Thermo Fisher Scientific Inc (TMO) — Q2 2016 Earnings Call Transcript

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 Investors section of our website, thermofisher.com, under the heading Webcasts & Presentations until August 26, 2016. A copy of the press release of our second quarter 2016 earnings and future expectations is available on the Investors section of the 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 quarterly report on Form 10-Q for the quarter ended April 02, 2016, under the caption Risk Factors, which is on file with the Securities and Exchange Commission, and also 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’ll be referring to certain financial measures not prepared in accordance with Generally Accepted Accounting Principles, or GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release of our second quarter 2016 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.

Thank you, Ken. Good morning, everyone. We’re pleased you could join us today for our Q2 earnings call. We had another great quarter with strong performance on the top and bottom line. We have a proven growth strategy, our team is executing well, and we continue to strengthen our offerings that help our customers meet their goals. Our result in Q2 contributed to a very good first half of the year. We’re also successfully executing our capital deployment strategy. As you know, a big highlight in the quarter was our agreement to acquire FEI. We’re really excited about the new opportunities this will bring, and I’ll discuss that in more detail later in my remarks. As usual, I’ll start by covering the Q2 financial highlights, give you a little color on our performance by end-markets and provide a recap of the quarter in the context of our growth strategy. Then, I’ll wrap up with our revised guidance. Starting with the financials, revenue in Q2 grew 6% to $4.54 billion. Adjusted operating income was up 9% and our adjusted operating margin increased 50 basis points to 22.8%. Last but most important, we extended our long track record of delivering strong adjusted EPS growth, with a 10% increase to a $2.03 per share. So, with another strong quarter behind us, we’re in a great position at the halfway point of the year. As you know, the global economic environment remains uncertain, but we’re using this as an opportunity to help our customers manage through it, and that will strengthen our competitive position and allow us to continue to gain share. Let me now turn to a high-level view of our performance in the context of our key end-markets. If we step back and look at the first half, our strong results were really a combination of good end-markets in aggregate and very good execution. Looking specifically at Q2, we were pleased to see continued strong growth in pharma and biotech, which grew in the high single digits. We’re benefiting from both the underlying strength of this end-market and our ability to successfully deliver our unique proposition to these customers. Growth in our bioproduction business was particularly strong in Q2. In healthcare and diagnostics, we grew at about the Company average, highlighted by strong performance in our ImmunoDiagnostics and next generation sequencing businesses. In academic and government end-markets, we continued to deliver low single-digit growth. And finally, we saw a continuation of low single-digit growth overall in industrial and applied. As we see for quite some time, industrial markets remain soft and applied markets continue to perform well, with especially strong growth in China and our chromatography business globally. Now, I will cover some of our Q2 business highlights in the context of our growth strategy. As most of you know, we increased our capabilities for our customers and drive growth for our Company by focusing on three strategic pillars, which are: High-impact innovation; scale in emerging markets; and delivering our unique customer value proposition to gain share. So, let me start with innovation where we participated in a number of major conferences in Q2, representing a broad cross-section of our customer base from cancer research to bioproduction, mass spectrometry, and applied markets. There are great opportunities for us to demonstrate our leadership and our commitment to our mission, which is to enable our customers to make the world healthier, cleaner, and safer. I use that as a framework to cover a few of the highlights. First, healthier: We exhibited our leading offering for bioproduction customers at INTERPHEX. In addition to our expanded line of single-use containers, we featured new products from our recent acquisition of ASI such as the ImPULSE single-use mixing system for biotherapeutics. We continue to benefit from strong demand for these technologies as our customers rapidly adopt single-use technology for the production of biologics and vaccines. At ASMS, we launched our new Q Exactive BioPharma mass spectrometer, which we designed specifically to help pharma and biotech customers more efficiently discover and develop new drugs. As these systems become more powerful and data much more plentiful, customers need to better track, manage, and share their results, as well as connect and monitor their instruments. We ramped up our efforts to address these rapidly changing needs and also launched a suite of new software and cloud-based solutions at ASMS to support a range of applications. So, back to our mission. In terms of enabling a cleaner world, the big event for applied markets in the quarter was analytic test, which was held in Europe. Sustainability is especially important to these customers and a key area of focus for us as well. We featured a range of laboratory equipment designed for a cleaner lab including our new TFX ultra-low temperature freezers that use natural refrigerants and reduce energy consumption. We also featured biosafety cabinets that require 75% less energy to operate. Last, a good example of safer is that our Gemini handheld chemical analyzer won the 2016 Edison Award for forensics and security. To remind you, Gemini was the first instrument to integrate Raman and FTIR spectroscopy in the handheld device that can be used by hazmat teams, first responders, and military personnel in the field. These are just some of the many examples of how we fulfill our mission by helping our customers meet their goals. Turning to emerging markets, our second pillar of growth, we had another strong quarter in these geographic regions with standout results in China, South Korea, India, and Southeast Asia. To mention a couple of highlights, China continues to be a great market for us, and we delivered another strong quarter with growth in the mid-teens. Our businesses across the Company continue to benefit from growth in applied markets such as environmental and food safety as well as life sciences which is expanding into new fields like precision medicine. In June, we announced our partnership with the West China Hospital of Sichuan University to develop a joint platform for advancing research in precision medicine. This is one of the largest single-site hospitals in the world, and we’re looking forward to helping our customers there improve the quality of pathology research and clinical diagnostics. This exciting opportunity underscores the importance of precision medicine as a global initiative and one that was identified as a key priority in China’s new five-year plan. In other emerging markets, robust growth in South Korea was driven by our leading presence in biopharma. It’s also great to see our investments in India paying off with another strong quarter of growth. We had strong performance in Southeast Asia as well. And I was traveling there last month and visited our regional headquarters in Singapore. We continue to expand our center of excellence in Singapore, which now supports manufacturing of our GC-MS products in addition to our life science solutions instrumentation. This site is a very good example of how we’re leveraging our scale to better serve our customers while improving the overall cost structure of our Company. I’ll make one last comment relative to the third pillar of our growth strategy, which is our unique customer value proposition. I mentioned precision medicine in my recap of China, and I want to give you another example of our efforts here because it illustrates how our scale and depth uniquely position us to play a key role. Precision medicine involves using a patient’s biological information down to the molecular level, to more effectively treat their disease. Cancer is a natural area of focus, and this information is being used to diagnose and treat a patient’s specific type of tumor. We had a significant presence at the American Association for Cancer Research where we featured a range of technologies suited to this important work including CRISPR and siRNA libraries, the iS5 and S5 XL next-generation sequencing systems as well as our leading mass spectrometry platforms. Our scientists also led numerous sessions on this topic covering solutions ranging from next-gen sequencing to liquid biopsy, qPCR-based pharmacogenomics, and targeted mass spectrometry. It’s clear that our customers are committed to finding better ways to treat this terrible disease, and our unmatched capabilities can help them accelerate their progress. Let me switch topics now and turn to capital deployment. We had big news on that front in late May, committing $4.2 billion to acquire FEI. This is a really exciting development, given FEI’s unique strategic fit with our Company and specifically within Analytical Instruments. As you know, we have an exceptional track record of developing Orbitrap mass spectrometry for protein identification and characterization, and it’s been the foundation of our highly successful franchise. FEI’s CryoEM system is also being used in protein research, specifically for the structural analysis of proteins. By combining these technologies of one company, we’ll be in the best position to help our customers capitalize on the rapid growth in structural biology. While FEI made progress moving more into life science applications, our unmatched presence in the industry will accelerate adoption with these customers. Since the announcement, I’ve had a chance to interact with quite a few of our future FEI colleagues, and it reinforces to me what a great business this is; it’s well-managed, has excellent technologies, and a talented and enthusiastic team. It’s going to be a great addition to our analytical instrument segment and a key growth driver for our Company. Let me also add that we’re making good progress towards closing the transaction. We now expect to close by the end of this year, versus our initial estimate of early 2017. The integration from both companies are in place, planning is underway, and we’re very confident in our ability to achieve the $80 million of total synergies we laid out when we announced the transaction. Now, let me give you a quick update on our guidance for 2016. As you saw in our press release, we’re updating our revenue and adjusted EPS guidance for the year. As usual, Stephen will cover the details and assumptions but in summary, we’re revising guidance based on our strong operating performance for the first half as well as for the more unfavorable foreign exchange environment. We now expect revenue for the year to be in the range of $17.84 billion to $18.0 billion. This would result in 5% to 6% growth over 2015, in line with our previous guidance. We’re raising our adjusted EPS guidance to a new range of $8.07 to $8.20, which is a 9% to 11% increase year-over-year. Before I turn the call over to Stephen, let me summarize my remarks with a couple of takeaways. We had another strong quarter of financial performance, which contributed to a great first half. We’re executing our growth strategy and complementing that with strategic acquisitions like FEI. We’re in an excellent position at the halfway point and on track to achieve our goals for the year. With that, I’ll now hand the call over to our CFO, Stephen Williamson.

Thanks, Marc; and good morning everyone. I’ll begin with an overview of our second quarter financial performance for the total Company; then, I’ll provide some color on our four segments; and conclude with an updated 2016 guidance. So, starting with the overall financial performance for Q2, as you saw in our press release, we grew adjusted EPS by 10% to $2.03. GAAP EPS was $1.30, up 2% through Q2 last year. On the top line, our reported revenue grew 6% year-over-year. Q2 reported revenue increased 4% organic growth, 3% growth from acquisitions while currency translation decreased revenues slightly. Please note the components of the Q2 change do not sum due to rounding. Given the FX volatility, I thought it’d be helpful to provide a little more color on the impact of foreign exchange in Q2. The revenue impact was a headwind of $16 million, but due to the mix of currency changes, the impact to adjusted operating income was actually a $4 million positive tailwind, resulting in a slight benefit to margins for the quarter and a $0.01 positive impact on adjusted earnings per share. At the very end of the quarter, rates changed significantly, and we’re expecting foreign exchange headwinds on both revenue and adjusted operating income for the remainder of the year. I’ll provide more detail on this later, when I go to the assumptions for our updated guidance. Looking at our growth by geography in Q2, both North America and Europe grew in the low single digits; Asia Pacific grew in the low double digits with continued strong momentum in China, good growth in South Korea, Southeast Asia, and India. The rest of the world declined mid-single-digits. Turning to our operational performance, Q2 adjusted operating income increased 9% and adjusted operating margin was 22.8%, up 50 basis points from Q2 of last year. Looking at the components of our adjusted operating margin performance in Q2, we achieved good margin expansion from our organic growth driven by robust contributions from our PPI business system, price, and volume. As we expected, Affymetrix was a 30 basis-point headwind on margins in Q2, but this was offset by the FX tailwinds that I just mentioned. Moving on to the details of the P&L, total Company adjusted gross margin came in at 48.6% in Q2, up 60 basis points from the prior year. The increase in adjusted gross margin was primarily due to strong productivity, acquisitions, and the FX tailwind, partially offset by unfavorable business mix. Adjusted SG&A in the quarter was 21.8% of revenue, which is up 10 basis points versus Q2 2015. R&D expense came in at 4% of revenue, down 10 basis points versus Q2 last year. R&D as a percent of our manufacturing revenue in the quarter was 6.2%. Looking at our results below the line, net interest expense was $106 million, up $11 million from Q2 last year, mainly as a result of financing related to capital deployment activities during the quarter. Our adjusted tax rate in the quarter was 13.5%, which is 50 basis points lower than last year, as a result of our tax planning initiatives. Average diluted shares in the quarter were $396.7 million, down $4.8 million year-over-year, mainly as a result of the share buybacks we completed in Q1, partially offset by stock option dilution. Turning to cash flow and the balance sheet, cash flow from continuing operations for the first half of the year was $1.2 billion, and free cash flow was $970 million after deducting net capital expenditures of $210 million. This is $310 million higher than the first half free cash flow in 2015. We ended the quarter with $665 million in cash and investments; and in Q2, we paid $60 million of dividends. As you know, we were very active in deploying capital during the first half of this year. We’ve acquired Affymetrix for $1.3 billion, executed $1 billion of share buybacks in Q1, and distributed about $120 million in shareholder dividends for a total of $2.4 billion in the first half of the year. In addition, we signed an agreement to acquire FEI committing an additional $4.2 billion of capital. Our total debt at the end of Q2 was $14.1 billion, down $900 million sequentially from Q1 as a result of paying down short-term debt. Our leverage ratio at the end of the quarter was 3.2 times total debt to adjusted EBITDA, down from 3.5 times at the end of Q1. Wrapping up my comments on our total Company performance, ROIC continues to improve. Our trailing 12 months adjusted ROIC at the end of Q2 was 9.8%, up 20 basis points sequentially from Q1. So with that, I’ll now provide you with some color on the performance of our four business segments. Starting with the Life Sciences Solutions segment, reported revenue increased 13% in Q2, and organic revenue growth was 7%. In the quarter, we continued to see very strong momentum in our bioproduction business and had good growth in our next-gen sequencing and bioscience businesses. Q2 adjusted operating income in Life Science Solutions increased 14%, and adjusted operating margin was 28.9%, up 30 basis points year-over-year. Adjusted operating margin was positively impacted by strong productivity and volume pull-through, partially offset by unfavorable business mix, acquisitions, and strategic investments. In the Analytical Instruments segment, reported revenue increased 2% in Q2 and organic revenue growth was 3%. In the quarter, we had strong growth contributions from our chromatography and mass spec, and our environmental instruments businesses, partially offset by continued weakness in some of our industrial markets. Q2 adjusted operating income in Analytical Instruments increased 4% and adjusted operating margin was 18.3%, up 30 basis points year-over-year. Very strong productivity, volume leverage, and favorable FX were partially offset by unfavorable business mix and strategic investments. Turning to the Specialty Diagnostics segment, in Q2, reported and organic revenue, both grew 4%. We saw good growth in the segment, led by the ImmunoDiagnostics business. Adjusted operating income increased 5% in Q2 and adjusted operating margin was 27.9%, up 10 basis points from the prior year. Adjusted operating margin was driven by productivity, volume leverage, and foreign exchange offset partly by the impact of strategic investments and unfavorable business mix. Finally, in the Lab Products and Services segment, Q2 reported revenue increased 6% and organic revenue growth was 5%. We had good growth across all businesses in the segment. Adjusted operating income in the segment increased 8% and adjusted operating margin was 15.5%, up 10 basis points from the prior year. Adjusted operating margin expansion in the quarter was driven by productivity and volume pull-through with partial offsets from strategic investments and unfavorable business mix. Now, I’ll review the details of our full year 2016 guidance. There are two primary changes from our previous guidance. First, we’re increasing our guidance based on strong operational performance; and second, we’re factoring in the recent changes in foreign exchange rates. I’ll take you through each of these in detail. The first is the increase in our operational performance outlook. With the good first half behind us, we’re increasing our expected organic growth for the full year from about 4% to about 4.5%. This increases revenue at the midpoint by $60 million from our previous guidance. The stronger organic growth outlook results in an additional $0.035 of adjusted earnings per share at the midpoint. Given that we’re one quarter further in the year, we’re also narrowing the range of our revenue guidance from $180 million to $160 million and narrowing our adjusted EPS range from $0.14 to $0.13. The second change relates to the impact of FX. As I’m sure you’re all aware, rates have moved significantly in the past several weeks. Given the continued uncertainty around FX rates, we’ve once again taken a conservative approach to arrive at the FX impact for the year. As a result, the change in FX reduces our revenue guidance for the year by an additional $19 million and reduces our adjusted earnings per share guidance by an additional $0.02. Our 2016 guidance now assumes the year-over-year FX headwind of $180 million of revenue or 1.1%, $42 million of adjusted operating income, and $0.10 of adjusted earnings per share. In terms of phasing of the $0.10 during the year, we’ve already incurred $0.05 of the headwind year-to-date and we’re assuming $0.03 headwind in Q3 and $0.02 in Q4. So, to sum all this up, the revised 2016 revenue guidance range is $17.84 billion to $18.0 billion, which represents 5% to 6% growth versus 2015, similar to our previous guidance. At the midpoint, revenue is increasing $60 million due to the improved operational performance outlook and decreasing $90 million with additional foreign exchange headwind. In terms of adjusting earnings per share, our increased 2016 guidance range is now $8.07 to $8.20 with a midpoint of $8.135. This represents growth of 9% to 11% versus 2015, also consistent with our previous guidance. Excluding the FX impact, this would represent adjusted earnings per share growth of 10% to 12% for the year. The midpoint of the adjusted earnings per share is increasing $0.015 with the additional $0.02 for foreign exchange headwind being more than offset by the $0.035 of improved operational performance. We’re now expecting 60 to 70 basis points of adjusted operating margin expansion year-over-year; this is slightly improved from my previous guidance of 50 to 70 basis points, primarily as a result of the change in FX. So, given the days impact on our 2016 fiscal calendar, I thought it’d also be helpful to add some more color around phasing. As a reminder, our Q1 had four more days and our Q4 will have four less days in the equivalent quarters in 2015. In Q1 2016, I reported organic growth of 10%, and we estimated the days-adjusted organic growth in that quarter was approximately 5%. As we look to Q4, given the days will be a headwind in that quarter, we’re expecting reported organic growth in Q4 to be essentially flat, consistent with our previous guidance. The days had a positive impact on Q1 and will have corresponding negative impact on Q4 organic growth. Overall, for the year, there is no impact. One final comment about the calendar, as I mentioned on previous calls, in Q4, we’ll have the benefit of four less days of costs, which we all expect to significantly benefit our adjusted operating margin and earnings in the quarter. As you think about the phasing of our adjusted earnings per share in the second half of the year, at the mid-point, we currently view approximately 55% being realized in Q4. A few other details behind the revised 2016 guidance, acquisitions are still expected to contribute about 2% to our reported revenue growth in 2016 and FX is expected to be about a 1% headwind. We continue to expect net interest expense to be about $390 million. We’re forecasting our adjusted income tax rate to be about 14%, no change from our previous guidance. In terms of capital deployment, we are still assuming we will return approximately $240 million of capital to shareholders through dividends. And our guidance does not include any future acquisitions, divestitures, or stock buybacks. Full year average diluted shares are estimated to be about 398 million, slightly lower than our previous guidance. We’re expecting net capital expenditure to be approximately $440 million, consistent with previous guidance. Finally, we’re expecting about $2.72 billion of free cash flow for the full year 2016; this is also consistent with our previous guidance. As always, in interpreting the revenue and adjusted EPS guidance ranges, you should focus on the midpoints as the most likely view of how we see the results playing out. So, in summary, we delivered another strong quarter in Q2, which positions us well at the halfway point to achieve our 2016 financial goals. With that, I’ll turn the call back over to Ken.

Thanks, Stephen. Operator, we’re ready for questions.

On the Analytical Instruments business, did you just talk a little bit about what the industrial headwinds have been to that business? And also just look back on a broader perspective on the overall Thermo business, can you talk a little bit about just what the overall industrial is? And this is going to lead to a question on potential fallout from slowing in Europe as a result of the Brexit and just if you are seeing anything there?

Sure, Derik. Let’s start with the Analytical Instruments. So, there are two business units within that segment, chromatography and mass spectrometry continues to grow high single digits and grew that in the quarter. Our chemical analysis, which is really the industrially related business, declined in the mid single digits. So, when you kind of look at it versus the various kind of sub peers, chromatography and mass spectrometry continues to do extraordinarily well in the marketplace, while chemical analysis is operating like most of the peers, very heavily industrially oriented. Towards the second part of your question, more of the broader Thermo Fisher industrial and applied exposure, about 20% of our revenue is industrial and applied; roughly half of that is applied and half is industrial. Applied markets continue to be strong. As I mentioned in my remarks, China continues to be very good for us. In the industrial markets, we really haven’t seen any inflection point; it’s really been continued soft conditions which we’ve had over the last few years. And then, in terms of Europe and Brexit, really just given how late the UK announcements came in at quarter, really had no impact in terms of the revenue outlook. It obviously had a lot of movement in volatility, and there might have been a little conservatism in the UK spend itself, but nothing significant in the quarter.

I wanted to ask a little bit about China and the underlying drivers there for the mid-teens growth. Could you remind us the rough mix of the end-markets there and just how strong was applied in the quarter?

So, in terms of our China business, in China at the end of last quarter really good strength across the end-markets. The pure industrial continues to be soft but applied markets very good, healthcare was very good in the quarter, as well as a big focus on the life sciences area, which is the convergence of historically, life science tools into the diagnostic applications with precision medicine. While we don’t manage our business by the end-markets, we manage by our businesses; what you see is in that particular end-market, applied markets because of the importance of environmental protection and food safety, is much larger as a percent of the total mix than the other markets around the world. So, those markets are good. China continues to deliver very strong growth, and bookings once again exceeded revenue in the quarter and it bodes well for the short term as well.

And then, just one follow-up on biopharma high single-digit in the quarter, I caught some of the feedback on bioproduction. Could you just maybe talk about the consumable service, clinical trial logistics, just how some of the other segments within there, performing will be great? Thank you.

Yes. So, in terms of biotech and pharma customers, another strong quarter due to the benefits of both the good end-market as well as really how well our value proposition resonates. In the quarter, the high single-digit growth, it really had the most challenging comparison year-over-year. So, that end-market continues to perform well. Bioproduction was the strongest of the businesses; the consumables channel business had a good quarter there, as well as did biosciences. We did get growth in our clinical trials logistics business, a little bit slower growth than the last few quarters, but that was something we anticipated because of very, very strong comparison in Q2. So, the fundamentals there are good, and the outlook continues to be strong in the biopharma end-market.

Marc, maybe to follow up on that last line of question for life science solutions, can you maybe just talk about how much of the outsized performance there is bioprocess versus next-gen sequencing? And on the latter point, are you starting to drive some revenue synergies between what you’re doing on the sequencing side and what the addition of Affymetrix would raise?

Sure. So, in terms of the life science solutions business, it had a very strong quarter, and it really is driven by good performance across the businesses. So, when you look at it, bioproduction had a very strong quarter, biosciences continues to grow well. Our next-gen sequencing business grew very strongly in the teens, and our genetic analysis business had organic growth that was also quite stable across all of its platforms. So, very strong execution across the quarter; obviously, the fastest growing portions are bioproduction and the next-gen sequencing businesses.

As a follow-up to Derek’s earlier question about industrial, we have noticed more positive comments from some of your competitors. One company had a good quarter, and another spoke optimistically about a recovery. Could you share your thoughts on when you believe the industrial sector will reach its lowest point, and do you anticipate an uptick in the latter half of the year?

Yes, I would say that while I have an economics degree, I am not an economist and I’m not going to predict when we reach the bottom. The various reports I've seen are quite mixed; some companies have very negative outlooks, while others are optimistic specifically about the industrial end-markets. So, I think it’s too early to determine if we’ve hit a bottom. However, if we do see it, that would clearly be a positive development since we are not factoring in any improvements for the rest of the year. If that occurs, it would definitely help us exceed the organic growth rates that Stephen mentioned.

So, one of your peers this week sort of dropped the idea that possibly this CapEx cycle for pharma will look different than prior and that maybe the sort of period will be elongated or we may actually not see sort of a down part of the cycle. And so, I guess as you step back and you think about, obviously you have a more unique viewpoint into a broad base of biopharma, what’s your sort of view on the sustainability of sort of the current trend and what are the pushes and pulls, whether it’s some of the emerging market pharma that are growing well, and the level of visibility or your feeling on that relative to maybe time past?

So, you’re clearly seeing an expansion of the biopharma industry in terms of the activity, not necessarily where drugs are consumed, but the activity in South Korea, China, and the other parts of the world. So, I think back over various cycles, they become so small relative to the U.S. and Western Europe but more meaningful. So, that’s clearly a positive. We’ve seen good growth there. India has been a good growth driver as well. So, it’s encouraging from kind of longevity. When you look at what’s going on, I think the single biggest driver is that the quality of the research and new entities getting approved, right? And because the funding ultimately is in Western Europe and the U.S., as long as drugs are getting through to the market and demand is strong there, they will be funding that’s very robust in R&D. So, it’s less cyclical than right now they are in a sweet spot of the science turning into drugs that’s turning into demand for our products. So, we feel good about it. And the fact, even in what I think are very good end-markets, there is an efficiency driver among that customer base, whether it’s small biotech or large pharma, and that plays to our sweet spot for sure. We see it in the results across quarters in and out, the very strong performance in the biopharma customer set for us. So, we feel very well-positioned in a good end-market.

And maybe just, it seems like broadly on the life sciences solution side, you had good numbers and I’d say the generic business did well. What about Affy? Obviously, you’ve now seen a little bit in terms of being in the organization, not very long, but enough to sort of get your hands around it. How are you feeling about sort of the different components there? And then in general, I think at the Analyst Day, you sort of highlighted the flow business a bit. I mean how are you feeling about that end-market?

Sure. Let me share our initial thoughts on Affy; we can’t focus on just one quarter. The integration is progressing very well, and we remain on track to achieve the EPS growth for 2016 that we had projected, which is about $0.06. We are ahead of schedule with synergies, particularly on the cost side, which is encouraging. The eBioscience business is performing well, and the flow cytometry market appears promising. Our Attune flow cytometer has seen good adoption, and we anticipate strong revenue synergies from that. Overall, the outlook is positive. However, the microarray business is not performing as well as we had expected. The situation with microarrays stems from a significant price drop by a major competitor before we completed the transaction, and Affymetrix as a standalone company chose not to respond. In Q2, we directed our R&D and marketing teams to address this competitive challenge. In early July, we launched the Axiom Precision Medicine Research Array, a comprehensive genotyping array that offers valuable insights regarding health issues, and we are providing it at very appealing price points. Overall, I am optimistic about the integration, synergies, accretion, and the performance of the flow and eBio businesses, and we are implementing strategies to address the challenges in microarrays.

My first question is on the academic government end-market. Does your guidance still embed an expectation that U.S. academic government demand picks up with the release of funding in the second half of this calendar year? And in Japan, recognizing others in the group have indicated that academic research demand was pretty weak in Q2, I’m just wondering if this is something you’re seeing as well.

Yes. So, Doug, from an academic and government perspective, as I mentioned, we grew in the low single digits. Q1, we saw a bit of an uptick in NIH release of funds; Q2 was consistent with that improvement. We expect the balance of the year to be consistent with that. In terms of Japan, we grew low single digits, in line with our expectations in the quarter. Academic was a little bit soft, and biopharma was quite good. So, Japan for us continues to be not particularly noteworthy; it’s not a very big end-market and generally performing in line with expectations.

Okay. And just one quick cleanup question. In terms of share repurchases, you did put an additional authorization in place over the last two months or so; doesn’t seem like there is any change in share count assumptions embedded into guidance. So, should we think that you’ve an incremental share reauthorization or larger share authorization to purchase more shares in place now, but that’s something that’s probably not going to be acted on until you get into next year and closer to the closing of the FEI M&A closure?

Yes, I think that’s a good observation and good assumption. Generally, we prefer to have an open authorization in place. We utilized the authorization when we conducted our share buybacks earlier in the year. The $1.5 billion is consistent with our long-term capital deployment strategy; I wanted to have a slightly larger authorization. However, given our active capital deployment in the first half of the year, we don’t have any immediate plans to utilize it. It’s mainly for housekeeping to ensure we are prepared to be opportunistic and aligned with our long-term capital deployment strategy.

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

Marc, looking at the quarter from a high-level perspective, it appears solid with many moving parts; it aligns well with your guidance, and there haven't been significant changes. Can you share any noteworthy highlights from the quarter that stood out to you? Although nothing seems particularly remarkable on the surface, is there anything you think we should take special note of?

Yes, I wish it was a video conference, so I could have a big smile on my face. This was actually an excellent quarter, Jon. When I think about it, many of you have heard me saying is generally, I don’t like to have investors have to really think about Thermo Fisher in terms of any of the nuances because it’s our job to manage through the various puts and takes in the economy. We executed very well. Effectively we were able to raise our organic growth outlook for the full year based on the half. We don’t typically raise organic growth guidance during the course of the year; we typically are more focused on the EPS, so we did both, which I think is great. When you look at the geographic strength, we went out of the way to highlight the strength in four different end markets in Asia Pacific, catering to specific customer needs. That really bodes well for the second half, given the fact that there is clearly some volatility and uncertainty in Europe that we don’t know. Nobody knows exactly how that will play out. Given how the U.S. is doing and given how Asia Pacific is doing, we’re very well-positioned to have an outstanding year. Capital deployment has gone well; margins were good. So, I like the fact that there is really not a tremendous amount of nuances. It’s a very clean ahead of expectations quarter and our ability to offset the FX headwinds that are there and raise guidance. And then, finally, as Stephen said in his remarks, we are a bit conservative on the outlook on foreign exchange in our guidance. If foreign exchange stays exactly as they closed on the spot rates, we actually have a little bit of upside to the guidance there. So, really, a very good time at the halfway point of the year.

Okay, that’s helpful. And as a quick follow-up to that Marc, if you think about the second half, as you mentioned you have the UK decision; you have the politics going on in the U.S.; you have the China precision medicine initiative, which seems to be really kicking up. I guess are you kind of handicapping your second half outlook?

So, the way we’re thinking about it is the outlook in the second half in aggregate is similar to the very original guidance we gave at the start of the year for the second half. So effectively, the first half was better than we expected, we put it all in the bank, raised our organic outlook, and we’re assuming consistent with our original guidance for the second half of the year. Geographically, probably it will be slightly different, meaning that it’s likely to be Asia Pacific and U.S. a little better than Europe, but we have enough room to achieve our goals even with some ups and downs in the various end markets.

First, a question on one product specific item and then, second on the financials. Marc, you mentioned you don’t want to get too into the specifics of products, but I was curious on your NGS comments, hoping to put that in context with the performance in OSS in total; just kind of curious how significant that was. And maybe curious to the extent that that business has been doing maybe better over the last couple of years than you might have expected; is it really a function of still growing the install base or is it really about the consumables pulling through a lot of utilization on the install base you have?

Isaac, I appreciate the question. And the reason I would say that I won’t get too much into the details of the products is that we have such a broad range of products and really it’s how we manage the portfolio. But I am happy to get into the NGS discussion. We had a very good quarter. The adoption of S5 and S5 XL sequencers is going really well; the feedback is very positive, and customers love the ease of installation and the ease of use of the instruments, and it’s fantastic feedback. The other thing that was exciting and may not be as clear, but at the European Association of Cancer Research conference, we were the first company to bring to market, a kit for liquid biopsy for cancer. And that was very well received as well. So, consumables are doing well, our product development is going well, and the option of instrumentation is going well in the quarter.

Steve, regarding the tax rate, you have maintained the 14% figure, which was slightly better this quarter. Should we expect an increase in the second half, or is there a chance that if the geographic mix changes, you could see an improvement in that tax rate?

So, we’re still guiding to 14% for the full year. I see that’s where it will end up, given what I can see now in terms of the discrete items. The lower tax rate in Q2 was really due to the timing of some of the discrete tax planning activities coming in stronger in Q2. I expect that to continue in Q3, so similar tax rate in Q3 versus Q2 and slightly higher in Q4, but overall for the year, 14%.

Marc, if I look at the growth rate in China in the quarter, on the one hand, it’s clearly a very good number, but then when I consider the comp and how tough it was, it’s actually the best quarter, growth wise you’ve had in China in I believe at least a few years. So, I wonder, given that context, if you could refresh your thoughts the impact of some of the initiatives we’re seeing in China, as much as they relate, not so much to what we’re seeing here in 2016, but a medium-term outlook there, now that you’ve got a little bit more evidence? And then, just one housekeeping question for Stephen. Sorry, if I missed it, but did you refresh any thinking on the free cash flow or working capital outlook for the year?

I’ll start with the second question on free cash flow. So, we didn’t change the guidance; it’s still $2.72 billion. At the half-year point, we’re actually doing very well; so, $310 million higher than the same half-year point last year, and that’s where some phasing of cash taxes and cash interest, more front-end loaded this year. So, working capital is going well; we’ve still got six months to go. If we continue the way we are, we will meet or exceed the full-year cash flow guidance.

And Steve, you’re 100% right; the stack comparison was the best performance in China in a while. So, as you know, we’ve been positive on China for a very long time. When we came out of the one soft year where we had the mid-single-digit organic growth a couple of years ago, what you’re seeing is a consistent trend of improvement. When I was there, I had the opportunity to meet with the Vice Minister of the Ministry of Science, and really talked about precision medicine. That is a huge focus. So, we continue to be very bullish on the long-term prospect for China.

I have two questions, the first one is for Stephen. Could you explain a bit about your thoughts on foreign exchange? I understood that you have a significant natural hedge in the UK. Additionally, I was under the impression that you would benefit from the stronger yen. What is the factor that is somewhat offsetting that benefit as it pertains to earnings per share related to foreign exchange?

Sure. So, when you look at the currencies we have overall, and the year-over-year change at this point, the yen is a positive, and that’s helping the overall picture for full-year FX impact. The majority of the revenue headwinds, about 75% of it is coming from that change in the pound. Then the mix of all the other currencies is pretty much negative against the dollar at this point. So, the mix of all of that basically gets you to where we are. Now, as I said in my prepared remarks, we have a cushion against the current spot rate. So, if current rates still stand, we’ll have some upside to the guidance that we give. Yen is a positive but it’s really offset by the other pretty every single other currency.

Okay, it makes sense. And then, just secondly, within the LSS business, it’s been a number of quarters now in a row where you guys are showing strong growth there. I was wondering, Marc, if you could comment at all on how much of that is end-market versus revenue synergies you might be experiencing with the Life Tech business?

Revenue synergies are very strong. The performance we're seeing is now deeply integrated into our organic growth, especially considering the time since the transaction. We achieved $60 million in revenue synergies for the full year in the first half, which means we will significantly exceed our revenue synergy targets. Tracking these synergies is evident in our organic growth, which remains a major advantage. As I've mentioned previously, one key aspect of our overall performance in Life Sciences Solutions is that the end market conditions have improved since we announced the transaction in 2013. The rest can be attributed to excellent execution by our team and the unique advantages that Thermo Fisher Scientific has brought to this business segment.

Maybe just two quick ones on the outlook, Marc, tying out the end market commentary on industrials with the softness that you are still seeing there; is flattish still the right way to think about things for the year? And then, Stephen, what at this point are you looking for in terms of the FX impact to gross margins for the year?

In terms of industrial and applied, while we don’t give a precise outlook during the course of the year, flattish to low single digits is a good assumption for the industrial and applied markets for the year.

Basically, I’m not expecting a significant impact on gross margins or operating margins for the full year the way the rates are today.

Hey, Marc, your internet strategy is obviously helping drive organic growth in your pricing ability. Can you talk about the investments you are making there and talk about where you are with your ability to price and even to discount?

Yes. So, first on pricing, another good quarter, in aggregate, about 60 basis points of price. We’ll look towards the change in currency rates that we saw at the end of the quarter; this should create some incremental pricing opportunities. Whether that will flow this year or flow into next year is hard to tell, but that should be an additional pricing opportunity. In terms of e-commerce, it’s been a really positive driver for the Company. As everybody knows, we have integrated down to two web platforms, our fishersci platform and our Thermo Fisher Scientific platform. And when you look at that, we continue to enable more products on the Thermo Fisher platform to be available on e-commerce. We took the old backbone from Life Technologies; we’re adding new capabilities and new products that are available for purchase online. That’s really good from a customer convenience, stickiness, and ultimately growth, and growth in profitability.

And Marc, without the metrics, any estimate on your part as to how much of an increase in their addressable customers they have with their microarray and their reagent business; is it you can open up the doors to 50% more customers, 25%, what are your thoughts there?

The way I would think about it, Paul, is for the flow cytometry business and the antibody business, we really have an exquisite reach around the world, and that’s going to be a very big expansion opportunity. In terms of the microarray, they were well-penetrated in the U.S. and Europe, and we will be able to expand the Asia Pacific presence where we have a very strong presence in genetic analysis. Asia Pacific probably represents say 20% of the world opportunity; they obviously cover the bigger hospitals and the bigger research customers, but it should be a nice expansion within that. Operator, we’re going to take just one more.

I just have one question. Marc, maybe if you could talk about the bioproduction business; obviously strength across the industry over the last number of quarters. And I was curious as to is the key driver essentially the number of new molecules entering the market or are there kind of other drivers like single-use technology kind of being the bigger driver, or maybe if you could just talk about other drivers as well?

Yes, Sung Ji, thanks for the question. So, the bioproduction market continues to be very strong. We have the leadership position in both cell culture and in the single-use technologies, which is two of the four verticals within that market. We’re seeing strong demand from drugs getting on the market where volume really picks up. The number of drugs actually in the process development stage is also a big consumption of demand. Vaccine production and the increase in vaccines is a big driver of demand. On top of all of that, for existing approaches, there has been a very large shift from stainless steel to single-use, and that also accentuates the good growth in the market. So, that’s been an excellent growth market for a number of years for us and one with a very bright future. So, with that, let me bring the call to a close with a couple of quick comments. First, thank you for participating. We had a really strong excellent first half, that’s behind us; we’re very well-positioned to deliver another strong year. And of course, we look forward to updating you on our progress in the third quarter. Thanks everyone.