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Thermo Fisher Scientific (NYSE:TMO)

Q2 2012 Earnings Call

July 25, 2012 8:30 am ET

Executives

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

Peter M. Wilver - Chief Financial Officer and Senior Vice President

Kenneth J. Apicerno - Vice President of Investor Relations and Treasurer

Analysts

Jonathan P. Groberg - Macquarie Research

Ross Muken - ISI Group Inc., Research Division

Vamil Divan - Crédit Suisse AG, Research Division

Daniel Brennan - Morgan Stanley, Research Division

Daniel L. Leonard - Leerink Swann LLC, Research Division

Amit Bhalla - Citigroup Inc, Research Division

Jon Davis Wood - Jefferies & Company, Inc., Research Division

Doug Schenkel - Cowen and Company, LLC, Research Division

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Derek De Vries - BofA Merrill Lynch, Research Division

Daniel Arias - UBS Investment Bank, Research Division

Isaac Ro - Goldman Sachs Group Inc., Research Division

Operator

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

Please note 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 24, 2012. A copy of the press release of our 2012 second quarter 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 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-K for the year ended December 31, 2011, under the caption Risk Factors, which is on file with the Securities and Exchange Commission and available in the Investors section of our website under the heading SEC Filings.

While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any 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 will be referring to certain financial measures not prepared in accordance with Generally Accepted Accounting Principles, or GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release of our first quarter 2012 earnings and future expectations and also in the Investors section of our website under the heading Financial Information.

With that, I will now turn the call over to Marc Casper.

Marc N. Casper

Well, good morning, and this is Marc. And don't worry, I know Pete is here as well as is Ken, and I know from our investors' perspective, Ken is always the highest rated IR executive out there in the industry, and he's smiling next to me. So no anxiety should be on the phone, we actually have good news to report throughout this call.

So I'm pleased to report that we had another excellent quarter, with record Q2 results on both the top and bottom line. The quarter was all about execution. Our team executed well to deliver solid revenue growth and another quarter of double-digit growth in adjusted EPS.

Our strong performance in the first half puts us in very good position to achieve our revenue and earnings goals for the full year. I'll frame my remarks this morning by first covering the financial highlights, give you a sense of what we're seeing in our key end markets relative to our results, and then review some of the exciting new developments we announced during the quarter and in recent weeks.

First, the financials. As I mentioned, we delivered record adjusted EPS again this quarter, a 23% increase over 2011. Our revenue grew by 9% over last year. Our adjusted operating income increased 16% in Q2, and we achieved 110 basis points of adjusted operating margin expansion. Our Q2 results clearly show that our teams are focused on the right priorities. Our growth initiatives are delivering real value for our customers, and our ongoing cost actions are strengthening the bottom line. On the growth side of the equation, our investments in Asia-Pacific are really paying off, with strong results again this quarter. I'll mention a little more on that in a few moments.

In new products, we're seeing nice uptake across our analytical instruments portfolio, and we continue to innovate to keep that pipeline full. Our unique value proposition is clearly resonating across a broader customer set from pharma and biotech where we initiated the approach, to medical device manufacturers, reference and contract testing labs as well.

Turning to cost actions for a moment. This is an area that we're always extremely focused on and is a key contributor to our margin expansion. Our PPI and PPI Lean business systems are a way of life at Thermo Fisher, and they have helped earn us a reputation for operational excellence. While PPI is just one of the ways that we drive margin expansion, as you know, we have multiple levers we can pull, and in the environment we're managing through today, this gives us the ability to quickly adapt to changing market conditions.

For example, our restructuring actions are being implemented smoothly and are contributing to our growth on the bottom line. Let me now put our second quarter performance in the context of our key end markets. We all know the world is uncertain. We're focused on planning accordingly and adjusting as necessary, always with a sharp eye on using our unique depth of capabilities to gain competitive advantage.

I'll start with a focus on our 4 key end markets and then I'll comment on our performance in the major geographies. From an overall perspective, our end markets remain consistent with what we've been seeing in recent quarters.

Let me provide a bit more detail. Starting with academic and government. These markets are consistent with what we've been seeing so far this year. They're still down low-single digits, as we expected, so our outlook here hasn't changed. As we said last quarter, our customers remained active in their research efforts, and Laboratory Consumables spending has been steady despite the capital equipment side being somewhat constrained.

Turning to healthcare and diagnostics. Conditions were basically a continuation of what we've seen over the last several quarters. In particular, sales of clinical diagnostic products remained very robust, driven largely by ongoing strength in our biomarkers business. In industrial and applied markets, we continue to do very well, in aggregate, with high-single-digit growth, even though not surprisingly, we did see some softness in Europe. We saw strong sales and bookings for our long lead time process analyzers again this quarter, particularly from key customers in the mining industry.

Last, we continue to see strength in pharma and biotech, where we believe we continue to gain share. Our BioProcess Production business had another great quarter. Demand for sera, media and single-use disposable products was driven by growth in biotherapeutics in the U.S. and increased production of vaccines and biosimilars in Asia-Pacific countries.

Let me make a few comments on end markets from a geographic perspective. We did see some weakening in Europe during the quarter as expected, although the positive news is that we're still growing there. We saw excellent growth in Asia-Pacific, and our performance there was slightly stronger than in Q1.

On the topic of Asia-Pacific, let me mention here that our company level strategy to expand our presence in emerging high-growth markets is really paying off. We had good growth in India and South Korea, and our team in China delivered another quarter of revenue growth, topping 20%.

Growth in China is coming from investments our customers are making across our key end markets, including Biopharma, healthcare and environmental monitoring. We continue to attract top talent in China as we build out our manufacturing, R&D and commercial capabilities to fully leverage our value proposition and gain market share.

Now I'll turn to a few of the business highlights in the second quarter, all of which are great examples of how we're creating value for our customers by strengthening our industry-leading offering. I said last quarter that I believe 2012 will be a banner year for innovation, and judging from the range of significant new products we've launched so far this year, I stand by that statement. You may recall the long list of products we launched in Q1, including the TRACE 1300 gas chromatograph, the new iCAP Q ICP mass spec and our next-generation portable Raman instrument, the TruNarc. I'm pleased to report that we're seeing very good customer uptake from these products.

We continued our innovation streak in Q2, with a number of launches at 2 important industry conferences for us, ASMS and ACHEMA. Let me give you a few of the highlights. First, I'll cover ASMS, which as most of you know, is the world's premiere gathering of scientists who are interested in learning how the latest mass spec technologies can accelerate their work. It's always a terrific opportunity for us to showcase our industry-leading offering, specifically our Orbitrap hybrid platform, which remains far and above the industry standard.

We launched our Q Exactive system a year ago, and it continues to hit the ball out of the park for our research customers. This year, we enhanced the capabilities of this flagship instrument by launching 3 next-generation software packages that help our customers fully leverage the power of the Q Exactive in key applications from research to applied markets. These are among the 8 software packages we introduced at ASMS.

In terms of new instruments, we launched the Exactive Plus LC/MS system for laboratory customers who need to perform high-volume screening in a range of applications from metabolomics to environmental analysis and food safety testing. The beauty of the Exactive Plus is that it can be readily upgraded to match the higher performance of the Premiere Q Exactive. We also introduced the new triple quad at ASMS, the TSQ 8000, so customers can view targeted compounds at much lower concentrations. This is especially relevant for food safety and environmental testing applications.

Turning to ACHEMA, which took place in late June, we showcased a range of products designed to help customers meet their productivity goals, whether they're working in pharma and biotech, petrochemical or applied markets. The headliner at ACHEMA was our new iS50 FT-IR Spectrometer, the first research-grade FT-IR instrument designed for simple one-touch operation. The iS50 combines accessory, software and our industry-leading FT-IR capabilities to create a powerful workforce instrument capable of extracting vast amounts of information from a wide range of samples. If you look at all of the new product launches so far this year, you'll see that we've had a significant new development in almost every one of our core analytical instrument platforms. We look forward to updating you on new developments in the balance of the year, as well as the customer uptake of new technologies we've launched in the past few months.

We've also strengthened our customer offering by deploying capital on strategic M&A. In May, we announced our acquisition of Doe & Ingalls, a premiere channel for specialty production chemicals and supply chain services for the life sciences industry. Doe & Ingalls strengthens our value proposition by adding products and services that address the production market within our customer base, which our channel has historically served from a research perspective. We now have the ability to help our customers manage risk, quality and total cost in our chemical supply chain to support their production needs.

You all probably saw our announcement last week about our agreement to acquire One Lambda, the global leader in transplant diagnostics. We believe it will be an excellent addition to our Specialty Diagnostics portfolio because it will enhance our leadership with strong technologies that generate high margins and create opportunities for long-term growth. One Lambda has great technology. Its human leucocyte antigen and antibody tests are designed to improve the success rate for transplant patients. It's a nice complement to our immunosuppressant assays for monitoring drugs in transplant patients and gives us a comprehensive offering for the transplant testing workflow. We're also excited about being able to leverage our strength in emerging markets to accelerate One Lambda's penetration there. We expect the transaction to close in Q4. Both of these acquisitions are good use of our capital and meet all of our acquisition criteria. They strengthen our strategic position. They expand our offering for our customers, and they create value for our shareholders.

Our capital deployment strategy also includes returning capital to our shareholders. Including the $100 million we spent to buy back our stocks in Q2, we have repurchased 400 million of our shares during the first half of this year. Last week, we announced an incremental buyback authorization of $500 million. If you add that to the $250 million we have remaining at the end of Q2, we have a total of $750 million available for buying back our stock in the second half of the year.

Before I turn it over to Pete, let me give you a high-level view of our full year guidance. In thinking about our guidance halfway through the year, we went into it with a view that our end markets are playing out pretty much as we have expected, and strong execution by our teams has delivered very good financial performance. Our guidance reflects the addition of Doe & Ingalls, as well as our decision to divest our laboratory workstations business. It also incorporates somewhat more unfavorable FX rates. I'll let Pete get into the details, but the net result is that we now expect to achieve revenue between $12.14 billion and $12.26 billion in 2012. This results in 5% to 6% revenue growth year-over-year, which is the same growth that we've guided to all year. On the bottom line, we're raising our adjusted EPS guidance to a new range of $4.74 to $4.84, which would lead to 14% to 16% EPS growth over 2011.

So let me summarize what I believe are the key takeaways from an outstanding quarter. The world has played out as we expected, and our teams executed very well, setting the right growth priorities while tightly managing costs. Our growth initiatives continue to deliver results, especially in new products and emerging markets. We complimented those activities with strategic M&A, and we look forward to adding One Lambda to our Specialty Diagnostics portfolio. All of this added up to a strong first half, and that positions us very well to deliver on our goals for the full year.

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

Peter M. Wilver

Thanks, Marc. Good morning, everyone. Similar to last quarter, I'm going to start with an overview of the total company's financial performance, and then I'll provide some color on each of our 3 segments before moving on to our updated guidance. As Marc mentioned, we moved our laboratory workstations business to discontinued operations effective with Q2 reporting. So all the continuing operations numbers I'm going to share with you today have been revised to exclude this business from both current and prior periods.

As Marc said, our strong financial results this quarter were driven by really solid execution by our teams. This led to another quarter of double-digit growth in adjusted EPS, with a 23% increase to a second quarter record of $1.22. GAAP EPS in Q2 was $0.63, down 54% from $1.36 in the prior year's quarter, primarily as a result of the gain on divestitures last year. GAAP EPS includes a $0.02 operating loss in the laboratory workstations business. So we would have reported $0.02 lower adjusted EPS and 21% growth have we not discontinued this business. Still a great quarter.

Starting with the top line. Total revenue increased 9% year-over-year. On a pro forma basis, as if Dionex and Phadia were owned for the second quarter in 2011, reported revenue was up 1%, and organic revenue was up 4%. Pro forma revenue included 1% growth from acquisitions other than Dionex and Phadia, which was more than offset by a 3% headwind from foreign currency translation. Please note that the components of the change in revenue do not sum due to rounding. We continue to strengthen our backlog with bookings exceeding revenue by $15 million or about 0.5%.

Looking at revenue by geography, our growth profile was pretty consistent with what we've been seeing for the past few quarters. North America and Europe grew in the low-single digits. Asia-Pacific grew in the low-double digits, with China coming in strong once again at over 20% growth, and the rest of world grew in the low-single digits. Turning to adjusted operating income,our teams once again delivered strong bottom line results. Q2 adjusted operating income was up 16%, reflecting great execution. Adjusted operating margin was up 19% or 110 basis points. Our margin expansion was driven by good pull-through on our organic growth, strong contribution from our productivity and cost actions and solid accretion from recent acquisitions. Similar to the last couple of quarters, inflation on resin and other oil-based products continues to be a minor headwind, but we continue to deliver on our sourcing efforts and more than offset these pressures.

As I mentioned last quarter, we continue to see the benefit of the $100 million restructuring program that we initiated last year and realized about $16 million of benefit in the quarter. As a reminder, we expect to achieve about $50 million of benefit this year and an incremental $15 million in 2013. We're also evaluating additional restructuring actions and continuing to maintain tight controls on our spending, given the uncertainty in some of our end markets.

Moving onto the details of the P&L. As a reminder, the Dionex and Phadia acquisitions both have higher-than-average gross margins, as well as higher-than-average SG&A and R&D expense. So until they anniversary, you'll continue to see that impact in our year-over-year margins. Total company adjusted gross margin came in at 44.7% in Q2, up 210 basis points from the prior year for another strong quarter of gross margin expansion. The improvement in gross margin came as a result of solid productivity, driven by global sourcing, site consolidations and our PPI business system in addition to the benefit from acquisitions. Adjusted SG&A in Q2 was 22.6% of revenue, up 80 basis points from the 2011 quarter, primarily as a result of acquisitions. And finally, R&D expense came in at 3% of revenues, up 10 basis points year-over-year, again, as a result of acquisitions. Below the line, net interest expense was the same as last quarter at $51 million, which was $18 million above Q2 last year as a result of the debt we issued last year to fund the acquisitions. Our adjusted tax rate in the quarter was 17.2%, down slightly from Q1 and down 280 basis points from last year, primarily as result of acquisition tax synergies and our ongoing tax planning efforts.

During the quarter, we deployed another $100 million of cash to buy back 2 million shares of our stock, and average diluted shares were $369 million in the quarter, down $1 million from Q1 and down $17 million or 4% from last year, reflecting the benefit of our 2011 and 2012 share buybacks.

Turning to cash flow and the balance sheet. We had excellent cash flow this quarter. Year-to-date cash flow from continuing operations was $909 million, and free cash flow was $782 million year-to-date after deducting net capital expenditures of $127 million. Year-to-date free cash flow was up 38% year-over-year, primarily as a result of higher income, lower cash taxes and improved working capital, partially offset by higher interest expense. We ended the quarter with about $735 million in cash and investments, down $56 million from Q1, primarily as a result of paying down some of our outstanding commercial paper, and our total debt at the end of Q2 was $6.5 billion, down $143 million from Q1.

So with that, let me turn to this quarter's performance by each of our 3 segments. Starting with Analytical Technologies, total revenue grew 8%. On a pro forma basis, assuming Dionex was owned for the full quarter in the prior year, Analytical Technologies' total revenue increased 1% and organic revenue growth was 5%. Consistent with last quarter, we saw strong growth in instruments sold to industrial and applied markets, as well as in our businesses serving BioProcess Production. Adjusted operating income in Analytical Technologies increased 10%, and adjusted operating margin was 17.5%, up 40 basis points. Margin expansion was driven by strong pull-through on organic growth and contribution from our productivity actions, partially offset by strategic investments, inflation and product mix.

Turning to the Specialty Diagnostics segment. Total revenue grew 28%. On a pro forma basis, assuming Phadia was owned in the second quarter of the prior year, total revenue increased 1% and organic revenue grew 3%. Also consistent with last quarter, we continue to see strong growth in clinical diagnostics, which was partially offset by weak demand in Southern Europe. Adjusted operating income in the segment increased 47%, with adjusted operating margin at 27.2%, up 340 basis points, primarily as a result of acquisitions. In the Laboratory Products and Services segment, total revenue grew 2% and organic revenue increased by 4%. In the quarter, we had solid growth in Laboratory Consumables, and our Clinical Trials Logistics business continued to deliver strong results. Adjusted operating income in Laboratory Products and Services grew 1%, with adjusted operating margin coming in at 14.2%. This was 30 basis points below the year-ago quarter, but up 20 basis points sequentially from Q1, so we're continuing to increase profitability in this segment.

Now moving on to our guidance. As you saw in our press release, we're updating our 2012 guidance to reflect classification of the laboratory workstations business as a discontinued operation, the acquisition of Doe & Ingalls and more unfavorable foreign currency exchange. The bridge from the midpoint of our previous guidance, removing lab work stations and lower FX rates, reduced revenue by about $185 million and $40 million, respectively, offset by about $75 million of additional revenue from Doe & Ingalls. Combined with our solid first half results, this leads to a new revenue guidance range of $12.14 billion to $12.26 billion, which represents reported growth of 5% to 6% compared to our prior year revenue of $11.56 billion.

On a pro forma basis, as if Dionex and Phadia were owned for all of the prior year, the midpoint of our organic growth guidance remains at about 3%, no change from our previous guidance. In terms of FX, the estimated full year impact is increased to $365 million, which results in a 3% headwind on our reported revenue and adjusted EPS, and we're assuming that completed acquisitions other than Dionex and Phadia will contribute approximately 1% to our expected growth in 2012. We also recently announced the acquisition of One Lambda and an additional $500 million share buyback authorization, along with an expected debt issuance of $1.3 billion to fund these 2 activities. We've not included any benefit from One Lambda in our guidance as we don't expect to close that acquisition until Q4. However, we have included the favorable impact of the share buyback and the unfavorable impact of interest expense related to prefunding the acquisition debt. As usual, we haven't attempted to forecast future foreign exchange rates, and our guidance does not include any future acquisitions or divestitures.

In terms of our full year 2012 adjusted EPS guidance, with the strong first half of the year under our belt and with the impact of these actions that I just described, we're raising the high and low ends of our guidance, as well as tightening the range, resulting in a $0.02 increase to the midpoint. Our revised adjusted EPS guidance range is $4.74 to $4.84, which represents 14% to 16% growth over 2011. To again bridge from the midpoint of our previous guidance, Doe & Ingalls adds about $0.02, and there's another $0.02 increase from the net impact of the share buyback and debt issuance. This $0.04 increase is offset by $0.02 of negative pull-through on the more unfavorable foreign currency translation.

In terms of adjusted operating margin, we're still expecting expansion of 70 to 90 basis points for the year. And below the line, we're expecting our net interest expense to be up about $70 million to $75 million over last year and up about $15 million versus our previous guidance as a result of the expected new debt issuance, and our adjusted income tax rate to remain in the range of 17% to 18%.

We're estimating our full year average diluted share count to be in the range of 364 million to 368 million, down 4% to 5% from last year, and down 1% from our previous range due to the additional share buyback authorization. This estimate assumes that we use the remaining $750 million of our current share buyback authorization through December of this year. Finally, we're assuming that we'll deploy $150 million towards dividends this year and we expect capital expenditures to be the range of $300 million and $310 million. In interpreting our guidance ranges, as I've stated previously, you should focus on the midpoint as our most likely view of how we see 2012 playing out. Results above or below the midpoint will depend on the relative strength of our markets during the balance of the year. So before we turn to Q&A, let me say that I'm very pleased to report an excellent second quarter and a strong first half of the year that positions us very well to meet our growth goals in 2012. Ken?

Kenneth J. Apicerno

Operator, we are ready to take calls.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Jon Groberg from Macquarie.

Jonathan P. Groberg - Macquarie Research

So first, I want to -- I really appreciate all the color that you gave, Marc, but I wondered if you could talk a little bit more -- unless I missed it, you didn't say much about the U.S. and before we've been talking about a bit of a slowing in U.S. I'm just curious kind of what you're seeing specifically in the U.S. and what your outlook there is for the second half of the year.

Marc N. Casper

So, Jon, U.S. was slightly stronger than the first quarter, but not materially so. So U.S. is hanging in there with low-single digit organic growth.

Jonathan P. Groberg - Macquarie Research

And is that the expectation for the second half as well?

Marc N. Casper

As we look at the second half, basically, when we started the year, we looked at organic growth being around 3% for the full year. We have -- staying with that guidance, so we had 4% first half organic growth, so that implies a 2% organic growth in the second half, and that basically implies a little bit of a slow down. But that's more likely to be in the U.S. and Western Europe than it is really in Asia-Pacific. So it's probably slightly slow in the second half, but we don't really forecast by geography. We typically forecast by our businesses.

Jonathan P. Groberg - Macquarie Research

Sure, I understand. And then the second, as a follow-up on that, I think you both kind of mentioned the past restructuring, but also same, like given the environment, is very uncertain. So considering maybe doing more, can you maybe just talk about, one, what the trigger would be for that and two, what that would entail on your end?

Marc N. Casper

Yes, the way that we think about it is we're always looking at our cost base, right? And that last year, we specifically put in $100 million program that we've been executing against. But in addition to that, we've been looking at selective cost actions, and those programs are not -- those actions that makes sense and have the right result for the mid- and long-term health of the business. We're taking those actions as we go. So it's probably incremental to it, but it's not under the banner of some incremental programs. It is more good management of the business.

Operator

Your next question is from the line of Ross Muken from ISI Group.

Ross Muken - ISI Group Inc., Research Division

So as far back as I can remember, at least, since you've taken over, Marc, this was probably the best quarter organically you had versus peers. As you look at sort of the components of where you saw strength, and I know you probably haven't had much time to check out all the earnings reports like we do. But I guess relative to either your internal expectations based on what you're seeing in the macro, based on what you had heard or throughout the quarter regionally, products, specific, et cetera, where do you feel like the biggest out-performance was for the business in the environment?

Marc N. Casper

So Ross, thanks for the question. Welcome back to the conference call. A couple of things. Actually, if you look at the results, and we do actually look at all of those reports, and we do read all of the competitor reports pretty much realtime. Actually, this quarter is actually very consistent to the last 2 quarters. So 3 quarters in a row, our organic growth has been very strong relative to the peer set. So I actually think you're seeing a nice consistent trend of us delivering very strong organic growth, 5% in Q4, 4% in Q1, 4% in Q2 and relative to the share gain initiatives we had. But I'd say where do I feel -- I think the teams are executing extraordinarily well. They're very focused on -- we have great products and are very focused on serving our customer needs. Our value proposition is incredibly relevant in today's environment, right? Our customers are living in a tougher world. They need productivity. They understand our scale. They understand our depth of capabilities. We've been at this for 5 years in terms of -- since the merger in building those capabilities and you're seeing us harvesting those hard work, and it's showing up in our organic growth results. So it's less about a particular geography or a particular product, it's really about a value proposition that resonates in today's environment. We feel great about it.

Ross Muken - ISI Group Inc., Research Division

And maybe on the guidance increase on EPS, obviously, I think that's not something we've seen from many businesses in this environment, given the macro backdrop and what we saw in -- through the June time frame. And so as you guys were sort of debating the forecast and we're looking at sort of early trends in July, how comfortable were you? Or how did you think about sort of how aggressive you wanted to get with sort of the guidance move vis-à-vis sort of the bigger picture and what other large corporates were doing with their outlooks? And then I have sort of a clean-up question on that as well.

Marc N. Casper

Sure. So Ross, in terms of guidance, the world isn't playing out, at least, the first half as we expected and articulated in February, right, when we set out our original guidance. So we expected Europe to get weaker as the year went on. We expected sequestration would not get resolved during this year. We factored those things into our guidance. So when you think about us sitting with good execution at the first half, and the world playing out as we laid out back at the beginning of the year, we don't see a big change in those expectations. When you look at the various actions that we've taken, we've kept the organic growth guidance the same, and which means that we are -- we have a couple of points deceleration in the second half, which is a cushion if you will, right, versus the way we've been trending. But we think that's realistic, given the market outlook. And when you look at the fact that we're doing an incremental buyback, you look at the fact that we closed a nice acquisition in Doe & Ingalls, those things are net positives even offsetting the headwinds from FX. So the $0.02 increase to the midpoint is, we think, a good reflection. And we always focus on the midpoint of our guidance, so we feel like the low end protects for a much more challenging world if it unfolds.

Ross Muken - ISI Group Inc., Research Division

And just one quick cleanup on the guidance. I know One Lambda is clearly not in there from a revenue EBIT perspective. But just to be clear, there is a bit of interest expense assumption in there or not to you?

Peter M. Wilver

Yes, we added about $15 million of interest and that's to prefund the acquisition, as well as to fund the share buyback.

Ross Muken - ISI Group Inc., Research Division

So that will happen at some point in 3 or 4Q, I'm assuming?

Peter M. Wilver

It will happen some time probably in the third quarter in terms of the debt issuance.

Operator

Your next question is from the line of Vamil Divan from Crédit Suisse.

Vamil Divan - Crédit Suisse AG, Research Division

So I guess, I just have a couple of questions here more related to what you're seeing kind of sequentially through the course of the quarter, heard some comments from other companies in terms of April through May through June. Have you seen any significant trends kind of through the course of the quarter or into July that give you any cause for -- that things are getting better or worse in any way?

Marc N. Casper

No, we looked at that. And when we do our guidance, we factor in through the first 2 weeks of the quarter that we're living in as well. So we feel that the guidance that we've given is reflecting those trends. We didn't see big changes in June or anything that would lead us to believe of a very different trend and a change in trend or trajectory. So fairly consistent throughout the quarter.

Vamil Divan - Crédit Suisse AG, Research Division

Okay, and then just one other one if I could with -- in terms of the -- I know you guys don't give beyond in terms of quarters, looking forward the rest of the year, but you've been getting a lot of questions just in terms of how the fourth quarter might play out with all the questions on sequestration and what's going on in Washington. Any guidance you can kind of give just even more qualitatively in terms of how you expect kind of third quarter versus fourth quarter. Just looking at the numbers right now, it looks like we're still seeing difference [ph] in terms of growth expectations over the third versus the fourth quarter?

Peter M. Wilver

So in terms of our quarterly phasing, just seasonally, Q3 is always a relatively weak quarter just because of the vacations in Europe and really around the world, I guess, and Q4 is always our strongest quarter in terms of the year-end push on instrumentation, so probably slightly stronger in Q4. But all that depends a little bit on what happens with sequestration.

Operator

Your next question is from that line of Daniel Brennan from Morgan Stanley.

Daniel Brennan - Morgan Stanley, Research Division

I wanted to ask a question on the lab products in terms of business. Second quarter in a row, solid organic growth there versus some peers pointing to more challenging environment. Can you just provide some color regarding the strength you're seeing there and the kind of the sustainability of those trends?

Marc N. Casper

Sure. When I look at lab products and services, we saw another good quarter in our Biopharma Services. The clinical trials outsourcing business is doing well. Our channel business is also performing well. So we like the trajectory that we're on in our lab products and services segment.

Daniel Brennan - Morgan Stanley, Research Division

Maybe related to that, the divestiture of the workstation business, can you just discuss kind of what kind of impact that had on the organic growth in the quarter?

Marc N. Casper

Yes, when you look at organic growth, we would have had as a company about 3.5% organic growth if lab workstations was in the numbers. And we had 4% organic growth with lab workstations out of the numbers. And we would have had $0.02 lower adjusted EPS if lab workstations was in the number versus what we did, as Pete highlighted. So the decision on lab workstation had nothing to do with any of that stuff. It was more a decision that we made as a management team that we really want the best owners for this business and decided that we were going to sell it to a business that could really help it thrive and grow for the future.

Daniel Brennan - Morgan Stanley, Research Division

Marc, and maybe if I can just sneak one more in. The gross margin strength in the quarter, it was better than we had modeled. Could you just tease out the components? Certainly, Phadia and Dionex coming to the mix are helping margins like is it possible to quantify like Phadia and Dionex contribution versus cost cutting? And in particular, did the company accelerate any facilities closings or any other cost measures that would have led to better gross margin leverage in the quarter?

Peter M. Wilver

Yes, so in terms of gross margins, certainly, the acquisitions benefited gross margins. That obviously is going to decrease in terms of the impact throughout the year as we anniversary those in Q2 -- or excuse me, Q3 Dionex will be fully out. And then Q4, both of them will be fully out. But the gross margin improvement is kind of on the core business is really coming from the areas that we continually drive productivity and which is sourcing our PPI business system and restructuring. And the benefit there, it's probably about 1/3, 1/3, 1/3 between those 3 in terms of improvement on the core business.

Operator

Your next question is from the line of Dan Leonard from Leerink Swann.

Daniel L. Leonard - Leerink Swann LLC, Research Division

Two quick ones. First off, in lab products and services, now that you've divested or you're planning to divest the workstations business, how should we think about the margin trajectory of that business going forward? Is that a business where you could increase margins commensurate with the corporate average annually? Or will that still be more lumpy?

Peter M. Wilver

Yes, I think in Laboratory Products and Services, it's lower than average, and we have the channel business there, which we don't have as much value-added cost that we can actually impact in terms of margin expansion. So there's a lot more direct material costs in that segment. So that segment, over time, will in general have lower-margin expansion than the average for the company just as a result of that.

Daniel L. Leonard - Leerink Swann LLC, Research Division

Okay. And then housekeeping, Pete. What are the foreign currency rates you're using in your guidance versus the euro?

Peter M. Wilver

Yes, so for the euro, it's about 121.

Operator

Your next question is from the line of Amit Bhalla from Citi.

Amit Bhalla - Citigroup Inc, Research Division

I wanted to just have you, Marc, elaborate on your comments on the CapEx budget releases within academic government. Can you give us a little bit more detail under the types of products that are being impacted and tie in what you're seeing within mass spec in the competitive environment?

Marc N. Casper

Sure. So academic and government really didn't change very much, didn't really change at all in Q2. Consumables, broadly did fine, which means it's logical, right? Customers, they're working, right, so they're doing research, so therefore, they're consuming plastics, reagents and so forth. Instrumentation really was more aligned with how differentiated the technologies were. So in particular, our mass spec business had a very nice quarter. But things like lab, equipment and more routine instrumentation would be -- would really be a little bit softer and more constrained.

Amit Bhalla - Citigroup Inc, Research Division

Okay, that's helpful. And the second part for my question is on the Analytical Technologies. You highlighted Biopharma within Analytical Technologies as a strength in the past. This quarter, I don't think Pete brought that one up, but you did talk about Biopharma strength overall. Can you talk specifically about Analytical Technologies, anything going on there that we should be aware of?

Marc N. Casper

No, within Analytical Technologies, we have our BioProcess Production business, which had another terrific quarter. That was there, I would say, on the instrument side of the business, so it was kind of an okay quarter in terms of Biopharma. It was up, but it was not probably as strong as some other quarters.

Amit Bhalla - Citigroup Inc, Research Division

Anything regionally that's impacting that or is it just across-the-board?

Marc N. Casper

I didn't really see any particular regional explanation. I think, generally, Europe was pretty soft.

Operator

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

Jon Davis Wood - Jefferies & Company, Inc., Research Division

So you guys have previously talked about something like 50% of free cash flow back to the shareholder dividends and repurchases. Obviously, you're going to do a lot more than that this year. But just wondering, should we think about a different rule of thumb going forward specifically in '13 just given the leverage ratio post the One Lambda deal, meaning, is deleveraging a greater priority for '13 at this point?

Marc N. Casper

I think when we get to -- we'll do that really in the February guidance. I mean, at a high level, our capital deployment strategy hasn't changed, which is a portion of our capital is going to get returned to our shareholders. A portion is going to be used for M&A that meets our strict criteria and in any given year may vary based on the environment. We're comfortable with our leverage ratios hovering between 2.5 and 3 at year-end. They should be relatively close to 2.5, so I don't -- I wouldn't assume major changes in the capital deployment strategy for '13, but we'll figure that out and communicate it crystal-clear in February.

Jon Davis Wood - Jefferies & Company, Inc., Research Division

Got it. Marc, one last one. Any view on the timing of Hamilton divestiture? And anything you've -- it looks like you've written the book value down to close to 0, is that accurate? And would you expect to get any material proceeds there?

Marc N. Casper

In terms of the divestiture process, it's ongoing. In terms of the gains and losses, I don't want to speculate on that because I want to wait til we actually have the buyer negotiate, and I don't want to handicap or really comment on the valuation. But I think the write-down is a reflection of what we think was an appropriate accounting at the point of time of the decision to divest it.

Peter M. Wilver

It is above 0 though.

Marc N. Casper

Yes.

Operator

Your next question is from the line of Doug Schenkel from Cowen and Company.

Doug Schenkel - Cowen and Company, LLC, Research Division

Maybe just building off of that last question, I think the conclusion has been you've done a good job divesting businesses when you think about Athena and Lancaster last year and certainly the one you're in the process of divesting makes sense. Could you just describe what the environment is like for these opportunities? And maybe more importantly, what's the criteria you're going to use moving forward to make divestiture decisions? Is it simply a question of in your words whether or not you're the best owner for an asset? Or is there something we can also look at in terms of size, margin profile, growth rate, any other criteria that you would be willing to share with us?

Marc N. Casper

Doug, so we're not contemplating any material divestiture. So if you want to define material, anything nearly as large as lab workstations. So we always do tiny little things and we'll continue to do that. But we like the portfolio. Our strategy is clearly working when you look at the organic growth that we're delivering over the last few quarters. That's because the package of businesses we have today fit together, work together and are valued by the customers. So I wouldn't expect really much more on the divestiture front. And if you think about it, you go back over the last 5 years, the ones we've divested are very logical and they've been telegraphed, if you will. We've never liked competing with our customers, so we sold our 2 testing labs, which is Athena Lancaster. And lab workstations has been a business that is a very heavy manufacturing business. It's very different than what we do. And when we look at the long-term fit, we think there are companies that have a better ownership with it than we would.

Doug Schenkel - Cowen and Company, LLC, Research Division

Okay. So if I have it right, it looks like restructuring expense picked up a little bit, Q1 to Q2. Was this as planned, assuming I have this right, or was it in response to anything that you're seeing in the environment? Or is there anything else that caused this to accelerate that was different than planned?

Peter M. Wilver

So we obviously put whether the $100 million restructuring plan last year, and we've been executing against that throughout the year. We're always doing some level of restructuring actions in addition to that. As Marc said, it's not kind of at the program level, it's more the one-offs, so I wouldn't necessarily read anything into that other than just normal actions that we do throughout the year.

Doug Schenkel - Cowen and Company, LLC, Research Division

Okay. And last one, you continue to pick up shares, the numbers suggests and as you mentioned in your prepared remarks, some of this is easy to see via new products in Analytical Technologies like Q Exactive. But beyond specific new product launches, are you evolving how you go-to-market with products, how you sell products within Analytical Technologies? In our channel checks and our conversations with some of your competitors, we're starting to hear more about Thermo doing a better job selling applications-wide solutions, if you will, really connecting different products and services across your analytical technology product portfolio? Is there something that's changing in terms of how you commercialize customer solutions? And if so, how far along are you in this process?

Marc N. Casper

That's a good comment, not much more to add, Doug. I like the feedback. I would say it's an area that we're focused on, and I think we're doing a better and better job of representing our solutions-based capabilities for our customers. And I still think we have a lot of work to do and a lot of opportunity ahead. So it's still young, if you will, but we've been working at it and our customers understand the value of it. I actually think when customers are more constrained and customers are trying to make sure they're successful, the broader your capabilities and the deeper your applications are, the better off you're going to be, and I think that's really paying off for us.

Operator

Your next question is from the line of Tycho Peterson from JPMorgan.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Actually, I want to kind of take a slightly different angle to Doug's last question there and this is really the second quarter in a row we've seen you outperform a lot of your equipment peers. Can you talk to how much of that is share gains versus other factors? We obviously, as Doug said, see it in mass spec. Are there other obvious areas where we should think about you pulling share? And then how much is pricing a factor in this environment, in particular, within mass spec?

Marc N. Casper

So there's no pure -- each company is a little bit different. So when we look at our mix of analytical technology, it's different than the other companies. I do think we have a good share gain in mass spec. I think our biosciences business is doing well and generally I view that the performance is strong. Pricing has -- was up slightly in the quarter, but it wasn't a big change from what we've seen. So I don't think price is a big factor one way or the other in the performance.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Okay. Just a couple of housekeeping ones. Is Phadia kind of back on track? That was a little bit soft last quarter. There was some seasonality there. Can you just talk to whether that's recovered?

Marc N. Casper

Yes, so Tycho, let me give a more holistic update on both acquisitions that we are almost at the one year anniversary. I think it's a good question. It hasn't been asked. So when you think about Dionex, when you think about Phadia, let's look at it in the 3 criteria that we look at which is how is the integration going, how's the business performing short term or what's the long-term prospects. Integration for both businesses has gone extraordinarily well. It's Thermo Fisher, I mean, at this point, both of them. They're very well integrated. The culture is very harmonious, and it's very positive. Synergies are ahead of plan when you look at accretion, which is now the reflection of the full package or performance. In 2012, accretion is going to be better for both of those acquisitions than the acquisition model. Phadia, in particular, will be very meaningfully more accretive than we articulated back on the $0.30 that we had talked about. When you look at the short-term performance of the business, both businesses actually have more European exposure than the company average. So both of them actually are growing slightly less than the company average in terms of organic growth. But if I look at the longer-term prospects for both businesses, we're very, very bullish on what both bring to our company and feel good about it. So generally feel good, but European exposure hasn't been particularly helpful.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Okay, and then last one. I know you've a number of questions on Hamilton, not to spend too much time on it, but I mean if we go back years and years ago, this was always viewed as a bad business. I think you and I used joke the competition was 2 guys in a sauce. So it hasn't gotten better over the years presumably. Why did it take so long to divest it? I mean, was there a period where you thought you could actually really truly turn it around?

Marc N. Casper

We have a terrific team of employees in that business, and they work very hard to make it the very best business that it can, and we gave them significant resources to try to make the most of it. And when we look at it today, we just think there are companies that it's more core to their activities than ours and we decided that that's right thing, so it's a decision. It's a tough business but at the same point, we think it has good prospects, and we think the right owner will bring it to its full potential.

Operator

The next question is from the line of Derek De Vries from Bank of America Merrill Lynch.

Derek De Vries - BofA Merrill Lynch, Research Division

So you're -- in Q3, you're going to anniversary the weak academic environment that hit you last September. Since comps get easier, I guess, what's kind of built into your academic numbers? Are you still expecting academic to be down year-over-year or is it more flat? I'm just kind of wondering how you're -- where are you on that thought process?

Marc N. Casper

So when you look at the comps, industrial gets harder both in Q3 and Q4 and obviously in academic, the comparison is easier. When we laid out our guidance, we obviously don't do quarterly guidance. When we laid out our guidance, we assumed that academic and government would be down low-single digits for the year. It's down low-single digits in the first half, and that sort of implies that it's going to be still down off of an easy comp. I mean, that would be what the math would imply, although, we're not -- we don't really sit down and say what's Q3 exactly going to be versus Q4 but hopefully, that helps you think about modeling.

Derek De Vries - BofA Merrill Lynch, Research Division

Yes, that's very helpful. So you've gotten beaten up in the past in your LPS business because organic growth lagged. Now that you've divested it, I know that you're planning to divest it. It's been 0.5% drag in your overall organic growth rate in Q2. But can you just give us a flavor of what it has been historically as a drag on the LPS segment?

Marc N. Casper

In terms of lab workstations, in particular?

Derek De Vries - BofA Merrill Lynch, Research Division

Yes, lab workstations, what was the drag on the overall LPS business? Because when the focus has been that business had not -- it did not grow as fast as it had previously thought, and I'm just wondering if this was a bigger -- if it's the large reason why that business have not done as well in the past?

Peter M. Wilver

The results in 2011 were relatively weak, but the numbers are so small that the accretion dilution on both organic growth and the margins is pretty minimal. For this year, it didn't really even affect our guidance taking the numbers out, so it wasn't so materially off of the averages that it was making a big impact.

Marc N. Casper

Yes, I mean, I think, Derek, you know us well enough and following this stuff which is it's not going -- it's not big enough to make a material change, but it was the right decision to sell it, so we're selling it. But we're not sitting here and trying to change the gross rate by 0.10 point one way or another. It's just -- in the scheme of things, it doesn't make a difference.

Derek De Vries - BofA Merrill Lynch, Research Division

Right. No, that's right. And then finally, can you just give us some more color on Asia? Is the growth you're seeing there share gains from peers? For example, the multinationals that you're selling to, are you just getting better share there? Are you taking share? Or is it brand new business from domestic Chinese or Asian customers that are showing up? Can you just give us a little bit of flavor of where you're seeing your growth and how that's working?

Marc N. Casper

Yes, so let's focus on China. China was very strong in excess of 20% of growth organically again. When you look at it, we had very good performance widely across the business, and I think a nice example is we talked about the 5-year plan and the focus on healthcare, the focus on environment, so it's not a surprise that our Specialty Diagnostics business is doing very well and growing rapidly in China, in particular, because basically there's a big healthcare availability opportunity in China, where they're trying to create more capacity, if you will, to serve the population. The other area that's doing incredibly well in China is our environmental business. There is regulations called PM2.5, which is basically breathing in particulates in your lungs, and the government has actually decided to accelerate on implementation of those regulations, and we're capturing about 70% share of all of the air monitors that are being used for that particular application. So it's really -- it's not taking share from the New York Stock Exchange listed competitors, taking share from companies that might be local or really, we don't think as much about. So the business is performing very well, and we continue to be optimistic about our outlook in China in particular.

Operator

Your next question is from the line of Dan Arias from UBS.

Daniel Arias - UBS Investment Bank, Research Division

Marc, I guess, just given the focus on cost control these days, curious whether you can give us a sense of where you think the biggest need to spend is in order to keep innovation where it needs to be and to keep people in the right places? Can you just update us on your current view on investment focus?

Marc N. Casper

Yes, I mean, I think the investment focus is straightforward. We're going to continue to support our R&D efforts, and we're going to continue to expand in emerging markets. Those are clear. We'll also make commercial investments around the applications marketing as Doug asked earlier, some things on the website, things that continue to strengthen the company. We will manage our costs tightly on all other areas, right? So we're being prudent and frugal on those other things, so making sure that we're as efficient as we can and looking for opportunities to streamline our cost base.

Daniel Arias - UBS Investment Bank, Research Division

And just a follow-up. I'm wondering if you can comment a bit more on applied market demand. Some reports elsewhere have maybe some potential slowing in food and environmental testing areas. Is that something that showed up anywhere for you guys at all?

Marc N. Casper

Nothing that really jumped out from our material perspective one way or the other. We continue to have good momentum in our applied markets.

Operator

And that question will come from the line of Isaac Ro from Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Just wanted to ask a general question on pricing. I think you guys mentioned in the earlier comments that pricing generally, not a big swing factor, but if you could maybe add a little bit of color in diagnostics and then in pharma. I think in diagnostics, we're clearly dealing with pretty stagnant volume environment and the lab companies have generally suggested they're going to look to try and save expenses. So what are you seeing in the diagnostics channel with regards to your basic supply side of the franchise? And then in pharma, some of these larger contracts, just wondering what kind of a tone you see on pricing there?

Peter M. Wilver

Yes, in terms of pricing in diagnostics, I mean, that's not an area where we generally get a lot of price. So that's consistent with the past. It's basically flat overall. I don't have a lot of data by market segment in relation to the price, but in overall, it's about flat.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Okay, and then in pharma?

Marc N. Casper

In pharma, again, we don't cut the business that way. I would say that probably the takeaway message on pricing in Q2 was pretty similar to what we saw in Q1 in aggregate and not really any major changes that we observed. So we pay a lot of attention to it. Obviously, we have a very high focus on pricing. We generally do a good job with it, so -- but we're not seeing anything, Isaac, that on the upside or downside that's material.

Isaac Ro - Goldman Sachs Group Inc., Research Division

That's helpful and just one last one for me on China, I know mentioned earlier the comments on the environmental business. But if we look at the economics side, there were some questions elsewhere in the industry about phasing on government funds, getting released over the course of this year, any update and commentary on that part of the China end market?

Marc N. Casper

No, when we look at China, we've been consistently growing north of 20%. And really, there wasn't major swings one way or the other within the business. So we feel good about the overall performance in China, and actually feel good about the outlook as well. So Isaac, thank you.

Let me just wrap up the call and add a few quick closing thoughts. One is that I think our team's executed very well to deliver a strong first half. Their focus on new products, emerging markets and strategic acquisitions is clearly driving growth. We continue to manage our costs tightly in line with the economic environment, and we're confident that we'll deliver on our growth goals for the year. Thanks for your support of Thermo Fisher Scientific, and we look forward to updating you on our Q3 call. Thank you, everyone.

Operator

And ladies and gentlemen, this concludes your presentation. You may now disconnect, and have a great day.

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