Life-sciences leader Thermo Fisher Scientific (TMO 0.46%) reported quarterly earnings on Thursday morning, and it's clear the company's strategic acquisition of Life Technologies is paying off. While on a GAAP basis Thermo Fisher may fall victim to Wall Street's expectations game, non-GAAP earnings that exclude one-time gains and charges beat those expectations, and when compared with the same period in 2013, they appear even more impressive.
| Metric | Q3 2013 | Q3 2014 Estimates | Q3 2014 | YoY growth |
|---|---|---|---|---|
| Revenue | $3.19 billion | $4.21 billion | $4.17 billion | 31% |
| GAAP EPS | $0.86 | $1.69 | $1.17 | 36% |
| Adjusted EPS | $1.30 | - | $1.71 | 32% |
Thirty percent growth for a company as large as Thermo Fisher is incredibly inspiring, yet the stock finished the day down more than 3%. Why is the market doubting the results? It's all about the outlook.
Revised guidance
As we near year end, management has a much clearer picture of the full-year results it'll be reporting in three months. And while the outlook still remains strong, predicting 27% EPS growth, management cut the midpoint of its guidance for full-year revenue from $16.92 billion to $16.78 billion.
While that may not seem like a lot, the revenue guidance speaks to a major risk for all international businesses moving forward: The strength of the U.S. dollar makes foreign sales less valuable. In 2013, 49% of Thermo Fisher's sales came from outside North America. In the long run, I believe that diversification is necessary for both growth and stability, but in the short run it can cause a few headaches.
Two other numbers to watch
Contributions from the acquisition of Life Technologies make interpretation of revenue and EPS growth rates slightly tricky to analyze, as the boost in those numbers is largely driven by the incorporation of Life's business and not growth in Thermo Fisher's core businesses. Organic revenue growth, which tracks growth not derived from acquisitions, came in at only 4%. It's important to remember that while Thermo Fisher's M&A strategy provides stepwise boosts to earnings, in the absence of acquisition the business is rather slow growing. Therefore, barring additional large purchases, don't expect eye-popping 30% growth to continue next year once Life has been fully incorporated into the business.
Another consequence of the M&A strategy is a dependence on debt. To help fund its acquisition of Life, Thermo Fisher took on several billion dollars in debt, raising its total leverage to 5.4 times EBITDA in the first quarter. Management committed to reducing that number to 2.5-3 by Q3 2015. In Q3 of 2014, a significant amount of free cash flow and existing cash were used to bring leverage down to 3.8.
What does all this mean for investors? Free cash flow is a measure of cash coming into the business after capital expenditures that management can invest back into the business or return to shareholders. The sooner Thermo Fisher can reduce its debt into the target range, the sooner it can apply its strong cash flow to shareholder value. For a business with slow organic growth, free cash flow can be important to ignite growth, and capital allocation will be important to watch.
