Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2006, and the nine months ended September 30, 2006, for Thermo Electron Corporation (now transitioning to Thermo Fisher Scientific Inc.). The company operates in two primary segments: Life and Laboratory Sciences and Measurement and Control. A defining event for the period is the pending merger with Fisher Scientific International Inc., approved by shareholders on August 30, 2006, with a target closing date of November 9, 2006, pending European Commission approval.
Key Financial Metrics
| Metric | Q3 2006 | Q3 2005 | 9M 2006 | 9M 2005 |
|---|---|---|---|---|
| Revenues | $724.96 million | $679.41 million | $2,122.72 million | $1,892.24 million |
| Operating Income | $75.11 million | $62.11 million | $215.13 million | $175.00 million |
| Operating Margin | 10.4% | 9.1% | 10.1% | 9.2% |
| Net Income | $48.83 million | $57.73 million | $143.62 million | $166.81 million |
| Diluted EPS (Continuing Ops) | $0.30 | $0.25 | $0.86 | $0.87 |
| Cash from Operations (9M) | $200.24 million | $144.86 million | ||
| Total Debt (Outstanding) | ||||
| Cash & Equivalents | $157.96 million | $214.33 million (Dec 31, 2005) | $157.96 million | $326.89 million (Dec 31, 2005) |
Note: Net Income for Q3 2005 included a $17.1 million gain from discontinued operations, whereas Q3 2006 had no such gain. Nine-month 2005 Net Income included a $23.9 million gain from discontinued operations.
Material Changes vs. Prior Period
- Revenue Growth: Revenues increased 7% in Q3 2006 and 12% in the first nine months of 2006 compared to the prior year. Organic growth (excluding acquisitions, divestitures, and currency) was 6% in Q3 and 7% in the nine-month period, driven by higher demand for mass spectrometry, spectroscopy, and anatomical pathology products.
- Operating Income: Operating income rose 21% in Q3 and 23% in the nine-month period. Margins expanded due to profit on incremental revenues and lower restructuring costs ($5.1 million lower in Q3; $8.8 million lower in 9M), partially offset by new stock-based compensation expenses.
- Restructuring Costs: Net restructuring and other costs decreased significantly to $5.2 million in Q3 2006 from $10.5 million in Q3 2005. The company expects to incur an additional $3 million in restructuring costs through 2007.
- Stock-Based Compensation: The adoption of SFAS No. 123R in 2006 resulted in an incremental pre-tax expense of $6.7 million in Q3 and $18.5 million in the nine-month period, reducing EPS by $0.03 and $0.08 respectively.
- Discontinued Operations: The prior year periods benefited significantly from gains on the disposal of discontinued operations ($17.1M in Q3 2005; $23.9M in 9M 2005), which were absent or minimal in 2006 ($2.2M gain in 9M 2006).
Guidance, Outlook, and Risks
- Merger with Fisher Scientific: The company expects to close the merger on November 9, 2006, assuming European Commission clearance. The combined entity will be named Thermo Fisher Scientific Inc. Thermo shareholders will own approximately 39% of the combined company. The company will assume Fisher's debt of approximately $2.15 billion.
- Capital Resources: The company negotiated a new $1 billion revolving credit agreement effective upon the merger closing. It expects to utilize approximately 25% of this facility immediately to refinance existing debt. Management believes existing cash, investments, and future cash flows are sufficient to meet requirements for at least the next 24 months.
- Stock Repurchases: The company repurchased $228 million of common stock in the first nine months of 2006. As of September 30, 2006, $72 million remained available under the current authorization.
- Key Risks:
- Merger Integration: Risks include failure to realize synergies, loss of key employees, and diversion of management attention.
- Intellectual Property Litigation: An ongoing lawsuit filed by Applera Corporation and others alleges patent infringement regarding mass spectrometer systems. An unfavorable outcome could have a material adverse effect.
- Goodwill Impairment: With $2.0 billion in goodwill, the company faces risk if future cash flows decline or if the merger does not proceed as planned.
- Market Cyclicality: The Measurement and Control segment is exposed to cyclical industries such as steel, petroleum, and semiconductors.
Investor Verification Checklist
- Merger Closing Date: Verify the status of the European Commission ruling expected by November 9, 2006, and the final closing of the Fisher Scientific merger.
- Debt Assumption: Confirm the final debt load post-merger, specifically the assumption of Fisher's $2.15 billion debt and the utilization of the new $1 billion credit facility.
- Restructuring Completion: Monitor the remaining $3 million of expected restructuring costs through 2007 and the finalization of the Kendro integration charges.
- Stock-Based Compensation Impact: Assess the full-year impact of SFAS No. 123R adoption on earnings and the potential acceleration of vesting upon merger completion.
- Patent Litigation: Track developments in the Applera/MDS patent infringement lawsuit regarding mass spectrometer systems.
- Segment Performance: Verify continued growth in the Life and Laboratory Sciences segment, which contributed 75% of total revenues in Q3 2006.