Thermo Fisher Scientific Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter ended September 29, 2018; results are unaudited. Thermo Fisher supplies analytical instruments, equipment, reagents, consumables, software and services to research, industrial, healthcare and diagnostics markets. Its four segments are Life Sciences Solutions, Analytical Instruments, Specialty Diagnostics, and Laboratory Products and Services.
Financial performance
| Metric | Q3 2018 | Q3 2017 | First nine months 2018 | First nine months 2017 |
|---|---|---|---|---|
| Revenue | $5.920 billion | $5.116 billion | $17.851 billion | $14.871 billion |
| Operating income | $912 million | $634 million | $2.635 billion | $2.003 billion |
| Operating margin | 15.4% | 12.4% | 14.8% | 13.5% |
| Net income | $709 million | $534 million | $2.040 billion | $1.697 billion |
| Diluted EPS | $1.75 | $1.34 | $5.03 | $4.29 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $2.742 billion | $2.139 billion |
- Q3 revenue grew 16% year over year. Acquisitions contributed $348 million; currency translation reduced revenue by $49 million; underlying operations added $505 million, or 10%.
- For the first nine months, revenue grew 20%. Acquisitions contributed $1.490 billion, favorable currency translation $267 million, and underlying operations $1.223 billion, or 8%.
- Q3 segment revenue and operating income: Life Sciences Solutions $1.504 billion and $495 million; Analytical Instruments $1.333 billion and $294 million; Specialty Diagnostics $894 million and $223 million; Laboratory Products and Services $2.470 billion and $299 million. Segment income is a company-defined measure before specified acquisition-related, restructuring and amortization items.
- Q3 segment margins were 32.9%, 22.0%, 25.0% and 12.1%, respectively. For the first nine months, segment margins were 33.5%, 21.3%, 25.9% and 12.3%, respectively. Laboratory Products and Services includes Patheon, acquired in 2017.
- Q3 other expense, net was $102 million, including $162 million interest expense partly offset by $41 million interest income. Nine-month other expense was $385 million; interest expense rose $69 million from 2017, primarily due to higher debt.
Cash flow, balance sheet and capital allocation
- Cash and cash equivalents were $1.098 billion at September 29, 2018, versus $1.335 billion at year-end 2017. Cash, cash equivalents and restricted cash totaled $1.111 billion.
- Nine-month operating cash flow was $2.742 billion, up from $2.139 billion. Investing used $532 million, including $474 million of capital expenditures; financing used $2.224 billion. Cash, cash equivalents and restricted cash declined by $250 million.
- Working capital was $4.37 billion, compared with $2.37 billion at December 31, 2017. Current assets were $9.566 billion and current liabilities $5.196 billion.
- Debt carrying value was $18.774 billion, down from $21.008 billion at year-end 2017; $1.014 billion was short-term, including $429 million of commercial paper. The $2.50 billion revolving credit facility had no borrowings outstanding, with capacity reduced by $83 million for letters of credit. The company reported compliance with facility covenants in the disclosure provided.
- Nine-month dividends paid were $198 million and share repurchases were $250 million. A new $2.00 billion repurchase authorization was approved in September; the filing states that $2.00 billion remained available at November 2, 2018.
Changes, outlook and notable items
- Management attributed operating-income growth principally to higher sales and, to a lesser extent, acquisitions. Strategic growth investment and unfavorable sales mix partly offset gains. Q3 reportable-segment margin declined to 22.1% from 22.9%, primarily due to Patheon’s dilutive effect; consolidated operating margin improved.
- Management expected a 2018 effective tax rate of 7%–10%, cash income-tax payments of $525–$575 million, and capital expenditures net of disposals of approximately $700–$730 million. It said cash, operating cash flow and available credit were expected to cover existing-business needs for at least 24 months.
- Q3 included a $52 million reversal of a previously accrued Promega patent-litigation liability after the U.S. Supreme Court denied review; this contributed to restructuring and other income. The income statement reported $27 million of net restructuring and other income for the quarter. The filing identified approximately $95 million of additional restructuring charges, primarily in 2018 and 2019.
- After quarter-end, Thermo Fisher completed the $477 million cash acquisition of Becton Dickinson’s Advanced Bioprocessing business on October 25. It also had an agreement to acquire Gatan for approximately $925 million, subject to customary conditions and regulatory approvals, with closing expected by year-end; management expected to use new debt financing and cash.
- Revenue recognition guidance adopted January 1, 2018 changed balance-sheet classifications, particularly for pharmaceutical development and manufacturing services. The company said it did not materially change reported income or cash flows for the periods presented. Management also expected lease-accounting adoption in 2019 to increase assets and liabilities, without a material impact on results or cash flows.
- Key risks include acquisition integration and substantial goodwill and intangible assets, high debt and covenant/refinancing exposure, foreign-exchange and tax uncertainty, regulatory and quality requirements in pharma services, litigation and product liability, market demand and government funding, supply or operating disruptions, and cybersecurity risks. Environmental remediation liabilities were approximately $50 million; the company said additional costs could arise. For certain pending claims, it could not meaningfully estimate reasonably possible losses.
Most important facts for investors to verify
- Whether underlying demand and segment growth persist, and whether margins recover in segments affected by mix, investment spending or Patheon dilution.
- Whether operating cash flow continues to cover working-capital needs, capital spending, dividends, buybacks and acquisition funding.
- Debt maturities, commercial-paper access, covenant headroom and the financing impact of the Gatan acquisition and other capital returns.
- Actual tax rate and cash taxes versus management’s 2018 ranges, including adjustments related to U.S. tax reform and foreign tax credits.
- Integration and performance of Patheon and subsequent acquisitions, and the timing and amount of the announced restructuring charges.
- Developments in disclosed litigation, environmental remediation and other contingencies that could exceed recorded accruals.