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Thermo Fisher Scientific, Inc. (NYSE:TMO)

Q2 2009 Earnings Call

July 23, 2009 8:30 am ET

Executives

Marijn Dekkers - President and CEO

Peter Wilver - SVP and CFO

Analysts

Ross Muken - Deutsche Bank

Tycho Peterson - JPMorgan

Quintin Lai - Robert W. Baird & Co.

Derik De Bruin - UBS

Jon Wood - Bank of America/Merrill Lynch

Jon Groberg -- Macquarie Research

Isaac Ro - Leerink Swann

Peter Lawson - Thomas Weisel Partners

Doug Schenkel - Cowen & Company

Operator

Good morning, ladies and gentlemen and welcome to the Thermo Fisher Scientific Second Quarter 2009 Earnings Call. I would like to introduce our moderator for the call Mr. Peter Wilver, Senior Vice President and Chief Financial Officer. Mr. Wilver, you may begin the call.

Peter Wilver

Good morning and thank you for joining us. Also joining me on the call today are Marijn Dekkers, President and Chief Executive Officer, and Marc Casper, Executive Vice President and Chief Operating Officer.

Please be aware that this call is being webcast live and will be archived on our website, thermofisher.com, until August 28, 2009. To reach the replay of the call on our website, click on Investors then Webcasts and Presentations.

Please also be aware that a copy of the press release of our second quarter 2009 earnings and future expectations is available in the investors section of our website, under the heading Financial Results.

Now 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 and as a result of various important factors including those discussed in the company's Form 10-Q for the quarter ended March 28, 2009, 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 of SEC filings.

While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligations to do so even if our estimates change and 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 principals or GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release of our second quarter 2009, earnings and future expectations and also in the investors section of our website thermofisher.com under the heading Financial Results.

With that I will turn the call over to Marijn.

Marijn Dekkers

Thanks Pete. Good morning everyone. Thank you for joining us on the call today. We are now at the midpoint of the year and while we continue to face challenging conditions in a number of our end markets, we are seeing some positive momentum on several fronts, which I will cover this morning. This leads us to believe that the worst is behind us and that the rest of 2009 will show gradual improvement, helped by easier year-over-year comparisons in the second half.

Let me start with an overview of our financial performance for the quarter. As you can see in our press release, the economic headwinds and the tough comparison with a strong Q2 last year hampered our growth in the quarter year-over-year. Revenues were down 8% and minus 5% organically.

Adjusted EPS declined by 6%. Our adjusted operating income decreased by 12% for an operating margin of 16.8% in the quarter, or 80 basis points lower than Q2 a year ago. Free cash flow, on the other hand continued to show positive momentum setting another record with nearly $350 million generated in Q2.

In the first half of the year we've generated a total of $660 million of free cash flow. So in spite of the economic pressures our business model allows us to generate a tremendous amount of cash.

Another positive is that we were pleased to see that our operating performance significantly improved over Q1 of this year. This is the result of two key drivers.

First, we saw improvement in sales of consumables. While it's clear that the economy is still causing our customers to continue to hold back on their spending for bigger-ticket capital items, like instrumentation and equipment, the inventory destocking activity we saw earlier in the year seems to be leveling off and sales of our consumables products got progressively better in the quarter.

Second, we had a very good quarter in terms of ongoing productivity initiatives, namely our PPI, Practical Process Improvement programs and our global sourcing activity.

In addition, we are now fully realizing the benefits of the various cost-cutting actions we began to implement at the end of 2008. All of this contributed to our improved profitability over Q1 and, of course, will benefit us going forward.

I want to make the point here that while we are taking appropriate actions in response to market conditions, we are also looking to the future and we are making strategic investments that will allow us to emerge from this period an even stronger industry leader. As we shared with you at our analysts meeting in New York back in May, this is our number one priority.

Now, let me spend a few minutes on what we are seeing in our primary end markets. For the most part, we haven't seen any dramatic shift compared with Q1, it's still a mixed bag. But at a high level, comments on biopharma, capital purchases are still slow, but we are encourage by good improvement overall in our top 20 accounts, which as you know are mostly large pharma customers.

We had mid-single digit growth in these accounts -- revenue growth in Q2. So we're back to our trend of outpacing the growth of the overall company. It's still a mix. Sales are up in some accounts and down in others. The fact that six of these companies had just announced mergers may have had something to do with the lower level of activity we saw in Q1.

Longer term, however, we still believe that big pharma consolidation will benefit Thermo Fisher, since we are in the best position to help these large global companies make their laboratory purchases more efficiently and more intelligently.

On healthcare markets, back to my earlier comment about inventory correction, the destocking of consumables in hospitals and research laboratories seems to have leveled off and sales are gradually improving. The H1N1 flu virus has been good to us, with our microbiology and healthcare catalog businesses benefiting from sales of test kits in the quarter.

On the industrial side, unfortunately, there is not much sign of improvement here. These markets remain especially difficult, and this is primarily affecting sales of our environmental and process instruments.

Now on government and academia, we talked a bit about global government stimulus programs last quarter and how Thermo Fisher is positioned very well to benefit here. We have a significant commercial effort focused on capturing these opportunities, and there has been a lot of quoting activity, and some orders filtering in, particularly in our scientific instruments business.

We believe that these stimulus programs will benefit us in a meaningful way in the range of $100 million to $200 million of revenue, over a 12-month period once these funds start to flow later in the year.

As I mentioned earlier our positive momentum on free cash flow continued in Q2 with another good quarter, a record quarter and our balance sheet remains very strong. We are putting our balance sheet to work by deploying our capital in ways that we believe will create shareholder value, whether it's for technology development, strategic acquisitions, or stock buy-back.

In the second quarter we did a combination of all three. First, our investment in developing innovative new technologies led to a number of key product launches under our Thermo Scientific brand that we highlighted at major industry events around the world.

At ACHEMA in Frankfort, Germany, one of the largest laboratory process exhibitions in the world, we showcased a breath of solutions we offer for a range of application. From high-end instrumentation for life sciences research, to work flows for food and environmental testing, to elemental and analyzers for industrial processing.

Then some of you attended the recent ASMS conference in Philadelphia, where we officially launched our next generation mass spectrometry system, the LTQ Velos ion trap and the LTQ Velos Orbitrap. These technologies leverage our history of breakthrough advances in mass spectrometry to address major needs of today's life sciences research particularly.

One, their ongoing demand for improved sensitivity and speed of analysis; second, their ability to manage and interpret large volumes of data; and then third, their need for highly advanced tools that are much easier to use, which allows the sophisticated instruments to now be operated by customers with different levels of technical expertise.

The new LTQ Velos platform delivers all of this. It was named the ASMS product of the show by the industry publication Instrument Business Outlook. We, and more importantly our customers, are very excited about the potential for these new products. It couldn't have come at a better time now that significant stimulus funds are becoming available for mass spectrometry systems.

Secondly, during Q2 we also significantly extended our global commercial reach by acquiring Biolab, the leading laboratory supply channel in Australia and New Zealand, for approximately US$130 million.

You can think of Biolab as the Fisher Scientific of Australia and New Zealand. It provides life sciences consumables, laboratory equipments and analytical instruments to research, environmental and healthcare markets in a part of the world where we had a significant opportunity to expand our presence. This is in line with our strategy of continued expansion of our Fisher Scientific customer channel in geographies where we believe we are underrepresented.

Third, we spent $415 million during the quarter to repurchase our stock, completing the $500 million stock buy-back program, we initiated in September 2008.

In summary, our strong balance sheet continues to give us a number of options for creating shareholder value in both the short and long-term.

Guidance, let me wrap up my comments by reviewing our revised guidance for 2009. As you saw in our press release, we are raising our revenues and also raising the low end of our adjusted EPS guidance for the year.

We are raising our revenue guidance to a new range of $9.80 billion to $10.10 billion, primarily due to a more favorable climate for foreign exchange at this point in the year, and our acquisition of Biolab. This new estimate would result in a 4% to 7% decline from our 2008 revenue results.

We are also raising the low end of our adjusted EPS guidance by $0.05 to a new range of $2.85 to $3.10 for the year. This would lead to a decline of 1% to 9% from our 2008 adjusted EPS of $3.13.

So, with that I will turn the call back over to our CFO, Pete Wilver for his detailed review of the financial. Pete?

Peter Wilver

Thanks Marijn. Our operating performance improved significantly in the second quarter despite continuing difficult economic conditions that affected our year-over-year comparisons. Adjusted EPS in the second quarter declined by 6% to $0.74, compared to $0.79 last year. GAAP EPS in Q2 was $0.49 down from $0.56 in the prior year's quarter.

Moving on to the details of our financial results, revenues in Q2 decreased 8% year-over-year to $2.48 billion. Organic revenues declined 5% in the quarter excluding foreign currency translation of negative 4% and a 1% favorable benefit from acquisitions, net of divestitures.

Consistent with my comments at our May analyst meeting, the Easter holiday lowered our growth in the quarter by about 1% and we had particularly tough comparison with 8% organic growth in Q2, 2008 compared to about 4% in the other quarters of 2008.

Bookings were slightly below revenues in the quarter by less than 1%. In the analytical technology segment Q2 revenue declined 13% on a reported basis and 9% organically. In the quarter, we saw softer demand across the majority of our businesses, most significantly in instrumentation, and those serving industrial markets, which continue to be weak.

On a positive note, we did have pockets of growth in specialty diagnostics and biosciences. Despite the overall decline new products continue to drive growth specifically in our scientific instruments, life science research and microbiology product lines.

In the Laboratory Products and Services segment future revenues decreased 3% on a reported basis and 2% organically. During the quarter we saw modest growth in our research catalog and clinical trials services businesses, which was more than offset by weakness in other areas primarily in our laboratory equipment business.

By geography, revenues declined organically across all our major regions with the exception of the rest of the world, which grew high single-digits from a relatively small base. North America declined at the company average and Europe declined a couple of points more than the company average. Asia-Pacific declined at about the company average against a very tough comparison of mid 20% growth last year.

Q2 adjusted operating income decreased 12% year-over-year to $419 million. Adjusted operating margin was 16.8% down 80 basis points from 17.6% in the year ago quarter. The year-over-year margin contraction resulted primarily from pull through on the organic volume decline at marginal rates partially offset by a favorable pricing actions, strong cost controls, and infrastructure structure reduction actions, as well as our global sourcing efforts.

Adjusted operating margin improved sequentially by a 130 basis points from Q1 as our cost reduction actions continue to take hold and revenues rebound somewhat from their low Q1 levels.

Analytical Technologies, Q2 adjusted operating income decreased by 18% year-over-year and adjusted operating margin was 20.1% down a 100 basis points versus 21.1% last year. Laboratory Products and Services, Q2 adjusted operating income decreased by 6%, and adjusted operating margin was 13.6%, down 40 basis points versus 14% in the 2008 quarter.

Both segments were affected by the factors mentioned for the whole company but the margin compression was more severe in Analytical Technologies, as a result of the steeper organic revenue decline and a higher rate of pull-through on lost revenues.

Total company adjusted gross margin was 41% in Q2, down 30 basis points from 41.3% in the year ago quarter, primarily as a result of lower volume, partially offset by increased prices and our sourcing and cost reduction initiatives. Specifically in the sourcing area, we've been able to claw back a lot of direct material inflation and are seeing a much lower negative impact than the past few quarters.

Adjusted SG&A was 21.9% of revenue in Q2, up 60 basis points from 21.3% in the year ago quarter as cost controls and cost reduction actions were more than offset by negative volume leverage and slightly higher stock compensation expense.

R&D expense was 2.3% of revenue in Q2 down 10 basis points from last year. We intend to maintain our spending level in this area consistent with 2008 to ensure that we preserve our new product pipeline to drive future growth.

During Q2 we continued our program of tight discretionary cost controls and have implemented further infrastructure cost reduction projects consistent with the plan we laid out at our May analyst meeting.

As we commented last quarter, these actions are focused on the portions of our business that are most directly affected by the economic downturn or where we would like to reduce our manufacturing footprint. We continue to invest in our key growth areas to ensure we are positioned to emerge from the recession as an even stronger industry leader.

Moving below the line, our Q2 adjusted net interest expense improved $2 million year-over-year to $25 million, primarily as a result of a $0.5 billion reduction in our net debt. This was almost entirely offset by a much less favorable interest rate environment. Other income was flat with last year at a loss of $1 million.

Our adjusted tax rate for the quarter was 20%, flat with Q1 and down 3.5 points from Q2 2008. The lower tax rate resulted primarily from the tax planning that we implemented during the second half of 2008 and so far this year, along with overall lower pre-tax income, particularly in higher tax jurisdictions.

During the quarter, we bought back 10.5 million shares and used up the remaining $415 million of our current $500 million buyback authorization. This brings the total amount we spend on buyback since the Fisher merger to $1.5 billion.

Average diluted shares were 424 million in the quarter, down 13 million from last year. The lower share count reflects the benefit of our share buyback programs in 2008 and 2009, as well as lower convertible dilution resulting from the lower stock price.

On a high note, our cash flow performance remains strong. Year-to-date cash flow from continuing operations was $735 million and year-to-date free cash flow from continuing operations was $659 million after deducting net capital expenditures of $75 million. Year-to-date free cash flow is up $173 million versus 2008 primarily as a result of favorable working capital performance.

We ended the quarter with $1.4 million in cash and investments, down $143 million from Q1, as our record free cash flow in the quarter was more than offset by cash used for share repurchases and acquisitions.

Our total debt was $2.03 billion essentially flat with Q1. We remained very comfortable with our liquidity position and ability to meet our financing needs for the foreseeable future.

With regard to working capital, we had reasonably good performance in the quarter given the economic climate. Accounts receivable day sales outstanding was 53 days, flat with the prior year and down sequentially four days from Q1. And inventory days of supply was 73 days, up one day from the prior year and down five days sequentially from Q1.

Now, moving onto our 2009 guidance; we are raising both the low and high end of our reported revenue guidance, from a range of $9.55 billion to $9.94 billion to a range of $9.80 billion to $10.10 billion, primarily as a result of improved foreign currency exchange rates and the addition of the Biolab acquisition. This range represents a decline of negative 4% to negative 7% compared to our 2008 reported revenues of $10.5 billion.

Our guidance assumes present foreign currency exchange rates, which are negatively affecting our reported revenue growth guidance by about 3%. It also assumes about 1% net growth from past acquisitions and divestitures. Our revised reported revenue guidance translates to organic revenue decline in the range of negative 2% to negative 5%, which remains unchanged from our previous guidance.

In terms of adjusted EPS, we are raising the low end of our guidance by $0.05 and maintaining the high end, resulting in a revised range of $2.85 to $3.10. This guidance represents a 1% to 9% decline compared to our 2008 adjusted EPS of $3.13.

In interpreting our guidance range you should focus on the midpoint as our most likely view of how we see 2009 playing out. Outcomes above and below the midpoint will be dependent upon the relative strength of the economic recovery in the second half and the magnitude of incremental stimulus revenues that we are able to convert by year-end. As always our guidance does not include any other significant assumptions with regard to potential future acquisitions, share buybacks or other usage of our capital.

Although, we have had a tough first half in a difficult economy, and the world is still uncertain, we are beginning to see signs of positive momentum. We believe we are striking the right balance between aggressive cost reductions and strategic investments and as a result are well positioned to emerge from this period as an even stronger industry leader.

With that I will turn the call over to the operator for Q&A.

Question-and-Answer Session

Operator

Thank you. 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 questions in turn. (Operator Instructions).

Our first question comes from the line of Ross Muken from Deutsche Bank. Please proceed.

Ross Muken - Deutsche Bank

You know, coming out of the first quarter I think there were sort of three key investor concerns that hopefully were sort of addressed today, but I think to a degree that maybe you could sort of comment and give yourself a bit of a report card in terms of how you reacted to. One, part of some of the issues that we have seen over the last four quarters in terms of the global downturn and then some of the key investor concerns and maybe I'll list them and you can comment on each.

And the first was sort of around consumable weakness, we have sort of seen that now bounce back so relative to sort of your initial expectations of how this business would perform in this market. Do you think this quarter was sort of more indicative of the trend?

The second was on operating leverage; a lot was made of sort of the fact that maybe you didn't restructure enough and obviously with the leverage in this quarter; I'm curious to think, to see now if you think sort of the steps you took were proper.

Then lastly, on capital deployment, you obviously bought back a lot of stock that was sort of a concern. Do you feel like the mix that you put forward this quarter again, sort of now positions you going forward, in sort of the way that probably best will serve shareholders versus some of the concerns heading out of Q1?

Marijn Dekkers

Good questions. Well, let me just give first a general comment and I think we made very clear during our analyst presentation back in May in New York, and also in the conference call after Q1, that our intention through this period is to come out of this recession as a stronger industry leader. And all the things that we've done since September of last year, when we were experiencing tougher times, have been with that in mind.

So particularly on the cost-cutting side, we have been very, very careful to make sure that we are not losing the momentum that we have built up after the merger between Thermo and Fisher.

I'll answer the second point first, in terms of operating leverage. We have driven significant productivity just in PPI and sourcing. We took a lot of cost measures, but in a very intelligent, I think balanced way. And we continue to look at our overall footprint and adjusting, you know the number of sides that we have down, because we have opportunities to consolidate.

And the combination of that I think you saw, pretty much the full effect of those activities in the second quarter, while in the first quarter some of that was still ongoing, as it has been put in place in the fourth quarter, and into the first quarter.

So there is more upside there, but we feel that, we've done the things that we needed to do to respond to the economy, and then also make sure that we come out of the economy stronger. So that's the operating leverage point.

On the consumables weakness in Q1, we were actually a little bit surprised by the consumables weakness, because normally in a recession, yes, people slowdown their purchases, but consumables they may see a few percent of decline, but not to the extent that we saw it in Q1.

What we weren't really prepared for was the combination of a recession and a credit crunch on top of it. And it was the credit crunch we believed that led to the destocking, people just trying to save, really, the last few dollars to make payroll for instance in a hospital.

That destocking now, in the last couple of months seems to be easing up quite a lot, and, therefore I think, we are now getting into a situation where consumables are more like they would react in a regular recession, and the piece of it from a credit crunch point-of-view, I think is pretty much behind us. That's why I think we saw in Q2, already, consumables returning to positive organic growth.

From a capital deployment point of view, we did some nice buybacks in Q2. Actually just looking here for the number in terms of what we've done since the merger …

Peter Wilver

It's a 1.5 billion that we've spent.

Marijn Dekkers

Yes. So, since the merger, in November of 2006, we spent $1.5 billion on buyback and $900 million on acquisitions. So, that gives you an idea of how we have deployed capital in pretty much last two-and-a-half to three years, a $1.5 billion in buybacks and $900 million in acquisitions.

Now acquisitions is still our priority, because we do believe as I have said many times that it's a very fragmented industry. As there are some great opportunities for us to acquire companies that are a very good fit in the portfolio and we're looking for them, but Biolab is an excellent example of how we're in a much stronger in that part of the world with a very, very nice channel. And we'll continue to look for those. So that's the priority, but at the same time if it makes sense to do buybacks, we will do so as well.

Ross Muken - Deutsche Bank

Excellent, and just one clarification on the healthcare business, you sort of said that the stocking leveled off, and obviously you probably got some benefit from flu there, would you say now we probably go to restocking, or do you think we're in sort of a leveled-off period for some time?

Marijn Dekkers

I think at some point when people are getting less nervous about credits, we will get through some restocking.

Operator

Our next question comes from the line of Tycho Peterson from JPMorgan. Please proceed.

Tycho Peterson - JPMorgan

On the AT segment, it looks like that was a little bit worse sequentially. Can you just talk about, obviously you had a difficult comp there as well. But can you talk about kind of the easy outlook for the industrials business? And, we heard some companies talk more positively lately about China, just generally speaking from a macro perspective, what do you think about for that business?

Marijn Dekkers

Well, I think anything that's related to industrial is still bouncing off the bottom, quite honestly. There hasn't been enough positive momentum there to say that that we are clearly seeing the end in sight.

Since our Analytical Technologies segment has our instruments capabilities in it, so it sort of gets double-hit because the instruments are capital items, so that's tough. And then that's where most of our industrial exposure is as well, which is really in total only about 30% for the whole company, but most of that is in Analytical Technologies.

So, I can't say that we have seen a tremendous up tick in -- we haven't seen an inflection point. Some businesses are beginning to see slightly better performance, but I can't say it's an inflection point.

China has been doing well. We have positive organic growth in China, so China is one of the brighter spots in terms of the regional distribution.

Tycho Peterson - JPMorgan

Okay. That's helpful. On the academic markets, I appreciate the color you provided last quarter on your view on stimulus. Has there been any change in kind of your sense of timing here and part of the question stems from the fact that we've seen some companies in the space talk about order delays ahead of grant disbursals.

Then as an adjunct, are you seeing any interest in new lab space being built out, obviously with the workstations business, if you're a good proxy for kind of where the new demand is going to be built?

Marijn Dekkers

Well, I mean its interesting comment Tycho about order delays ahead of new grants, because I definitely think that that has been going on the last two quarters. People might have even already gotten money from their own institutions to buy something, but they say, hey, before I do that, let me resubmit to see if I can get the money from the government, and then I will use the money from my own institution for something else later.

So I think this extravaganza of putting proposals together has led to some order delay. But we believe that most of the stimulus will start to begin to come in Q4. And then obviously go through 2010.

In terms of new lab space, it's not bad. It's, I would say, probably slightly better than what one would expect in an economy like this. And that's encouraging, particularly in Asia there is significant lab space being built.

Tycho Peterson - JPMorgan

And then just one last one on pricing trends are the single-digit price increases kind of sustainable here longer-term? And as we think about obviously where pharma R&D budgets are going are you getting any push back on pricing from pharma at this point?

Marijn Dekkers

You know, you really have to differentiate right now between capital and expense budgets, and consumables that are typically paid by expense budgets, there really is not any significant price pressure there. We do as we always do at our annual price increases and that is expected by our customers and understood.

We do see somewhat tougher price environment on the instrument side, because our customers want to get more bang for the buck there. Those are larger ticket items, and it illustrates how incredibly important technology differentiation is in instrumentation, because that gets you out of that discussion and that's why we're so focused on new product introductions, and making sure we have the best technology out there.

Operator

Our next question comes from the line of Quintin Lai from Baird. Please proceed.

Quintin Lai - Robert W. Baird & Co.

First, just in terms of the H1N1 and kind of pandemic preparation, pretty decent performance here this last quarter. Have you been approached or has there been any talk about increasing inventory ahead of what could be a very strong flu season in Q3, Q4?

Marijn Dekkers

Approach by whom? By our customers?

Quintin Lai - Robert W. Baird & Co.

By customers or maybe organizations like WHO?

Marijn Dekkers

By our customers, yes, but not by official government organizations, at least not that I'm aware of.

Quintin Lai - Robert W. Baird & Co.

Then just kind of at a higher level, healthcare reforms has been talked about a lot here Marijn, of late, and there are different proposals out there. Assuming, that something does go through, and who knows what form it will be, but I guess, what are your long-term outlooks with respect to being a tool provider in a healthcare reform environment?

Marijn Dekkers

I think that my long-term vision on this is that we as a society will be under more pressure to deliver healthcare efficiently. And a big part of that is tailored trucks, so not sort of the big wonder trucks that everybody can take and maybe it has a good effect on some and not a good effect on others and we don't really understand the difference.

But much more tailoring, much more understanding, much more companion diagnostics, much more knowledge upfront on whether or not a patient is going to react positively or negatively on a prescription, and that understanding has to do with science.

Therefore I think, the days are over when we can just throw a lot of things against the wall and hoping that something sticks and call it a Blood Buster drug. I think we really have to in drug development and in diagnostics development be more refined in our approach, and that's exactly the sweet spot of Thermo Fisher, in helping our customers to be more refined, developing more in-depth capability knowledge, with our tools.

So I think for us as an industry, if we can really partner up with our customers that way, it is actually an extremely positive trend, because we will get the waste out of the system that is in there right now.

Quintin Lai - Robert W. Baird & Co.

Thank you, and then just kind of the follow-up to that. Does that impact your kind of idea of M&A going forward, potentially more specialized diagnostics to fit that type of future?

Marijn Dekkers

Well, I would say yes. For instance, one area that I think will go out of favor or has gotten already out of favor, is all of the high throughput screening capabilities that we heard about five, six, seven years ago that were so popular, which was really focused on. As long as I do as many experiments as possible in the lab at any time, something good will come out of it. Trial and error, a lot of trial and error and I think those days are behind us.

I think things will be done much more focused, and then to your point I think there will be much more convergence between life sciences tools and specialty diagnostics over time. There is no doubt in my mind that mass spectrometry will become a very important diagnostic tool in the future. And our internal development, our relationships that we have with key scientists outside of our company, and our M&A technology targets are all aligned with that vision.

Operator

Our next question comes from the line of Derik De Bruin from UBS. Please proceed.

Derik De Bruin - UBS

So, 3Q is always a bit of conundrum in life sciences space and that is seasonally a weaker quarter than Q2 or Q4. Now this year we've kind of got the added uncertainty of the overall end markets. I guess, could you just give us some commentary on your FX expectations for the rest of the year and I guess how should we kind of look about, the ramp from Q2 to Q3. Yes, you got [these] easier comps so I'm just wondering, Pete can you give us a little bit more guidance and color on how to look at those?

Peter Wilver

Well, basically you're asking me to give you a Q3 guidance, which we don't do. Essentially in terms of foreign exchange, we're assuming that rates stay about where they were on average in Q2. So, that obviously, that comparison gets easier in the prior year as you go through the year.

In terms of the way we're looking at things, we would expect Q3 to still be seasonally similar to the way it was in the past. We don't expect a significant impact from stimulus or anything like that. That's going to come probably in Q4, if it comes meaningfully in 2009. So other than those two things, we're sort of assuming a normal year in terms of the comps.

Certainly versus Q2, Q2 was against a very difficult comparison last year, basically all the other quarters of 2008 were 4%, and this quarter, we are comparing against an 8% quarter. So if you look at our organic growth for the first half, it averages to minus six to get to the midpoint of our range of minus two to minus five. You really need to be at a something about minus two in the second half. And that's what we're assuming is going to happen.

Derik De Bruin - UBS

That's fine. I just wanted a little bit of just direction to make sure I was thinking about it the right way. And I guess, could you, you still said that your industrial end markets were still feeling quite a bit of pressure. What's your best guess on when you could potentially see a meaningful rebound in those markets?

Marijn Dekkers

Quite honestly, I personally think, I'm not saying that it's, in our guidance, but I personally think that in the fourth quarter things will start picking up on that side. I mean, let's not forget the panic that broke out in the fourth quarter of last year, where people suddenly stopped buying commodities, they were starting to bring down inventories and certainly Q1 was very, very tough in that concept.

I mean, in Q1, and at the end of Q4, I think half the chemical plants in the world were shutdown. So that's a pretty easy comparison. So I think we will see an uplift in demand in Q4 on the industrial side, but my goodness if I was sure of it, I probably wouldn't be CEO of this company, I would be doing something else.

Derik De Bruin - UBS

Okay. And one final question, it's like have you seen any changes in the biomanufacturing space its given the Roche Genentech consolidation, I guess and some of the other data points we've had recently from you know some product delays at Genzyme and some shutdowns there. Any comment on the manufacturing?

Marijn Dekkers

I think, it looked pretty, really stable, actually in Q2. So there weren't for us, not particularly wide swings.

Operator

Your next question comes from the line of Jon Wood from Bank of America. Please proceed.

Jon Wood - Bank of America/Merrill Lynch

Pete, obligatory free cash flow question here, it's tracking a little bit better than your guidance. Any updated or thoughts there?

Peter Wilver

No, the guidance we gave at our May meeting was to be in a range of $1.2 billion to $1.3 billion were basically half of that through half of the year. Obviously, we're expecting our revenues to go up in the second half of the year, which will consume some working capital all things being equal. So I think we're still in that $1.2 billion and $1.3 billion range.

Jon Wood - Bank of America/Merrill Lynch

Okay, understood. And then Marijn, from your comments, it sounds like the sequential improvement in the top 20 account base would have basically driven the entire up tick in the organic revenue trend from 1Q to 2Q. Yet it seems like the healthcare catalog got quite a bit better as well. So, what am I missing, did any product line or business get worse sequentially?

Marijn Dekkers

Well. Yes, sure. Sequentially, not by much no, maybe here and there a pocket, but you can think of the top 20 as a segment, right? Because, they buy pretty much across the Board from us.

Jon Wood - Bank of America/Merrill Lynch

All right.

Marijn Dekkers

So it's a customer group, it's just another slice of the pie, in a different dimension, but these customers buy everything from us, from the simplest [glass slide] to a mass spectrometer. So it's pretty consistent. Really the big difference, Jon, between Q1 and Q2 was that consumables got more robust, and that was pretty much true across the board of our consumables, but probably most pronounced in sort of healthcare-oriented consumables.

Jon Wood - Bank of America/Merrill Lynch

Understood. So, did the consumables growth build sequentially each month of the quarter, meaning like was June the strongest there?

Marijn Dekkers

Well, April was still weak. April, the whole quarter, if you would have asked me at the end of April, how does it look? I would have said it looks a lot like Q1. But once we were already mid-May in our analysts meeting in New York, we had a few weeks of clearly improvement on the consumables side behind us. That's why I made that comment there and that continued for the rest of the quarter. But April was nothing to write home about.

Jon Wood - Bank of America/Merrill Lynch

Okay, understood. And one last one. Just on the general comment on the M&A environment. Has it changed at all from your perspective either in terms of the size or number of opportunities you are looking at?

Marijn Dekkers

Well, it's hard to sort of define it as now it's getting better or now it's getting worse. But I think what's helping now is that people are beginning to realize that, okay, we had a significant retraction in values of the company, and everybody was going to weight that out to some extent. But now that markets have been stabilizing and it's clear that we're not going to jump back to [$14,000] any time soon.

I think companies are now probably becoming more open. If they had planned to be acquired anyway to say maybe this is not such a terrible time to do it. So who is going to sell at the absolute low point? Pretty much nobody. But now that things are stabilizing and valuations are stabilizing, people will say this is maybe not a bad time to begin to consider this.

So in that sense there will be more opportunities, in the next 6 to 12 months than there were in the last six months.

Operator

Our next question comes from the line of Jon Groberg from Macquarie Research. Please proceed.

Jon Groberg -- Macquarie Research

Just two questions; the first Pete it looks like, you are going to be about basically no net debt by the end of the year. And I didn't hear any reauthorization for a buy back. Is that something we should look forward to or are you assuming no buy-backs for the rest of the year?

Peter Wilver

Certainly we don't have any buy-backs assumed in our guidance for the rest of the year and we don't really talk about future authorizations, but you're correct, we do not have a new authorization in place.

Jon Groberg -- Macquarie Research

And then Marijn in the last quarter you helped walk us through this, and I haven't heard this exactly. When you think of instruments versus consumables and then kind of segment those, even a little bit further in terms of some of your higher end instruments versus your more routine instruments and same on the consumables, the more specialty reagents versus more routine. Can you break out how those went in the quarter, with a bit more granularity in terms of declines or rises?

Marijn Dekkers

Yes. Let me start on the instrument side. Actually it wasn't so much a high versus a low end, but it was more application-related, which is that, if the application was more industrially oriented, and it was weaker than if it was life sciences oriented. And I would say the only exception to that was food safety, which is obviously in my mind an industrial application that was doing quite well. But life sciences and clinical applications of instruments clearly stronger than industrial applications of instruments, with the exception of food quality.

Jon Groberg - Macquarie Research

And overall instrument I think in the first quarter you said were kind of down close to double-digits. Is that still the same case in this quarter?

Marijn Dekkers

Yeah, same thing, yeah. On the consumables it's clear that the higher-end consumables are doing better than the lower end consumables. That was the case in Q1, and also still in Q2, because people tend to de-stock on the lower end consumables. Because they will more quickly de-stock on a glass slide, box of glass slides than on some high-end reagents that are really critical to their application that they're working on in the lab, say, in research.

So it's a natural thing, the more routine it is, the more you say, okay, I can probably get this relatively quickly when I really run out of it, anyway. While a high science reagent might have a longer lead time and be more specific to your test, or its harder to go to the lab next door and see if they still have the product lying around there, so that you can borrow it. So lower end consumable's tougher than higher-end consumables.

Jon Groberg - Macquarie Research

And if you do the math for overall consumables, given what you said on instruments, kind of flattish then?

Marijn Dekkers

No, it was positive. We had some positive organic growth on low single-digits, but it was positive on the total consumable side.

Operator

And our next question comes from the line of Isaac Ro, from Leerink Swann. Please proceed.

Isaac Ro - Leerink Swann

I just had a thought on, or a question on how you look at gaining market share in this environment from two perspectives. On the one hand in Big Pharma it does seems like integration planning for the announced deals is perhaps progressing a bit faster than in previous merger. So I'm wondering are you already getting signs that you'll be a bigger vendor for the combined entities or is it perhaps too early.

And then secondly in the academic channel it does seems like a lot of this stimulus quotes and grant activity have been driven by demands specifically for existing products. And I know several of your competitors have new products that probably don't hit till the second half. So I'm wondering if there is an opportunity for you to also gain share in the academic channel when the first wave of stimulus money [hits].

Marijn Dekkers

Yes. Good questions. From a Big Pharma market share point of view we have been gaining share there for the last three years. And as I mentioned, we've outgrown the average growth of the company, with those top 20 accounts for, nine out of the last 10 quarters, with the exception of Q1.

So we are obviously taking the second very seriously, large pharma, because we think we have such a specific capability that they need really a very strong value proposition. And needless to say that when some of these customers are merging, we're right in front of them, explaining over and over again what our value proposition is; so we're hard on that.

On the academic side, we came out, as I mentioned, with two excellent new platforms at ASMS in Mass Spectrometry, and I did say in my comments, it couldn't have come at a better time, because we are ready to ship these products now and we are getting a lot of quoting done, which is very positive, and from a timing point of view, works out very well for us.

Isaac Ro - Leerink Swann

Okay. And then if you think about how you look at driving incremental margin improvement, does it make sense to maybe try and drive more of your business away from the distribution of other vendors' product and if so, how do you achieve that most efficiently? Is it through the acquisition of some of your vendors, or do you maybe replace them with your own internal development efforts?

Marijn Dekkers

Well, it's obvious that if we are able to sell a product that we manufacture ourselves, our margins are higher than when we get that product from a third party supplier. So that's clear. And where we have a possibility and some controlled way, we may promote that to some extent.

On the other hand, we are also providing our customers with choice. We carry in the catalogs of every product, three to four different brands, and most of them are third-party brands. So, it's very, very important through the catalogs to promote third-party products.

Operator

Our next question comes from the line of Peter Lawson from Thomas Weisel. Please proceed.

Peter Lawson - Thomas Weisel Partners

Marijn, I wonder if you could just talk to the strength you saw in the specialty diagnostic business.

Marijn Dekkers

Yes, obviously the strength in specialty diagnostics areas like anatomical pathology, microbiology are key for US, and I would say specifically [stood out] microbiology because of the flu situation in the second quarter. Second quarter is normally a weak flu season, but this quarter it was exceptionally strong because of H1N1. So microbiology stood out in specialty diagnostics.

Peter Lawson - Thomas Weisel Partners

Have you seen other areas of strength in that hospital end market such as capital spending?

Marijn Dekkers

No, I wouldn't say that there are other areas of specific strengths, no. I would still say that instruments are under pressure as well. And diagnostic instrumentation is under pressure more so than the consumables in the hospital end markets.

Peter Lawson - Thomas Weisel Partners

And what were the countries driving the growth in the rest of the world?

Peter Wilver

Just a bunch of small countries. That comprises primarily Latin America would be the most of the countries in that grouping. So operator we have time for one more question.

Operator

Okay. Sir, the next question comes from the line of Doug Schenkel from Cowen & Company. Please proceed.

Doug Schenkel - Cowen & Company

Just a few -- I think fairly quick follow-ups. You talked about consumables improving over the course of the second quarter. When did de-stocking start to improve specifically and how material was the impact of that on Q2 results? I was trying to see if the improving in de-stocking was a material impact, beneficial impact on Q2, or is this something that, that should start to become more material heading into the second half?

Marijn Dekkers

Well, you know, we can't really completely put our fingers on that, because when we don't get orders we're not going to ask every single customer, is it because of destocking or you're not doing experiments anymore. But I would say that, as I mentioned, consumables started to get better early May, and so in the quarter we had, two good months of better months while we still had a weak April. And, therefore, I would say that probably destocking started to improve in May.

Doug Schenkel - Cowen & Company

Okay.

Marijn Dekkers

And then how exactly that helps us from a revenue point of view is very difficult to pinpoint, but it is helpful. Peter can you make a guess?

Peter Wilver

No, sequentially it's something less than a percent. We had a 1% impact, because of destocking in the first quarter, it was maybe a 0.5% in the second quarter, and if things continue then we would say that would probably go away as a discussion point in Q3.

Doug Schenkel - Cowen & Company

Okay. And then a follow-up I think to one of Derik's earlier questions regarding industrial. I know you said it's not guidance, but you did talk about the potential for a Q4 rebound in the industrial end market. You're not simply talking about improving growth optics as a result of favorable comps you're actually talking about an increase in demand sequentially. Is that correct?

Marijn Dekkers

Well, we were at the bottom now. We will have a relatively easy comp in Q4 from an industrial point of view. So I would be talking both.

Doug Schenkel - Cowen & Company

Okay. And then last question, you clearly reiterated your previous full year organic sales growth guidance. You put up a really solid Q2, at least a bit better than I think what most in the street were looking for. Does this imply that given that you didn't increase the sales growth guidance for the year on an organic basis, does it imply that Q2 is as expected for you guys, or was Q2 a little bit better than what you guys had expected similar to what the street was looking for?

Marijn Dekkers

I think it was pretty much in line with what we expected from an organic growth point of view. Of course, we weren't sure on the consumables side, but logic would have it that people can't keep destocking forever. So, with all of the gives and takes in a company that has $10 billion of revenue annually, it came out pretty close to where we thought it would be.

Doug Schenkel - Cowen & Company

Great. Thanks a lot.

Marijn Dekkers

Okay. Thank you very much. So just in closing, thank you for being on the call today. I think you must be clear that we continue to manage through the economic headwinds, and that we believe the worst is behind us, in terms of the economic effect on Thermo Fisher Scientific.

We continue to focus both on productivity and strategic investments because I want to reiterate again that our number one objective is to emerge from this period as an even stronger industry leader. So thank you all for listening to the call today, and for your continued support of Thermo Fisher. Thank you.

Operator

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

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Source: Thermo Fisher Scientific, Inc. Q2 2009 Earnings Call Transcript
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