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Effects of one-time charges on operating profit margins.

Every company in the world looks to make as much money as possible while paying the least amount of taxes as possible. Over the last decade or so, companies have been growing their businesses by acquiring other smaller companies in the same industry. This allows corporations to take advantage of new technologies, economies of scale, and other capabilities that were not previously available to them, as well as increasing their market share by absorbing the competitor's market share. At the same time, these acquisitions lead to a number of changes within the operating statement of the acquiring company.

To the delight of corporations, the government has allowed acquiring companies to deduct a number of the acquisition expenses from their annual income. These expenses include amortization of goodwill, write-offs for in-process inventory that is no longer used, write-offs for excess lease space no longer used, severance pay expenses, and other general restructuring costs involved in combining business operations.

Corporations face quite a dilemma in that they want to save as much money as possible on taxes, but would also prefer to show positive earnings to please their investors. They solve this problem by filing tax returns including all of these one-time charges, but when filing their annual report they very often include net income before extraordinary items to better represent their profitability of ongoing operations.

After reviewing the consolidated operating statements of 24 of the top companies in the laboratory instrumentation industry * over the last three-and-a-half years, a definite effect on operating profit margin can be seen. During 1999, 2000, and the first half of 2002, the effect of one-time charges created roughly a 2% decrease in operating profit margin. The difference in operating profit margin before and after those charges was 2.0%, 1.6% and 2.3% for those respective time frames. However, the year ended 2001 reported a much larger difference equaling 6.4%, which more than doubled the net operating margin for those companies.

Only a few companies making some large acquisitions created this large increase in one-time charges. Thermo Electron deducted approximately $160 million in 2001 derived from general restructuring charges caused by the discontinuation of a number of product lines and the consolidation of their facilities to streamline operations. About 25% of the restructuring charges stemmed from severance costs paid to former employees of their discontinued operations. Most of the cutbacks and discontinued operations occurred at the Spectra-Physics division of Thermo Electron, where they reported large write-downs of telecommunication equipment and excess telecommunication inventory.

Applied Biosystems deducted approximately $113 million in 2001 in amortization of goodwill and impairment of goodwill created by the Celera Genomics group's acquisition of Paracel in the fourth quarter of 2000 (see IBO 5/31/00). Paracel is a manufacturer of advanced genomic and text analysis technologies. Due to the lower than expected performance by Paracel, Celera was forced to record the impairment charge to better represent the value of future cash flows from operations.

Waters deducted $75 million in 2001 for the expected cost of a pending litigation involving a patent infringement violation of a mass spectrometer patent owned by Applera (see IBO 3/15/ 02).

Finally, Invitrogen deducted approximately $266 million in 2001 for the amortization of goodwill created by a merger with Life Technologies through a buy-out of Dexter (see IBO 7/ 15/00). Dexter owned 75% of Life Technologies' common stock prior to the merger, so Invitrogen purchased Dexter in order to acquire Life Technologies and sold all of the businesses and operations of Dexter prior to completing the merger. Life Technologies is a supplier of molecular biology and cell culture products for the life science industry. The 2001 deduction of $266 million dwarfs that made in 1999 by Invitrogen of only $16,000. Also, that one charge was greater than the amount of charges all 24 companies combined deducted in both 1999 and 2000.

Many of these reorganized companies are fairly new or are just now beginning to produce positive returns. All of these acquisitions made over the last few years will likely increase the sales and profitability of the acquiring companies. So, even though profit margin may appear quite low right now due to all of the one-time charges, future profit margins will definitely rise for individual companies and the industry as a whole.

However, investors may not see these increased profit margins immediately for the laboratory instrumentation industry is still in a growth phase and continues to go through a number of reorganizations, meaning companies will most likely continue to have large deductions of one-time charges.

* Companies: Affymetrix, Amersham Biosciences, Applied Biosystems, Beckman Coulter, Biacore, Bioanalytical Systems, Bio-Rad Laboratories, Ciphergen, Bruker Daltonics, Dionex, Harvard Bioscience, Illumina, Invirtogen, Isco, Luminex, Molecular Devices, OI Corp., PerkinElmer, Qiagen, Strategic Diagnostics, Thermo Electron, Varian, Visible Genetics, Waters.

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Comment:Effects of one-time charges on operating profit margins.
Publication:Instrument Business Outlook
Geographic Code:1USA
Date:Oct 31, 2002
Previous Article:October ends on a high note for three IBO stock indices.
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