Thermo Fisher Scientific Inc. — Q2 2016 Form 10-Q
Business context and period. Thermo Fisher supplies instruments, equipment, reagents, consumables, software and services to research, industrial, healthcare and diagnostic markets. This unaudited report covers the quarter ended July 2, 2016, and the six months then ended; comparisons are with the periods ended June 27, 2015. Dollar amounts below are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Revenue | $4,535.2 | $4,270.9 | $8,830.0 | $8,189.7 |
| Operating income | $637.6 | $595.8 | $1,155.5 | $1,083.1 |
| Operating margin | 14.1% | 14.0% | 13.1% | 13.2% |
| Income from continuing operations | $516.8 | $511.6 | $919.1 | $896.7 |
| Net income | $516.6 | $511.6 | $918.8 | $896.7 |
| Diluted EPS | $1.30 | $1.27 | $2.31 | $2.23 |
- Revenue rose 6% in Q2 and 8% in the first half. Excluding acquisitions, divestitures and currency, revenue increased 4% in Q2 and 7% in the first half, according to management. First-half operating growth also benefited from four additional selling days in Q1.
- Q2 net income increased modestly despite higher interest expense and other charges. The Q2 effective tax rate was 0.8%; the first-half rate was 2.6%, helped by tax-planning-related foreign tax credits.
- Operating cash flow was $1,178.6 in the first half, versus $844.9 in 2015. Management attributed the improvement primarily to lower working-capital investment. Capital expenditures were $229.9; acquisition spending was $1,033.1; investing cash outflow totaled $1,248.0.
- Cash and cash equivalents were $663.1 at July 2, up from $452.1 at December 31, 2015. Working capital was $803, down from $1.59 billion, primarily reflecting short-term debt used to fund Affymetrix and stock repurchases.
- Total borrowings at carrying value were $14,147.8, compared with $12,472.0 at year-end 2015. Short-term obligations and current maturities were $2,515.9; long-term obligations were $11,631.9. Commercial paper was $989.4 and a term loan balance was $625.0.
- The company had a $2.50 billion revolving credit facility, with no borrowings outstanding at quarter-end and capacity reduced by about $64 for letters of credit. Management said available cash, operating cash flow, revolver capacity and committed FEI financing should cover existing-business requirements for at least 24 months.
Material changes and segment performance
- Q2 revenue increased $264.3: acquisitions contributed $108.0, currency reduced sales by $16.4, and operations contributed $172.7. Management cited particularly strong pharmaceutical and biotech demand; growth was modest in North America, moderate in Europe and strong in Asia.
- First-half operating income rose 7%, while operating margin edged down to 13.1% from 13.2%. Productivity and higher sales helped results; strategic investments, unfavorable mix, and higher restructuring and acquisition-related charges weighed on them.
- Q2 segment revenue and segment income growth were: Life Sciences Solutions, 13% and 14%; Analytical Instruments, 2% and 4%; Specialty Diagnostics, 4% and 5%; Laboratory Products and Services, 6% and 8%. These segment income measures exclude specified acquisition-related charges, restructuring and intangible amortization.
- Analytical Instruments’ first-half operating margin declined to 16.5% from 17.4%, reflecting mix, strategic investments and costs associated with extra selling days. Other segment first-half margins were broadly stable or improved.
- Restructuring and other costs were $56.6 in Q2 and $146.7 in the first half, versus $25 and $65, respectively, in the comparable 2015 periods. The first-half charges included acquisition integration, inventory revaluation, facility consolidation, severance and other items. Management identified approximately $40 of additional restructuring charges, primarily in 2016.
Outlook, transactions and notable matters
- Management forecast a 2016 effective tax rate of 2%–4% and cash income tax payments of $625–$675. Tax benefits depend partly on foreign earnings, cash flows and applicable tax laws and may vary by period.
- Management expected 2016 capital expenditures, net of disposals, of approximately $435–$445. It noted that four fewer selling days in Q4 2016 versus Q4 2015 would create a corresponding opposite effect to the first-half extra selling days.
- Affymetrix was acquired on March 31 for $1.34 billion net of cash acquired, including assumed debt. The company agreed in May to acquire FEI for approximately $4.2 billion in cash, expected to close by year-end subject to shareholder and regulatory approvals and other customary conditions. Committed financing included a $2.0 billion bridge facility and a $2.0 billion term-loan facility; management intended to replace part of the bridge financing with long-term debt.
- After quarter-end, Thermo Fisher agreed to issue €600 million of floating-rate notes due 2018, with proceeds intended in part to repay the remaining $625 million 364-day term loan. On July 7, the board authorized up to $1.5 billion of additional share repurchases. The company repurchased $1.0 billion of shares in the first half; no repurchases occurred in Q2.
- Management cited productivity improvements and higher local-currency sales as positive factors, offset by inflation, mix, growth investments and integration/restructuring costs. The filing identifies risks from indebtedness and covenant compliance, acquisition completion and integration, foreign exchange, economic and customer spending conditions, Brexit-related uncertainty, product and intellectual-property litigation, regulation, taxes and operations.
- Contingencies include approximately $51 of environmental liabilities. Thermo Fisher retained $61 and $52 accruals for separate intellectual-property cases with appeals or proceedings pending; it paid $35 to settle another Enzo matter in May. Allergy-services antitrust litigation had a trial date set for October 24, 2016. Management said an adverse outcome exceeding existing accruals could materially affect results, financial position or cash flows.
- Disclosure controls were assessed as effective at the reasonable-assurance level, and the filing reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether FEI closes on schedule and at the expected terms, and the final mix, cost and timing of acquisition financing.
- Post-acquisition leverage, covenant headroom, refinancing of near-term maturities and the company’s ability to fund repurchases while integrating acquisitions.
- Underlying organic growth and segment margins, especially whether Analytical Instruments’ first-half margin weakness persists and how selling-day timing affects comparisons.
- How sustainable the unusually low 2016 tax-rate guidance is, including the effect of foreign tax-credit initiatives and higher cash tax payments.
- Whether restructuring charges, environmental estimates and litigation accruals change materially as integration and legal matters progress.