Thermo Fisher Scientific Inc. — Q3 2016 Form 10-Q
Business context and period. Unaudited results cover the three and nine months ended October 1, 2016, compared with the periods ended September 26, 2015. Thermo Fisher supplies instruments, products, reagents, software and services across life sciences, analytical instruments, diagnostics, and laboratory products and services.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $4.491B | $4.123B | $13.321B | $12.313B |
| Operating income | $541M | $563M | $1.697B | $1.646B |
| Operating margin | 12.0% | 13.7% | 12.7% | 13.4% |
| Net income | $474M | $476M | $1.392B | $1.373B |
| Diluted EPS | $1.19 | $1.18 | $3.50 | $3.42 |
| Operating cash flow | Not separately reported | Not separately reported | $1.950B | $1.589B |
- Q3 revenue rose 9%; excluding acquisitions, divestitures and currency, revenue increased 4%. Nine-month revenue rose 8%, with 6% growth from operations on the company’s stated basis.
- Q3 reportable segment income increased 11% to $1.033B, while consolidated operating income declined 4%. Higher acquisition and restructuring charges weighed on consolidated results.
- Nine-month operating cash flow increased about 23%, mainly due to lower working-capital investment. Capital expenditures were $311M; operating cash flow less capital expenditures was approximately $1.64B.
Liquidity, debt and capital allocation
- At October 1, cash and cash equivalents were $1.970B; current assets were $8.204B and current liabilities $5.260B. Reported working capital was $2.94B.
- Total borrowings at carrying value were $18.913B, including $1.972B short-term obligations and current maturities. Long-term obligations were $16.940B. Cash less total borrowings implies net debt of approximately $16.94B.
- The company had a $2.50B revolving credit facility with no borrowings outstanding; availability was reduced by $67M of letters of credit. Management said cash, operating cash flow and available borrowing capacity were sufficient for needs including at least the next 24 months.
- In October 2016, the company repaid $1.4B of debt, including $900M of notes due in 2017. Nine-month financing included $7.606B of net debt issuance, $1.0B of share repurchases and $179M of dividends. A further $1.5B remained authorized for repurchases at October 1.
Material changes and management commentary
- Thermo Fisher acquired Affymetrix on March 31 for $1.34B net of cash, including assumed debt, and FEI Company on September 19 for $4.08B net of cash. The acquisitions expanded genetic-analysis and electron-microscopy offerings. FEI contributed about $100M of post-acquisition Q3 revenue; its operating profit was not material due to acquisition-related charges.
- Acquisitions materially expanded the balance sheet: goodwill rose to $21.58B from $18.83B at year-end 2015, and acquisition-related intangible assets rose to $14.52B from $12.76B.
- Management attributed underlying sales growth to stronger demand, particularly from pharmaceutical and biotech customers. Q3 growth was modest in North America, moderate in Europe and strong in Asia; industrial and applied market sales decreased slightly.
- Productivity improvements supported segment results, but consolidated Q3 margin was pressured by acquisition and restructuring costs, strategic growth investments and, in some segments, mix. The company noted four additional selling days in Q1 2016 versus 2015 and four fewer selling days expected in Q4 2016 versus the prior-year quarter.
Outlook, unusual items and risks
- Management expected a 2016 effective tax rate below 2%, based on then-current forecasts, and cash income-tax payments of $630M–$700M for the year. The nine-month tax benefit included a $74M net benefit from foreign tax-credit planning and $39M of discrete benefits related to prior-year filings; future benefits from similar distributions may vary.
- Expected 2016 capital expenditures, net of disposals, were $435M–$445M. Management identified approximately $70M of additional restructuring charges, primarily in 2016 and 2017.
- Q3 restructuring and other costs totaled $150M; the nine-month total was $297M. These included acquisition transaction/integration costs, inventory revaluation and accounting-conformity charges, facility consolidation and severance, and litigation-related costs.
- Key contingencies include intellectual-property disputes, including an accrued $61M Enzo judgment pending appeal and a $52M Promega accrual while Supreme Court review proceeds; antitrust/commercial litigation; product-liability claims; and environmental remediation liabilities of approximately $49M. The company cautioned that unfavorable outcomes exceeding accruals could materially affect results, financial position or cash flows.
- Principal disclosed risks include acquisition integration and goodwill/intangible impairment, elevated leverage and covenant compliance, economic and customer-budget uncertainty, foreign-exchange exposure, technological competition, regulation, intellectual-property claims and operational or supply-chain disruptions. The filing reported disclosure controls as effective and no material change in internal controls during the quarter.
Important facts for investors to verify
- How much of reported growth and future earnings reflects acquired businesses versus organic demand, and whether FEI and Affymetrix deliver expected integration benefits.
- Debt, interest expense and covenant headroom following the acquisitions and October debt repayment; confirm the company’s leverage against its stepped-down leverage limits.
- Whether operating margins recover as acquisition, restructuring and integration costs subside, and how the Q4 selling-day comparison affects results.
- The durability of unusually low tax expense and the timing and amount of cash tax payments; assess the role of discrete tax benefits.
- Developments in the cited litigation and environmental matters, and whether recorded accruals adequately reflect potential exposure.