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Thermo Fisher Scientific, Inc. (NYSE:TMO)

Q3 2009 Earnings Call

October 22, 2009 8:30 am ET

Executives

Kenneth Apicerno - VP of IR

Marc Casper - President and CEO

Peter Wilver - SVP and CFO

Analysts

Ross Muken - Deutsche Bank

Quintin Lai - Robert W. Baird

Derik De Bruin - UBS

Tycho Peterson - JPMorgan

Jon Groberg - Macquarie Research

Marshall Urist - Morgan Stanley

Doug Schenkel - Cowen & Company

Isaac Ro - Leerink Swann

Peter Lawson - Thomas Weisel Partners

Rob Hawkins - Stifel Nicolaus

Operator

Good morning, ladies and gentlemen and welcome to the Thermo Fisher Scientific Third Quarter 2009 Earnings Call. I would like to introduce a moderator for the call Mr. Kenneth Apicerno Vice President, Investor Relations. Mr. Apicerno, you may begin the call.

Kenneth Apicerno

On the call today with me is Marc Casper, our President and Chief Executive Officer and Peter Wilver, Senior Vice President and Chief Financial Officer.

Please be aware that this call is being webcast live and will be archived on our website, thermofisher.com, until November 20, 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 third quarter 2009 earnings and future expectations is available in the Investors section of our website, under the heading Financial Results.

Let me start by briefly covering the Safe Harbor statement. Various remarks that we may make about the company's future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the company's Form 10-Q for the quarter ended June 27, 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 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 the call today, we will be referring to certain financial measures not prepared in accordance with Generally Accepted Accounting Principles or GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release of our third 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 would like to now turn the call over to Marc.

Marc Casper

Thanks for joining our third quarter earnings call. I am Marc Casper, President and CEO of Thermo Fisher, as of October 15th. I just want to take a minute to say that I am honored to step into this role, excited about the opportunities we have, as the world leader in serving science, and ready to lead our company to achieve our goals for long-term growth, with the support of course of our 35,000 employees around the world.

I would also like to thank Marijn Dekkers for all that he has done for Thermo Fisher and for me personally. We have worked together closely over the past eight years developing and executing the company strategy, and I appreciate the support and the opportunities he has given me along the way. He is handed over a company that is built on the solid foundation with many exciting growth prospects that we only begun to tap. I wish Marijn the best as he takes on the top job at Bayer.

Turning to our Q3 performance, I will review our financials at a high level, give you a sense of what we are seeing in our markets at this point in the year, and highlight a few of the growth opportunities that are helping us to create long-term shareholder value.

First the financials, to sum up our Q3 results, we are extremely pleased to report a continued trend of improving revenue and operating performance as the year has progressed. Our results came in very much as we expected keeping us solidly on track to achieve our financial goals for 2009.

Our reported revenues declined by 2% compared with a year ago quarter. Organic revenues also declined 2%, however this was an improvement over the minus 5% we recorded in Q2 of this year. Although we haven't seen significant changes in the capital side of our business yet, we do believe the worst is behind us.

Sales of consumables on the other hand are recovering nicely and getting progressively better every quarter. In Q3, sales of consumables grew better than 5% organically, compared with the 1% organic growth, we reported in Q2. This was a major contributor to our overall revenue improvements for the company.

We've also been able to leverage the top line to deliver good sequential margin improvement. Compared with Q2, we improved our adjusted operating margin by 50 basis points to 17.3%. We're especially pleased that we were able to deliver adjusted EPS growth, on both the sequential and year-to-year basis, with 4% growth in adjusted EPS over our 2008 results.

Two primary factors led to our improved profitability. First, the increasing sales of consumables were key contributors. Second, the cost cutting actions that we began to implement, at around this time last year, are really taking hold.

This included selective layoffs, furloughs, and site consolidation in certain parts of the company, along with tight controls around discretionary spending company-wide. These were difficult decisions and very carefully weighed, but I believe they were the right thing to do to ensure the long-term strength of the company.

Of course, we have a culture of continuous improvement from PPI, our Practical Process Improvement program. This continues to create an ongoing focus on productivity improvement for employees that has reflected in our results as well.

Finally, we delivered on another strong quarter of free cash flow, totaling $346 million, which is near record levels. So, our business model continues to generate a tremendous amount of cash. We continue to use our cash to invest for growth in the long-term, and our acquisition of B.R.A.H.M.S. AG in the third quarter, which I'll talk about more in a few minutes, is a great example of that.

Let me now turn to a brief update on our TN market, and what we’re seeing from our primary customer base.

In biopharma market, the key takeaway is sequential improvement. The overall softness that we experienced with our large pharma customers is clearly abating, and we continue to see steady improvement since the beginning of the year.

In Q2, we told you that growth in our top 20 accounts was well in the mid-single digits. I’m pleased to report that we doubled that performance in Q3.

Long-term, we’re confident that our leading position in the industry and our strong relationships with key account offers us a significant opportunity to serve these customers in a way that nobody else in our space can.

The tougher economic climate has actually been a good catalyst for change, that should benefit our business model, which is based on more effective purchasing through our breadth of products and services and easier access to our extensive commercial channels.

In addition, we saw a nice uptick in our BioProcess Container and Media businesses and sales of our BioReagents for life science research was also strong.

Turning to government and academic markets, it’s apparent that were innovations really makes a difference, our customers are managing to find the money to buy these products in spite of the economy. We had an excellent quarter in sales of mass spectrometry systems for life science research.

As I mentioned before, we believe that roughly half of all mass spectrometry grants tie to stimulus programs have been written around our technology. This can also play out well for sales of our reagents and consumables, since they will be needed to support new mass spec installations over the long-term.

Government stimulus is definitely a bright spot on the horizon, but it’s hard to predict exactly when the bulk of the monies will start to flow. So far, we haven’t seen much here in the US, although some grant money is trickling in. Our customers are confident they will be getting these funds, and we should see some activity in Q4. We expect the stimulus programs to benefit us most in 2010, and we remain confident that it's a $100 million to $200 million opportunity globally for Thermo Fisher over 12 months.

In addition, we have already seen some activity from stimulus programs in China and Japan, particularly around air quality, food safety and forensic applications. So, these geographies offer another opportunity for positive growth momentum.

In healthcare markets, we saw more stability this quarter than earlier in the year, as evidenced by much stronger sales of consumables to hospitals through our healthcare catalog. Also the H1N1 flu has led to a ramp up in sales of test kits provided by our microbiology and healthcare catalog businesses.

Last, industrial markets are relatively stable, similar to what we saw last quarter. We do believe that we have seen the worst and that these markets have leveled off, albeit at a much, much lower level of activity.

At the moment, we anticipate more of the same in Q4. We expect to begin seeing some signs of a pick up in 2010, and the comparisons will certainly get easier then. Let me mention that certain applied markets such as food safety continue to be the bright spot here, as we have seen throughout the year. So, overall no dramatic changes in our key end-markets.

Now I would like to shift gears and talk about some of the highlights this quarter in our key long-term growth drivers. When you really think about our capabilities, we have an incredible unique combination all-in-one company.

One, an unmatched breadth of technologies, second, extensive geographic presence and third, the resources that come with size and scale. It's this combination that differentiates us in our space and fuels our prospects for growth. I am excited about continuing our strategy by building on the strength, as well as the solid foundation we have already established.

Let me give you some examples. First, technology innovation continues to be one of our most important growth drivers. We talked last quarter about the launch of our new Thermo Scientific LTQ Velos mass spectrometry platform, which includes our flagship Velos ion trap and Velos Orbitrap systems.

I visited the customer, who installed our first Velos system to get his feedback and I can honestly tell you, that he was raving about what this technology is doing for the field of mass spectrometry, especially proteomics. He actually thanked us for developing Velos, because the amount of data in inside is researchers are able to clean from this level of analysis is quite remarkable.

I am pleased to report that shipments of the new Velos platform since the June introduction at ASMS have been very strong and we expect orders to continue to accelerate, even beyond the introduction of Velos, our Orbitrap platform continues to dominate this market.

We also focus of strengthening our presence outside of life sciences to more routine applications for our technology, such as food safety and clinical applications.

The second key growth driver is Asia, where we continue to increase our market leading presence, especially in China and India. Just to remind you we have nearly a 1,000 employees in China today and although we are one of the largest players there in our space, we still have a lot of opportunity for continued growth in the region.

As I mentioned earlier, we are seeing steady activity in air quality and food safety, some of which is related to government stimulus. During the quarter, our air quality business secured multiple large orders, continuous monitoring stations as part of the China National Air Quality Monitoring Network.

In food safety, we were awarded for our role and helping Chinese laboratories quickly develop capabilities for detecting Melamine in milk and baby formula. [Quarters] have been very strong for us all year from state and local laboratories that need to comply with food quality standards mandated by Chinese version of the FDA.

To sum it up, we were pleased to report revenue growth in the high-teens in China during Q3, despite of very difficult comparison with the year-ago period.

The third important element of our growth plan is our ability to make strategic acquisitions that complement our broad portfolio of technologies, the most recent being our additional of B.R.A.H.M.S. AG, a leading provider of specialty in-vitro diagnostic tests. The business is based in Berlin with 2008 revenues of about $105 million and approximately 400 employees.

B.R.A.H.M.S. tests are based on patented biomarkers for diagnosing various infections and disease. It's a very exciting business, probably best known today for its premier product, Procalcitonin or PCT, which is a biomarker for the early detection of sepsis.

Sepsis is a life-threatening condition, in which a patient's bloodstream is overtaken by bacteria. The PCT test has become the gold standard in Europe, and with recent FDA clearance, we plan to extend its use for the US market through our extensive channels here.

By leveraging our diagnostic sales force and our healthcare market catalog, we have the ability to grow this business at a very rapid pace, with little incremental investment in commercial infrastructure.

B.R.A.H.M.S. also has a robust pipeline of proprietary biomarker tests in development for various heart conditions as well as neurological disorders. Let me remind you that our goal in diagnostics is not to compete with the broad suppliers, but to pick the specialty segment with attractive margins where we can be the clear leader and B.R.A.H.M.S. is perfectly into that strategy.

I'll also mention here that our integration of Biolab, the leading laboratory channel in Australia and New Zealand is going very well, since we completed that acquisition in Q2. This is a great example of our strategy to expand geographically in this part of our business.

To wrap up, let me give you an update on our guidance for 2009, which we’ve refined now that we’re in the last quarter of the year. We are raising the midpoint of our annual revenue guidance and narrowing the range to $9.95 billion to $10.05 billion, which would be a decline of 4% to 5% from our 2008 results. This includes the negative effect of currency exchange and also includes the B.R.A.H.M.S. acquisition.

We are also raising the midpoint of our adjusted EPS guidance and narrowing the range by $0.15 to a new range of $2.95 to $3.05, which would lead to a 3% to 6% decrease from our 2008 results of $3.13.

So to summarize, I feel good about the progress we’ve made this year, especially our ability to return to adjusted EPS growth in spite of the top-line pressure. Sales of consumables are growing again. This along with the prudent actions we’ve taken to control costs positions us well to meet our financial goals for the year.

With that, I’ll now turn the call to Pete Wilver, our CFO, for his detailed reviews of the financials. Pete?

Peter Wilver

Thanks, Marc. Good morning, everyone. As Marc said, our operating performance again improved significantly in the third quarter, despite continuing difficult economic conditions that affected our year-over-year comparisons. We’re especially pleased to have delivered positive growth and adjusted EPS in the quarter, reporting $0.78 in adjusted EPS or 4% growth compared to $0.75 last year. GAAP EPS in Q3 was $0.53, up from $0.50 in the prior year’s quarter.

Moving on to the details of our financial results, reported revenues in Q3 declined 2% year-over-year to $2.53 billion. Organic revenues also declined 2% in the quarter, excluding foreign currency translation of negative 2% and positive 2% from acquisitions.

Our results in Q3 continued our trend of good sequential improvement in organic revenue growth, driven primarily by mid single-digit organic growth in consumables. Bookings in the quarter were essentially inline with revenues.

By segment, Analytical Technologies' Q3 revenues declined 6% on a reported basis and 4% organically. In the quarter demand across our instrumentation businesses, particularly those serving industrial markets continue to be weak, although we did see sequential improvement over the second quarter.

On a further positive note, our Specialty Diagnostics and Biosciences business had solid growth and new products continue to drive growth, specifically in our scientific instruments product line as Marc mentioned in his comments.

In the Laboratory Products and Services Segment, Q3 revenues grew 1% on both the reported and organic basis. During the quarter, we saw consumables growth return to prerecession levels. This was partially offset by continued weakness in our routine laboratory equipment business, although the year-over-year declines slowed from what we saw in Q2.

Looking at organic revenue growth by geography, Asia-Pac grew in the low single-digits against the very tough comparison of growth in the mid-teens last year. Both North America and Europe declined at about the company average, and the rest of the world declined high single-digits against a very tough comparison of almost 40% growth in the prior year.

Turning to adjusted operating income, Q3 decreased 4% year-over-year to $437 million. Adjusted operating margin was 17.3%, down from 17.5% in the year ago quarter, but the good news is that the decline was just 20 basis points.

The year-over-year margin contraction resulted primarily from pull-through on the organic volume decline at marginal rates, partially offset by favorable pricing actions, strong cost controls and infrastructure reduction actions as well as our global sourcing and practical process improvement efforts.

Adjusted operating margin again showed considerable improvement sequentially, up 50 basis points from Q2, as revenue strengthened and our cost reduction actions continue to take hold.

By segment, Analytical Technologies Q3 adjusted operating income decreased by 11% year-over-year and adjusted operating margin was 19.9%, down a 120 basis points versus 21.1% last year. Laboratory Products and Services Q3 adjusted operating income increased by 4% and adjusted operating margin was 14.4%, up 40 basis points versus 14% in the 2008 quarter.

Moving to the details of the P&L, total company adjusted gross margin was 41.2% in Q3, up 10 basis points from the year ago quarter. This was primarily result of increased prices and our global sourcing and cost reduction initiatives partially offset by the impact of lower volume.

Adjusted SG&A was 21.5% of revenue in Q3, up 30 basis points from 21.2% in the year ago quarter as cost controls and cost reduction actions were offset by negative volume leverage and slightly higher stock-compensation expense.

R&D expense was 2.4% of revenue in Q3, flat with last year. We intend to maintain our spending level for technology development consistent with 2008 to ensure that we preserve our new product pipeline to drive future growth.

During Q3, we maintained our program of tight discretionary cost controls and have continued to implement 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 the 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 opportunities to ensure we are positioned to emerge from the recession, as an even stronger industry leader.

Moving below the line, our Q3 adjusted net interest expense increased $2 million year-over-year to $27 million, as a much less favorable interest income environment more than offset a $600 million reduction in our net debt. Other income was a gain of $1 million, up $3 million from last year, primary as a result of lower currency transaction losses on foreign entity cash.

Our adjusted tax rate for the quarter was 20% flat with Q2 and down three points from Q3 2008. The lower tax rate versus last year resulted primarily from the tax planning that we implemented during the second half of 2008, and, so far, this year along with lower overall pre-tax income, particularly in high tax jurisdictions.

Average diluted shares were 420 million in the quarter, down 18 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 a lower stock price.

Our cash flow performance remains very strong. Year-to-date, free cash flow from continuing ops exceeded $1 billion after deducting net capital expenditures of $116 million. Year-to-date, free cash flow was up a $194 million versus 2008, primarily as a result of lower working capital.

We ended the quarter with $1.76 billion in cash and investments, up $330 million from Q2, primarily as a result of our free cash flow. Our total debt was $2.02 billion, essentially flat with Q2. Shortly after quarter end, we closed down the B.R.A.H.M.S. acquisition, which we funded with 450 million of our European cash. We also assumed about $30 million of debt.

With regard to working capital, we had a good performance in the quarter, given the economic climate. Account receivable day sales outstanding was 53 days, down one day from the prior year and flat with Q2 and inventory days of supply was 71 days, down three days from the prior year and down two days sequentially from Q2.

Moving on to our 2009 guidance, we’re raising the midpoint and narrowing our reported revenue guidance from a range of $9.80 billion to $10.10 billion to a range of $9.95 billion to $10.05 billion. The increase in the midpoint from our previous guidance is primarily as a result of more favorable foreign currency translation and the addition of the B.R.A.H.M.S acquisition.

Our guidance assumes present foreign currency exchange rates, which are negatively affecting our reported revenue growth guidance by about 2%, but also assumes about 1.5% net growth from past acquisitions and divestitures.

This new range represents a decline of 4% to 5% compared to our 2008 reported revenues of $10.5 billion. On an organic basis, our new full year revenue guidance translates to a decline of about 4%, which remains within the previous guidance range of negative 2% to negative 5%.

In terms of adjusted EPS, we are raising the low end of our previous guidance by $0.10 and lowering the high end by $0.05, resulting in a higher midpoint and a much narrower range of $2.95 to $3.05, compared to our previous guidance range of $2.85 to $3.10. This range represents a 3% to 6% decline compared to our 2008 adjusted EPS of $3.13.

In interpreting our revenue and adjusted EPS guidance ranges, 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 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 uses of capital.

In summary, we have been delivering strong sequential improvement in our operating performance through the year, which positions us well to achieve our 2009 financial goals. We continue to believe for striking the right balance between cost reductions and strategic investments, and as a result are well-position to emerge in this period as an even stronger industry leader.

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 of Deutsche Bank. Please proceed.

Ross Muken - Deutsche Bank

I want to start off by saying congrats, Marc on the new position. I speak for broad audience given the e-mail flow; you did pretty well on your first official conference call. In terms of the commentary, it seems like the general theme is stability to improvement across most of the end market.

So, I guess certainly these were good numbers and the consumables being up, where they were. It is pretty encouraging going forward. So, I guess the key point at least that I'm focused on is the trajectory of more of the equipment and instrumentation businesses. If we look to other reports across the third quarter, it seems like a lot of the early cycle companies are starting to see some general interest.

How far do you think you lag across the different businesses and wherever you start to see activity first? So that the commentary on some of the industrial market isn't very, very slow or slight improvement as opposed to more significant and in turn how do you the activity you’re seeing of the order rates or whatever the sales force is saying. How is that comparing to the last cycle we came out of, I know its tough because this was a much deeper decline, but I'm just trying to get a sense for, where you think we are and when you think we'll have more visibility to an improvement and what business units we'll see at first?

Marc Casper

As I think about the industrial end markets and the focus on the capital equipment side of things, clearly these are segments from an economic cycle that are going to lag by at least a couple of quarters. So, you need to be in a strengthening economy and then you start to see the effects of capital flow into these types of products in our instrumentation and then especially both instrumentation that are related to capacity expansion.

So, they definitely a lagging general economic cycle and that we've known over the many, many years in one of these businesses. When we look at that today, clearly we see the fourth quarter looking very similar to the third quarter in terms of low levels of activity. The comparisons get easier in 2010, but right now we are not forecasting a very robust economy.

So, you are going to have easier comparisons, but we are still waiting for more GDP-driven economic growth to really drive that demand. As and everything, there were certain applied market that are doing well. Food safety has been the nice driver for us even in the difficult environment. Around the world we've seen a lot of demand in that area.

More broadly in our instrumentation business, mass spectrometry as I mentioned in my prepared remarks continues to do well despite the fact that those are high priced in terms of ticket prices for those instruments often selling at a $0.5 million. We've had very good demand for them, because the innovation there is just so incredibly profound. So from that perspective, a few bright spots, but we're looking at certainly not until 2010 to see easier comparisons in the industrial customer base.

Operator

Your next question comes from the line of Quintin Lai of Robert W. Baird. Please proceed.

Quintin Lai - Robert W. Baird

With respect to just maybe a higher level, we see more acquisition-based strategies showing up like Agilent and Danaher coming into this space. Marc, from a high level, what are some of the challenges that you see as Thermo for the next few years and with respect to like M&A? Then kind of as a follow-up to that, tell us a little bit about B.R.A.H.M.S and what attracted you to that segment?

Marc Casper

So as I look at the acquisition landscape, which has clearly accelerated over the last couple of quarters, I think it's probably useful to say first how do we think about M&A and how do we evaluate M&A and then talk more about the broader landscape.

When you look at our M&A strategy, the first thing that we look at is, does doing an acquisition strengthen the company's offering for our customers? Does adding a capability make a meaningful difference for our customers?

If the answer is clearly, yes, to that question, we come to the second question, which is of very, very significant importance, which is, can we generate significant shareholder returns on that use of capital?

If the answer to that is, you then come down to the question of availability and those things, but we use a filter. We don’t need to get bigger for the sense of bigger, but we do look at deals actively to strengthen our company’s offering to our customers and generate returns for our shareholders. So that’s the high level view.

B.R.A.H.M.S fits very, very well within those criteria. We have an excellent set of capabilities in specialty diagnostics. We have leadership positions in the niches that we play. We have incredible reach to the market through our direct sales force, through our OEM relationships, through our healthcare channel business.

When you look at B.R.A.H.M.S., they have not only a product that’s going to be commercialized in the US after building a nice set of momentum in Europe and we have incredible reach to the market, but they have a very attractive R&D pipeline with their biomarkers, which gives us not only the ability to generate short to mid-term growth but also to have long-term growth from that acquisitions. So we feel very good about an acquisition like B.R.A.H.M.S.

Operator

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

Derik De Bruin - UBS

Pete, did you comment on the equipment organic revenue growth rate and, I guess, could you differentiate between the industrial and life sciences growth of businesses?

Peter Wilver

We didn’t say what the equipment growth rate was, but it certainly is better than Q2. In Q2, we reported mid-teens decline and it was more like high single-digit decline, in Q3. So, it improved as well as the consumables. I don't really have a differentiation between the industrial versus the life science, but certainly the industrial getting hit a lot harder on the life sciences side.

Derik De Bruin - UBS

I guess one other question like on the equipment space. You commented on the mass spec shipments in the quarter, were all those recognized during the quarter that you shipped?

Marc Casper

When you look at, when we say shipments, those will be recognized.

Derik De Bruin - UBS

I think some of your competitors have been coming on the Orbitrap, then that is going after with some of the new products launches. Could you talk about what you’re seeing the dynamics in end market, is there pricing pressure? I guess, I was pretty taken by the comment that you felt like half of the stimulus grants on mass spec, that were using mass spec (inaudible). Could you just give us a little bit of more color on that comment, in terms of how you get that and just the overall pricing environment, what you’re seeing in the competitive landscape in that space?

Marc Casper

As you look first of all, we had a very exciting launches at the American Society of Mass Spectrometry conference in June. That translated in to very quick pickup in bookings and ultimately shipments because the product was ready to go and that helped our results in the quarter that we just reported.

Really within those orders and shipments, there was nothing that came from stimulus in those numbers, so that's a positive on the horizon. Our view on that is probably more meaningful in 2010 than in the fourth quarter. We've done surveys. We have read surveys. We talk to our customers. We've written and helped write a lot of grants. So, we have a pretty good sense of what's going on in the mass spectrometry landscape.

When you look at the number of grants written, about half it appears were written around our technology. So, we feel good about that and we feel good about the fact that our customers even the [early read] is that the technology is so profound that even those customers pre-stimulus money is actually going out and buying these product. So we always, we keep a close eye on the competition. We've got good tough competitors, but the [early read] is not a surprise to us, which is our product looks to be very, very well received in the market.

Operator

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

Tycho Peterson - JPMorgan

Maybe just a question on the consumable performance, I mean, obviously, you've seen some good strength here sequentially throughout the year. Can you just comment on how much of this is, is market related versus share shift and also maybe if you can add some comment about mix whether you’re emphasizing consumables a little bit more? I think based on your comments on the top 20 pharma or biopharma accounts, it seems like obviously you’re pulling a lot of shares. So, just wondering if that’s accelerated in the past couple quarters?

Marc Casper

When you look at the consumable performance, we clearly had strengthening in the hospital customer base. Part of that is driven by preparation for H1N1 and that helps both microbiology and our healthcare businesses. We also saw a strength within biopharma customers, particularly in both our life science research, reagents as well as our BioProcess, media and plastic containers, sterile containers, if you will.

So we saw a nice pickup in both biopharma and hospitals. We are not emphasizing consumables more than capital equipment. So, it’s less flat and consumables are more reflective that activity is starting to pick up at the customer level, but the capital budgets still remain tight.

Peter Wilver

The one other data point is flu came in significant stronger than we had expected. We picked up almost $20 million in revenue incremental year-over-year in flu in Q3. So, obviously, that was a nice benefit to the organic growth rate.

Tycho Peterson - JPMorgan

Then just on the acquisition question you had before. Is it fair to assume diagnostics are going to continue to be kind of a focus area given B.R.A.H.M.S and your comments previously?

Marc Casper

As you look at the company, we like our growth platforms, the six growth platforms that we have very much, and that's our customer channels and our lab products and services, as well as biopharma service, analytical instruments, specialty diagnostics and bioscience reagents. So I think you should look at us not favoring one of our six children more than another if you will, but looking at the right things to strengthen our offering.

We really do like those businesses. There was a great opportunity in specialty diagnostics. So, we made a meaningful acquisition last quarter, but the quarter before when we brought Biolab was a great acquisition for our customer channels business and has a same type of rationale of strengthening our competitiveness and we made a move there.

Larger deals are clearly going to be focused on analytical instruments, bioscience, the specialty diagnostics, the bolt-on would be more in the lab products and services if you want to think about size of transactions. You are going to see larger emphasis if they become available on the higher tech portion of our company.

Operator

Your next question comes from the line of Jon Groberg with Macquarie. Please proceed.

Jon Groberg - Macquarie Research

Just a follow-up on the consumable question, that was actually where I was going to go. The flu obviously is maybe not repeatable, hospitals were severely destocking until the first six months of the year, so there is some restocking going on. So I guess question is, how confident are you that this kind of getting back to average or above average growth of north of 5% is sustainable?

Marc Casper

When we look at the hospital portion and whole flu side for a moment, we don’t believe that there was a big restocking activity that went on in the period but more representative of usage, Jon, in terms of what happened. A number of our team went out and talked to customers about what they are doing, including me going to a couple of our large customers and let’s say, what was going on from the behavioral standpoint. Clearly, they took inventory levels down, but nobody is in a rush to rebuild inventory.

I don’t expect that really to happen in a meaningful way at any point in time. I think customers are just going to expect suppliers to meet their needs and not have to carry buffers on site. So that’s what I think about that issue.

In terms of sustainability, our view on flu is that the fourth quarter is likely to be at least comparable to last year which was a strong flu quarter, if not better, because you have two different strains of flu going on out there. So that should be a continuation and then obviously, it’s hard to predict what it means for the future getting beyond Q4 in terms of what flu represents.

Jon Groberg - Macquarie Research

So year-over-year, if I were to extrapolate, it would be, you don’t really see restocking more usage related. The flu obviously is a bit of a wild card, but, on the other, you think it is more, you’re kind of stabilizing at this level in terms of usage and it’s not necessary that restocking that’s going on in the quarter?

Marc Casper

I did.

Jon Groberg - Macquarie Research

Then, Pete, service revenue has actually been more mechanized under the radar in terms of growth. I know it’s actually been kind of weak. Did you see any improvement there in terms of may be some utilization coming back online or what’s going on in the service revenues?

Peter Wilver

Yes. Actually, service revenue was probably the one low point in the quarter. We saw mid-single-digits decline in service versus low single digits in the first and second quarter. So it actually deteriorated a little bit, some of that was just a tougher comp in Q3. The areas of weakness were really the industrial side of our equipment business. Those service revenues are particularly weak right now.

We are also seeing little bit of reluctance on the part of our biopharma customers to do large outsourcing projects, which is impacting some of our biopharma services business. So I think this is not necessarily indicative of our new trend here, it’s probably one of the weakest data point we expect to see, but certainly a little bit of a disappointment for us this quarter.

Operator

Your next question comes from the line of Marshall Urist with Morgan Stanley. Please proceed.

Marshall Urist - Morgan Stanley

So a few questions, lot of questions on consumables. I just wanted to confirm one point here. Last quarter you guys had talked about things getting better throughout the quarter on the consumable side. So, is that 5% number you talked about, is that sort of stabilizing here and was that sort of consistent through the quarter or were things still improving?

Marc Casper

I would say consistent through the quarter when we were doing investor conferences in about a month ago. Our view then is pretty much our view now is. What we saw throughout the quarter was pretty consistent and that resulted in a 5% roughly organic growth for consumables.

Marshall Urist - Morgan Stanley

Then second question is when you start to think about next year, cost cutting and furlough programs you guys have put in place. How much do you guys think if things start to get better next year, both organically and then also just on comps I guess too. To what extent, are you guys happy with where the cost structure is now and sort of how much upside will can we think about flowing through from the big picture perspective versus places you guys feel like you’ve held back and then want to reinvest as we said the thing about 2010?

Marc Casper

I think we are happy with the cost structure for the level of revenue that we are at today. The wild card for 2010 is obviously things like you just said the furloughs and some of the more discretionary type cost controls, which are durable in the short-term, but long-term you can't just cut out all travel and those types of things. So some of that is going to come back into the P&L in 2010, assuming that we have even really if stay at the revenue levels that we are today.

So we are going to get some headwind from that. In terms of investing incrementally to that, I think it will in synch with what we see in terms of revenue. As revenues start to creep up, we'll reinvest in the areas that we think we need to invest in. So that won't be a drag to the P&L. It will really just be those things that were sort of artificial in 2009.

Marshall Urist - Morgan Stanley

In anyway you can quantify that or sort of help us to think about how much of the headwind that is?

Peter Wilver

In terms of the discretionary and the furloughs, it’s probably something in the range of 30 to 40 basis points of headwind depending on how that plays out.

Operator

Your next question comes from the line of Doug Schenkel from Cowen & Company. Please proceed.

Doug Schenkel - Cowen & Company

So again you guys got a stimulus benefits to about $100 million to $200 million over the next 12 months. It sounds like that's a worldwide number. Any chance you would give us any details on what you think the US contribution can be? I guess as part of the question or part of answering the question, could you may be talk about what of that is instruments and infrastructure versus consumables?

Marc Casper

In terms of the details of that number, that that's obviously a very, very high level number and at this point, we don't have it at that level of detail in terms of the forecast. It is very difficult even on an actual basis to know what those numbers are.

Doug Schenkel - Cowen & Company

Would it be fair to assume that maybe it’s a with all easier to take a look at instruments and infrastructure and that the consumable side is a little more squishy because it takes a little longer to flow through?

Marc Casper

Certainly, the equipment and instrument side of the equation is pretty easily identifiable, but the other piece is pretty tough.

Doug Schenkel - Cowen & Company

We’ve talked about this a few times already, but you guys had a good consumables quarter. I was wondering if there was potentially any negative impact on consumables in the quarter from having a late Labor Day, especially on the research side? Maybe I can just ask one cleanup and I'll get back in the queue as a follow-up, what were the days comparisons in the third quarter and what does that look like in the fourth quarter? Thank you.

Marc Casper

Sure. In the third quarter, the days were the same as last year, so no impact and we don’t believe that the late Labor Day had any material impact on the numbers. In Q4, we pick up a one day year-over-year.

Operator

Your next question comes from the line of Isaac Ro of Leerink Swann. Please proceed.

Isaac Ro - Leerink Swann

I just wanted to think a little bit for a minute about the longer-term opportunities for Thermo as you kind of take the helm here. Specifically looking at expansion of overseas, distribution and assets, that's been a theme this year, I'm wondering in terms of your M&A activity. I'm wondering if you see any specific emerging markets where making cross-border type acquisitions are particularly challenging versus others, and, as a result, how does that inform you plans to sort of to grow the business on a build versus buy approach?

Marc Casper

As we look at our expansion geographically, we always start with the build versus buy and which is going to generate the best shareholder returns you’re often trading off a time to market versus a large upfront capital outlay on a relative basis. We do that trade-off each case and then you also look at the environmental, and say, if you wanted to do a buy strategy to jump start growth, are there available assets that could really help you and is the environment that felt good about it.

We have been comfortable doing some M&A in India in terms of how we’ve approached it and we brought some good companies that have helped us there. Obviously, we’re comfortable in Australia and New Zealand and we’ve done the same small deal in Malaysia. So there’ve been a number of markets that we have gone in and out. There are also market that we have been much more of develop at yourself.

China is an example where very dramatic investments are building our infrastructure in terms of make versus buy. We’ve supplemented a lot of our acquisitions and India was very heavy investments to build our capabilities. In a country like Ireland, certainly not Asia, we chose to do a make strategy and really build out our presence there from the ground up.

Isaac Ro - Leerink Swann

Then if you think about the relative opportunity in the long run for India, obviously China has been a great market for you, but I’m wondering does India present the same type of opportunity over the long run, given the footprint maybe in the generic field and maybe future growth biosimilars, that kind of thing or do you see still China is sort of your larger opportunity?

Marc Casper

I think both are very significant opportunities for the company. They have different emphasis points. India is clearly much more of a life science orientation to what our business is developing to be and China is much more balanced in terms of having a reasonably high industrial safety quality focus. So you also have life science demand, but you also have a lot of demand for things like quality monitoring, process instruments, portable analyzers, lot of infrastructure support and quality support.

So in a way it's growing a little bit more quickly, because you are firing on more cylinders than just life sciences, but we are very excited about the long-term prospects for India because of the life science investment, that's clearly going to go on there.

Isaac Ro - Leerink Swann

Last question, I'll ask here is on the mass spec side. Some of your major competitors are influx right now with M&A deals they are trying to close and you mentioned the strength that your are seeing in Orbitrap Velos for non-stimulus type customer. So I'm wondering if you see a meaningful opportunity to pick up some market share at least in the near-term in that business?

Marc Casper

We have a very good offering. We have a terrific team. We have a great set of technologies and a loyal set of customers, and I think that positions us well in our mass spec business and we also have tough competitors and we wake up everyday and make sure that we are running our business the best we possible can to make sure that our customer select our products versus the competitors out there. So we certainly try to gain share. We feel good about our technology, but we never underestimate the tough competition that's out there.

Operator

Your next question comes from the line of Peter Lawson of Thomas Weisel Partners.

Peter Lawson - Thomas Weisel Partners

Just wondering if you can talk about how you are going to run the company differently, what things you are going to emphasize more or less versus Marijn and kind of the plans for the first year?

Marc Casper

It's a good question and it's one that a month ago or so when I went out on the first road show, first announcements kind of a lot of time talking about I think it's worthwhile repeating some of the themes that I communicated at one of the conferences.

The first of which is that Marijn, Pete and I have worked together very closely for the last eight years in developing and executing the company strategy, and certainly Pete and I feel great ownership as the rest of the leadership team and our strategy has been the world leader in serving science and the growth drivers that come with us. So from a strategic perspective, we feel very comfortable with this direction, with feel great ownership in developing that strategy and executing against it.

When you look what are we trying to accomplish? We obviously want to leverage those unique capabilities to grow our business and continue to gain strength with our customers. We're very focused on Asia. We're very focused on innovation, that's two areas, but those were focuses that we had in the past. So I think that in these markets that are very important to continue to focus on and we will.

When I look at changes probably the one change I'll just do a quick uptick because there was question that was more difficult to answer a month ago, and the transition which is, what happened to the Chief Operating Officer position that I have filled and in that particular case, I chose not to replace that position given the strength of our leadership team that we have in the company.

Most of our investors have had exposure in our annual analyst meeting to our group presidents and members of our management team and our group presidents and the rest of the leadership team will be picking up those responsibilities as the Chief Operating Officer. That's really the only change that I would say has happened in a meaningful way since the last interaction with investors, but the strategy is one that we're very energized by.

Peter Lawson - Thomas Weisel Partners

Marc, you previously kind of mentioned, the business has been bouncing along the bottom, have we moved beyond that now?

Marc Casper

No, I think, I didn't use the exact same words but I had the exact same meaning. When you look at the industrial side of the business which is where I was focusing those comments, that's where we feel we are. Early in the year you had this continued deceleration of the business, it stabilized, it continues to be stable but at much, much lower levels of activity. So we feel like that is bouncing along the bottom.

As we look to Q4, as I mentioned earlier, we feel like it's going to be the same and then which you wind up having is that the comparisons get easier. So even if demand doesn't necessarily change much, you wind up just reporting better sets of numbers just because of the comparison.

Operator

(Operator Instructions). Your next question comes from the line of Rob Hawkins with Stifel Nicolaus. Please proceed.

Rob Hawkins - Stifel Nicolaus

If we can I would like just maybe parse some of your comments related to NIH stimulus the 100 million and 200 million, from comments made by you and others related to typical academic budget. For 2009 a lot of these guys in prior quarters were hoarding their cash, waiting kind to see what happen with the stimulus and holding off on purchases. Now that this first kind of wave of (inaudible), now what's your thought, I mean are we going to see kind of a big rush to spend money here in the fourth quarter, where are you guys thinking about that and do you think that's going to help instruments I mean and maybe how that might play out?

Marc Casper

We're dealing with many, many customers and many, many brands, it’s hard to totally generalize, but our view is that customers aren't going to rush out. They have [dead loans] and when they have to spend the money, so it's not as if they can sit on the money for ever. But our view is that in the tougher environment where endowments are tough and customers are worried about where they are funding sources are, they are going to be thoughtful about how they spend their money. They are obviously going to follow what they wrote in their brands and our belief is that we'll see some flow of funds in Q4, based on the discussions we've had, but that is going to pick up more meaningfully in 2010 particularly in the first half of 2010. That's our best read as of today.

Operator

(Operator Instructions). You have a follow-up question from the line of Rob Hawkins. Please proceed.

Rob Hawkins - Stifel Nicolaus

Can we talk a little bit then about the B.R.A.H.M.S. and the sepsis kits? You’re going to do this by a reference lab and then you have these other products. Have you guys kind of disclosed the timeline maybe for some of the CV and these other products in terms of a broad timeline in terms of when maybe some of these things might be approved?

Marc Casper

No. I think when we thought about the acquisition and the price that we paid and the returns we generated, we made an assumption that effectively you get nothing from the pipeline, not that we believe that but that we believe that we can commercialize what has been cleared by the FDA and generate appropriate returns based on that. We’re very excited about the pipeline that happens, but it’s very hard to speculate on where those go through regulatory processes and I don’t think we would expect to have anything meaningful in terms of revenue from that in the near future.

However, you may see some launches of those products as they go through regulatory clearance, maybe even in the near term, just to develop markets and those things. So view of that is more of a discussion, probably late 2010 to give you an outlook on that for future years, not something that’s going to have any impact on the next year or so.

Rob Hawkins - Stifel Nicolaus

Right, thanks. Great color.

Marc Casper

So let me make a couple of closing comments. First of all, we are pleased with our steady improvements in revenue and operating performance, as the year has progressed. We are also more excited than ever about our long-term growth prospects. Thanks to our continued investments in technology, global expansion and complementary acquisition. Thanks for listening today. We look forward to reporting our year end results on our next call. Thanks.

Operator

Thank you for joining today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Thermo Fisher Scientific, Inc. Q3 2009 Earnings Call Transcript
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