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Thermo Fisher Scientific (NYSE:TMO)

Q2 2011 Earnings Call

July 27, 2011 8:30 am ET

Executives

Peter Wilver - Chief Financial Officer and Senior Vice President

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

Kenneth Apicerno - Vice President of Investor Relations and Treasurer

Analysts

Dane Leone - Macquarie Research

Nandita Koshal - Barclays Capital

Ross Muken - Deutsche Bank AG

Steve Willoughby - Cleveland Research Company

Dan Arias - UBS

Tycho Peterson - JP Morgan Chase & Co

Quintin Lai - Robert W. Baird & Co. Incorporated

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

Doug Schenkel - Cowen and Company, LLC

Peter Lawson - Mizuho Securities USA Inc.

Isaac Ro - Goldman Sachs Group Inc.

Jon Wood - Jefferies & Company, Inc.

Amit Bhalla - Citigroup Inc

Operator

Good morning, ladies and gentlemen, and welcome to the Thermo Fisher Scientific Second Quarter 2011 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, our Senior Vice President and Chief Financial Officer.

Please note that this call is being webcast live and will be archived on the Investors section of our website, thermofisher.com, under the heading Webcasts and Presentations until August 19, 2011. A copy of the press release of the second quarter 2011 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 2, 2011, under the caption Risk Factors, which is on file with the Securities and Exchange Commission and available on the Investors section of our website under the heading SEC Filings.

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

Also during the call, 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 2011 earnings and future expectations, and also in the Investors section of our website under the heading Financial Information.

With that, I'll now turn the call over to Marc.

Marc Casper

Thanks, Ken. Good morning, everyone, and thank you for joining us for our second quarter 2011 earnings call. We're pleased to deliver another quarter of solid performance. As we discussed at the Analyst Meeting back in May, we're focused on consistently delivering strong adjusted EPS growth, and we continued our excellent track record with 22% growth in Q2. I want to thank our teams across the company who worked hard to meet this goal and contributed to our outstanding results. Our commitment to investing in new products and emerging markets is clearly paying off and our performance in Q2 positions us well to achieve our ambitious goals for the year.

Let me get right into our second quarter financial highlights. Our adjusted EPS was $0.99, a second quarter record. We also achieved record revenue in the quarter with a 12% increase to $2.90 billion. Our adjusted operating margin increased 40 basis points to 17.6%, reflecting our continued investments to develop new products, expanding growing markets, and strengthen our commercial capabilities worldwide.

You heard me talk about our EPS growth strategy in the context of our 3 key drivers. They are top line growth through continuous new product innovation and expansion in emerging markets; operational excellence; and deploying our capital to create shareholder value. We run the company by focusing on these key drivers, so I'll continually use them as a framework for my comments around the highlights this quarter.

First, let me cover revenue growth. As I just mentioned, we had double-digit revenue growth in the quarter, and I'll give you a little color on which businesses stood out in terms of their contribution to our top line performance. Similar to what we've seen for the past few quarters, we continue to reap the benefits of strong industrial and applied markets served by a number of our businesses. In particular, our Process Instruments business performed very well across the board, from short lead time products such as our handheld instruments to our longer lead time systems for metals, mining and commodity material applications. Our leading ion chromatography business which we gained with the Dionex acquisition performed very well in the quarter, especially in applied markets.

We also continue to see strong demand for our clinical diagnostic products, specifically our assays for drugs-of-abuse testing and our biomarker tests, which I'll talk a little more about in a few moments.

Moving to pharma and biotech. Our Biopharma Services business had a very strong quarter. We have the scale and depth of capabilities to offer outsourcing for clinical trials manufacturing, packaging and distribution. This enables our customers to safely and efficiently deliver clinical trial materials to investigators and patients worldwide.

And a quick comment on Asia-Pacific. Again, we are pleased to see that our investments to expand our presence there are paying off. We had a great quarter across all of our emerging markets with China, India, Korea and Brazil delivering double-digit growth. These continue to be our fastest-growing regions and we're experiencing healthy growth in multiple market segments there.

Turning specifically to China for a moment, we're very encouraged by the momentum we're seeing in environmental markets there. You may recall that we moved the headquarters of our environmental business to Shanghai a couple of years ago. We've been collaborating closely with the Shangshi EPA, and recently won a significant order for our analytical instruments for soil and water testing. Our efforts also resulting in early adoption of our Mercury air quality monitors, which we believe will present a terrific opportunity for us as China implements its 5-year plan.

As you know, we're a company that's committed to investing in technology development and we had an exceptional quarter in terms of new product launches. Our showing at ASMS this year was our strongest yet, with 3 new mass spectrometry systems that redefine performance in resolution, speed, sensitivity and accuracy. Our new Prima PRO, Orbitrap Elite and QEC systems take analysis to new levels for applications ranging from life sciences to environmental protection and food safety.

I recently met with one of our academic customers who bought an Orbitrap Elite. He was so thrilled by the proteomics analysis made possible by the system that he actually helped us sell another instrument to a CRO that he collaborates with. In our chromatography business, we launched a new nano LC system at ASMS that integrates our entire portfolio of mass spectrometry products. In Specialty Diagnostics, we launched 6 oral fluid immunoassays that have been cleared by the FDA for drugs-of-abuse testing. There are obvious benefits in terms of specimen collection from these new tests.

On a final note here, I'm pleased to report that 2 of our new Thermo Scientific products made R&D Magazine's list of this year's top 100 innovations. One was our evolution 200 spectrophotometer, which was designed for routine QA/QC analysis in the life science, food and beverage and materials science industries. The second was the Dionex ICS-5000, the market's first capillary ion chromatography system, which is used to identify and measure contaminants in water and other liquids for a range of industries.

Our second key EPS growth driver, operational excellence, continues to give us the ability to translate top line growth into strong bottom line results. I'd like to make 2 points here today. One is that I'm pleased to say that our PPI and other productivity initiatives across the company are allowing us to once again gain SG&A leverage. And two, I used Dionex as an example of how we apply our proven operating processes to integrate new businesses smoothly and efficiently. We've owned Dionex since mid-May, but the integration planning began on the day we announced our agreement back in December. It's obviously a great business and our objective is to go through a very detailed integration process to ensure that we capture the expected synergies. I am pleased to say that the integration is going extremely well and the business is off to a great start financially, with revenue growth right in line with our expectations. With strong results across the board, the Dionex business has already made a positive contribution to our overall performance.

Our third key contributor to EPS growth is effective capital deployment and that continues to create shareholder value. First, let me cover acquisitions. We've deployed $2.1 billion on acquisitions completed so far this year. I just mentioned Dionex and let me add that we're very pleased to welcome their 1,600 employees to our team. We also made 2 smaller strategic acquisitions over the last couple of months, Sterilin a leading provider of plastic laboratory consumables in the United Kingdom broadens our customer offering and gives us another opportunity to leverage our global commercial organization. And just after quarter end, we extended our microbiology offering by acquiring TREK Diagnostic Systems. TREK is a provider of products used for blood culture, identifying microorganisms and conducting antibiotics susceptibility testing. Both of these businesses have about $35 million in annual revenues and we look forward to the growth opportunities they present by increasing our depth of capabilities for our customers.

As you know, in the quarter, we also announced the acquisition of Phadia, a global leader in allergy and autoimmune diagnostic testing. We talked a lot about this at the time of signing and at our Analyst meeting, so I'm not going to go to the details again. But at a high-level, Phadia will significantly enhance our leadership in the high-growth Specialty Diagnostics market, which is a key growth platform for our company. As you saw in the press release, I'm pleased to report that the acquisition process is moving along a little faster than we expected and we now expect to close Phadia late in Q3.

Clearly, it's been an active year in M&A so far, but I also want to make the point that we're focused on deploying our capital to buy back our stock and we spent $225 million during the quarter to repurchase 3.8 million shares. For the first half of this year, we spent $763 million and have repurchased 13.5 million of our shares. So we continue to create shareholder value both through M&A and share buybacks.

Switching gears, I'd like now to highlight a key growth theme as I've done over the past few quarters. To remind you the intent is to describe how our investments broaden the growth opportunities for Thermo Fisher by collectively driving our revenue growth, leveraging our unique depth of capabilities across the company and fulfilling our mission, which is to enable our customers to make the world healthier, cleaner and safer. This quarter, the theme is about meeting the important needs that healthcare has for both patients, and at the same time, lowering the cost of care. You've heard me talk about our biomarker business and the strong performance it's delivered over the past couple of years. Increasing awareness of biomarkers has been driven by the adoption of our PCT test for sepsis, which is a whole body inflammatory response to an infection that is often life-threatening. Every year, sepsis strikes an estimated 750,000 people in the U.S. alone with a total cost of the healthcare system of approximately $16 billion. Mainly as a result of the aging population, the incidence of severe sepsis in the U.S. is expected to rise to 1 million by the end of the decade. Early diagnosis and treatment would result in fewer lives loss and lower cost of care.

In Europe and other parts of the world, you can find our PCT biomarker assays on some of the leading central lab platforms, including bioMérieux, Siemens and Roche. BioMérieux's Vitus[ph] platform is also cleared by the FDA to run our PCT test in the U.S. We provide other biomarker tests that can differentiate a patient who is having a heart attack from those with less severe medical conditions associated with difficulty in breathing. While it's important to treat the underlying conditions, it may not necessitate costly levels of care associated with a heart attack.

We had a significant development in our biomarker business last week when we signed a long-term license agreement with Alere to add a number of our biomarker assays to the menu of their leading Triage platform. Alere Triage systems are found in more than 70% of U.S. hospitals in about 50 countries worldwide. This extensive install base of instruments significantly strengthens our ability to raise awareness of these tests and make them accessible to a much broader population of patients. The agreement extends the availability of these tests to include emergency rooms and physicians labs, opening an entirely new market for our biomarker test for sepsis, cardiovascular and lower respiratory diseases. As Alere works through the regulatory approval process, we anticipate even more opportunities to bring these important diagnostic tools to physicians and patients worldwide.

Before I wrap up, let me give you an update on our annual guidance for 2011. So far, the year is playing out as we expected, with some added benefit due to foreign exchange, bolt-on acquisitions that we've closed recently and additional tax efficiencies that we've generated. As you saw in our press release, we're raising both our revenue and adjusted EPS guidance. We're raising our adjusted EPS guidance by $0.03 to a new range of $4.08 to $4.18 for the full year in 2011. This would result in 18% to 21% growth over our 2010 results. We are also raising our revenue guidance for the year and now expect to achieve 2011 revenues in the range of $11.60 billion to $11.70 billion for 10% to 11% revenue growth over 2010.

So before I hand the call over to Pete, let me summarize my remarks this morning with a few key points. We remain committed to continuing our track record of delivering strong adjusted EPS growth. Our investments in new products and emerging markets are paying off and contributed to our solid performance in Q2. We executed well in the first half and we're on track to achieve our financial goals for the year.

So now I'll turn the call over to Pete Wilver. Pete?

Peter Wilver

Thanks, Marc. Good morning, everyone. As you know, we completed the acquisition of Dionex in mid-May. Given the significant size of this investment, we're providing visibility to the revenue growth performance of the combined companies by calculating organic growth on a pro forma basis as if Dionex were owned for the entire second quarter in both years. We'll follow the same approach with Phadia upon completion of that acquisition.

We're pleased to report another quarter of strong adjusted earnings per share with 22% year-over-year growth to a second quarter record of $0.99 compared to $0.81 last year. GAAP EPS in Q2 was $1.36, up 139% from $0.57 in the prior year's quarter, including a $0.79 gain on the divestitures of Athena Diagnostics and Lancaster Laboratories.

Moving on to our top line performance. Reported revenues increased 12% year-over-year to a second quarter record $2.90 billion. On a pro forma basis, as if Dionex were owned for the entire second quarter in both years, total revenues increased by 9% year-over-year and organic revenue growth was 4% consistent with the outlook I provided on last quarter's call.

In terms of Dionex' contribution to organic growth in the quarter, we can't calculate it exactly because we're already seeing some HPLC product substitution, but it's about 0.2% to 0.3%. In addition to organic growth, Q2 pro forma revenues increased by 4% as a result of favorable foreign currency translation and another 1% from acquisitions other than Dionex.

In the quarter, the net impact of the Biosite headwind lowered our organic growth by about 1%, and I'm happy to say that this is the last quarter that Biosite will be impacting our year-over-year growth comparisons. We continue to strengthen backlog this quarter with bookings finally exceeding revenues. By segment, Analytical Technologies Q2 revenues grew 19% on a reported basis. On a pro forma basis as if Dionex were owned for the entire second quarter in both years, Analytical Technologies revenues increased 13% year-over-year and organic revenue growth was 6%.

In the quarter, as Marc highlighted, we continue to see strong growth in clinical diagnostics, specifically our biomarkers business and our instruments businesses is serving industrial and applied markets also continued to deliver strong year-over-year growth. In the Laboratory Products and Services Segment, Q2 revenues increased 6% on a reported basis and grew 2% organically. In the quarter, our Biopharma Services business had strong growth that helped to offset the impact of the Biosite transition.

By geography in Q2, Asia-Pacific continued high-teens organic growth with strong growth in China, India and Japan. North America, which was impacted unfavorably by Biosite, grew in the low-single digits and Europe declined slightly against a tougher comparison of high single-digit growth in the prior year. Rest of the world grew in the mid-teens driven by Brazil.

Turning to the bottom line. We had strong adjusted operating income with our Q2 results up 14% year-over-year to $510 million. Adjusted operating margin was 17.6%, up 40 basis points from 17.2% in the year-ago quarter. The year-over-year margin expansion was driven by pull-through on organic growth and strong cost productivity from our PPI and PPI Lean projects, global sourcing initiatives and ongoing restructuring actions. We also continue to see nice accretion in the quarter from our recent acquisitions.

These gains were partially offset by strategic investments in R&D and commercial resources to drive future growth. And our pull-through on incremental revenue from foreign currency translation, which typically comes in at around our average adjusted EBITDA margin, was only about half of what we normally see in the quarter. This resulted from substantial foreign exchange movements during the quarter, which impacted our revenue and cost differently than they have historically. We're anticipating -- we aren't anticipating this to be a trend and expect to be closer to our historical average pull-through in future quarters.

By segment, Q2 adjusted operating income and Analytical Technologies increased 27% year-over-year. Adjusted operating margin was 21.1%, up 120 basis points versus 19.9% last year, driven by pull-through on organic volume growth, the benefits of global sourcing and productivity, moderately higher prices and acquisitions.

Turning to our Laboratory Products and Services Segment. Q2 adjusted operating income was 13.6%, down 50 basis points from the year-ago quarter. In this segment, solid productivity was offset by unfavorable mix, strategic investments to drive growth and inflationary pressure on raw material costs, particularly in steel and plastic resin. While we expect raw material inflation to remain somewhat of a challenge for the remainder of 2011, we put in place additional sourcing at pricing actions to offset the impact of expected impact.

Moving on to the details of the P&L. Total company adjusted gross margin was 42.2% in Q2, up 40 basis points from the prior quarter -- from the year-ago quarter, excuse me. This margin expansion was driven by the benefits of our global sourcing and strong cost productivity actions along with acquisitions, partially offset by increased raw material inflation.

Adjusted SG&A in Q2 was 21.7% of revenue, a 10-basis point improvement from the year-ago quarter, as a result of volume leverage and cost-reduction actions. R&D expense was 2.9% of revenue in Q2, up 20 basis points from last year.

Moving below the line, our Q2 net interest expense increased $11 million year-over-year to $32 million, driven by higher interest expense as a result of issuing $2.2 billion of new debt to fund our acquisition of Dionex, partially offset by savings we realized from refinancing more expensive debt. Our adjusted tax rate in the quarter was 20%, down 70 basis points from last year as a result of our tax planning initiatives, including tax synergies related to Dionex and last year's extension of the R&D tax credit into 2011.

During the quarter, we deployed $225 million of our cash to buy back 3.8 million shares of our stock, which left $475 million remaining at quarter end under our current $750 million authorization that expires in February 2012. Average diluted shares were 386 million in the quarter, down 30 million or 7% from last year, reflecting the benefit of our 2010 and 2011 share buyback programs as well as redemption of our convertible debt.

Turning to the balance sheet. Our cash flow performance remains solid. Year-to-date, cash flow from continuing operations was $680 million and free cash flow was $560 million after deducting net capital expenditures of $120 million. Year-to-date, free cash flow was up $55 million year-over-year, primarily as a result of higher operating income and improved working capital performance, partially offset by the timing of cash tax payments.

We ended the quarter with $1.36 billion in cash and investments, down $1.43 billion from Q1, primarily as a result of closing Dionex, partially offset by proceeds from the sale of Athena Diagnostics and Lancaster Laboratories. Our total debt was $4.0 billion, down $273 million from Q1, primarily as a result of redeeming our 3.25% convertible notes.

Now moving on to our guidance for 2011. As Marc mentioned, we're raising our adjusted EPS guidance by $0.03 to a new range of $4.08 to $4.18, which represents 18% to 21% growth over our 2010 adjusted EPS of $3.46. This guidance includes our completed acquisition of Dionex but it does not include any impact from the pending acquisition of Phadia.

In terms of revenue, we're raising our 2011 guidance by $80 million to a new range of $11.60 billion to $11.70 billion. This range represents 10% to 11% growth over our 2010 reported revenues of $10.57 billion.

Compared to our previous guidance, about $50 million of the revenue increase is related to more favorable foreign currency translation and the remainder comes from the Sterilin and TREK Diagnostic acquisitions that we recently closed. The total impact of favorable foreign currency on our 2011 revenue guidance is a little less than 2.5% growth and the total revenue impact from completed acquisitions, other than Dionex, is a little more than 1% growth. Consistent with past practice, we haven't attempted to forecast future foreign currency exchange rates.

In terms of pro forma organic revenue growth, the midpoint of our revenue guidance remains unchanged at about 4% growth. As I mentioned last quarter, excluding the Biosite and Japan stimulus headwinds we experienced in the first half of the year, this would be 5%.

Our adjusted income tax rate is expected to be around 20%, which is flat with last year and down 0.5% from our previous outlook, primarily as a result of incremental tax synergies related to Dionex. And our full year average diluted shares are estimated to be in the range of 387 million to 389 million, up slightly from our previous range as a result of the accounting impact of our higher stock price. This estimate assumes that we use the remaining $475 million of our current share buyback authorization through its expiration in February 2012. All these adds up to the $0.03 increase in adjusted EPS and the $80 million increase in reported revenues.

Finally, as Marc mentioned, we're very pleased to report that we now expect to close on Phadia in late Q3. Adding Phadia from late Q3 onward would add about $0.06 of adjusted EPS to our 2011 results, with about $0.01 coming in Q3, depending on when we finance the transaction and the actual close date.

So in summary, we're pleased to report another solid quarter which keeps us right on track to achieve our 2011 financial goals.

With that, I'll turn the call over to the operator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Quintin Lai with Robert W. Baird.

Quintin Lai - Robert W. Baird & Co. Incorporated

This earnings season has been a really interesting one. Lots of noise on the academic side. Marc, maybe you could give a little color on what you're seeing -- have things changed? Are they steady? Did you see any change with respect to maybe daily orders or instrument orders for the quarter?

Marc Casper

Quintin, thanks for the question. Maybe I can give a kind of a holistic view of what's happening with our 4 end markets to put some context there. From an overall perspective, there really were no significant changes in our 4 end markets from what we saw in Q1. I think that's an important point. Starting with industrial and applied, which is the fastest-growing, demand continues to be very strong across all the geographies. We saw robust growth in the businesses that served the markets, especially Process Instruments businesses in particular. Biopharma, which is always an area of interest, market conditions again were very similar to what we've seen in the past few quarters. For us, Biopharma grew, Quintin, at about the company average. And in particular, I'm very pleased with how our bioprocess production and our Biopharma Services businesses performed in serving those customer base. Healthcare and Diagnostics, as I mentioned in my first remarks, our Clinical Diagnostics business once again had a really good quarter, particularly biomarkers and drugs-of-abuse and therapeutic drug monitoring. And as Pete mentioned, this is the last quarter we need to mention Biosite, that's good news for everybody. And then academic and government, which is what prompted my thoughts here, they're very similar, those markets to what we saw in Q1. So no, particularly significant changes.

Quintin Lai - Robert W. Baird & Co. Incorporated

Great. And then a quick follow-up for us is that we hear a lot of questions on what your appetite for future acquisitions are, given the fact that you've got a lot in your plate now, those that are on are doing pretty well. So any update there?

Marc Casper

Yes. In terms of the acquisitions, as I mentioned, Dionex integration is going well. Phadia planning is going well. We're excited about those 2. We're very focused on getting those right, so that's where we're putting our attention. And we did a couple nice bolt-ons as well. So really, no surprise to anybody on the call. We're really focused on executing extremely well against the acquisitions we are committed to.

Operator

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

Amit Bhalla - Citigroup Inc

First question, I just wanted to go into a little more detail on the pricing environment. I think you made some comments there on the prepared statements about the pricing environment. And Pete, can you also just expand on the commodity impacts that you're seeing across the globe?

Peter Wilver

Yes, in terms of the pricing environment, it's pretty similar to what we've been seeing for the last several quarters so we're getting price between 0.5% and 1% right now, a little bit stronger on consumables than on the instruments and equipment. So that environment really hasn't really changed much. In terms of the commodities, as I said, it's primarily, for us, anyway, plastic resins. We have a few other things that are oil-based and in terms of what we buy as a commodity, that's only about $100 million of our input costs in total. So it's not a huge number but those costs fluctuated quite a bit. And then we're seeing it a little bit in raw steel, again, that cost base is only around $35 million for the company. So we are seeing some dramatic inflation there that we, as I said, have put in some price increases to offset and then we're driving further sourcing actions to offset it in the second half of the year.

Amit Bhalla - Citigroup Inc

And just as a follow-up on the first question on end markets specifically, Academic Government, what kind of visibility do you feel like you have? How far out is your visibility on that end market?

Marc Casper

When I think about visibility, we obviously serve most every academic institution around the world. So we have tremendous amount of dialogue with our customers in terms of what's going on. So it's more qualitative visibility and what I would say is that in the first 6 months of the year, there hasn't been a big shift in the tone of what's going on amongst those customers.

Operator

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

Ross Muken - Deutsche Bank AG

So if we think about the Lab Products division, obviously, margins there have been kind of up and down the last few quarters. If you think about investments you've put in place kind of revenue growth which is obviously been a drag, vis-à-vis Biosite and flu last year. How are we to think about sort of the trajectory of that business, given the mix we're seeing. And in turn, given some of the changes you've made maybe on the pricing side more recently, which is typical and so I'm just trying to get a sense for kind of how you're thinking about leverage there and how happy you are with kind of how margins have trended?

Marc Casper

So Ross, as I look at Lab Products and Services, first of all, thinking on the top line, the comparisons get substantially easier in the second half of the year because Biosite sits in that part of the business. So we'll see better top line performance based on just that fact. From a margin perspective, some of the things that we've been focused on from an investment perspective, we have less exposure to Asia-Pacific currently in those markets and less exposure to industrial in that part of our business. We are seeing the early benefits of the work in Asia-Pacific, so actually the growth is going to improve and then obviously we're spending a lot in the advance of the growth in Asia-Pacific, so that creates a little bit of a margin pressure. But that's going to improve as you get through the year.

Ross Muken - Deutsche Bank AG

And just touching back on sort of the geographic breakdown, I mean, from an emerging market perspective, if you sort of look at China, India, Lat Am, obviously you've seen some pretty substantial growth there in the last few years and into this quarter. If you think about sort of ordering trends and the pacing of demand in those various areas, I mean, have we seen it fairly constant? Has it been more choppy? I mean, obviously, on China, there's been a lot of concern. As the government put the brakes on with inflation that we're going to see some soft patches there and obviously GDP has come down a bit. I mean, how should we think about that relative to kind of the steadiness of the order rate your seeing based on the mix?

Marc Casper

So in terms of China, let's focus there because it's the most significant. We grew about 20% in the quarter, which was exactly how we performed in Q1. Bookings were larger than revenue, so we built backlog. In reviewing with the team a few days ago, very confident in the second half outlook. I know it's a common question that we get but our team is performing well and the markets continue to look strong.

Operator

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

Isaac Ro - Goldman Sachs Group Inc.

First, I just want to touch on the Pharma spending environment. Are you guys seeing any major capital purchases being pushed back in a material way, whether it be in the research labs or in the commercial labs?

Marc Casper

No. I think the conditions are pretty similar to what we've seen on the capital side with pharma over the last few quarters, which is the customers are buying the products that they need. They're conservative, but they are spending and we continue to see pretty similar conditions.

Isaac Ro - Goldman Sachs Group Inc.

Great. Okay. And then maybe just secondly, on Phadia, can you just remind us kind of what hurdles are left across, pursuant to that late 3Q close?

Marc Casper

Yes, so from a Phadia perspective, integration planning is going really well. The teams are ready for day one, which is terrific, so that's the most important. We did receive FTC clearance in the U.S., so that's behind us. And we actually got our filings, actually faster than we expected, which is why we are moving the expected close day from Q4 into later into Q3, so we moved it up. And the primary jurisdiction that we are just waiting on is the EU.

Operator

Your next question comes from the line of Doug Schenkel with Cowen and Company.[Technical Difficulty] Your next question comes from the line of Tycho Peterson with JPMorgan.

Tycho Peterson - JP Morgan Chase & Co

If we go back and look at some of the areas where you run into issues a year ago, the healthcare channel and biopharma services, it seems like there's been improvement in both of those. Is that a function of easy comps or are you feeling like those businesses are back in the growth trajectory?

Peter Wilver

So let's start with Biopharma Services. The business is executing extremely well and the value proposition is very meaningful to our pharmaceutical customers. So what we're doing is providing outsourcing capabilities for what many customers used to do in-house. So we're doing the packaging, logistics and some cases the manufacturing of clinical trials materials. You might recall that a company like Lilly had turned over those operations to us. I had the chance to visit with the team out in Indianapolis as well as the customer they are very happy with the performance. So the business is just doing a good job of serving the customer, and that's really good fundamental, operational performance. Healthcare market, that part of our business does benefit from -- it didn't benefit yet from an easier comparison, it benefits going forward from an easier comparison because Biosite sits there. But it seems it's actually executing very well and in fact our relationship with Abbott where we are their channel partner for many of their products is going extraordinarily well and that's good execution. So there -- the benefits coming in the future, meaning Q3.

Tycho Peterson - JP Morgan Chase & Co

Okay. And then, I think in Pete's comments he mentioned some initial revenue captures synergies with Dionex. Can you just talk a little about how are you thinking about top line synergies here in the near term? And are you starting to see additional column attached rates associated with that business?

Marc Casper

Yes, right now it's obviously small because we've only owned the business 6 weeks in the quarter. But there actually was some specific instrument wins, where Thermo Fisher Scientific colleagues identified new chromatography opportunities on the ion chromatography side for Dionex and there are some specific environmental wins, where our Dionex colleagues now, of course, Thermo Fisher colleagues, identified ICP, which is a key Environmental Instruments wins -- mass spec wins right off of day one. So people have been thinking about it and converting it into orders. The column attached rates, that's way too soon. That takes applications work and so forth but that will happen over time.

Tycho Peterson - JP Morgan Chase & Co

And then maybe just last one on the applied markets, are you anticipating kind of accelerating growth here? I mean we've seen a number of regulations around, obviously, food testing but there's been some additional environmental ones lately. Can you just talk about your outlook on kind of the applied testing market?

Marc Casper

Yes, so both applied and industrial we're seeing very strong growth, we're expecting that to continue. I certainly found it heartening that the President said the other night about the importance of food safety that made his top 10 list, so that's good for Thermo Fisher Scientific in terms of a focus. So yes, I don't know whether it is for the strengthening or not, but we've had very good markets and we're seeing all the signs that they're going to continue.

Operator

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

Dane Leone - Macquarie Research

This is Dane in for Jon. I was just wondering if you could provide a little additional color with regards to the leverage on the operating margin line. I know you explained Lab Products and Services, but I'm just wondering if there's anything else going on there that we should be thinking about or anything we should be thinking about going forward?

Peter Wilver

In terms of our operating margin expansion in the quarter, it's about 40 basis points. So like a number of moving parts but pretty similar with what we've seen in the past. We had nice contribution from productivity, about 2.5 percentage points improvement on productivity. That was offset by inflation, which as I said is a bit higher than normal at 1.5 percentage points. And then we made investments that totaled almost 1 percentage point. So those all sort of net to 0. As I mentioned, FX was a little bit dilutive in the quarter, which is unusual. We don't expect that to continue. That basically offset the acquisition benefit that we've got. So again those 2 net to 0. And then the balance, so the 40 basis points is basically price/volume mix. So that's the story there. The components are similar to the previous quarters but, let's say, the FX was a little bit of an unusual drag on the expansion in the quarter.

Dane Leone - Macquarie Research

All right. Could you maybe provide a little bit of color on what you saw in consumables, services and instrument trends during the quarter? And how you think those might play out for the rest of the year?

Peter Wilver

In terms of the split between equipment, consumables and service, we actually, as Marc said, Biopharma Services was very strong in the quarter. So that was kind of 10-plus percent growth in the quarter, equipment was around 5% and then consumables was basically flat, but that again is impacted by the Biosite transition. Going forward, I would expect more normal growth in consumables and comparable growth in equipment.

Dane Leone - Macquarie Research

All right, great. Any idea what that has been ex Biosite?

Peter Wilver

I don't have the number off the top of my head.

Operator

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

Dan Arias - UBS

Just on manufacturing, you've stated pretty consistently that the move towards low-cost regions is something that you look to improve margins. How much do global macro concerns play a role in the decision-making and timing for those operational changes?

Marc Casper

So when you look at our global manufacturing footprint, we serve from a low-cost region perspective really in 4 geographies, which is Mexico, Eastern Europe, Singapore and China. So we haven't put all of our manufacturing in one site. So our drive towards more low-cost manufacturing is going to continue and then we select the country based on what we think is the optimal economic risk and so forth, and we have a pretty detailed way if thinking through that. If one country becomes more favorable or not, or -- doesn't change the strategy, just means we shift the focus where we put the lower cost of production.

Dan Arias - UBS

Okay. And just looking at your 5% target for organic growth next year. Has anything changed over a short, but I'd say, eventful 2 months in terms of where you see the most opportunity or the biggest challenges to get to that level?

Marc Casper

So obviously in February we'll certainly give our 2012 guidance. But as I said, in answering Quintin's question in the beginning, the market conditions have been very similar to what we saw in the first quarter. So it would have also been very similar to what we saw in May. So nothing really has changed.

Operator

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

Steve Willoughby - Cleveland Research Company

Pete, on your guidance for organic growth for the year of 4%, does that include the -- how you're showing pro forma Dionex internal growth now in the AP business, I'm just trying to figure out what impact that's having in -- what true internal growth was this quarter?

Peter Wilver

Yes, the 4% includes -- it's on a pro forma basis including Dionex, it's the same answer whether you include Dionex or not. As I said, we can't calculate it exactly but it's only about 0.2% for the full year in terms of the impact.

Steve Willoughby - Cleveland Research Company

Okay, and then Marc, I'm just wondering if you could expand upon your comments regarding new product launches, especially the products at ASMS? How those are going, the availability of those products so far, your ability to meet demand?

Marc Casper

So we had a wonderful American Society of Mass Spectrometry, which was in early June, and when you look at the feedback, the feedback from the customers has been fantastic, and one of the things that is a really good indicator of that is from a new product launch, we have the largest number of demo requests. Basically, customer give some samples to run, then we can remember for any products that we've launched. It's incredible the demand we have for demonstrations, especially if the queue is active. That bodes well for a meaningful contribution of new products in the second half of the year. So obviously, because of a June launch, the impact in Q2 was immaterial but the leading indicators are very encouraging for the impact, which is good because when we set up our guidance for the year, we said that new products will be a nice driver in the second half and when your customers are telling you that the new products look really good that puts us in position to have confidence in our outlook.

Steve Willoughby - Cleveland Research Company

Do those products, the new launches, probably hit in the third quarter or in the fourth quarter?

Marc Casper

They're all ready to ship. We shipped a few of all of those instruments in Q2 so that will affect both quarters. Obviously a little more in Q4 because customers that are asking for demos want to see the result and get funding, but Q3 we'll have a nice impact as well.

Operator

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

Paul Knight - Credit Agricole Securities (USA) Inc.

I've been looking at the off margins. I believe I see a 13.6% versus 14.1% Lab Products margin. Is that from the higher commodity costs?

Peter Wilver

Yes, certainly. As I said in my comments, lab products and services was impacted by the commodity prices, most. That's the segment where we have input costs from plastic, as well as steel. So that impact comes in that segment and we also had impact from mix as well in that segment.

Paul Knight - Credit Agricole Securities (USA) Inc.

And then Marc, can you talk about what you saw in the tone of capital equipment like mass spec versus the tone you saw in Lab Products like products from the old Fisher catalog?

Marc Casper

Yes, from a tone perspective actually, not a big difference from the types of products. I think customers are just thinking about funding environments in general, and that's where we saw nice consistency across both quarters, which is effectively our instruments business continues to grow a little faster than the consumables business simply because it's benefiting from an economic recovery and you have more stability in consumables, if you will, but not a big difference in tone between the product types.

Paul Knight - Credit Agricole Securities (USA) Inc.

And then lastly, how long do you think it takes to have a truly integrated LC/MS system?

Marc Casper

When you think about optimizing all the software and all of the different permutations, you'll start to see the benefit of that in the next couple of quarters and some of those will take longer than that. But some of that is already happening today. But to get everything optimize, it takes a couple of quarters work.

Operator

Your next question comes from the line of Nandita Koshal with Barclays Capital.

Nandita Koshal - Barclays Capital

Marc, was there noticeable disruption in the quarter because of the continuing resolution related uncertainty? Just looking forward could we think about orders getting pushed sort of later and later into the NIH fiscal because of the wrangling that we are seeing over the budget?

Marc Casper

No. When you think about Academic and Government, very similar to what we saw in Q1. I think when I think about it, basically what we said at the end of the quarter last time was we thought that the continuing resolution once that was behind us. We'd see a slight improvement in the end markets -- in the academic markets for the balance of the year and what we're seeing in Q2 is pretty much exactly as we saw in Q1. So you didn't see a pickup, but I don't think you're seeing like a deferral or a big bolas of activity that's going to happen later. We're expecting very much consistent markets in Academic and Government for the balance of the year. That means flattish to down a few points in terms of the U.S. environment.

Nandita Koshal - Barclays Capital

Okay, that's helpful. And then how did the order book look at the end of the quarter in terms of later cycle and markets, especially in the more developed geographies, did that start to improve or as that trend through the quarter, how did the order book trend?

Marc Casper

The orders for our longer lead times instrumentation was very strong. The quarter was similar to the previous quarter, which is signs of a strong industrial economy with customers that are making long-term decisions for capital expansions, capital refurbishments, meaning projects that are from their perspective is going to happen 12 or 18 months from now, they're making those decisions so we're seeing really, really nice orders across those types of markets.

Nandita Koshal - Barclays Capital

Thanks, Marc. And Pete just a quick one on capital deployment. It's obviously a consistent theme and I was wondering how you think about dividend versus more tactical buybacks?

Peter Wilver

At this point, that's not something we're contemplating in the near term.

Operator

Your next question comes from the line of Peter Lawson with Mizuho.

Peter Lawson - Mizuho Securities USA Inc.

What drove the strength within the Diagnostics? Did you see any of the weakness from patient visits, deferrals, et cetera?

Marc Casper

When we look at our business, typically the big drivers are cancer incidence and infectious disease are the 2 big drivers of which that's going to be a little bit more immune from what you might read in the popular press. So we didn't see a big impact from patient visits one way or the other. I mean that's historically been our comments in the space and that's -- that continues to be true and particularly, our Clinical Diagnostics business performed extraordinary well in terms of our performance and that's been a lot of quarters in a row. So we're very pleased with how our team is executing and the quality of our products.

Peter Lawson - Mizuho Securities USA Inc.

Peter, I might have missed this but my call dropped, but what was the contribution of Dionex in the quarter and that 4% organic was that -- if you include it or even if you excluded Dionex completely?

Peter Wilver

Yes, it's about -- as I said, we can't really calculate it exactly because we do have some product substitution on HPLC, but it's about 0.2% to 0.3% in the quarter.

Peter Lawson - Mizuho Securities USA Inc.

Okay, thank you. And then expectations of hybrid systems coming out from Dionex and Thermo, when do you expect those coming through, Marc?

Marc Casper

Customers can get them today but when they'll be fully optimized, next couple of quarters, you'll see that all come out.

Operator

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

Jon Wood - Jefferies & Company, Inc.

Pete, so the obligatory cash flow question, any changes at the margin of on the operating or CapEx outlook for '11?

Peter Wilver

No, it's basically the same, $1.3 billion to $1.4 billion of free cash flow and around $300 million of CapEx.

Jon Wood - Jefferies & Company, Inc.

Okay. And then on the Phadia deal, any changes to the financing assumptions? It looks like you put a big commercial paper program in. So would you comment on your kind of updated expectations for the blended interest costs for that deal?

Peter Wilver

Yes, at this point, and what I included in the numbers in the expectations for post close in 2011, we haven't really changed the assumption for financing. We do have a commercial paper as the components of the financing but of course until we actually close the financing we don't really no what the actual interest rate is going to be, so we're kind of sticking with the original assumption which is around 3%. We do plan to access the capital markets a couple of weeks ahead of time prior to the close, which obviously is a little bit dilutive to Q3, but nothing has really change from our original assumptions.

Jon Wood - Jefferies & Company, Inc.

Okay, got it. And the last one, can you parse out the actual Dionex revenue like the absolute dollar number in the quarter?

Peter Wilver

We do, of course, know what Dionex revenue was in the quarter but as I said, we do have product substitution between the 2 businesses. The total contribution of Dionex was a little more than 2% growth.

Operator

[Operator Instructions] And your next question comes from the line of Doug Schenkel with Cowen and Company.

Doug Schenkel - Cowen and Company, LLC

Maybe just a very quick follow-up to the Dionex math because I think folks are obviously focused on this and not completely clear. If it weren't for Dionex, if you excluded it out both periods, would organic growth have been north of 4% for you?

Peter Wilver

Not north of 4%, no -- basically the same number yes.

Doug Schenkel - Cowen and Company, LLC

Okay, and then it sounds like an obvious question, but I think it's an important one given how jittery the markets are right now so I am going to ask it. If over the course of July there were any material slowdowns in any geography or end market, you would have seen this at this point and obviously contemplated that in guidance, correct?

Marc Casper

Yes, of course, we would of. We don't stop at June 30 and then say, we're not going to do any thinking between now and then, Doug. So we're taking the reflections of what's going on in the world, what our performance was in the first few weeks of July into our guidance. And I want to make it clear because for our investors, our organic outlook and our performance outlook for the year is exactly as we articulated from the previous quarter and the fact that we're putting Dionex in it is to provide clarity into the numbers exactly how we did the methodology for when we put Thermo and Fisher together some years ago. So this doesn't change our outlook. So we benefited from raising our guidance from the 3 factors, a little bit more favorable foreign exchange, we closed 2 bolt-on acquisitions, which we reflected in the numbers and our tax team have done some really good work and actually generated some nice upsides that weren't fully contemplated from the Dionex acquisitions. So hopefully that provides some clarity around what we are trying to do.

Doug Schenkel - Cowen and Company, LLC

Okay. Thanks for your patience on that one. And then just one last modeling question. I believe last quarter, you talked about gross margin improvement of about a point year-over-year, offset by some increase in operating expenses I think about 35 basis points as a percentage of sales year-over-year. More or less, does that guidance remain intact for the year?

Peter Wilver

I think actually -- Yes, it's about the same as those numbers. Yes.

Operator

And at this time, we have no further questions. I would now like to turn the call back over to Mr. Marc Casper for any closing remarks.

Marc Casper

So let me just make a quick comment to close up the call. First, thank you, of course. We're pleased to report solid financial performance in this past quarter and really starting to see the benefits of our past investments paying off in terms of the new product launches and the growth we're seeing in emerging markets. We're right on track to meet our growth goals for the year and we look forward to reporting our progress in Q3. As always, thank you for the support of Thermo Fisher.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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