coe - Deutsche Bank AG

Just to be clear, the 85 bps and the reconciliation, that's GAAP restructuring, whereas pay-to-go restructuring is within the 255?

Daniel Comas

That restructuring is a prior-year restructuring.

Nigel Coe - Deutsche Bank AG

And then turning to the guidance, I'm just looking back over the last six, seven years and 3Q EPS is always higher than 2Q EPS from a seasonal perspective. And obviously, you're guiding for it to be flat down. Can you maybe talk about that and maybe still into that conversation, the full sense of dilution from Tools, how that phases? And is that all non-cash innovation?

Daniel Comas

Maybe starting on the Tools piece, the $0.04 of dilution that we expect in the second half in our guidance, should be roughly $0.02 a quarter. It is a combination of the non-cash charges, a big piece of which is the inventory step-up, which impacts, primarily Q3. But in addition, we're pretty happy with the way the teams come together here, and we're going to let them go after some activities and cost reduction activities in the second half. And that's reflected in that dilution number as well. In terms of sequentially, if you look historically, stripping out acquisitions and FX and now stripping out DTG, revenues tend to be flat to slightly down Q2 to Q3. We're looking at that same dynamic here, so no change from previous years. Obviously, it got stronger sequentially in Q3 '09, but if you look back, '06 to '08 tends to be relatively flat. You layer in the dilution from the JV, as well as, kind of, the step up in the incremental step up in growth investment, kind of gets you to a relatively flat to slightly.

Nigel Coe - Deutsche Bank AG

For the industry step-up in 3Q on the JV, that's going to be within the guidance?

Daniel Comas

Yes, there are $0.04 of dilution covers. It covers everything and it's in the guidance.

Operator

We'll take our next question from Ajit Pai with Stifel, Nicolaus.

Ajit Pai - Stifel, Nicolaus & Co., Inc.

The first question is just looking at the emerging markets, I think you pointed out that as a percent of revenue, what it is, could you give us some color right now, one as to, what the impact of, sort of, Chinese labor costs increasing on the East Coast of China has had in your business? And how you're thinking about future instead of capacity expansion in the area?

H. Culp

Well, I think that for several years now, we've seen labor input inflation in China as we have on other emerging markets. We obviously have our biggest manufacturing and R&D footprint in China, so that's where it's been most relevant. I think we've just been able to manage through it. We're not, I think, ignorant or otherwise discounting what's in the papers recently, but that really has not had a material effect on our cost structure. And we don't anticipate it materially changing, the same going forward. In terms of our investment level, again, I think if we execute well with the core growth and the margin fall through, we're looking to put as many feet on the street in the emerging markets in terms of sales marketing service headcount as we possibly can. And that's not only in China, but really across the globe. And in turn, make sure that we have an appropriately local R&D and manufacturing capabilities to support those efforts. For us, it's been most pronounced in China, but not exclusively. And as you saw last year, there was some inorganic investments in Brazil and India, let alone, what we did organically. Those footprints are becoming much more global than they were, say, three or four years ago.

Ajit Pai - Stifel, Nicolaus & Co., Inc.

And the second question is just looking at carriers. I think you highlighted a video as one area of investment for your Test & Measurement business. Could you give us some color as to what you're seeing from carriers? I think you talked about some year-over-year comps being difficult there, but on the wireless and wireline side, you're actually looking at the increased investment? And how significant a driver of that overall business is video going to be?

Daniel Comas

Well I think that, if I answer it on, kind of, an all-out basis, including video as well as the other data drivers that are there, I think by and large, what we've seen is that the mobile carriers that we serve principally through TEK Comm, continue to wrestle with bandwidth constraints. Obviously, the iPhone, probably the best publicized story. The more of those that Apple sells, the more COGS some of the networks become. And that's good for us because we help clear those network problem. I think video, clearly, is a high bandwidth-consumption driver and more of this video IP that we see be in YouTube or otherwise, it's all good for us at TEK Comm. I think here in the short term, what we try to allude to in our prepared remarks, is that some of this business can be a little bit bumpy just because of installation and turn-on schedules. But these are amongst the most pressing problems our mobile carriers have right now. We're fortunate to be in there working with some of the best trying to solve them.

Ajit Pai - Stifel, Nicolaus & Co., Inc.

But would you say that you're at an inflection point, in terms of spending in this particular category, the beginning of a multi-year cycle of increased spending over there? Or do you think you're somewhat in the middle of a spending cycle there?

H. Culp

Well, I would characterize it, and again in broader terms, as being in the middle of that cycle because video is, but one, driver of bandwidth consumption. And those drivers in aggregate have been obviously pressuring networks, and that's really created demand for our products at TEK Comm. More video can only help.

Operator

We'll take our next question from Julian Mitchell with Crèdit Suisse.

Julian Mitchell

The first one was on the pricing outlook. I mean you mentioned Professional Instruments and Industrial Tech. The pricing trends look in line with what you had last year. Just if you could comment on some of the other businesses, how pricing is looking? And secondly, you talked about China a couple of times on the, sort of, the cost side of things, but in terms of demand, is there any change there in terms of what you're seeing? I mean, obviously, the overall global organic growth rate moderates in the second half, is that really just sort of a tougher comps-type issue?

Daniel Comas

Julian, on the price side, we track about a half point of price through the first half. It seems to be getting a little bit better, and we're looking for that to improve a little bit in the second half, and maybe we'll get about a point of price in the second half. Clearly, the better volume demand is giving us a little bit more latitude on price, and hopefully, we'll see some of that in the second half.

H. Culp

Julian, with respect to China, as you'll recall, we really saw China begin to recover last year in the second half, so the comps do get a bit tougher there. We were with the team Monday night. I mean, by and large, the team is very optimistic about the tone and the outlook here in the short-term. So I think what we've tried to capture in our guidance is a bit of a moderation in emerging market growth. We'll probably be somewhere in the low to mid-teens range. I think, in part, because of those comps, but China, by and large to us right now, still looks really good. Maybe the numbers won't print as big as they did, but the strength there seems to be steady, very, very steady.

Operator

We'll take our next question from Richard Eastman with Robert W. Baird.

Richard Eastman - Robert W. Baird & Co. Incorporated

Just a quick question. On the Motion side of the business, we've seen a snapback in this commentary about the Symbian Electronics Assembly businesses snapping back pretty aggressively. The comps are still very easy there for the balance of the year. So maybe the question is just around the end market exposure? You had mentioned maybe the Otis, the Lift Business being better. Is there any traction on the electric vehicle side? You had some products in there, but just give us a sense of the growth rate in Motion? How sustainable that is, rather than how cyclical it appears to be?

H. Culp

Well certainly, I think the facts that you pointed out there, Rick, are spot on. I think that as we look at what we saw in the second quarter, we were obviously up at a very healthy level, in part, because of the comps. We look at the third quarter, looked at the second half. I think we're going to be up mid-teens. Again, it will be moderating as the year goes on because the comps get less easy. Some of that is a market bounce back, but as we alluded to earlier, I think this team is really executing well. That's hard to pinpoint a share point here, share point there at this point in the cycle, but I think at Kollmorgen and at Thomson, they are executing better. Our new motors and drives out at Kollmorgen, particularly, have been well received. When we go into the growth greenhouse down there with the team, the leading indicators look positive. We work to limit some of our more volatile exposure and, to say, some of the tech end markets, but that's a work in process. So I would just maybe summarize by saying, clearly, Motion's going to be a little bit more cyclical and volatile than the rest of the portfolio. We saw that last year. They're bouncing back well. I don't think that is only a function of the market. I do think they are executing quite well.

Richard Eastman - Robert W. Baird & Co. Incorporated

And then the second question I have, given some of the portfolio moves that you're making here of some size, we've got the $90 million of dividend on the tool side coming in. If A&D piece does get sold an eight multiple on that, that's $1 billion plus. We have some strong cash flow. We've got good capacity now, but are the items -- are the potential transactions in your M&A pipeline, have they gravitated up in size? I mean, do you see this as maybe an interesting opportunity to expand the platform and add a platform here? Just give me your thoughts on that?

Daniel Comas

Rick, I think that we are very fortunate to have the strategic and the financial degrees of freedom that we have here, in large part because of our track record and the very strong cash generation that you've seen us put up over time. I think that, obviously, we're not going to comment on some of the rumors that are out there, but suffice it to say, I think the acquisition playbook, the way we think about attractive markets, the way we think about entry points into those markets are preference for bolt-ons as opposed to new platforms, but our success with new platforms is unchanged. And as we look forward relative to how we spend that next $2 billion, next 10, next 20 deals, I would really encourage folks to look back at the last $2 billion, the last 10 or 20 transactions as the best indicator as to the type of businesses we're likely to acquire and the way in which we're likely to bring them into Danaher.

Richard Eastman - Robert W. Baird & Co. Incorporated

Larry, we're kind of picking up a little bit of feedback out of Europe that just, in a general sense, that reimbursement rates on the medical side for procedures, but also for equipment, that they're starting to see some pressure there on reimbursement rates more from the government entities in Northern Europe. Do you see any of that, just as general comment? Do you see any of that as a concern for the second half just given the Med Tech platform and the various ways you get paid there?

H. Culp

Rick, it really depends on where you sit, and as you know, I sit on a European Pharma board and I understand that European reimbursement dynamic quite well. Their focal point, that's a harsh reality in their business. We haven't seen it as much, you can't discount anything, I think, these days in that regard. But frankly, that sort of pressure in our businesses is, at present, not a high-priority concern for me.

Operator

We'll take our next question from Wendy Caplan with SunTrust.

Wendy Caplan - SunTrust Robinson Humphrey Capital Markets

Given your very disciplined M&A strategy and your comments that you prefer, want to buy 50-plus percent gross margin businesses -- another couple other M&A questions, what are you seeing in terms of the quality of potential targets relative to that margin? The multiples you're being asked to pay, we're starting to hear that some multiples are contracting a bit and the competition for those properties. And just a clarification, if you wouldn't mind, are you seeking a new platform or are you sticking to the ones you have?

H. Culp

I think with respect to just quantity and quality of activity, as Dan alluded to earlier, it's been steady and good, so I don't think we've seen a change there. I think what we saw here in the last six months is probably an uptick in the quality and in turn, the expectation's clearly, I think, one of the good things that's happened here, with the first half being as robust as it has broadly, is that certain targets are growing into some of those expectations, which has to be good. We look at a lot of things, not only in gross margin. As you say, I think our bias toward our strong branded positions often correlates well with higher gross margins. And gosh, we're just 50 bps away from printing own 50% gross margin here. And that's pretty neat given where we were 20 years ago when I joined the company. Our appetite for new platforms, I think that happens once every several years. Again, I think that's always going to be in balance for us as long as we execute well and the ones we bring in. But by and large, I think with the opportunities we have in Med Tech, both in our Life Sciences & Diagnostics, Dental, everything happening, Instrumentation, be it Environmental, be it T&M, certainly, we'd love to see product ID bigger. We've got plenty of running room in and around those businesses to deploy capital smartly, but we would never say never relative to that next platform. It will come, it's just not something I should expect happening in the near term here. And we'd be fine with that.

Wendy Caplan - SunTrust Robinson Humphrey Capital Markets

And again, the multiples that you're being asked to pay for these and the degree of competition? And who are the competitors here?

H. Culp

Well, we compete with lots of different folks, but I think by and large, the competition we compete with will often be strategic, more so than financial sponsors. In the multiples, it have maybe come down a bit because businesses are growing into certain expectation. But I think by and large, it's been fairly steady through the course of 2010 so far.

Wendy Caplan - SunTrust Robinson Humphrey Capital Markets

And you mentioned the gross margin. I looked back and yes, it's improved steadily since, certainly, over the past dozen or more years, but you called out volumes and restructuring for this quarter, how much of the overall gross margin expansion is related to that mix of companies and through acquisition? And how high do you expect it to go?

H. Culp

Maybe offline, Matt could do a -- he can get you some numbers, Wendy. I'd be hard pressed here on the call to discern how much of our margin expansion over time would be a function of just great DBS execution, the restructuring, say from last year. Obviously, the improvements in the overall quality of the portfolio types of businesses that we have been bringing in are also a part of that equation. I don't think we have a goal. I'd love to print a few quarters here with our gross margin having a five on it, but there will be other businesses that we'll bring in. I'm sure that we'll dilute that gross margin for a period of time as we work to improve their performance and in turn, create returns for shareholders. So we're not wed to any one number on the P&L, but it seems to be closer to 50 there than 30 for sure.

Terry Darling - Goldman Sachs Group Inc.

Thanks, John. Just as a reminder, the replay number is (888) 203-1112 in the U.S., (719) 457-0820 internationally, with confirmation code of 6884014. Dan and I are around all day today for any follow-up calls. Thanks, everyone.

Operator

That concludes today's conference. Thank you for your participation.

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Source: Danaher Q2 2010 Earnings Call Transcript
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