Thermo Fisher Scientific - Earnings Call - Q2 2011
July 27, 2011
Transcript
Speaker 6
Good morning, ladies and gentlemen, and welcome to the Thermo Fisher Scientific Second Quarter 2011 Earnings Conference Call. I would like to introduce our moderator for the call, Mr. Kenneth Appio, Vice President, Investor Relations. Mr. Appio, you may begin the call.
Good morning, and thank you for joining us. On the call with me today is Marc N. Casper, our President and Chief Executive Officer, and Peter Wilver, Senior Vice President and Chief Financial Officer. Please note that this call is being webcast live and will be archived on the Investors section of our website, thermofisher.com, under the heading "Webcasts and Presentations" until August 19, 2011. A copy of the press release of the Second Quarter 2011 Earnings and Future Expectations is available on our website under the heading "Financial Results." Before we begin, let me briefly cover our Safe Harbor statement. Various remarks that we may make about the company's future expectations, plans, and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.
Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the company's Form 10-Q for the quarter ended April 2, 2011, under the caption "Risk Factors," which is on file with the Securities and Exchange Commission and available in the Investors section of our website under the heading "SEC Filings." While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change. Therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today. Also, during the call, we'll be referring to certain financial measures not prepared in accordance with generally accepted accounting principles, or GAAP.
A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release of our Second Quarter 2011 Earnings and Future Expectations and also in the Investors section of our website under the heading "Financial Information." With that, I'll now turn the call over to Marc.
Speaker 5
Thanks, Ken. Good morning, everyone, and thank you for joining us for our Second Quarter 2011 Earnings Call. We're pleased to deliver another quarter of solid performance. As we discussed at the analyst meeting back in May, we're focused on consistently delivering strong adjusted EPS growth, and we continued our excellent track record with 22% growth in Q2. I want to thank our teams across the company who worked hard to meet this goal and contributed to our outstanding results. Our commitment to investing in new products and emerging markets is clearly paying off, and our performance in Q2 positions us well to achieve our ambitious goals for the year. Let me get right into our Second Quarter financial highlights. Our adjusted EPS was $0.99, a second quarter record. We also achieved record revenue in the quarter with a 12% increase to $2.90 billion.
Our adjusted operating margin increased 40 basis points to 17.6%, reflecting our continued investments to develop new products, expand in growing markets, and strengthen our commercial capabilities worldwide. You heard me talk about our EPS growth strategy in the context of our three key drivers. They are top-line growth through continuous new product innovation and expansion in emerging markets, operational excellence, and deploying our capital to create shareholder value. We run the company by focusing on these key drivers, so I'll continue to use them as a framework for my comments around the highlights this quarter. First, let me cover revenue growth. As I just mentioned, we had double-digit revenue growth in the quarter, and I'll give you a little color on which businesses stood out in terms of their contribution to our top-line performance.
Similar to what we've seen for the past few quarters, we continue to reap the benefits of strong industrial and applied markets served by a number of our businesses. In particular, our process instruments business performed very well across the board, from short lead-time products such as our handheld instruments to our longer lead-time systems for metals, mining, and commodity material applications. Our leading ion chromatography business, which we gained with the Dionex acquisition, performed very well in the quarter, especially in applied markets. We also continue to see strong demand for our clinical diagnostic products, specifically our assays for drugs and abuse testing and our biomarker tests, which I'll talk a little more about in a few moments. Moving to pharma and biotech, our biopharma services business had a very strong quarter.
We have the scale and depth of capabilities to offer outsourcing for clinical trials manufacturing, packaging, and distribution. This enables our customers to safely and efficiently deliver clinical trial materials to investigators and patients worldwide. A quick comment on Asia Pacific. We are pleased to see that our investments to expand our presence there are paying off. We had a great quarter across all of our emerging markets, with China, India, Korea, and Brazil delivering double-digit growth. These continue to be our fastest growing regions, and we're experiencing healthy growth in multiple market segments there. Turning specifically to China for a moment, we're very encouraged by the momentum we're seeing in environmental markets there. You may recall that we moved the headquarters of our environmental business to Shanghai a couple of years ago.
We've been collaborating closely with the Shang Shi EPA and recently won a significant order for our analytical instruments for soil and water testing. Our efforts are also resulting in early adoption of our mercury air quality monitors, which we believe will present a terrific opportunity for us as China implements its five-year plan. As you know, we're a company that's committed to investing in technology development, and we had an exceptional quarter in terms of new product launches. Our showing at ASMS this year was our strongest yet, with three new mass spectrometry systems that redefined performance in resolution, speed, sensitivity, and accuracy. Our new VALOS Pro, Orbitrap Elite, and Q Exactive systems take analysis to new levels for applications ranging from life sciences to environmental protection and food safety. I recently met with one of our academic customers who bought an Orbitrap Elite.
He was so thrilled by the proteomics analyses made possible by the system that he actually helped us sell another instrument to a CRO that he collaborates with. In our chromatography business, we launched a new nano-LC system at ASMS that integrates with our entire portfolio of mass spectrometry products. In specialty diagnostics, we launched six oral fluid immunoassays that have been cleared by the FDA for drugs of abuse testing. There are obvious benefits in terms of specimen collection from these new tests. On a final note here, I'm pleased to report that two of our new Thermo Scientific products made R&D Magazine's list of this year's top 100 innovations. One was our Evolution 200 Spectrophotometer, which is designed for routine QA/QC analysis in the life science, food and beverage, and material science industries.
The second was the Dionex ICS-5000, the market's first capillary ion chromatography system, which is used to identify and measure contaminants in water and other liquids for a range of industries. Our second key EPS growth driver, operational excellence, continues to give us the ability to translate top-line growth into strong bottom-line results. I'd like to make two points here today. One is I'm pleased to say that our PPI and other productivity initiatives across the company are allowing us to once again gain SG&A leverage. Two, I'll use Dionex as an example of how we apply our proven operating processes to integrate new businesses smoothly and efficiently. We've owned Dionex since mid-May, but the integration planning began on the day we announced our agreement back in December.
It's obviously a great business, and our objective is to go through a very detailed integration process to ensure that we capture the expected synergies. I'm pleased to say that the integration is going extremely well, and the business is off to a great start financially, with revenue growth right in line with our expectations. With strong results across the board, the Dionex business has already made a positive contribution to our overall performance. Our third key contributor to EPS growth is effective capital deployment, and that continues to create shareholder value. First, let me cover acquisitions. We've deployed $2.1 billion on acquisitions completed so far this year. I just mentioned Dionex, and let me add that we're very pleased to welcome their 1,600 employees to our team. We also made two smaller but strategic acquisitions in the last couple of months.
Sterilin, a leading provider of plastic laboratory consumables in the United Kingdom, broadens our customer offering and gives us another opportunity to leverage our global commercial organization. Just after quarter end, we extended our microbiology offering by acquiring Trek Diagnostic Systems. Trek is a provider of products used for blood culture, identifying microorganisms, and conducting antibiotic susceptibility testing. Both of these businesses have about $35 million in annual revenues, and we look forward to the growth opportunities they present by increasing our depth of capabilities for our customers. As you know, in the quarter, we also announced the acquisition of Phadia, a global leader in allergy and autoimmune diagnostic testing. We talked a lot about this at the time of signing and at our analyst meeting, so I'm not going to go into the details again.
At a high level, Phadia will significantly enhance our leadership in the high-growth specialty diagnostics market, which is a key growth platform for our company. As you saw in the press release, I'm pleased to report that the acquisition process is moving along a little faster than we expected, and we now expect to close Phadia late in Q3. Clearly, it's been an active year in M&A so far. I also want to make the point that we're focused on deploying our capital to buy back our stock, and we spent $225 million during the quarter to repurchase 3.8 million shares. For the first half of this year, we spent $763 million and have repurchased 13.5 million of our shares. We continue to create shareholder value both through M&A and share buybacks.
Switching gears, I'd like now to highlight a key growth theme, as I've done over the past few quarters. To remind you, the intent is to describe how our investments broaden the growth opportunities for Thermo Fisher Scientific by collectively driving our revenue growth, leveraging our unique depth of capabilities across the company, and fulfilling our mission, which is to enable our customers to make the world healthier, cleaner, and safer. This quarter, the theme is about meeting the important needs that health care has for both patients and, at the same time, lowering the cost of care. You've heard me talk about our biomarker business and the strong performance it's delivered over the past couple of years. Increasing awareness of biomarkers has been driven by the adoption of our PCT tests for sepsis, which is a whole-body inflammatory response to an infection that is often life-threatening.
Every year, sepsis strikes an estimated 750,000 people in the U.S. alone, with a total cost to the health care system of approximately $16 billion. Mainly as a result of the aging population, the incidence of severe sepsis in the U.S. is expected to rise to 1 million by the end of the decade. Early diagnosis and treatment would result in fewer lives lost and lower cost of care. In Europe and other parts of the world, you can find our PCT biomarker assays on some of the leading central lab platforms, including bioMérieux, Siemens, and Roche. bioMérieux's VITIS platform is also cleared by the FDA to run our PCT tests in the U.S. We provide other biomarker tests that can differentiate a patient who's having a heart attack from those with less severe medical conditions associated with difficulty in breathing.
While it's important to treat the underlying condition, it may not necessitate the costly level of care associated with a heart attack. We had a significant development in our biomarker business last week when we signed a long-term license agreement with Alere to add a number of our biomarker assays to the menu of their leading triage platform. Alere triage systems are found in more than 70% of U.S. hospitals in about 50 countries worldwide. This extensive install base of instruments significantly strengthens our ability to raise awareness of these tests and make them accessible to a much broader population of patients. The agreement extends the availability of these tests to include emergency rooms and physicians' labs, opening an entirely new market for our biomarker tests for sepsis, cardiovascular, and lower respiratory diseases.
As Alere works through the regulatory approval process, we anticipate even more opportunities to bring these important diagnostic tools to physicians and patients worldwide. Before I wrap up, let me give you an update on our annual guidance for 2011. So far, the year's playing out as we expected, with some added benefit due to foreign exchange, bolt-on acquisitions that we've closed recently, and additional tax efficiencies that we've generated. As you saw in our press release, we're raising both our revenue and adjusted EPS guidance. We're raising our adjusted EPS guidance by $0.03 to a new range of $4.08 to $4.18 for the full year in 2011. This would result in 18% to 21% growth over our 2010 results.
We're also raising our revenue guidance for the year and now expect to achieve 2011 revenues in the range of $11.60 billion to $11.70 billion for 10% to 11% revenue growth over 2010. Before I hand the call over to Pete, let me summarize my remarks this morning with a few key points. We remain committed to continuing our track record of delivering strong adjusted EPS growth. Our investments in new products and emerging markets are paying off and contributed to our solid performance in Q2. We executed well in the first half and were on track to achieve our financial goals for the year. I will now turn the call over to Peter Wilver. Peter.
Speaker 4
Thanks, Mark. Good morning, everyone. As you know, we completed the acquisition of Dionex in mid-May. Given the significant size of this investment, we're providing visibility to the revenue growth performance of the combined companies by calculating organic growth on a pro forma basis, as if Dionex were owned for the entire second quarter in both years. We'll follow the same approach with Phadia upon completion of that acquisition. We're pleased to report another quarter of strong adjusted earnings per share, with 22% year-over-year growth to a second quarter record of $0.99 compared to $0.81 last year. The adjusted EPS in Q2 was $1.36, up 139% from $0.57 in the prior year's quarter, including a $0.79 gain on the divestitures of Athena Diagnostics and Lancaster Laboratories. Moving on to our top-line performance, reported revenues increased 12% year-over-year to a second quarter record $2.90 billion.
On a pro forma basis, as if Dionex were owned for the entire second quarter in both years, total revenues increased by 9% year-over-year, and organic revenue growth was 4%, consistent with the outlook I provided on last quarter's call. In terms of Dionex's contribution to organic growth in the quarter, we can't calculate it exactly because we're already seeing some HPLC product substitution, but it's about 0.2% to 0.3%. In addition to organic growth, Q2 pro forma revenues increased by 4% as a result of favorable foreign currency translation and another 1% from acquisitions other than Dionex. In the quarter, the net impact of the BioSite headwind lowered our organic growth by about 1%, and I'm happy to say that this is the last quarter that BioSite will be impacting our year-over-year growth comparisons. We continue to strengthen backlog this quarter with bookings slightly exceeding revenues.
By segment, Analytical Technologies' Q2 revenues grew 19% on a reported basis. On a pro forma basis, as if Dionex were owned for the entire second quarter in both years, Analytical Technologies' revenues increased 13% year-over-year, and organic revenue growth was 6%. In the quarter, as Mark highlighted, we continue to see strong growth in clinical diagnostics, specifically our biomarker assays business, and our instruments businesses serving industrial and applied markets also continued to deliver strong year-over-year growth. In the laboratory products and services segment, Q2 revenues increased 6% on a reported basis and grew 2% organically. In the quarter, our biopharma services business had strong growth that helped offset the impact of the BioSite transition. By geography in Q2, Asia Pacific continued high teens organic growth, with strong growth in China, India, and Japan.
North America, which was impacted unfavorably by BioSite, grew in the low single digits, and Europe declined slightly against a tougher comparison of high single-digit growth in the prior year. The rest of the world grew in the mid-teens, driven by Brazil. Turning to the bottom line, we had strong adjusted operating income, with our Q2 results up 14% year-over-year to $510 million. Adjusted operating margin was 17.6%, up 40 basis points from 17.2% in the year-ago quarter. The year-over-year margin expansion was driven by pull-through on organic growth and strong cost productivity from our PPI and PPI lean projects, global sourcing initiatives, and ongoing restructuring actions. We also continued to see nice accretion in the quarter from our recent acquisitions. These gains were partially offset by strategic investments in R&D and commercial resources to drive future growth.
Our pull-through on incremental revenue from foreign currency translation, which typically comes in at around our average adjusted EBITDA margin, was only about half of what we normally see in the quarter. This resulted from substantial foreign exchange movements during the quarter, which impacted our revenue and costs differently than they have historically. We aren't anticipating this to be a trend and expect to be closer to our historical average pull-through in future quarters. By segment, Q2 adjusted operating income in analytical technologies increased 27% year-over-year. Adjusted operating margin was 21.1%, up 120 basis points versus 19.9% last year, driven by pull-through on organic volume growth, the benefits of global sourcing and productivity, moderately higher prices, and acquisitions. Turning to our laboratory products and services segment, Q2 adjusted operating income margin was 13.6%, down 50 basis points from the year-ago quarter.
In this segment, solid productivity was offset by unfavorable mix, strategic investments to drive growth, and inflationary pressure on raw material costs, particularly in steel and plastic resin. While we expect raw material inflation to remain somewhat of a challenge for the remainder of 2011, we put in place additional sourcing and pricing actions to offset the expected impact. Moving on to the details of the P&L, total company adjusted gross margin was 42.2% in Q2, up 40 basis points from the year-ago quarter, excuse me. This margin expansion was driven by the benefits of our global sourcing and strong cost productivity actions, along with acquisitions, partially offset by increased raw material inflation. Adjusted SG&A in Q2 was 21.7% of revenue, a 10 basis point improvement from the year-ago quarter as a result of volume leverage and cost reduction actions.
R&D expense was 2.9% of revenue in Q2, up 20 basis points from last year. Moving below the line, our Q2 net interest expense increased $11 million year-over-year to $32 million, driven by higher interest expense as a result of issuing $2.2 billion of new debt to fund our acquisition of Dionex, partially offset by savings we realized from refinancing more expensive debt. Our adjusted tax rate in the quarter was 20%, down 70 basis points from last year as a result of our tax planning initiatives, including tax synergies related to Dionex, and last year's extension of the R&D tax credit into 2011. During the quarter, we deployed $225 million of our cash to buy back 3.8 million shares of our stock, which left $475 million remaining at quarter end under our current $750 million authorization that expires in February 2012.
Average diluted shares were 386 million in the quarter, down 30 million or 7% from last year, reflecting the benefit of our 2010 and 2011 share buyback programs, as well as redemption of our convertible debt. Turning to the balance sheet, our cash flow performance remains solid. Year-to-date cash flow from continuing operations was $680 million, and free cash flow was $560 million after deducting net capital expenditures of $120 million. Year-to-date free cash flow was up $55 million year-over-year, primarily as a result of higher operating income and improved working capital performance, partially offset by the timing of cash tax payments. We ended the quarter with $1.36 billion in cash and investments, down $1.43 billion from Q1, primarily as a result of closing Dionex, partially offset by proceeds from the sale of Athena Diagnostics and Lancaster Laboratories.
Our total debt was $4.0 billion, down $273 million from Q1, primarily as a result of redeeming our 3.25% convertible notes. Now, moving on to our guidance for 2011, as Mark mentioned, we're raising our adjusted EPS guidance by $0.03 to a new range of $4.08 to $4.18, which represents 18% to 21% growth over our 2010 adjusted EPS of $3.46. This guidance includes our completed acquisition of Dionex, but it does not include any impact from the pending acquisition of Phadia. In terms of revenue, we're raising our 2011 guidance by $80 million to a new range of $11.60 to $11.70 billion. This range represents 10% to 11% growth over our 2010 reported revenues of $10.57 billion.
Compared to our previous guidance, about $50 million of the revenue increase is related to more favorable foreign currency translation, and the remainder comes from the Sterilin and Trek Diagnostic Systems acquisitions that we recently closed. The total impact of favorable foreign currency on our 2011 revenue guidance is a little less than 2.5% growth, and the total revenue impact from completed acquisitions other than Dionex is a little more than 1% growth. Consistent with past practice, we haven't attempted to forecast future foreign currency exchange rates. In terms of pro forma organic revenue growth, the midpoint of our revenue guidance remains unchanged at about 4% growth. As I mentioned last quarter, excluding the BioSite and Japan stimulus headwinds we experienced in the first half of the year, this would be 5%.
Our adjusted income tax rate is expected to be around 20%, which is flat with last year and down 0.5% from our previous outlook, primarily as a result of incremental tax synergies related to Dionex. Our full-year average diluted shares are estimated to be in the range of 387 million to 389 million, up slightly from our previous range as a result of the accounting impact of our higher stock price. This estimate assumes that we'll use the remaining $475 million of our current share buyback authorization through its expiration in February 2012. All this adds up to the $0.03 increase in adjusted EPS and the $80 million increase in reported revenues. Finally, as Mark mentioned, we're very pleased to report that we now expect to close on Phadia in late Q3.
Adding Phadia from late Q3 onward would add about $0.06 of adjusted EPS to our 2011 results, with about a penny coming in Q3, depending on when we finance the transaction and the actual close date. In summary, we're pleased to report another solid quarter, which keeps us right on track to achieve our 2011 financial goals. With that, I'll turn the call over to the operator for Q&A.
Speaker 0
Thank you, ladies and gentlemen. If you have a question, please press star followed by one on your phone. If your question has been answered or you would like to withdraw your question, press star followed by two. In order to allow everyone in the queue an opportunity to address the Thermo Fisher Scientific Management team, I would like to ask that you limit your time on the call to one or two questions. If you have additional questions, please return to the queue and pose your question in turn. Your first question comes from the line of Quentin Lai with Robert W. Baird. Please proceed.
Speaker 1
Hi, good morning.
Speaker 5
Morning, Quentin.
Speaker 1
You know, this earnings—by the way, congrats on a nice quarter. This earnings season has been a really interesting one. Lots of noise on the academic side. Mark, maybe you could give a little color on what you're seeing. You know, have things changed? Are they steady? Did you see any change with respect to maybe daily orders or instrument orders through the quarter?
Speaker 5
Quentin, thanks for the question. Maybe I can give a kind of a holistic view on what's happening with our foreign markets to put some context there. From an overall perspective, there really were no significant changes in our foreign markets from what we saw in Q1. I think that's an important point. Starting with industrial and applied, which is the fastest growing, demand continues to be very strong across all the geographies. We saw robust growth in the businesses that serve the markets, especially process instruments businesses in particular. Biopharma, which is always an area of interest, market conditions again were very similar to what we've seen in the past few quarters. For us, biopharma grew, Quentin, at about the company average. In particular, I'm very pleased with how our bioprocess production and our biopharma services businesses performed in serving those customer bases.
Health care and diagnostics, you know, as I mentioned in my first remarks, our clinical diagnostics business once again had a really good quarter, particularly biomarkers and drugs of abuse and therapeutic drug monitoring. As Pete mentioned, you know, this is the last quarter we need to mention BioSite. That's good news for everybody. Academic and government, which is what prompted my thoughts here, they're very similar to those markets to what we saw in Q1. No particularly significant changes.
Speaker 1
Great, thanks. A quick follow-up for us is that we get a lot of questions on what your appetite for future acquisitions are, given the fact that you've got a lot on your plate now, and those that are on are doing pretty well. Any update there?
Speaker 5
Yeah, you know, in terms of the acquisitions, as I mentioned, you know, Dionex integration is going well. Phadia planning is going well. We're excited about those two. We're very focused on getting those right. That's where we're putting our attention. We did a couple of nice bolt-ons as well. Really, you know, no surprise to anybody on the call is, you know, we're really focused on executing extremely well against the acquisitions we're committed to.
Speaker 1
All right, thanks. I'll jump back in the queue.
Speaker 5
Thanks, Quentin.
Speaker 0
Your next question comes from the line of Amit Balawasiddhi. Please proceed.
Speaker 3
Hi, good morning.
Speaker 1
Good morning.
Speaker 3
First question, I just wanted to go into a little more detail on the pricing environment. I think you made some comments there in the prepared statements about the pricing environment. Pete, can you also just expand on the commodity impacts that you're seeing across the globe?
Speaker 4
Yeah, in terms of the pricing environment, you know, it's pretty similar to what we've been seeing for the last several quarters. We're getting priced, you know, between 0.5% and 1% right now, a little bit stronger on consumables than on the instruments and equipment. That environment really hasn't changed much. In terms of the commodities, as I said, it's primarily for us anyway, plastic resin. We have a few other things that are oil-based. In terms of what we buy as a commodity, that's only about $100 million of our input costs in total. It's not a huge number, but those costs fluctuated quite a bit. We're seeing it a little bit in raw steel. Again, that cost base is only around $35 million for the company.
We are seeing some dramatic inflation there that we, as I said, have put in some price increases to offset, and we're driving further sourcing actions to offset it in the second half of the year.
Speaker 3
To follow up on the first question on end markets, specifically academic government, what kind of visibility do you feel like you have? How far out is your visibility on that end market?
Speaker 5
When I think about visibility, we obviously serve most every academic institution around the world. We have a tremendous amount of dialogue with our customers in terms of what's going on. It's more qualitative visibility. What I would say is that in the first six months of the year, there hasn't been a big shift in the tone of what's going on amongst those customers.
Speaker 1
Okay, thank you.
Speaker 0
Your next question comes from the line of Ross Mucken with Deutsche Bank. Please proceed.
Speaker 1
Good morning, Ross.
Speaker 3
Good morning, guys. If we think about the lab products division, obviously margins there have been kind of up and down in the last few quarters. If you think about the investments you've put in place, kind of revenue growth, which has obviously been a drag vis-à-vis BioSite and Flu last year, how are we to think about sort of the trajectory of that business given the mix we're seeing and, in turn, given some of the changes you've made maybe on the pricing side more recently, which is typical? I'm just trying to get a sense for kind of how you're thinking about leverage there and how happy you are with kind of how margins have trended.
Speaker 5
As I look at lab products and services, first of all, thinking on the top line, the comparisons get substantially easier in the second half of the year because BioSite sits in that part of the business. We'll see better top-line performance just based on that fact. From a margin perspective, some of the things that we've been focused on from an investment perspective, we have less exposure to Asia Pacific currently in those markets and less exposure to industrial in that part of our business. We're seeing the early benefits of the work in Asia Pacific. We actually think the growth is going to improve. Obviously, we're spending a lot in advance of that growth on Asia Pacific, so that creates a little bit of margin pressure. That's going to improve as you get through the year.
Speaker 3
Just touching back on the geographic breakdown, from an emerging market perspective, if you look at China, India, LatAm, obviously you've seen some pretty substantial growth there the last few years and into this quarter. If you think about ordering trends and the pacing of demand in those various areas, have we seen it fairly constant? Has it been more choppy? Obviously on China, there's been a lot of concern as the governments put the brakes on with inflation that we're going to see some soft patches there and GDPs come down a bit. How should we think about that relative to the steadiness of the order rate you're seeing based on the mix?
Speaker 5
In terms of China, let's focus there because it's the most significant. We grew about 20% in the quarter, which was exactly how we performed in Q1. Bookings were larger than revenue, so we built backlog. In reviewing with the team a few days ago, very, very confident in the second half outlook. I know it's a common question that we get, but our team is performing well and the markets continue to look strong.
Speaker 1
Great, thanks, guys, and congrats on a great quarter.
Speaker 5
Thank you, Ross.
Speaker 0
Your next question comes from the line of Isaac Rowe with Goldman Sachs. Please proceed.
Speaker 3
Hi, good morning. Thank you for taking the question. First off, I just want to touch on the pharma spending environment. Are you guys seeing any major capital purchases being pushed back in a material way, whether it be in the research labs or in the commercial labs?
Speaker 5
No, I think the conditions are pretty similar to what we've seen on the capital side with pharma over the last few quarters, which is the customers are buying the products that they need. They're conservative, but they are spending, and we continue to see pretty similar conditions.
Speaker 3
Great, okay. Maybe just secondly on Phadia, could you just remind us kind of what hurdles are left to cross pursuant to that late Q3 close?
Speaker 5
Yeah, from a Phadia perspective, integration planning is going really well. The teams are ready for day one, which is terrific. That's the most important. We did receive FTC clearance in the U.S., so that's behind us. We actually got our filings in a little faster than we expected, which is why we are moving the expected close date from Q4 into later into Q3. We moved it up. The primary jurisdiction that we're just waiting on is the EU.
Speaker 3
Got it. Great, thanks very much.
Speaker 5
You're welcome.
Speaker 0
Your next question comes from the line of Doug Schenkel with Cowen & Company. Please proceed.
Speaker 1
Doug, are you there?
Speaker 0
Doug, your line is open.
Speaker 5
Okay, why don't we put Doug at the back of the queue and we'll come back to him?
Speaker 1
We'll take the next question.
Speaker 0
Your next question comes from the line of Tycho W. Peterson with JP Morgan. Please proceed.
Speaker 3
If we go back and look at some of the areas where you ran into issues a year ago, the healthcare channel and biopharma services, it seems like there's been improvement in both those. Is that a function of easy comps or are you feeling like those businesses are back on a growth trajectory?
Speaker 5
Let's start with biopharma services. The business is executing extremely well, and the value proposition is very meaningful to our pharmaceutical customers. What we're doing is providing outsourcing capabilities for what many customers used to do in-house. We're doing the packaging, logistics, and in some cases, the manufacturing of clinical trials materials. You might recall that a company like Lilly had turned over those operations to us. I had a chance to visit with the team in Indianapolis, as well as the customer. They're very happy with the performance. The business is just doing a good job of serving the customer, and that's really good fundamental operational performance. Healthcare market, that part of our business does benefit from, didn't benefit yet from the easier comparison. It benefits going forward from an easier comparison because BioSite sits there. The team is actually executing very well.
In fact, our relationship with Abbott, where we are their channel partner for many of their products, is going extraordinarily well, and that's good execution. The benefits are coming in the future, meaning Q3.
Speaker 3
Okay, I think in Pete's comments, he mentioned some initial revenue capture synergies with Dionex. Can you just talk a little bit about how you're thinking about top-line synergies here in the near term? Are you starting to see additional column attach rates associated with that business?
Speaker 5
Yeah, right now it's obviously small because we've only owned the business six weeks in the quarter. There actually were some specific instrument wins where, you know, Thermo Fisher Scientific colleagues identified new chromatography opportunities on the ion chromatography side for Dionex. There are some specific environmental wins where our Dionex colleagues, now of course Thermo Fisher colleagues, identified ICP, which is a key environmental instrument, wins and mass spec wins right off of day one. People have been thinking about it and converting it into orders. The column attach rate, that's way too, I mean, that's way too soon. That takes, you know, applications work and so forth. That'll happen over time.
Speaker 3
Maybe just last one on the applied markets. Are you anticipating kind of accelerating growth here? We've seen a number of regulations around obviously food testing, but there's been some additional environmental ones lately. Can you just talk about your outlook on kind of the applied testing market?
Speaker 5
Yeah, both applied and industrial, we're seeing very strong growth, and we're expecting that to continue. I certainly found it heartening that the President said the other night about the importance of food safety. That made his top 10 list. That's good for Thermo Fisher Scientific in terms of a focus. I don't know whether this is for the strengthening or not, but we've had very good markets and we're seeing all the signs that they're going to continue.
Speaker 3
Okay, thank you.
Speaker 0
Your next question comes from the line of John Groberg with Macquarie. Please proceed.
Speaker 5
Hi, John.
Speaker 0
Mr. Groberg, your line is open.
Speaker 4
Hi, this is Danain for John. Thanks for taking the questions. I was just wondering if you could provide a little additional color in regards to the leverage on the operating margin line. I know you explained lab products and services, but I was just wondering if there was anything else going on there that we should be thinking about or anything we should be thinking about going forward. In terms of our operating margin expansion in the quarter, it is about 40 basis points. A number of moving parts, but pretty similar to what we've seen in the past. We had a nice contribution from productivity, about 2.5% points improvement on productivity. That was offset by inflation, which, as I said, was a little bit higher than normal at 1.5% points. We made investments that totaled almost 1% point. Those all sort of net to zero.
As I mentioned, FX was a little bit diluted in the quarter, which is unusual, and we don't expect that to continue. That basically offset the acquisition benefit that we got. Those two net to zero. The balance, so the 40 basis points, is basically price volume mix. That's the story. The components are similar to the previous quarters, but I'd say the FX was a little bit of an unusual drag on the expansion in the quarter. All right, thanks. Could you maybe provide a little bit of color on what you saw in consumable services and instrument trends during the quarter and how you think those might play out for the rest of the year? In terms of the split between equipment, consumables, and service, we actually, as Marc said, biopharma services was very strong in the quarter. That was kind of 10+% growth in the quarter.
Equipment was around 5%, and then consumables was basically flat, but that again is impacted by the BioSite transition. Going forward, I would expect more normal growth in consumables and comparable growth in equipment. All right, great. Any idea what that would have been ex-BioSite? I don't have the number off the top of my head. All right, thank you guys.
Speaker 5
Thanks.
Speaker 0
Your next question comes from the line of Daniel Anthony Arias with UBS. Please proceed.
Speaker 5
Hi, thanks for the questions. Just on manufacturing, you've stated pretty consistently that the move towards low-cost regions is something that you look to to improve margins. How much do global macro concerns play a role in the decision-making and timing for those operational changes? When you look at our global manufacturing footprint, we serve from a low-cost region perspective really in four geographies, which is Mexico, Eastern Europe, Singapore, and China. We haven't put all of our manufacturing in one site. Our drive towards more low-cost manufacturing is going to continue. We select the country based on what we think is the optimal economic risk and so forth. We have a pretty detailed way of thinking through that. If one country becomes more favorable or another, it doesn't change the strategy. It just means we shift the focus of where we put the lower cost of production. Okay, thanks.
Just looking at your 5% target for organic growth next year, has anything changed over a short, but I'd say eventful two months in terms of where you see the most opportunity or the biggest challenges to getting to that level? Obviously in February, we'll certainly give our 2012 guidance. As I said in answering Quentin's question at the beginning, the market conditions have been very similar to what we saw in the first quarter. It would have also been very similar to what we saw in May. Nothing really has changed. Okay, thanks.
Speaker 0
Your next question comes from the line of Steve Willoughby with Cleveland Research. Please proceed.
Speaker 1
Hi, good morning. Pete, on your guidance for organic growth for the year of 4%.
Speaker 5
Yep.
Speaker 1
Does that include how you're showing pro forma Dionex internal growth now in the AT business? I'm just trying to figure out, you know, what impact that's having and, you know, what true internal growth was this quarter.
Speaker 4
Yes, the 4% includes, it's on a pro forma basis, including Dionex. It's the same answer whether you include Dionex or not. As I said, we can't calculate it exactly, but it's only about 0.2% for the full year in terms of the impact.
Speaker 1
Okay. Mark, I was just wondering if you could expand upon your comments regarding new product launches, especially the products at ASMS. You know, how those are going, the availability of those products so far, your ability to meet demand?
Speaker 5
Yeah, we had a wonderful, you know, American Society for Mass Spectrometry, which was in early June. When you look at the feedback, the feedback from customers has been fantastic. One of the things that is a really good indicator of that is from a new product launch, we have the largest number of demo requests. Basically, customers give us samples to run than we can remember for any products that we've launched. It's incredible, the demand we have for demonstrations, especially of the Q Exactive. That bodes well for a meaningful contribution of new products in the second half of the year. Obviously, because of a June launch, the impact in Q2 was immaterial, but the leading indicators are very encouraging for the impact, which is good.
When we set up our guidance for the year, we said that new products would be a nice driver in the second half. When your customers are telling you that the new products look really good, that puts us in position to have confidence in our outlook.
Speaker 1
Do those products, the new launches, probably hit in the third quarter or in the fourth quarter?
Speaker 5
They're all ready to ship. You know, we shipped a few of all of those instruments in Q2, so they'll affect both quarters. Obviously, a little more in Q4 because customers, you know, that are asking for demos want to see the results and get funding. For Q3, it'll have a nice impact as well.
Speaker 1
Okay, thanks very much.
Speaker 5
You're welcome.
Speaker 0
Your next question comes from the line of Paul Knight with CLSA. Please proceed.
Speaker 3
Good morning.
Speaker 5
Morning, Paul.
Speaker 3
How are you? I've been looking at the op margins. I believe I see a 13.6% versus 14.1% lab products margin. Is that from these higher commodity costs?
Speaker 4
Yeah, certainly. As I said in my comments, lab products and services were impacted by the commodity prices most. That's the segment where we have input costs from plastic as well as steel. That impact comes in that segment. We also had some impact from mix as well in that segment.
Speaker 3
Mark, can you talk about what you saw in the tone of capital equipment like mass spec versus the tone you saw in lab products like products from the old Fisher catalog?
Speaker 5
Yeah, from a tone perspective, actually, not a big difference from the types of products. I think customers are just thinking about funding environments in general. That's where we saw nice consistency across both quarters, which is, you know, effectively, our insurance business continues to grow, you know, a little faster than the consumables business simply because it's, you know, benefiting from an economic recovery, and you have more stability in consumables, if you will. Not a big difference in tone between the product types.
Speaker 3
How long do you think it takes to have a truly integrated LCMS system?
Speaker 5
When you think about optimizing all of the software and all of the different permutations, you'll start to see the benefit of that in the next couple of quarters. Some of it will take a little longer than that. Some of it's already happening today. To get everything optimized, it takes a couple of quarters of work.
Speaker 3
Thanks.
Speaker 1
You're welcome.
Speaker 0
Your next question comes from the line of Nandita Kosha with Barclays Capital. Please proceed.
Speaker 2
Good morning. Thanks for taking the questions. Mark, was there a noticeable disruption in the quarter because of the continuing resolution-related uncertainty? Just looking forward, could we think about orders getting pushed sort of later and later into the NIH fiscal because of the wrangling that we are seeing over the budget?
Speaker 5
No, I mean, when you think about academic and government, it's very similar to what we saw in Q1. I think when I think about it, basically, what we said at the end of the quarter last time was we thought that the continuing resolution, once that was behind us, we'd see a slight improvement in the end markets, in the academic markets for the balance of the year. What we're seeing in Q2 is pretty much exactly as we saw in Q1. You didn't see a pickup, but I don't think you're seeing like a deferral or a big bolus of activity that's going to happen later. We're expecting very much consistent markets in academic and government for the balance of the year. That means flattish to down a few points in terms of the U.S. environment.
Speaker 2
Okay, that's helpful. How did the order book look at the end of the quarter in terms of later cycle end markets, especially in the more developed geographies? Did that start to improve, or as in the trend through the quarter, how did the order book trend?
Speaker 5
The orders for our longer lead time instrumentation was very strong. The quarter was similar to the previous quarter, which is signs of a strong industrial economy with customers that are making long-term decisions for capital expansions, capital refurbishments, meaning projects that are, from their perspective, going to happen 12-18 months from now. They're making those decisions. We're seeing really, really nice orders across those types of markets.
Speaker 2
Thanks, Mark. Pete, just a quick one on capital deployment. It's obviously a consistent theme. I was wondering how you think about a dividend versus more tactical buybacks. Thank you.
Speaker 4
At this point, that's not something that we're contemplating in the near term.
Speaker 0
Your next question comes from the line of Peter Lawson with Mizuho. Please proceed.
Speaker 2
Hi, I'm just asking, congratulations on the quarter.
Speaker 5
Thanks, Peter.
Speaker 2
What drove the strength in diagnostics? Did you see any of the weakness from the low patient visits, deferrals, etc.?
Speaker 5
You know, when we look at our business, typically the big drivers are cancer incidents and infectious disease are the two big drivers, of which that's going to be a little bit more immune from what you might read in the popular press. We didn't see a big impact from patient visits one way or the other. I mean, that's historically been our comments in this space, and that continues to be true. Particularly our clinical diagnostics business performed extraordinarily well in terms of performance. That's been a lot of quarters in a row. We're very pleased with how our team is executing and the quality of our products.
Speaker 2
Peter, I may have missed this, my call dropped, but what was the contribution from Dionex in the quarter? That 4% organic, was that if you included it or even if you excluded Dionex completely?
Speaker 4
Yeah, it's about, as I said, we can't really calculate it exactly because we do have some product substitution on HBLC, but it's about 0.2% to 0.3% in the quarter.
Speaker 2
Okay, thank you. Expectations of kind of hybrid systems coming out from Dionex and Thermo. When do you expect those coming through, Marc?
Speaker 5
You know, customers can get them today, but when they'll be fully optimized, next couple of quarters, you'll see that all come out.
Speaker 2
Great, thank you so much.
Speaker 0
Your next question comes from the line of John Wood with Jefferies. Please proceed.
Speaker 1
Hey, good morning.
Speaker 5
Morning.
Speaker 1
Hey, Pete, the obligatory cash flow question, any changes at the margin on the operating or cash CapEx outlook for 2011?
Speaker 4
No, it's basically the same. $1.3 to $1.4 billion of free cash flow, and then around $300 million of CapEx.
Speaker 1
Okay. On the Phadia deal, any changes to the financing assumptions? It looks like you put a big commercial paper program in. Would you comment on your kind of updated expectations for the blended interest cost for that deal?
Speaker 4
At this point, and what I included in the numbers in the expectations for post-close in 2011, we haven't really changed the assumption for financing. We do have commercial paper as a component of the financing, but of course, until we actually close the financing, we don't really know what the actual interest rate is going to be. We're kind of sticking with the original assumption, which was around 3%. We do plan to access the capital markets a couple of weeks ahead of time, prior to the close, which obviously is a little bit diluted to Q3. Nothing has really changed from our original assumptions.
Speaker 1
Okay, got it. The last one is, can you parse out the actual Dionex revenue, like the absolute dollar number in the quarter?
Speaker 4
We do, of course, know what Dionex's revenue was in the quarter. As I said, we do have product substitution between the two businesses. The total contribution of Dionex was a little more than 2% growth.
Speaker 1
Okay, great. Thank you.
Speaker 0
As a reminder, ladies and gentlemen, please press star one to ask a question. Your next question comes from the line of Doug Shenkel with Cowen & Company. Please proceed.
Speaker 4
Hi, good morning, guys.
Speaker 5
Hi there.
Speaker 4
Maybe just a very quick follow-up to the Dionex math because I think folks are obviously focused on this and not completely clear. If it weren't for Dionex, if you excluded it out of both periods, would organic growth have been north of 4%, Pete?
Speaker 5
Not north of 4%, no. It would have been about 4%.
Speaker 4
About 4%.
Speaker 5
Basically the same number, yeah.
Speaker 4
Same number, okay. It sounds like an obvious question, but I think it's an important one given how jittery the markets are right now. I'm going to ask it. If over the course of July there were any material slowdowns in any geography or end market, you would have seen this at this point and obviously contemplated that in guidance, correct?
Speaker 5
Yes, of course we would have. No, we don't stop at June 30th and say we're not going to do any thinking between now and then, Doug. We're taking the reflections of what's going on in the world, what our performance was in the first few weeks of July into our guidance. I want to make it clear because for our investors, our organic outlook and our performance outlook for the year is exactly as we articulated from the previous quarter. The fact that we're putting Dionex in it is to provide clarity into the numbers, exactly how we did the methodology for when we put Thermo and Fisher together some years ago. That doesn't change our outlook. We benefited from raising our guidance from the three factors, a little bit more favorable foreign exchange. We closed two bolt-on acquisitions, which we reflected in the numbers.
Our tax team has done some really good work and actually generated some nice upsides that weren't fully contemplated from the Dionex acquisition. Hopefully that provides some clarity around what we're trying to do.
Speaker 4
Okay, thanks for your patience on that one. Just one last modeling question. I believe last quarter you talked about gross margin improvement of about a point year-over-year, offset by some increase in operating expenses, I think about 35 basis points as a percentage of sales year-over-year. More or less, does that guidance remain intact for the year?
Speaker 5
I think actually, yeah, it's about the same as those numbers.
Speaker 4
Okay, thanks for taking the questions.
Speaker 5
Yep.
Speaker 0
At this time, we have no further questions. I would now like to turn the call back over to Mr. Marc N. Casper for any closing remarks.
Speaker 5
Let me just make a quick comment to close out the call. First, thank you, of course. We're pleased to report solid financial performance in this past quarter and really starting to see the benefits of our past investments paying off in terms of the new product launches and the growth we're seeing in emerging markets. We're right on track to meet our growth goals for the year, and we look forward to reporting our progress in Q3. As always, thank you for the support of Thermo Fisher Scientific.
Speaker 0
Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.