Item 1.
Business
General Development of Business
Thermo Fisher Scientific Inc. (also referred to in this document as "Thermo Fisher," "we," the "company," or the "registrant") is the world leader in serving science. Our mission is to enable our customers to make the world healthier, cleaner and safer. We help our customers accelerate life sciences research, solve complex analytical challenges, improve patient diagnostics, deliver medicines to market and increase laboratory productivity.
Thermo Fisher has approximately 70,000 employees and serves more than 400,000 customers within pharmaceutical and biotech companies, hospitals and clinical diagnostic labs, universities, research institutions and government agencies, as well as environmental, industrial quality and process control settings.
We serve our customers through our premier brands, Thermo Scientific, Applied Biosystems, Invitrogen, Fisher Scientific and Unity Lab Services:
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The Thermo Scientific brand offers customers in research, diagnostics, industrial, and applied markets a complete range of high-end analytical instruments as well as laboratory equipment, software, services, consumables and reagents. Our portfolio of products includes innovative technologies for mass spectrometry, chromatography, elemental analysis, electron microscopy, molecular spectroscopy, sample preparation, informatics, chemical research and analysis, cell culture, bioprocess production, cellular, protein and molecular biology research, allergy testing, drugs-of-abuse testing, therapeutic drug monitoring testing, microbiology, anatomical pathology, as well as environmental monitoring and process control.
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The Applied Biosystems brand offers customers in research, clinical and applied markets integrated instrument systems, reagents, and software for genetic analysis. Our portfolio includes innovative technologies for genetic sequencing and real-time, digital and end point polymerase chain reaction (PCR), that are used to determine meaningful genetic information in applications such as cancer diagnostics, human identification testing, and animal health, as well as inherited and infectious disease.
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The Invitrogen brand offers life science customers a broad range of consumables and instruments that accelerate research and ensure consistency of results. Our portfolio of products includes innovative solutions for cellular analysis and biology, flow cytometry, cell culture, protein expression, synthetic biology, molecular biology and protein biology.
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Fisher Scientific is our channels brand, offering customers a complete portfolio of laboratory equipment and consumables, chemicals, supplies and services used in scientific research, healthcare, safety, and education markets. These products are offered through an extensive network of direct sales professionals, segment-relevant printed collateral and digital content, a state-of-the-art website, and supply-chain management services. We also offer a range of biopharma services for clinical trials management and biospecimen storage.
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Unity Lab Services is our instrument and equipment services brand, offering a complete portfolio of services from enterprise level engagements to individual instruments and laboratory equipment, regardless of the original manufacturer. Through our network of world-class service and support personnel, we provide services that are designed to help our customers improve productivity, reduce costs, and drive decisions with better data.
We continuously increase our depth of capabilities in technologies, software and services, and leverage our extensive global channels to address our customers’ emerging needs. For example, in October 2018, we acquired, within the Life Sciences Solutions segment, Becton Dickinson and Company's Advanced Bioprocessing business, expanding our bioproduction offerings. Our goal is to make our customers more productive in an increasingly competitive business environment, and to allow them to solve their challenges, from complex research to improved patient care, environmental and process monitoring, and consumer safety.
Thermo Fisher is a Delaware corporation and was incorporated in 1956. The company completed its initial public offering in 1967 and was listed on the New York Stock Exchange in 1980.
Forward-looking Statements
Forward-looking statements, within the meaning of Section 21E of the Securities Exchange Act of 1934 (the Exchange Act), are made throughout this Annual Report on Form 10-K. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements, including without limitation statements regarding: projections of revenue, expenses, earnings, margins, tax rates, tax provisions, cash flows, pension and benefit obligations and funding
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Business (continued)
requirements, our liquidity position; cost reductions, restructuring activities, new product and service developments, competitive strengths or market position, acquisitions or divestitures; growth, declines and other trends in markets we sell into; new or modified laws, regulations and accounting pronouncements; outstanding claims, legal proceedings, tax audits and assessments and other contingent liabilities; foreign currency exchange rates and fluctuations in those rates; general economic and capital markets conditions; the timing of any of the foregoing; assumptions underlying any of the foregoing; and any other statements that address events or developments that Thermo Fisher intends or believes will or may occur in the future. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects," "seeks," "estimates," and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements are accompanied by such words. While the company may elect to update forward-looking statements in the future, it specifically disclaims any obligation to do so, even if the company’s estimates change, and readers should not rely on those forward-looking statements as representing the company’s views as of any date subsequent to the date of the filing of this report.
A number of important factors could cause the results of the company to differ materially from those indicated by such forward-looking statements, including those detailed under the heading, "Risk Factors" in Part I, Item 1A.
Item 1A.
Risk Factors
Set forth below are the risks that we believe are material to our investors. This section contains forward-looking statements. You should refer to the explanation of the qualifications and limitations on forward-looking statements in Item 1. Business under the caption "Forward-looking Statements".
We must develop new products, adapt to rapid and significant technological change and respond to introductions of new products by competitors to remain competitive. Our growth strategy includes significant investment in and expenditures for product development. We sell our products in several industries that are characterized by rapid and significant technological changes, frequent new product and service introductions and enhancements and evolving industry standards. Competitive factors include technological innovation, price, service and delivery, breadth of product line, customer support, e-business capabilities and the ability to meet the special requirements of customers. Our competitors may adapt more quickly to new technologies and changes in customers’ requirements than we can. Without the timely introduction of new products, services and enhancements, our products and services will likely become technologically obsolete over time, in which case our revenue and operating results would suffer.
Many of our existing products and those under development are technologically innovative and require significant planning, design, development and testing at the technological, product and manufacturing-process levels. Our customers use many of our products to develop, test and manufacture their own products. As a result, we must anticipate industry trends and develop products in advance of the commercialization of our customers’ products. If we fail to adequately predict our customers’ needs and future activities, we may invest heavily in research and development of products and services that do not lead to significant revenue.
It may be difficult for us to implement our strategies for improving internal growth. Our growth depends in part on the growth of the markets which we serve. Any decline or lower than expected growth in our served markets could diminish demand for our products and services, which would adversely affect our results of operations and financial condition. To address this issue, we are pursuing a number of strategies to improve our internal growth, including:
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strengthening our presence in selected geographic markets;
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allocating research and development funding to products with higher growth prospects;
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Risk Factors (continued)
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developing new applications for our technologies;
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expanding our service offerings;
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continuing key customer initiatives;
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combining sales and marketing operations in appropriate markets to compete more effectively;
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finding new markets for our products; and
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continuing the development of commercial tools and infrastructure to increase and support cross-selling opportunities of products and services to take advantage of our depth in product offerings.
We may not be able to successfully implement these strategies, and these strategies may not result in the expected growth of our business.
Our business is affected by general economic conditions and related uncertainties affecting markets in which we operate. Our business is affected by general economic conditions, both inside and outside the U.S. If the global economy and financial markets, or economic conditions in Europe, the U.S. or other key markets, are unstable, it could adversely affect the business, results of operations and financial condition of the company and its customers, distributors, and suppliers, having the effect of
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reducing demand for some of our products;
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increasing the rate of order cancellations or delays;
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increasing the risk of excess and obsolete inventories;
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increasing pressure on the prices for our products and services;
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causing supply interruptions which could disrupt our ability to produce our products; and
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creating longer sales cycles and greater difficulty in collecting sales proceeds.
Demand for some of our products depends on capital spending policies of our customers and on government funding policies. Our customers include pharmaceutical and chemical companies, laboratories, universities, healthcare providers, government agencies and public and private research institutions. Many factors, including public policy spending priorities, available resources and product and economic cycles, have a significant effect on the capital spending policies of these entities.
Spending by some of these customers fluctuates based on budget allocations and the timely passage of the annual federal budget. An impasse in federal government budget decisions could lead to substantial delays or reductions in federal spending.
Economic, political, foreign currency and other risks associated with international sales and operations could adversely affect our results of operations. International markets contribute a substantial portion of our revenues, and we intend to continue expanding our presence in these regions. The exposure to fluctuations in currency exchange rates takes on different forms. International revenues and costs are subject to the risk that fluctuations in exchange rates could adversely affect our reported revenues and profitability when translated into U.S. dollars for financial reporting purposes. These fluctuations could also adversely affect the demand for products and services provided by us. As a multinational corporation, our businesses occasionally invoice third-party customers in currencies other than the one in which they primarily do business (the "functional currency"). Movements in the invoiced currency relative to the functional currency could adversely impact our cash flows and our results of operations. As our international sales grow, exposure to fluctuations in currency exchange rates could have a larger effect on our financial results. In 2018, currency translation had a favorable effect of $173 million on revenues due to the weakening of the U.S. dollar relative to other currencies in which the company sells products and services.
In addition, many of our employees, contract manufacturers, suppliers, job functions, outsourcing activities and manufacturing facilities are located outside the United States. Accordingly, our future results could be harmed by a variety of factors, including:
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interruption to transportation flows for delivery of parts to us and finished goods to our customers;
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changes in a specific country's or region's political, economic or other conditions;
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changes in diplomatic and trade relationships, including new tariffs, trade protection measures, import or export licensing requirements, trade embargoes and sanctions and other trade barriers;
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Risk Factors (continued)
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tariffs imposed by the U.S. on goods from other countries and tariffs imposed by other countries on U.S. goods, including the tariffs recently adopted by the U.S. government on various imports from China and by the Chinese government on certain U.S. goods;
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negative consequences from changes in tax laws;
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difficulty in staffing and managing widespread operations;
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differing labor regulations;
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differing protection of intellectual property;
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unexpected changes in regulatory requirements; and
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geopolitical uncertainty or turmoil, including terrorism and war.
Significant developments stemming from the U.S. administration or the U.K.’s referendum on membership in the EU could have an adverse effect on us. The U.S. administration has called for substantial changes to trade agreements and is imposing significant increases on tariffs on goods imported into the United States. The administration has also indicated an intention to request Congress to make significant changes, replacement or elimination of the Patient Protection and Affordable Care Act, and government negotiation/regulation of drug prices paid by government programs. Changes in U.S. social, political, regulatory and economic conditions or laws and policies governing the health care system and drug prices, foreign trade, manufacturing, and development and investment in the territories and countries where we or our customers operate could adversely affect our operating results and our business.
Additionally, on June 23, 2016, the United Kingdom held a referendum and voted in favor of leaving the European Union, or EU. This referendum has created political and economic uncertainty, particularly in the United Kingdom and the EU, and this uncertainty may last for years. Our business could be affected during this period of uncertainty, and perhaps longer, by the impact of the United Kingdom’s referendum. In addition, our business could be negatively affected by new trade agreements between the United Kingdom and other countries, including the United States, and by the possible imposition of trade or other regulatory barriers in the United Kingdom. These possible negative impacts, and others resulting from the United Kingdom’s actual or threatened withdrawal from the EU, may adversely affect our operating results and our customers’ businesses.
Our inability to protect our intellectual property could have a material adverse effect on our business. In addition, third parties may claim that we infringe their intellectual property, and we could suffer significant litigation or licensing expense as a result. We place considerable emphasis on obtaining patent and trade secret protection for significant new technologies, products and processes because of the length of time and expense associated with bringing new products through the development process and into the marketplace. Our success depends in part on our ability to develop patentable products and obtain and enforce patent protection for our products both in the United States and in other countries. We own numerous U.S. and foreign patents, and we intend to file additional applications, as appropriate, for patents covering our products. Patents may not be issued for any pending or future patent applications owned by or licensed to us, and the claims allowed under any issued patents may not be sufficiently broad to protect our technology. Any issued patents owned by or licensed to us may be challenged, invalidated or circumvented, and the rights under these patents may not provide us with competitive advantages. In addition, competitors may design around our technology or develop competing technologies. Intellectual property rights may also be unavailable or limited in some foreign countries, which could make it easier for competitors to capture increased market position. We could incur substantial costs to defend ourselves in suits brought against us or in suits in which we may assert our patent rights against others. An unfavorable outcome of any such litigation could materially adversely affect our business and results of operations.
We also rely on trade secrets and proprietary know-how with which we seek to protect our products, in part, by confidentiality agreements with our collaborators, employees and consultants. These agreements may be breached and we may not have adequate remedies for any breach. In addition, our trade secrets may otherwise become known or be independently developed by our competitors.
Third parties may assert claims against us to the effect that we are infringing on their intellectual property rights. In the event that a claim relating to intellectual property is asserted against us, or third parties not affiliated with us hold pending or issued patents that relate to our products or technology, we may seek licenses to such intellectual property or challenge those patents. However, we may be unable to obtain these licenses on commercially reasonable terms, if at all, and our challenge of the patents may be unsuccessful. Our failure to obtain the necessary licenses or other rights could prevent the sale, manufacture, or distribution of our products and, therefore, could have a material adverse effect on our business, financial condition and results of operations.
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Risk Factors (continued)
Changes in governmental regulations may reduce demand for our products or increase our expenses. We compete in many markets in which we and our customers must comply with federal, state, local and international regulations, such as environmental, health and safety and food and drug regulations. We develop, configure and market our products to meet customer needs created by those regulations. Any significant change in regulations could reduce demand for our products or increase our expenses. For example, many of our instruments are marketed to the pharmaceutical industry for use in discovering and developing drugs. Changes in the U.S. Food and Drug Administration’s regulation of the drug discovery and development process could have an adverse effect on the demand for these products.
Our pharma services offerings are highly complex, and if we are unable to provide quality and timely offerings to our customers, our business could suffer. Our pharma services offerings are highly exacting and complex, due in part to strict quality and regulatory requirements. Our operating results in this business depend on our ability to execute and, when necessary, improve our quality management strategy and systems, and our ability to effectively train and maintain our employee base with respect to quality management. A failure of our quality control systems could result in problems with facility operations or preparation or provision of products. In each case, such problems could arise for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials or environmental factors and damage to, or loss of, manufacturing operations. Such problems could affect production of a particular batch or series of batches of products, requiring the destruction of such products or a halt of facility production altogether.
In addition, our failure to meet required quality standards may result in our failure to timely deliver products to our customers, which in turn could damage our reputation for quality and service. Any such failure could, among other things, lead to increased costs, lost revenue, reimbursement to customers for lost drug product, registered intermediates, registered starting materials, and active pharmaceutical ingredients, other customer claims, damage to and possibly termination of existing customer relationships, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. Production problems in our drug and biologic manufacturing operations could be particularly significant because the cost of raw materials for such manufacturing is often high. If problems in preparation or manufacture of a product or failures to meet required quality standards for that product are not discovered before such product is released to the market, we may be subject to adverse regulatory actions, including product recalls, product seizures, injunctions to halt manufacture and distribution, restrictions on our operations, civil sanctions, including monetary sanctions, and criminal actions. In addition, such problems or failures could subject us to litigation claims, including claims from our customers for reimbursement for the cost of lost or damaged active pharmaceutical ingredients, the cost of which could be significant.
We are subject to product and other liability risks for which we may not have adequate insurance coverage. We may be named as a defendant in product liability lawsuits, which may allege that products or services we have provided from our pharma services offerings have resulted or could result in an unsafe condition or injury to consumers. Additionally, products currently or previously sold by our environmental and process instruments and radiation measurement and security instruments businesses include fixed and portable instruments used for chemical, radiation and trace explosives detection. These products are used in airports, embassies, cargo facilities, border crossings and other high-threat facilities for the detection and prevention of terrorist acts. If any of these products were to malfunction, it is possible that explosive or radioactive material could fail to be detected by our product, which could lead to product liability claims. There are also many other factors beyond our control that could lead to liability claims, such as the reliability and competence of the customers’ operators and the training of such operators.
Any such product liability claims brought against us could be significant and any adverse determination may result in liabilities in excess of our insurance coverage. Although we carry product liability insurance, we cannot be certain that our current insurance will be sufficient to cover these claims or that it can be maintained on acceptable terms, if at all.
Our inability to complete any pending acquisitions or to successfully integrate any new or previous acquisitions could have a material adverse effect on our business. Our business strategy includes the acquisition of technologies and businesses that complement or augment our existing products and services. Certain acquisitions may be difficult to complete for a number of reasons, including the need for antitrust and/or other regulatory approvals. Any acquisition we may complete may be made at a substantial premium over the fair value of the net identifiable assets of the acquired company. Further, we may not be able to integrate acquired businesses successfully into our existing businesses, make such businesses profitable, or realize anticipated cost savings or synergies, if any, from these acquisitions, which could adversely affect our business.
Moreover, we have acquired many companies and businesses. As a result of these acquisitions, we recorded significant goodwill and indefinite-lived intangible assets (primarily tradenames) on our balance sheet, which amount to approximately $25.35 billion and $1.27 billion, respectively, as of December 31, 2018. In addition, we have definite-lived intangible assets totaling $13.71 billion as of December 31, 2018. We assess the realizability of goodwill and indefinite-lived intangible assets annually as well as whenever events or changes in circumstances indicate that these assets may be impaired. We assess the
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Risk Factors (continued)
realizability of definite-lived intangible assets whenever events or changes in circumstances indicate that these assets may be impaired. These events or circumstances would generally include operating losses or a significant decline in earnings associated with the acquired business or asset. Our ability to realize the value of the goodwill and intangible assets will depend on the future cash flows of these businesses. These cash flows in turn depend in part on how well we have integrated these businesses. If we are not able to realize the value of the goodwill and intangible assets, we may be required to incur material charges relating to the impairment of those assets.
We are subject to laws and regulations governing government contracts, and failure to address these laws and regulations or comply with government contracts could harm our business by leading to a reduction in revenue associated with these customers. We have agreements relating to the sale of our products to government entities and, as a result, we are subject to various statutes and regulations that apply to companies doing business with the government. The laws governing government contracts differ from the laws governing private contracts and government contracts may contain pricing terms and conditions that are not applicable to private contracts. We are also subject to investigation for compliance with the regulations governing government contracts. A failure to comply with these regulations could result in suspension of these contracts, criminal, civil and administrative penalties or debarment.
Because we compete directly with certain of our larger customers and product suppliers, our results of operations could be adversely affected in the short term if these customers or suppliers abruptly discontinue or significantly modify their relationship with us. Our largest customer in the laboratory products business is also a significant competitor. Our business may be harmed in the short term if our competitive relationship in the marketplace with certain of our large customers results in a discontinuation of their purchases from us. In addition, we manufacture products that compete directly with products that we source from third-party suppliers. We also source competitive products from multiple suppliers. Our business could be adversely affected in the short term if any of our large third-party suppliers abruptly discontinues selling products to us.
Because we rely heavily on third-party package-delivery services, a significant disruption in these services or significant increases in prices may disrupt our ability to ship products, increase our costs and lower our profitability. We ship a significant portion of our products to our customers through independent package delivery companies, such as Federal Express in the U.S. and DHL in Europe. We also maintain a small fleet of vehicles dedicated to the delivery of our products and ship our products through other carriers, including national and regional trucking firms, overnight carrier services and the U.S. Postal Service. If one or more of these third-party package-delivery providers were to experience a major work stoppage, preventing our products from being delivered in a timely fashion or causing us to incur additional shipping costs we could not pass on to our customers, our costs could increase and our relationships with certain of our customers could be adversely affected. In addition, if one or more of these third-party package-delivery providers were to increase prices, and we were not able to find comparable alternatives or make adjustments in our delivery network, our profitability could be adversely affected.
We are required to comply with a wide variety of laws and regulations, and are subject to regulation by various federal, state and foreign agencies. We are subject to various local, state, federal, foreign and transnational laws and regulations, which include the operating and security standards of the U.S. Federal Drug Administration (the FDA), the U.S. Drug Enforcement Agency (the DEA), various state boards of pharmacy, state health departments, the U.S. Department of Health and Human Services (the DHHS), the European Medicines Agency (the EMA), in Europe, the EU member states and other comparable agencies and, in the future, any changes to such laws and regulations could adversely affect us. In particular, we are subject to laws and regulations concerning current good manufacturing practices and drug safety. Our subsidiaries may be required to register for permits and/or licenses with, and may be required to comply with the laws and regulations of the DEA, the FDA, the DHHS, foreign agencies including the EMA, and other various state boards of pharmacy, state health departments and/or comparable state agencies as well as certain accrediting bodies depending upon the type of operations and location of product distribution, manufacturing and sale.
The manufacture, distribution and marketing of many of our products and services, including medical devices and pharma services, are subject to extensive ongoing regulation by the FDA, the DEA, the EMA, and other equivalent local, state, federal and non-U.S. regulatory authorities. In addition, we are subject to inspections by these regulatory authorities. Failure by us or by our customers to comply with the requirements of these regulatory authorities, including without limitation, remediating any inspectional observations to the satisfaction of these regulatory authorities, could result in warning letters, product recalls or seizures, monetary sanctions, injunctions to halt manufacture and distribution, restrictions on our operations, civil or criminal sanctions, or withdrawal of existing or denial of pending approvals, including those relating to products or facilities. In addition, such a failure could expose us to contractual or product liability claims, contractual claims from our customers, including claims for reimbursement for lost or damaged active pharmaceutical ingredients, as well as ongoing remediation and increased compliance costs, any or all of which could be significant. We are the sole manufacturer of a number of
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Risk Factors (continued)
pharmaceuticals for many of our customers and a negative regulatory event could impact our customers' ability to provide products to their customers.
We are also subject to a variety of federal, state, local and international laws and regulations that govern, among other things, the importation and exportation of products, the handling, transportation and manufacture of substances that could be classified as hazardous, and our business practices in the U.S. and abroad such as anti-corruption, anti-competition and privacy and data protection laws. Any noncompliance by us with applicable laws and regulations or the failure to maintain, renew or obtain necessary permits and licenses could result in criminal, civil and administrative penalties and could have an adverse effect on our results of operations.
Our business could be adversely affected by disruptions at our sites. We rely upon our manufacturing operations to produce many of the products we sell and our warehouse facilities to store products, pending sale. Any significant disruption of those operations for any reason, such as strikes or other labor unrest, power interruptions, fire, hurricanes or other events beyond our control could adversely affect our sales and customer relationships and therefore adversely affect our business. We have significant operations in California, near major earthquake faults, which make us susceptible to earthquake risk. Although most of our raw materials are available from a number of potential suppliers, our operations also depend upon our ability to obtain raw materials at reasonable prices. If we are unable to obtain the materials we need at a reasonable price, we may not be able to produce certain of our products or we may not be able to produce certain of these products at a marketable price, which could have an adverse effect on our results of operations.
Fluctuations in our effective tax rate may adversely affect our results of operations and cash flows. As a global company, we are subject to taxation in numerous countries, states and other jurisdictions. In preparing our financial statements, we record the amount of tax that is payable in each of the countries, states and other jurisdictions in which we operate. Our future effective tax rate, however, may be lower or higher than experienced in the past due to numerous factors, including a change in the mix of our profitability from country to country, changes in accounting for income taxes and recently enacted and future changes in tax laws in jurisdictions in which we operate. Any of these factors could cause us to experience an effective tax rate significantly different from previous periods or our current expectations, which could have an adverse effect on our business, results of operations and cash flows.
We may incur unexpected costs from increases in fuel and raw material prices, which could reduce our earnings and cash flow. Our primary commodity exposures are for fuel, petroleum-based resins and steel. While we may seek to minimize the impact of price increases through higher prices to customers and various cost-saving measures, our earnings and cash flows could be adversely affected in the event these measures are insufficient to cover our costs.
A significant disruption in, or breach in security of, our information technology systems or violation of data privacy laws could adversely affect our business. As a part of our ongoing effort to upgrade our current information systems, we periodically implement new enterprise resource planning software and other software applications to manage certain of our business operations. As we implement and add functionality, problems could arise that we have not foreseen. Such problems could disrupt our ability to provide quotes, take customer orders and otherwise run our business in a timely manner. When we upgrade or change systems, we may suffer interruptions in service, loss of data or reduced functionality. In addition, if our new systems fail to provide accurate pricing and cost data our results of operations and cash flows could be adversely affected.
We also rely on our information technology systems to process, transmit and store electronic information (including sensitive data such as confidential business information and personally identifiable data relating to employees, customers and other business partners) and to manage or support a variety of critical business processes and activities (such as interacting with suppliers, selling our products and services, fulfilling orders and billing, collecting and making payments, shipping products, providing services and support to customers, tracking customer activity, fulfilling contractual obligations and otherwise conducting business). Our systems may be vulnerable to damage or interruption from natural disasters, power loss, telecommunication failures, terrorist attacks, computer hackers, computer viruses, ransomware, phishing, computer denial-of-service attacks, unauthorized access to customer or employee data or company trade secrets, and other attempts to harm our systems. Certain of our systems are not redundant, and our disaster recovery planning is not sufficient for every eventuality. Despite any precautions we may take, such problems could result in, among other consequences, interruptions in our services, which could harm our reputation and financial results. Any of the cyber-attacks, breaches or other disruptions or damage described above, if significant, could materially interrupt our operations, delay production and shipments, result in theft of our and our customers’ intellectual property and trade secrets, damage customer, business partner and employee relationships and our reputation or result in defective products or services, legal claims and proceedings, liability and penalties under privacy laws and increased cost for security and remediation, each of which could adversely affect our business and financial results.
If we are unable to maintain reliable information technology systems and appropriate controls with respect to global data privacy and security requirements and prevent data breaches, we may suffer regulatory consequences in addition to business
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consequences. As a global organization, we are subject to data privacy and security laws, regulations, and customer-imposed controls in numerous jurisdictions as a result of having access to and processing confidential, personal and/or sensitive data in the course of our business. For example, in the United States, individual states regulate data breach and security requirements and multiple governmental bodies assert authority over aspects of the protection of personal privacy. European laws require us to have an approved legal mechanism to transfer personal data out of Europe, and the recently-enacted EU General Data Protection Regulation, which took effect in May 2018, imposes significantly stricter requirements in how we collect and process personal data. Several countries, such as China and Russia, have passed laws that require personal data relating to their citizens to be maintained on local servers and impose additional data transfer restrictions. Government enforcement actions can be costly and interrupt the regular operation of our business, and data breaches or violations of data privacy laws can result in fines, reputational damage and civil lawsuits, any of which may adversely affect our business, reputation and financial statements.
Our debt may restrict our investment opportunities or limit our activities. As of December 31, 2018, we had approximately $18.99 billion in outstanding indebtedness. In addition, we have availability to borrow under a revolving credit facility that provides for up to $2.50 billion of unsecured multi-currency revolving credit. We may also obtain additional long-term debt and lines of credit to meet future financing needs, which would have the effect of increasing our total leverage.
Our leverage could have negative consequences, including increasing our vulnerability to adverse economic and industry conditions, limiting our ability to obtain additional financing and limiting our ability to acquire new products and technologies through strategic acquisitions.
Our ability to make scheduled payments, refinance our obligations or obtain additional financing will depend on our future operating performance and on economic, financial, competitive and other factors beyond our control. Our business may not generate sufficient cash flow to meet our obligations. If we are unable to service our debt, refinance our existing debt or obtain additional financing, we may be forced to delay strategic acquisitions, capital expenditures or research and development expenditures.
Additionally, the agreements governing our debt require that we maintain certain financial ratios, and contain affirmative and negative covenants that restrict our activities by, among other limitations, limiting our ability to incur additional indebtedness, merge or consolidate with other entities, make investments, create liens, sell assets and enter into transactions with affiliates. The covenants in our revolving credit facility (the Facility) include a Consolidated Leverage Ratio (total debt-to-Consolidated EBITDA) and a Consolidated Interest Coverage Ratio (Consolidated EBITDA to Consolidated Interest Expense), as such terms are defined in the Facility. Specifically, the company has agreed that, so long as any lender has any commitment under the Facility, any letter of credit is outstanding under the Facility, or any loan or other obligation is outstanding under the Facility, it will maintain a maximum Consolidated Leverage Ratio of 3.5:1.0. The company has also agreed that so long as any lender has any commitment under the Facility or any letter of credit is outstanding under the Facility, or any loan or other obligation is outstanding under the Facility, it will maintain a minimum Consolidated Interest Coverage Ratio of 3.0:1.0 as of the last day of any fiscal quarter.
Our ability to comply with these financial restrictions and covenants is dependent on our future performance, which is subject to prevailing economic conditions and other factors, including factors that are beyond our control such as foreign exchange rates and interest rates. Our failure to comply with any of these restrictions or covenants may result in an event of default under the applicable debt instrument, which could permit acceleration of the debt under that instrument and require us to prepay that debt before its scheduled due date. Also, an acceleration of the debt under certain of our debt instruments would trigger an event of default under other of our debt instruments.
Item 1B.
Item 1B.
Unresolved Staff Comments
Not applicable.
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Item 2.
Item 2.
Properties
The location and general character of our principal properties by segment are as follows:
Life Sciences Solutions
We own approximately 2.9 million square feet of office, engineering, laboratory and production space, principally in California, New York, Florida, Michigan, Maryland, Illinois, Oregon, Wisconsin and Pennsylvania, within the U.S., and in Lithuania, the U.K. and New Zealand. We lease approximately 3.1 million square feet of office, engineering, laboratory and production space, principally in California, Maryland, Utah, Massachusetts and Texas, within the U.S., and in Singapore, China, Netherlands, Germany, India, South Korea, Norway, Japan and Brazil under various leases that expire between 2019 and 2033.
Analytical Instruments
We own approximately 2.2 million square feet of office, engineering, laboratory and production space, principally in California, Massachusetts, Wisconsin, Oregon and Minnesota, within the U.S., and in Germany, Netherlands and Italy. We lease approximately 2.5 million square feet of office, engineering, laboratory and production space, principally in California, Texas, Tennessee, Illinois, Oregon, Pennsylvania, Colorado and Florida, within the U.S., and in Czech Republic, China, Germany, Switzerland, Netherlands, the U.K., Japan, Australia and India, under various leases that expire between 2019 and 2034.
Specialty Diagnostics
We own approximately 2.0 million square feet of office, engineering, laboratory and production space, principally in Virginia, Kansas, New Hampshire and California, within the U.S., and in Sweden, Germany, the U.K. and Switzerland. We lease approximately 1.6 million square feet of office, engineering, laboratory and production space, principally in California, Kansas and Michigan, within the U.S., and in Finland, China, the U.K., France, Canada and Japan under various leases that expire between 2019 and 2034.
Laboratory Products and Services
We own approximately 12.8 million square feet of office, engineering, laboratory, warehouse and production space, principally in North Carolina, Pennsylvania, Ohio, Puerto Rico, New York, New Jersey, South Carolina, Illinois and California, within the U.S., and in the U.K., Austria, Italy, Canada, France, Germany and China. We lease approximately 4.7 million square feet of office, engineering, laboratory, warehouse and production space, principally in California, Pennsylvania, New York, Maryland, Ohio, North Carolina, Massachusetts, Tennessee and Texas, within the U.S., and in Australia, Germany, China, the U.K., Mexico, India, Singapore, New Zealand and Sweden under various leases that expire between 2019 and 2038.
Corporate Headquarters
We own approximately 127,000 square feet of office space in Massachusetts.
We believe that all of the facilities that we are currently using are in good condition and are suitable and adequate to meet our current needs. If we are unable to renew any of the leases that are due to expire in 2019 or 2020, we believe that suitable replacement properties are available on commercially reasonable terms.
Item 3.
Item 3.
Legal Proceedings
There are various lawsuits and claims against the company involving product liability, intellectual property, employment and commercial issues. See "Note 11 to our Consolidated Financial Statements - Commitments and Contingencies."
Item 4.
Item 4.
Mine Safety Disclosures
Not applicable.
THERMO FISHER SCIENTIFIC INC.
PART II
Item 5.
Item 5.
Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Price of Common Stock
Our common stock is traded on the New York Stock Exchange under the symbol TMO.
Holders of Common Stock
As of February 2, 2019, the company had 3,344 holders of record of its common stock. This does not include holdings in street or nominee names.
Issuer Purchases of Equity Securities
A summary of the share repurchase activity for the company's fourth quarter of 2018 follows:
(1)
On July 7, 2016, the Board of Directors authorized the repurchase of up to $1.50 billion of the company’s common stock. All of the shares of common stock repurchased by the company during the fourth quarter of 2018 were purchased under this program. On September 7, 2018, the Board of Directors authorized the repurchase of up to $2.00 billion of the company’s common stock. In January 2019, the company repurchased $750 million of the company's common stock under the 2018 authorization.
THERMO FISHER SCIENTIFIC INC.
Item 6.
Item 6.
Selected Financial Data
The caption "restructuring and other costs/income" in the notes below includes amounts charged to cost of revenues, primarily for the sale of inventories revalued at the date of acquisition, and charges/credits to selling, general and administrative expense primarily for significant acquisition transaction costs.
(a)
Reflects $91 million of pre-tax charges for restructuring and other costs.
(b)
Reflects $298 million of pre-tax charges for restructuring and other costs. Also reflects the acquisition of Patheon N.V. in August 2017.
(c)
Reflects $395 million of pre-tax charges for restructuring and other costs. Also reflects the acquisitions of Affymetrix, Inc. in March 2016 and FEI Company in September 2016.
(d)
Reflects $171 million of pre-tax charges for restructuring and other costs.
(e)
Reflects $140 million of pre-tax income from gains on sale of businesses, net of restructuring and other costs. Also reflects the acquisition of Life Technologies Corporation in February 2014.
THERMO FISHER SCIENTIFIC INC.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Reference is made throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations to Notes to Consolidated Financial Statements, which begin on page of this report.
Overview
The company develops, manufactures and sells a broad range of products that are sold worldwide. The company expands the product lines and services it offers by developing and commercializing its own technologies and by making strategic acquisitions of complementary businesses. The company’s continuing operations fall into four business segments (see Note 4): Life Sciences Solutions, Analytical Instruments, Specialty Diagnostics and Laboratory Products and Services.
Recent Acquisitions
The company’s strategy is to augment internal growth at existing businesses with complementary acquisitions. The company’s principal recent acquisitions are described below.
On March 31, 2016, the company acquired, primarily within the Life Sciences Solutions segment, Affymetrix, Inc., a North America-based provider of cellular and genetic analysis products, for a total purchase price of $1.34 billion, net of cash acquired, including the assumption of $254 million of debt. The acquisition expanded the company's existing portfolio of antibodies and assays for flow cytometry and single-cell biology applications. Additionally, the acquisition expanded the company's genetic analysis portfolio through the addition of microarrays. Revenues of Affymetrix were $360 million in 2015.
On September 19, 2016, the company acquired, within the Analytical Instruments segment, FEI Company, a North America-based provider of high-performance electron microscopy, for a total purchase price of $4.08 billion, net of cash acquired. The acquisition strengthened the company's analytical instrument portfolio with the addition of high-end electron microscopes. Revenues of FEI were $930 million in 2015.
On February 14, 2017, the company acquired, within the Life Sciences Solutions segment, Finesse Solutions, Inc., a North America-based developer of scalable control automation systems and software for bioproduction, for a total purchase price of $221 million, net of cash acquired. The acquisition expanded the company's bioproduction offerings. Revenues of Finesse Solutions were approximately $50 million in 2016.
On March 2, 2017, the company acquired, within the Analytical Instruments segment, Core Informatics, a North America-based provider of cloud-based platforms supporting scientific data management, for a total purchase price of $94 million, net of cash acquired. The acquisition enhanced the company's existing informatics solutions. Revenues of Core Informatics were approximately $10 million in 2016.
On August 29, 2017, the company acquired, within the Laboratory Products and Services segment, Patheon N.V., a leading global provider of high-quality drug development and delivery solutions to the pharmaceutical and biopharma sectors, for $35.00 per share in cash, or $7.36 billion, including the assumption of net debt. The company financed the purchase price, including the repayment of indebtedness of Patheon, with issuances of debt and equity.
Patheon provides comprehensive, integrated and highly customizable solutions as well as the expertise to help biopharmaceutical companies of all sizes satisfy complex development and manufacturing needs. The acquisition provided entry into the pharmaceutical contract development and manufacturing organization market and added a complementary service to the company's existing pharmaceutical services portfolio. Patheon's revenues totaled $1.87 billion for the year ended October 31, 2016.
On October 25, 2018, the company acquired, within the Life Sciences Solutions segment, Becton Dickinson and Company's Advanced Bioprocessing business for $477 million in cash. This North America-based business adds complementary cell culture products that expand the segment's bioproduction offerings to help customers increase yield during production of biologic drugs. Revenues of the Advanced Bioprocessing business were $100 million in 2017.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview of Results of Operations and Liquidity
Sales in 2018 were $24.36 billion, an increase of $3.44 billion from 2017. Sales increased $1.53 billion due to acquisitions. The favorable effects of currency translation resulted in an increase in revenues of $173 million in 2018. Aside from the effects of acquisitions and currency translation, revenues increased $1.74 billion (8%) primarily due to increased demand. Sales to customers in each of the company's primary end markets grew. Sales growth was strong in each of the company's primary geographic areas, particularly Asia.
In 2018, total company operating income and operating income margin were $3.78 billion and 15.5%, respectively, compared with $2.96 billion and 14.2%, respectively, in 2017. The increase in operating income was primarily due to profit on higher sales and, to a lesser extent, the effects of acquisitions and productivity improvements, net of inflationary cost increases, offset in part by an increase in strategic growth investments, unfavorable sales mix and amortization of acquisition-related intangible assets, due to recent acquisitions. The company’s references to strategic growth investments generally refer to targeted spending for enhancing commercial capabilities, including expansion of geographic sales reach and e-commerce platforms, marketing initiatives, expanded service and operational infrastructure, focused research projects and other expenditures to enhance the customer experience. The company’s references throughout this discussion to productivity improvements generally refer to improved cost efficiencies from its Practical Process Improvement (PPI) business system, reduced costs resulting from global sourcing initiatives, a lower cost structure following restructuring actions, including headcount reductions and consolidation of facilities, and low cost region manufacturing.
The company recorded a provision for income taxes in 2018 including a net provision of $68 million to adjust the estimated initial effects of the Tax Cuts and Jobs Act of 2017 (the Tax Act) recorded in 2017, consisting of an incremental provision of $117 million offset in part by a $49 million reduction of related unrecognized tax benefits established in 2017. These adjustments were required based on new U.S. Treasury guidance and further analysis of available tax accounting methods and elections, legislative updates, regulations, earnings and profit computations and foreign taxes. In 2018, the provision for income taxes also included a $71 million charge to establish a valuation allowance against net operating losses that will not be utilized as a result of the planned sale of the Anatomical Pathology business (Note 2).
The company recorded a provision for income taxes in 2017 principally due to a net provision of $204 million from the effects of the Tax Act consisting primarily of a one-time transition tax on deemed repatriated earnings and profits of foreign subsidiaries, net of a benefit from adjusting the deferred tax balances for the U.S. statutory tax rate reduction. In 2017, the company refinanced certain long term inter-company debt which resulted in an income tax benefit of $237 million related to a foreign exchange loss recognized for income tax purposes. In addition, in 2017 the company recorded a $65 million favorable adjustment to deferred tax balances due to extension of a tax holiday agreement in Singapore. The company continued to implement tax planning initiatives related to non-U.S. subsidiaries in 2017. These non-U.S. subsidiaries incurred foreign tax obligations, and made cash and deemed distributions to the company’s U.S. operations which resulted in no net tax cost. As a result of these distributions, the company benefitted from U.S. foreign tax credits of $86 million, offset in part by additional U.S. income taxes of $53 million on the related foreign income (which reduced the benefit from the foreign rate differential in 2017) for a net benefit of $33 million. The foreign tax credits are the result of foreign earnings and profits remitted or deemed remitted to the U.S. during the reporting year and the U.S. treatment of taxes paid in the foreign jurisdictions in the years those profits were originally earned. The company also implemented foreign tax credit planning in Sweden which resulted in $20 million of foreign tax credits, with no related incremental U.S. income tax expense.,
The effective tax rate in both 2018 and 2017 was also affected by relatively significant earnings in lower tax jurisdictions. Due primarily to the non-deductibility of intangible asset amortization for tax purposes, the company’s cash payments for
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview of Results of Operations and Liquidity (continued)
income taxes were higher than its income tax expense for financial reporting purposes and totaled $591 million and $479 million in 2018 and 2017, respectively.
The company expects its effective tax rate in 2019 will be between 7% and 10% based on currently forecasted rates of profitability in the countries in which the company conducts business and expected generation of foreign tax credits. The effective tax rate can vary significantly from period to period as a result of discrete income tax factors and events.
Income from continuing operations increased to $2.94 billion in 2018, from $2.23 billion in 2017 principally due to increase in operating income in 2018 (discussed above).
During 2018, the company’s cash flow from operations totaled $4.54 billion compared with $4.01 billion for 2017. The increase primarily resulted from higher income before amortization and depreciation in the 2018 period, offset in part by higher investment in working capital to support sales growth.
As of December 31, 2018, the company’s short-term debt totaled $1.27 billion, including $693 million of commercial paper obligations and $573 million of senior notes due within the next twelve months. The company has a revolving credit facility with a bank group that provides up to $2.50 billion of unsecured multi-currency revolving credit. If the company borrows under this facility, it intends to leave undrawn an amount equivalent to outstanding commercial paper to provide a source of funds in the event that commercial paper markets are not available. As of December 31, 2018, no borrowings were outstanding under the company’s revolving credit facility, although available capacity was reduced by approximately $82 million as a result of outstanding letters of credit.
The company expects to fund the acquisition of Gatan Inc. with a combination of existing cash balances and short-term borrowings. The company believes that its existing cash and cash equivalents of $2.10 billion as of December 31, 2018 and its future cash flow from operations together with available borrowing capacity under its revolving credit agreement will be sufficient to meet the cash requirements of its existing businesses for the foreseeable future, including at least the next 24 months.
Critical Accounting Policies and Estimates
The company’s discussion and analysis of its financial condition and results of operations is based upon its financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent liabilities. On an on-going basis, management evaluates its estimates, including those related to intangible assets and goodwill, income taxes, contingencies and litigation, and pension costs. Management believes the most complex and sensitive judgments, because of their significance to the consolidated financial statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Management bases its estimates on historical experience, current market and economic conditions and other assumptions that management believes are reasonable. The results of these estimates form the basis for judgments about the carrying value of assets and liabilities where the values are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The company believes the following represent its critical accounting policies and estimates used in the preparation of its financial statements:
(a)
Intangible Assets and Goodwill
The company uses assumptions and estimates in determining the fair value of assets acquired and liabilities assumed in a business combination. The determination of the fair value of intangible assets, which represent a significant portion of the purchase price in many of the company’s acquisitions, requires the use of significant judgment with regard to (i) the fair value; and (ii) whether such intangibles are amortizable or non-amortizable and, if the former, the period and the method by which the intangible asset will be amortized. The company estimates the fair value of acquisition-related intangible assets principally based on projections of cash flows that will arise from identifiable intangible assets of acquired businesses. The projected cash flows are discounted to determine the present value of the assets at the dates of acquisition. Definite-lived intangible assets totaled $13.71 billion at December 31, 2018. The company reviews definite-lived intangible assets for impairment when indication of potential impairment exists, such as a significant reduction in cash flows associated with the assets. Actual cash flows arising from a particular intangible asset could vary from projected cash flows which could imply different carrying values from those established at the dates of acquisition and which could result in impairment of such asset.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Critical Accounting Policies and Estimates (continued)
The company evaluates goodwill and indefinite-lived intangible assets for impairment annually and when events occur or circumstances change that would more-likely-than-not reduce the fair value of the asset below its carrying amount. Events or circumstances that might require an interim evaluation include unexpected adverse business conditions, economic factors, unanticipated technological changes or competitive activities, loss of key personnel and acts by governments and courts. Goodwill and indefinite-lived intangible assets totaled $25.35 billion and $1.27 billion, respectively, at December 31, 2018. Estimates of discounted future cash flows require assumptions related to revenue and operating income growth, discount rates and other factors. For the goodwill impairment tests, the company considers peer revenues and earnings trading multiples from companies that have operational and financial characteristics that are similar to the respective reporting units and estimated weighted average costs of capital. Different assumptions from those made in the company’s analysis could materially affect projected cash flows and the company’s evaluation of goodwill and indefinite-lived intangible assets for impairment.
For reporting units where the company performed the quantitative goodwill impairment test, indications of fair value based on projections of profitability for 2019 and thereafter and on peer revenues and earnings trading multiples were sufficient to conclude that no impairment of goodwill or indefinite-lived intangible assets existed at the end of the tenth fiscal month of 2018, the date of the company’s impairment testing. There can be no assurance, however, that an economic downturn will not materially adversely affect peer trading multiples and the company’s businesses such that they do not achieve their forecasted profitability and these assets become impaired. Should the fair value of the company’s goodwill or indefinite-lived intangible assets decline because of reduced operating performance, market declines, or other indicators of impairment, or as a result of changes in the discount rate, charges for impairment may be necessary.
With the completion of the Patheon acquisition in August 2017, the company established a new reporting unit, called Pharma Services, which solely consists of the legacy Patheon business, the book carrying value of which equaled its fair value as of the acquisition date. During its annual 2018 goodwill impairment assessment, the company determined that the Pharma Services reporting unit's cushion of fair value over book value had increased to 5%. Despite this favorable increase, given that the fair value of the reporting unit was not substantially in excess of its carrying value, relatively small decreases in future cash flows from anticipated results could result in impairment of goodwill. The key variables that drive the valuation of the reporting unit are revenue and operating income growth rate assumptions, peer revenue and earnings trading multiples, as well as the weighted average cost of capital rate applied. The estimates used for these assumptions represent management's best estimates, which the company believes are reasonable. These assumptions, however are subject to variability and uncertainty, including the degree to which the reporting unit will grow revenue and profitability levels. The Pharma Services reporting unit had $3.37 billion of goodwill, and an overall carrying value of $7.70 billion as of December 31, 2018.
(b)
Income Taxes
In the ordinary course of business there is inherent uncertainty in quantifying the company’s income tax positions. The company assesses income tax positions and records tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, the company has recorded the largest amount of tax benefit with a greater than 50 percent likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. Should tax return positions that the company expects are sustainable not be sustained upon audit, the company could be required to record an incremental tax provision for such taxes. The company’s liability for these unrecognized tax benefits totaled $1.44 billion at December 31, 2018.
The company operates in numerous countries under many legal forms and, as a result, is subject to the jurisdiction of numerous domestic and non-U.S. tax authorities, as well as to tax agreements and treaties among these governments. Determination of taxable income in any jurisdiction requires the interpretation of the related tax laws and regulations and the use of estimates and assumptions regarding significant future events, such as the amount, timing and character of deductions, permissible revenue recognition methods under the tax law and the sources and character of income and tax credits. Changes in tax laws, regulations, agreements and treaties, currency exchange restrictions or the company’s level of operations or profitability in each taxing jurisdiction could have an impact upon the amount of current and deferred tax balances and hence the company’s net income.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Critical Accounting Policies and Estimates (continued)
The company estimates the degree to which tax assets and loss carryforwards will result in a benefit, after consideration of all positive and negative evidence, and provides a valuation allowance for tax assets and loss carryforwards that it believes will more likely than not go unused. In situations in which the company has been able to conclude that its deferred tax assets will be realized, it has generally relied on future reversals of taxable temporary differences, expected future taxable income where such estimates have historically been reliable, and other factors. If it becomes more likely than not that a tax asset or loss carryforward will be used, the company reverses the related valuation allowance. Any such reversals are recorded as a reduction of the company’s tax provision. The company’s tax valuation allowance totaled $471 million at December 31, 2018. Should the company’s actual future taxable income by tax jurisdiction vary from estimates, additional allowances or reversals thereof may be necessary.
The company has not provided state income or foreign withholding taxes on certain of its non-U.S. subsidiaries’ undistributed earnings, as such amounts are intended to be reinvested outside the United States indefinitely in the respective jurisdictions based on specific business plans and tax strategies. These business plans and tax strategies consider: short-term and long-term forecasts and budgets of the U.S. parent and non-U.S. subsidiaries; working capital and other needs in locations where earnings are generated; the company’s past practices regarding non-U.S. subsidiary dividends; sources of financing by the U.S. parent, such as issuing debt or equity; and uses of cash by the U.S. parent that are more discretionary in nature, such as business combinations and share repurchase programs. However, should the company change its business plans and tax strategies in the future and decide to repatriate a portion of these earnings to one of its U.S. subsidiaries, including cash maintained by these non-U.S. subsidiaries, the company would recognize additional tax liabilities. It is not practicable to estimate the amount of additional state and foreign withholding tax liabilities that the company would incur. The company’s intent is to only make distributions from non-U.S. subsidiaries in the future when they can be made at no net tax costs.
(c)
Contingencies and Litigation
The company records accruals for various contingencies, including legal proceedings, environmental, workers’ compensation, product, general and auto liabilities, and other claims that arise in the normal course of business. The accruals are based on management’s judgment, historical claims experience, the probability of losses and, where applicable, the consideration of opinions of internal and or external legal counsel and actuarial estimates. Accruals of acquired businesses, including product liability and environmental accruals, were initially recorded at fair value and discounted to their net present value. Additionally, the company records receivables from third-party insurers when recovery has been determined to be probable.
(d)
Pension and Other Retiree Benefits
Several of the company’s U.S. and non-U.S. subsidiaries sponsor defined benefit pension and other retiree benefit plans. The cost and obligations of these arrangements are calculated using many assumptions to estimate the benefits that the employee earns while working, the amount of which cannot be completely determined until the benefit payments cease. Major assumptions used in the accounting for these employee benefit plans include the discount rate, expected return on plan assets and rate of increase in employee compensation levels. Assumptions are determined based on company data and appropriate market indicators in consultation with third-party actuaries, and are evaluated each year as of the plans’ measurement date. Net periodic pension costs for the company’s pension and other postretirement benefit plans totaled $22 million in 2018. The company’s unfunded benefit obligation totaled $391 million at year-end 2018 compared with $486 million at year-end 2017. Should any of these assumptions change, they would have an effect on net periodic pension costs and the unfunded benefit obligation. For example, a 10% decrease in the discount rate would result in an annual increase in pension and other postretirement benefit expense of approximately $2 million and an increase in the benefit obligation of approximately $93 million.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations
2018 Compared With 2017
Sales in 2018 were $24.36 billion, an increase of $3.44 billion from 2017. Sales increased $1.53 billion due to acquisitions. The favorable effects of currency translation resulted in an increase in revenues of $173 million in 2018. Aside from the effects of acquisitions and currency translation, revenues increased $1.74 billion (8%) primarily due to increased demand. Sales to customers in each of the company's primary end markets grew. Sales growth was strong in each of the company's primary geographic areas, particularly Asia.
In 2018, total company operating income and operating income margin were $3.78 billion and 15.5%, respectively, compared with $2.96 billion and 14.2%, respectively, in 2017. The increase in operating income was primarily due to profit on higher sales and, to a lesser extent, the effects of acquisitions and productivity improvements, net of inflationary cost increases, offset in part by an increase in strategic growth investments, unfavorable sales mix and amortization of acquisition-related intangible assets, due to recent acquisitions.
In 2018, the company recorded restructuring and other costs, net, of $91 million, including $12 million of charges to cost of revenues primarily for the sale of inventories revalued at the date of acquisition. The company recorded $29 million of net charges to selling, general and administrative expenses, principally third-party transaction and integration costs associated with recent and pending acquisitions, offset in part by income from the favorable results of product liability litigation. In addition, the company recorded $88 million of cash restructuring costs in its continuing effort to streamline operations, including severance at several businesses and abandoned facility expenses at businesses that have been or are being consolidated in the U.S. and Europe. The company also recorded $38 million of other income, net, principally for resolution of a litigation matter (see Note 15).
In 2017, the company recorded restructuring and other costs, net, of $298 million, including $123 million of charges to cost of revenues primarily for the sale of inventories revalued at the date of acquisition and, to a lesser extent, to conform the accounting policies of Patheon to the company's accounting policies; $78 million of charges to selling, general and administrative expenses primarily for third-party transaction and integration costs associated with recent acquisitions and changes in estimates of acquisition contingent consideration. In addition, the company recorded $97 million of cash restructuring costs, primarily to achieve acquisition synergies, including severance and abandoned facilities costs associated with the closure and consolidation of facilities in the U.S. and Europe. The company’s other businesses incurred costs for continued headcount reductions and facility consolidations in an effort to streamline operations, including severance at several businesses and abandoned facility expenses at businesses that have been or are being consolidated in the U.S., Europe and Asia. The company also recorded $27 million of net credits for litigation-related matters, which were mostly offset by compensation due at Patheon on the date of acquisition, hurricane response/impairment costs, and net charges for the settlement/curtailment of retirement plans.
As of February 27, 2019, the company has identified restructuring actions that will result in additional charges of approximately $65 million, primarily in 2019, and expects to identify additional actions during 2019 which will be recorded when specified criteria are met, such as communication of benefit arrangements and abandonment of leased facilities. Approximately 40% of the additional charges will be incurred in the Life Sciences Solutions segment, 25% in the Analytical Instruments segment, 30% in the Laboratory Products and Services segment, and 5% in the Specialty Diagnostics segment. The restructuring projects for which charges were incurred in 2018 are expected to result in annual cost savings of approximately
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations (continued)
$65 million beginning in part in 2018 and, to a greater extent, in 2019, including $20 million in the Life Sciences Solutions segment, $10 million in the Analytical Instruments segment, $5 million in the Specialty Diagnostics segment and $30 million in the Laboratory Products and Services segment. The restructuring actions for which charges were incurred in 2017 resulted in annual cost savings of approximately $90 million beginning in part in 2017 and to a greater extent in 2018, including $50 million in the Life Sciences Solutions segment, $20 million in the Analytical Instruments segment, $10 million in the Specialty Diagnostics segment and $10 million in the Laboratory Products and Services segment.
Segment Results
The company’s management evaluates segment operating performance using operating income before certain charges/credits to cost of revenues and selling, general and administrative expenses, principally associated with acquisition-related activities; restructuring and other costs/income including costs arising from facility consolidations such as severance and abandoned lease expense and gains and losses from the sale of real estate and product lines; and amortization of acquisition-related intangible assets. The company uses this measure because it helps management understand and evaluate the segments’ core operating results and facilitate comparison of performance for determining compensation (Note 4). Accordingly, the following segment data is reported on this basis.
Income from the company’s reportable segments increased 16% to $5.62 billion in 2018 due primarily to profit on higher sales and, to a lesser extent, the effects of acquisitions, and productivity improvements, net of inflationary cost increases, offset in part by strategic growth investments and unfavorable sales mix.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations (continued)
Life Sciences Solutions
Sales in the Life Sciences Solutions segment increased $541 million to $6.27 billion in 2018. Sales increased $464 million (8%) due to higher revenues at existing businesses, $49 million due to the favorable effects of currency translation and $28 million due to acquisitions. The increase in revenue at existing businesses was primarily due to increased demand at each of the segment's primary businesses, with particular strength from sales of biosciences products and bioprocess production products.
Operating income margin was 34.4% in 2018 compared to 33.1% in 2017. The increase in operating margin resulted primarily from profit on higher sales and productivity improvements, net of inflationary cost increases. These increases were offset in part by unfavorable sales mix, and strategic growth investments.
Analytical Instruments
Sales in the Analytical Instruments segment increased $648 million to $5.47 billion in 2018. Sales increased $562 million (12%) due to higher revenues at existing businesses, $45 million due to acquisitions and $41 million due to the favorable effects of currency translation. The increase in revenue at existing businesses was primarily due to increased demand at each of the segment's primary businesses.
Operating income margin was 22.8% in 2018 compared to 21.3% in 2017. The increase resulted primarily from profit on higher sales and, to a lesser extent, productivity improvements, net of inflationary cost increases, offset in part by strategic growth investments.
Specialty Diagnostics
Sales in the Specialty Diagnostics segment increased $238 million to $3.72 billion in 2018. Sales increased $189 million (5%) due to higher revenues at existing businesses, $41 million due to the favorable effects of currency translation and $8 million due to an acquisition. The increase in revenue at existing businesses was due to broad based higher demand in each of the segment's primary businesses with particular strength in sales of products sold through the segment’s healthcare market channel.
Operating income margin was 25.6% in 2018 and 26.6% in 2017. The decrease resulted primarily from strategic growth investments and, to a lesser extent, unfavorable sales mix, offset in part by profit on higher sales and, to a lesser extent, favorable foreign currency exchange.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations (continued)
Laboratory Products and Services
Sales in the Laboratory Products and Services segment increased $2.21 billion to $10.04 billion in 2018. Sales increased $1.47 billion due to an acquisition, $694 million (9%) due to higher revenues at existing businesses and $50 million due to the favorable effects of currency translation. The increase in revenue at existing businesses was primarily due to increased demand in each of the segment's principal businesses with particular strength in its research and safety market channel business and its clinical trials business.
Operating income margin was 12.5% in 2018 compared to 12.8% in 2017. The decrease was primarily due to unfavorable sales mix and, to a lesser extent, strategic growth investments, offset in part by profit on higher sales.
Other Expense, Net
The company reported other expense, net, of $521 million and $531 million in 2018 and 2017, respectively (Note 5). An increase in interest expense of $75 million was offset in part by an increase in interest income of $56 million in 2018. In 2017, other expense, net included $32 million of charges related to the amortization of fees paid to obtain bridge financing commitments related to the acquisition of Patheon.
Provision for Income Taxes
The company recorded a provision for income taxes in 2018 including a net provision of $68 million to adjust the estimated initial effects of the Tax Cuts and Jobs Act of 2017 recorded in 2017, consisting of an incremental provision of $117 million offset in part by a $49 million reduction of related unrecognized tax benefits established in 2017. These adjustments were required based on new U.S. Treasury guidance and further analysis of available tax accounting methods and elections, legislative updates, regulations, earnings and profit computations and foreign taxes. In 2018, the provision for income taxes also included a $71 million charge to establish a valuation allowance against net operating losses that will not be utilized as a result of the planned sale of the Anatomical Pathology business (Note 2).
The company recorded a provision for income taxes in 2017 principally due to a net provision of $204 million from the effects of the Tax Act consisting primarily of a one-time transition tax on deemed repatriated earnings and profits of foreign subsidiaries, net of a benefit from adjusting the deferred tax balances for the U.S. statutory tax rate reduction. In 2017, the company refinanced certain long term inter-company debt which resulted in an income tax benefit of $237 million related to a foreign exchange loss recognized for income tax purposes. In addition, in 2017 the company recorded a $65 million favorable adjustment to deferred tax balances due to extension of a tax holiday agreement in Singapore. The company continued to implement tax planning initiatives related to non-U.S. subsidiaries in 2017. These non-U.S. subsidiaries incurred foreign tax obligations, and made cash and deemed distributions to the company’s U.S. operations which resulted in no net tax cost. As a result of these distributions, the company benefitted from U.S. foreign tax credits of $86 million, offset in part by additional U.S. income taxes of $53 million on the related foreign income (which reduced the benefit from the foreign rate differential in 2017) for a net benefit of $33 million. The foreign tax credits are the result of foreign earnings and profits remitted or deemed remitted to the U.S. during the reporting year and the U.S. treatment of taxes paid in the foreign jurisdictions in the years those profits were originally earned. The company also implemented foreign tax credit planning in Sweden which resulted in $20 million of foreign tax credits, with no related incremental U.S. income tax expense.
The effective tax rate in both 2018 and 2017 was also affected by relatively significant earnings in lower tax jurisdictions. Due primarily to the non-deductibility of intangible asset amortization for tax purposes, the company’s cash payments for income taxes were higher than its income tax expense for financial reporting purposes and totaled $591 million and $479 million in 2018 and 2017, respectively.
The company expects its effective tax rate in 2019 will be between 7% and 10% based on currently forecasted rates of profitability in the countries in which the company conducts business and expected generation of foreign tax credits. The effective tax rate can vary significantly from period to period as a result of discrete income tax factors and events.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations (continued)
The company has operations and a taxable presence in approximately 50 countries outside the U.S. Some of these countries have lower tax rates than the U.S. The company’s ability to obtain a benefit from lower tax rates outside the U.S. is dependent on its relative levels of income in countries outside the U.S. and on the statutory tax rates in those countries. Based on the dispersion of the company’s non-U.S. income tax provision among many countries, the company believes that a change in the statutory tax rate in any individual country is not likely to materially affect the company’s income tax provision or net income, aside from any resulting one-time adjustment to the company’s deferred tax balances to reflect a new rate.
Recent Accounting Pronouncements
A description of recently issued accounting standards is included under the heading "Recent Accounting Pronouncements" in Note 1.
Contingent Liabilities
The company is contingently liable with respect to certain legal proceedings and related matters. An unfavorable outcome that differs materially from current accrual estimates, if any, for one or more of the matters described under the headings "Product Liability, Workers Compensation and Other Personal Injury Matters," and "Intellectual Property Matters" in Note 11 could have a material adverse effect on the company’s financial position as well as its results of operations and cash flows.
2017 Compared With 2016
Sales in 2017 were $20.92 billion, an increase of $2.64 billion from 2016. Sales increased $1.63 billion due to acquisitions. The favorable effects of currency translation resulted in an increase in revenues of $70 million in 2017. Aside from the effects of acquisitions and currency translation, revenues increased $949 million (5%) primarily due to increased demand. Sales to customers in each of the company's primary end markets grew. Sales growth was moderate in North America and Europe and particularly strong in Asia.
In 2017, total company operating income and operating income margin were $2.96 billion and 14.2%, respectively, compared with $2.46 billion and 13.5%, respectively, in 2016. The increase in operating income was primarily due to profit on higher sales in local currencies, the effects of acquisitions and productivity improvements, net of inflationary cost increases, offset in part by an increase in amortization of acquisition-related intangible assets, due to recent acquisitions, and strategic growth investments.
In 2017, the company recorded restructuring and other costs, net, of $298 million, including $123 million of charges to cost of revenues primarily for the sale of inventories revalued at the date of acquisition, and, to a lesser extent, to conform the accounting policies of Patheon to the company's accounting policies. The company recorded $78 million of charges to selling, general and administrative expenses, primarily for third-party transaction and integration costs associated with recent acquisitions and changes in estimates of acquisition contingent consideration. In addition, the company recorded $97 million of cash restructuring costs, primarily to achieve acquisition synergies, including severance and abandoned facilities costs associated with the closure and consolidation of facilities in the U.S and Europe. The company’s other businesses incurred costs for continued headcount reductions and facility consolidations in an effort to streamline operations including severance at several businesses and abandoned facility expenses at businesses that have been or are being consolidated in the U.S., Europe and Asia. The company also recorded $27 million of net credits for litigation-related matters, which were mostly offset by compensation due at Patheon on the date of the acquisition, hurricane response/impairment costs, and net charges for the settlement/curtailment of retirement plans (see Note 15).
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations (continued)
In 2016, the company recorded restructuring and other costs, net, of $395 million, including $102 million of charges to cost of revenues for the sale of inventories revalued at the date of acquisition and to conform the accounting policies of FEI and Affymetrix to the company's accounting policies; $104 million of charges to selling, general and administrative expenses primarily for third-party transaction and integration costs related to the acquisitions of FEI and Affymetrix. In addition, the company recorded $164 million of cash restructuring costs, primarily to achieve acquisition synergies, including severance and abandoned facilities costs associated with the closure and consolidation of facilities in the U.S. The company’s other businesses incurred costs for continued headcount reductions and facility consolidations in an effort to streamline operations, including severance at several businesses and abandoned facility expenses at businesses that have been or are being consolidated in the U.S., Europe and Asia. The company also recorded charges for litigation and environmental remediation matters. These costs were partially offset by gains on the sales of real estate.
The restructuring actions for which charges were incurred in 2016 resulted in annual cost savings of approximately $100 million beginning in part in 2016 and to a greater extent in 2017, including $60 million in the Life Sciences Solutions segment, $25 million in the Analytical Instruments segment, $5 million in the Specialty Diagnostics segment and $10 million in the Laboratory Products and Services segment.
Segment Results
Income from the company’s reportable segments increased 15% to $4.85 billion in 2017 due primarily to profit on higher sales in local currencies, the effects of acquisitions and productivity improvements, net of inflationary cost increases, offset in part by strategic growth investments.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations (continued)
Life Sciences Solutions
Sales in the Life Sciences Solutions segment increased $411 million to $5.73 billion in 2017. Sales increased $300 million (6%) due to higher revenues at existing businesses, $99 million due to acquisitions and $12 million due to the favorable effects of currency translation. The increase in revenue at existing businesses was primarily due to increased demand for biosciences products and, to a lesser extent, bioprocess production products as well as genetic sciences products.
Operating income margin was 33.1% in 2017 compared to 30.1% in 2016. The increase in operating margin resulted primarily from productivity improvements, net of inflationary cost increases, and, to a lesser extent, profit on higher sales in local currencies and price increases. These increases were offset in part by strategic growth investments and acquisition dilution.
Analytical Instruments
Sales in the Analytical Instruments segment increased $1.15 billion to $4.82 billion in 2017. Sales increased $794 million due to acquisitions, $330 million (9%) due to higher revenues at existing businesses and $29 million due to the favorable effects of currency translation. The increase in revenue at existing businesses was primarily due to increased demand in each of the segment's primary businesses particularly products sold by the segment's chromatography and mass spectrometry business and materials and structural analysis business.
Operating income margin was 21.3% in 2017 compared to 20.4% in 2016. The increase resulted primarily from profit on higher sales in local currencies, productivity improvements, net of inflationary cost increases and, to a lesser extent, the effect of acquisitions, offset in part by strategic growth investments and, to a lesser extent, unfavorable foreign currency exchange and unfavorable sales mix.
Specialty Diagnostics
Sales in the Specialty Diagnostics segment increased $147 million to $3.49 billion in 2017. Sales increased $126 million (4%) due to higher revenues at existing businesses, $12 million due to the favorable effects of currency translation and $9 million due to acquisitions. The increase in revenue at existing businesses was primarily due to higher demand for products sold through the segment's healthcare market channel as well as clinical diagnostics products and immunodiagnostics products.
Operating income margin was 26.6% in 2017 and 27.3% in 2016. The decrease resulted primarily from strategic growth investments and, to a lesser extent, unfavorable sales mix, offset in part by profit on higher sales in local currencies and productivity improvements, net of inflationary cost increases.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations (continued)
Laboratory Products and Services
Sales in the Laboratory Products and Services segment increased $1.10 billion to $7.83 billion in 2017. Sales increased $727 million due to acquisitions, $361 million (5%) due to higher revenues at existing businesses and $13 million due to the favorable effects of currency translation. The increase in revenue at existing businesses was primarily due to increased demand for products sold through the segment's channel business and, to a lesser extent, laboratory equipment and consumables.
Operating income margin was 12.8% in 2017 compared to 14.5% in 2016. The decrease was primarily due to unfavorable sales mix and strategic growth investments offset in part by profit on higher sales in local currencies and, to a lesser extent, the effect of acquisitions.
Other Expense, Net
The company reported other expense, net, of $531 million and $434 million in 2017 and 2016, respectively (Note 5). Interest expense increased $123 million, primarily due to an increase in outstanding debt.
Provision for Income Taxes
The company recorded a provision for income taxes in 2017 principally due to a net provision of $204 million from the effects of the Tax Act consisting primarily of a one-time transition tax on deemed repatriated earnings and profits of foreign subsidiaries, net of a benefit from adjusting the deferred tax balances for the U.S. statutory tax rate reduction. In 2017, the company refinanced certain long term inter-company debt which resulted in an income tax benefit of $237 million related to a foreign exchange loss recognized for income tax purposes. In addition, in 2017 the company recorded a $65 million favorable adjustment to deferred tax balances due to extension of a tax holiday agreement in Singapore. The company continued to implement tax planning initiatives related to non-U.S. subsidiaries in 2017. These non-U.S. subsidiaries incurred foreign tax obligations, and made cash and deemed distributions to the company’s U.S. operations which resulted in no net tax cost. As a result of these distributions, the company benefitted from U.S. foreign tax credits of $86 million, offset in part by additional U.S. income taxes of $53 million on the related foreign income (which reduced the benefit from the foreign rate differential in 2017) for a net benefit of $33 million. The foreign tax credits are the result of foreign earnings and profits remitted or deemed remitted to the U.S. during the reporting year and the U.S. treatment of taxes paid in the foreign jurisdictions in the years those profits were originally earned. The company also implemented foreign tax credit planning in Sweden which resulted in $20 million of foreign tax credits, with no related incremental U.S. income tax expense.
The company recorded a benefit from income taxes in 2016. In 2016, the company continued to implement tax planning initiatives related to non-U.S. subsidiaries. These non-U.S. subsidiaries incurred foreign tax obligations, and made cash and deemed distributions to the company’s U.S. operations which resulted in no net tax cost. As a result of these distributions, the company benefitted from U.S. foreign tax credits of $91 million, offset in part by additional U.S. taxes of $37 million on the related foreign income (which reduced the benefit from the foreign rate differential in 2016) for a net benefit of $54 million. The company also implemented foreign tax credit planning in Sweden which resulted in $100 million of foreign tax credits, with no related incremental U.S. income tax expense. In addition, the company recorded discrete benefits in 2016 totaling $39 million related to prior year tax filings and net charges of $12 million related to tax audits.
The effective tax rate in both 2017 and 2016 was also affected by relatively significant earnings in lower tax jurisdictions. Due primarily to the non-deductibility of intangible asset amortization for tax purposes, the company’s cash payments for income taxes were higher than its income tax expense for financial reporting purposes and totaled $479 million and $663 million in 2017 and 2016, respectively.
Liquidity and Capital Resources
Consolidated working capital was $4.48 billion at December 31, 2018, compared with $2.37 billion at December 31, 2017, primarily due to higher cash and lower short-term debt. Included in working capital were cash and cash equivalents of $2.10 billion at December 31, 2018 and $1.34 billion at December 31, 2017.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Liquidity and Capital Resources (continued)
Cash provided by operating activities was $4.54 billion during 2018. Cash provided by income was offset in part by investments in working capital. Increases in accounts receivable and inventories used cash of $366 million and $324 million, respectively, primarily to support growth in sales. Cash payments for income taxes increased to $591 million during 2018, compared with $479 million in 2017. The company made cash contributions to its pension and postretirement benefit plans totaling $93 million during 2018. Payments for restructuring actions, principally severance costs and lease and other expenses of real estate consolidation, used cash of $83 million during 2018.
During 2018, the company’s investing activities used $1.25 billion of cash. Acquisitions used cash of $536 million. The company’s investing activities also included the purchase of $758 million of property, plant and equipment. On January 28, 2019, the company entered into an agreement to sell its Anatomical Pathology business to PHC Holdings Corporation for approximately $1.14 billion. The sale is subject to customary closing conditions and applicable regulatory approvals.
The company’s financing activities used $2.24 billion of cash during 2018. Repayment of senior notes used cash of $2.05 billion. New long-term borrowings provided cash of $690 million. A net decrease in commercial paper obligations used cash of $194 million. The company’s financing activities also included the repurchase of $500 million of the company’s common stock and the payment of $266 million in cash dividends, offset in part by $136 million of net proceeds from employee stock option exercises. On July 7, 2016, the Board of Directors authorized the repurchase of up to $1.50 billion of the company’s common stock. In 2018, the company repurchased $500 million of the company's common stock, depleting the 2016 authorization. On September 7, 2018, the Board of Directors authorized the repurchase of up to $2.00 billion of the company’s common stock. In January 2019, the company repurchased $750 million of the company's common stock. At February 27, 2019, authorization remained for $1.25 billion of future repurchases of the company’s common stock.
As of December 31, 2018, the company’s short-term debt totaled $1.27 billion, including $693 million of commercial paper obligations and $573 million of senior notes due within the next twelve months. The company has a revolving credit facility with a bank group that provides up to $2.50 billion of unsecured multi-currency revolving credit. If the company borrows under this facility, it intends to leave undrawn an amount equivalent to outstanding commercial paper to provide a source of funds in the event that commercial paper markets are not available. As of December 31, 2018, no borrowings were outstanding under the company’s revolving credit facility, although available capacity was reduced by approximately $82 million as a result of outstanding letters of credit.
Approximately half of the company’s cash balances and cash flows from operations are from outside the U.S. The company uses its non-U.S. cash for needs outside of the U.S. including acquisitions and repayment of acquisition-related intercompany debt to the U.S. In addition, the company also transfers cash to the U.S. using non-taxable returns of capital as well as dividends where the related U.S. dividend received deduction or foreign tax credit equals any tax cost arising from the dividends. As a result of using such means of transferring cash to the U.S., the company does not expect any material adverse liquidity effects from its significant non-U.S. cash balances for the foreseeable future.
The company expects to fund the acquisition of Gatan Inc. with a combination of existing cash balances and short-term borrowings. The company believes that its existing cash and cash equivalents of $2.10 billion as of December 31, 2018 and its future cash flow from operations together with available borrowing capacity under its revolving credit agreement will be sufficient to meet the cash requirements of its existing businesses for the foreseeable future, including at least the next 24 months.
Cash provided by operating activities was $4.01 billion during 2017. An increase in other liabilities provided cash of $1.02 billion primarily due to the Tax Act's one-time transition tax on deemed repatriated earnings and profits of foreign subsidiaries. Given the availability of foreign tax credits, the company does not expect the transition tax to result in significant cash requirements. An increase in accounts payable provided cash of $274 million due to the timing of payments. Increases in accounts receivable and inventories used cash of $362 million and $81 million, respectively, primarily to support growth in sales in local currencies. An increase in other assets used cash of $153 million primarily due to the timing of income tax refunds. Cash payments for income taxes decreased to $479 million during 2017, compared with $663 million in 2016. The company made cash contributions to its pension and postretirement benefit plans totaling $200 million during 2017. Payments for restructuring actions, principally severance costs and lease and other expenses of real estate consolidation, used cash of $93 million during 2017.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Liquidity and Capital Resources (continued)
During 2017, the company’s investing activities used $7.73 billion of cash. Acquisitions used cash of $7.23 billion. The company’s investing activities also included the purchase of $508 million of property, plant and equipment.
The company’s financing activities provided $3.85 billion of cash during 2017. Issuance of senior notes and borrowings under a term loan provided cash of $6.46 billion. The company also issued 10 million shares of its common stock for net proceeds of $1.69 billion. Repayment of senior notes and term loans used cash of $3.30 billion and a net decrease in commercial paper obligations used cash of $134 million. The company’s financing activities also included the repurchase of $750 million of the company’s common stock and the payment of $237 million in cash dividends, offset in part by $128 million of net proceeds from employee stock option exercises.
Cash provided by operating activities was $3.26 billion during 2016. An increase in accounts receivable used cash of $352 million primarily to support growth in sales in local currencies and due to the mid-month timing of the acquisition of FEI when receivables are commonly lower than at quarter-end. Inventories provided cash of $98 million due to a reduction associated with fourth quarter 2016 sales. An increase in other assets used cash of $153 million primarily due to the timing of payments. An increase in other liabilities provided cash of $216 million primarily due to the timing of payments for income taxes and incentive compensation. Cash payments for income taxes increased to $663 million during 2016, compared with $477 million in 2015. The company made cash contributions to its pension and postretirement benefit plans totaling $43 million during 2016. Payments for restructuring actions, principally severance costs and lease and other expenses of real estate consolidation, used cash of $122 million during 2016.
During 2016, the company’s investing activities used $5.52 billion of cash. Acquisitions used cash of $5.18 billion. The company’s investing activities also included the purchase of $444 million of property, plant and equipment.
The company’s financing activities provided $2.76 billion of cash during 2016. Issuance of senior notes and borrowings under term loans provided cash of $7.60 billion and an increase in commercial paper obligations provided cash of $904 million. Repayment of senior notes, the 364-day term loan and acquired debt used cash of $4.33 billion. The company’s financing activities also included the repurchase of $1.25 billion of the company’s common stock and the payment of $238 million in cash dividends, offset in part by $87 million of proceeds from employee stock option exercises.
Off-Balance Sheet Arrangements
The company did not use special purpose entities or other off-balance-sheet financing arrangements in 2016, 2017 or 2018, except for letters of credit, bank guarantees, residual value guarantees under three lease agreements, surety bonds and other guarantees disclosed in the table or discussed below. The amounts disclosed in the table below for letters of credit, bank guarantees, surety bonds and other guarantees relate to guarantees of the company’s performance, primarily in the ordinary course of business.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Liquidity and Capital Resources (continued)
Contractual Obligations and Other Commercial Commitments
The table below summarizes, by period due or expiration of commitment, the company’s contractual obligations and other commercial commitments as of December 31, 2018.
(a)
Amounts represent the expected cash payments for debt and do not include any deferred issuance costs.
(b)
Unconditional purchase obligations include agreements to purchase goods, services or fixed assets that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable at any time without penalty.
The contractual obligation at December 31, 2018 to acquire Gatan Inc. for approximately $925 million has been omitted from the above table. The transaction is subject to customary closing conditions, including regulatory approvals.
Reserves for unrecognized tax benefits of $1.44 billion have not been included in the above table due to the inability to predict the timing of tax audit resolutions.
The company has no material commitments for purchases of property, plant and equipment, other than those included in the above table, but expects that for 2019, such expenditures will be between $800 and $850 million.
Guarantees of residual value under lease arrangements for three facilities have not been included in the above table due to the inability to predict if and when the guarantees may require payment (see Note 11). The residual value guarantees become operative at the end of the leases for up to a maximum of $147 million. The initial terms of these leases end in 2019, 2020 and 2023, although renewal options exist for each.
A guarantee of pension plan obligations of a divested business has not been included in the preceding table due to the inability to predict if and when the guarantee may require payment. The purchaser of the divested business has agreed to pay for the pension benefits, however the company was required to guarantee payment of these pension benefits should the purchaser fail to do so. The amount of the guarantee at December 31, 2018 was $38 million.
In disposing of assets or businesses, the company often provides representations, warranties and/or indemnities to cover various risks including, for example, unknown damage to the assets, environmental risks involved in the sale of real estate, liability to investigate and remediate environmental contamination at waste facilities, and unidentified tax liabilities and related legal fees. The company does not have the ability to estimate the potential liability from such indemnities because they relate to unknown conditions. However, the company has no reason to believe that these uncertainties would have a material adverse effect on its financial position, annual results of operations or cash flows.
THERMO FISHER SCIENTIFIC INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Liquidity and Capital Resources (continued)
The company has recorded liabilities for known indemnifications included as part of environmental liabilities. See Item 1. Business - Environmental Matters for a discussion of these liabilities.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
The company is exposed to market risk from changes in interest rates and currency exchange rates, which could affect its future results of operations and financial condition. The company manages its exposure to these risks through its regular operating and financing activities. The company has periodically hedged interest rate risks of fixed-rate instruments with offsetting interest rate swaps. Additionally, the company uses short-term forward and option contracts primarily to hedge certain balance sheet and operational exposures resulting from changes in currency exchange rates. Such exposures result from purchases, sales, cash and intercompany loans that are denominated in currencies other than the functional currencies of the respective operations. The currency-exchange contracts principally hedge transactions denominated in euro, British pounds sterling, Swiss franc, Norwegian kroner, Canadian dollars, Japanese yen and Swedish kronor. Income and losses arising from these derivative contracts are recognized as offsets to losses and income resulting from the underlying exposure being hedged. The company does not enter into speculative derivative agreements.
Interest Rates
The company is exposed to changes in interest rates while conducting normal business operations as a result of ongoing investing and financing activities, which affect the company’s debt as well as cash and cash equivalents. As of December 31, 2018, the company’s debt portfolio was comprised primarily of fixed rate borrowings. The fair market value of the company’s fixed interest rate debt is subject to interest rate risk. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. The total estimated fair value of the company’s debt at December 31, 2018 was $19.04 billion (see Note 13). Fair values were determined from available market prices using current interest rates and terms to maturity. If interest rates were to decrease by 100 basis points, the fair value of the company’s debt at December 31, 2018 would increase by approximately $1.06 billion. If interest rates were to increase by 100 basis points, the fair value of the company’s debt at December 31, 2018 would decrease by approximately $0.98 billion.
In addition, interest rate changes would result in a change in the company’s interest expense due to variable-rate debt instruments including swap arrangements. In 2018, a 100 basis point increase in interest rates on the swap arrangements and variable-rate debt would have increased the company’s annual pre-tax interest expense by approximately $43 million.
Currency Exchange Rates
The company views its investment in international subsidiaries with a functional currency other than the U.S. dollar as permanent. The company’s investment in international subsidiaries is sensitive to fluctuations in currency exchange rates. The functional currencies of the company’s international subsidiaries are principally denominated in British pounds sterling, Swedish kronor, euro, Canadian dollars, Swiss franc, Norwegian kroner and Danish kroner. The effect of a change in the period ending currency exchange rates on the company’s net investment in international subsidiaries is reflected in the "accumulated other comprehensive items" component of shareholders’ equity. The company also uses foreign currency-denominated debt to partially hedge its net investments in foreign operations against adverse movements in exchange rates. A 10% depreciation in year-end 2018 functional currencies, relative to the U.S. dollar, would result in a reduction of shareholders’ equity of $0.84 billion.
The fair value of forward currency-exchange contracts is sensitive to changes in currency exchange rates. The fair value of forward currency-exchange contracts is the estimated amount that the company would pay or receive upon termination of the contract, taking into account the change in currency exchange rates. A 10% depreciation in year-end 2018 non-functional currency exchange rates related to the company’s contracts would result in an additional unrealized loss on forward currency-exchange contracts of $145 million. A 10% appreciation in year-end 2018 non-functional currency exchange rates related to the company’s contracts would result in an unrealized gain on forward currency-exchange contracts of $138 million. The unrealized gains or losses on forward currency-exchange contracts resulting from changes in currency exchange rates are expected to approximately offset losses or gains on the exposures being hedged.
Certain of the company’s cash and cash equivalents are denominated in currencies other than the functional currency of the depositor and are sensitive to changes in currency exchange rates. A 10% depreciation in the related year-end 2018 non-functional currency exchange rates applied to such cash balances would result in a negative impact of $25 million on the company’s net income.
THERMO FISHER SCIENTIFIC INC.
Item 8.
Item 8.
Financial Statements and Supplementary Data
This data is submitted as a separate section to this report. See Item 15 "Exhibits and Financial Statement Schedules."
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A.
Controls and Procedures
Management’s Evaluation of Disclosure Controls and Procedures
The company’s management, with the participation of the company’s chief executive officer and chief financial officer, has evaluated the effectiveness of the company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, the company’s chief executive officer and chief financial officer concluded that, as of the end of such period, the company’s disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control over Financial Reporting
There have been no changes in the company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the fiscal quarter ended December 31, 2018, that have materially affected or are reasonably likely to materially affect the company’s internal control over financial reporting.
Management’s Annual Report on Internal Control Over Financial Reporting
The company’s management, including the company’s chief executive officer and chief financial officer, is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the company. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The company’s management conducted an assessment of the effectiveness of the company’s internal control over financial reporting as of December 31, 2018 based on criteria established in "Internal Control - Integrated Framework" (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, the company’s management concluded that, as of December 31, 2018, the company’s internal control over financial reporting was effective.
The company’s independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited the effectiveness of the company’s internal control over financial reporting as of December 31, 2018, as stated in their report that appears on page of this Annual Report on Form 10-K.
Item 9B.
Item 9B.
Other Information
Not applicable.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
The information with respect to directors required by this Item will be contained in our definitive proxy statement to be filed with the SEC not later than 120 days after the close of business of the fiscal year (2019 Definitive Proxy Statement) and is incorporated in this report by reference.
The information with respect to executive officers required by this Item is included in Item 1 of Part I of this report.
The other information required by this Item will be contained in our 2019 Definitive Proxy Statement and is incorporated in this report by reference.
THERMO FISHER SCIENTIFIC INC.
Item 11.
Item 11.
Executive Compensation
The information required by this Item will be contained in our 2019 Definitive Proxy Statement and is incorporated in this report by reference.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item will be contained in our 2019 Definitive Proxy Statement and is incorporated in this report by reference.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by this Item will be contained in our 2019 Definitive Proxy Statement and is incorporated in this report by reference.
Item 14.
Item 14.
Principal Accountant Fees and Services
The information required by this Item will be contained in our 2019 Definitive Proxy Statement and is incorporated in this report by reference.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a)
The following documents are filed as part of this report:
(1)
Consolidated Financial Statements (see Index on page of this report)
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheet
Consolidated Statement of Income
Consolidated Statement of Comprehensive Income
Consolidated Statement of Cash Flows
Consolidated Statement of Shareholders’ Equity
Notes to Consolidated Financial Statements
(2)
All schedules are omitted because they are not applicable or not required, or because the required information is included either in the consolidated financial statements or in the notes thereto.
(b)
Exhibits
Item 16.
Form 10-K Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated, as of February 27, 2019.
By:
/s/ Marc N. Casper
By:
/s/ Judy C. Lewent
Marc N. Casper
Judy C. Lewent
President, Chief Executive Officer and Director
Director
(Principal Executive Officer)
By:
/s/ Jim P. Manzi
By:
/s/ Thomas J. Lynch
Jim P. Manzi
Thomas J. Lynch
Chairman of the Board and Director
Director
By:
/s/ Stephen Williamson
By:
/s/ James C. Mullen
Stephen Williamson
James C. Mullen
Senior Vice President and Chief Financial Officer
Director
(Principal Financial Officer)
By:
/s/ Peter E. Hornstra
By:
/s/ Lars R. Sørensen
Peter E. Hornstra
Lars R. Sørensen
Vice President and Chief Accounting Officer
Director
(Principal Accounting Officer)
By:
/s/ Nelson J. Chai
By:
/s/ Scott M. Sperling
Nelson J. Chai
Scott M. Sperling
Director
Director
By:
/s/ C. Martin Harris
By:
/s/ Elaine S. Ullian
C. Martin Harris
Elaine S. Ullian
Director
Director
By:
/s/ Tyler E. Jacks
By:
/s/ Dion J. Weisler
Tyler E. Jacks
Dion J. Weisler
Director
Director
THERMO FISHER SCIENTIFIC INC.
EXHIBIT INDEX
THERMO FISHER SCIENTIFIC INC.
EXHIBIT INDEX
THERMO FISHER SCIENTIFIC INC.
EXHIBIT INDEX
THERMO FISHER SCIENTIFIC INC.
EXHIBIT INDEX
_______________________
*Indicates management contract or compensatory plan, contract or arrangement.
** Certification is not deemed "filed" for purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section. Such certification is not deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act except to the extent that the registrant specifically incorporates it by reference.
Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheet at December 31, 2018, and 2017, (ii) Consolidated Statement of Income for the years ended December 31, 2018, 2017 and 2016, (iii) Consolidated Statement of Comprehensive Income for the years ended December 31, 2018, 2017 and 2016 (iv) Consolidated Statement of Cash Flows for the years ended December 31, 2018, 2017 and 2016, (v) Consolidated Statement of Shareholders’ Equity for the years ended December 31, 2018, 2017 and 2016 and (vi) Notes to Consolidated Financial Statements.
THERMO FISHER SCIENTIFIC INC.
INDEX OF CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
The following Consolidated Financial Statements of the Registrant and its subsidiaries are required to be included in Item 15:
F- 1
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Thermo Fisher Scientific Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Thermo Fisher Scientific Inc. and its subsidiaries (the “Company”) as of December 31, 2018 and December 31, 2017, and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and December 31, 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
F- 2
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
February 27, 2019
We have served as the Company’s auditor since 2002.
F- 3
THERMO FISHER SCIENTIFIC INC.
CONSOLIDATED BALANCE SHEET
The accompanying notes are an integral part of these consolidated financial statements.
F- 4
THERMO FISHER SCIENTIFIC INC.
CONSOLIDATED STATEMENT OF INCOME
The accompanying notes are an integral part of these consolidated financial statements.
F- 5
THERMO FISHER SCIENTIFIC INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
The accompanying notes are an integral part of these consolidated financial statements.
F- 6
THERMO FISHER SCIENTIFIC INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
F- 7
THERMO FISHER SCIENTIFIC INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
F- 8
THERMO FISHER SCIENTIFIC INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1.
Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Thermo Fisher Scientific Inc. (the company or Thermo Fisher) enables customers to make the world healthier, cleaner and safer by helping them accelerate life sciences research, solve complex analytical challenges, improve patient diagnostics, deliver medicines to market and increase laboratory productivity. Markets served include pharmaceutical and biotech, academic and government, industrial and applied, as well as healthcare and diagnostics.
Principles of Consolidation
The accompanying financial statements include the accounts of the company and its wholly and majority-owned subsidiaries. All material intercompany accounts and transactions have been eliminated. The company accounts for investments in businesses using the equity method when it has significant influence but not control (generally between 20% and 50% ownership) and is not the primary beneficiary.
Presentation
Certain reclassifications of prior year amounts have been made to conform to the current year presentation.
Revenue Recognition
Prior to 2018, the company recognized revenue after all significant obligations had been met, collectability was probable and title had passed, which typically occurred upon shipment, delivery, completion of services, or ratably over the contract period. Beginning in 2018, the company recognizes revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. See recent accounting pronouncements below for a discussion of the change in revenue recognition accounting that became effective in 2018.
Consumables revenues consist of single-use products and are recognized at a point in time following the transfer of control of such products to the customer, which generally occurs upon shipment. Instruments revenues typically consist of longer-lived assets that, for the substantial majority of sales, are recognized at a point in time in a manner similar to consumables. Service revenues (clinical trial logistics, pharmaceutical development and manufacturing services, asset management, diagnostic testing, training, service contracts, and field services including related time and materials) are recognized over time as customers receive and consume the benefits of such services. For revenues recognized over time, the company generally uses costs accumulated as inputs to measure progress. For contracts that contain multiple performance obligations, the company allocates the consideration to which it expects to be entitled to each performance obligation based on relative standalone selling prices and recognizes the related revenue when or as control of each individual performance obligation is transferred to customers. The company exercises judgment in determining the timing of revenue by analyzing the point in time or the period over which the customer has the ability to direct the use of and obtain substantially all of the remaining benefits of the asset. The company immediately expenses contract costs that would otherwise be capitalized and amortized over a period of less than one year.
Payments from customers for most instruments, consumables and services are typically due in a fixed number of days after shipment or delivery of the product. Service arrangements commonly call for payments in advance of performing the work (e.g. extended service contracts), upon completion of the service (e.g. pharmaceutical development and manufacturing) or a mix of both.
See Note 3 for revenue disaggregated by type and by geographic region as well as further information about remaining performance obligations.
Contract-related Balances
Accounts receivable include amounts that have been billed and are currently due from customers. They are recorded at the invoiced amount and do not bear interest. The company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to pay amounts due. The allowance for doubtful accounts is the company’s best estimate of the amount of probable credit losses in existing accounts receivable. The company determines the allowance based on the age of the receivable, the creditworthiness of the customer and any other information that is relevant to the judgment. Account balances are charged off against the allowance when the company believes it is probable the receivable will not be recovered. The company does not have any off-balance-sheet credit exposure related to customers.
F- 9
THERMO FISHER SCIENTIFIC INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The changes in the allowance for doubtful accounts are as follows:
Contract assets include revenues recognized in advance of billings and are recorded net of estimated losses resulting from the inability to invoice customers. Contract assets are classified as current or noncurrent based on the amount of time expected to lapse until the company's right to consideration becomes unconditional. Current contract assets and noncurrent contract assets are included within other current assets and other assets, respectively, in the accompanying balance sheet.
Contract liabilities include billings in excess of revenues recognized, such as those resulting from customer advances and deposits and unearned revenue on service contracts. Contract liabilities are classified as current or noncurrent based on the periods over which remaining performance obligations are expected to be transferred to customers. Noncurrent contract liabilities are included within other long-term liabilities in the accompanying balance sheet.
Contract asset and liability balances are as follows:
Substantially all of the current contract liabilities balance at January 1, 2018 was recognized in revenue during 2018.
Warranty Obligations
The company provides for the estimated cost of standard product warranties, primarily from historical information, in cost of product revenues at the time product revenue is recognized. While the company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component supplies, the company’s warranty obligation is affected by product failure rates, utilization levels, material usage, service delivery costs incurred in correcting a product failure and supplier warranties on parts delivered to the company. Should actual product failure rates, utilization levels, material usage, service delivery costs or supplier warranties on parts differ from the company’s estimates, revisions to the estimated warranty liability would be required. The liability for warranties is included in other accrued expenses in the accompanying balance sheet. Extended warranty agreements are considered service contracts, which are discussed above. Costs of service contracts are recognized as incurred. The changes in the carrying amount of standard product warranty obligations are as follows:
F- 10
THERMO FISHER SCIENTIFIC INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Research and Development
The company conducts research and development activities to increase its depth of capabilities in technologies, software and services. Research and development costs include employee compensation and benefits, consultants, facilities related costs, material costs, depreciation and travel. Research and development costs are expensed as incurred.
Restructuring Costs
Accounting for the timing and amount of termination benefits provided by the company to employees is determined based on whether: (a) the company has a substantive plan to provide such benefits, (b) the company has a written employment contract with the affected employees that includes a provision for such benefits, (c) the termination benefits are due to the occurrence of an event specified in an existing plan or agreement, or (d) the termination benefits are a one-time benefit. In certain circumstances, employee termination benefits may meet more than one of the characteristics listed above and therefore, may have individual elements that are subject to different accounting models.
From time to time when executing a restructuring or exit plan, the company also incurs costs other than termination benefits, such as lease termination costs, that are not associated with or will not be incurred to generate revenues. These include costs that represent amounts under contractual obligations that exist prior to the restructuring plan communication date and will either continue after the restructuring plan is completed with no economic benefit or result in a penalty to cancel a contractual obligation. Such costs are recognized when incurred, which generally occurs at the contract termination or cease-use date but may continue over the remainder of the original contractual period.
Income Taxes
The company recognizes deferred income taxes based on the expected future tax consequences of differences between the financial statement basis and the tax basis of assets and liabilities, calculated using enacted tax rates in effect for the year in which the differences are expected to be reflected in the tax return.
The financial statements reflect expected future tax consequences of uncertain tax positions that the company has taken or expects to take on a tax return presuming the taxing authorities’ full knowledge of the positions and all relevant facts, but without discounting for the time value of money (Note 8).
Earnings per Share
Basic earnings per share has been computed by dividing net income by the weighted average number of shares outstanding during the year. Except where the result would be antidilutive to income from continuing operations, diluted earnings per share has been computed using the treasury stock method for outstanding stock options and restricted units (Note 9).
Cash and Cash Equivalents
Cash equivalents consists principally of money market funds, commercial paper and other marketable securities purchased with an original maturity of three months or less. These investments are carried at cost, which approximates market value.
Inventories
Inventories are valued at the lower of cost or net realizable value, cost being determined principally by the first-in, first-out (FIFO) method with certain of the company’s businesses utilizing the last-in, first-out (LIFO) method. The company periodically reviews quantities of inventories on hand and compares these amounts to the expected use of each product or product line. In addition, the company has certain inventory that is subject to fluctuating market pricing. The company assesses the carrying value of this inventory based on a lower of cost or net realizable value analysis. The company records a charge to cost of sales for the amount required to reduce the carrying value of inventory to net realizable value. Costs associated with the procurement of inventories, such as inbound freight charges, purchasing and receiving costs, and internal transfer costs, are included in cost of revenues in the accompanying statement of income. The components of inventories are as follows:
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THERMO FISHER SCIENTIFIC INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The value of inventories maintained using the LIFO method was $244 million and $219 million at December 31, 2018 and 2017, respectively, which was below estimated replacement cost by $34 million and $31 million, respectively. Reductions to cost of revenues as a result of the liquidation of LIFO inventories were nominal during the three years ended December 31, 2018.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. The costs of additions and improvements are capitalized, while maintenance and repairs are charged to expense as incurred. The company provides for depreciation and amortization using the straight-line method over the estimated useful lives of the property as follows: buildings and improvements, 25 to 40 years; machinery and equipment (including software), 3 to 10 years; and leasehold improvements, the shorter of the term of the lease or the life of the asset. When assets are retired or otherwise disposed of, the assets and related accumulated depreciation are eliminated from the accounts and the resulting gain or loss is reflected in the accompanying statement of income. Property, plant and equipment consists of the following:
Depreciation and amortization expense of property, plant and equipment was $526 million, $439 million and $380 million in 2018, 2017 and 2016, respectively.
Acquisition-related Intangible Assets
Acquisition-related intangible assets include the costs of acquired customer relationships, product technology, tradenames and other specifically identifiable intangible assets, and are being amortized using the straight-line method over their estimated useful lives, which range from 3 to 20 years. In addition, the company has tradenames and in-process research and development that have indefinite lives and which are not amortized. The company reviews intangible assets for impairment when indication of potential impairment exists, such as a significant reduction in cash flows associated with the assets. Intangible assets with indefinite lives are reviewed for impairment annually or whenever events or changes in circumstances indicate they may be impaired. Acquisition-related intangible assets are as follows:
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THERMO FISHER SCIENTIFIC INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The estimated future amortization expense of acquisition-related intangible assets with definite lives is as follows:
Amortization of acquisition-related intangible assets was $1.74 billion, $1.59 billion and $1.38 billion in 2018, 2017 and 2016, respectively.
Other Assets
Other assets in the accompanying balance sheet include deferred tax assets, cash surrender value of life insurance, insurance recovery receivables related to product liability matters, pension assets, investments, notes receivable, restricted cash and other assets.
Prior to January 1, 2018, investments for which there are not readily determinable market values were accounted for under the cost method of accounting. The company periodically evaluated the carrying value of its investments accounted for under the cost method of accounting, which provided that they are recorded at the lower of cost or estimated net realizable value. Effective January 1, 2018, equity investments that do not have readily determinable fair values are measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investments of the same issuer. The company performs qualitative assessments to identify impairments of these investments. At December 31, 2018 and 2017, the company had such investments with carrying amounts of $36 million and $32 million, respectively, which are included in other assets.
Goodwill
The company assesses goodwill for impairment at the reporting unit level annually and whenever events occur or circumstances change that would more-likely-than-not reduce the fair value of a reporting unit below its carrying amount. Such events or circumstances generally include the occurrence of operating losses or a significant decline in earnings associated with one or more of the company’s reporting units. The company is permitted to first assess qualitative factors to determine whether the goodwill impairment test is necessary. If the qualitative assessment results in a determination that the fair value of a
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THERMO FISHER SCIENTIFIC INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
reporting unit is more-likely-than-not less than its carrying amount, the company performs the goodwill impairment test. The company may bypass the qualitative assessment for the reporting unit in any period and proceed directly to the goodwill impairment test. The company estimates the fair value of its reporting units by using forecasts of discounted future cash flows and peer market multiples. The company would record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. The company determined that no impairments existed in 2018, 2017 or 2016.
The changes in the carrying amount of goodwill by segment are as follows:
Loss Contingencies
Accruals are recorded for various contingencies, including legal proceedings, environmental, workers’ compensation, product, general and auto liabilities, self-insurance and other claims that arise in the normal course of business. The accruals are based on management’s judgment, historical claims experience, the probability of losses and, where applicable, the consideration of opinions of internal and/or external legal counsel and actuarial estimates. Additionally, the company records receivables from third-party insurers up to the amount of the loss when recovery has been determined to be probable. Liabilities acquired in acquisitions have been recorded at fair value and, as such, were discounted to present value at the dates of acquisition.
Currency Translation
All assets and liabilities of the company’s non-U.S. subsidiaries are translated at year-end exchange rates. Resulting translation adjustments are reflected in the "accumulated other comprehensive items" component of shareholders’ equity. Revenues and expenses are translated at average exchange rates for the year. Currency transaction (losses) gains are included in the accompanying statement of income and in aggregate were $19 million, $(31) million and $19 million in 2018, 2017 and 2016, respectively.
Derivative Contracts
The company is exposed to certain risks relating to its ongoing business operations including changes to interest rates and currency exchange rates. The company uses derivative instruments primarily to manage currency exchange and interest rate risks. The company recognizes derivative instruments as either assets or liabilities and measures those instruments at fair value. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative are either offset against the change in fair value of the hedged item through earnings or recognized in other comprehensive items until the hedged item is recognized in earnings. Derivatives that are not designated as hedges are recorded at fair value through earnings.
The company uses short-term forward and option currency exchange contracts primarily to hedge certain balance sheet and operational exposures resulting from changes in currency exchange rates, predominantly intercompany loans and cash balances that are denominated in currencies other than the functional currencies of the respective operations. The currency-exchange contracts principally hedge transactions denominated in euro, British pounds sterling, Swiss franc, Norwegian kroner, Canadian
F- 14
THERMO FISHER SCIENTIFIC INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
dollars, Japanese yen and Swedish kronor. The company does not hold or engage in transactions involving derivative instruments for purposes other than risk management.
Cash flow hedges. For derivative instruments that are designated and qualify as a cash flow hedge, the gain or loss on the derivative is reported as a component of other comprehensive items and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings and is presented in the same income statement line item as the earnings effect of the hedged item.
Fair value hedges. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in earnings. During 2016, in connection with new debt issuances, the company entered into interest rate swap arrangements. The company includes the gain or loss on the hedged items (fixed-rate debt) in the same line item (interest expense) as the offsetting effective portion of the loss or gain on the related interest rate swaps.
Net investment hedges. The company also uses foreign currency-denominated debt and cross-currency interest rate swaps to partially hedge its net investments in foreign operations against adverse movements in exchange rates. The majority of the company’s euro-denominated senior notes and cross-currency interest rate swaps have been designated as, and are effective as, economic hedges of part of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments and contract fair value changes on the cross-currency interest rate swaps, excluding interest accruals, are included in currency translation adjustment within other comprehensive items and shareholders’ equity.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In addition, significant estimates were made in estimating future cash flows to assess potential impairment of assets and in determining the fair value of acquired intangible assets (Note 2) and the ultimate loss from abandoning leases at facilities being exited (Note 15). Actual results could differ from those estimates.
Recent Accounting Pronouncements
In August 2018, the FASB issued new guidance to align the accounting for implementation costs incurred in a hosting arrangement that is a service contract with the accounting for implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal-use software license. Under the new guidance, certain implementation costs that previously were required to be expensed will be capitalized and amortized over the term of the hosting arrangement. The company adopted the guidance in the fourth quarter of 2018, prospectively to all implementation costs incurred after the date of adoption. The adoption of this guidance did not have a material impact on the company’s consolidated financial statements.
In August 2018, the FASB issued new guidance to modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The company expects to adopt the guidance when it is effective in 2020 using a retrospective method. The adoption of this guidance is not expected to have a material impact on the company’s disclosures.
In August 2018, the FASB issued new guidance to modify the disclosure requirements on fair value measurements. The company expects to adopt the guidance when it is effective in 2020 with some items requiring a prospective method and others requiring a retrospective method. The adoption of this guidance is not expected to have a material impact on the company’s disclosures.
In February 2018, the FASB issued new guidance to allow reclassifications from accumulated other comprehensive items (AOCI) to retained earnings for certain tax effects on items within AOCI resulting from the Tax Cuts and Jobs Act of 2017 (the Tax Act). The company adopted this guidance in January 2018 and recorded the reclassifications in the period of adoption. The balance sheet impact of adopting this guidance is included in the table below. This guidance only relates to the effects of the Tax Act. For all other tax law changes that have occurred or may occur in the future, the company reclassifies the tax effects to the consolidated statement of income on an item-by-item basis when the pre-tax item in AOCI is reclassified to income.
In December 2017, the SEC staff issued guidance to address the application of accounting guidance in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act enacted on December 22, 2017. The company reported provisional amounts in its 2017 financial statements for certain income tax effects of the Tax Act for which a
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THERMO FISHER SCIENTIFIC INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
reasonable estimate could be determined. Adjustments to provisional amounts identified during the measurement period, which ended December 22, 2018, are included as adjustments to Provision for Income Taxes in 2018 (Note 8).
In August 2017, the FASB issued new guidance to simplify the application of hedge accounting guidance. Among other things, the new guidance will permit more hedging strategies to qualify for hedge accounting, allow for additional time to perform an initial assessment of a hedge’s effectiveness, and permit a qualitative effectiveness test for certain hedges after initial qualification. The company adopted this guidance in January 2018. The balance sheet impact of adopting this guidance is included in the table below.
In March 2017, the FASB issued new guidance intended to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. The new guidance requires the service cost component of net periodic cost be reported in the same line item(s) as other employee compensation costs and all other components of the net periodic cost be reported in the income statement below operating income. The company adopted this guidance on January 1, 2018 and applied the changes to the statement of income retrospectively. As a result of adoption of this guidance, the accompanying 2017 and 2016 statements of income reflect the following changes from previously reported amounts:
In January 2017, the FASB issued new guidance clarifying the definition of a business and providing criteria to determine when an integrated set of assets and activities is not defined as a business. The new guidance requires such integrated sets to be defined as an asset (and not a business) if substantially all of the fair value of the gross assets acquired or disposed is concentrated in a single identifiable asset or a group of similar identifiable assets. The adoption of this guidance as of January 1, 2018 did not have a material impact on the company’s consolidated financial statements.
In October 2016, the FASB issued new guidance eliminating the deferral of the tax effects of intra-entity asset transfers. The impact of this guidance in future periods will be dependent on the extent of future asset transfers which usually occur in connection with planning around acquisitions and other business structuring activities. The balance sheet impact of adopting this guidance as of January 1, 2018 is included in the table below.
In June 2016, the FASB issued new guidance to require a financial asset measured at amortized cost basis, such as accounts receivable, to be presented at the net amount expected to be collected based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. During 2018, the FASB issued additional guidance and clarification. The company expects to adopt the guidance when it is effective in 2020 using a modified retrospective method. The adoption of this guidance is not expected to have a material impact on the company’s consolidated financial statements.
In February 2016, the FASB issued new guidance which requires lessees to record most leases on their balance sheets as lease liabilities, initially measured at the present value of the future lease payments, with corresponding right-of-use assets. The new guidance also sets forth new disclosure requirements related to leases. During 2017 and 2018, the FASB issued additional guidance and clarification. The guidance is effective for the company in 2019. The company has elected to adopt the guidance using a modified retrospective method, by applying the transition approach as of the beginning of the period of adoption. Comparative periods will not be restated. The company has substantially completed its analysis of the new guidance by considering which practical expedients and policies to elect, deploying a software tool to assist in the accounting calculations, surveying functional groups that oversee vendor relationships, and developing processes and controls to manage the new lease accounting guidance and gather information for the required disclosures. The company expects the impact to the balance sheet of recording right-of-use assets and lease liabilities will be less than 2% of total assets and less than 3% of total liabilities. The company also expects that the impact of adoption of the guidance to its results of operations and cash flows will be nominal. The company’s future commitments under lease obligations are summarized in Note 11.
In January 2016, the FASB issued new guidance which affects the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. This guidance requires equity investments to be measured at fair value with subsequent changes recognized in net income, except for those accounted for under the equity method or requiring consolidation. The guidance also changes the accounting for investments without a
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THERMO FISHER SCIENTIFIC INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
readily determinable fair value and that do not qualify for the practical expedient permitted by the guidance to estimate fair value. The balance sheet impact of adopting this guidance as of January 1, 2018 is included in the table below.
In May 2014, the FASB issued new revenue recognition guidance which provides a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most previous revenue recognition guidance. The new standard also requires significantly expanded disclosures regarding the qualitative and quantitative information of an entity's nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. During 2016 and 2017, the FASB issued additional guidance and clarification, including the elimination of certain SEC Staff Guidance. The guidance is effective for the company in 2018. The company elected to adopt this guidance through application of the modified retrospective method by applying it to contracts that were not completed as of December 31, 2017 (in addition to new contracts in 2018).
Adoption of new guidance that became effective on January 1, 2018, impacted the company's Consolidated Balance Sheet as follows:
Had the company continued to use the revenue recognition guidance in effect prior to 2018, no material changes would have resulted to the consolidated statements of income, comprehensive income, or cash flows for the year ended December 31, 2018, from amounts reported therein. However, inventories would have been $357 million higher and other current assets would have been $359 million lower as of December 31, 2018, primarily as a result of differences in the accounting for pharmaceutical development and manufacturing services under the new revenue guidance. Under the prior guidance, costs of these services were recorded in inventory and revenues were recognized generally when the products were delivered to customers. Under the new guidance, costs are expensed and revenues are recognized as the manufacturing service is performed and the company's rights to consideration are recorded as contract assets and included in other current assets.
Note 2.
Acquisitions and Dispositions
The company’s acquisitions have historically been made at prices above the determined fair value of the acquired identifiable net assets, resulting in goodwill, due to expectations of the synergies that will be realized by combining the businesses. These synergies include the elimination of redundant facilities, functions and staffing; use of the company’s existing commercial infrastructure to expand sales of the acquired businesses’ products; and use of the commercial infrastructure of the acquired businesses to cost-effectively expand sales of company products.
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Acquisitions have been accounted for using the purchase method of accounting, and the acquired companies’ results have been included in the accompanying financial statements from their respective dates of acquisition. Acquisition transaction costs are recorded in selling, general and administrative expenses as incurred.
The company has entered into an agreement to acquire Gatan, Inc., a wholly owned subsidiary of Roper Technologies, Inc., for approximately $925 million in cash. Gatan is a leading manufacturer of instrumentation and software used to enhance and extend the operation and performance of electron microscopes. The transaction is subject to customary closing conditions, including regulatory approvals.
On October 25, 2018, the company acquired, within the Life Sciences Solutions segment, Becton Dickinson and Company's Advanced Bioprocessing business for $477 million in cash. This North America-based business adds complementary cell culture products that expand the segment's bioproduction offerings to help customers increase yield during production of biologic drugs. Revenues of the Advanced Bioprocessing business were $100 million in 2017. The purchase price exceeded the fair value of the identifiable net assets and, accordingly, $146 million was allocated to goodwill, all of which is tax deductible.
In 2018, the company acquired, within the Life Sciences Solutions segment, IntegenX Inc., a North America-based provider of a rapid DNA platform for use in forensics and law enforcement applications, for an aggregate purchase price of $65 million.
The components of the purchase price and net assets acquired for 2018 acquisitions are as follows:
The weighted-average amortization periods for definite-lived intangible assets acquired in 2018 are 14 years for customer relationships, 13 years for product technology and 6 years for tradenames and other. The weighted average amortization period for all definite-lived intangible assets acquired in 2018 is 13 years.
On August 29, 2017, the company acquired, within the Laboratory Products and Services segment, Patheon N.V., a leading global provider of high-quality drug development and delivery solutions to the pharmaceutical and biopharma sectors, for
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$35.00 per share in cash, or $7.36 billion, including the assumption of net debt. The company financed the purchase price, including the repayment of indebtedness of Patheon, with issuances of debt and equity.
Patheon provides comprehensive, integrated and highly customizable solutions as well as the expertise to help biopharmaceutical companies of all sizes satisfy complex development and manufacturing needs. The acquisition provided entry into the pharmaceutical contract development and manufacturing organization market and added a complementary service to the company's existing pharmaceutical services portfolio. Patheon's revenues totaled $1.87 billion for the year ended October 31, 2016. The purchase price exceeded the fair market value of the identifiable net assets and, accordingly, $3.28 billion was allocated to goodwill, $125 million of which is tax deductible.
On March 2, 2017, the company acquired, within the Analytical Instruments segment, Core Informatics, a North America-based provider of cloud-based platforms supporting scientific data management, for a total purchase price of $94 million, net of cash acquired. The acquisition enhanced the company's existing informatics solutions. Revenues of Core Informatics were approximately $10 million in 2016. The purchase price exceeded the fair market value of the identifiable net assets and, accordingly, $63 million was allocated to goodwill, $50 million of which is tax deductible.
On February 14, 2017, the company acquired, within the Life Sciences Solutions segment, Finesse Solutions, Inc., a North America-based developer of scalable control automation systems and software for bioproduction, for a total purchase price of $221 million, net of cash acquired. The acquisition expanded the company's bioproduction offerings. Revenues of Finesse Solutions were approximately $50 million in 2016. The purchase price exceeded the fair market value of the identifiable net assets and, accordingly, $136 million was allocated to goodwill, none of which is tax deductible.
In addition, in 2017 the company acquired, within the Specialty Diagnostics segment, a North America-based molecular diagnostics company offering qPCR tests to the transplant community and, within the Analytical Instruments segment, a provider of desktop scanning electron microscopy solutions and a manufacturer of volatile organic compound monitoring instruments and integrated systems, for an aggregate purchase price of $110 million.
The components of the purchase price and net assets acquired for 2017 acquisitions are as follows:
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The weighted-average amortization periods for definite-lived intangible assets acquired in 2017 are 17 years for customer relationships, 9 years for product technology and 4 years for tradenames and other. The weighted average amortization period for all definite-lived intangible assets acquired in 2017 is 16 years.
On September 19, 2016, the company acquired, within the Analytical Instruments segment, FEI Company, a North America-based provider of high-performance electron microscopy, for a total purchase price of $4.08 billion, net of cash acquired. The acquisition strengthened the company's analytical instrument portfolio with the addition of high-end electron microscopes. Revenues of FEI were $930 million in 2015. The purchase price exceeded the fair value of the identifiable net assets and, accordingly, $2.13 billion was allocated to goodwill, approximately $65 million of which is tax deductible.
On March 31, 2016, the company acquired, primarily within the Life Sciences Solutions segment, Affymetrix, Inc., a North America-based provider of cellular and genetic analysis products, for a total purchase price of $1.34 billion, net of cash acquired, including the assumption of $254 million of debt. The acquisition expanded the company's existing portfolio of antibodies and assays for flow cytometry and single-cell biology applications. Additionally, the acquisition expanded the company's genetic analysis portfolio through the addition of microarrays. Revenues of Affymetrix were $360 million in 2015. The purchase price exceeded the fair value of the identifiable net assets and, accordingly, $615 million was allocated to goodwill, none of which is tax deductible.
In addition, in 2016, the company acquired, within the Life Sciences Solutions segment, a manufacturer of transfection reagents and cell-related products and selected assets of an existing channel partner, within the Analytical Instruments segment, a provider of X-ray diffraction solutions for material science and industrial applications and, within the Specialty Diagnostics segment, an existing channel partner for its microbiology media products, for an aggregate purchase price of $33 million.
The components of the purchase price and net assets acquired for 2016 acquisitions are as follows:
The weighted-average amortization periods for definite-lived intangible assets acquired in 2016 are 16 years for customer relationships, 8 years for product technology and 8 years for tradenames and other. The weighted average amortization period for all definite-lived intangible assets acquired in 2016 is 13 years.
The company recorded a deferred tax liability of $156 million in the acquisition accounting related to the outside basis difference of the Affymetrix Singapore operations as the company does not intend to permanently reinvest the pre-acquisition Singapore earnings. This deferred tax liability was reversed in 2017 as a result of the enactment of the Tax Act.
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Unaudited Pro Forma Information
The following unaudited pro forma information provides the effect of the company's 2017 acquisition of Patheon as if the acquisition had occurred on January 1, 2016, and the effects of the company's 2016 acquisitions of FEI and Affymetrix as if the acquisitions had occurred on January 1, 2015:
The historical consolidated financial information of the company, Patheon, FEI, and Affymetrix has been adjusted in the pro forma information to give effect to pro forma events that are directly attributable to the acquisitions and related financing arrangements, are expected to have a continuing impact on the company, and are factually supportable.
To reflect the acquisition of Patheon as if it had occurred on January 1, 2016, and the acquisitions of FEI and Affymetrix as if they had occurred on January 1, 2015, the unaudited pro forma results include adjustments to reflect, among other things, the incremental intangible asset amortization to be incurred based on the preliminary values of each identifiable intangible asset and the interest expense from debt financings obtained to partially fund the cash consideration transferred. Pro forma adjustments were tax effected at the company's historical statutory rates in effect for the respective periods. The unaudited pro forma amounts are not necessarily indicative of the combined results of operations that would have been realized had the acquisitions and related financings occurred on the aforementioned dates, nor are they meant to be indicative of any anticipated combined results of operations that the company will experience after the transaction. In addition, the amounts do not include any adjustments for actions that may be taken following the completion of the transaction, such as expected cost savings, operating synergies, or revenue enhancements that may be realized subsequent to the transaction.
Pro forma net income for the year ended December 31, 2017, excludes certain items associated with the Patheon acquisition that were included in the determination of net income for that period. These items have been included in the determination of pro forma net income for the year ended December 31, 2016, and are as follows: $54 million of direct transaction costs, $39 million of accounting policy conformity adjustments, $21 million of initial restructuring costs, $40 million reduction of revenues for revaluing the deferred revenue obligations to fair value, and $55 million of expense related to the fair value adjustment to acquisition-date inventories.
Pro forma net income for the year ended December 31, 2016, excludes certain items associated with the FEI and Affymetrix acquisitions that were included in the determination of net income for that period. These items have been included in the determination of pro forma net income for the year ended December 31, 2015 (not presented), and are as follows: $102 million of direct transaction costs, $33 million of accounting policy conformity adjustments, $46 million of initial restructuring costs, $6 million reduction of revenues for revaluing the deferred revenue obligations to fair value, and $99 million of expense related to the fair value adjustment to acquisition-date inventories.
The company’s results would not have been materially different from its pro forma results had the company’s other 2018, 2017 or 2016 acquisitions occurred at the beginning of 2017, 2016 or 2015, respectively.
Disposition
On January 28, 2019, the company entered into an agreement to sell its Anatomical Pathology business to PHC Holdings Corporation for approximately $1.14 billion. The business is part of the Specialty Diagnostics segment. Revenues in 2018 of the business to be sold were approximately $344 million. The sale is subject to customary closing conditions and applicable regulatory approvals. The assets and liabilities of the Anatomical Pathology business were as follows on December 31, 2018:
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Note 3.
Revenue
Disaggregated Revenue
Revenue by type is as follows:
Revenue by geographic region is as follows:
(a)
Revenues are attributed to regions based on customer location.
Each reportable segment earns revenues from consumables, instruments and services in North America, Europe, Asia-Pacific and other regions. See note 4 for revenue by reportable segment and other geographic data.
Remaining Performance Obligations
The aggregate amount of the transaction price allocated to the remaining performance obligations for all open customer contracts as of December 31, 2018 was $5.09 billion. The company will recognize revenue for these performance obligations as they are satisfied, approximately 90% of which is expected to occur within the next twelve months.
Note 4.
Business Segment and Geographical Information
The company’s financial performance is reported in four segments. A description of each segment follows.
Life Sciences Solutions: provides an extensive portfolio of reagents, instruments and consumables used in biological and medical research, discovery and production of new drugs and vaccines as well as diagnosis of disease. These products and services are used by customers in pharmaceutical, biotechnology, agricultural, clinical, academic, and government markets.
Analytical Instruments: provides a broad offering of instruments, consumables, software and services that are used for a range of applications in the laboratory, on the production line and in the field. These products and services are used by customers in pharmaceutical, biotechnology, academic, government, environmental and other research and industrial markets, as well as the clinical laboratory.
Specialty Diagnostics: provides a wide range of diagnostic test kits, reagents, culture media, instruments and associated products used to increase the speed and accuracy of diagnoses. These products are used by customers in healthcare, clinical, pharmaceutical, industrial and food safety laboratories.
Laboratory Products and Services: provides virtually everything needed for the laboratory, including a combination of self-manufactured and sourced products for customers in research, academic, government, industrial and healthcare settings. The segment also includes a comprehensive offering of outsourced services used by the pharmaceutical and biotech industries for drug development, clinical trials logistics and commercial drug manufacturing.
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The company’s management evaluates segment operating performance based on operating income before certain charges/credits to cost of revenues and selling, general and administrative expenses, principally associated with acquisition accounting; restructuring and other costs/income including costs arising from facility consolidations such as severance and abandoned lease expense and gains and losses from the sale of real estate and product lines as well as from significant litigation-related matters; and amortization of acquisition-related intangible assets. The company uses this measure because it helps management understand and evaluate the segments’ core operating results and facilitates comparison of performance for determining compensation.
Business Segment Information
(a)
Represents operating income before certain charges to cost of revenues and selling, general and administrative expenses; restructuring and other costs, net; and amortization of acquisition-related intangibles.
(b)
The company does not allocate other expense, net to its segments.
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(c)
Corporate assets consist primarily of cash and cash equivalents, short-term investments, property and equipment at the company's corporate offices.
Geographical Information
(d)
Revenues are attributed to countries based on customer location.
(e)
Includes property, plant and equipment, net.
Note 5.
Other Expense, Net
The components of other expense, net, in the accompanying statement of income are as follows:
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Other Items, Net
In all periods, other items, net includes currency transaction gains and losses on monetary assets and liabilities and net periodic pension benefit cost/income, excluding the service cost component which is included in operating expenses on the accompanying statement of income. In 2018, other items, net also includes $15 million of net losses on investments.
In 2017, other items, net includes $32 million of charges related to amortization of fees paid to obtain bridge financing commitments related to the Patheon acquisition (Note 2) and $4 million of losses on the early extinguishment of debt, offset in part by $17 million of gains on investments.
In 2016, other items, net includes $22 million of charges related to amortization of fees paid to obtain bridge financing commitments for the acquisition of FEI (Note 2) and $9 million of losses on the early extinguishment of debt, offset in part by $13 million of gains on investments. The investment gains include an $8 million gain on the sale of a joint venture for net proceeds of $65 million.
Note 6.
Stock-based Compensation Expense
The company has stock-based compensation plans for its key employees, directors and others. These plans permit the grant of a variety of stock and stock-based awards, including restricted stock units, stock options or performance-based shares, as determined by the compensation committee of the company’s Board of Directors or, for certain non-officer grants, by the company’s employee equity committee, which consists of its chief executive officer. The company generally issues new shares of its common stock to satisfy option exercises and restricted unit vestings. Grants of stock options and restricted units generally provide that in the event of both a change in control of the company and a qualifying termination of an option or unit holder’s employment, all options and service-based restricted unit awards held by the recipient become immediately vested (unless an employment or other agreement with the employee provides for different treatment).
Compensation cost is based on the grant-date fair value and is recognized ratably over the requisite vesting period or to the date based on qualifying retirement eligibility, if earlier.
The components of stock-based compensation expense are primarily included in selling, general and administrative expenses and are as follows:
Stock Options
The company’s practice is to grant stock options at fair market value. Options vest over 3-5 years with terms of 7-10 years, assuming continued employment with certain exceptions. Vesting of the option awards is contingent upon meeting certain service conditions. The fair value of most option grants is estimated using the Black-Scholes option pricing model. For option grants that require the achievement of both service and market conditions, a lattice model is used to estimate fair value. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Use of a valuation model requires management to make certain assumptions with respect to selected model inputs. Expected volatility was calculated based on the historical volatility of the company’s stock. Historical data on exercise patterns is the basis for estimating the expected life of an option. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term which approximates the expected life assumed at the date of grant. The expected annual dividend rate was calculated by dividing the company’s annual dividend, based on the most recent quarterly dividend rate, by the closing stock price on the grant date. The compensation expense recognized for all stock-based awards is net of estimated forfeitures. Forfeitures are estimated based on an analysis of actual option forfeitures.
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The weighted average assumptions used in the Black-Scholes option pricing model are as follows:
The weighted average per share grant-date fair values of options granted during 2018, 2017 and 2016 were $43.45, $30.73 and $24.54, respectively. The total intrinsic value of options exercised during the same periods was $312 million, $199 million and $176 million, respectively. The intrinsic value is the difference between the market value of the shares on the exercise date and the exercise price of the option.
A summary of the company’s option activity for the year ended December 31, 2018 is presented below:
(a)
Market price per share on December 31, 2018 was $223.79. The intrinsic value is zero for options with exercise prices above the market price.
As of December 31, 2018, there was $101 million of total unrecognized compensation cost related to unvested stock options granted. The cost is expected to be recognized through 2022 with a weighted average amortization period of 2.4 years.
Restricted Share/Unit Awards
Awards of restricted units convert into an equivalent number of shares of common stock. The awards generally vest over 3-4 years, assuming continued employment, with some exceptions. Vesting of the awards is contingent upon meeting certain service conditions and may also be contingent upon meeting certain performance and/or market conditions. The fair market value of the award at the time of the grant is amortized to expense over the requisite service period of the award, which is generally the vesting period. Recipients of restricted units have no voting rights but are entitled to accrue dividend equivalents. The fair value of service- and performance-based restricted unit awards is determined based on the number of units granted and the market value of the company’s shares on the grant date. For awards with market-based vesting conditions, the company uses a lattice model to estimate the grant-date fair value of the award.
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A summary of the company’s restricted unit activity for the year ended December 31, 2018 is presented below:
The total fair value of shares vested during 2018, 2017 and 2016 was $114 million, $97 million and $91 million, respectively.
As of December 31, 2018, there was $144 million of total unrecognized compensation cost related to unvested restricted stock unit awards. The cost is expected to be recognized through 2022 with a weighted average amortization period of 1.9 years.
Employee Stock Purchase Plans
Qualifying employees are eligible to participate in an employee stock purchase plan sponsored by the company. Shares may be purchased under the program at 95% of the fair market value at the end of the purchase period and the shares purchased are not subject to a holding period. Shares are purchased through payroll deductions of up to 10% of each participating employee’s qualifying gross wages. The company issued 0.1 million, 0.1 million and 0.2 million shares, respectively, of its common stock in 2018, 2017 and 2016 under the employee stock purchase plan.
Note 7.
Pension and Other Postretirement Benefit Plans
401(k) Savings Plan and Other Defined Contribution Plans
The company’s 401(k) savings and other defined contribution plans cover the majority of the company’s eligible U.S. and certain non-U.S. employees. Contributions to the plans are made by both the employee and the company. Company contributions are based on the level of employee contributions. Company contributions to these plans are based on formulas determined by the company. In 2018, 2017 and 2016, the company charged to expense $204 million, $161 million and $140 million, respectively, related to its defined contribution plans.
Defined Benefit Pension Plans
Employees of a number of the company’s non-U.S. and certain U.S. subsidiaries participate in defined benefit pension plans covering substantially all full-time employees at those subsidiaries. Some of the plans are unfunded, as permitted under the plans and applicable laws. The company also maintains postretirement healthcare programs at several acquired businesses where certain employees are eligible to participate. The costs of the postretirement healthcare programs are generally funded on a self-insured and insured-premium basis.
The company recognizes the funded status of defined benefit pension and other postretirement benefit plans as an asset or liability. This amount is defined as the difference between the fair value of plan assets and the benefit obligation. The company is required to recognize as a component of other comprehensive items, net of tax, the actuarial gains/losses and prior service costs/credits that arise but were not previously required to be recognized as components of net periodic benefit cost. Other comprehensive items is adjusted as these amounts are later recognized in income as components of net periodic benefit cost.
When a company with a pension plan is acquired, any excess of projected benefit obligation over the plan assets is recognized as a liability and any excess of plan assets over the projected benefit obligation is recognized as an asset. The recognition of a new liability or a new asset results in the elimination of (a) previously existing unrecognized net gain or loss and (b) unrecognized prior service cost or credits.
The company funds annually, at a minimum, the statutorily required minimum amount as actuarially determined. During 2018, 2017 and 2016, the company made cash contributions of approximately $93 million, $200 million and $43 million, respectively. Additionally, in 2016, the company contributed insurance contracts valued at $16 million to two of its German
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defined benefit plans. Contributions to the plans included in the following table are estimated at between $35 and $65 million for 2019.
The following table provides a reconciliation of benefit obligations and plan assets of the company’s domestic and non-U.S. pension plans and postretirement benefit plans:
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The actuarial assumptions used to compute the funded status for the plans are based upon information available as of December 31, 2018 and 2017 and are as follows:
The actuarial assumptions used to compute the net periodic pension benefit cost (income) are based upon information available as of the beginning of the year, as presented in the following table:
The ultimate healthcare cost trend rates for the postretirement benefit plans are expected to be reached between 2019 and 2040.
The discount rate reflects the rate the company would have to pay to purchase high-quality investments that would provide cash sufficient to settle its current pension obligations. The discount rate is determined based on a range of factors, including the rates of return on high-quality, fixed-income corporate bonds and the related expected duration of the obligations or, in certain instances, the company has used a hypothetical portfolio of high quality instruments with maturities that mirror the benefit obligation in order to accurately estimate the discount rate relevant to a particular plan.
The company utilizes a full yield curve approach in the estimation of these components by applying the specific spot-rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows.
The expected long-term rate of return on plan assets reflects the average rate of earnings expected on the funds invested, or to be invested, to provide for the benefits included in the projected benefit obligations. In determining the expected long-term rate of return on plan assets, the company considers the relative weighting of plan assets, the historical performance of total plan assets and individual asset classes and economic and other indicators of future performance. In addition, the company may consult with and consider the opinions of financial and other professionals in developing appropriate return benchmarks.
Asset management objectives include maintaining an adequate level of diversification to reduce interest rate and market risk and providing adequate liquidity to meet immediate and future benefit payment requirements.
The expected rate of compensation increase reflects the long-term average rate of salary increases and is based on historic salary increase experience and management’s expectations of future salary increases.
The amounts in accumulated other comprehensive items expected to be recognized as components of net periodic benefit cost in 2019 are not material.
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The projected benefit obligation and fair value of plan assets for the company’s qualified and non-qualified pension plans with projected benefit obligations in excess of plan assets are as follows:
The accumulated benefit obligation and fair value of plan assets for the company's qualified and non-qualified pension plans with accumulated benefit obligations in excess of plan assets are as follows:
The measurement date used to determine benefit information is December 31 for all plan assets and benefit obligations.
The net periodic pension benefit cost (income) includes the following components:
The net periodic postretirement benefit cost was not material in 2018, 2017 and 2016.
Expected benefit payments are estimated using the same assumptions used in determining the company’s benefit obligation at December 31, 2018. Benefit payments will depend on future employment and compensation levels, average years employed and average life spans, among other factors, and changes in any of these factors could significantly affect these estimated future benefit payments. Estimated future benefit payments during the next five years and in the aggregate for the five fiscal years thereafter, are as follows:
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A change in the assumed healthcare cost trend rate by one percentage point effective January 2018 would not have caused a material change in the accumulated postretirement benefit obligation as of December 31, 2018 and the 2018 aggregate of service and interest costs.
Domestic Pension Plan Assets
The company’s overall objective is to manage the assets in a liability framework where investments are selected that are expected to have similar changes in fair value as the related liabilities will have upon changes in interest rates. The company invests in a portfolio of both return-seeking and liability-hedging assets, primarily through the use of institutional collective funds, to achieve long-term growth and to insulate the funded position from interest rate volatility. The strategic asset allocation uses a combination of risk controlled and index strategies in fixed income and global equities. The company also has a small portfolio (comprising less than 1% of invested assets) of private equity investments. The target allocations for the remaining investments are approximately 10% to funds investing in U.S. equities, approximately 10% to funds investing in international equities and approximately 80% to funds investing in fixed income securities. The portfolio maintains enough liquidity at all times to meet the near-term benefit payments.
Non-U.S. Pension Plan Assets
The company maintains specific plan assets for many of the individual pension plans outside the U.S. The investment strategy of each plan has been uniquely established based on the country specific standards and characteristics of the plans. Several of the plans have contracts with insurance companies whereby the market risks of the benefit obligations are borne by the insurance companies. When assets are held directly in investments, generally the objective is to invest in a portfolio of diversified assets with a variety of fund managers. The investments may include hedge funds, multi-asset funds, alternative investments and derivative funds with the target asset allocations ranging from approximately 0% - 25% for equities, 0% - 55% for fixed income, 0% - 20% for hedge funds, 0% - 100% for multi-asset funds, 0% to 15% for alternative investments and 0% - 22% for funds holding derivatives. The derivatives held by the funds are primarily interest rate swaps intended to match the movements in the plan liabilities as well as equity futures in a synthetic equity fund which provide targeted exposure to equity markets without the fund holding individual equity positions. Each plan maintains enough liquidity at all times to meet the near-term benefit payments.
The fair values of the company’s plan assets at December 31, 2018 and 2017, by asset category are as follows:
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The tables above present the fair value of the company’s plan assets in accordance with the fair value hierarchy (Note 13). Certain investments that are measured at fair value using the net asset value per share practical expedient have not been classified in the fair value hierarchy. The fair value amounts of these investments presented in the above tables are intended to permit reconciliation of the fair value hierarchy to the amounts presented for the total pension plan assets. These investments were also redeemable at the balance sheet date or within limited time restrictions.
Note 8.
Income Taxes
The components of income from continuing operations before provision for income taxes are as follows:
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The components of the provision for income taxes of continuing operations are as follows:
The provision for income taxes in the accompanying statement of income differs from the provision calculated by applying the statutory federal income tax rate to income from continuing operations before provision for income taxes due to the following:
The company has operations and a taxable presence in approximately 50 countries outside the U.S. The company's effective income tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes, and foreign taxes that are different than the U.S. federal statutory rate.
U.S. Tax Reform Impacts
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was enacted. The Tax Act includes significant changes to existing U.S. tax laws that affect the company, including a reduction of the U.S. corporate income tax rate from 35% to 21% beginning in 2018 and creation of a territorial tax system with a one-time transition tax on deemed repatriated earnings and
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profits of foreign subsidiaries (transition tax). As detailed below, the company recognized a net charge of $204 million for certain aspects of the Tax Act in its 2017 financial statements for which the accounting was provisional, but a reasonable estimate could be determined. During 2018, the company completed its accounting for the income tax effects of the Tax Act and recognized net adjustments (detailed below) to the provisional amounts, totaling a net charge of $68 million, as a component of income tax expense.
The transition tax is based on the company's total post-1986 earnings and profits, the tax on which was previously deferred from U.S. income taxes under U.S. law. The company recorded a provisional amount for the transition tax liability for each of the foreign subsidiaries, resulting in a total transition liability of $1.25 billion at December 31, 2017. After further analysis of new U.S. Treasury guidance, available tax accounting methods and elections, legislative updates, regulations, earnings and profits computations and foreign taxes, the company finalized the calculations of the transition tax liability during 2018. The increase in the liability for the transition tax in 2018 consisted of an incremental provision of $117 million offset in part by a $49 million reduction of related unrecognized tax benefits established in 2017.
In 2017, as a result of the Tax Act, the company remeasured certain deferred tax assets and liabilities based on the rates at which they were expected to reverse in the future (which was generally 21%), by recording a provisional tax benefit of $1.06 billion. During 2018, no material changes to this provisional amount were made.
The Tax Act included a provision for global intangible low-taxed income. The company has adopted a policy to account for this provision as a period cost.
Other Tax Impacts
In 2018, the provision for income taxes also included a $71 million charge to establish a valuation allowance against net operating losses that will not be utilized as a result of the planned sale of the Anatomical Pathology business (Note 2).
The foreign tax credits discussed below are the result of foreign earnings and profits remitted or deemed remitted to the U.S. during the reporting year and the U.S. treatment of taxes paid in the foreign jurisdictions in the years those profits were originally earned.
In 2017, the company continued to implement tax planning initiatives related to non U.S. subsidiaries. These non-U.S. subsidiaries incurred foreign tax obligations, and made cash and deemed distributions to the company’s U.S. operations which resulted in no net tax cost. As a result of these distributions, the company benefitted from U.S. foreign tax credits of $86 million, offset in part by additional U.S. income taxes of $53 million on the related foreign income (which reduced the benefit from the foreign rate differential in 2017). The company also implemented foreign tax credit planning in Sweden which resulted in $20 million of foreign tax credits, with no related incremental U.S. income tax expense. In 2017 the company refinanced certain long term inter-company debt which resulted in an income tax benefit of $237 million related to a foreign exchange loss recognized for income tax purposes.
In 2016, the company continued to implement tax planning initiatives related to non-U.S. subsidiaries. These non-U.S. subsidiaries incurred foreign tax obligations, and made cash and deemed distributions to the company’s U.S. operations which resulted in no net tax cost. As a result of these distributions, the company benefitted from U.S. foreign tax credits of $91 million, offset in part by additional U.S. income taxes of $37 million on the related foreign income (which reduced the benefit from the foreign rate differential in 2016). The company also implemented foreign tax credit planning in Sweden which resulted in $100 million of foreign tax credits, with no related incremental U.S. income tax expense.
The company generally receives a tax deduction upon the exercise of non-qualified stock options by employees, or the vesting of restricted stock units held by employees, for the difference between the exercise price and the market price of the underlying common stock on the date of exercise. The company uses the incremental tax benefit approach for utilization of tax attributes. Prior to 2017, the amount of the tax deduction in excess of compensation cost recognized was allocated to capital in excess of par value. Beginning in 2017, these excess tax benefits reduce the tax provision. In 2018 and 2017, the company's tax provision was reduced by $77 million and $65 million, respectively, of such benefits. In 2016, $53 million of such benefits were allocated to capital in excess of par value.
The company has significant activities in Singapore and has received considerable tax incentives. The local taxing authority granted the company pioneer company status which provides an incentive encouraging companies to undertake activities that have the effect of promoting economic or technological development in Singapore. This incentive equates to a tax exemption on earnings associated with most of the company’s manufacturing activities in Singapore and continues through December 31, 2026. In 2018, 2017 and 2016, the impact of this tax holiday decreased the annual effective tax rates by 0.9 percentage points, 1.0 percentage points and 1.1 percentage points, respectively, and increased diluted earnings per share by approximately $0.07, $0.06 and $0.06, respectively. In connection with the March 2017 extension of this agreement until 2026,
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the company recorded a benefit in the first quarter of 2017 of approximately $65 million ($0.16 per diluted share) for the effect on deferred tax balances of the extended tax holiday.
Net deferred tax asset (liability) in the accompanying balance sheet consists of the following:
The company estimates the degree to which tax assets and loss and credit carryforwards will result in a benefit based on expected profitability by tax jurisdiction and provides a valuation allowance for tax assets and loss and credit carryforwards that it believes will more likely than not expire unutilized. At December 31, 2018, all of the company’s valuation allowance relates to deferred tax assets, primarily net operating losses, for which any subsequently recognized tax benefits will reduce income tax expense.
The changes in the valuation allowance are as follows:
At December 31, 2018, the company had federal, state and non-U.S. net operating loss carryforwards of $412 million, $1.69 billion and $4.41 billion, respectively. Use of the carryforwards is limited based on the future income of certain subsidiaries. The federal and state net operating loss carryforwards expire in the years 2019 through 2038. Of the non-U.S. net operating loss carryforwards, $2.15 billion expire in the years 2019 through 2038, and the remainder do not expire.
The company operates in various jurisdictions around the world. A provision has not been made for certain U.S. state income taxes or additional non-U.S. taxes on $14.4 billion of undistributed earnings of international subsidiaries that could be subject to taxation if remitted to the U.S. because such amounts are intended to be reinvested outside the United States indefinitely. It is not practicable to estimate the unrecognized tax liability due to i) the extent of uncertainty as to which remittance structure would be used (among several possibilities) should a decision be made to repatriate; and ii) the implications of indirect taxes, including withholding taxes that could potentially be required depending on the repatriation structure. The company’s intent is to only make distributions from non-U.S. subsidiaries in the future when they can be made at no net tax costs.
Unrecognized Tax Benefits
As of December 31, 2018, the company had $1.44 billion of unrecognized tax benefits which, if recognized, would reduce the effective tax rate.
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A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows:
During 2018, the company's unrecognized tax benefits increased $85 million as a result of uncertain tax positions relating to foreign tax positions and $45 million relating to U.S. federal and state tax positions. All of the total $1.44 billion liability is classified as a long-term liability. The company does not expect its unrecognized tax benefits to change significantly over the next twelve months.
During 2017, the company’s unrecognized tax benefits provisionally increased $511 million as a result of uncertain tax positions relating to the scope of the Tax Act’s one-time transition tax, $54 million relating to foreign tax positions, $43 million as a result of a foreign exchange loss recognized on the refinancing of certain long term inter-company debt and $31 million due to an acquisition.
During 2016, the company’s unrecognized tax benefits increased $342 million due to the uncertainty around the deductibility of a foreign exchange loss on intercompany investments, $54 million due to acquisitions, $43 million due to tax planning related to prior years that resulted in amended tax filings, $35 million relating to foreign tax positions and $14 million due to the utilization of deferred tax assets. In 2016, the company also settled the Life Technologies tax audit for the 2012 to 2014 tax years which reduced the reserve on unrecognized tax benefits by $10 million.
The company classified interest and penalties related to unrecognized tax benefits as income tax expense. The total amount of interest and penalties related to uncertain tax positions and recognized in the balance sheet as of December 31, 2018 and 2017 was $59 million and $31 million, respectively.
The company conducts business globally and, as a result, Thermo Fisher or one or more of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, the company is subject to examination by taxing authorities throughout the world, including such major jurisdictions as Australia, Canada, China, Denmark, Finland, France, Germany, Japan, Singapore, Sweden, the United Kingdom and the United States. With few exceptions, the company is no longer subject to U.S. federal, state and local, or non-U.S., income tax examinations for years before 2011.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 9.
Earnings per Share
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 10.
Debt and Other Financing Arrangements
The effective interest rates for the fixed-rate debt include the stated interest on the notes, the accretion of any discount or amortization of any premium, the amortization of any debt issuance costs and, if applicable, adjustments related to hedging.
See Note 13 for fair value information pertaining to the company’s long-term obligations.
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As of December 31, 2018, the annual repayment requirements for debt obligations are as follows:
As of December 31, 2018 and 2017, short-term obligations and current maturities of long-term obligations in the accompanying balance sheet included $693 million and $960 million, respectively, of commercial paper, short-term bank borrowings and borrowings under lines of credit of certain of the company’s subsidiaries. The weighted average interest rate for short-term borrowings was 0.74% and slightly below 0% at December 31, 2018 and 2017, respectively. In addition to available borrowings under the company’s revolving credit agreements, discussed below, the company had unused lines of credit of $68 million as of December 31, 2018. These unused lines of credit generally provide for short-term unsecured borrowings at various interest rates.
Credit Facilities
The company has a revolving credit facility with a bank group that provides for up to $2.50 billion of unsecured multi-currency revolving credit. The facility expires in July 2021. The agreement calls for interest at either a LIBOR-based rate, a EURIBOR-based rate (for funds drawn in Euro) or a rate based on the prime lending rate of the agent bank, at the company’s option. The agreement contains affirmative, negative and financial covenants, and events of default customary for facilities of this type. The covenants in our revolving credit facility (the Facility) include a Consolidated Leverage Ratio (total debt-to-Consolidated EBITDA) and a Consolidated Interest Coverage Ratio (Consolidated EBITDA to Consolidated Interest Expense), as such terms are defined in the Facility. Specifically, the company has agreed that, so long as any lender has any commitment under the Facility, any letter of credit is outstanding under the Facility, or any loan or other obligation is outstanding under the Facility, it will maintain a maximum Consolidated Leverage Ratio of 3.5:1.0. The company has also agreed that so long as any lender has any commitment under the Facility or any letter of credit is outstanding under the Facility, or any loan or other obligation is outstanding under the Facility, it will maintain a minimum Consolidated Interest Coverage Ratio of 3.0:1.0 as of the last day of any fiscal quarter. As of December 31, 2018, no borrowings were outstanding under the Facility, although available capacity was reduced by approximately $82 million as a result of outstanding letters of credit.
Commercial Paper Programs
The company has commercial paper programs pursuant to which it may issue and sell unsecured, short-term promissory notes (CP Notes). Under the U.S. program, a) maturities may not exceed 397 days from the date of issue and b) the CP Notes are issued on a private placement basis under customary terms in the commercial paper market and are not redeemable prior to maturity nor subject to voluntary prepayment. Under the euro program, maturities may not exceed 183 days and may be denominated in euro, U.S. dollars, Japanese yen, British pounds sterling, Swiss franc, Canadian dollars or other currencies. Under both programs, the CP Notes are issued at a discount from par (or premium to par, in the case of negative interest rates), or, alternatively, are sold at par and bear varying interest rates on a fixed or floating basis. As of December 31, 2018, outstanding borrowings under these programs were $693 million, with a weighted average remaining period to maturity of 51 days and are classified as short-term obligations in the accompanying balance sheet.
Senior Notes
Interest on the floating rate senior notes is payable quarterly. Interest is payable annually on the other euro-denominated senior notes and semi-annually on all other senior notes. Each of the notes may be redeemed at a redemption price of 100% of the principal amount plus a specified make-whole premium and accrued interest. The company is subject to certain affirmative and negative covenants under the indentures governing the senior notes, the most restrictive of which limits the ability of the company to pledge principal properties as security under borrowing arrangements.
In 2018, Thermo Fisher Scientific (Finance I) B.V., a wholly-owned finance subsidiary of the company, issued the Floating Rate Senior Notes due 2020 included in the table above. This subsidiary has no independent function other than financing
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
activities. The Floating Rate Senior Notes due 2020 are fully and unconditionally guaranteed by the company and no other subsidiaries of the company have guaranteed the obligations.
Prior to issuing the 3.00% Senior Notes due 2023, the company had entered into an agreement to hedge its exposure related to the interest rate on the anticipated borrowings (described under the heading "Cash Flow Hedge Arrangements" in Note 13) that was terminated in April 2016. The company had a cash outlay of $75 million in 2016 associated with termination of the arrangement, included in other financing activities, net, in the accompanying statement of cash flows.
Interest Rate Swap Arrangements
In 2016, the company terminated certain of its fixed to floating rate swap arrangements. The terminated swaps were accounted for as fair value hedges. As a result of terminating these arrangements, the company received $61 million (excluding accrued interest) in cash in 2016, included in other financing activities, net, in the accompanying statement of cash flows. The proceeds were recorded as part of the carrying value of the underlying debt and will be amortized as a reduction to interest expense over the remaining terms of the respective debt instruments. Subsequently, the company entered into new swap arrangements which are included in the table below.
The company has entered into LIBOR-based interest rate swap arrangements with various banks on several of its outstanding senior notes. The aggregate amounts of the swaps are equal to the principal amounts of the notes and the payment dates of the swaps coincide with the interest payment dates of the notes. The swap contracts provide for the company to pay a variable interest rate and receive a fixed rate. The variable interest rates reset monthly. The swaps have been accounted for as fair value hedges of the notes. See Note 13 for additional information on the interest rate swap arrangements and related cross-currency interest rate swap arrangements. The following table summarizes the outstanding interest rate swap arrangements on the company's senior notes at December 31, 2018:
(a)
The payments on $1.5 billion notional value of these interest rate swaps are offset in part by cross-currency interest rate swaps which effectively reduced the pay rate as of December 31, 2018 from a weighted average of 5.00% to a weighted average of 1.96%.
In 2018, the company entered into $1.5 billion notional value of cross-currency interest rate swaps, which effectively convert a portion of the semi-annual payments related to the variable rate, U.S. dollar denominated, LIBOR-based interest rate swaps to payments on variable rate, euro denominated, EURIBOR-based cross-currency interest rate swaps.
Note 11.
Commitments and Contingencies
Operating Leases
The company leases certain logistics, office, and manufacturing facilities. Income from continuing operations includes expense from operating leases of $211 million, $198 million and $182 million in 2018, 2017 and 2016, respectively. The following is a summary of annual future minimum lease and rental commitments under noncancelable operating leases as of December 31, 2018:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Purchase Obligations
The company has entered into unconditional purchase obligations, in the ordinary course of business, that include agreements to purchase goods, services or fixed assets and to pay royalties that are enforceable and legally binding and that specify all significant terms including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable at any time without penalty. The aggregate amount of the company’s unconditional purchase obligations totaled $745 million at December 31, 2018 and the majority of these obligations are expected to be settled during 2019.
Letters of Credit, Guarantees and Other Commitments
Outstanding letters of credit and bank guarantees totaled $218 million at December 31, 2018. Substantially all of these letters of credit and guarantees expire before 2025.
Outstanding surety bonds and other guarantees totaled $28 million at December 31, 2018. The expiration of these bonds and guarantees ranges through 2020.
The letters of credit, bank guarantees and surety bonds principally secure performance obligations, and allow the holder to draw funds up to the face amount of the letter of credit, bank guarantee or surety bond if the applicable business unit does not perform as contractually required.
The company is a guarantor of pension plan obligations of a divested business. The purchaser of the divested business has agreed to pay for the pension benefits, however the company was required to guarantee payment of these pension benefits should the purchaser fail to do so. The amount of the guarantee at December 31, 2018 was $38 million.
In connection with the sale of businesses of the company, the buyers have assumed certain contractual obligations of such businesses and have agreed to indemnify the company with respect to those assumed liabilities. In the event a third-party to a transferred contract does not recognize the transfer of obligations or a buyer defaults on its obligations under the transferred contract, the company could be liable to the third-party for such obligations. However, in such event, the company would be entitled to seek indemnification from the buyer.
The company has guaranteed the residual value of three leased operating facilities with initial lease terms ending in 2019, 2020 and 2023. The company has agreed with the lessor to comply with certain financial covenants consistent with its other debt arrangements (Note 10). The aggregate maximum guarantee under these three lease arrangements is $147 million.
Indemnifications
In conjunction with certain transactions, primarily divestitures, the company has agreed to indemnify the other parties with respect to certain liabilities related to the businesses that were sold or leased properties that were abandoned (e.g., retention of certain environmental, tax, employee and product liabilities). The scope and duration of such indemnity obligations vary from transaction to transaction. Where probable, an obligation for such indemnifications is recorded as a liability. Generally, a maximum obligation cannot be reasonably estimated. Other than obligations recorded as liabilities at the time of divestiture, historically the company has not made significant payments for these indemnifications.
In connection with the company’s efforts to reduce the number of facilities that it occupies, the company has vacated some of its leased facilities or sublet them to third parties. When the company sublets a facility to a third-party, it remains the primary obligor under the master lease agreement with the owner of the facility. As a result, if a third-party vacates the sublet facility, the company would be obligated to make lease or other payments under the master lease agreement. The company believes that the financial risk of default by sublessors is individually and in the aggregate not material to the company’s financial position or results of operations.
In connection with the sale of products in the ordinary course of business, the company often makes representations affirming, among other things, that its products do not infringe on the intellectual property rights of others and agrees to indemnify customers against third-party claims for such infringement. The company has not been required to make material payments under such provisions.
Environmental Matters
The company is currently involved in various stages of investigation and remediation related to environmental matters. The company cannot predict all potential costs related to environmental remediation matters and the possible impact on future operations given the uncertainties regarding the extent of the required cleanup, the complexity and interpretation of applicable laws and regulations, the varying costs of alternative cleanup methods and the extent of the company’s responsibility. Expenses for environmental remediation matters related to the costs of installing, operating and maintaining groundwater-treatment
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systems and other remedial activities related to historical environmental contamination at the company’s domestic and international facilities were not material in any period presented. The company records accruals for environmental remediation liabilities, based on current interpretations of environmental laws and regulations, when it is probable that a liability has been incurred and the amount of such liability can be reasonably estimated. The company calculates estimates based upon several factors, including reports prepared by environmental specialists and management’s knowledge of and experience with these environmental matters. The company includes in these estimates potential costs for investigation, remediation and operation and maintenance of cleanup sites. At December 31, 2018, the company’s total environmental liability was approximately $69 million. While management believes the accruals for environmental remediation are adequate based on current estimates of remediation costs, the company may be subject to additional remedial or compliance costs due to future events such as changes in existing laws and regulations, changes in agency direction or enforcement policies, developments in remediation technologies or changes in the conduct of the company’s operations, which could have a material adverse effect on the company’s financial position, results of operations or cash flows.
Litigation and Related Contingencies
There are various lawsuits and claims pending against the company including matters involving product liability, intellectual property, employment and commercial issues. The company determines the probability and range of possible loss based on the current status of each of these matters. A liability is recorded in the financial statements if it is believed to be probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The company establishes a liability that is an estimate of amounts expected to be paid in the future for events that have already occurred. The company accrues the most likely amount or at least the minimum of the range of probable loss when a range of probable loss can be estimated. The accrued liabilities are based on management’s judgment as to the probability of losses for asserted and unasserted claims and, where applicable, actuarially determined estimates. Accrual estimates are adjusted as additional information becomes known or payments are made. The amount of ultimate loss may differ from these estimates. Due to the inherent uncertainties associated with pending litigation or claims, the company cannot predict the outcome, nor, with respect to certain pending litigation or claims where no liability has been accrued, make a meaningful estimate of the reasonably possible loss or range of loss that could result from an unfavorable outcome. The company has no material accruals for pending litigation or claims for which accrual amounts are not disclosed below, nor are material losses deemed probable for such matters. It is reasonably possible, however, that an unfavorable outcome that exceeds the company’s current accrual estimate, if any, for one or more of the matters described below could have a material adverse effect on the company’s results of operations, financial position and cash flows.
Product Liability, Workers Compensation and Other Personal Injury Matters
The range of probable loss for product liability, workers compensation and other personal injury matters of the company’s continuing operations at December 31, 2018, was approximately $215 million to $349 million on an undiscounted basis. The portion of these liabilities assumed in the 2006 merger with Fisher was recorded at its fair (present) value at the date of merger. The company’s accrual for all such matters in total, including the discounted liabilities, was $204 million at December 31, 2018 (or $221 million undiscounted). The accrual includes estimated defense costs and is gross of estimated amounts due from insurers of $86 million at December 31, 2018 (or $97 million undiscounted) that are included in other assets in the accompanying balance sheet. The portion of these insurance assets assumed in the merger with Fisher was also recorded at its fair value at the date of merger. In addition to the above accrual, as of December 31, 2018, the company had a product liability accrual of $10 million (undiscounted) relating to divested businesses.
The assets and liabilities assumed at the Fisher merger date were ascribed a fair value based on the present value of expected future cash flows, using a discount rate equivalent to the risk free rate of interest for monetary assets with comparable maturities (weighted average discount rate of 4.67%). The discount on the liabilities of approximately $17 million and the discount on the assets of approximately $11 million (net discount $6 million) are being accreted to interest expense over the expected settlement period.
Although the company believes that the amounts accrued and estimated recoveries are probable and appropriate based on available information, including actuarial studies of loss estimates, the process of estimating losses and insurance recoveries involves a considerable degree of judgment by management and the ultimate amounts could vary materially. Insurance contracts do not relieve the company of its primary obligation with respect to any losses incurred. The collectability of amounts due from its insurers is subject to the solvency and willingness of the insurer to pay, as well as the legal sufficiency of the insurance claims. Management monitors the payment history as well as the financial condition and ratings of its insurers on an ongoing basis.
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Intellectual Property Matters
On June 3, 2013, Unisone Strategic IP filed a complaint against Life Technologies in the United States District Court for the Southern District of California alleging patent infringement by Life Technologies’ supply chain management system software, which operates with product "supply centers" installed at customer sites. Plaintiff seeks damages for alleged willful infringement, attorneys’ fees, costs, and injunctive relief. On August 24, 2017, Unisone filed an appeal from a decision by the Patent Trial and Appeal Board that found the challenged patent claims invalid. The United States Court of Appeals for the Federal Circuit upheld the Patent Trial and Appeal Board’s ruling finding the challenged claims in the Unisone patent invalid. Unisone has until March 11, 2019 to file an appeal with the United States Supreme Court.
Note 12.
Comprehensive Income and Shareholders' Equity
Comprehensive Income (Loss)
Comprehensive income (loss) combines net income and other comprehensive items. Other comprehensive items represent certain amounts that are reported as components of shareholders’ equity in the accompanying balance sheet.
In the fourth quarter of 2017, the company recorded an out of period adjustment to correct an error in the accounting for income taxes associated with the partial hedge of its net investment in a foreign operation in 2014 through the third quarter of 2017. The adjustment affected deferred income taxes and other comprehensive income and, in the aggregate, increased comprehensive income by $101 million for the year ended December 31, 2017. The adjustment does not have any impact on the company’s statements of income or cash flows. The company determined that the adjustment was not material to the consolidated financial statements for any previously reported annual or interim periods.
Changes in each component of accumulated other comprehensive items, net of tax are as follows:
Shareholders’ Equity
At December 31, 2018, the company had reserved 30 million unissued shares of its common stock for possible issuance under stock-based compensation plans.
Note 13.
Fair Value Measurements and Fair Value of Financial Instruments
Fair Value Measurements
The company uses the market approach technique to value its financial instruments and there were no changes in valuation techniques during 2018. The company’s financial assets and liabilities carried at fair value are primarily comprised of insurance contracts, investments in money market funds, derivative contracts, mutual funds holding publicly traded securities and other
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investments in unit trusts held as assets to satisfy outstanding deferred compensation and retirement liabilities; and acquisition-related contingent consideration.
The fair value accounting guidance requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
Level 1: Quoted market prices in active markets for identical assets or liabilities that the company has the ability to access.
Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data such as quoted prices, interest rates and yield curves.
Level 3: Inputs are unobservable data points that are not corroborated by market data.
The following tables present information about the company’s financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2018 and December 31, 2017:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The company uses the Black-Scholes model to value its warrants. The company determines the fair value of its insurance contracts by obtaining the cash surrender value of the contracts from the issuer. The fair value of derivative contracts is the estimated amount that the company would receive/pay upon liquidation of the contracts, taking into account the change in interest rates and currency exchange rates. The company determines the fair value of acquisition-related contingent consideration based on the probability-weighted discounted cash flows associated with such future payments. Changes to the fair value of contingent consideration are recorded in selling, general and administrative expense. The following table provides a rollforward of the fair value, as determined by level 3 inputs, of the contingent consideration.
Derivative Contracts
The following table provides the aggregate notional value of outstanding derivative contracts.
While certain derivatives are subject to netting arrangements with counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheet. The following tables present the fair value of derivative instruments in the consolidated balance sheet and statement of income.
(a)
The fair value of the interest rate swaps is included in the consolidated balance sheet under the caption other long-term liabilities.
(b)
The fair value of the cross-currency interest rate swaps is included in the consolidated balance sheet under the caption other assets.
(c)
The fair value of the currency exchange contracts is included in the consolidated balance sheet under the captions other current assets or other accrued expenses.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following amounts related to cumulative basis adjustments for fair value hedges were included in the consolidated balance sheet under the caption long-term obligations:
(d)
Includes increases in the carrying amount of $30 million and $43 million at December 31, 2018 and December 31, 2017, respectively, on discontinued hedging relationships.
Gains and losses recognized on currency exchange contracts and the interest rate swaps designated as fair value hedges are included in the consolidated statement of income together with the corresponding, offsetting losses and gains on the underlying hedged transactions.
The company also uses foreign currency-denominated debt and cross-currency interest rate swaps to partially hedge its net investments in foreign operations against adverse movements in exchange rates. The majority of the company’s euro-denominated senior notes and cross-currency interest rate swaps have been designated as, and are effective as, economic hedges of part of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments and contract fair value changes on the cross-currency interest rate swaps, excluding interest accruals, are included in currency translation adjustment within other comprehensive items and shareholders’ equity.
See Note 1 and Note 10 for additional information on the company's risk management objectives and strategies.
Cash Flow Hedge Arrangements
In 2015, the company entered into interest rate swap arrangements to mitigate the risk of interest rates rising prior to completion of a debt offering in 2016. Based on the company’s conclusion that a debt offering was probable as a result of debt maturing in 2016 and that such debt would carry semi-annual interest payments over a 10-year term, the swaps hedged the cash flow risk for each of the semi-annual fixed-rate interest payments on $1.00 billion of principal amount of the planned fixed-rate debt issue. The hedge was terminated in advance of completing a debt offering in April 2016 (Note 10). The fair value of the hedge at that time, $46 million, net of tax, was classified as a reduction to accumulated other comprehensive items and is being amortized to interest expense over the term of the debt.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Fair Value of Other Financial Instruments
The carrying value and fair value of the company’s notes receivable and debt obligations are as follows:
The fair value of debt obligations was determined based on quoted market prices and on borrowing rates available to the company at the respective period ends which represent level 2 measurements.
Note 14.
Supplemental Cash Flow Information
Cash, cash equivalents and restricted cash is included in the consolidated balance sheet as follows:
Amounts included in restricted cash represent funds held as collateral for bank guarantees and incoming cash in China awaiting government administrative clearance.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 15.
Restructuring and Other Costs, Net
Restructuring and other costs in 2018 included continuing charges for headcount reductions and facility consolidations in an effort to streamline operations, including the closure and consolidation of operations within several facilities in the U.S. and Europe; third-party transaction/integration costs primarily related to recent acquisitions; sales of inventories revalued at the date of acquisition; and environmental remediation charges. These charges were partially offset by gains on sales of real estate and favorable results of litigation. In 2018, severance actions associated with facility consolidations and cost reduction measures affected approximately 1% of the company’s workforce.
Restructuring and other costs in 2017 included continuing charges for headcount reductions and facility consolidations in an effort to streamline operations, including the closure and consolidation of operations within several facilities in the U.S., Europe and Asia; costs to achieve synergies related to acquisitions, including severance and abandoned facility costs; third-party acquisition transaction and integration costs primarily associated with the acquisitions of FEI and Patheon; sales of inventories revalued at the date of acquisition; charges to conform the accounting policies of Patheon to the company's accounting policies; charges for changes in estimates of acquisition contingent consideration; hurricane response/impairment costs; net charges for the settlement/curtailment of retirement plans; and net credits for litigation matters. In 2017, severance actions associated with facility consolidations and cost reduction measures affected less than 2% of the company’s workforce.
Restructuring and other costs in 2016 included continuing charges for headcount reductions and facility consolidations in an effort to streamline operations, including the closure and consolidation of operations within several facilities in the U.S., Europe and Asia; third-party acquisition transaction and integration costs primarily associated with the acquisitions of FEI and Affymetrix; sales of inventories revalued at the date of acquisition; costs to conform the accounting policies of FEI and Affymetrix to the company's accounting policies; costs to achieve synergies related to acquisitions, including severance and abandoned facility costs; and net charges for environmental and litigation-related matters. These charges were partially offset by gains on sales of assets. In 2016, severance actions associated with facility consolidations and cost reduction measures affected less than 3% of the company’s workforce.
As of February 27, 2019, the company has identified restructuring actions that will result in additional charges of approximately $65 million, primarily in 2019, which will be recorded when specified criteria are met, such as communication of benefit arrangements and abandonment of leased facilities.
During 2018, the company recorded net restructuring and other costs by segment as follows:
The principal components of net restructuring and other costs by segment are as follows:
Life Sciences Solutions
In 2018, the Life Sciences Solutions segment recorded $1 million of net restructuring and other income. The segment recorded charges to cost of revenues of $4 million for the sales of inventory revalued at the date of acquisition, as well as $12 million of charges to selling, general, and administrative expenses, primarily third-party transaction/integration costs related to recent acquisitions. The segment also recorded $17 million of net restructuring and other income, principally for a $46 million net gain on the resolution of litigation, partially offset by charges for severance other costs associated with facility consolidations in the U.S.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Analytical Instruments
In 2018, the Analytical Instruments segment recorded $39 million of net restructuring and other charges. The segment recorded net charges to cost of revenues of $3 million for the sales of inventory revalued at the date of acquisition; $8 million of net charges to selling, general, and administrative expense, principally third-party transaction costs related to the acquisition of Gatan; and $28 million of restructuring and other costs, primarily for employee severance and other costs associated with facility consolidations in the U.S. and Europe, as well as abandoned facilities costs associated with the remediation and closure of a manufacturing facility in the U.S.
Specialty Diagnostics
In 2018, the Specialty Diagnostics segment recorded $2 million of net restructuring and other charges, including $3 million of net charges to selling, general, and administrative expense, principally third-party transaction costs in connection with the planned sale of the Anatomical Pathology business. The segment also recorded $1 million of net restructuring and other income, including a $6 million gain on the sale of real estate, mostly offset by cash charges for severance and other costs associated with facility consolidations in the U.S. and Europe.
Laboratory Products and Services
In 2018, the Laboratory Products and Services segment recorded $52 million of net restructuring and other charges. The segment recorded charges to cost of revenues of $5 million, principally for the sales of inventory revalued at the date of acquisition, and $16 million of charges to selling, general, and administrative expenses for third-party transaction/integration costs related to the acquisition of Patheon. The segment also recorded $31 million of restructuring and other costs, primarily charges for environmental remediation associated with a Superfund site in the U.S., employee severance, and, to a lesser extent, hurricane response costs.
Corporate
In 2018, the company recorded $1 million of net restructuring and other income, principally income from favorable results of product liability litigation, mostly offset by charges for environmental remediation at an abandoned facility and, to a lesser extent, severance at its corporate operations.
During 2017, the company recorded net restructuring and other costs by segment as follows:
The principal components of net restructuring and other costs by segment are as follows:
Life Sciences Solutions
In 2017, the Life Sciences Solutions segment recorded $14 million of net restructuring and other charges. The segment recorded $29 million of charges to selling, general and administrative expenses, principally for changes in estimates of acquisition contingent consideration. The segment also recorded $16 million of restructuring and other income, net, including $64 million of net credits principally for pre-acquisition litigation-related matters, and, to a lesser extent, net gains on the settlement of retirement plans. These credits were largely offset by $48 million of cash restructuring costs, including $23 million of severance and related costs primarily to achieve acquisition synergies, and $25 million of abandoned facilities costs primarily for the consolidation of facilities in the U.S.
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Analytical Instruments
In 2017, the Analytical Instruments segment recorded $59 million of net restructuring and other charges. The segment recorded charges to cost of revenues of $31 million for the sales of inventory revalued at the date of acquisition, as well as $30 million of restructuring and other costs, primarily for severance and other costs to achieve acquisition synergies, as well as charges for the settlement of retirement plans.
Specialty Diagnostics
In 2017, the Specialty Diagnostics segment recorded $38 million of net restructuring and other charges, principally charges for litigation-related matters, and, to a lesser extent, cash costs for employee severance and other costs associated with headcount reductions in the U.S. and Europe.
Laboratory Products and Services
In 2017, the Laboratory Products and Services segment recorded $192 million of net restructuring and other charges. The segment recorded charges to cost of revenues of $90 million, including $33 million to conform the accounting policies of Patheon to the company's accounting policies and $55 million for sales of inventory revalued at the date of acquisition. The segment also recorded $61 million of charges to selling, general, and administrative expenses, including $55 million for third-party acquisition transaction costs, as well as $6 million to conform the accounting policies of Patheon to the company's accounting policies. The segment also recorded $41 million of restructuring and other costs, primarily for employee severance and compensation due at Patheon on the date of acquisition, and, to a lesser extent, hurricane response/impairment charges.
Corporate
In 2017, the company recorded $5 million of net restructuring and other income, principally $8 million of income from favorable results of product liability litigation, partially offset by charges for the settlement of a retirement plan and severance at its corporate operations.
During 2016, the company recorded net restructuring and other costs by segment as follows:
Life Sciences Solutions
In 2016, the Life Sciences Solutions segment recorded $155 million of net restructuring and other charges. The segment recorded charges to cost of revenues of $31 million, including $27 million for sales of inventories revalued at the date of acquisition and $4 million to conform the accounting policies of Affymetrix to the company's accounting policies. The segment recorded $36 million of charges to selling, general and administrative expenses, including $34 million of third-party transaction and integration costs primarily related to the acquisition of Affymetrix, $4 million for accelerated depreciation at facilities closing due to real estate consolidation, offset in part by credits of $2 million from changes in estimates of contingent acquisition consideration. In addition, the segment recorded $78 million of cash restructuring costs, including $60 million of severance and related costs primarily to achieve acquisition synergies, and $18 million of abandoned facilities costs principally for the consolidation of facilities in the U.S. The segment also recorded $10 million of other costs, net, primarily for charges associated with litigation-related matters at acquired businesses.
Analytical Instruments
In 2016, the Analytical Instruments segment recorded $177 million of net restructuring and other charges. The segment recorded charges to cost of revenues of $63 million, including $21 million to conform the accounting policies of FEI to the
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company's accounting policies and $42 million for the sales of inventory revalued at the date of acquisition. The segment recorded $46 million of charges to selling, general, and administrative expense, including $38 million of third-party transaction costs related to the acquisition of FEI, as well as $9 million of charges to conform the accounting policies of FEI to the company's accounting policies. The segment also recorded $68 million of cash restructuring costs primarily for severance obligations payable to former FEI executives and charges associated with abandoned facilities, including remediation and other closure costs of a manufacturing facility in the U.S.
Specialty Diagnostics
In 2016, the Specialty Diagnostics segment recorded $15 million of net restructuring and other charges. These costs were principally comprised of $10 million for charges associated with litigation-related matters and $6 million of cash restructuring costs for severance and other costs associated with headcount reductions and facility consolidations. The segment also recorded $1 million of other income, net, primarily gains on the sale of real estate, offset in part by charges for the settlement of retirement plans.
Laboratory Products and Services
In 2016, the Laboratory Products and Services segment recorded $26 million of net restructuring and other charges. The segment recorded charges to cost of revenues of $8 million, including $6 million for sales of inventories revalued at the date of acquisition, and $2 million for accelerated depreciation at facilities closing due to real estate consolidation. The segment recorded $11 million of cash restructuring costs, primarily for employee severance and other costs associated with headcount reductions and facility consolidations. In addition, the segment recorded $8 million of charges for an increase in environmental remediation cost estimates associated with a Superfund site in the U.S., offset in part by $1 million of gains on the settlement of litigation.
Corporate
In 2016, the company recorded $22 million of restructuring and other costs, principally within selling, general, and administrative expenses, including $17 million of charges for product liability litigation and $4 million of accelerated depreciation on information systems to be abandoned due to integration synergies. The segment also recorded $1 million of restructuring charges for severance and other costs associated with facility consolidation at its corporate operations.
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The following table summarizes the cash components of the company’s restructuring plans. The non-cash components and other amounts reported as restructuring and other costs, net, in the accompanying statement of income have been summarized in the notes to the tables. Accrued restructuring costs are included in other accrued expenses in the accompanying balance sheet.
(a)
Other includes relocation and moving expenses associated with facility consolidations, as well as employee retention costs which are accrued ratably over the period through which employees must work to qualify for a payment.
(b)
Represents reductions in cost of plans.
(c)
Excludes $24 million of provision for losses on litigation-related matters; $8 million of provision for environmental remediation; $5 million of net gains on the sale of real estate; and an aggregate of $3 million of non-cash income, net.
(d)
Excludes $27 million of net credits associated with litigation-related matters, and $27 million of other restructuring charges, net, primarily for hurricane response/impairment, charges associated with the settlement/curtailment of retirement plans, and non-cash compensation due at an acquired business.
(e)
Excludes $38 million of income, net, primarily associated with litigation-related matters, gains on sales of real estate, charges for environmental remediation, and hurricane response costs.
The company expects to pay accrued restructuring costs as follows: severance, employee-retention obligations and other costs, primarily through 2019; and abandoned-facility payments, over lease terms expiring through 2027.
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Note 16.
Unaudited Quarterly Information
Amounts reflect aggregate restructuring and other items, net, as follows:
(a)
Costs of $56 million.
(b)
Costs of $25 million.
(c)
Income of $32 million.
(d)
Costs of $42 million.
Amounts reflect aggregate restructuring and other items, net, as follows:
(a)
Costs of $86 million.
(b)
Costs of $30 million.
(c)
Costs of $131 million.
(d)
Costs of $51 million.
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