Thermo Fisher Scientific - Earnings Call - Q4 2011
February 1, 2012
Transcript
Speaker 0
Good morning, ladies and gentlemen, and welcome to the Thermo Fisher Scientific 2011 Fourth Quarter and Full Year Earnings Conference Call. I would like to introduce our moderator for the call, Mr. Kenneth Apicerno, Vice President, Investor Relations. Mr. Apicerno, you may begin the call.
Speaker 2
Thank you. 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 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 March 2, 2012. A copy of the press release of our 2011 Fourth Quarter and Full Year 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 October 1, 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 this call, we will 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 Fourth Quarter 2011 Earnings and Future Expectations, and also in the Investors section of our website under the heading "Financial Information." With that, I will now turn the call over to Marc.
Speaker 1
Thanks, Ken. Good morning, everyone. Thank you for joining us today for our 2011 Fourth Quarter and Year-End Earnings Call. As I look back at 2011, it was a year where we significantly advanced Thermo Fisher Scientific's strategic position as the industry leader, and it was another year of consistently executing our proven strategy to create shareholder value. In 2011, we delivered excellent adjusted EPS growth, with a 20% increase year-over-year for another record performance. I am proud of our teams for executing on their plans to translate our top-line results into strong bottom-line growth. You will recall from our analyst meeting last year that I said our priority was to consistently deliver strong adjusted EPS growth, and we clearly met that objective again in 2011.
Before I cover our achievements for the full year, let's turn to the Fourth Quarter financials, and I will try to give you a sense of the playing field as we see it based on how our businesses closed out the year. As you read in our press release, adjusted EPS for Q4 grew 23% to a record $1.18. Revenues in the fourth quarter increased 15% to a record $3.13 billion. We also expanded our adjusted operating margin by 100 basis points in the quarter to 18.9%. We ended the year on a strong note, and I am especially pleased with our top-line growth. We came in just above the high end of our expectations due to three reasons. First, our teams executed well against their plans.
Second, we benefited from early traction on the additional share gain initiatives we put in place in the third quarter, which I will highlight later in my remarks. Third, while the market conditions played out pretty much as we expected, we did see sequential improvement in the academic and government customer segment later in the quarter. Let me take a few minutes to provide an overview of what we saw in our end markets in more detail. Let's start with academic and government. As you recall, we saw a significant slowdown in this end market in Q3. Uncertainty around the future of NIH budgets, as well as the budget crisis in many European countries, was causing many of our customers to put their buying decisions on hold. In Q4, although conditions got sequentially better, the market was still relatively weak overall.
Once the U.S. The federal budget for 2012 was passed, with a small increase for NIH. We believe that our customers gained more confidence and that some pent-up demand kicked in late in the quarter, especially in spending for laboratory consumables. In addition, we believe that some of our new share gain initiatives began to take hold. By share gain initiatives, I am referring to our focus on arming our commercial teams with the best products, targeting our sales efforts to the greatest opportunities, and then converting those opportunities into revenues by closing sales. Specific examples include our Q Exactive launch, adding new HPLC capabilities from Dionex, and leveraging our channels to drive sales of our specialty diagnostic products. Turning to pharma and biotech, we had a very strong finish to the year in this customer set, driven by demand in research, development, and manufacturing.
In research applications, we had solid momentum in mass spectrometry. I am especially pleased with the robust demand for our new Q Exactive system, which we believe is already gaining share in the QTOF space for protein identification and metabolomic research. In drug development, our biopharma services business also continues to perform very well. Our value proposition here around outsourcing clinical trials, logistics, and packaging is really resonating with these customers at a time when increased productivity is critical to their success. In manufacturing, our bioprocess production products continue to enjoy strong growth. In healthcare and diagnostics, market conditions have remained consistent with what we have seen throughout the year. Demand for our specialty diagnostic products remains strong, especially in our clinical diagnostics business and in the legacy Phadia business now called Immunodiagnostics. I will give you an update on Phadia in a few moments.
Last, demand from industrial applied markets generated strong growth in both revenues and bookings during the quarter. As an example, our process instruments businesses continued the excellent momentum we have seen here all year long. To summarize, academic and government, although still relatively weak, improved sequentially. Pharma and biotech had a slight uptick, and two of our end markets, industrial and applied, and healthcare and diagnostics, performed similarly to what we saw in Q3. Let me also comment here that from a geographic perspective, emerging markets had another terrific quarter, with China, India, and Brazil all reporting better than 20% revenue growth. This is a good time to turn to our scorecard for the year because the progress we made in 2011 sets us up well to meet our growth goals for 2012.
Looking at our full-year financial results, as I mentioned in my opening comments, we delivered 20% adjusted EPS growth to a record $4.16. We grew revenues by 11% to $11.73 billion. We expanded our adjusted operating margins for the full year to 18.1%, and finally, we had a strong year for free cash flow, generating $1.42 billion. You can see we delivered solid operating performance, and that led to our record EPS results. You have heard me talk about the three key contributors to growing our EPS. The first is top-line growth, the second is margin expansion, and the third is effective capital deployment. I will use this as the framework for my 2011 overview, with a few highlights of how these achievements ideally position us for growth in 2012. First, I will cover top-line growth.
As I just mentioned, emerging markets generated strong double-digit growth in the fourth quarter, in line with the trend we have seen throughout the year. Asia-Pacific alone now accounts for 15% of our total company revenues. That is up from 13% in 2010. We are benefiting from our unique scale and depth of capabilities, and that is translating into above-market growth in India and China, as well as significant growth in Brazil. Our expanding presence in emerging markets will continue to be an important growth driver for us in 2012. Another key aspect of our revenue growth, new product innovation, continues to reinforce our position as the technology leader across all of our business segments. We had numerous examples in 2011. Let me highlight three. One is our flagship mass spectrometry launch, the Q Exactive, which integrates a quadrupole mass spec with our leading Orbitrap technology.
As I mentioned earlier, the Q Exactive is gaining share for us in the QToF market, which we have not historically participated in. We are very excited about the possibilities and what this means for our customers in both research and applied markets. An example in specialty diagnostics is a new version of our market-leading MRSA test that we launched in Europe. This makes screening for deadly hospital-acquired infections even more accurate. In laboratory products, you may recall that we launched a new line of ultra-low-temperature freezers that consolidates all of our legacy product lines into a single platform. With this new platform, we are now able to manufacture high-quality freezers more efficiently and in the regions closer to our customers, which allows us to significantly drive down logistics costs.
We will continue our strong momentum in technology innovation in 2012, and I am looking forward to highlighting a number of significant new products that we will introduce during the course of the year at major industry events, including PIPCON, ANALYTICA, ASMS, and AACC, to name a few. Another key aspect of our top-line growth is how we deliver a unique value proposition to our customers by lowering their costs, improving their productivity, while at the same time accelerating their innovation. One example that I already mentioned is our outsourcing capability through our biopharma services business, which had a very strong growth in 2011. A new example is our Unity Lab Services brand, which we officially launched a few weeks ago.
We are excited about the potential here because Unity Lab Services combines our extensive instrument and equipment service organizations with our asset management and outsourcing services, now all under a single brand. This covers third-party vendors as well. The ability to bring all these capabilities together is a real differentiator for us in the marketplace. We see this as yet another vehicle for accelerating our top-line growth, not only in 2012, but well into the future. Let me now turn to our second key contributor to EPS growth, and that is margin expansion. As you know, we have a number of levers that drive our margin performance, including pricing, volume leverage, PPI, our global sourcing efforts, low-cost region manufacturing, and restructuring. In a typical year, we generate about 2% of productivity savings from these activities.
That was the case in 2011, where we achieved more than $200 million in productivity savings that contributed directly to our bottom line. While we are always focused on carefully managing our costs, as economic conditions change, we can quickly adjust by launching additional restructuring actions. For instance, in Q3 and Q4 of 2011, we implemented a number of incremental actions to address the academic and government weakness. This included tightening our discretionary spend, initiating additional site consolidations, and targeted workforce reductions in some of our businesses. In 2011, we initiated restructuring activities with an annualized benefit of about $100 million. We realized a portion of that benefit at the end of 2011, and we expect to reap the balance of it in 2012 and a small amount in 2013.
I want to point out that these activities are about two to three times what we would do as a matter of course during the year. The third key contributor to our EPS growth is effective capital deployment. Here we focus on our growth investments, such as strategic acquisitions, as well as returning capital to our shareholders. You know that we made a number of strategic acquisitions in 2011. Dionex and Phadia were by far the largest, but we also made several smaller acquisitions, such as Sterilin and Trek that added key capabilities to strengthen our competitive position and create value for both our customers and our shareholders. Let me take a few minutes to update you on the progress we have made with Dionex and Phadia. First, Dionex, which brought a leading offering of chromatography instruments, software, consumables, and services to our analytical technology segment.
If you remember back when we closed the deal in May of 2011, we outlined about $60 million in the total adjusted operating income synergies by year three. That included $40 million from cost synergies and about $20 million from revenue synergies. We also plan to gain greater tax efficiencies by leveraging our global financial structure. To give you a sense of how we are tracking at this point, in terms of cost synergies, we are ahead of our goal of capturing $15 million in year one. In terms of revenue synergies, our results to date are even better, with us being well ahead of our goal, and we believe we will achieve our year-three revenue synergy target as early as one year ahead of plan. Our commercial teams are clearly demonstrating to our customers the value we have created by combining Dionex and Thermo Fisher Scientific.
As a result, we are accelerating our momentum in mass spectrometry, clearly gaining share in HPLC, and strengthening our presence in high-growth life sciences and applied markets. Turning to Phadia, we closed the acquisition in August of 2011, adding leading specialty in vitro diagnostic products for allergy and autoimmune testing to our portfolio. This meaningfully increased our scale and depth of capabilities in high-growth specialty diagnostic markets. We are only five months in, and both the cost and revenue synergies are tracking according to our plans. In terms of upside, we are already seeing significant incremental value from better-than-expected tax synergies, as well as from lower financing costs. From the standpoint of returning capital to our shareholders, we deployed $1.3 billion in 2011 to buy back more than 24 million shares of our stock.
Even in a year that was very active on the acquisition front, we were able to use our strong cash flow and balance sheet to increase shareholder value while maintaining our financial flexibility. Moving on to our guidance for 2012, let me provide you with a high-level view on our outlook. Pete will get into the details in his commentary, but our general assumption going into 2012 is that our end markets will be about the same as they were in the second half of 2011. Also, given the relative strength of the dollar, we believe we will face some pretty significant headwinds from foreign exchange. With the uncertainty that still exists in the global economy, we are assuming about 3% organic growth for 2012.
As I mentioned, we have a number of actions in place to reduce costs, as well as contingency plans that we can quickly implement if end markets get worse. We have also implemented share gain initiatives that will drive our top-line growth into the future. Based on this macro view, let me quickly give our expectations for 2012 adjusted EPS and revenues. As you can read in our press release, we expect to achieve adjusted EPS in the range of $4.67 to $4.82 for 2012, which would result in 12% to 16% EPS growth over our strong performance in 2011. In terms of revenue growth, we expect to generate a range of $12.15 billion to $12.35 billion for a 4% to 5% increase year over year.
For the longer term, when market conditions become less choppy, we remain confident that Thermo Fisher Scientific is a company that is well positioned to achieve strong mid-single-digit organic growth and continue to deliver strong adjusted EPS growth as well. To sum up my remarks, we are pleased to end 2011 with an excellent fourth quarter in both revenues and earnings, and to deliver 20% of adjusted EPS growth for the full year. We believe that our combination of momentum in emerging markets, successful new product launches, and strong performance by new acquisitions, coupled with decisive cost actions, positions us well to achieve our goals for 2012. With that, I will now hand the call over to Peter Wilver, our CFO. Pete.
Speaker 2
Thanks, Mark. Good morning, everyone. We are pleased to report another quarter of strong adjusted earnings per share, with 23% year-over-year growth to a fourth quarter record of $1.18 compared to $0.96 last year. For the full year, adjusted EPS was a record $4.16, up 20% from $3.46 last year. GAAP earnings per share in Q4 was $0.77, up 3% from $0.75 in the prior year's quarter, and GAAP EPS for the full year was $3.46, up 37% from $2.53 last year, reflecting the gain on sale of discontinued operations. Starting with our top-line performance, for the quarter, reported revenue increased 15% year over year to a fourth quarter record $3.13 billion. On a pro forma basis in Q4, as if Dionex and Phadia were owned in both years, total revenue increased by 6% year over year, and organic revenue growth was 5%.
In addition to organic growth, Q4 pro forma revenue increased by 1% from acquisitions other than Dionex and Phadia. Foreign currency translation had a negligible impact on our reported revenue this quarter, as average foreign exchange rates were essentially flat year over year. For the full year, reported revenues increased by 11% year over year to $11.73 billion. On a pro forma basis, including the results of Dionex and Phadia from the beginning of the quarter they were acquired and for the comparable periods in 2010, full-year revenue increased by 7% year over year, and organic revenue growth was 3%. The Japan stimulus and biopsy transition headwinds that we experienced in the first half of the year negatively affected our full-year organic growth by about $100 million or 1%. Excluding these two items, our full-year organic growth was 4%.
For the year, favorable foreign currency translation increased revenue by slightly more than 2%, and we added a little more than 1% from acquisitions other than Dionex and Phadia. We continued to strengthen backlog in the quarter, with bookings exceeding revenue by 2% in the quarter and by 1% for the full year. Now, let me cover our revenue performance by each of the three segments. First, Analytical Technologies Q4 revenue grew 23% on a reported basis. On a pro forma basis, including Dionex, Analytical Technologies revenue increased 8% year over year, and organic revenue growth was also 8%. In the quarter, we continued to see particularly strong growth in our instrument businesses serving industrial and applied markets and in our bioprocess production products. Our mass spec and chromatography business also delivered strong year-over-year growth.
For the full year, Analytical Technologies reported revenue grew 19%, and on a pro forma basis, including Dionex, Analytical Technologies revenue increased 9% year over year, and organic revenue growth was 6%. Turning to the Specialty Diagnostics segment, Q4 revenue grew 32% on a reported basis. On a pro forma basis, including Phadia, Specialty Diagnostics revenue increased 7% year over year, and organic revenue growth was 6%. In the segment, we continued to see strong growth in clinical diagnostics, and Phadia, now called Immunodiagnostics, again contributed nicely to growth. For the full year, Specialty Diagnostics reported revenue grew 15%. On a pro forma basis, including Phadia, revenue increased 7% year over year, and organic revenue growth was 4%. In the Laboratory Products and Services segment, Q4 revenue increased 5% on a reported basis and grew 3% organically. In the quarter, our biopharma services business continued to deliver strong growth.
However, similar to last quarter, this segment was most affected by the challenging conditions in our academic and government markets, which declined low single digits in the quarter. For the full year, Laboratory Products and Services revenue grew 5% on a reported basis and 2% organically. By geography, as Mark mentioned, we continued to see organic growth in double digits in Asia-Pacific, with both China and India again growing above 20%. North America grew in the low single digits, Europe in the mid-single digits, and the rest of the world, which is less than 3% of our revenue, declined in the low single digits versus a tough comparison in the prior year's quarter driven by several large orders. For the full year, we also saw double-digit growth in Asia-Pacific, with China and India both growing above 20%.
North America and Europe grew in the low single digits, and the rest of the world grew in the mid-single digits. Turning to adjusted operating income, we had strong bottom-line results, with Q4 adjusted operating income up 22% year over year to $592 million. Adjusted operating margin was 18.9%, up 100 basis points from 17.9% in the year-ago quarter. The year-over-year margin expansion was driven by pull-through on organic growth and strong contribution from our productivity and cost actions. We continued to see good accretion in the quarter from our recent acquisitions. However, similar to last quarter, we also continued to see inflationary pressure in some of our direct material costs, particularly oil-based raw materials like plastic resin, which we partially offset with additional sourcing initiatives. We also continued to see some pricing pressure on equipment, particularly in our laboratory products and services segment.
We are executing as planned on the incremental restructuring actions that we talked about on last quarter's call and realized about $9 million of benefit from those actions in the quarter, over and above our normal productivity and restructuring efforts. During the year, we initiated about $100 million of restructuring actions in response to the tougher market conditions, which, as Marc said, is significantly above our normal run rate. I will discuss the 2012 impact of these and other restructuring actions later in my comments when I talk about our 2012 guidance. By segment, Q4 adjusted operating income in analytical technologies increased 38% year over year. Adjusted operating margin was 21.1%, up 240 basis points versus 18.7% last year. In specialty diagnostics, Q4 adjusted operating income increased 42% year over year, with adjusted operating margin at 24%, up 180 basis points from the year ago quarter.
In our laboratory products and services segment, Q4 adjusted operating income declined by 4%, with adjusted operating margin at 13.2%, 110 basis points below the year ago quarter. We generated a strong productivity of over 125 basis points in laboratory products and services again this quarter, and we reinvested about 40 basis points into Asia and other growth investments. This net productivity was more than offset by inflation, unfavorable mix, and some non-recurring items. For the full year, total company adjusted operating margin increased to 18.1%, up 75 basis points year over year. By segment, full-year analytical technologies adjusted operating margin increased 170 basis points to 18.7%, specialty diagnostics was up 150 basis points to 24.2%, and laboratory products and services decreased 50 basis points to 13.7%.
Moving on to the details of the P&L, total company adjusted gross margin was 44.3% in Q4, up 170 basis points from the year ago quarter. Year over year, gross margin expansion benefited from our productivity actions and the accretive impact of recent acquisitions, but raw material inflation and mix were dilutive in the quarter. For the full year, adjusted gross margin was 43.2%, up 120 basis points from 42% in the prior year. Adjusted SG&A in Q4 was 22.3% of revenue, 50 basis points higher than 21.8% last year, driven by the dilutive impact of our acquisitions. Excluding acquisitions, we delivered good year-over-year margin expansion as we continued to tightly control discretionary cost and restructure our cost base. For the full year, adjusted SG&A was 22.1%, an increase of 20 basis points, again driven by the dilutive impact of acquisitions.
R&D expense was 3.1% of revenue in Q4, up 20 basis points from last year as a result of our recent acquisitions. For the full year, R&D was 2.9%, also up 20 basis points or $55 million, driven by our recent acquisitions and slightly increased investments to expand our new product pipeline for the future. Moving below the line, Q4 net interest expense increased $35 million year over year to $51 million, driven by higher interest expense as a result of issuing debt to fund the Dionex and Phadia acquisitions. Our adjusted tax rate in the quarter was 17.6%, down 90 basis points from last year as a result of our ongoing tax planning initiatives, including tax synergies enabled by the Dionex and Phadia acquisitions. For the full year, our adjusted tax rate was 19.1%, at the favorable end of previous guidance and down 80 basis points from 2010.
During the quarter, we deployed $350 million of our cash to buy back 7 million shares of our stock. In total, we spent $1.3 billion to repurchase 24.5 million shares in 2011, and at the beginning of the year, we had $650 million left against our current authorization that expires in November 2012. Average diluted shares were 376 million in the quarter, down 23 million or 6% from last year, reflecting the benefit of our 2010 and 2011 share buyback programs, as well as redemption of our convertible debt. For the full year, average diluted shares were 385 million, down 25 million or 6% from 2010. Turning to the balance sheet, our cash flow was exceptionally strong in Q4. Full-year cash flow from continuing operations was $1.68 billion, and free cash flow was $1.42 billion after deducting net capital expenditures of $258 million.
Full-year free cash flow was up about $250 million year over year, primarily as a result of higher adjusted net income, partially offset by higher cash restructuring. We ended the quarter with $1 billion in cash and investments, up $126 million from Q3. The increase in the quarter was driven by our free cash flow, partially offset by share buybacks and paydown of a portion of our outstanding commercial paper. Our total debt was $7.0 billion, down $100 million from Q3 as a result of paying down outstanding commercial paper. Now, moving on to our guidance for 2012, we are initiating adjusted EPS guidance of $4.67 to $4.82, which represents growth of 12% to 16% over our 2011 EPS of $4.16. In terms of revenue, we are initiating 2012 guidance in the range of $12.15 to $12.35 billion, 4% to 5% above our 2011 reported revenues of $11.73 billion.
On a pro forma basis, as if Dionex and Phadia were owned in both years, the midpoint of our organic growth guidance is about 3%. Foreign currency, as Marc indicated, is unfavorable in 2012, assuming current rates, resulting in a $400 million year-over-year headwind in revenue and a 4% headwind in adjusted EPS. Completed acquisitions other than Dionex and Phadia contribute a little less than a half a percent to our expected growth in 2012. Consistent with past practice, we haven't attempted to forecast future foreign currency exchange rates, and our guidance does not include any future acquisitions or divestitures. To give you a little more detail on our earnings guidance, we are expecting adjusted operating margin expansion of 70 to 90 basis points compared to 2011.
Positive contributors to our margin expansion are expected to be pull-through on organic revenue growth at marginal rates, moderate price increases comparable to the environment we experienced in 2011, the full-year benefit of our 2011 acquisitions, including incremental synergies, and productivity and cost reduction actions that contribute over 200 basis points, including PPI and PPI lean, as well as low-cost region manufacturing, global sourcing, including low-cost region sourcing net of direct material inflation, and over $50 million of benefit from the full-year impact of the restructuring actions we initiated in 2011, as well as planned actions in 2012. These benefits will be offset by normal inflation on our indirect cost base, slight margin dilution from foreign exchange given the significant top-line impact, and some select strategic investments that will drive growth in emerging markets and enhance our customer experience.
Moving below the line, we are expecting net interest expense to be up $55 to $60 million year over year, reflecting the full-year interest cost of the debt issued to fund the Dionex and Phadia acquisitions. Our adjusted income tax rate is forecast to be in the range of 17% to 18%, down from 19.1% in 2011, primarily as a result of our continuing tax planning initiatives and tax synergies related to the Dionex and Phadia acquisitions. Full-year average diluted shares are estimated to be in the range of 365 to 370 million, down 4% to 5% from 2011, which assumes that we will use the remaining $650 million of our current share buyback authorization through its expiration in November 2012. Finally, we expect capital expenditures to be in the range of $300 to $325 million and free cash flow to exceed $1.5 billion.
In interpreting our revenue and adjusted EPS guidance ranges, as I have said in the past, you should focus on the midpoint as our most likely view of how we see 2012 playing out. Results above or below the midpoint will depend on the relative strength of our markets during the year. We set a fairly wide range on revenue at this point, given the uncertainty in the global economy, but we are committed to taking the cost actions required to meet our earnings goals. In summary, we finished 2011 on a strong note, and overall, it was a good year for us. We successfully completed and integrated a number of key strategic acquisitions, and we also delivered exceptionally strong adjusted EPS growth while funding a number of growth investments, such as new products and emerging markets.
While our academic and government markets continue to face some challenges, we have responded with decisive cost actions and are positioned well to achieve our earnings growth goals in 2012. I am excited about our growth prospects for the long term and believe that we will continue to strike the right balance between disciplined cost management and growth investments to maximize our performance. With that, I will turn the call over to the operator for Q&A.
Speaker 0
Thank you. Ladies and gentlemen, to ask a question at this time, please press star one. If your question has been answered or you would like to have your question be removed, please press star two. Again, that is star one to ask a question. 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. Again, that is star one to ask a question. Your first question comes from the line of Ross Mugen of Deutsche Bank. Please go ahead.
Speaker 1
Good morning, gentlemen.
Speaker 2
Good morning, Ross.
Speaker 1
Obviously, the tone of this call is decidedly better than the last. You gave a lot of commentary, Mark, on the back half, sort of changes in some of your end markets. As we head into 2012 and you think about sort of the upper and lower ranges in the guidance and what would cause us to maybe get to a level outside of it, where do you see the biggest potential changes as we head into 2012 that could cause results to be on either side? Are there two or three places where you think there is the biggest potential delta, or is it all either moderately better or moderately worse?
Speaker 2
Ross, thanks. I would say the deltas are really going to be driven by the macroeconomy, either on the favorable or on the unfavorable end. We are assuming, you know, muted economic growth globally, no major changes in the academic and government funding environment assumed here that we saw in the second half, which is obviously the weakest environment that we have seen, you know, certainly in the 10-plus years that we have been, you know, at the company. We are assuming conditions pretty similar to that, and it's really going to be macroeconomic effects for the positive and negative that could drive, you know, big changes off of that.
Speaker 1
I guess now that you had time to reflect on Q3 and some of the extraordinary things you saw, and you dug into some of the reasoning, and you gave obviously on the academic market some of the explanation, do you feel like your ability to react to some of these changes now is going to be better? In looking back, do you feel as if that was probably not an event that was within any standard deviation of the normal, and hopefully not something that likely repeats itself in the future?
Speaker 2
I think if you think about how well we responded, it's actually quite impressive, right? You have unprecedented change in demand. In that quarter, we initiated a huge amount of restructuring, significant share gain activities, and drove the strongest organic growth that we had all year in the fourth quarter with 5% organic growth. We saw weakness in the second half of Q3, and we reacted on a dime with that. It doesn't mean that you're going to translate those actions into revenue in that first 30-day period, but to see the results coming out really right after that, I think it's fantastic. The company is moving well. I'm proud of the 39,000 employees. I mean, phenomenal effort around the world to deliver just a great finish to the year.
Speaker 1
I promise the last one. Pete, just in terms of, you know, sort of callouts for this year, I mean, you know, we have obviously had the last couple of years, whether it's contract-based or days-based sort of comp effects, anything specific on the sequential sort of progression this year just to keep in mind as we do our models?
Speaker 2
No, there's nothing really significant in 2012. The only thing to note is that the headline organic growth numbers that form the compared for 2012 are a little bit misleading because of the prior year comparisons we had in 2010. It would look like the comps are easier in the first half and harder in the second half, and it's actually opposite to that just because of some of the prior year comps.
Speaker 1
Just to clarify, if we think about it, it's, you know, the way the guidance works now, it's, you know, just based on that comp effect, you'd assume that you're higher in the first part of the year and lower in the back half of the year?
Speaker 2
No, the comps are tougher in the first half of the year.
Speaker 1
Yeah, no, organically, right?
Speaker 2
Yeah, you're talking about 2011, you mean?
Speaker 1
Yeah, '12.
Speaker 2
2012, the comps are tougher in the first half. Organically, that would make it generally lower in the first half than in the second half.
Speaker 1
Okay. All right, thanks, guys.
Speaker 2
Thank you, Ross.
Speaker 0
Your next question comes from the line of Paul Knight of CLSA.
Speaker 2
Paul, are you there?
Speaker 1
Yeah, I am. Marc, as you look about and think about the capital allocation, $650 million left on the buyback, what's your balance right now on capital? Is it a buyback orientation, or are you seeing M&A opportunities in the world?
Speaker 2
Yeah, Paul, thanks for the question. In terms of our capital deployment strategy, it's been very consistent with a balance of focus on growing the business with acquisitions that meet our criteria and strengthening our company's competitive position, improving the offering from a customer perspective, and clearly creating shareholder value, as well as some return of capital. What we said when we did our last authorization is that we are assuming about half of our cash flow is going to be returned in the form of buybacks and that if acquisitions meet our criteria, then we will pursue them. As we look at our pipeline, we have a good pipeline, but we are only going to pursue acquisitions that we feel excited about, and we are very focused on executing well against Dionex and Phadia, and the good news there is that they're going well.
Speaker 1
What portion of your CapEx goes to emerging markets this year?
Speaker 2
In terms of CapEx, we have got a big facility expansion, but I would say it's a little more than the weighting of the business. I would say probably 15% to 20% would be the mix of our CapEx in emerging markets.
Speaker 1
Okay, thanks.
Speaker 0
Your next question comes from the line of John Goldberg of Montgomery Capital.
Speaker 2
Hi, good morning. Thanks. Just two quick questions from me. One, Marc, you know, a lot of us are trying to kind of figure out the whole, you know, wind down of the stimulus, and maybe just kind of talk about how you expect that playing out in 2012. The second question with respect to your commercial strategy, there's been a lot of commentary that maybe you might be more inclined to use, you know, price as a part of your commercial strategy to gain share. Your gross margins look pretty good in the fourth quarter. Just curious kind of, you know, what you see with pricing as you move into 2012. Sure. Stimulus was not a big factor for us in terms of demand last year. We don't see it as a big effect.
Obviously, for those customers that had some stimulus funds, they obviously are going to have to, you know, find alternative funds, but we don't see that as a big factor in 2012. From a commercial strategy, as you certainly, you know, you have heard me say for many years, we are very focused on getting appropriate price for our products. We are not a company that is, you know, driving discounting or aggressive pricing behavior. In fact, what we have done, you know, in certain customer sets where they're under more pressure is we have helped them select the right products from a value perspective, but we have been very disciplined on maintaining and maximizing our price.
If I can just quickly follow up on that, maybe if you think about your guidance, your op margin guidance for 2012 of 70 to 90 bps, I know you don't like to give all the details of the different pieces, but would you expect gross margins to kind of also continue to see the updraft that you have seen over your history?
Speaker 3
Hey, John, this is Pete. When you look at the pieces of the P&L, the 70 to 90 basis points, it gets a little bit clouded by the acquisition impact because we are going to get a full year of Dionex and Phadia, and both of them had higher than average gross margin and higher than average SG&A and R&D. What you're going to see is gross margin go up and also SG&A and R&D percent of revenue go up. If you take that out of the equation, you would see gross margin improving and SG&A leverage improving and R&D about flat.
Speaker 2
Okay, thanks for the morning. Thanks, John.
Speaker 0
Your next question comes from the line of Doug Schenkel of Cowen & Company.
Speaker 3
Hi, good morning.
Speaker 2
Hi, Doug.
Speaker 3
I guess starting with the question on cash deployment, you haven't described anything different from what you have described in the past on today's call. That being said, you completed a series of big deals last year from a financial flexibility and integration perspective. With that in mind, do you feel that you are ready to do another deal of similar size if there were one that made sense for you? On the same topic, any change in how you guys are thinking about dividends?
Speaker 2
Yeah, Doug, in terms of M&A, we follow our criteria strictly. We are focused on executing well against the deals that we completed last year. That's our priority. We evaluate the various opportunities out there. If the right thing came up that met our criteria that was great for our shareholders, we would consider it, but right now our focus is executing well on what we did. In terms of dividends, if I look back over the years, it's been a very small topic of discussion. There's been a lot more questions about dividend policy over the last six to nine months. It's something that we obviously return a lot of capital to our shareholders, and it's a topic that we will continue to discuss with our board about what's the right mix of return of capital.
Speaker 3
Okay, and then an unrelated follow-up, Mark, again for you, you highlighted successful share initiatives as one of the three key drivers to revenue growth in the quarter, and in fact, you know, what drove you to exceed the high end of the guidance range. How broad-based were these wins? I know you mentioned some specifics in mass spec and HPLC, but I'm curious if these were much broader than that, and how do you think about these heading into next year in terms of what's incorporated into guidance?
Speaker 2
Yeah, I mean, they're focused on a few areas, right, in terms of the ones I highlighted. They were also focused on the fact that we had our commercial teams out in the field with customers. We took out a lot of just the normal routine paperwork and stuff you do and just basically said, you know what, Q4, we are going to just focus on our customers, not worry about a lot of those administrative things. That helps as well. In terms of what's in our guidance, we have some great products and some very targeted commercial strategies that's embedded in the guidance, and, you know, as we continue to see new opportunities, we will add them to the mix.
Speaker 3
Okay, and if I could sneak in one last one for Pete, one of the few blemishes on this quarter, if you will, was maybe the lab products and services operating margin coming in a bit lighter, at least relative to what I was expecting. Anything unusual here, and is this an area where you think you can get some material improvement in 2012? Thanks again for taking the questions.
Speaker 2
Sure. As I said in my comments, we did generate strong cost productivity in lab products and services as the norm, but that was more than offset by we had some unfavorable mix and several unfavorable items, a number of which were non-recurring or the result of year-over-year comparison. If you look at the net impact of operational provisions in the quarter, this quarter, this year it was negative, and last year it was positive. We had sort of the double impact of favorability last year and unfavorability this year. Normally, those things sort of net out to, you know, negligible impact. As well, you know, we are talking about doing a lot of restructuring, and in particular, we have got our laboratory workstations business and one of our other laboratory products manufacturing businesses in the middle of some pretty significant projects to reduce their cost.
This is obviously good for the longer term in terms of lowering their cost base, but in the short term, in the quarter, they incurred duplicate operating costs as we consolidated their operations. We had a number of things that I would consider to be one-offs in the quarter. Looking forward, obviously, we don't provide specific margin guidance by segment, but under most scenarios, I would expect laboratory products and services margins to be stable in 2012.
Speaker 0
Your next question comes from the line of Amit Balastiddy.
Speaker 3
Hi, good morning. I wanted to talk about just the academic and government end market for a second. Can you talk about the trajectory that you saw throughout the fourth quarter and January, and talk to us a little bit about your comfort with visibility with your assumptions into 2012?
Speaker 2
Sure. In terms of the fourth quarter in academic and government, it improved sequentially from what we experienced in Q3, and we believe that the improvement was really driven by pent-up demand that we saw late in the quarter, particularly in our lab consumables business, as well as some of the share gain initiatives that we implemented in Q3. That's pretty much how it played out in Q4. In terms of January, we don't have it by every single customer set globally. I would say in aggregate, our January performance is very consistent with the guidance that we outlined for the full year.
Speaker 3
In terms of the Unity Lab Services, obviously, you are pretty excited about the opportunity. Can you talk a little bit about what kind of revenue opportunity that is and what you are seeing in the pharmaceutical outsourcing market? Thanks.
Speaker 2
Yeah, when you look at the Unity Lab Services, and this is the focus on the laboratory, it's not the clinical trials outsourcing business, that represents in the order of magnitude, 7% to 8% of our revenue and growing, high single digits type growth. Very strong growth, and we think with the capabilities we are pulling together, it can actually grow faster than that over time. That's a good opportunity. The other half of our services is the outsourcing activities and clinical trials, and that's been a strong grower for us for quite a period of time.
Speaker 3
Any chance you could put some numbers around that strong growth that you are talking about in outsourcing? I just want to get a better idea of the trend there.
Speaker 2
High single-digit type growth.
Speaker 3
Okay, all right, thanks.
Speaker 0
Your next question comes from the line of John Wood Jeffries.
Speaker 1
Hey, good morning. Marc, can you give us some sense of at least directionally how to think about the various segments in 2012 vis-à-vis that 3% kind of midpoint consolidated?
Speaker 2
Yeah, I mean, at a high level, if you think about the guidance, what I would say is, you know, clearly academic and government we are assuming to be on, you know, on the negative equation on growth. When I look at the other three segments, we are looking for strong growth across, as we have demonstrated in biopharma, healthcare, diagnostics, and industrial applied. That's the basic mix. If you kind of dig into that in a little bit more detail, in biopharma, we have a very unique value proposition around customer productivity. We have a number of new products, services, and very deep relationships with the customers. We think we are very well positioned to gain share with this customer set. We have demonstrated that over a long period of time. In healthcare and diagnostics, our products are very well attuned to the needs of those customers.
Our portfolio is really focused on improving patient care and lowering the cost of care, and we have lots of examples of that. We think good solid growth here is reasonable with our products really focused on infectious disease diagnostics, monitoring, therapeutic drugs for organ transplantation patients, helping pediatricians identify and treat allergies or the kinds of things we do. Then industrial and applied, a lot of our products are used to drive customer productivity, so that positions us well there, and we are expecting continued growth. Obviously, that market has done very well for us, so comps get a little bit harder, but I think that gives you a framework for the four markets.
Speaker 1
No, that's great. Thank you. My last one, my follow-up for Pete, just want to make sure I am thinking about the various buckets correctly. If I look at in 2012 the incremental Dionex and Phadia accretion, the FX, and then the tax benefit, it looks like your guidance assumes somewhere around 6% to 10% kind of core EPS growth. Does that sound correct to you?
Speaker 3
I haven't thought about it excluding all those things, but if you think about the growth year over year, we are guiding to 12% to 16%. Maybe a third of that comes from the acquisition, and the balance is the core and the capital deployment. Obviously, the tax rate relates to Phadia and Dionex as well, some of that. It's part of that accretion.
Speaker 1
Okay, we should think about some of that tax benefit as included in the net accretion.
Speaker 3
Exactly.
Speaker 1
All right, got it. Thank you.
Speaker 0
Your next question comes from the line of Tycho W. Peterson of JP Morgan.
Speaker 1
Hey, good morning. Maybe first for Pete, are you able to break out specifically what the contribution from Phadia and Dionex were in the quarter with the HCA to the top line?
Speaker 3
Yeah, in terms of the top line, you know, total acquisitions on Phadia and Dionex combined was about 50 basis points.
Speaker 1
Okay. As we think about some of the cost initiatives you have taken, you announced some additional ones back in January. Understanding your operating margin guidance, how should we think about additional initiatives flowing through versus being reinvested in Asia? How much of this is you proactively trying to manage your footprint into faster growing markets, i.e., Asia, and maybe less indicative of some of the end market headwinds that are out there?
Speaker 3
Certainly, you know, on an ongoing basis, we do restructuring efforts, and some of that flows to the bottom line, and some of it we do reinvest. Certainly, we made pretty significant reinvestments in 2011. At the same time, we were expanding margins. The plan is to do that in 2012 as well. We have about, I would say, 50 basis points of investments that are funded by both our productivity actions as well as some of those restructuring actions.
Speaker 1
If we think about those reinvestments, you are at 15% from Asia today. Do you have a target of 20% in the next two years? How do we think about where you see those reinvestments taking you in Asia?
Speaker 2
I would say that we continue to increase our Asian percentage. If you go back five years ago, it was 8%, so we have doubled it. A point-ish a year is a reasonable assumption. It may be a little more than that, but somewhere in that range, we keep increasing the mix in terms of Asia.
Speaker 1
Okay. Are there additional investments in R&D that you are making? You were pretty vocal not too long ago about stepping up your R&D investment. How do we think about R&D spend on a go-forward basis?
Speaker 2
R&D spend, we did a ramp-up back in 2010, and other than the effect of acquisitions, you know, just Phadia and Dionex will increase, you know, just as a % of sales for the company on the full-year effect, we are comfortable with the level of R&D. R&D excluding acquisitions is pretty flat as a % of sales.
Speaker 1
All right, and then last one for Pete on free cash flow guidance. Rough math looks like about 85% of net income. How do you think about the opportunity to maybe improve cash conversion? Some of your peers are well north of 110% or 120%. How do you think about the opportunity to more effectively convert some of that cash?
Speaker 3
I don't think very many of our peers are 120% of adjusted net. They might be that number on GAAP net income, but certainly, our goal is to get to 90%. That would be about $1.55 billion for the year. Sort of setting the minimum at $1.5 billion, and we are certainly going to drive to get to at least 90% of our adjusted net. You know, obviously, the lever there is working capital.
Speaker 1
Okay, thanks.
Speaker 0
Your next question comes from the line of Clinton Lai of Robert W. Baird.
Speaker 1
Hey, most of my questions have been answered, but Marc, if you would, could you kind of go over a little bit of how Europe was in the quarter, and then what your expectations are in 2012?
Speaker 2
Yeah, we had a good finish in Europe. We saw strong demand for our analytical instruments, and it appeared to us that some of our industrial and some of our pharmaceutical customers in Europe released funds late in the quarter. It was a nice finish to the year. We are assuming that the conditions in Europe will be on the slower end of growth in terms of a geographic perspective, and obviously, you know, Asia-Pacific emerging markets continuing to have strong momentum next year for this year.
Speaker 0
Your next question comes from the line of Peter Arlasen of Mizuho Securities.
Speaker 1
Mark, I just wonder if you could give us some more color around the diagnostic business, the volume trends, and utilization you are kind of seeing in Q1 and expectations for 2012?
Speaker 2
Yeah, in terms of specialty diagnostics, we had a good year last year. Our clinical diagnostics business, which is our biomarkers, our drugs of abuse testing, our therapeutic drug monitoring products, all did very well. Phadia, our Immunodiagnostics business, had a very, very good year both in the period that we owned it and in the period prior to our ownership as well. 2011, that's the majority of our business, very strong performance. As we look at 2012, we are confident that that's going to be a good growth driver for the company. Utilization is something that we look at. Typically, we don't get hugely affected by utilization because most of our products are used for things that you typically don't defer from a medical perspective. It's typically infectious disease, very children-oriented stuff as well, and cancer.
Folks that are very sick or parents, obviously, if you can't afford it, you may not go, but we typically do better than your more routine type products or more areas that we don't play.
Speaker 1
What was your exposure in Q4 on the emerging market business, and the potential negative impact on gross margins in 2012?
Speaker 2
In terms of exposure, just clarify a little bit, Peter?
Speaker 1
Just revenue exposure for end of Q4.
Speaker 3
You are saying our percentage of revenue, it was the 15% of our totals. That's for Asia-Pac. We don't really report an emerging market number.
Speaker 1
Was that for the full year or just Q4?
Speaker 2
It was just the full year, and for.
Speaker 3
Might be slightly higher. We don't really measure it, as it swings a little bit quarter to quarter. We don't really measure it on a quarterly basis.
Speaker 1
do the gross margins on that business look like versus corporate?
Speaker 2
The margin structure in Asia-Pacific is pretty similar to what we see across the world. It may be slightly lower, but not material.
Speaker 1
Okay, thanks so much.
Speaker 2
Brady, we have time for only one more.
Speaker 0
Sure. Your final question comes from Derek DeBrown of Bank of America.
Speaker 1
Hi, good morning.
Speaker 2
Hi, Derek.
Speaker 1
Hey, a couple of questions. I think I might have misheard you. Could you clarify what your implied contribution is from M&A in 2012?
Speaker 3
Implied contribution?
Speaker 1
In your guidance, in the top line guidance, what's your M&A impact?
Speaker 3
In the top line, it's about 50 bps, so it's the same number whether it's in or it's out.
Speaker 1
All right, I'm just a little bit confused then.
Speaker 2
That's using pro forma.
Speaker 1
That's using pro forma. Okay.
Speaker 2
All the other acquisitions are contributing about a half point of growth.
Speaker 1
Right, gotcha. Okay.
Speaker 2
You got that one?
Speaker 1
That's fine. That's what I was looking for. Thanks. I guess, Mark, when you kind of look at your, you know, you are talking about a 2% to 3%, 2% to 4% top line number in what's arguably a difficult market. When you kind of look at the longer-term growth opportunity for the business, do you think the market right now is, you know, is it dampening your growth by a point? Is it dampening your growth by two points? I guess, if we were under more normalized market conditions, what's the business doing?
Speaker 2
Yeah, I mean, at a very simplistic analysis, if you say, if we say that, you know, academic and government is down low single digits, you know, type range, and historically over long, long periods of history, you know, it is a, you know, low single digit grower, you know, that's roughly a 6-point swing quarter of our business. You have got a couple of points, I am doing very simple math, a couple of points of tougher market conditions than what you historically had seen pretty much, you know, for the last decade. That's the way to frame it. Everything else I would say is in the range of normalcy, and I think we are performing, you know, well. I think we finished on a strong note. I think I feel, you know, reasonable with the guidance from where we sit today.
Most importantly, I couldn't be more confident about this company being a mid-single digit growth, not even in strong, you know, not even in strong markets, but just, you know, a little bit less choppy than what we are seeing right now.
Speaker 1
When you kind of look at where they are, I realize it's a little early to start thinking about 2013, but obviously, you know, we saw the overhangs in this orchestration and everything that's out there. What is your working model right now for how you think that whole debacle is going to be clarified?
Speaker 2
I think our assumption is that the conditions we are seeing in academic and government are going to play out the way I articulated it during the course of the full year, and we are not expecting big changes in trajectory one way or another right now in academic and government just based on the environment we are living in.
Speaker 1
Okay, great. Thanks a lot.
Speaker 2
Thanks, Doug. Let me just make a final couple closing comments. Obviously, we are pleased to have ended the year on a strong note. We delivered solid growth in revenues and adjusted EPS in the fourth quarter and again achieved our earnings growth goals for 2011. I am confident that our proven strategy for creating shareholder value through top line growth, margin expansion, and effective capital deployment positions us to achieve our goals for 2012. I look forward to updating you in April during our Q1 call, and of course, thank you for your support of Thermo Fisher Scientific.
Speaker 1
Thank you.
Speaker 0
Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.