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Thermo Fisher Scientific (NYSE:TMO)

Q2 2010 Earnings Call

July 27, 2010 8:30 am ET

Executives

Peter Wilver - Chief Financial Officer and Senior Vice President

Kenneth Apicerno - Vice President of Investor Relations and Treasurer

Marc Casper - Chief Executive Officer, President and Director

Analysts

Derik De Bruin - UBS Investment Bank

Jonathan Groberg - Macquarie Research

Ross Muken - Deutsche Bank AG

Tycho Peterson - JP Morgan Chase & Co

Quintin Lai - Robert W. Baird & Co. Incorporated

Paul Knight - Credit Agricole Securities (NYSE:USA) Inc.

Marshall Urist - Morgan Stanley

Doug Schenkel - Cowen and Company, LLC

Jon Wood - Jefferies & Company, Inc.

Charles Butler - Barclays Capital

Amit Bhalla - Citigroup Inc

Operator

Good day, ladies and gentlemen, and welcome to the Thermo Fisher Scientific Second Quarter 2010 Earnings Conference Call. I would like to introduce our moderator for the call, Mr. Kenneth Apicerno, Vice President Investor Relations. Mr. Apicerno, you may begin the call.

Kenneth Apicerno

Good morning, and thank you for joining us. On the call with me today is Marc Casper, our President and Chief Executive Officer; and Pete Wilver, Senior Vice President and Chief Financial Officer.

Please be aware that this call is being webcast live and will be archived on the Investors section of our website, thermofisher.com, under the headings Webcasts and Presentations, until August 27, 2010. A copy of the press release of the second quarter 2010 earnings and future expectations is available on our website under the heading Financial Results.

So before we begin, let me briefly cover our Safe Harbor statement. Various remarks that we may make about the company's future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the company's Form 10-Q for the quarter ended April 3, 2010, under the caption Risk Factors, which is on file with the Securities and Exchange Commission and is available in the Investors section of the website under the heading SEC Filings.

While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change. Therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

Also during the call, we'll be referring to certain financial measures not prepared in accordance with Generally Accepted Accounting Principles, or GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release of our second quarter 2010 earnings and future expectations and also in the Investors section of our website under the heading Financial Results.

So with that, I will now turn the call over to Marc.

Marc Casper

Thanks, Ken. Good morning, everyone, and thank you for joining us for our review of the second quarter. The last time I spoke to most of you was at our Analyst Meeting back in May. If you recall, our theme for the meeting was leveraging our leadership to drive earnings growth. It was a great opportunity to share with you how we are driving a combination of growth investment and operating performance to achieve our earnings goals. I'm pleased to tell you that we're right on track with our strategy and that we delivered record EPS performance again in Q2 on solid top line results. I'm especially pleased with our performance because the business environment obviously still has its challenges. However, we have built a company that is the recognized industry leader. As such, we have three key strengths that gives us a market advantage and drive our performance.

These strengths are: our unique depth of capabilities; second, our proven track record of operating performance; and third, our commitment to continued investment for growth, a combination of developing new technologies and making complementary acquisitions. We discussed this back in May in some detail. I will highlight some recent examples today that show you how these strengths not only contributed to our strong results for the quarter but position us for a great future.

First, I will run through our Q2 financial highlights. We reported second quarter revenues of $2.65 billion, 7% higher than 2009. This translated to 5% organic growth, which was in line with our expectation for the quarter. Our revenue growth reflected strong performance across our Laboratory Equipment, Consumables, Clinical Diagnostics and Biosciences businesses. We also saw strength in our Analytical Instrument businesses that serve applied markets, such as food safety testing and environmental monitoring. We are especially pleased with our organic growth results, given the headwinds of a weak flu season and the Biosite contract transition, which, together, lowered our organic growth by over a percentage point in the quarter.

We delivered solid adjusted operating margin expansion in Q2, achieving 17.6% versus 16.8% in the year-ago quarter. Through proven operating discipline, we are fully leveraging our top line revenue growth for pull-through to the bottom line and benefiting from our ongoing cost-saving activities, including practical process improvement, PPI lean and global sourcing.

Last, we're pleased to report that adjusted EPS was a second quarter record at $0.84, 14% higher than 2009. We continue to build on our strong track record of delivering double-digit EPS growth.

So I'm proud of how our teams executed operationally and their efforts resulted in a strong quarter. This, combined with our excellent performance in Q1, added up to a great first half of the year for Thermo Fisher.

I'll spend a couple minutes now framing what we're seeing in our key end markets at this point in the year. Interestingly, despite everything we hear about in the news, as a company, we haven't seen any dramatic changes since Q1.

In biopharma markets, capital spending is still under pressure. Our view is that the pharma market got tougher as these customers continue to evaluate their cost structures. I'm sure you've heard about the recent site consolidations in a number of big pharma companies, and we don't see this abating in Q3. While pharma is weak, we continue to see strength in biotech, as evidenced by strong performance in our Biosciences business in Q2.

Turning to academic and government markets. We benefited modestly from stimulus programs, with some additional funding being released in the U.S. This complements the strong revenue we recorded in Q1 tied to stimulus programs in Japan. We expect to see some continuation of stimulus-related orders in revenue from U.S. programs in the second half.

Looking at healthcare. As you see from other companies, demand in this market is generally soft. This is driven by fewer doctor and hospital visits along with the very weak flu season. From a Thermo Fisher perspective, on the other hand, our Clinical Diagnostics business, in particular, such as drugs of abuse tests and specialty assays, showed strong growth in the quarter.

Finally, I'll cover industrial markets. While we had an easy comparison with the 2009 quarter, we are definitely seeing some improvement in the industrial economy across the globe. For example, our Portable Analyzers business, which serves a broad sector of the industrial market, showed very strong growth in the quarter.

Let me now turn to some business highlights from Q2. At the beginning of my comments, I referred to our depth of capabilities and commitment to growth investment as key differentiators for us in the marketplace. I'll give you a few examples of how this positions us to meet the changing needs of our customers.

First, we were the headliner again this year at ASMS, the leading mass spectrometry conference. One highlight was our new suite of informatics products. These software advancements, such as Proteome Discoverer, virtually reinvent mass spec-based workflows for life sciences, fully leveraging the power of our leading Thermo Scientific technologies including the Orbitrap.

For more routine applications, such as water or pesticide analysis, our new triple quad system, the TSQ Quantum XLS, significantly raised the bar. It offers the flexibility, speed and sensitivity our customers need to improve productivities in their laboratories.

In the clinical research and specialty diagnostics markets, we are highlighting our capabilities at the AACC Expo, which is happening as we speak out in Anaheim. Among several launches at this show is our new workflow for the analysis of immunosuppressant drugs. This comprehensive solution offers clinical researchers a workflow that is seamless and easy-to-use. It leverages technologies across several of our businesses including Specialty Diagnostics, Analytical Instruments and Laboratory Consumables.

Also on display at AACC are biomarker market tests from our Bronze business, which we acquired last fall. This is the first time we showcased these product at a major trade show under the Thermo Scientific brand. We are extremely pleased with the performance of this business, which has continued to deliver strong double-digit growth.

Shifting gears a bit. The devastating news about the crisis in the Gulf of Mexico has been front-and-center in the media. But I'm pleased to report that we're playing a positive role here. During the quarter, we developed new analytical screening methods to rapidly detect oil contamination in seafood. You may recall that we announced the opening of our new Food Safety Response Center back in early April. Well, our timing couldn't have been better. We secured samples from the Gulf and our scientists at the center worked around-the-clock to develop step-by-step testing procedures that can be implemented at food safety and environmental laboratories. These new methods, which are based on our instruments, equipment and consumables, are available to any government agency, company or laboratory around the world.

I'd also like to mention some of our notable accomplishments in China as well, which, as you know, is a key growth a geography for us. We won a multimillion dollar project from China's major oil and coal company to design, construct and equip their new R&D center, which is being built from the ground up. The center will focus on developing various clean coal technologies. We also continue to see strong demand for our environmental instruments across China, and in fact, our air and radiation monitors are being used at the World Expo currently being held in Shanghai.

In addition to these business highlights, let me cover our recent capital deployment activities and what we've done there to create shareholder value. In the first half of the year, we deployed approximately $0.75 billion of our capital. Our focus during the time has been on both acquisitions and stock buybacks.

First an acquisition update. In Q2, we completed the acquisition of Proxeon, and just after quarter end, we closed on the acquisition of Fermentas. Proxeon, as we mentioned last quarter, is a supplier of products that creates simplified workflows for proteomics applications. These technologies complement our leading ion trap and hybrid systems by adding capabilities for nanoflow liquid chromatography.

Fermentas, which we closed just a couple weeks ago, is a global provider of molecular and cellular biology tools for genomics research. Its broad product line includes reagents, enzymes and other life science research and diagnostic tools. Fermentas also offers key technologies for PCR-based testing. This, along with our Finnzymes acquisition in Q1, significantly strengthens our offering for high-growth PCR market applications.

Also of note, the integration of Ahura Scientific, which we acquired in Q1, is going very well. To remind you, Ahura Scientific is the leading provider of portable spectroscopy analyzers. With these products, we now have an impressive lineup of portable analyzers that bring advanced technologies to our customers who need to perform rapid precise analysis in the field.

Another way we have deployed capital is through stock buybacks. We spent $187 million in Q2 under our $750 million repurchase program, which was authorized in April. Pete will cover this in more detail in his remarks.

Moving on to our guidance. We're pleased with our strong performance in the first half, which puts us solidly on track to meet our goals for the full year. We remain confident in our outlook for earnings growth in 2010 and are, therefore, maintaining our adjusted EPS guidance of $3.40 and $3.50 per share. This would lead to 11% to 15% growth over 2009.

On the top line, we're adjusting our guidance to reflect less favorable foreign exchange rates and the addition of our recent acquisitions. We now expect to generate from $10.60 billion to $10.75 billion in revenues in 2010, which would result in 5% to 6% growth year-to-year.

Before I turn the call over to Pete, let me summarize our key takeaways for Q2. We had another strong quarter delivering solid performance at the top line and record EPS results. These results led to a great first half of the year and position us well to achieve our objectives for 2010. While we will face FX headwinds and tougher comparisons in the third and fourth quarters, we are confident in our ability to deliver on our financial goals for the second half of the year.

With that, I'd like to turn the call to our CFO, Pete Wilver. Pete?

Peter Wilver

Thanks, Marc. Good morning, everyone. As Marc said, we delivered another quarter of strong operating performance, with 14% growth in our adjusted earnings per share to a second quarter record of $0.84 compared to $0.74 last year. Our results were even stronger if you take into account weakening foreign exchange rates, which, as I mentioned in our May Analyst Meeting, created $0.01 per share headwind compared to our guidance assumptions at the beginning of the quarter.

GAAP EPS in Q2 was $0.57, up from $0.49 in the prior year's quarter, primarily as a result of our improved operating performance.

Moving on to our top line performance. Reported revenue in Q2 increased 7% year-over-year to $2.65 billion. Organic revenue growth was 5% in the quarter excluding foreign currency translation of negative 1% and a 3% benefit from acquisitions net of divestitures.

As Marc said, flu and the Biosite transition negatively affected organic growth by over a percentage point in the quarter.

Our results in Q2 continued our trend of solid growth across our portfolio, with Instruments and Equipment and Consumables both growing in the mid-single digits and Services growing in the low-single digits.

We also continued to strengthen our backlog with bookings exceeding revenues in the quarter by 2%. In the Analytical Technology segment, Q2 revenues grew 10% on a reported basis and 5% organically. In the quarter, we saw especially strong growth in our Mass Spec, Clinical Diagnostics and Biosciences businesses. Also, a number of our Instruments businesses serving industrial markets continued to strengthen and contributed nicely to growth.

On the other hand, growth in our Microbiology business was negatively affected by a tough year-over-year comparison with high H1N1 flu sales in the prior year and overall weakness in the healthcare markets, as Marc mentioned.

In the Laboratory Products and Services segment, Q2 revenues grew 5% on both the reported and organic basis. During the quarter, we saw strong growth in Laboratory Equipment and Consumables, partially offset by the same flu headwinds and soft healthcare market that are affecting our Microbiology business as well as the Biosite contract transition that we announced previously.

Looking at organic growth by geography. North America, Europe and Asia-Pacific all grew in the mid-single digits in Q2 this year versus mid-single-digit declines in each region last year. Rest of the world grew slower than the company average against a tougher comparison of high-single-digit growth in the prior year.

Q2 adjusted operating income increased 11% year-over-year to $466 million. Adjusted operating margin was 17.6%, up about 75 basis points from 16.8% in the year-ago quarter. The year-over-year margin expansion resulted primarily from strong pull-through on the organic volume growth and the benefits of global sourcing and practical process improvements. This was partially offset by strategic investments in R&D and commercial resources to drive future growth.

By segment, Analytical Technologies' Q2 adjusted operating income increased by 13% year-over-year, and adjusted operating margin was 20.6%, up about 55 basis points versus 20.1% last year.

Q2 adjusted operating income in Laboratory Products and Services increased by 10% year-over-year, and adjusted operating margin was 14.2%, up about 60 basis points versus 13.6% in the 2009 quarter.

Moving on to the details of the P&L. Total company adjusted gross margin was 42.3% in Q2, up about 125 basis points from the year-ago quarter. The increase was driven primarily by strong pull-through on organic revenue growth and our global sourcing efforts, along with PPI and the cost-reduction initiatives that we implemented in 2009.

Adjusted SG&A was 22.0% of revenue in Q2, up about 10 basis points from 21.9% in the year-ago quarter, reflecting our continued investment in commercial expansion and slightly higher stock compensation expense.

R&D expense was 2.7% of revenue in Q2, up $12 million or about 30 basis points from last year, reflecting our increased investment in technology development to expand our new product pipeline for future growth.

Moving below the line. Our Q2 adjusted net interest expense decreased $4 million year-over-year to $21 million, driven by lower interest expense as a result of our debt refinancing initiatives, partially offset by lower interest income due to lower interest rates earned on our cash balances.

Other income was a gain of $0.2 million, up $1.3 million from last year, primarily as a result of currency transaction gains of foreign entity cash this year compared with transaction losses in the 2009 quarter.

Our adjusted tax rate for the quarter was 21.5%, flat with Q1 and up 1½ points from Q2 2009, primarily as a result of higher income at marginal rates.

As Marc mentioned, during the quarter, we used $187.5 million of our current $750 million stock buyback authorization to purchase 3.7 million shares. Average diluted shares were 416 million in the quarter, down 8 million from last year, reflecting the benefit of our share buyback programs in 2009 and 2010, as well as the redemption of a significant portion of our convertible debt.

I'm pleased to report that we continue to maintain a strong balance sheet and that our cash flow performance remains solid considering the working capital investment required to support our top line growth. Year-to-date free cash flow from continuing ops was $520 million after deducting net capital expenditures of $107 million.

We ended the quarter with $1.32 billion in cash and investments, down $123 million from Q1, as free cash flow in the quarter was more than offset by cash used to repurchase our shares, pay down debt and make complementary acquisitions.

Our total debt was $2.13 billion, up $62 million from Q1 as a result of our Q2 debt refinancing.

With regard to working capital, we continued to have good performance this quarter. Accounts receivable days sales outstanding were 50 days, down three days from the prior year, and inventory days of supply were 68 days, down five days from the prior year.

Moving on to our 2010 guidance. As you saw in the press release and heard from Marc, we are maintaining our previous adjusted EPS guidance range of $3.40 to $3.50. This represents 11% to 15% growth compared to our 2009 adjusted EPS of $3.05. We're also confident in our previous outlook for 2010 organic revenue growth of 3% to 5% as a result of our solid first half results and our current outlook for the second half.

As I mentioned at our May Analyst Meeting, the strengthening of the U.S. dollar over the past several months against many of our key foreign currencies has created about 1% headwind in terms of our reported revenue growth for the year. And this is being partially offset by our recent acquisitions, which will contribute about ½% to our full year reported growth.

As a result of these factors, we are adjusting our revenue guidance from our previous range of $10.65 to $10.80 billion to a new range of $10.60 billion to $10.75 billion. This revised range represents growth of 5% to 6% compared to our 2009 revenues of $10.11 billion.

As usual, our guidance does not include any significant assumptions with regard to future uses of capital, other than our previously announced $750 million share buyback authorization, which we expect to continue to utilize over the remaining nine months of the authorization.

In interpreting our revenue and adjusted EPS guidance ranges, as I've said in the past, you should focus on the midpoint as our most likely view of how we see the rest of 2010 playing out. Results above or below the midpoint will depend on the relative strength of our markets for the remainder of the year.

To reiterate some specifics about our second half outlook, as we stated in our call last quarter, our growth in margin comparisons get much tougher in the second half, and in Q4, we'll lose the four calendar days that we picked up in Q1. We also faced significant headwinds in the second half, with the termination of the Biosite contract as of July 1 and a very strong flu season last year versus our outlook for a normal flu season this year. Both of these items will impact Q3 comparisons more heavily than Q4.

So in summary, we delivered another quarter of solid operating performance and strong financial results. With a great first half behind us, we're well positioned to achieve our 2010 financial goals.

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 Marshall Urist from Morgan Stanley.

Marshall Urist - Morgan Stanley

I just wasn't clear about your comments on the healthcare environment. I know Thermo is a little bit more diversified relative to some of the other tools players. So did you see an organic growth headwind from volumes in the quarter similar to a lot of other healthcare companies? And can you quantify that for us?

Marc Casper

Sure, Marshall. Let me give you a context of what's going in healthcare. We clearly, from a market perspective, which we serve, represents about a quarter of our revenue. The U.S. portion, clearly, saw headwinds in the market. As you read in the papers, as you see from other companies, I'm sure healthcare companies, it appears that doctor visits, hospital visits are down, and we see that in some of our Consumables businesses. When you look at Thermo Fisher specific, you have at the beginning of the Biosite transition, which puts a little bit more headwind on us, but we also had very, very strong positive performance, again company-specific, in our Clinical Diagnostics business, where drugs-of-abuse, specialty assay, as I said, extraordinarily strong growth in the quarter. So I think we're actually executing well, but the market conditions was clearly tougher.

Marshall Urist - Morgan Stanley

Okay, great. That's helpful. And then second one from me is just on Europe. I know you had touched on this lately, but there's been mixed signals sort of across the board and maybe just give us your thoughts on, specifically, what you're seeing there, both on the Consumables side and Instruments side and maybe comment on some of the different end markets in Europe and what your thought is in the quarter and what you're thinking for the rest of the year.

Marc Casper

So in terms of Europe, the performance regionally didn't vary a lot around the globe in the quarter. Obviously, we all read the headlines about Europe, but we're not actually seeing that in our business performance. So the business performed well in Europe. We saw strength across our Specialty Diagnostic businesses, both Anatomical Pathology Clinical Diagnostics did well. Our Industrial businesses did well in Europe. So while we read things, when you look to the Thermo Fisher specific, actions, we haven't seen really a change in trajectory in Europe at the end of the quarter.

Operator

Your next question comes from the line of Ross Muken from Deutsche Bank.

Ross Muken - Deutsche Bank AG

So a lot of moving parts in terms of your business, and I just want to sort of follow up with what Marshall was keying in on. And so relative to coming into the year, as we look to the various end markets or the geographies, I mean, I know organic growth guidance hasn't changed meaningfully. But I think the end markets, we've seen some trends, whether it's in biopharma in terms of, you cited the site consolidations or in the healthcare market or in the industrial market that have either improved or deteriorated. As you look across the base piece of business, is there anything you're seeing trend-wise that was a bit of a surprise to you versus the beginning of the year? And then relative to that, as we think about kind of the organic growth guidance for the back half of the year, does it sort of assume most of the things that we see today kind of stay as is, e.g. no sort of industrial pickup and kind of the weak hospital volumes kind of continuing into the back half?

Marc Casper

So a few thoughts, Ross. One is I think one of the things that our investors appreciate is that the company is very predictable and has good visibility into the end markets. So if I think about our organic growth outlook that we've had for the year, what we said at the beginning of the year, what we said at the end of the first quarter and what we say today is we still feel good about the organic growth outlook for the full year. So I think that's a positive. We serve four key end markets and I think it's important to realize that there haven't been dramatic changes, but I think it's always helpful to say were the subtleties are. So industrial's getting a little bit better. Healthcare got slightly weaker. Pharma got slightly weaker. Biotech got slightly stronger, but these are all very, very subtle changes. When you look to the second half of the year, what we're assuming is exactly what we assume with our guidance, which is a slowly recovering economy, which we're seeing the signs of in our performance, and not dramatic changes off of that. There are upsides to it, which is a strengthening economy, more stimulus funds would be upsides. A double-dip recession would be downside. But right now, we're not seeing really big deviations from our original guidance.

Ross Muken - Deutsche Bank AG

And do you feel like, Marc, that as we sort of see this gradual recovery and we get to a more normalized environment, that the way the business is performing versus what you see in the market from your peers, kind of affirms sort of the strategy originally behind the merger and that you're kind of able to gain share, able to leverage the size and scale and then able to inevitably deploy the cash flow on nice acquisitions like Fermentas?

Marc Casper

Yes, I feel great about our strategy and our execution. If I think about where we are from building the company, we have clear advantages with our depth of capabilities; we gaining share with our large customers; we continue to build out our Biosciences and Analytical Instruments business, which have better growth prospects; we're accelerating R&D investments. All of those things allow us for a continued improving long-term growth profile for the company and continuing to capitalize on our position as the undisputed world leader in serving science.

Ross Muken - Deutsche Bank AG

Perfect. One quick point for Pete. Looks like there was a little bit of a change to the amortizable intangibles. Could you just sort of walk through that and whether or not that has any sort of EPS impact or core earnings impact?

Peter Wilver

Well, we excluded intangibles from our adjusted earnings per share calculations, so it wouldn't impact our adjusted earnings per share.

Ross Muken - Deutsche Bank AG

But there was a change in the assumption, correct?

Peter Wilver

Not in terms of an assumption. I mean, we hit the end of the Kendro amortization, so the number went down slightly. But that was the only thing that I'm aware of [indiscernible] (0:37:36.9).

Operator

Your next question comes from the line of Tycho Peterson from JP Morgan.

Tycho Peterson - JP Morgan Chase & Co

Marc, in your comments, I think you talked a little bit about pharma maybe getting tougher. I just want to kind of parse that out a little bit. I've always kind of been of the view that you're able to gain traction among your pharma customers, despite some of the consolidations. So can you talk a little bit about what you're seeing from your top accounts, the top 20? And then are you seeing more interest in strategic agreements like you have with Lilly? If you could just talk about the dynamic on pharma, that would be helpful.

Marc Casper

Sure. So, Tycho, once again, this was another quarter where our top accounts grew faster than the company average. From everything that we read, we continue to gain share at those accounts. So I think clearly, the strategy that we have is being executed well and our customers appreciate the value proposition. So I feel very good about that. I'd put just the additional context, which is I think with all the site closures, I just think you have pharmaceutical customers, in general, just tightening up on capital spent right now, and I think that's going to continue at least through the third quarter. Do I think that's a permanent trend? No, I don't. But do I think it's a shorter-term thing that companies in our space face in the market? Sure. And like our position better than everybody because we have a unique value proposition that helps our customers through more challenging times.

Tycho Peterson - JP Morgan Chase & Co

And is there risk, I guess, in the near-term that there's a glut of kind of used equipment coming on the market with the site closures? Or I mean how do we think about whether that's going to be disruptive?

Marc Casper

There have been site closures in the past. You see stuff in second hand. It really has never materially affected, I think, anybody in terms of performance, in terms of really that much stuff coming at our markets. So I don't think that'll be a big issue.

Tycho Peterson - JP Morgan Chase & Co

Okay. Just a question on the M&A deals. With Fermentas and Finnzymes, you've got some nice products and PCR. Can you talk a little bit about where you see your PCR franchise going? And how you're looking to build that out?

Marc Casper

Sure. So first of all, PCR is a major product category and I think it's one that as a company, historically, we really didn't participate much in, and I think it's important that we do participate in the market. The two acquisitions that you mentioned, Finnzymes and Fermentas, it really just helped strengthen our offering. It adds enzymes, reagents that obviously complement some of the existing products that we had as well as Finnzymes also adds instrumentation capabilities for us as well. So it's an area that other companies have very large positions. We are an early participant. I think the patent landscape is changing over the next couple of years and I think will be well positioned to accelerate organic growth in our Biosciences business by making some moves now and get ourselves set up for some good growth down the road in that market segment.

Tycho Peterson - JP Morgan Chase & Co

Okay. And then just one last quick one on food safety. You called that out and I think in conjunction with the issues done in the Gulf. Can you quantify that? And is that something we have the think about in terms of presenting comp next year? Or are we at kind of a steady state now where the food testing business is off a reasonable growth rate and it's really going to be impacted?

Marc Casper

I don't think you have to worry about the comps. I think you're seeing steady growth there. Particularly, what's going on in the Gulf is not material to our business, but I think it shows you what kind of huge impact we can have with our customers in terms of making a difference in society. But you're not going to hear us talk next quarter or next year about tough comparisons versus food safety as a headwind down in the future.

Operator

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

Quintin Lai - Robert W. Baird & Co. Incorporated

Marc, could you give us a little color on how the demand was between your kind of high-end Consumables and Instruments and your low end? I mean, did you see any difference? And then kind of as an addition to that, give us an update on your vitality index parameters.

Peter Wilver

Yes, In terms of the difference between the high-end Instruments and Reagents and the Basic Equipment, you can essentially look at the two segments, and the organic growth rates were essentially the same. So I would say there's not a material difference between the two pieces of business. And as I said, also you can look at the Instruments and Equipment and Consumables growing at a mid-single-digit growth rate. So it's pretty much across-the-board performance. And in terms of our product vitality, we are seeing an increase year-over-year in our product vitality as a result of some of the investments that we made last year and that we're continuing to make this year. It's not a huge percentage increased but we are seeing an improvement in the metric.

Quintin Lai - Robert W. Baird & Co. Incorporated

One of the questions I think that also came around this quarter was China and China demand going forward. A lot of the stuff that you -- you signed contracts, like in oil and gas and the nuclear side environment. I guess what's your long-term view on the commitment to Chinese demand in these areas that Thermo serves?

Marc Casper

So Quintin, when you look at the situation in China, I highlighted a couple very different types of examples. One that you've heard a lot about, which is environmental monitoring, instrumentation for infrastructure and that continues to be strong. And we continue to believe that there are good prospects there. We are starting to do more new lab works. And what was particularly interesting about the new lab win that I highlighted in this particular quarter is that it is a Chinese organization. So we've done a lot of new lab establishments, but they've been traditionally for multinationals. And this is a huge government entity that has toured the multinationals, and basically said, "I want Thermo Fisher to set up my lab." When I was over in China last, I met with their new CTO of this organization, and he's excited about equipping those laboratories with our equipment. When I look forward to what's going on in China, I think it's always helpful to know that the comparisons bounce around every quarter. So we don't expect smooth, steady growth every single quarter, but we do expect China to be the fastest-growing geography for a number of years to come. And we see a broad-based growth prospects for the business.

Operator

Your next question comes from the line of Jon Wood from Jefferies.

Jon Wood - Jefferies & Company, Inc.

Pete, could you give us kind of the update on the major margin drivers, kind of quantify raw materials and sourcing and PPI? And also talk about the net pricing contribution you realized, both top and kind of direct margin, if you will, in the quarter.

Peter Wilver

I'll start with the pricing. As we said last quarter, the pricing environment is a little bit tougher today, specifically on routine instrumentation, than it has been in the past. So we're not seeing as significant contribution from price. On a gross level, it's around 1%, where in the past, we've seen more like 1½% and 2%. So that contribution is not as strong. In terms of PPI, global sourcing and the other cost actions that we took last year, that's having a pretty significant positive impact on our EBITDA margin year-over-year to the tune of, we could say, one and a half to two percentage points. That's being offset, obviously, by inflation, which we start out the year every year in a hole and also some of our investment in R&D and commercial resources, which is diluting margins by around 50 basis points or so.

Jon Wood - Jefferies & Company, Inc.

That comment, the 50 basis points was inflation, R&D and commercial? Or just R&D and commercial?

Peter Wilver

No, just R&D and commercial. The inflation doesn't quite offset the productivity but it's a pretty significant number.

Jon Wood - Jefferies & Company, Inc.

Okay, great. And then just commenting on the Asia. You commented that that your Asia growth was mid-single digits. Was that off a harder comparison? I'm surprised that growth rate's not a bit higher. And I'm just forgetting exactly what happened in this period last year in terms of the Asia comp, if you will.

Peter Wilver

The Asia comp was a little tougher last year. It wasn't a huge comp. The toughest comp that we had was rest of the world, which is a high-single-digit positive number. I think in Asia, we're just looking at some timing. Obviously, in Q1, we had a huge order in Japan. So we don't have that particular volume in Q2. So I think it's just timing of orders rather than a comparison issue.

Operator

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

Jonathan Groberg - Macquarie Research

Marc, can you maybe just talk a little bit more, you made a couple acquisitions in the PCR and you answered some questions surrounding those. But can you maybe broaden that out a little bit more, I guess, in terms of maybe your appetite for moving into some of the other areas of genetic analysis within the life sciences side of your end markets maybe one of the faster-growing buckets? And I think previously, there was a little bit more reluctance to move in there, and I don't know if you're looking at PCR as a unique situation given some of the patent issues or if there's a bit more of an appetite to maybe move into some of those other markets.

Marc Casper

So when you look at the acquisitions, Jon -- let me answer it. Let's look at what we've done this year. We spent a little over $500 billion. And what we have focused on, certainly, in 2010 is buying businesses that serve attractive markets, that in our combination with our business, will help us accelerate growth and that we add unique value. So you can just look at something that's more industrially oriented, kind of field-based, Ahura Scientific, while we have the best channel to market with our portable elemental analyzers. We have an incredible stable of spectroscopy technologies. You put those two businesses together, it not only serves a more attractive market, on average, but also, we bring unique value to it. If you look at our bioscience acquisitions, both in Finnzymes and Fermentas, the same thing. We have a very strong Biosciences presence; we didn't participate as much in PCR. These two assets together plus our reach to the market and some interesting changes to the IP landscape gives us an ability to accelerate growth from those businesses. So that's how we think about it. Proxeon, we obviously have great strengths in proteomics. We're adding to the workflow there, again, attractive markets. When we think about genetic analysis, the way we participate today is really on the diagnostics side. We have a very strong presence in doing genetic analysis there. We don't play in the sequencing market in any material fashion. It's not a space that we've spent a lot of time or effort to think about in terms of trying to get into. So that's how we think about the various segments and how we're deploying capital to leverage our unique depth of capabilities and ultimately continue to add to our organic growth long-term.

Jonathan Groberg - Macquarie Research

Okay, thanks. That's helpful. I think in your guidance, Pete, you said you assume that flu would be normal. A lot of people are talking about maybe not having any flu, whatsoever, given a lot of flu in the channel from last year and also just not seeing much in the Southern Hemisphere. And so I'm just curious, if flu were to come in -- if it weren't to be a normal season in the second half, if it were to be more minimal, just what kind of impact would you expect that to have on your guidance, all else equal, obviously?

Peter Wilver

Yes, that's a very difficult number to get at because our flu revenues are not just the actual flu kits, there's also kind of flu-related revenue based on that sort of tends to drive hospital visits and usage of other consumables that we sell. So it's a tough number to get at. Just to give you an idea, we've already got baked into our numbers a $20 million decline year-over-year because of flu. Between kind of the H1N1 blip, it gives you a rough order of magnitude of what kind of revenue we're looking at there. So it's just impossible to predict what that would be.

Jonathan Groberg - Macquarie Research

Right. So just to clarify, $20 million reduction year-over-year for the second half?

Peter Wilver

Yes, that's what we have baked into the numbers right now. That's to get back to a normal season.

Operator

Your next question comes from the line of Paul Knight from CLSA.

Paul Knight - Credit Agricole Securities (USA) Inc.

Pete, first, Biosite is at about $25 million a quarter in the second half?

Peter Wilver

No. for the second half, the total impact is around $90 million negative. So it's about $45 million negative. Now we do have an alternative supplier that we're bringing up to speed that's going to offset some of that. So it probably net's down to around $55 million, I guess, pretty close to your $25 million a quarter.

Paul Knight - Credit Agricole Securities (USA) Inc.

So in the second half, between H1N1 and Biosite, is that, what, about 200 basis points of impact on organic growth?

Peter Wilver

No, not quite 200. It's about 150 basis points, I would say.

Paul Knight - Credit Agricole Securities (USA) Inc.

What is the assumption for organic growth in the last two quarters of this year?

Peter Wilver

So the range, if you look at our full year guidance range, it's 3% to 5%. So for the second half of the year, it's basically negative 1% to plus 2% is what that range translates to.

Paul Knight - Credit Agricole Securities (USA) Inc.

Why is that?

Peter Wilver

In terms of the negative 1% to plus 2%?

Paul Knight - Credit Agricole Securities (USA) Inc.

Yes.

Peter Wilver

And I know it feels a bit weak compared to what we've reported in the first half of the year. So again, as I said, if you look at our full year, it's 3% to 5% organic growth. If you take out flu and Biosite, it's more like 4% to 6% growth. If you look at the first half, it 8½% growth organically, and the midpoint of that guidance range would basically be flat. So we've got 8½% going to flat. As we talked about, we have a calendar shift between the first and fourth quarters as well as the flu and Biosite headwinds would actually impact the second half more dramatically than the first half. And we also have much different comparisons between the two halves of the year. So if you basically adjust all the results to remove all the noise, the first half grew about 7% organically, that's adjusting for the calendar and Biosite and flu compared to minus 6%. So you've got plus 7% compared to minus 6% in the first half. At the midpoint of our guidance, the second half, again, adjusting for all that, is around 4% growth compared to flat last year. So if you net the two, you basically have flat in the first half and say, positive 2% in the second half. So we're really looking at accelerating growth into the second half of the year.

Paul Knight - Credit Agricole Securities (USA) Inc.

Okay. And then, Marc, Europe, mid-single digits seems to be a good bright spot, geographically. What's going on there?

Marc Casper

So in terms of Europe, a few things: One is when I look at the performance of the business, we saw good performance across the geographies. No particular geography within Europe was materially worse than another. And I was particularly pleased because our healthcare-related Diagnostics business did very well. Our industrially related businesses also did quite well. My pharma comments are probably equally true in Europe and North America, where there's a little bit more reticence to spend right now. But we saw a good second quarter. We're paying close attention to what's going on from everything we read about, governmental austerity programs. But on the other side, there's been some early talk about increasing funding in Europe in 2011 for research and innovation, which could be a positive next year as well. So we keep a close eye on it, but right now things continue to progress well in Europe.

Operator

Your next question comes from the line of Amit Bhalli (sic) [Bhalla] from Citi.

Amit Bhalla - Citigroup Inc

Just wanted to follow up on that Europe question. Can you talk a little bit about pricing that you're seeing in Europe? I hear what you said earlier about the 1% rising you've gotten overall, but I'm curious about Europe, specifically. And then can you also quantify the impact of stimulus in the quarter?

Marc Casper

Sure. So in terms of pricing, it didn't vary much in Europe versus other geographies in terms of price competitiveness. As Pete said, high-end instruments a little bit more competitive in terms of where pricing environment is globally versus Consumables where pricing is sticking more easily. So we didn't see a big geographic view at this point. From a stimulus perspective, roughly in the quarter, $15 million of revenue. That puts us, when stimulus started last year at about $125 million. We're well within the $100 million to $200 million range. We're well within the range we said this year. We continue to expect to see some stimulus funding in the back half of the year as well.

Amit Bhalla - Citigroup Inc

You mentioned that the Analytical Instruments were strong in the applied markets. Just wondering if you could expand on Analytical Instrument performance in some of your other end markets, if there were also growth or were there any declines.

Marc Casper

Yes, so when you look at our Analytical Instruments businesses, applied markets were strong; portable analyzers, which serves broad-based industrial was strong; in general, mass spec did well. There was nothing that we really had very significant headwinds, other than our part of our Process Instruments business, which is our metals and minerals business, the very, very long cycle economically capital-intensive business. Those are late-cycle business. That still is weak, but there's some brighter spots starting to pick up there as well. So the things you'd expect to be picking up in this stage of the economy define. The very late cycle stuff is still a few quarters out, but in general, I feel good about what's going on in Analytical Instruments.

Operator

Your next question comes from the line of Tony Butler from Barclays Capital.

Charles Butler - Barclays Capital

Marc, you commented about the industrial markets having easy comps and improving. But the question is can you say that on a sequential basis, such that even in the back half, that would be an improvement?

Marc Casper

So the comparisons get, as Pete said, broadly tougher in the second half of the year, which will make the organic growth number on a reported basis a little bit lower. But I believe that the end markets will continue to improve slightly as the year progresses. So I think that the market conditions are continuing to improve. The late-cycle stuff will slowly improve as well, and that means that I'm feeling better about industrial halfway through the year than I did at the beginning of the year. It just translates, as we anticipated, into a very, very strong organic first half and a slower organic growth in the second half. But that's exactly as we articulated in February. We articulated that again exactly in the same way in April. And we're just reminding everybody today in July of how the calendarization works, but we feel that the markets are improving.

Charles Butler - Barclays Capital

Thanks very much, and, Pete, based upon that articulation for guidance in May, there were comments made, I seem to recall, around the acquisitions contributing 2%. Obviously, FX at that time was $1.22 and currently at $1.29. I'm actually curious if, in fact, your projections for the rest of the year are for a weaker or stronger dollar. And moreover, is the acquisition pace going to decline based upon May versus the second half?

Peter Wilver

So the comments back in May -- so what's included in our guidance today is about a 3% tailwind from acquisitions, so that's including all the acquisitions that we've completed to date. Our forward-looking revenue guidance doesn't include any other assumptions for future acquisitions, so it's just that 3%, which is the acquisitions that we've completed so far. The ½% that I referenced in terms of our guidance in terms of the headwind, that was versus our previous guidance that we gave in our Q1 earnings call. In May, that was sort of a middle point. We chose not to change guidance. We did reference the fact that we had FX headwinds at that point in time and we weren't changing guidance until it settled down a little bit. At this point in time, the rates that we have included in our guidance at this point are lower than they were in Q1, but they are slightly better than what was happening in the May time frame. We just chose not to update guidance at that point in time.

Operator

Your next question comes from the line of Doug Schenkels (sic) [Schenkel] from Cohen and Company.

Doug Schenkel - Cowen and Company, LLC

So in your prepared remarks, you stated that end markets are holding up at about levels you saw in the first quarter. Just to be clear, were there any surprises related to, say, sales patterns in Europe or the industrial end market or biopharma related to the broader macroeconomic backdrop that became more pronounced, say, at the end of the quarter and the early part of Q3? Or is it really business as usual, and that's the way it's been throughout the first half?

Marc Casper

Pretty much business as usual, very much in line with what we expected, which is slowly improving economic situations. So we weren't surprised. Healthcare, clearly, got a little bit weaker. Hospital visits, doctor visits were down. I don't think anybody had a crystal ball on the particular one. But surprise is a strong word. I'd say that I tried to give you the nuances of each of the segments and what kind of little better, what were kind of little worse, but nothing really surprised us per se.

Doug Schenkel - Cowen and Company, LLC

And nothing more pronounced at the end of the quarter?

Marc Casper

No, nothing from a timing perspective that really changed.

Doug Schenkel - Cowen and Company, LLC

Okay. You spent a lot of time talking about hospital weakness, particularly in the U.S. It doesn't sound like things really changed any pronounced way in other geographies. With that in mind, assuming that's correct, if there were to be a slowdown in Europe, should we be concerned about anything along the lines of the destocking dynamics that we saw last year, I believe, to some degree in the U.S. market?

Marc Casper

We're not overly concerned about that. The European healthcare portion of our business is not a huge portion of our business. Because in healthcare in particular, within the company, it's more heavily weighted towards the U.S. So even if there were dramatic changes, of which we're not clearly not anticipating, I wouldn't expect that to have a very significant impact on our performance.

Doug Schenkel - Cowen and Company, LLC

Okay. Japan was a bright spot for a lot of companies in the first quarter. I'm not sure if you mentioned that in your prepared remarks. If you did, I missed it. But how did Japan fare relative to Q1?

Marc Casper

So Japan was phenomenal in Q1. We had an incredible mass spec performance, which we're very proud of, in terms of capturing stimulus funds. The first half was good but the second quarter was clearly weaker than the first, not a surprise, which is why Asia-Pacific growth was around the company average. Now clearly, China and India continue to perform well for us. So broadly, we feel fine about what's going on in Asia.

Doug Schenkel - Cowen and Company, LLC

Okay. Does a stronger dollar, at all, increase the likelihood that you might do more M&A in sort of geographies? I'm just wondering if, Pete, that affects the way you guys think about things in a material way.

Peter Wilver

No, it really doesn't. Obviously, you can't exactly time those kinds of things anyway. If you look at how quickly the euro changed over the last month or so, it takes a while to close deals, so it just doesn't enter into the equation when we're looking at acquisitions.

Operator

And your final question comes from the line of Derik De Bruin from UBS.

Derik De Bruin - UBS Investment Bank

Hey, Pete, your net interest expense for the quarter was several million dollars higher than what I was expecting. And it's like [ph] (1:04:22.6) what's your target for that for the full year?

Peter Wilver

Well, the net interest expense, probably why it's higher than what you thought it would be is that we had to carry the kind of double debt until we could retire the $500 million note that didn't get retired until July 1. So the full year is basically consistent with what we were saying last quarter, other than we did a couple of acquisitions. So it's between $70 million, $75 million.

Derik De Bruin - UBS Investment Bank

Got you. And I know last year -- I'm going back to the question of the Biosite contract. I know last year, you had roughly $20 million headwind in Q1, Q2, Q3. But I thought that was kind of annualized in Q4. There wasn't any problem in Q4. Was there another change in that contract that I completely missed?

Peter Wilver

Other than the fact that, yes, it's totally transitioning away from us as of July 1, but we did experience basically not as quick a transition away from us on the BNP product, which was the original contract modification. So we actually did have a little more revenue in Q4 last year than what we might have expected. So that still created a little bit of a tough comp for us, again, this year in Q4.

Derik De Bruin - UBS Investment Bank

Okay. And the calendar days issues in Q4, that's, by my calculations, somewhere between a negative 2%, negative 3% headwind that it created.

Peter Wilver

No, as we said in Q1, we could benefitted about 4% to 5% in Q1, so we expect to lose 4% to 5% in Q4.

Derik De Bruin - UBS Investment Bank

Okay. And I guess the -- you had about $0.01 impact on FX for this quarter that you took. Is it I mean roughly the same type of impact the next two quarters?

Peter Wilver

Well the $0.01 was just the change in guidance. So the full impact of FX -- I don't have it off of the top of my head. I mean the change is basically $0.03 from our previous guidance, so yes, the change is about $0.01 a quarter from where we were before.

Marc Casper

So said another way, Derik, when you think about maintaining the guidance effectively, what we're saying is that we're going to offset the FX headwinds that we saw, about $0.03. We feel good about the organic growth prospects and the operating performance and feel like we can offset the FX headwind. So that's really the only thing that changed when you look at last quarter to this quarter.

Derik De Bruin - UBS Investment Bank

Okay. And then just one final comment because I'm getting from investors. I mean you have any crystal balls in terms of looking at what happens to the NIH funding and the government funding as you kind of look at next year. There's going to be elections I think 2011. What are your sources telling you?

Marc Casper

We don't have a crystal ball. More is always better. That's what we always prefer. There's probably going to be some increase in governmental spending in Europe in that realm. And clearly, what we read and hear about the priorities is that NIH is an important priority. Exactly how that's going to translate into funding is unclear.

Thanks. So let me just do a couple quick closing remarks. First, we are pleased to deliver the record EPS results that we did in the quarter. We had a very strong first half of the year, driven by our operating performance. That puts us on track to achieve our financial goals for the year. Thanks, as always, for your continued support of the company, and I certainly, and Pete certainly looks forward to updating you next quarter. Thank you, everybody.

Operator

Ladies and gentlemen, thank you for your participation in today's conference call. You may now disconnect. Have a wonderful day.

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