Thermo Fisher Scientific (TMO) Marc N. Casper on Q4 2015 Results - Earnings Call Transcript

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Thermo Fisher Scientific, Inc. (NYSE:TMO)

Q4 2015 Earnings Call

January 28, 2016 8:30 am ET

Executives

Kenneth J. Apicerno - Vice President-Investor Relations

Marc N. Casper - President, Chief Executive Officer & Director

Stephen Williamson - Chief Financial Officer & Senior Vice President

Analysts

Derik De Bruin - Bank of America Merrill Lynch

Ross Muken - Evercore ISI

Tycho W. Peterson - JPMorgan Securities LLC

Steve C. Beuchaw - Morgan Stanley & Co. LLC

Isaac Ro - Goldman Sachs & Co.

Jonathan Groberg - UBS Securities LLC

Jack Meehan - Barclays Capital, Inc.

Operator

Good morning, ladies and gentlemen, and welcome to the Thermo Fisher Scientific 2015 Fourth Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you.

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 J. Apicerno - Vice President-Investor Relations

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

Please note, this call is being webcast live and will be archived on the Investor section of our website, thermofisher.com, under the heading Webcast & Presentations until February 26, 2016. A copy of the press release of our fourth quarter 2015 earnings and future expectations is available in the Investors section of 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 Annual Report on Form 10-Q for the quarter ended September 26, 2015 under the caption Risk Factors, which is on file with the Securities and Exchange Commission and also available on the Investors section of our website under the heading SEC Filings.

While we may elect to update future-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 this 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 fourth quarter 2015 earnings and future expectations and also in the Investors section of our website under the heading Financial Information.

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

Marc N. Casper - President, Chief Executive Officer & Director

Thanks, Ken. Good morning, everyone, and thanks, of course, for joining us today for our Q4 and year-end call. As you saw in our press release, we ended the year on a very strong note, delivering excellent fourth quarter results. Our teams identified and capitalized on year-end opportunities, delivered our value proposition to help our customers meet their objectives, and executed well to achieve our goals for the year.

I think our performance demonstrates that no matter what we're facing in the macro environment, we have many opportunities to gain share. At the same time, we're steadily expanding our capabilities in line with our growth strategy, and this gives us even more potential to create value for all of our key stakeholders: customers, employees and shareholders.

I'll cover some of my business highlights of the quarter and the year later on in my remarks, but first I'll give you a summary of our financial performance, discuss our growth relative to our key end markets, and wrap up with an overview of our annual guidance for 2016.

So starting with the quarter, we grew our adjusted earnings per share by 7% to $2.12, continuing our long track record of strong adjusted EPS performance. Our revenue in Q4 grew 4% year-over-year, our adjusted operating income increased 5%, and we expanded our adjusted operating margin by 40 basis points to 23.2%.

Looking at our Q4 performance in the context of our key end markets, I'm pleased to say that we did a great job of capitalizing on year-end opportunities to deliver strong growth overall. Starting with industrial and applied, our performance was similar to what we've seen all year with very low single-digit growth. Our industrial businesses remained soft while our businesses serving applied markets continued to perform well, particularly our analytical instruments used for environmental and food safety applications.

As an example, I'm very pleased with the performance of our chromatography business. Some of this is due to the success of the Vanquish UHPLC system we launched a little over a year ago. But fundamentally, the benefits of the Dionex acquisition in 2011 are really playing out. We're seeing strength across our entire portfolio from HPLC to GC to ion chromatography as well as software and consumables.

Turning to diagnostics and healthcare, it was good to see stronger results in this end market in Q4. We delivered mid-single-digit growth with especially strong performance in our clinical diagnostics and immunodiagnostics businesses.

In academic and government, conditions in this end market were the strongest we've seen all year. We executed well to take advantage of strong spending at the end of the year in the U.S. and Europe and we delivered mid-single-digit growth. It's good to see positive momentum in this end market, and we're encouraged about our prospects here given the more favorable funding environment in the U.S. in 2016.

Last, I'm pleased to say that we capped off a very strong year in pharma and biotech with another outstanding quarter with growth in the mid-teens. We're clearly benefiting from the underlying strength of this end market and the power of our customer value proposition, which is creating a significant competitive advantage for us and drove strong performance across our businesses that served this end market.

Our results show that in this economic environment, our customers turn to us to help them be successful, whether they're driving more innovation or increasing productivity to fund those R&D investments. Our scale and depth of capabilities is a key differentiator that creates value for our customers across our end markets.

So in summary, we took full advantage of the year-end opportunities, executed well and delivered very strong Q4 performance that led to a great year overall.

Now, I'll transition to our full year results. The main take-away is very clear: we achieved all the goals we set out to achieve. It wasn't the easiest of environments, but with thoughtful planning, great operational execution and intense focus on our customers, we delivered another strong year.

Among our key objectives in 2015, we focused on meeting or exceeding our financial commitments, making good progress in advancing our growth strategy, capturing the synergies from the Life Technologies acquisition and strengthening our balance sheet.

I'm pleased to report that we accomplished each of these objectives and I'll cover them in a bit more detail, starting with the financials.

Obviously, it was a challenging environment from an FX perspective and the strengthening of the dollar impacted every multinational company. But we effectively navigated those headwinds, which Stephen will discuss later in his remarks, and achieved what I feel was a very solid year.

We delivered $7.39 of adjusted EPS, which was a 6% increase year-over-year despite an 11% headwind from foreign exchange. We grew revenues to a record $16.97 billion for the full year. Adjusted operating income increased 3%, and we achieved adjusted operating income margin of 60 basis points to 22.5%.

Let me take a moment here to give you some insight into how we're thinking about margin expansion. As you know, we've been able to steadily expand our operating margins over the years. We do this by leveraging our PPI Business System and all the levers we have to drive margins, whether it's pricing, sourcing or footprint optimization.

You can see in our results that we did a great job of expanding margins despite a very significant FX headwind. Given that we will continue to face FX challenges in 2016, we remain very focused on driving productivity by continuing to use our operational levers.

We've also decided to take some additional actions that will help us further down the road. We will fund those additional productivity actions through the benefits we gain from the temporary repeal of the medical device tax. This will enable us to further strengthen our operating margins going into 2017. We have a substantial opportunity to expand our margins and we still think it's reasonable to take them to the 24% to 26% range by 2018.

So we delivered solid performance for the year by staying true to our growth strategy and making sure that every decision we made put us in a stronger position in the eyes of our customers.

Now, let me hit some of the highlights and accomplishments from the year and from the quarter in the context of our growth strategy. As you know, it's based on three elements: developing high-impact innovative new products, capitalizing on our scale in Asia Pacific and emerging markets, and leveraging our unique customer value proposition. The success of this strategy creates a significant competitive advantage for us and that gives us many opportunities to gain share.

Starting with innovation, 2015 was another very strong year for us. I covered our new product highlights during the course of the year, so I'm not going to get into much detail today. We did have strong launches serving the research scientists as well as for our customers working in clinical and applied markets.

Starting with the research community, the big news last year was our launch of the Orbitrap Fusion Lumos Tribrid mass spectrometer for proteomics. We actually just learned yesterday that the Lumos was voted by customers who read SelectScience magazine as the Best New Drug Discovery Product of 2015. Our industry-leading Orbitrap platform gives us a foundation for expansion into a range of applications, and we continue to fully leverage that capability.

We also had a number of exciting products launched in genetic analysis, but let me just mention a couple of them. One was our cloud-enabled QuantStudio 3 and 5 real-time qPCR systems, which support our increasing focus on oncology. The other was the new Ion S5 and S5 XL product line, which makes targeted next-gen sequencing more accessible for a range of research applications.

Moving to the clinic, we introduced a number of new immunoassays during the year as well as a new Phadia instrument that effectively leverages our customers' capital investment by running tests for both allergy and autoimmunity.

One example from the quarter that I do want to highlight is our collaboration with the Karolinska Institute of Sweden on a groundbreaking clinical study aimed at developing a more effective test for prostate cancer. Using our proteomic, genomic and assay technologies, this test can predict, or more precisely, distinguish between benign and aggressive cancers, thus reducing the number of biopsies required without compromising the number of actual cancers diagnosed. These are early days and there's still much more work here to be done, but it's very exciting and may be an alternative to the PSA test. This development would not have happened without the ability to leverage all of these capabilities across our company.

Turning to applied markets, our new Q Exactive Focus LC/MS created a powerful alternative to Q-TOF technology for a number of applications, including toxicology, pharma QA/QC, food and environmental analysis as well. The Focus is really gaining traction and significantly contributed to our growth in our Analytical Instruments business in Q4.

So as you can see, 2015 was another outstanding year for innovation. We put our R&D dollars and expertise to work to deliver high-impact products that help our customers achieve their goals. I look forward to discussing the exciting innovations we plan to launch during 2016 as the year unfolds.

Let me now turn to the second element of our growth strategy, which is about using our scale as a competitive advantage in Asia Pacific and emerging markets. You saw in our press release that we highlighted China growth. Well, I have to steal Stephen's thunder a little by telling you that we achieved high-teens growth in China in Q4. Really outstanding performance by the team.

The question I get a lot with China is how have we been doing so well given the magnitude of change taking place in that country. Well, from my perspective, I think it boils down to two things. First, China has challenges that we are in the best position to help our customers address, like poor air and water quality, unsafe food supplies, and strains on their healthcare system.

The second reason is that we've taken advantage of our scale but also have a very localized approach to running our business there. We have a team that understands the market and where the funding is and has executed very well.

Let me give you one example from the quarter, which is a new product we launched from our China Innovation Center in Shanghai. Contaminated water is a big issue there and some important new regulations were put in place by the government to control various water pollutants. We worked closely with our customers to understand their requirements and launched the Orion 3106 COD water analyzer in Q4. In addition to it detecting pollutants, this new product will also help our customers lower their operating costs by reducing maintenance and reagent consumption.

During the year, we also expanded our capabilities to capture opportunities in other emerging markets such as Southeast Asia. Our most recent development was the November opening of a new GMP biopharma clinical services facility in Singapore to serve the growing needs of pharma and biotech customers in the region.

Our strong performance in 2015 shows that we're effectively leveraging our global scale to best serve our customers and drive growth.

Turning to our customer value proposition, the third element of our growth strategy. I think the best example here is our successful integration of Life Technologies. We had high expectations for this business when we acquired it two years ago, and it's been a home run for us, not only in terms of the financial benefits but also in strengthening our customer offering and the strategic position of our company.

Regarding the financials, the metrics we laid out in early 2015, which were higher than the original deal model, were $115 million of additional cost synergies and $60 million of revenue synergies for the year. I'm very pleased to report that in 2015, we delivered $130 million of cost synergies and ended the year at our target year three run rate.

In terms of revenue synergies, we really gained early traction here and achieved approximately $90 million of revenue synergies in 2015, much faster than we anticipated. This performance puts us in a great position to achieve our 2016 revenue synergy goals.

From a customer perspective, we have a clear advantage as a result of combining our capabilities across the company. Our bioproduction and biosciences businesses are now growing faster than they were independently.

Having genetic and protein analysis technologies in one company is creating exciting new opportunities, like the prostate cancer test I mentioned earlier. And the commercial presence we now have by combining our channel and e-commerce capabilities is really starting to drive growth.

In terms of our strategic position, at our Analyst Meeting last May we said we expected Life Sciences Solutions to grow organically at 3% or better for the year, and I'm very pleased to report that the business grew organically at 5% in 2015, which contributed to our strong performance for the company overall. This is a great example of how we put our capital to work to create value for our customers and our shareholders.

Let me now give you a quick update on our balance sheet. You know that last year we were focused on delevering, following the Life Technologies acquisition. I'm pleased to tell you that we achieved our target leverage ratio of 3 times leverage at the end of 2015.

This timing is slightly ahead of what we expected when we announced the transaction, and we accomplished this while repurchasing $500 million of our stock early last year and paying about $240 million of dividends as well as spending $700 million on two complementary bolt-on acquisitions.

To remind you, ASI strengthened our capabilities, serving the high-growth bioproduction market, and Alfa Aesar expanded our offering of chemicals for the research laboratory.

So we put ourselves in a great position from a balance sheet perspective as we begin 2016, and we're able to kick off the year by announcing our agreement to acquire Affymetrix. Many of you are familiar with this business, which is a leader in cellular and genetic analysis. Affymetrix has a strong position on flow cytometry and antibodies, which will strengthen our biosciences offering. It was also the pioneer of microarray technology and will be a nice complement to our genetic sciences business.

This transaction also offers attractive financial benefits. We expect $0.10 of adjusted EPS accretion in the first full year of ownership, and we also expect to generate $70 million of synergies by year three following the close. So, good financial returns and also a very good fit for our Life Sciences Solutions business.

Let me now turn to our guidance for 2016. Stephen will cover the details and outline all of the assumptions for our revenue and earnings guidance, but I'd like to make a couple of comments.

Our 2016 guidance reflects the fact that foreign exchange will continue to have a negative impact on our top and bottom line performance, although we anticipate to a lesser degree than it did in 2015 based on where rates are today.

So, we're guiding to adjusted EPS in the range of $7.80 to $7.96. This would result in 6% to 8% growth over the $7.39 we delivered in 2015. In terms of the revenues, we expect to deliver between $17.36 billion and $17.56 billion in 2016.

So before I turn the call over to Stephen, let me leave with you a few take-aways. We focused on our customers and effectively navigated the macro environment to achieve our goals for the year. We continued to innovate, expand our global reach, and enhance our customer value proposition in line with our growth strategy. We also strengthened our balance sheet so we can resume our normal capital deployment in 2016 and identify new opportunities to create shareholder value.

With that, I'll now hand over the call to Stephen Williamson, our CFO. Stephen?

Stephen Williamson - Chief Financial Officer & Senior Vice President

Thanks, Marc and good morning, everyone. I'll begin with an overview of our Q4 and full year 2015 financial performance for the total company, then I'll provide some color on our four segments and conclude with a detailed review of our 2016 guidance.

So starting with our overall financial performance for the fourth quarter, as you saw in our press release, we grew adjusted EPS by 7% to $2.12. For the full year, adjusted EPS was $7.39, up 6% from 2014. The midpoint of our guidance that we gave you at the end of Q3 was $7.37 of adjusted EPS for the full year 2015. Subsequent to this guidance, the negative foreign exchange impact on Q4 increased significantly, resulting in a further $0.06 of headwind in the quarter. I'm pleased to say that we're able to offset all of this and still able to deliver $7.39 for the full year, $0.02 more than the midpoint of our last guidance.

GAAP EPS was $1.50 in Q4, up 1% from $1.49 in the prior year's quarter and $4.92 for full year 2015, up 4% from $4.71 in 2014.

On the top line, we delivered 7% organic revenue growth this quarter and our reported revenue increased 4% year over year. Q4 reported revenue includes 1% growth from acquisitions, and a 4% headwind from foreign exchange. For the full year 2015, reported revenue was flat year over year, and organic revenue growth was 5%.

Full year reported revenue includes 1% growth from acquisitions, net of divestitures and a 6% negative impact from foreign exchange. Looking at the growth by geography in Q4, North America grew in the mid-single digits, and Europe grew in the high-single digits. Asia-Pacific grew in the low double digits, and as Marc mentioned, China was growing in the high teens. And the rest of the world declined in the high-single digits.

For the full year, both North America and Europe grew in the mid-single digits. Asia-Pacific grew in the high single digits and China growing in the mid-teens. And the rest of the world declined in the low-single digits.

So looking at our operational performance Q4 adjusted operating income increased 5% and adjusted operating margin was 23.2%, up 40 basis points from Q4 last year, despite an 80 basis point headwind from foreign exchange. For the full year, adjusted operating income increased 3%, and adjusted operating margin was 22.5%, up 60 basis points from 2014, despite a 90 basis point headwind from foreign exchange.

At a high level, our adjusted operating margin expansion from the quarter and the full year was driven by continued strong contribution from the PPI Business System productivity levers, including pricing, global sourcing and footprint optimization, as well as the continued contribution from cost synergies.

In Q4, we realized $18 million of cost synergy benefits from the Life Technologies acquisition, and $130 million for the full year 2015. And as Marc said we were able to accelerate the capture of revenue synergies and realized $40 million during Q4 and $90 million for the full year 2015. This puts us in great position to deliver on the three-year run rate target of $150 million of revenue synergies in 2016.

We took advantage of our strong performance in Q4 to make additional strategic investments primarily to strengthen our commercial capabilities and to accelerate growth.

Moving on to the details of the P&L, total company adjusted gross margin came in at 47.7% in Q4, down 130 basis points from the prior year. For the full year, adjusted gross margin was 48.3%, down 50 basis points from 2014. The decreases in gross margin in both Q4 and the full year are primarily attributed to foreign exchange and unfavorable business mix.

Adjusted SG&A in Q4 was 20.6% of revenue, which is 150 basis points favorable to Q4 2014, driven primarily by foreign exchange, cost synergies, and our productivity actions.

For the full year, adjusted SG&A was 21.7%, 120 basis points favorable to 2014. And finally R&D expense came in at 3.9% of revenue in Q4, 20 basis points favorable to Q4 2014, and full year R&D expense was 4.1%, flat to full year 2014. And R&D as a percent of our manufacturing revenue for full year 2015 was 6.4%, also flat to the full year 2014.

So looking at our results below the line, net interest expense in Q4 was $94 million, down $13 million from Q4 last year, as result of reducing our debt over the past 12 months. Net interest expense for the full year was $384 million, a decrease of $48 million from 2014. Adjusted other income for Q4 was negative $7 million, $16 million lower than Q4 2014, and for the full year, it was $6 million, which is $7 million lower than last year. Both driven primarily by non-operating foreign exchange net losses in 2015, compared to net gains in 2014. Our adjusted tax rate in the quarter was 13%, 20 basis points below last year.

Our full year rate was 13.7%, down from 14.5% in 2014, primarily as a result of realizing our benefits of our acquisition tax planning. And average diluted shares were 402.4 million in Q4, down 1.7 million year over year, primarily as a result of the share buybacks we completed in Q1, partially offset by option dilution. For the full year, average diluted shares were 401.9 million, down 0.4 million from 2014.

Turning to cash flow and the balance sheet, cash flow from continuing operations for the year was $2.83 billion, and free cash flow was $2.42 billion, after deducting net capital expenditure of $405 million. This is slightly lower than our previous guidance due to additional investments in working capital. We ended the year with $455 million in cash and investments. During 2015, we continued to return capital to shareholders with $500 million of share buybacks in Q1 and $240 million of dividends, including $60 million of dividends in Q4.

We also continued to make strategic acquisitions in 2015, spending $300 million in Q1 to acquire ASI, and $400 million in Q4 to acquire Alfa Aesar. Our total debt at the end of Q4 was $12.5 billion, down $800 million sequentially from Q3 and we achieved our year-end target leverage ratio of 3 times total debt to adjusted EBITDA. And wrapping up my comments on our total company performance, we continue to make progress on our ROIC. Our trailing 12 months adjusted ROIC in Q4 was 9.5%, up 20 basis points sequentially from Q3 and up 60 basis points from Q1 2015, when the Life Technologies acquisition was fully included in the average investment base.

So with that, I'll now provide you with some color on the performance of our four business segments. As I highlighted for the total company, foreign exchange continued to be a significant headwind for the top line for our segments and impacted their year-over-year revenue growth and adjusted operating margins to varying degrees.

Starting with Life Sciences Solutions segment, reported revenue increased 2% in Q4 and organic revenue grew 5%. In the quarter, we continued to see strong growth in our bioproduction and biosciences businesses. For the full year, reported revenue grew 6% on organic growth of 5%. Q4 adjusted operating income in Life Sciences Solutions increased 5% and adjusted operating margin was 31.6%, up 80 basis points, benefiting from very strong productivity and incremental cost synergies, partially offset by some unfavorable product mix, significantly unfavorable foreign exchange and strategic growth investments.

For the full year 2015, adjusted operating margin was 30.1%, 110 basis points higher than the prior year.

In the Analytical Instruments segment, reported revenue increased 3% in Q4 and organic revenue growth was 7%. In the quarter, we had strong growth in our chromatography and mass spectrometry businesses, partially offset by weaknesses that we continue to see in some of our core industrial markets.

For the full year, reported revenue declined 1%, and organic growth was 4%. Q4 adjusted operating income in Analytical Instruments increased 13%, and adjusted operating margin was 22.1%, up 190 basis points.

We delivered very strong productivity in this segment, partially offset by foreign exchange, unfavorable mix and strategic growth investments. For the full year 2015, adjusted operating income increased 5%, and adjusted operating margin was 19.1%, 120 basis points higher than 2014.

Turning to Specialty Diagnostics segment. In Q4, total revenue grew slightly and organic revenue growth was 4%. This was driven by good growth in our immunodiagnostics and clinical diagnostics businesses, partially offset by the expiration of the OEM contract that I mentioned on our Q3 call. For the full year, reported revenue declined 3%, and organic growth was 3%.

Adjusted operating income in the segment decreased 3% in Q4 and adjusted operating margin was 26.2%, down 90 basis points from the prior year. In the segment, we drove very good productivity; however this was more than offset by the expiration of the OEM contract, unfavorable foreign exchange and strategic growth investments. For the full year 2015, adjusted operating income decreased 5%, and adjusted operating margin was 26.9%, down 50 basis points from 2014.

And finally in the Laboratory Products and Services segment, Q4 reported revenue increased 8%, and organic revenue growth was 10%. This segment continues to benefit from our strong performance in the pharma and biotech end market with the biopharma services channel and Laboratory Products businesses all delivering very strong growth. For the full year, reported revenue grew 1% and organic revenue grew 7%. Adjusted operating income in this segment increased 9%, and adjusted operating margin was 14.7%, up 20 basis points from the prior year. Margin expansion in the quarter was driven by productivity improvements partially offset by strategic growth investments. For full year 2015, adjusted operating income increased 2% and adjusting operating margin was 15%, up 10 basis points from the prior year.

So with that, I'd like to review the details of our 2016 guidance. Consistent with our usual practice, our guidance does not include any future acquisitions or divestitures. As a result, it does not include the impact of our recently announced Affymetrix acquisition, which we expect to close by the end of Q2. We will update our guidance after that deal closes. As Marc mentioned, we're initiating a 2016 adjusted EPS guidance range of $7.80 to $7.96, which represents growth of 6% to 8% over our 2015 adjusted EPS of $7.39.

In terms of revenue, our guidance range is $17.36 billion to $17.56 billion, which represents growth of about 2.5% to 3.5% versus our reported revenue of $16.97 billion in 2015. On an organic basis, our revenue range assumes an organic growth midpoint of about 4%. As Marc mentioned, we're seeing another year of negative impact on both the top and bottom line as a result of the continued strengthening of the U.S. dollar versus major foreign currencies.

As always, we're focused on our reported numbers, but I thought I'd give you a bit more color on the foreign exchange to give you some perspective on how it's impacting our guidance. On the top line, foreign exchange is lowering our revenue by approximately $290 million, which equates to just under a 2% revenue headwind. Foreign currency is reducing our adjusted EPS growth by $0.19, or just over 2.5%. If you were to look at our 2015 guidance or our 2016 guidance on an FX-neutral basis, adjusted EPS growth would be in the range of 8% to 10%, which represents another strong year of underlying operating performance. Consistent with past practice, our guidance assumes current foreign currency exchange rates, and we haven't attempted to forecast future changes in rates.

Moving on to the details of our guidance, acquisitions completed in 2015 are expected to contribute about $100 million or 60 basis points to our reported revenue growth in 2016.

Giving some color on our assumptions on growth by end market, starting with pharma and biotech, we expect strong performance in this market – in that market in 2016, and assume mid to high single-digit growth over our very strong low teens growth in 2015. In academic and government, with a better funding environment in the U.S., we expect growth in this end market to improve around the company average. And we expect growth in diagnostics and healthcare to be slightly better in 2016 as well, also growing around the company average. And in industrial and applied, we don't expect any improvement year over year, with growth remaining flat to 2015.

Turning to adjusted operating margins, we're expecting around 60 to 70 basis points of expansion year over year. Strong productivity and acquisition synergies will be partially offset by strategic growth investments and the impact of foreign exchange. I will walk you through each of these elements of our margin expansion. So starting with productivity. Here we will continue to use the proven productivity levers of our PPI Business System, including pricing, volume leverage, global sourcing and footprint optimization. These will continue to have a very positive impact on our margin profile. In terms of synergies from the Life Technologies acquisition, we expect to deliver $55 million of year-over-year cost synergy benefit in 2016, and we expect to realize a further $60 million of revenue synergies, which will yield approximately $20 million of adjusted operating income benefit. This will enable us to deliver the three-year goal of $350 million of total cost and revenue synergies in 2016.

During the year, we will continue to make strategic investments to continue to drive growth, enhance the impact of innovation, and to improve our customer experience. It was good to see the repeal of the medical device tax in the recently approved federal budget. Unfortunately, it's only repealed for two years, not eliminated entirely. However, as Marc mentioned, we're going to take advantage of this opportunity and plan to reinvest the approximately $15 million of annual impact of the repeal back into the business. The majority will go towards accelerating our long-term productivity initiatives to help counteract some of the impact that foreign exchange has had on our operating margins.

In terms of pull-through on the foreign exchange headwind, we're expecting an unfavorable impact on the bottom line totaling $90 million or 30% average margin. This creates 10 basis points of adjusted operating margin dilution. If you were to look at our 2016 adjusted operating margin guidance on an FX-neutral basis, our margin expansion would be 70 basis points to 80 basis points. We will continue to look for ways to minimize the impact of foreign exchange on our P&L.

Moving below the line, we expect net interest expense to be in the range of $370 million to $380 million, about $10 million lower than 2015, primarily as a result of the debt reduction actions taken in 2015. For 2016, we are assuming that we will refinance our debt as it matures; we are not planning any further pay down of debt during the year. We're expecting our adjusted income tax rate to be about 14%, slightly higher than 2015. And in terms of capital deployment, we're assuming that we'll return approximately $240 million of capital to shareholders this year through dividends. The guidance assumes a total of $500 million of share buybacks in 2016, which we've already completed in January. There is no other capital deployment assumed in this guidance.

Full year average diluted shares are estimated to be in the range of 401 million to 402 million, down slightly from 2015 with the impact of the buybacks offsetting option dilution. We're assuming net capital expenditures to be approximately $440 million. And finally, in terms of full year 2016 free cash flow, we're expecting between $2.68 – we are expecting about $2.68 billion, up $260 million compared to 2015.

As a final note from guidance, I wanted to highlight the calendar timing within 2016. Our Q1 2016 fiscal calendar has four more days than Q1 2015. And our Q4 2016 fiscal calendar has four less days than Q4 2015, with no net overall impact for the year. As you know, we do not give quarterly guidance, but given the scale of the days difference, I thought it would be helpful to give you some insight on what we are expecting for Q1 2016. With about 4% organic growth for the full year 2016, we're assuming about 7% growth in Q1. In terms of margin expansion, because we have four extra days of costs in Q1 2016, we are assuming that margins will be flat versus Q1 2015.

As always, in interpreting our revenue and adjusted EPS guidance ranges, you should focus on the midpoint as the most likely view on how we see things playing out. Results above or below the midpoint will depend on the relative strength of our markets as well as foreign exchange rate fluctuations during the rest of the year.

So in summary, we're pleased to deliver a strong finish to the year, and that positions us well to achieve our financial goals for 2016.

With that, I'll turn the call back over to Ken.

Kenneth J. Apicerno - Vice President-Investor Relations

Thanks, Stephen. Operator, we're ready to take questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now conduct the question-and-answer session. Your first question comes from the line of Derik De Bruin from Bank of America. Please go ahead.

Derik De Bruin - Bank of America Merrill Lynch

Hi, good morning.

Marc N. Casper - President, Chief Executive Officer & Director

Good morning.

Stephen Williamson - Chief Financial Officer & Senior Vice President

Good morning.

Derik De Bruin - Bank of America Merrill Lynch

Great. So, I think we're all a little bit surprised that the EPS guidance is a little bit lower for 2016 than we had anticipated. I guess – I mean, Stephen, you went through a number of the ones, I think where our model was off. I think we had the share count was a little higher and the interest expense was a little bit higher, I think, sort of giving the biggest hits there.

But can you just talk a little bit more about sort of like the mix impacts? If I remember correctly from the old Invitrogen, Life days, as that business sort of picks up, it has a much bigger impact in terms of the hit to the gross margin on that business from FX. I guess, can you talk a little bit more about sort of like mix dynamics, how that's playing out and sort of – you obviously are seeing stronger strength in the LPS business, and just sort of walk through what's going on and just sort of how you're thinking about sort of the product mix here and how much of that is impacting the business?

Marc N. Casper - President, Chief Executive Officer & Director

So, Derik, I'll start and then Stephen will add to it. So, thanks for the question. There's $0.19 of FX headwind in the 2016 numbers, right? So, that's actually what the big thing that needs to be understood, right? There was $0.06 incremental after our guidance in the fourth quarter that we drove past and actually beat.

So when you take it, 6% to 8% is our guidance for the year; on an FX-neutral basis, it's 8% to 10%. And obviously, it's only assuming the $500 million of capital deployment, which is the buybacks we already did in 2016. Obviously, we're going to get the benefit of Affymetrix later in the year. And we obviously have tremendous amount of capacity to do other things. We just don't want to decide exactly what we're going to do, sitting here, at the end of January, but there are things that we will do to drive more but we wanted to provide absolute clarity of very strong underlying operating performance, big FX headwind that we're working our way through and lots of balance sheet opportunity down the road.

Stephen, anything you want to talk about on mix?

Stephen Williamson - Chief Financial Officer & Senior Vice President

So, mix, no, nothing unusual in the mix side that's driving anything positive or negative in 2016.

Derik De Bruin - Bank of America Merrill Lynch

Great. And just one quick follow-up question. When you sort of look at the end markets, what are sort of your expectations in terms of China and Latin America and sort of how does that flow into 2016?

Marc N. Casper - President, Chief Executive Officer & Director

So from a geographic perspective, we executed very well in China during the course of last year. We clearly gained share from everything that we've heard from others. And we're expecting China to be one of our fastest-growing markets, probably low-double-digit type growth. It's hard to predict exactly but it will be a nice contributor to our growth for this year.

For Latin America, Brazil was very soft last year. It's not a huge market for us and we're not assuming any improvement in our numbers. You can see it when Stephen was talking about rest of world. That's primarily Latin America declined a little bit last year and we're assuming a similar type environment.

Derik De Bruin - Bank of America Merrill Lynch

Great. Thanks. I'll get back in the queue.

Marc N. Casper - President, Chief Executive Officer & Director

Thank you, Derik.

Operator

Your next question comes from the line of Ross Muken from Evercore ISI. Please go ahead.

Ross Muken - Evercore ISI

Hi. Good morning, guys. So, I guess as you guys were sort of staring at the consensus estimates and the $8 to $8.18 range, and you guys were contemplating where the guidance was and you were feeling where there were pushes and pulls in the P&L and where the Street had sort of gotten it wrong.

I mean I guess what was sort of the internal debate around what you could push forward, whether or not – Affy [Affymetrix], which obviously pushed off some cap allocation, e.g., you could have done more buyback, had you not done that and that may have helped, I guess, versus the range but longer term may not have been the right decision.

I guess, what were some of the key debate points? And then from a messaging perspective, do you feel like you kind of outlined enough for us to have figured this out more so than we did or do you think it really, with some of the macro moves, whether it was FX, et cetera, in the back half of the year, that stuff was moving around too much and it was difficult to sort of message?

Marc N. Casper - President, Chief Executive Officer & Director

So, Ross, great question. There was no debate. We run the company to do the right thing for our shareholders and for our customers. We don't sit there and say that the consensus is right or wrong. We say what is great operating performance and great use of our capital to create shareholder value.

So literally, there was zero debate. We look at what's out there externally. I mean that's why you heard longer remarks today, to really provide clarity on how we're thinking about the world.

I think the things that I would take away so that you can look to the future is, one, when we started out 2015 and you looked at our guidance range, we said the following: we would do all of our best without damaging the bright future that the company has to offset the FX headwinds. Last year, we picked up 2% incremental EPS headwinds after our original guidance. We offset all of it and we're able to deliver the high end of our original guidance.

When we look at this year, we have a number of actions that we're taking to chip away that FX, but which is why Stephen and I talked a little bit about, we don't just stop. We're actually taking other actions that ensure that if we continue to live in a tough FX environment, that 2017 will also be a fantastic year for the company. So, we're very proactively managing the business.

In terms of the capital deployment, hey, we spent – committed $1.8 billion in the, what, first two weeks of the year. I think we're being pretty aggressive. And it doesn't matter which month these different things happen. We're using our competitive position to create value for shareholders. So, we have incredibly bright prospects and I know that the analysts will look at the numbers and feel good about them.

Ross Muken - Evercore ISI

So, when you think about – obviously, again, this is a tough macro, so clearly the underlying ex FX is pretty good growth. Where do you see the biggest pushes and pulls just from an economic perspective in terms of some of the volatility? Obviously, we've looked at what's happened to the biotech sector and people worry about funding. There's been, obviously, the industrial side, some dislocations in parts of the world. FX movements have been a big deal. When you look at where the pushes and pulls are in the guide where you can really have on a top line basis sort of a differentiated outcome, where do you see the most sensitivity, I guess?

Marc N. Casper - President, Chief Executive Officer & Director

Yes, so, Ross, so if you think about last year, we entered the year with a challenging environment. We delivered our strongest organic growth of 5% in a long time, right? And delivered it very solidly despite the fact that not every end market was robust.

When we think about this year, we're assuming, as we did last year, we'll finish with about 4%. That's what we're targeting, but if we can do better we will. And if I think about the environment, one, academic and government, a little bit better than last year because of NIH funding. So we're expecting to be at the company average, which is better than the low-single digits last year. Diagnostics and healthcare, we're also expecting to be at the company average or about the company average, which is a little bit better than last year.

The big swing factor is going to be biopharma. And it's not going to be the end market conditions; it's just going to be, we had a teens growth or low-double-digit growth last year and we're assuming from a starting point that we're going to grow mid- to high-single digits against the tough comps.

So, that's the swing factor on the upside to it. And the team has done a good job over the last five years, six years, seven years of executing in that segment, and we'll keep you posted on how we do. So, I think it gives you good sense of how we're thinking about the world.

Ross Muken - Evercore ISI

Great. Thanks.

Marc N. Casper - President, Chief Executive Officer & Director

Thanks, Ross.

Operator

Your next question comes from the line of Tycho Peterson from JPMorgan. Please go ahead.

Tycho W. Peterson - JPMorgan Securities LLC

Hey, thanks. A question on the restructuring initiatives you talked about. If you look at kind of what's going on in the industrial world, all these companies are taking pretty aggressive restructuring actions. Can you maybe talk about whether this is the first of potentially several steps, whether you think you're doing enough with this initial step, and how you came to kind of the magnitude of the initial restructuring?

Marc N. Casper - President, Chief Executive Officer & Director

Our business is growing 5% organically, so we're not in restructuring mode. What we're doing is saying we want to ensure we're going to drive strong profitability growth for the long term and there are things that we can do that have good paybacks but cost a bunch of money up front in terms of optimizing facilities and you have double costs, those kinds of things. So, we're getting them underway now so that when those things are put into place, basically in 2017, you get a further tailwind on restructuring.

We've managed this company through multiple recessions. Both Stephen and I have been here 15 years, right? But right now, end markets are good. Bookings were very strong, right? So if something happens that slows growth down, we know how to take the actions to drive short-term profit growth to deal with a tough environment.

But we ended the year with our best quarter in many years and very strong bookings. So, we're just doing the prudent things to drive earnings growth and we'll monitor the end markets very, very closely.

Tycho W. Peterson - JPMorgan Securities LLC

And then on capital deployment, as you get back in the back half of the year, should we think about maybe more emphasis on buybacks in light of the multiples you're seeing from an M&A standpoint right now?

Marc N. Casper - President, Chief Executive Officer & Director

What I would say is that we have a significant capacity to deploy, and we will look at what is the right thing for the shareholder base as the months unfold this year, whether it's more buybacks or more M&A opportunities. We're evaluating the different choices. We got a good M&A pipeline. We have an attractive stock. So, you'll see us continue to be active as the year unfolds.

Tycho W. Peterson - JPMorgan Securities LLC

Okay. Then, last one for Stephen. Can you just quantify the extra day impact?

Stephen Williamson - Chief Financial Officer & Senior Vice President

The extra day impact in Q4?

Tycho W. Peterson - JPMorgan Securities LLC

Correct.

Stephen Williamson - Chief Financial Officer & Senior Vice President

I'm sure it contributed to the overall number, but it's not a significant part of the growth.

Tycho W. Peterson - JPMorgan Securities LLC

Okay, thank you.

Marc N. Casper - President, Chief Executive Officer & Director

Thanks, Tycho.

Operator

Your next question comes from the line of Steve Beuchaw from Morgan Stanley. Please go ahead.

Steve C. Beuchaw - Morgan Stanley & Co. LLC

Hi, good morning, and thanks for taking the questions. I'm going to do my best to try to put words in your mouth. As I listen to the commentary around the strength of the order funnel, the commentary around end market outlooks for 2016, it sounds like the one growth consideration that might drive a bit of incremental slowing is a normal and appropriate degree of caution around pharma, just because the comps are simply tough, no signal of slowing in the order funnel. So as I look at the model and I say, okay, there's a guide for 7% organic in the first quarter, 4% for the full year, it implies some slowing over the balance of the year. I want to say that's just because we're taking a conservative view on how pharma plays out here in the early days of the year. Is that the right way to think about it?

Marc N. Casper - President, Chief Executive Officer & Director

Steve, everything is accurate up until the calendarization issue. So we're being prudent on the full year guidance, because we have a tough comparison in biopharma. Our aspirations, of course, will be high, and we'll keep you posted. The layout for the calendarization is we literally have almost a full extra week in Q1 and obviously a full – almost a full less week in Q4. So from a modeling perspective, roughly 7% in the first quarter, and obviously a bigger offset in Q4, kind of still gets to the 4%. So we are actually assuming kind of level activity, and the calendar just leads you to 7% in the first quarter. So don't read into anything beyond that.

Steve C. Beuchaw - Morgan Stanley & Co. LLC

And an extra week historically has generated maybe 2 points, 3 points of incremental growth – is that a fair number?

Stephen Williamson - Chief Financial Officer & Senior Vice President

The last time we had an extra week, we were coming off one of the worst recessions ever. So I don't think there's a norm when it comes to it, so we feel good at this point with – about 7% for Q1.

Steve C. Beuchaw - Morgan Stanley & Co. LLC

Got it. And then just one housekeeping question for me. I wonder if you could put numbers around some of the items that we're thinking about on the P&L for this year. I mean, we have got a little bit of a tailwind from the NIH, maybe that's a couple pennies. The R&D credit you called out, and – I'm sorry, the medtech tax you called out, the R&D credit I know was passed, and we have that for 2016. Could you quantify any of these for us?

Stephen Williamson - Chief Financial Officer & Senior Vice President

Well, the medical device tax grossed about $15 million, and as we said, we're going to reinvest that. The R&D tax credit is about $23 million impact and that's in both years. So, there's no year-over-year impact, and NIH is part of the organic growth that we outlined in terms of the tailwind.

Marc N. Casper - President, Chief Executive Officer & Director

Yeah, organic growth, so a way to think about that one, Steve, would be for the company, it should be about 30 basis points of growth tailwind organically. Roughly a little more than a point in the academic and government end markets. So when you saw us being low single-digits last year, and about the company average this year, that really reflects the improved NIH funding. So hopefully that frames that up pretty well.

Steve C. Beuchaw - Morgan Stanley & Co. LLC

Got it. Thanks so much.

Marc N. Casper - President, Chief Executive Officer & Director

Thanks, Steve.

Operator

Your next question comes from the line of Isaac Ro from Goldman Sachs. Please go ahead.

Isaac Ro - Goldman Sachs & Co.

Good morning, guys. Thanks. I wanted to ask a question about your 2016 guidance, as it relates to gross margin. I don't think you guys gave a lot of color on what you're expecting there. But as I look at the fourth quarter performance, obviously, LPS had a great result, and that tends to be your lowest-margin division. So as I think about what you're looking for for this year, should we assume that out-performance in LPS could weigh a little bit on gross margin and accordingly drop through to EPS as well? I'm just trying to square up the other questions on the 2016 EPS guide.

Stephen Williamson - Chief Financial Officer & Senior Vice President

Yes. So I'm expecting a slight improvement in gross margins year over year in aggregate, and then the rest of the expansion comes from SG&A. So in terms of mix, I'm not expecting a dramatic change in mix the way that we're assuming that these things play out over the coming year.

Isaac Ro - Goldman Sachs & Co.

Okay. So if I had to kind of deconstruct the delta between sell side 2016, kind of consensus EPS and your guidance, it looks like it's mostly FX, and then maybe to a lesser extent share repurchase?

Stephen Williamson - Chief Financial Officer & Senior Vice President

I – I don't know. I don't know what you are modeling, so we gave you – we gave the detailed guidance of what we are assuming in our model. So -

Isaac Ro - Goldman Sachs & Co.

Right, but assuming you guys have a view on what consensus numbers we're looking at, I just want to make sure I understood the sources of the delta.

Stephen Williamson - Chief Financial Officer & Senior Vice President

Honestly, I have no idea what people are assuming for foreign exchange. The estimates give a top line and give an EPS number, and I don't see any detail there. So I can tell you what we have assumed in our model going forward.

Isaac Ro - Goldman Sachs & Co.

Right. Right, no. I got the FX guidance. Thanks a bunch. Thank you.

Operator

Your next question comes from the line of Jon Groberg from UBS. Please go ahead.

Jonathan Groberg - UBS Securities LLC

Great. Thanks and first of all, congratulations on a strong quarter. I think it was your highest growth rate since first quarter of 2010, if we're right here, so congratulations on that.

Marc N. Casper - President, Chief Executive Officer & Director

Thank you.

Jonathan Groberg - UBS Securities LLC

I guess if I'm doing the math, it looks like on your organic growth, plus the life synergies you laid out, the life EBITDA synergies it kind of gives you $0.66 cents or so, and then you're talking about a 2% headwind from FX, you don't include any of the capital deployment. I guess I'm thinking a little bit further out, Marc, if you think about what you laid out at your analyst day on 2018, it sounds like you went out of your way to highlight that you still think the margin target is achievable. Kind of – what's your view on what you laid out at 2018 as what the EPS could look like? Has that changed at all today?

Marc N. Casper - President, Chief Executive Officer & Director

I mean, obviously, Jon, we'll get into that in May. We've never been concerned, even if we didn't take the actions about the ability to get to the 24 to 26 or drive a very strong performance that we outlined in May, but our goal is not to be at the lower end of that range. Our goal is to be at the higher end of that range, right? So we're taking the actions now to put us higher, you know, higher up in those ranges. So, when I think about last year, one of the things we got tremendously positive feedback was talking about philosophy and the philosophy of how we're dealing with FX, and I think what you're getting today is we're telling about you the philosophy that we – when we laid out our commitments in May, the world looks different, and we sort of don't care. We're going to navigate through it and deliver outstanding short and long-term financial performance and hence while picking a small point around a $15 million investment, I think it gives you the sense of the philosophy that we're very proactive in managing the business to deliver a really great financial performance.

Jonathan Groberg - UBS Securities LLC

Okay. That's helpful. And then just a quick follow-up, it looks like, one, just to clarify, it looks like you're not going to provide book-to-bill anymore and then what are your pricing expectations for 2016?

Stephen Williamson - Chief Financial Officer & Senior Vice President

Yes, so, actually, Jon, so I didn't give book-to-bill information. It's just not that relevant a metric for the company now, where we have over 75% recurring revenue stream. So, yes, for a large instruments business, it's a relevant metric. For us, it's – we just don't see it as that relevant. I didn't include it in my script and we don't include it in the recon package. Just so you know what the number is, it's actually slightly positive, 0.5% for Q4. So – but as I said, it's just not that relevant of a metric for us. And then in terms of your second question – I've completely forgotten what your second question was.

Jonathan Groberg - UBS Securities LLC

Just in terms of pricing benefit you expect in 2016.

Stephen Williamson - Chief Financial Officer & Senior Vice President

Sure. So, I think about the underlying pricing environment hasn't really changed from what we're seeing of our end markets from the last – really the last sort of three years or four years including this year. Now what we did in 2015 was drive some FX offset actions with some additional targeted price actions which brought our pricing number up. And we'll get a little bit of carryover from that, so pricing year over year in 2016, it will be very similar to 2015, so just over half a percent of price, but underlying, I don't think the pricing dynamics are significantly different in the industry.

Jonathan Groberg - UBS Securities LLC

Thanks.

Kenneth J. Apicerno - Vice President-Investor Relations

Thanks, Jon. So, operator, we have time for one more.

Operator

Certainly, your last question comes from the line of Jack Meehan from Barclays, please go ahead.

Jack Meehan - Barclays Capital, Inc.

Hi, thanks. Good morning.

Marc N. Casper - President, Chief Executive Officer & Director

Good morning.

Jack Meehan - Barclays Capital, Inc.

I'm curious for the fourth quarter we have now seen a few years where the fourth quarter was seasonally stronger. I guess I'm curious what your view was on budget flushes toward the end of the year, what was sort of true growth in the fourth quarter and what might have – what we can be expecting in terms of the first quarter, whether there are some moving parts there.

Marc N. Casper - President, Chief Executive Officer & Director

So, Jack, good question. So, the way the world is playing out over the last few years is that customers generally are being conservative early in the year, and I don't mean just one quarter but literally in first three quarters of the year, to deal with, you know, kind of unexpected adverse events whether they are macroeconomic or geopolitical. So we are seeing it across a wide range of customers where there's a conservatism. And as the year unfolds, and bad things really haven't happened, there's a much stronger year-end money, and we were very well positioned to capture it. Our team did a great job.

When we look at the first quarter, because customers do a lot of activity late in the year, their demand is going to be a little bit softer but it's been a little bit softer in each of the previous few quarters. So I think as Stephen laid out the outlook for the year, that reflects the fact that customers start out conservatively and then build their spend as the year goes on. So I think we have that well characterized.

Jack Meehan - Barclays Capital, Inc.

Got it. And then just one follow-up similar to that, the academic segment, specifically, just given the NIH budget getting wrapped up toward year-end. What is your view? I think historically, it's been more the visibility around funding than the actual rate of growth itself. Just curious around the pace of some of that new funding going to work, what your expectations are for 2016.

Marc N. Casper - President, Chief Executive Officer & Director

Yeah, so obviously, it's good news that our customers know that they can have better budgets. We think that some of that will be in Q1, but more likely Q2, Q3 is where you'll see the strength on the NIH-derived spending in terms of how the year will play out.

Marc N. Casper - President, Chief Executive Officer & Director

So let me wrap it up. We are very pleased to deliver another solid year. We're obviously looking forward to continuing that momentum in 2016, and, of course, thank you for your support of Thermo Fisher Scientific. Thank you, everyone.

Operator

This concludes today's conference call. You may now disconnect.

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