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Danaher Corp. (NYSE:DHR)

Q2 2007 Earnings Call

July 19, 2007 8:00 am ET

Executives

Andy Wilson - VP, IR

Larry Culp - President & CEO

Dan Comas - CFO

Analysts

Bob Cornell - Lehman Brothers

Deane Dray - Goldman Sachs

Andy - Credit Suisse

John Inch - Merrill Lynch

Jeff Sprague - Citigroup

Ann Duignan - Bear Stearns

Stephen Tusa - JP Morgan

Robert LaGaipa - CIBC World Markets

Chris Kotowicz - A.G. Edwards & Sons

Ajit Pai - Thomas Weisel Partners

Operator

Good morning. My name is Matt Halper, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the Danaher Corporation's Second Quarter 2007 Earnings Results Conference Call. All lines have been placed on a mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period (Operator Instructions).

As a reminder, today's call is being recorded.

And now, I'd like to turn the call over to Mr. Andy Wilson, Vice President of Investor Relations. Mr. Wilson, please go ahead.

Andy Wilson

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 and 10-Q are available on our website under the heading "Investor Events." Access to our webcast presentation supplementing today's call can be found under the same heading, "Investor Events."

In addition, we've included in the webcast presentation materials, supplemental documentations detailing the impact of acquisitions, and currency translation on company and segment revenues, as well as additional information identifying factors impacting company and segment margins for the relevant periods.

The call will be replayed through July 23rd, and the audio portion will be archived on our website later today and will remain archived until our next quarterly call. The replay number is 888-203-1112, and the confirmation code is 2914902. I'll repeat this information at the end of the call for late arrivals.

I'd also like to note that in order to help you understand the Company's direction, 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 they are made, and we do not intend to update any forward-looking statements. With respect to any non-GAAP financial measures provided during the call today, the accompanying information required by SEC Regulation G relating to those measures can be found in the "Investors" section of our website, www.danaher.com, under the heading "Earnings."

And one final note. Earlier this month, we announced the signing of a definitive agreement to sell our power business to Thomas & Betts. This transaction is subject to regulatory approval and other customary closing conditions and is expected to close early in the third quarter of 2007. We are currently evaluating the accounting treatment for this transaction.

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

Larry Culp

Andy, thanks. Good morning everyone. We are very pleased to report this morning that our second quarter earnings per share were $0.96. Included in our 2007 second quarter earnings per share is approximately $0.02 per share resulting from the April 2007 collection of indemnification proceeds related to a preexisting litigation matter at Accu-Sort.

Absent this item, earnings per share increased 17.5% as compared to last year's second quarter earnings per share of $0.80, which excludes the prior year impact of a gain of $0.03 per share related to the sale of interest in the shares of First Technology and the impact from certain tax reserve reductions of approximately $0.15.

Revenues for the quarter increased 13.5% to 2.7 billion, as revenue from existing business also described as "core revenues" grew 4.5%. As we communicated last quarter, the completion of several large US Postal projects, primarily in the first half of last year, within our product identification business as well as the impact of emission regulations on our Jacobs Vehicle Systems business, negatively impacted second quarter core revenue by approximately 150 basis points.

Year-to-date, revenues were up 16.5% to 5.2 billion, as revenues from existing businesses grew 4%. Our gross margin in the second quarter was 45.5%, a 160-basis-point increase when compared to same period last year, as gross margins were positively impacted by leverage from higher revenues, ongoing cost savings, and from the higher gross margins in our recent acquisitions, primarily Sybron and Vision.

Selling, general and administrative expenses for the quarter were 29.3% of sales, an increase of 90 basis points versus last year. This increase was driven by higher SG&A structures and our recent acquisitions, primarily again Sybron and Vision, and increased R&D and sales and marketing spending to fund future growth. Year-to-date, SG&A expenses were 29.8%, an increase of a 120 basis points over the first half of last year.

Operating profit was a record of $448 million for the quarter, a 17.5% increase over last year. And for the first half, operating profit was $822 million, a 21% increase over 2006. Operating margins for the quarter were 16.8%, a 60-basis-point improvement over last year with core operating margins up 90 basis points, a result of ongoing cost reductions as well as leverage from higher core revenues.

We were particularly pleased with the margin improvement in our med-tech and industrial technology segments. Year-to-date, operating margins were 15.7%, an increase of 60 basis points compared to the last year with core margins up approximately 75 basis points.

Net interest expense for the second quarter was $23 million compared with $13 million for the second quarter of last year. The increase in interest expense is primarily due to higher debt levels related to the CP borrowings utilized to fund the Sybron and Vision acquisitions.

Our effective tax rate for the second quarter was 26.7% compared to 14.5% last year. Last year's second-quarter tax rate was positively impacted by the reduction of certain tax reserves, which resulted from the favorable resolution of various domestic and international examinations related to prior years and the realization of certain foreign tax credits. For the balance of 2007, we anticipate an effective tax rate of approximately 27%.

Net income was $311 million, a 1% decrease over the prior-year second quarter, due to the aforementioned First Technology gain and a reduction of prior-year tax reserves, which positively impacted 2006 net earnings by approximately $58 million. For the first half of 2007, net income was a record $566 million, an increase of 7% over last year's first half.

Excluding the impact of the current-year gain related to the collection of indemnification proceeds as well as last year's First Technology gain and reduction of prior-year tax reserves, net income increased 18% and 19% for the second quarter and first half, respectively.

Operating cash flow for the first six months of 2007 was $692 million, 6% higher than last year. Gross capital expenditures year-to-date increased to $70 million, representing a 19% increase over the first half of last year. Our current full-year estimate remains at approximately $175 million to $200 million.

Second-quarter free cash flow, defined as operating cash flow less capital expenditures, increased 17% over the same period last year. Free cash flow for the first half was $621 million, representing a 5% increase as compared to 2006, despite approximately $140 million in additional income tax payments in the first half of this year. Our free cash to net income conversion ratio for the first six months of 2007 was 110%.

For the year, we remain solidly on track to deliver free cash in excess of net income for what would be our 16th year in a row. Our balance sheet remains solid with a debt-to-total capital ratio of 23% and $175 million in cash and cash equivalents at quarter's end.

Let me turn now to the operating performance in the quarter and start with our professional instrumentation segment, where revenues were up 14.5% for the quarter to $820 million. Revenues from existing businesses grew 8.5%. For the first half of 2007, revenues were up 13% to 1.6 billion. Revenues from existing businesses increased 7%.

Operating margins for the quarter were 23.2%, down 60 basis points versus a very strong prior-year performance. The prior-year gain from the collection of previously written-off receivables negatively impacted margin comparisons by 60 basis points, while the dilutive effect of acquisitions and the impact of prior-year real estate gains impacted margins by an additional 40 basis points. Absent these items, operating margins improved approximately 40 basis points in the quarter.

Year-to-date, operating margins decreased 20 basis points to 21.4%, when compared to 2006, due to the same factors. Absent those items, operating margins for the first half also improved approximately 40 basis points.

Environmental revenues for the quarter were strong, up 11.5% with core revenues growing 8.5%. For the first half, sales are up 10% with core revenues growing 6.5%. Water quality core revenues grew at a double-digit rate in the second quarter, a result of broad-based strength in both our lab and process products lines.

Geographically, Asia was up over 20%, Europe was up double digits, and North America was up at a high single-digit rate. During the quarter, we acquired Zulich (ph), a $10 million Switzerland-based company that provides measurement instrumentation used by the beverage industry for drinking and wastewater applications.

Sales in our water treatment business were up more than 20% in the quarter, led by a strong performance in the municipal wastewater market here in the US. During the quarter, Trojan won three new significant wastewater purification tenders in Australia, which represent more than $10 million of future revenue that are scheduled for delivery over the next year.

Subsequent to the second quarter, we completed our acquisition of ChemTreat. ChemTreat is a $200 million leading provider of water treatment solutions for commercial and industrial applications, which nicely complements our existing water treatment offering and brings with it an attractive consumables and service business mix. We are obviously very pleased to have ChemTreat and the ChemTreat team with Danaher today.

Moving over to Gilbarco Veeder-Root, core revenues grew at a mid single-digit rate in the quarter, driven by healthy dispenser sales in the US and Mexico, as well as demand for our recently launched air quality products. Sales of our Veeder-Root monitoring systems were up double digits, reflecting strong international demand.

Moving over to electronic test. Revenues grew 20% in the quarter with core revenues up 10%. Sales increased 19% in the first half with core revenues up 9% over the same period. New product introductions in thermography, power quality and precision measurement contributed to the high single-digit growth rate that we saw at Fluke. Geographically, Europe and Asia were particularly robust, both up at mid-teens level during the quarter.

During the second quarter, Fluke introduced their new process clamp meter, a breakthrough tool, which provides preventative maintenance technicians the ability to measure and calibrate electrical current without having to disconnect or power-down the equipment they're working on, thereby, driving productivity and uptime. Shipments of this new clamp meter have significantly exceeded initial expectations and have been a key driver to our mid-teens -- excuse me -- high-teens growth during the quarter.

In June, we acquired Ircon Group, a $15 million designer and manufacturer of infrared temperature measurement and fixed thermal imaging products utilized for quality-assurance applications. The acquisition of Ircon further enhances Fluke's leading position in both temperature and thermal imaging instrumentation.

Fluke Networks' core revenue increased at a mid-teens rate, driven by copper and fiber certification products and by strength in both Europe and in North America. During the quarter, Fluke Networks received a multimillion-dollar order from a major US telecommunications service provider to facilitate their deployment of voice, video and data services. Also during the quarter, Fluke Networks received the AT&T Key Supplier Recognition Awards.

Moving to med-tech. Revenues for the quarter were up 38% to $707 million. Core revenues up 7% in the quarter contributed to the growth. Year-to-date, sales were up 54% to approximately 1.4 billion with core revenues growing 7.5%.

Med-tech operating margins for the quarter were 11.1%, 260 basis points higher than the same period last year. This performance was driven by core margin improvement of 95 basis points as well as the year-over-year impact from inventory charges associated with the acquisition of Sybron, which accounted for approximately 190 basis points of the increase.

Op margins for the first half increased 340 basis points to 11.8% as compared to the first half of last year, a result of the same items as well as the higher margins of recently acquired businesses, particularly Sybron. Year-to-date, core margins improved 85 basis points.

Core revenues in our dental business grew at a low single-digit rate for the quarter. Our consumables business, principally Sybron, grew at a mid single-digit rate, led by demand in both Europe and Asia, while the US benefited from double-digit growth in our Damon orthodontics product line, which I now proudly wear myself.

Dental equipment revenues were essentially flat in the quarter as a strong US performance in imaging and treatment units was offset by a softer European market. Asia revenues declined in the quarter due to a tough year-over-year comparison, primarily the result of a large Korean program that shipped in the prior year and did not reoccur.

Radiometer core revenues grew at a high single-digit rate in the second quarter, driven by double-digit instrument placement growth, primarily in our high-end ABL800 line. These instrument places, as many of you know, help generate additional high-margin consumables sales in future years.

Leica Microsystems' core revenues grew at a mid-teens rate in the quarter, driven by demand for both our microscopy and pathology diagnostic products. Increased research spending in North America in addition to increased sales resources in Europe were the key contributors to this exceptional mid-teens core growth performance in the quarter and on a year-to-date basis.

Last month, we introduced the SEM 1000, the first in vivo imaging system enabling researchers to view microscopic images of cells and tissue within small living animals, utilizing fiber optics. This is a breakthrough technology, which provides access to virtually any space in the living animal, generating high-speed recordings of cellular and vascular events critical to drug discovery research.

We also recently announced the establishment of Leica Biosystems, the combination of our Vision BioSystems and Leica pathology diagnostics businesses. Sales force integration activities have been very successful to date with cross-selling synergies driving record sales of our Peloris branded tissue processors during the quarter. Revenue growth compared to prior-year periods we envision with a standalone company continues to be robust, up over 20% in the quarter.

Moving to industrial technologies. Revenues increased 4% for the quarter to $831 million. Revenues from existing businesses were up 1.5%. For the first half, revenues grew 5.5% to approximately $1.6 billion. Revenues from existing businesses grew 1.5%.

Operating margins for the quarter were 18.4%, a 320-basis-point improvement versus the same period last year. Core margins improved 135 basis points, while the gain arising from the collection of indemnification proceeds related to the Accu-Sort litigation contributed 155 basis points. Year-to-date, operating margins increased over 210 basis points to 17%, as core margins improved by 110 basis points.

Product identification revenues decreased one-half of 1% during the quarter with core revenues contributing 3.5% of the decline. Sales for the non-US Postal Service marketing business grew at a high single-digit rate, reflecting very healthy demand for equipment across all major geographies.

As we've previously discussed, core revenues for the first half were negatively impacted by several large USPS programs in the first half of '06, which did not reoccur this year. Sales were flat for the first half with core revenues decreasing 4.5%.

Videojet core revenues grew at a high single-digit rate during the quarter. Continued strength in equipment sales, including laser and CIJ offerings, as well as high single-digit growth in consumables were the primary contributors to this performance.

During the quarter, Videojet launched a new thermal transfer overprinter, or TTO. The new 6210 provides a digital solution for clocking (ph) variable data, including lot and date codes on flexible food packaging, such as foil bags for pretzels or potato chips. The 6210 improves print quality and increases uptime and is aimed at the emerging markets such as China, India and Brazil.

Moving over to motion. Revenues were flat in the quarter with core revenues declining 2.5%. In the first half, sales are up 2.5% with core revenues declining one-half of 1%. The strength in our elevator, electric vehicle, and aerospace and defense initiatives, as well as demand for our custom motors business was offset by weaker tech markets.

Revenue declines in these tech markets negatively impacted organic growth by more than 500 basis points in the quarter. We continue to make progress with our cost-reduction and pricing initiatives in Motion, as operating margins improved compared to the same period a year ago, despite the decline in revenues.

Turning to tools and components. Total revenue was $314 million for the quarter with core revenues declining 2%. For the first half, revenues were $635 million with core revenues decreasing 1.5%.

Operating margins for the quarter were 13.9%, a decrease of 80 basis points over the prior year, primarily due to lower production levels related to the impact of emission regulations on our Jacobs Vehicle Systems businesses as well as increased material and production costs in our US operation.

Previously implemented cost actions have mitigated margin declines despite lower revenues in the quarter. Year-to-date, operating margins decreased approximately 110 basis points to 12.5% compared to 2006. Margins were negatively impacted in the quarter, primarily due to these same factors.

Mechanics hand tools revenues decreased one half of 1% during the quarter, and for the first half sales, are up 1%, all of which is core revenue growth.

Double-digit growth at Lowe's with our Craftsman industrial initiative and in our Asia business partially offset a double-digit revenue decline at Sears in the quarter. The revenue decline at Sears Holdings was primarily due to their inventory reduction efforts and relatively flat sell-through.

Matco revenues increased at a low single-digit rate. The loss of Matco’s new toolbox product line earlier in the year generated sequential sales momentum through the second quarter with June revenues in toolboxes up at a low double-digit rate.

As Andy mentioned at the beginning of the call, we announced the signing of a definitive agreement to sell our power-quality business to Thomas & Betts. Upon closing, the purchase price is expected to result in an estimated gain of $150 million or approximately $0.46 per share.

Finally, during the second quarter, we repurchased approximately 1.6 million shares at an average price of $71.50 for a total spend of about $117 million. We are pleased with our performance through the first half of the year. The majority of the difficult first-half comparisons are now behind us. As we go forward to the remainder of 2007, we remain confident that we will deliver on our growth and profitability expectations for the year, and we continue to see strength across the majority of the portfolio.

We expect our earnings per share in the third quarter to be in the range of $0.92 to $0.97. And we are increasing our full-year earnings per share guidance from $3.70 to $3.80 to a new range of $3.74 to $3.82, up 16 to 18% versus last year.

It's important to note that both of these ranges exclude the second quarter gain related to the previously mentioned indemnification proceeds, as well as the estimated gain related to our sale of Power Quality. However, it does include approximately 1-end per share of dilution in each of the third and fourth quarters related to the divestiture of Power Quality.

Andy Wilson

Thank you, Larry. That concludes our formal comments. Matt, we are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Bob Cornell with Lehman Brothers.

Bob Cornell - Lehman Brothers

Yes, you know the quarter shows that the more disclosure you make, the more questions you get, right?

Dan Comas

That's the downside.

Larry Culp

There is a correlation, Bob.

Bob Cornell - Lehman Brothers

Yes. You know, I guess my first question is how about the drag in Motion from tech? I mean you have the 500 basis points. What's that going to look like in the third quarter and the fourth quarter? When do we anniversary those issues?

Larry Culp

Well, we're looking at the second half, Bob and frankly, at this point, I think taking a fairly conservative posture. You know, we had anticipated that we would see sequential improvement in tech. I think, right now, we're not expecting to see particular strengthening in those various markets, those end markets in the third quarter and, frankly, not hoping for anything miraculous to occur in the fourth quarter.

So I think, right now, we are thinking that rebound, at least from a planning perspective, is more of an '08 phenomenon than a second half '07 story.

Bob Cornell - Lehman Brothers

Yes, you didn't reiterate your organic growth guidance for the year. Is there a comment there in the context of that first comment in the aggregate quarter result?

Larry Culp

Sure, Bob, I didn't mean to omit that. I think that, as we said in December and have said all along this year, we think we will do 5% plus. I think the math, given what we've done in the first half, particularly on the back of the guidance raise here this morning, suggests we are looking at a back half at 6% plus.

And given where we are today with the portfolio, I think with the economic conditions being as strong as they are, let alone what we are seeing from our I2E and DBS initiatives, we feel very good about the second half, both topline and bottom line. And that's with, obviously, the dilution we mentioned coming out of the Power Quality sale.

Bob Cornell - Lehman Brothers

Yes, I guess my final question is, with the third quarter guidance and the full-year guidance, I mean, it looks like you got a little bit of a disproportional split between third quarter and fourth quarter. Is that the right way to think about this? Maybe what are the reasons for that?

Dan Comas

Well, if you look at the old high-end of 380 and you take $0.02 out of that for the dilution from Power in the second half, you're looking at going from 378 on the high end to 382.

It's probably looking at a penny increase coming out of Q2, a penny coming out of Q3, and probably $0.02 coming out of Q4. So you are right. A little bit of what we're seeing right now is a little more upside here in Q4.

Bob Cornell - Lehman Brothers

A little more upside you said, Dan?

Dan Comas

Yes, well, I mean, kind of the net 4-cent increase, about 2-cent of that coming in the fourth quarter, though that, if you look at the math, would be kind of a similar growth rate in earnings to what we've had all along.

Bob Cornell - Lehman Brothers

I guess one final comment from me is that, in my model anyway -- and maybe it's just me -- the Medtech earnings second quarter over first quarter look a little unusual. You would expect those to be sequentially higher. I mean, is there a thought there? Are we looking at a new seasonal pattern?

Dan Comas

Well, I think that Q2 is a little seasonally weaker in that sector. I think the margins were hurt a little bit by the fact that dental equipment was flat, topline, in the second quarter.

So as we talked about, the core margin improvement in Q2 in Medtech was actually a little more than it was in Q1. But I think it's in seasonal patterns. You should see a pretty significant increase sequentially, Q2 to Q3, here in Medtech, and then another increase from Q3 to Q4.

Bob Cornell - Lehman Brothers

Okay, thanks very much, guys.

Larry Culp

Bob, I would just add to that. We certainly saw in dental equipment during the quarter the opportunity to step-up some of our go-to-market investments, particularly in the developing markets.

And we also saw an increase in some of our growth break through spending around three particular new product initiatives, which obviously have out-year potential, which created some of that dynamic that you're pointing at as well.

Bob Cornell - Lehman Brothers

I would love to see it. Thank you very much.

Dan Comas

Thanks Bob.

Operator

We’ll go next to Deane Dray with Goldman Sachs.

Deane Dray - Goldman Sachs

Thank you. Good morning.

Dan Comas

Hi Deane.

Deane Dray - Goldman Sachs

Two questions, the first is, could you comment broadly on the M&A pipeline, pricing, and what expectations for transactions out the next several quarters? And then the second question I'd like to come back to is some specifics on the ChemTreat, so talk about M&A first, please.

Larry Culp

Sure, Deane, good morning. Let me take that. I think the M&A environment that we see today continues to be very positive. And you've heard us say that we couldn't be busier, given the review Dan and I had with the team just yesterday. I think that description is still very much the order of the day. And I think you should expect us to continue to be active acquirers here in the second half of '07.

Obviously, we're going to continue to target transactions around our four platforms that have seen the bulk of the investment and the growth. Obviously, Medtech, Environmental, certainly electronic test and product ID all have very active deal pipelines working right now. And frankly, there is some interesting situations that we're looking at around some of our stronger niche businesses that might be good additions for us later on here in the year.

Deane Dray - Goldman Sachs

It's interesting that one of your comments that you're not making is some of the competition with private equity or pricing. How about those two factors?

Larry Culp

Well, I think we've had the view for some time that obviously there is a lot of private equity money out there with some smart people looking to put it to work. They tend, I think, on balance, to focus on properties that aren't necessarily high on our list.

And when we take the long view -- because we're building businesses and we're not buying to sell -- when we look at our synergies and the other things that we would bring to a transaction, we tend to see, frankly, other strategics as really the relevant competitive set, much more so than private equity. Not that they won't be there, but we find they, more often than not, are going to set a floor in a process as opposed to be a finalist with the company like Danaher, particularly around properties that we covet.

Deane Dray - Goldman Sachs

Good. And this is a good segue into a question on ChemTreat. And one of the obvious benefits here is you're broadening out your offerings in water, but you're also noticeably moving down the technology scale away from water test and UV water treatment.

So is this more a reflection of your interest in broadening out the offering, or is it very expensive at the high-end scale between filtration, ultra filtration and so forth?

Larry Culp

Deane, I think you should look at ChemTreat as a classic Danaher water-quality transaction. I think we've thought for over a decade -- and remember, we got started to in water back in the mid-90s. That -- there isn't a single water market, but the market is made up of a number of segments and niches, some of which we think are highly attractive, others not so much. And what we've done with Hach/Lange and what we've done with Trojan is target the segments where we see good growth, and good margin potential.

And I think, with ChemTreat, what you see us do is really building out a portfolio in water treatment, a business here that has been a very high grower with very healthy operating margins. And we see that runway, both domestically and internationally, very much intact.

Now, obviously, as a related business, they will be able to do some things with Trojan, which I think will help both businesses. And the same will apply to Hach/Lange, particularly outside of the US. But you shouldn't look at ChemTreat, as anything other than a continuation of Danaher targeting the attractive segments in the water space.

Deane Dray - Goldman Sachs

Great. And just to clarify your comment on ChemTreat, where you mentioned the consumables, this is much more than a chemical business. Isn't it more of a solutions business?

Larry Culp

Very much so. At the end of the day, what we really are helping our customers, primarily in their boiler and cooler operations with, is solve the operational challenges that water in the system can create. Whether we're talking about bacteria or scaling or corrosion, those sorts of things. And we think the due diligence and certainly their own results have proved this out, that the ChemTreat team does a superior job in providing those solutions to their customers.

Operator

We’ll go next to Nicole Parent with Credit Suisse.

Andy - Credit Suisse

Good morning guys. It’s actually Andy on behalf of Nicole.

Larry Culp

Good morning, Andy.

Andy - Credit Suisse

Good morning. I was just wondering if you could comment on what you're seeing in the global growth environment, and how you see that going forward.

Larry Culp

I think we look around the globe, Andy, and see our markets is particularly strong. And certainly, as we look to Europe, we look throughout Asia-Pac, Latin America, we just look at those spaces, particularly in our larger, and more global platforms, as target rich environments, both for organic growth and, frankly, for M&A. So, we have no complaints about the macro environment right now.

Andy - Credit Suisse

Thank you very much.

Operator

We’ll go to John Inch with Merrill Lynch.

John Inch - Merrill Lynch

Thank you, and good morning.

Larry Culp

Good morning John.

John Inch - Merrill Lynch

Hi. Hey, just to start off, I think someone may have been out there suggesting 5% organic growth this quarter was an important threshold. Given the tough comps in Motion, I thought the 4.5 you did was very consistent, if not better than the way you had laid out expectations. So, my first question is am I missing something, or were you actually thinking you might be able to hit 5% this quarter?

Larry Culp

I think what we were flagging all along, John, was that we would do sequentially better than we did in the first quarter. And we think we delivered on that.

John Inch - Merrill Lynch

Larry, the sale or proposed sale of Power Quality, you guys haven't divested sort of on scale for quite awhile. Does this represent some kind of strategic shift in the way you're sort of thinking about portfolio management?

And I’ll tell you where I'm going with this. Specifically, I'm just thinking of Motion, and really how that business fits the long-term kind of company that you're trying to build.

Larry Culp

John, I think, that if you look at the quarter, you're looking at the Power Quality divestiture. I think you should look at that in concert with the opportunistic buyback, in concert with the business we were just talking about with Deane coming in, ChemTreat. It's really great examples of how we've always approached, and always will approach capital allocation in a very strategic, very disciplined way.

So we looked at Power Quality, as we've discussed, a business that could have been larger with Danaher if a couple of transactions over time had occurred. They didn't. This is a business that was more valuable to other strategics than ourselves. And obviously, at this point in the cycle, a timely time to see those businesses off. By the same token, we were able to take advantage of a low stock price during the quarter, during a very limited window for us, and put capital to work in the buyback, however modest.

But obviously, looking to continue to build, both organically and inorganically and you see that with ChemTreat. So I'd like to think that what you have in the second quarter are a number of examples of Danaher doing what it has always done, running the plays that have worked for us, that have created value for shareholders over a long period of time.

And that's, frankly, the playbook we're going to run in the second half of '07 and the one we're going to use going forward in '08 and beyond. Will there be other divestitures? You can never rule that out. I think we've said, in trying to flag or to foreshadow what would happen with Power Quality, that this would be the year in which you might see us prune at a little more of an active rate. Obviously, you see the transaction on the table. Is there more pruning to come? I wouldn't rule it out.

John Inch - Merrill Lynch

Okay. But the timing of Power Quality in the second quarter, was that -- I mean maybe Dan can answer this. Is it just because that's the way the strap plan, sort of ultimately culminated in the decision, or were there something that you started at the year, Larry, and said we're just going to get a lot more aggressive in terms of trying to prune the portfolio, and this is sort of what fell out of that analysis?

Dan Comas

I think we’re very sensitive to when other companies talk to us about their interests in some of our businesses. And I think, given the environment, we felt it was a very opportune time to sell the business. There wasn't a specific decision made a year ago. We're trying to add value and try to recognize when there are strategic buyers that really come forward with a great deal of interest.

John Inch - Merrill Lynch

No, that's fair. One more quick one. So Roche is proposing to acquire Ventana. It looks like it would represent a substantial premium to what you guys actually paid for Vision.

So Larry, does this dynamic perhaps open some new possible M&A doors for you in terms of -- I'm thinking of sort of new possibilities in the market, given the market's tolerance for what appears to be higher multiples for these types of properties, versus sort of what Danaher has traditionally paid for some of its businesses, particularly as you build out your medical platform over time?

Larry Culp

Well, I think we would -- again, we’re trying to stay smart and stay disciplined. Obviously, the price being contemplated for that transaction, putting multiples aside is probably petty cash at Roche. It would be a significant situation, much more significant for us.

But John, I was in San Diego earlier this week at the Clinical Chemistry show, obviously a market undergoing great, great change even with the aborted GE/Abbott transaction, lots of companies there with new flagship brands on the boost. And I think our strategy really, in diagnostics, will continue to be a focused one. You see what we've done in acute care with Radiometer.

Obviously, we focused on the tissue-base, the histology, pathology laboratory with Leica and Vision, and obviously with the price is being talked about for Ventana, our pricing on vision looks very attractive today. I think, as I talk to customers to show doctors are very demanding.

And our focused strategy aimed at trying to meet their needs around accuracy or reliability with the instrumentation, workflow solutions, let alone doctor and nurse safety, is a strategy that's going to work very well. We had a couple of new products that we were unveiling, some publicly, some quietly, particularly Radiometer, which seemed to generate a lot interest, at least in the showings where I was. And I think what you'll see us do is continue to grow those businesses inorganically and complement that with smart acquisitions, not deviating wildly from our financial discipline.

John Inch - Merrill Lynch

Thank you.

Dan Comas

Thanks, John.

Larry Culp

Thank you, John.

Operator

We will go next to Jeff Sprague with Citi.

Jeff Sprague - Citigroup

Thanks. Good morning.

Dan Comas

Good morning, Jeff.

Jeff Sprague - Citigroup

Just a couple of things. First on, Larry, you noted the strength in the community water business. Is there some change and just kind of disbursement of funds or something going on or that market has been in kind of fits and starts lately?

Larry Culp

Yeah. I think that’s a good characterization, Jeff. I think we've had a number of projects here of late that have finally begun to be installed. I think that's what you're seeing is a pipeline that has been building, as you say in fits and starts, finally coming to reality. We're going to have a very good year at Trojan, domestically in particular.

Dan Comas

And I think what was encouraging is that we’re pretty confident, based on our wins last year, that the topline at Trojan would be real strong this year, but we were worried about the order book kind of going into '08, '09, and that's been very good as well. So, not only I think we are well positioned in topline this year, but going into '08 and '09 as well.

Jeff Sprague - Citigroup

And then on Medtech, Dan, just to understand what you were saying to Bob Cornell's question, that acceleration you were talking about -- is that a margin comment or was that a topline comment?

Dan Comas

It was primarily a margin comment. You know, the segment grew high single digits, both in the first and second quarter. We think that sort of growth rate will continue. My guess is it will -- Leica won't sustain in the mid teens but will continue to grow quite nicely while the dental equipment, which was, as you mentioned, was flatter in the second quarter, will accelerate. So kind of net-net kind of keep us in those high single digit growth rates, but with an improvement in margins.

Jeff Sprague - Citigroup

Then I'm just trying to understand what was going on in dental, because obviously the 7% growth is not shabby but it's a deceleration from Q1 against what looks like an easier comp. I think Sybron actually rolled in, at least for a month, into your organic. Is there something with reimbursements or some other dynamic that's going on in Dental? I think Larry mentioned the Korea thing. Was that really big enough to matter substantially?

Larry Culp

Jeff, yes, I think, if you break it down from a geographic perspective, the US was strong, particularly in imaging, where we were up over 20%. Europe was softer, I think, than anybody expected on the equipment side, quite honestly. We had the big IDS show in March.

We tend to see a good tale coming out of that show. It looks like Europe is really going to be more of a second-half story. We have seen, I think, a very encouraging order book here the last four or five weeks, which bodes well for the second half. Asia, particularly Korea, given it was a large basically one-time program over there, did create a bit of a tougher comp in that regard.

So, you roll that all up, not the best quarter dental equipment will ever put up, but I think we look at those geographic dynamics and again feel better about the second half and have already begun to see the start of some of that acceleration sequentially.

Jeff Sprague - Citigroup

And then just one last one, Dan, you had this big lump of cash taxes in H1. Is that behind you? Was there anything unusual? Is that just kind of timing or was it…

Dan Comas

It is timing. You know, as you know, it's quite unusual that our cash taxes equal our provision, as it was in the first half, and that is an anomaly. You know, we have flagged that our cash tax rate would increase over time, but it's not going to equal our provision this year. So you'll see relatively lower tax payments here in the second half.

Jeff Sprague - Citigroup

Thank you very much.

Dan Comas

Thank you Jeff.

Operator

And we’ll go to Ann Duignan, Bear Stearns.

Ann Duignan - Bear Stearns

Hi, good morning.

Dan Comas

Good morning Ann.

Ann Duignan - Bear Stearns

I might know the answer to why your dental business was weaker than you expected in Germany. Currently, 100,000 dentists in Germany have ownership in biodiesel plants and they're not making much money right now, so maybe that's your answer?

Larry Culp

I will use that next time, Ann. Thank you.

Ann Duignan - Bear Stearns

Yes, it all comes back to ethanol or biodiesel issues. My questions run the same, the same issue. You did note that life science instruments in Leica Microsystems was strong in Europe. Can you just compare and contrast what you think was going on in dental versus what you think was going on in Leica in Europe?

Larry Culp

Well, again, I think the independent dentist, the spending psychology is different than the more corporate and more institutional spending that we see, both on the research and on the clinical side at Leica. That's a worldwide phenomena. I think we saw a first half, whether it was their biodiesel investments or some other considerations.

Dennis in Germany particularly, we saw the UK a little bit soft as well, not spending in the way we would've thought in the first half, but again feel like things are picking up as we speak.

We've had a very good run with Leica and are optimistic that, as Dan says, it will probably slow a bit sequentially but still be very healthy, very healthy growth rates there, because of the spending, again both from a research and from a clinical perspective.

Ann Duignan - Bear Stearns

Okay, thank you. Just on pricing, you noted the pricing contributed in both the industrial technologies and tools and components. But what's the pricing environment like in the other businesses, or at least, again, could you compare and contrast maybe pricing in the US versus pricing outside of the US?

Dan Comas

Ann, the price we've been getting kind of between 1.5 and 2 points the last six or seven quarters has been pretty consistent. Both within the professional instrumentation and Medtech businesses we continue to get it, particularly in the consumable businesses, the consumable pieces of those businesses.

So they're probably -- they obviously don't have quite the raw materials to offset that we do in tools and Motion, so it's probably a little bit less than a 1.5 points across those segments.

Ann Duignan - Bear Stearns

Okay. Then the other businesses, or just in general, - are you seeing the ability to increase prices better in the US versus the rest of world, or vice versa?

Dan Comas

I think, on the equipment side, it's easier in the US I think, its on the consumables piece, we get in both regions.

Ann Duignan - Bear Stearns

Okay. That’s quite helpful. Thank you.

Dan Comas

Thank you Ann.

Operator

We’ll go next to Stephen Tusa with JP Morgan.

Stephen Tusa - JP Morgan

Good morning. On the product ID business, a pretty good result in the core business there, and I know Domino is talking about some pretty positive market trends. Could you just comment on the market there and what you are seeing, and any opportunities with all this news around the track and trace from China, that kind of opportunity with, being a little bit more on top of imports coming in with, you know -- the track and trace opportunity internationally?

Larry Culp

Sure. Well, I think maybe two comments, Steve. First of all, this in terms of the core coding and marking businesses, as you said, we think we're doing very well against a backdrop that suggests healthy market demand. And we would say that is a worldwide phenomena right now.

I think we're very pleased with the performance we've seen out of Videojet in the first half, as they have built sequentially strength in the core business, obviously camouflaged a bit because of the tough comps with the low-margin USPS programs that didn't repeat this year. With respect to track and trace, let's just step back for a moment.

We love this business because there are a number of application trends like track and trace, like product safety, supply chain efficiency and the like, where we can really help the Unilevers, the Nestles, the Pepsis, the Procters of the world tackle those challenges. I think what's happened recently around product safety and counterfeiting -- that plays very well both to the core products and the core applications that we serve today, as well as some of the newer opportunities out there, like track and trace.

So we remain very bullish, both inorganically as well as organically, around these opportunities. Recent headlines help, but I think the undercurrent has been there for some time.

Stephen Tusa - JP Morgan

Then on the guidance, I'm just -- sorry, I might have missed this. But what is included in that guidance? Is the 2-cent gain from this quarter included in that guidance, but the dilution from the deal?

Dan Comas

Yes, the $0.02 gain is not in the guidance. The $0.02 we're going to have dilution from Power, which we have just gotten regulatory approval and the transaction will close in the next, in the coming days.

Stephen Tusa - JP Morgan

Okay.

Dan Comas

That $0.02 of dilution is in the guidance.

Stephen Tusa - JP Morgan

I got you. Then, did you put out a core growth number? Did you kind of reaffirm the 5%-plus for the year? Is that what you did on core growth?

Dan Comas

Larry did that in the Q&A earlier.

Stephen Tusa - JP Morgan

Okay. All right, I appreciate it. Thank you.

Dan Comas

Thank you, Steve.

Operator

We’ll go next to Robert LaGaipa with CIBC World Markets.

Robert LaGaipa - CIBC World Markets

Hi. Good morning. Just a few questions -- I guess, one, with the 5%-plus core growth, can you just talk about the composition of that and how that's changed in terms of your expectations moving forward?

I think you had mentioned earlier, you know, tax being a little bit more conservative on that end. You mentioned the acceleration in dental on the Medtech side. Any other changes in terms of the composition we should be looking for?

Larry Culp

Well, I think, if you just go around the more than professional instrumentation I think has been growing at a high single digit rate here. That continues with both engines, both test and environmental are inspiring nice and well. Obviously, at Medtech we've alluded to, I think, continued strength in aggregate with a bit of a mix shift with a slight sequential slowing at Leica off some white-hot numbers. And we would expect, as I mentioned on the last call, to see the dental equipment business in the second half pick-up.

We would look at I think industrial tech is also improving sequentially during the second half, though obviously our expectations, as I indicated to Bob Cornell, are modest in the Motion businesses. And tools and components again, I think there we will see sequential improvement and are optimistic, particularly as we get closer to the holidays, that we will see improvement in mechanics and tools, particularly.

Robert LaGaipa - CIBC World Markets

Specific to tools and components, what gives you that level of optimism moving forward? Obviously, in light of Sears and in light of big-box stores, etcetera, are you more optimistic on the sales end of things, or are you more optimistic on the margins moving forward?

Larry Culp

Well, we can and should improve the margins in tools. That's more in our control, volume being somewhat stable. I think, as we see what works and what doesn't at retail and in the industrial channels and tools, we learn a little bit more each quarter and obviously are optimistic, assuming no change in the economic conditions, that we can improve our performance sequentially at the top line, as we get into the second half.

Dan Comas

Bob, just back on your first question on the sequential improvement in growth.

Robert LaGaipa - CIBC World Markets

Sure.

Dan Comas

Just the absence of these comp issues, if everything else stayed the same of what we did in Q2, we would be right around 6% in Q3.

Robert LaGaipa - CIBC World Markets

All right. Okay.

Dan Comas

So, we don't need an acceleration of Motion to get to that level, if everything else stays the same and just the last thing is some of the comp issues.

Robert LaGaipa - CIBC World Markets

Right. And with regard to tools margins, are you speaking sequentially improvement or do you think there's a possibility that you can actually get higher year-over-year margins in the back half, in tools?

Larry Culp

Well, we're going to continue to struggle. Jake Brake will be down every quarter this year, won't be down as much in the second half as it was in the first half, so in terms of the total segment, we will probably continue to be down. We are fighting some headwinds in the commodity side in the tool business, which we are largely offsetting but not entirely.

Robert LaGaipa - CIBC World Markets

I got you. Lastly, just a clarification -- just with regard to the core growth, I noticed that, we noticed that in professional instrumentation, I mean, obviously a consistent environmental and electronic test, but you mentioned the core growth in professional instrumentation being 8.5%, but environmental 8.5 and electronic test at 10. So I would think that that number would be a little bit higher. What am I missing there?

Larry Culp

Electronic test is just under 10, and environmental was just over 8, so kind of blending two, and with a little bit more weight on environmental gets you to that.

Robert LaGaipa - CIBC World Markets

I got you. Great. Thank you very much.

Operator

And we'll go next to Chris Kotowicz, AG Edwards.

Chris Kotowicz - AG Edwards

Hey, good morning, guys.

Larry Culp

Good morning Chris.

Chris Kotowicz - AG Edwards

Larry, we all know that you bought Sybron to have better access to products for your company dental plan.

Larry Culp

Well, call it my Victory call at moment. I'm learning a lot, let me tell you.

Chris Kotowicz - AG Edwards

The core growth, I will take it maybe a different angle. How much of the second-half strength would you break out as easier comparisons versus orders in hand, right? You mentioned Trojan has got a pretty good backlog and looks good into the second half. Some of your other businesses maybe have the same. Could you kind of give us a sense of how much of that you can see pretty tangibly versus just kind of an expectation?

Larry Culp

Well, I think, if you look around our business, Chris, as you know, we don't have a long list of businesses that stack up the backlog several quarters in advance. I think the optimism we have about our performance here and to come in the second half is really a function of the momentum we have in many businesses, a view that the economic environment will continue to stay positive and helpful.

And I think a recognition that is we have stepped up our sales and marketing a new product introductions, that we'll continue to, on-balance, see contributions from those investments.

We could break it down business by business, but again we don't carry a lot of backlog into the second half here that guarantees us that 6% plus we have to go make that happen, but are confident we can, given what we see right now.

Chris Kotowicz - AG Edwards

Okay. And then maybe geographically, Europe and Asia have been really strong for a lot of companies. In the absence of that, I think we have a very different reaction to the industrial sector, just given what's going on in North America. What are you guys seeing?

Are you seeing more growth in Europe, in particular relative to North America on a core sales standpoint, or are your businesses really isolated from that, given the platforms that you have?

Dan Comas

We are seeing good strength in Europe. Europe grew kind of high single-digit rate in the second quarter. China, almost all of our businesses were up kind of mid teens in China.

In the US, if you kind of adjust for postal, I think we highlighted that we adjusted for postal grew up just grew slightly in the first quarter, but grew a little faster here in the second quarter.

Chris Kotowicz - AG Edwards

Okay. So maybe some acceleration there and then maybe just a clarification, because I thought I heard Larry say, Vision Systems was up 20% in the quarter, year-over-year?

Larry Culp

I know that's correct.

Chris Kotowicz - AG Edwards

Okay. I just wanted to be sure I had it right.

Dan Comas

Yes, they are performing very well.

Larry Culp

Thanks, Chris.

Chris Kotowicz - AG Edwards

Bye-bye.

Operator

And we’ll take our final question from Ajit Pai with Thomas Weisel Partners.

Ajit Pai - Thomas Weisel Partners

Yeah, good morning.

Dan Comas

Hi Ajit.

Larry Culp

Good morning.

Ajit Pai - Thomas Weisel Partners

Two quick questions, if I may? The first is you mentioned the growth in China, could you give us some color as to, in this quarter, what the percentage of overall sales was from China and then overall from Asia?

And the second question would be just your balance sheet, you know we had some pretty solid cash flows here. You know, the pace of acquisitions has been fairly moderate, and a number of companies have been opportunistic in raising debt in an environment like this.

So could you give us some color as to how you're thinking about leveraging your balance sheet, and potentially how you prioritize potential uses for cash right now in terms of acquisitions, dividends, potentially a buyback? And yes, those two.

Dan Comas

Maybe, Ajit, on the second point, I think, as an A plus rated company, we've got a lot of capacity here and we are clearly spending a lot -- as Larry mentioned earlier in the call, we are spending a lot of time looking at acquisitions and think that our balance sheet has a lot of capacity to take on additional leverage without impacting our credit rating.

So I don't, given our access to commercial paper, I don't think we feel the need to go out and lock in some long-term debt but we’re clearly spending the time looking to deploy more capital here.

Larry Culp

And again, I think, Ajit, we would, at this point, be rather optimistic that we will make some meaningful moves here in the second half of 2007. I mean, you never can forecast that, but again, given the activity level, given the pipeline that we reviewed just yesterday, and we feel pretty good in the regard about what could happen here in the back half.

Ajit Pai - Thomas Weisel Partners

I got it. And then, on Asia and China, the percentage of sales?

Dan Comas

I think, in terms of the first question, growth, China was up mid-teens in the second quarter, for the full year looking to be $600 million, $700 million. And for the whole company, Ajit, I would have to get back to you with that number.

Ajit Pai - Thomas Weisel Partners

Okay. Thank you so much.

Larry Culp

All right. Thanks Ajit.

Dan Comas

Thank you.

Operator

And with no other questions, I would like to turn the call back to Mr. Wilson for any additional or closing comments.

Andy Wilson

I want to thank everybody for joining us today. As a reminder, the replay number is 888-203-1112 with the confirmation code of 2914902. As always, Dan and I will be available for questions after the call. Thanks again.

Operator

Again, that does conclude today's call. Thank you for your participation and have a good day.

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Source: Danaher Q2 2007 Earnings Call Transcript
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