Thermo Fisher Scientific Inc. — Q2 2018 Form 10-Q
Business context and period. Thermo Fisher supplies instruments, reagents, consumables, software and services to life sciences, diagnostics, healthcare and industrial markets. This unaudited filing covers the quarter and six months ended June 30, 2018; comparisons are with the quarter and six months ended July 1, 2017, except balance-sheet comparisons, which are with December 31, 2017. Amounts below are U.S. dollars.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $6.078 billion | $4.990 billion | $11.931 billion | $9.755 billion |
| Operating income | $937 million | $749 million | $1.723 billion | $1.369 billion |
| Operating margin | 15.4% | 15.0% | 14.4% | 14.0% |
| Net income | $752 million | $612 million | $1.331 billion | $1.163 billion |
| Diluted EPS | $1.85 | $1.56 | $3.28 | $2.95 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $1.522 billion | $1.210 billion |
- Q2 revenue grew 22%; management attributed $577 million of the $1.088 billion increase to acquisitions, $107 million to favorable currency translation and $404 million (8%) to operations, primarily higher demand. For the first half, revenue rose 22%, including $1.142 billion from acquisitions, $316 million from currency and $718 million (7%) from operations.
- Q2 segment revenue growth was 12% in Life Sciences Solutions, 12% in Analytical Instruments, 8% in Specialty Diagnostics and 42% in Laboratory Products and Services. Patheon was a major contributor to the latter segment’s acquisition-driven growth.
- Reportable-segment operating income increased 21% in Q2 and 20% in the first half. Segment margins were mixed: Laboratory Products and Services margin declined to 13.2% in Q2 and 12.4% for the half; Specialty Diagnostics’ first-half margin declined to 26.4%. Management cited sales mix and strategic investments as offsets to growth and productivity gains.
- Other expense was $131 million in Q2 and $283 million for the half, including interest expense of $170 million and $333 million, respectively. Management said higher interest expense primarily reflected increased debt.
- First-half investing cash outflow was $364 million, including $301 million of capital spending and $59 million for acquisitions. Financing cash outflow was $1.348 billion, including $1.353 billion of debt repayments and $129 million of dividends. Cash, cash equivalents and restricted cash ended the half at $956 million; cash and cash equivalents on the balance sheet were $937 million.
Balance sheet, debt and liquidity
- At June 30, 2018, total borrowings at carrying value were $19.420 billion, down from $21.008 billion at year-end 2017. This included $1.711 billion of short-term obligations and current maturities, including $1.005 billion of commercial paper.
- Working capital was $3.49 billion, compared with $2.37 billion at year-end. The company had a $2.50 billion revolving credit facility, with no borrowings outstanding and availability reduced by $83 million for letters of credit. Management said cash, operating cash flow and available credit should cover existing business needs for at least the next 24 months.
- First-half cash flow from operations improved by $312 million year over year. Management cited higher income before depreciation and amortization, partly offset by greater working-capital investment. Accounts receivable and inventory increases used $97 million and $195 million of cash, respectively.
Changes, outlook and notable items
- Growth reflected both stronger underlying demand and acquisitions. The company acquired IntegenX for $65 million in 2018 and agreed to acquire Gatan for approximately $925 million in cash, expected to close by year-end subject to customary conditions and regulatory approvals. Gatan is expected to be funded with new debt and cash.
- Management forecast a 2018 effective tax rate of 6%–9%, cash income-tax payments of $525–$575 million and capital expenditures, net of disposals, of approximately $700–$730 million. The Q2 effective tax rate was 6.5%. The filing attributes tax outcomes in part to geographic earnings mix, foreign tax credits and U.S. tax reform adjustments.
- As of August 3, 2018, the company identified approximately $100 million of additional restructuring charges, primarily in 2018 and 2019. It recorded $81 million of restructuring and other costs in the first half, including facility actions, acquisition integration costs, litigation-related matters and hurricane response costs.
- Revenue-recognition guidance adopted January 1, 2018 changed balance-sheet classification and timing for certain pharmaceutical development and manufacturing service costs. The company said prior guidance would not have materially changed reported income, comprehensive income or cash flows for the first half. Remaining performance obligations were $5.12 billion, approximately 90% expected to be recognized within 12 months.
- Foreign-currency translation reduced first-half other comprehensive income by $415 million; accumulated other comprehensive items were a loss of $2.491 billion at June 30. The company reported no material change in its market-risk exposure from year-end 2017.
- Contingencies include approximately $52 million of environmental liabilities and a maintained $52 million accrual in the Promega patent case, despite favorable appellate rulings; Promega petitioned the U.S. Supreme Court for review. The company stated that other pending matters could have a material adverse effect if outcomes exceed current estimates. Unrecognized tax benefits totaled $1.287 billion.
- Other investor-relevant items: the company repurchased no shares in Q2, then repurchased $250 million in July 2018; $250 million remained available under the authorization at August 3. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported growth and future performance depends on acquisitions, especially Patheon, and how acquired operations affect segment margins and integration costs.
- Whether underlying demand, particularly in Asia, continues to support the reported 7%–8% operational revenue growth, apart from currency and acquisitions.
- Debt maturities, commercial-paper refinancing access, interest costs and covenant headroom as the company funds the Gatan acquisition; the filing states covenant limits but does not provide actual leverage or coverage ratios.
- Whether the tax-rate and cash-tax outlook remains achievable, including the effect of tax reform adjustments, foreign tax credits and the $1.287 billion of unrecognized tax benefits.
- The timing and cash impact of the additional approximately $100 million restructuring charges, capital spending plan and pending Gatan transaction.
- Developments in the Promega matter and other litigation, environmental remediation, and the quality and regulatory risks associated with pharmaceutical services.