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Executives

Kenneth J. Apicerno - Vice President of Investor Relations and Treasurer

Marc N. Casper - Chief Executive Officer, President, Director, Member of Strategy & Finance Committee and Member of Science & Technology Committee

Peter M. Wilver - Chief Financial Officer and Senior Vice President

Analysts

Ross Muken - ISI Group Inc., Research Division

Jonathan P. Groberg - Macquarie Research

Daniel Brennan - Morgan Stanley, Research Division

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Isaac Ro - Goldman Sachs Group Inc., Research Division

Daniel Arias - UBS Investment Bank, Research Division

Jon Davis Wood - Jefferies & Company, Inc., Research Division

Doug Schenkel - Cowen and Company, LLC, Research Division

Steve Willoughby - Cleveland Research Company

Jeffrey T. Elliott - Robert W. Baird & Co. Incorporated, Research Division

Derik De Bruin - BofA Merrill Lynch, Research Division

Thermo Fisher Scientific (TMO) Q4 2012 Earnings Call January 31, 2013 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Thermo Fisher Scientific 2012 Fourth Quarter and Full Year Earnings Conference Call. My name is Shaquanna, and I will be your coordinator for today. [Operator Instructions] I would now like to introduce our moderator for the call, Mr. Kenneth Apicerno, Vice President, Investor Relations. Mr. Apicerno, you may begin the call.

Kenneth J. Apicerno

Good morning, and thank you for joining us. On the call with me today is Marc Casper, our President and Chief Executive Officer; and Pete 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 & Presentations until March 1 this year. A copy of the press release of our 2012 fourth quarter and full year earnings and future expectations is available on our website under the heading Financial Results.

So 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 quarterly report on Form 10-Q for the quarter ended September 29, 2012, 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 today 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 fourth quarter 2012 earnings and future expectations and also in the Investors section of our website under the heading Financial Information. So with that, I'll now turn the call over to Marc.

Marc N. Casper

Thanks, Ken, and good morning, everyone. I'm glad you could join us today for our 2012 fourth quarter, and year-end earnings call. I've been looking forward to this call because we're reporting another great quarter and a strong finish to what has turned out to be an outstanding year for us. I'm very proud of what our team has accomplished in 2012 in spite of the challenging environment. It reinforces to me that our team is second to none and our position as the global industry leader is only getting stronger. We have a proven strategy, a sound operating plan and a well-executed -- and we executed well to deliver record revenue and adjusted EPS performance. This morning, I'll cover the Q4 financial highlights first, discuss what we saw in our end markets, then get into what I consider to be our key takeaways for the year. I'll wrap up by setting the stage for 2013 with our annual guidance.

So turning to the quarter. As you read in our press release, we continued our trend of consistently delivering strong double-digit adjusted EPS growth. We set a Q4 record with a 14% increase in adjusted EPS. Revenue for the quarter was also a record, growing 6% year-over-year. And we achieved a 7% increase in our adjusted operating income and operating margin of 19.6%. So thanks to the strong execution by our teams, we were able to deliver another excellent quarter. Now let me take a few minutes to put our performance in the context of our 4 primary end markets.

I'll start with pharma and biotech, which continues to be our strongest end market. I'm pleased to report that the excellent momentum we've had all year carried into Q4, with growth in the high single digits. Our BioProcess Production and clinical trials logistics businesses stood out again this quarter. And in general, we're really executing well commercially to leverage our capabilities across the company for our biopharma customers. Our value proposition is making a difference for these customers, and it's pretty clear from our top line performance that we continue to gain share.

In health care and diagnostics, we delivered a good quarter, with our Specialty Diagnostics businesses generating mid-single-digit growth. We continued to see strong demand for our biomarker test and clinical diagnostic products as we have all year and we also benefited from the strong flu season. Another dynamic worth noting geographically, we're leveraging our extensive presence in the Asia-Pacific to meet the growing needs for the health care in that region, and we're starting to see the benefit there.

Turning to academic and government, market conditions played out pretty much as we expected, resulting in a slight decline in Q4 versus the prior year. As we've seen all year long, growth here was muted due to the uncertain funding environment. Until our customers have a clearer view of how this may unfold, their spending on capital equipment will continue to be constrained while purchases of laboratory consumables will be less effective.

Last, industrial and applied markets' demand was soft overall, similar to what we saw in Q3. And that has led to growth in the low single digits. Some of our industrial customers appear to be delaying purchase decisions in the current environment, and we're planning for that to continue. In applied markets, however, we're still seeing pockets of strength, including high demand for our air quality and particulate monitors in China, as an example.

So in summary, no dramatic changes compared to previous quarters in terms of market demand and our strong performance overall underscores how well we're navigating the environment. Now let's turn to our results for the full year, starting with what I consider to be our most significant accomplishment.

We had record adjusted EPS for the year, growing 19% over 2011. Our revenue was also a record. We grew by 8%, to $12.5 billion. We expanded our adjusted operating margin for the full year by 60 basis points and we did that while investing for a bright future by strengthening our R&D pipeline, commercial capabilities and our presence in emerging markets. Last, we had a record year for free cash flow, generating $1.77 billion in 2012.

We were able to achieve our goals for the year even in a challenging environment because we have a proven strategy that leverages all of our strengths as a company to consistently generate strong EPS growth. You've heard me say this many times, but the key drivers of our EPS performance are: top line growth, margin expansion and effective capital deployment. I'll use these as a framework to highlight what I believe are the key takeaways from 2012.

First, top line growth. As I said earlier, this is driven by innovation, commercial excellence and emerging markets. 2012 was a banner year for innovation. We launched significant new Thermo Scientific products at the major global industry conferences across our key technology platforms. Many of the names should be familiar by now: the iCAP Q, iS50, TRACE 1300, TSQ 8000, TruNarc, LYNX superspeed, PikoReal, Indiko Plus. We've highlighted them throughout the year, and then a few weeks ago at an investor conference, so I won't list them all. But the key takeaway is I can't remember a time when we've had such a significant lineup of new technologies. I think this speaks to our commitment to innovation, our ability to partner with our customers to develop the right solutions and our expertise in turning our ideas into commercial successes.

A little side note. We held our annual leadership meeting during the first week of January with our top 260 employees in the company. This is how we always kick off the year and align our key goals and priorities. One of the highlights of the meeting is our awards ceremony, which includes our most prestigious honor, the George Hatsopoulos Award for Technical Innovation, named after one of our founders.

We actually had a break from tradition this year by granting 2 awards: one, for the inventor of our FirstDefender portable chemical analyzer; the other went to the team that developed our Q Exactive mass spec. It was really inspiring to see the commitment and passion that led to this technology breakthrough. Since the launch of the Q Exactive, we've built a $100 million plus business in the Q-TOF market, a segment where we previously didn't compete.

So 2012 was a terrific year for innovation. And 2013 has the potential to be an even better year based on the new product launches we have planned. I look forward to highlighting those as the year unfolds.

Our second growth driver is commercial excellence. This is another differentiator for our company. Our teams are doing an excellent job of delivering our value proposition to our customers and is helping us gain share. You can see it in our results. We want our customers to see Thermo Fisher as much more than a supplier. We partner with our customers to help them meet their goals for innovation and productivity by leveraging our capabilities across the company.

As you know, we've done this a very effectively with our biopharma customers for a number of years, and we've been gaining share. These initiatives are also really resonating in the current environment, and I'm pleased to say that they're attractive to customers in a number of industries, such as contract testing labs, medical device companies and petrochemical companies as well. We're investing to strengthen our commercial capabilities to further capitalize on the many opportunities we see here.

Our presence in emerging markets, our third key growth driver, is another important differentiator for Thermo Fisher. As you know, we've been investing heavily in the Asia-Pacific region for the past few years, and it's really paying off. Asia-Pacific now represents 17% of our total company revenue, up from 15% a year ago. Given our size, that's a material increase in revenue. Among those countries, China was the standout again this quarter, with 23% growth in Q4 and 22% for the year. Our team there has really delivered. China became our second largest geography by revenue during 2012, with more than $700 million in annual sales. After my most recent visit to China last November, I remain optimistic about our prospects for growth. Between ongoing demand for our environmental instruments, our food safety capabilities and the growth we're experiencing in Specialty Diagnostics, I'm confident that China will continue to be a key growth driver for us.

Going forward, we'll continue to focus on capturing more opportunities from emerging markets, such as Russia, South Korea and Brazil. Our strategy in these countries is twofold. We're scaling up our commercial presence to go where the growth is. The new demo center we opened in South Korea last year is a good example of that. We're also optimizing our service and support infrastructure, so we can serve our customers more efficiently. We made significant progress in emerging markets and this will continue to be a focus for us in 2013.

Let me now move from the top line and talk about the second major contributor to our EPS performance, margin expansion. The main point I want to make here is that we were able to deliver good margin expansion in 2012 while continuing to invest for the future. As you know, in addition to the benefits of volume leverage, we have a number of levers that we pull to drive margins. This includes our Practical Process Improvement business system, or PPI, our company-wide sourcing programs and optimizing our global footprint.

Since late 2011, we've taken restructuring actions to help us navigate the macro environment and have realized significant benefits that we're using to fuel growth. With the economic uncertainty that still exists, we have contingency plans in place across our businesses to further reduce costs if necessary. We're prepared to execute quickly on these plans if the world gets more challenging, so I'm confident in our ability to effectively manage our costs in line with the business environment.

The third contributor to our strong EPS growth is effective capital deployment, and 2012 was a standout year in that regard as well. We deployed our capital on strategic acquisitions and returned significant capital to our shareholders. We invested $1.1 billion last year on complementary acquisitions.

I'll highlight the largest, One Lambda, which we completed last September. Through One Lambda, we strengthened our Specialty Diagnostics offering with the addition of the leading portfolio of transplant diagnostic tests. I'll just add here that they had a strong Q4, their first full quarter as part of Thermo Fisher. As I've said previously, One Lambda serves an attractive market, has a very strong market position and we believe will generate a strong return on our invested capital.

As I mentioned, we also returned $1.3 billion of our capital to our shareholders in 2012 between our stock buybacks and the dividend we initiated early in the year. This was our first dividend in the company's history and was a real vote of confidence from our Board that our company is on the right track. Looking ahead, we remain committed to leveraging our strong cash flow to create shareholder value through disciplined capital deployment.

I'll now spend a few minutes on our outlook for 2013, as well as our guidance for the year, which Pete will review in more detail. While it is difficult to predict what's going to happen in the world, we're planning for the global economic environment to remain challenging. That said, we feel good about our performance in 2012 and believe that our track record of delivering top line growth, margin expansion and effectively deploying our capital positions us well for 2013. A simple way to think about this is if the environment gets worse than we expect, we'll put our contingency plans into effect right away. If it ends up being better, we're in a great position to quickly capitalize on the opportunities created by a stronger global economy.

So, turning to our guidance for the year. We're expecting to achieve adjusted EPS in the range of $5.32 to $5.46, which would result in 8% to 11% growth over our record EPS performance in 2012. In terms of the top line, we expect to achieve revenue in the range of $12.8 billion to $13.0 billion for 2% to 4% revenue growth year-over-year.

We had great momentum throughout 2012. Our strategy is clearly working. And by using our depth of capabilities to help our customers succeed, we will gain share. When you combine our value proposition with the power of our PPI business system, operational discipline and effective capital deployment, I'm confident we'll deliver a successful 2013. With that, I'll now hand the call over to Pete Wilver, our CFO. Pete?

Peter M. Wilver

Thanks, Marc. Good morning, everyone. As Marc said, we had a strong Q4, which closed out a great year driven largely by the outstanding operational execution by our teams around the globe. I'm very pleased with our accomplishments this year, given the macro challenges. So I'll start with an overview of our overall financial performance, and then provide some color on each of our 3 segments before moving on to guidance.

As you saw in our press release, we delivered another quarter of strong top and bottom line results, which led to a 14% increase in adjusted EPS to a fourth quarter record of $1.36. For the full year, adjusted EPS was a record $4.94, up 19% from $4.16 last year. GAAP EPS in Q4 was $1.04, up 35% from $0.70 -- $0.77 in Q4 last year, and $3.21 for the full year, down 7% from $3.46 in 2011, as a result of last year's divestiture gains.

Looking at the top line, Q4 total revenue increased 6% year-over-year and we delivered 4% organic growth. Q4 reported revenue includes 2% growth from acquisitions and a 1% headwind from FX. Similar to last quarter, the revenue components I had just mentioned do not sum due to rounding.

For the full year, total revenue increased 8% year-over-year. And on a pro forma basis, as if Dionex and Phadia were owned for all of 2011, reported revenue was up 3% and organic revenue was up 4%. Pro forma revenue growth includes 1% growth from acquisitions other than Dionex and Phadia, which was offset by a 2% headwind from FX. In terms of bookings, we continued to strengthen our backlog, with bookings exceeding revenue by about 1 percentage point in the quarter.

Moving to geography. We saw growth across all regions in the quarter, as well as for the full year. In Q4, North America and Europe grew in the low single digits and Asia Pac grew in the high single digits, with China coming in very strong once again at over 20% growth. And rest of the world grew in the low double-digits, so very similar to what we've seen all year. And our performance for the year mirrored the quarter, with the only difference being that Rest of the World grew in the mid-single-digits.

Turning to the bottom line, Q4 adjusted operating income was up 7% and adjusted operating margin was 19.6%, up 40 basis points from the prior year. In addition to the pull-through on our top line growth, we once again had very strong contribution from our productivity and cost actions. For the full year, adjusted operating income was up 12% and adjusted operating margin was 19.0%, up 60 basis points from 2011. This is slightly below our previous full year guidance of about 70 basis points, principally as a result of unfavorable FX in the quarter.

We continue to realize the benefit of the $100 million restructuring program that we initiated in 2011 and the $75 million program that we initiated in 2012. In total, we realized about $18 million of benefit in Q4 and about $65 million of benefit for the full year from these actions. I'll cover what we expect for 2013 later in my comments when I discuss our guidance. We continued to make strategic investments this quarter, primarily in emerging markets, to enable us to capitalize on our growth momentum and expand our global presence. We also invested in information technology to improve the customer experience and our overall efficiency.

Moving on to the details of the P&L, total company adjusted gross margin came in at 44.7% in Q4, down 10 basis points from the prior year. As I mentioned, we once again delivered very strong productivity in the quarter, which was driven by our primary productivity levers: global sourcing, site consolidations and our PPI business system. These benefits were partially offset by foreign exchange, specifically the devaluation of the Japanese yen and unfavorable mix. For the full year, adjusted gross margin was 44.5%, up 90 basis points from 2011, driven primarily by acquisitions and strong productivity.

Adjusted SG&A in Q4 was 22.1% of revenue, down 40 basis points from the 2011 quarter as a result of volume leverage and our restructuring actions. For the year, adjusted SG&A was 22.5% of revenue, up 20 basis points from 2011, primarily as a result of acquisitions partially offset by volume leverage and restructuring. And finally, R&D expense came in at 3.0% of revenues, both for the quarter and full year, essentially in line with 2011. As a reminder, R&D as a percentage of manufacturing revenue is over 5%.

Below the line, net interest expense in Q4 was $60 million, which was $9 million above Q4 of last year as a result of the debt we issued in Q3 to fund the One Lambda acquisition. Adjusted other income was $3 million, up about $5 million year-over-year, primarily as a result of increased JV income, investment gains and below-the-line FX. For the full year, net interest expense was $216 million, which was $68 million above 2011 due to the additional debt we have issued to fund the acquisitions of Dionex, Phadia and One Lambda.

Our adjusted tax rate in the quarter was 15.2%, 250 basis points lower than last year and 200 basis points lower than our guidance as a result of acquisition tax synergies and our ongoing tax-planning efforts. For the full year, our adjusted tax rate was 16.7%, 240 basis points lower than last year for the reasons I just stated.

As you saw in our press release and as Marc mentioned, we had another significant quarter in terms of returning capital to our shareholders. During Q4 we spent $350 million to buy back 5.7 million shares of our stock. And for the full year, we deployed $1.15 billion to repurchase 20.8 million of our shares. As you know, we initiated a dividend this year and paid out $142 million in dividends to our shareholders during 2012. And in Q4, we also increased our quarterly dividend by 15%, to $0.15 per share. Average diluted shares were 367 -- 361.7 million in the quarter, down 3.7 million from Q3 and down 14 million, or 4%, from last year, reflecting the benefit of our 2011 and 2012 share buyback programs. For the full year, average diluted shares were 366.6 million, down 18 million, or 5%.

Turning to the cash flow and the balance sheet. We finished the year by delivering the strongest quarterly and full year cash flow in our history. Full year cash flow from continuing operations was $2.07 billion and free cash flow was $1.77 billion after deducting net capital expenditures of $300 million. Full year free cash flow was up 24% year-over-year as a result of strong operating income, solid improvements in working capital and lower cash taxes, partially offset by higher capital expenditures and interest expense.

Driving cash flow is a key focus for our organization and we delivered very strong performance here again in 2012. We ended the year with $855 million in cash and investments, up $19 million from Q3 and our total debt at the end of Q4 was $7.12 billion, down $348 million from Q3 as a result of paying down $350 million of senior notes which matured in the fourth quarter.

To wrap up the total company section, I wanted to provide you with a quick update on our return on invested capital. As you may recall at our analyst meeting back in May, we said that we expected to report adjusted ROIC in the range of 9.3% to 9.5% for 2012, which did not contemplate our 2012 acquisitions, versus 9.2% in 2011. Our actual adjusted ROIC in 2012 was 9.3%, so within the range we communicated in May, including acquisitions, which indicates the strength of the underlying business.

So with that, now I'll walk you through the performance of each of our 3 business segments. Starting with Analytical Technologies, in Q4, total revenue grew 2% and organic revenue increased 3%. In the quarter, we saw strong growth in our BioProcess Production, mass spec and air quality businesses. And this was partially offset by the softness we've been experiencing in some industrial markets. For the year, reported revenue grew 7%. On a pro forma basis, including Dionex in both years, Analytical Technologies revenues increased 3% and organic revenue increased 5%.

In Q4, adjusted operating income in Analytical Technologies decreased 3% and adjusted operating margin was 20%, down 110 basis points. During the quarter, we delivered very strong productivity, which was offset by strategic investments, as well as unfavorable product mix and foreign exchange. For all of 2012, adjusted operating income increased 7% and adjusted operating margin was about flat, at 18.7%.

Turning to the Specialty Diagnostics Segment, in Q4, total revenue grew 12% and organic growth was 6%. For the full year, total revenue grew 20%. And on a pro forma basis, including Phadia in both years, total revenue and organic revenue both grew 4%. Consistent with what we've been -- what we've seen throughout the year, we continued to deliver strong growth in our clinical diagnostics business, including biomarkers. In general, we delivered good growth across this segment and our microbiology and health care market channel businesses benefited from a strong flu season.

In Q4, adjusted operating income in the segment increased 21%, with adjusted operating margin at 25.9%, up 190 basis points from the prior year primarily as a result of volume, pull-through, acquisitions and strong productivity, partially offset by strategic investments. And for the full year, adjusted operating income increased 27% and adjusted operating margin was 25.7%, up 150 basis points from 2011.

In the quarter, total revenue in Laboratory Products and Services Segment grew 4% and organic revenue grew 3%. We had good growth in our research market channel and laboratory consumables businesses and our clinical trials logistics business continued to deliver strong growth. This was partially offset by continued weakness in our laboratory equipment business. For the full year, both reported and organic growth grew 4%. For the quarter, adjusted operating income in Laboratory Products and Services grew 8% and adjusted operating margin was 14.1%, up 40 basis points, driven by solid cost productivity. And for the full year, adjusted operating income increased 4% and adjusted operating margin was 14.1%, flat with the prior year but up 35 basis points in the second half.

So moving on to our guidance. As you saw in the press release, for 2013 we're initiating adjusted EPS guidance of $5.32 to $5.46, which represents growth of 8% to 11% over our 2012 EPS of $4.94. In terms of revenue, our guidance range is $12.80 billion to $13.00 billion, which is 2% to 4% above our 2012 reported revenue of $12.51 billion. On an organic basis, this represents growth of about 1% to 3%, which is down from our strong growth in 2012, primarily as a result of our expectations related to sequestration and for softer demand in our industrial markets.

Assuming current FX rates, foreign currency will be slightly negative year-over-year in terms of revenue, and we're expecting some unfavorable margin impact resulting from the Japanese yen being weaker, which pretty much flows directly through to the bottom line. Completed acquisitions are expected to contribute about 1.5% to our revenue growth in 2013. And consistent with past practice, we haven't attempted to forecast future foreign currency exchange rates and our guidance doesn't include any future acquisitions or divestitures.

Turning to adjusted operating margin. We're expecting adjusted operating margin expansion of 30 to 50 basis points. We expect margin expansion to be driven by pull-through on organic revenue growth at marginal rates; the full year benefit of our 2012 acquisitions, including incremental synergies; and productivity and cost reduction actions that contribute about 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 about $65 million of benefit from the impact of the restructuring actions we initiated in 2011 and 2012, as well as currently planned actions for 2013. These benefits will be offset by normal inflation on our indirect cost base; the medical device excise tax, which impacts our gross margin by over $20 million; select strategic investments to continue to drive growth in emerging markets and enhance our customer experience; and about $15 million in higher stock comp expense.

Moving below the line. We're expecting net interest expense to be up about $20 million to $25 million year-over-year, reflecting the full year interest cost of the debt issued to fund the One Lambda acquisition. We're forecasting our adjusted income tax rate to be in the range of 14.5% to 15%, down from 16.7% in 2012 primarily as a result of the double benefit on the R&D tax credit and tax synergies related to the acquisitions and our ongoing tax planning benefits.

We're assuming that we will return approximately $800 million of capital to our shareholders, composed of $600 million in share buybacks and about $200 million in dividends. And full year average diluted shares are estimated to be in the range of 357 million to 362 million, down 1% to 3% from 2012. Finally, we expect capital expenditures to be in the range of $300 million to $325 million and free cash flow to be in the range of $1.8 billion to $1.9 billion. In interpreting our revenue and adjusted EPS guidance ranges, as I said in the past, you should focus on the midpoint as our most likely view of how we see the year playing out. Results above or below the midpoint will depend on the relative strength of our markets during the year, as well as the economic factors we've discussed.

So in summary, despite a challenging environment in the second half, 2012 was a strong 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 strategic growth investments. And while our academic and government and industrial markets continue to face some challenges, we've responded with decisive cost actions and are positioned well to achieve our earnings growth goals in 2013. I'm excited about our growth prospects for the long term and believe that we'll continue to strike the right balance between disciplined cost management and investments to drive growth. With that, I'll turn the call over to the operator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Ross Muken, representing ISI Group.

Ross Muken - ISI Group Inc., Research Division

So on the top line, as we think about guidance for the year, I mean, how are you thinking about sort of the progression of core growth given the trends that you see in the business and then transposing that against obviously the 1Q uncertainty with the sequester debate coming up in March, and then obviously the macro data, where most of the PMIs or other indicators are kind of net improving? So how are you sort of thinking about those puts and takes as it relates to kind of the trending throughout the year?

Marc N. Casper

As we looked at 2012, we delivered consistent performance throughout the year, with 4% organic growth in each quarter. And while each quarter has some puts and takes, we think that 2013 will be pretty consistent as well in terms of organic growth within the guidance. So we're not looking at big changes quarter-to-quarter. What we are assuming, as I think it came out from Pete's and my comments, is really 2 factors. One, we're assuming that sequestration will happen, which is consistent with what we have been saying since January of last year. So what's baked into our guidance here is that, that happens on March 1. And second is that the industrial economy continues to be soft and the range within the guidance on the top line is depending on how soft we see the industrial markets playing out.

Ross Muken - ISI Group Inc., Research Division

Great. And maybe my second question, I want to use a little bit of imagination here. Periodically, across the space, peers go through different things and folks will maybe look at sort of a strategic process. And so occasionally, you've done more tuck-in type deals the last year, 1.5 years. But occasionally, obviously large assets within the space, peers become available. As you think about the potential of things like that, what are the 2 or 3 things that come to mind for you as you're thinking about more transformative transactions and the sort of metrics you think about when you're contemplating what to do there?

Marc N. Casper

Thanks for the question and it's one that -- probably from just a high level, you know that we don't comment on kind of the chatter in the marketplace, right? And I know a number you sent some emails to Ken. And we certainly don't want to comment on speculation about M&A. I think what you should get a sense of from Pete's and my comment is that we had a really strong year. Our results show that we're gaining share and that our competitive position has never been stronger. So I think that's how I think about what others in the world might be thinking about. M&A criteria, you guys, everybody knows where our M&A criteria is on every transaction. And we follow that criteria, which is create value for our customers, strengthen the company strategically and then, obviously, focus on creating shareholder value as measured by ROIC as the primary metric. Hopefully, that covers that question for everybody in the queue.

Operator

Your next question comes from the line of Jon Groberg representing Macquarie Research.

Jonathan P. Groberg - Macquarie Research

I know you just said you hoped it answered the question for everyone in the queue, but I just want to ask it a little bit differently, I guess, with your stock having had a tremendous run. Last time you issued equity was with Fisher. So can you maybe just remind us when you'd be willing to issue equity for a deal, kind of if you look at that differently, and then maybe some of the more recent deals, where you've been able to do them all debt? Can you maybe just talk a little bit around your comments of when you might be willing to issue equity versus just some of the debt deals that you've done?

Marc N. Casper

Jon, I think again on sort of speculation, it's not one that we're going to spend time on here or subsequently. I think, as you know, every transaction in any context gets evaluated individually, and it's based on some merits. And that's how we would think about anything of that sort. And for those of you that listened to or were at the JPMorgan Conference back in January or read the transcript, one of the things I talked about very early in that presentation I gave was that we're very optimistic about our prospects. And we showed our valuation relative to the S&P Healthcare Index, the S&P 500 Index. And we feel that we think we have very bright prospects relative to the very broad alternatives of investments out there.

Jonathan P. Groberg - Macquarie Research

Okay. I don't want to put words in your mouth, but you gave your investment criteria. So is it fair to say you don't necessarily have an aversion to using equity if everything met the criteria that you just talked about previously?

Marc N. Casper

I think right now I'm focused on how we did last year and where we're focused on for 2013.

Jonathan P. Groberg - Macquarie Research

Okay. Fair enough. And then my question is, biopharma has been really strong for you. Can you maybe talk about the outlook, because maybe you have tougher comps, some of the bio production business can be a bit lumpier? Can you maybe just talk about your expectation for that business in 2013?

Marc N. Casper

Yes. From our view, we had strong momentum all year in pharma and biotech, high single-digit growth. And from my prepared remarks, we're gaining traction with that customer set because of our value proposition. And we're doing that because we're helping those customers improve their productivity, as well as accelerate their innovation. And that's why we're doing so well. We remain clearly optimistic based on our track record that 2013 will be another good year. Personally, I had the opportunity to meet with many of the CEOs of the largest biotech and pharma companies in the month of January. I had a significant number of interactions, and they appreciate the momentum that we have with them and the impact that we're having. So, we think that will continue to have strong growth as we get into 2013, probably not as quite as strong always, every single quarter, but we're expecting strong growth.

Operator

Next question comes from the line of Daniel Brennan, representing Morgan Stanley.

Daniel Brennan - Morgan Stanley, Research Division

So just on maybe first on Phadia and Dionex. Marc and Pete, can you just discuss -- and you certainly faced some headwinds in 2012 on both businesses, given Europe and the flu. So, I'm just wondering like -- can you remind us? I know you broke out contribution overall, and then you kind of backed out kind of where Phadia and Dionex were. But explicitly, how did this business do in '12? And how should we think about 2013, given some of the easy compares they must have?

Marc N. Casper

So when I look at Phadia and Dionex, both of those integrations are essentially complete. They've gone smoothly. When I look at the businesses, both of them from a ROIC perspective are tracking to what we thought they would do. We are benefiting from stronger synergies. In the case of those businesses, significantly favorable tax synergies as well, and obviously a little bit softer top line performance with Phadia because of weakness in Southern Europe from a diagnostic perspective, as well as the very weak Japan pollen season. The good news within Phadia is the U.S. business performed very well, so that core growth thesis that we've had there continues to be very much intact.

Daniel Brennan - Morgan Stanley, Research Division

Okay. Great. And then maybe second, just focusing on one of your kind of the key businesses, mass spec, which, Marc, you pointed out, the Q Exactive and the strength that you had there in 2012. Just how should we be thinking about momentum that you have in that business going forward in kind of '13? Is it just really the Q Exactive continuing with more opportunity, I mean, particularly against some of your competitors that are in the midst of some pretty impressive product launches? So I'm just wondering, are you going to ride the heels of Q Exactive for another year or there's some new initiatives that we should be thinking about to help sustain growth in that business?

Marc N. Casper

Sure. So, Dan, when I look at our mass spec business, we had really a very strong year, and we are very bullish on our prospects for 2013, as well. Q Exactive has incredible momentum so that will continue to propel us. But in addition to that, we have a very exciting set of products in the pipeline for launches during the course of this year. So I think when you look at the full year outlook for mass spec, it'll be more than just a Q Exactive story, but the Q Exactive will give us substantial growth during the course of the year. That's our expectation.

Operator

Your next question comes from the line of Tycho Peterson, representing JPMorgan.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

One for Pete. You've done a great job on the tax rate, kind of bringing that down. Can you just talk about theoretically how you're thinking about that going forward, and to the extent you're doing bolt-ons, large or small, how protected your current tax structure would be?

Peter M. Wilver

Yes. So as I said, we did 16.7% in 2012. We're guiding to 14.5% to 15% in 2013. A lot of that does come from structures that we're able to put in place and planning that we're able to do as a result of acquisitions. So, certainly Dionex, Phadia and One Lambda have helped that out. It's tough to say going forward on a given acquisition whether or not we'll have those opportunities. But I certainly feel good about staying in this kind of range for the near term.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Okay. And I know you had a question before on kind of the sequential trends throughout the quarter. We did hear from one of your peers about kind of demand pull-forward. Any comments there, maybe as it relates to some of the more industrial-type customers?

Peter M. Wilver

It wasn't insignificant, no different than any other Q4.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Okay. And then last one, Marc, you've talked a lot about kind of incremental R&D investments. As we think about '13, any areas that you can call out in terms of priorities, whether it's within Specialty Diagnostics or Analytical Technologies? You obviously talked about some new product cycles, we should think about this year?

Marc N. Casper

No, actually, in Specialty Diagnostics -- first of all, high-level R&D this year is basically going to grow in line with our top line. So as a percent of sales, it'll be pretty consistent. When I think about where we're putting additional focus from an R&D perspective, companion diagnostics is a big effort for us. There's a significant opportunity in taking what are historically life science tools and apply them in diagnostic applications. So, that's important. And then we have a great set of lineup for products for the ASMS and other conferences in mass spec. So that's just some of the focus areas for R&D this year.

Operator

Your next question comes from the line of Amit Bhalla, representing Citi.

Unknown Analyst

This is Nick Nolan [ph] in for Amit today. First off, on guidance, what is your end market assumptions and your geographic assumptions underneath that? And, two, could you flesh out China a little bit? Just because some of the competition we've seen is just a bifurcation in that market with the health care environment and in the industrial space.

Peter M. Wilver

So I'll handle the first part. In terms of our 4 end markets: pharma and biotech assumes mid- to high-single-digit growth; academic and government, down low single digits; industrial and applied, around flat; and then health care and diagnostics, low to mid single digits. So those are the ranges for the market segments. And then from a geographic standpoint: North America, flat to down low single digits; Europe, low single digits; Asia Pac, mid to high single digits; and rest of the world, mid to high single digits.

Marc N. Casper

From a China perspective, it's 2 years in a row of 20% organic growth. It's been very consistent every quarter in that range. I just returned from China in November and there's a lot of really positive macro factors helping our business. And they look to be quite sustainable. Big emphasis on food safety, huge expansion of the health care system, intense focus on air quality. These are things that benefit Thermo Fisher substantially, which is why we feel good about our outlook in China.

Operator

Your next question comes from the line of Isaac Ro, representing Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc., Research Division

First one would be just on some of your recent acquisitions? I don't think you guys mentioned in your prepared comments, but what you guys saw in terms of performance from Princeton, One Lambda, Doe & Ingalls this quarter, and then maybe what expectations for those businesses you have baked in for 2013?

Marc N. Casper

Sure. So really One Lambda is the only one of any real substantial nature, and that's relatively small. So One Lambda's off to a great start. We closed that in mid-September. That business is growing very well. The integration has gone incredibly smoothly. We feel good about our prospects for 2013 with that business, so we feel good. And the other acquisitions generally are performing along our expeditions.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Great. And then maybe a more thematic question. You guys in the past have talked a little bit about the potential to benefit as your biopharma customers streamline their supply chains, work with fewer vendors. Can you maybe comment on the opportunities you see to benefit from that theme and other verticals that you guys serve?

Marc N. Casper

Yes. It's one that clearly is resonating. Obviously, biopharma is the biggest customer set that it's relevant to. But chemical, petrochem, contract testing labs clearly benefiting or benefit from this value proposition. Med device companies really has been a substantial focus, and that's gone well. Really any company that has gone through a shift in environment, where productivity is more important and they have a reasonably high level of laboratory spend, that what we do is very relevant and the value proposition resonates.

Isaac Ro - Goldman Sachs Group Inc., Research Division

And I guess I should have been more specific. Given we're in theoretically a period of sustained austerity in a lot of budgets, even in a better economic environment, do you think there's any potential for acceleration of that theme in the nonhealth care markets you serve this year and next?

Marc N. Casper

I do. I mean, I think like everything, I think as you get more experienced with different verticals, you learn from them and you get better at doing it. So I think the answer is yes, I think the choppier end markets allow for us to have a very differentiated dialogue versus the competition, because we drive huge productivity for our customers. And that actually is helping us gain share across a number of verticals.

Operator

Your next question comes from the line of Dan Arias, representing UBS.

Daniel Arias - UBS Investment Bank, Research Division

Marc, you talked about the ability to put through new cost actions through right away if things worsen. So I guess, how would you view sequestration in those terms? Is that the type of worsening that you think has you doing something right away? Or do you sort of wait to see what the customer reaction is post any decision?

Marc N. Casper

So we're already taking cost actions because of sequestration. So that is already embedded in our operating plan and our guidance. So that's happening. It's more of if things get even more muted on the industrial side would we take the incremental contingency plan. So that's our base assumption on sequestration.

Daniel Arias - UBS Investment Bank, Research Division

Okay. Great. And then, I guess, just following up a bit more specifically on Phadia, just wondering if you could touch on the expansion of the autoimmune portion of that business. Obviously, a great position in Europe, so I'm just guessing that things are positive in the U.S. But I'm wondering if you could comment about extending that #1 position in the U.S.

Marc N. Casper

Yes. Autoimmune is a really good category for us because historically as opposed to many categories in diagnostics, where you have large instruments with a large menu, autoimmune is a lot of one-offs, independent platforms, manual methods, lab-developed tests. And we have an automated platform with a very extensive menu. So we have nice momentum. It's still small, it's still young in terms of our focus on it, but we think autoimmune is going to be a really nice growth driver as we expand beyond the traditional base in Europe, and the U.S. is off to a good start.

Operator

Next question comes from the line of Jon Wood, representing Jefferies.

Jon Davis Wood - Jefferies & Company, Inc., Research Division

So, Marc, thanks for comments on just the industrial outlook. I'd like to kind of pick apart the applied markets versus some of the later-cycle materials, process industrial markets. How do you see those pacing? Have you seen that, that later-cycle piece start to bottom out? Or are we still kind of grinding lower? How does that industrial piece kind of pace throughout 2013, in your view?

Marc N. Casper

So from when you pick apart industrial and applied, it covers a lot of different things. The applied markets are generally showing more pockets of strength than the industrial. When you break into the industrial, I'd say the longest lead time, the latest cycle parts of the portfolio have obviously still good revenue momentum. Bookings softened as we got later into 2012 as customers became more uncertain about the economic environment. So that's the comments, when Pete or I are saying that some customers are holding off on purchase decisions, the capital projects exist, it's just pulling the trigger. So that's why we're assuming that industrial markets are going to be soft during the course of '13. And there are obviously potential upsides to that, but that's our base assumption going into our guidance.

Jon Davis Wood - Jefferies & Company, Inc., Research Division

Okay. Appreciate it. Follow-up is it's been a while -- obviously, a great year in pharma. It's been a while since you talked about the top 20. Can you give us some color around how you're doing in that big-customer group and what the forward look appears like today?

Marc N. Casper

Yes. If you look at -- we don't talk that much about it because we're covering so many more customers with the valuable proposition in the top 20. But if we grew -- and we grew high single-digits with biotech and pharma last year, our top 20 actually grew a little faster than that.

Operator

Your next question comes from the line of Doug Schenkel, representing Cowen and Company.

Doug Schenkel - Cowen and Company, LLC, Research Division

First, I think this is really for Pete. On the Lab Products and Services side, margins were flat in 2012 versus 2011. You had some really nice large account wins in 2012, which I would think would benefit margins increasingly as you move further into those agreements. You've directed some spend towards improving that business operationally, and it also seems like you're making some nice progress in converting customers from third-party to self-produced products in the catalog. Would it be fair to conclude, given all these dynamics, that you should have some margin momentum in LPS heading into 2013?

Peter M. Wilver

Yes. As I said in my comments, in the second half we actually expanded margins by 35 basis points. So I would expect for the full year in 2013, if the top line plays out the way we have in our guidance, that you would see some margin expansion there, not to the tune of the second half performance but certainly some good margin expansion.

Doug Schenkel - Cowen and Company, LLC, Research Division

Okay. And I'm going to risk incurring your wrath by asking one more M&A criteria question. I just wanted to -- so in the past, you've articulated that you don't want to go meaningfully above 3x debt-to-EBITDA. In certain instances, you'd stretch to 3.5. How stringent should we think about that part of the criteria?

Marc N. Casper

That's something from a high level that we've talked about for a long time, so I think that's a good reflection of how we think about our balance sheet.

Operator

Your next question comes from the line of Steve Willoughby, representing Cleveland Research.

Steve Willoughby - Cleveland Research Company

Question on margins. If you could just talk about how you guys are thinking about getting to that 30 to 50 basis points of margin improvement. Marc, you said how you expect R&D to kind of grow in line with sales, and then you've got the medical device tax coming in. So I'm just kind of thinking about how much leverage you can get on the SG&A line there.

Peter M. Wilver

Yes. So in terms of margin expansion going into 2013, I guided to 30 to 50 basis points. About, say, 30 basis points of that is coming from gross margin, and that's primarily driven by all the productivity actions that we have. But we also do see the impact of the medical device tax in gross margins. So it's almost 20 basis points of dilution. So good productivity offset by the medical device tax. And then SG&A, probably around 10 or so basis points, maybe 15 basis points of expansion just by volume leverage and a little bit impacted by higher stock comp, and then R&D, as you said, about growing with revenue.

Steve Willoughby - Cleveland Research Company

Okay. And then just my second thing was on the restructuring savings. If I heard you correctly, and maybe I missed it, did that come in a little bit higher in 2012 than what you initially had laid out? I thought you were initially expecting maybe a $50 million worth of benefit. Is that correct? And then the $65 million or $60 million for 2013, is that still a good number of what you expect to benefit from these restructurings?

Peter M. Wilver

Yes. In 2012, we started the year guiding to about $50 million. I pretty much updated that number last quarter. So we came in at $65 million, and that's a result of some of the actions that we'd put in place during the year. So we'll get the benefit of those more in 2013 than we did in 2012. So when you add up the benefit of the 2011, 2012 actions, as well as some of the other things that we currently have planned, you get to about $65 million of benefit in 2013 from all of the restructuring actions.

Operator

Your next question comes from the line of Jeff Elliott, representing Robert W. Baird.

Jeffrey T. Elliott - Robert W. Baird & Co. Incorporated, Research Division

I understand the conservatism around sequestrations. But I'm wondering if you can break out, I guess, what's baked into revenue and EPS guidance for the sequestration cut. And can you just confirm that you're assuming an 8% cut on the sequester?

Marc N. Casper

So when -- I had the benefit of talking to Dr. Collins yesterday, who's the head of the NIH, and spent a fair amount of time with a key Republican congressman last week to talk through this issue. I think 2 things, one is we continue to believe that sequestration will happen. I think the conventional wisdom is that it's going to be a little over a 5% cut over the -- on a full year budget. So that's what the conventional wisdom is on the cut is going to be. So it's compressed, obviously, in a period from March and through the end of September. Less clear is what's going to happen in the fourth quarter, because it's a new fiscal year for the government. But a little over 5% seems to be the conventional wisdom on the cut. That's what's assumed baked into our numbers.

Jeffrey T. Elliott - Robert W. Baird & Co. Incorporated, Research Division

Okay. And sorry if I missed this, but could you give your ROIC targets for 2013?

Marc N. Casper

We gave long-term. We have the 2016 goal and in terms of what we're targeting and with the goal of increasing it steadily over time. So back in the EMEA, [indiscernible] has a good view on that.

Operator

And your question comes from the line of Derik De Bruin, representing Bank of America.

Derik De Bruin - BofA Merrill Lynch, Research Division

So I'm looking at -- what is the -- you said you're expecting the academic and government business to be down roughly mid single digits, and that's about 25% of your business. So that's roughly 1 to 1.5 percentage points of growth there that would under a more normal circumstance would be in your organic guidance. And then so what do you think the industrial softness is costing you as well? I'm just trying to figure out what is sort of the normalized growth rate for the guidance would be if we were in a more -- less crazy market.

Peter M. Wilver

Derik, it's Pete. So on the academic and government, it is actually down low single digits, not mid single digits. But the industrial and applied probably cost us about 1 percentage point year-over-year in terms of the growth rate.

Derik De Bruin - BofA Merrill Lynch, Research Division

So one of the real standouts in 2012 was the Lab Products and Services business. I mean, it put up a 4% organic number, and it hasn't done that in a while. And obviously that's sort of with some of the headwinds going on in the markets there. Is sort of this growth rate for LPS in the 3% to 5% range, do you think that's sustainable going forward for the next several years?

Marc N. Casper

Yes. When you -- and actually, this was a number of times, and I think 2012 is a great reflection of it, right? We feel very confident about our ability to be a mid-single-digit organic growth company. We obviously were in 2012. We laid out our assumptions, Derik, about how we're thinking about the economic end markets being very difficult in 2013. So we're saying at the midpoint, we're a 2% grower. And when you bridge that, as Pete said, mostly most industrial as well as sequestration gets you from the 4% to the 2%. Once you get out of that period of time, we feel like mid-single-digit growth is where we're going to grow as a company and we think that Lab Products and Services is very consistent with that in terms of organic growth outlook. Remember, in that business, you've got an incredible Biopharma Services business, which is clinical trials, outsourcing. We've got the leading channel that has great momentum in the marketplace. So we feel good about our prospects for growth across our portfolio.

Derik De Bruin - BofA Merrill Lynch, Research Division

And I guess, certainly, a lot of investors are very happy to see you guys increase the dividend -- and stay with the dividend and increase it this year. Could you sort of talk about how you're thinking about the dividend going forward and how should we think about modeling it from an increase standpoint? Is this something you're going to do on an annual basis?

Marc N. Casper

This is something that we review with the Board periodically. It's obviously -- we're very new in this. We initiated it beginning of last year, and we raised it in November and the Board will review it on a periodic basis. We're assuming in our guidance that we're going to return $200 million roughly of capital via the dividend, which is assuming a $0.15 per quarter. That's what the basic assumption is at this point. But our Board will review that over time.

So let me just wrap it up. So thank you, everyone. We had a very successful year in 2012. We feel we're well positioned to carry our momentum into 2013 by focusing our customers to drive growth, using our productivity to strengthen the bottom line, and then obviously deploying capital to create shareholder value. We're looking forward to updating you on our Q1 call. And, of course, thank you for your continued support of Thermo Fisher Scientific. Everyone, have a nice day.

Operator

Thank you for your participation in today's conference. And this concludes the presentation. You may now disconnect, and have a great day.

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