Thermo Fisher Scientific Inc

NYSE:TMO

Earnings Call Transcript 2018-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to the Thermo Fisher Scientific 2018 Second Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you.

I would like to introduce our moderator for the call, Mr. Kenneth Apicerno, Vice President, Investor Relations. Mr. Apicerno you may begin the call.

[Kenneth J. Apicerno, Thermo Fisher Scientific, Inc.]

Good morning and thank you for joining us today. On the call with me 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 and Presentations until August 10, 2018. A copy of the press release of our second quarter 2018 earnings and future expectations is available in the Investors section of our website under the heading Financial Results. So before we begin, let me briefly cover our Safe Harbor statement.

Various remarks that we may make about the company's future expectations, plans and prospects constitute forward looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those discussed in the company's quarterly report on Form 10-Q for the report ended March 31, 2018 under the caption Risk Factors which is on file with the Securities and Exchange Commission and is 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 the call we'll be referring to certain financial measures not prepared in accordance with generally accepted accounting principles or GAAP. A reconciliation of these non GAAP financial measures to the most directly comparable GAAP measures is available on the press release of our second quarter 2018 earnings and future expectations and also in the Investors section of our website under the heading Financial Information.

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

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Thank you Ken. Good morning everyone. Thanks for joining us today for our Q2 call. As you saw in our press release, we delivered another terrific quarter. We achieved excellent growth in revenue and earnings. Our team executed well to capitalize on the continued strength of our end markets. We also continued to make great progress in advancing our growth strategy by launching new products that address key customer needs leveraging scale in emerging markets and delivering our unique customer value proposition. As a result we continue to both strengthen and capitalize on our competitive position. With an excellent first half behind us, we're in a great position to achieve another very successful year.

I'll cover the highlights for the quarter starting with an overview of our financial results. Our adjusted earnings per share grew 20% to $2.75 per share in Q2. Our revenue in the quarter was also very strong increasing 22% year-over-year to $6.08 billion. And adjusted operating income increased 21% to $1.4 billion. And our adjusted operating margin in Q2 was 23.1%.

While we're clearly benefiting from favorable end market dynamics, our performance is primarily the result of our commitment to a proven growth strategy well executed over a long period of time and that has now put us in a unique competitive position and allowed us to continue our share gain momentum.

Now let me give you a little color on the performance by end market. In Q2, we saw strength in all of our end markets whether you slice it by customer set or geography. Starting with pharma and biotech, we delivered mid-teens growth in the quarter with ongoing strength across our businesses serving this end market. Conditions here have remained robust and we continue to gain share with these customers by delivering our unique value proposition to help them drive innovation and productivity.

In diagnostics and healthcare, we grew in the mid-single digits in Q2 with broad-based strength across our businesses serving this end market.

Turning to industrial and applied, we delivered mid-single digit growth in the quarter, highlighted by continued strong customer demand in our analytical instrument businesses. Last, in academic and government, we grew in the high-single-digits in Q2. We did well in this end market in all geographies and it was good to see an increase in the flow of funds in the U.S.

Let me make a quick comment on our overall performance from a geographic perspective. We saw good conditions in our end markets across the globe and we continued our strong momentum in China with better than 20% growth in the quarter. So the strength of our global competitive position coupled with strong market conditions and great execution by our team led to excellent growth during Q2.

Now, let me make some remarks on our business highlights in the context of our growth strategy. As you know, one element of our strategy is developing high impact innovative new products. Our ongoing success here is a result of the deep insights we gain from our customers. We collaborate closely to ensure that we're putting our industry-leading R&D investment to work in a way that creates the most value for them.

We had a number of great examples in Q2 for customers working in research, applied markets and the clinic and I'll cover a few of them this morning. First, at the American Society of (sic) [for] Mass Spectrometry Conference in June we had a number of launches including two new instruments that expand our leading Orbitrap platform.

The Thermo Scientific Q Exactive UHMR Hybrid Quadruple system creates an integrated workflow to streamline protein analysis in structural biology applications. And the Thermo Scientific ID-X Tribrid system combines our leading technologies to improve small molecule characterization in applications ranging from drug discovery to food safety.

In our next-gen sequencing business, we developed a new Oncomine panel in collaboration with Children's Hospital in Los Angeles. This assay specifically identifies mutations that indicate cancers in pediatric and young adult patients. And in Specialty Diagnostics, we launched the Thermo Scientific B.R.A.H.M.S. KRYPTOR GOLD instrument in Europe. This is an automated immunoassay analyzer that helps customers process blood samples much faster increasing lab productivity while providing the assay quality that KRYPTOR is known for.

One last comment on innovation is that we opened a Precision Medicine Science Center here in the U.S. during the quarter. The center will give customers access to the comprehensive range of technologies we offer to help them advance their work in genomic, proteomic and metabolomic analysis. It complements the Precision Medicine Center we opened last year in China and promotes the global collaboration necessary to make real progress in individualized patient care.

The second element of our growth strategy is leveraging our scale in emerging and high growth markets. As I mentioned earlier, we saw continued strength across these geographies in Q2. The highlight was China where we delivered another outstanding quarter. Our strategy of leveraging our unmatched scale and depth of capabilities along with great tactical execution is enabling us to take full advantage of the many growth opportunities we have. This sets us up very well to help our customers in China meet the objectives outlined in the country's five year plan.

Precision medicine is one of those key priorities in the plan and you may recall that earlier this year we organized a scientific summit in Beijing with global thought leaders from government, academia and healthcare. One of the outcomes is that we're now providing a range of our Analytical Technologies, to help build an infrastructure in China for multi-omics applications in support of precision medicine. This is another great example of the advantages we have because of our industry-leading scale and depth. Our long-term focus on expanding our presence in the region has clearly created a competitive advantage for us and we feel very good about our prospects.

Now, I'll turn to the last element of our growth strategy, which is our unique customer value proposition. The key point I want to make here is that we're always making it stronger both organically and through complementary M&A. This allows us to deepen our customer relationships and drive share gain.

Let me give you a couple examples of how we executed our M&A strategy to create more value for our customers and strengthen the position of our businesses to drive growth. First, you know about the addition of our electron microscopy business through the acquisition of FEI a couple of years ago. Since then, the business has performed extremely well as part of our company.

We recently announced our agreement to acquire Gatan, a leading manufacturer of filters, cameras and software for electron microscopes. Adding these capabilities will allow us to improve performance of these systems to help electron microscopy customers accelerate their discoveries. We expect to complete the transaction by the end of 2018.

Another great example of enhancing our customer value proposition is our biosciences business. I haven't talked about this business in a while, and to remind you, this is the industry leading life science reagent and consumables offering that we created through a combination with Life Technologies in 2014. At that time, the business was growing in the low-single-digits. We had a clear strategy on how to accelerate the growth and we've seen the fruits of that strategy. Today, the business is growing in the high-single-digits.

We expanded customer access by leveraging our scale in emerging markets, our Fisher Scientific channel, and the strong customer relationships we've established through our corporate accounts program. We implemented our PPI Business System to drive operational excellence and significantly expand our margins while creating additional capacity to accelerate our investments in R&D to further strengthen our portfolio. We launched a number of successful new products like the Attune Flow Cytometer that we've highlighted in the past.

We also made investments in new web and digital capabilities helping to further differentiate our strong Invitrogen premier brand. Both the electron microscopy and biosciences examples reinforce our commitment to enhancing value for our customers by adding new capabilities and then leveraging our scale and depth to continually make the business stronger.

To give you a quick update on the Patheon acquisition we're excited about our growth prospects for this business. The integration is going very smoothly and the business is performing well with another quarter of very strong growth in Q2. From a synergy perspective, we're running slightly ahead on our year one synergy targets as well. We're already seeing strong development of the revenue synergy pipeline and believe this will have a meaningful impact on growth over the long-term.

Before I cover our revised guidance, I'll give you an update on capital deployment. As a reminder, we outlined our objectives at the beginning of the year, which were a combination of delevering from the Patheon acquisition, maintaining an active M&A pipeline, and returning capital to our shareholders. So far this year we've made great progress in delevering and Stephen will give you the details.

From an M&A perspective, we've committed $1 billion through strategic bolt-ons including the pending acquisition of Gatan for $925 million and we've also returned $390 million of capital through dividends and stock buybacks including $250 million worth of shares that we repurchased in July. So we continue to successfully execute our capital deployment strategy to create value for our customers and shareholders.

Turning to our guidance. As you saw in our press release, we're raising both our revenue and adjusted EPS guidance for the year. The increase is based primarily on our strong operational performance, partially offset by a less favorable foreign exchange environment. We're raising our revenue guidance to a new range of $23.68 billion to $23.86 billion for 2018. This would result in 13% to 14% growth over 2017.

In terms of our adjusted EPS guidance, we now expect to deliver between $10.89 and $11.01 per share. This will lead to 15% to 16% growth over the strong adjusted EPS performance we delivered in 2017.

So to summarize our key takeaways from Q2, our teams continue to do an outstanding job of executing our growth strategy to strengthen our competitive position. And our excellent results in the first half of 2018 sets us up to achieve another very successful year.

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

[Stephen Williamson, Thermo Fisher Scientific, Inc.]

Thanks, Marc and good morning, everyone. I'll take you through an overview of our second quarter results for the total company, provide some color on our four business segments, then conclude with our updated 2018 guidance.

I'll start with a high level framing of our Q2 performance versus our expectations at the time of our last earnings call. You saw in the press release we had a very strong quarter with 8% organic growth and 20% adjusted EPS growth. This was driven by great operational execution and continued strong market conditions.

We delivered $0.14 more adjusted earnings per share in Q2 than we'd assumed at the midpoint of our previous guidance. Of that $0.11 was driven by stronger organic growth, $0.01 by continued strong contributions from the Patheon acquisition, and $0.02 from more favorable below the line FX in the quarter. So another excellent quarter.

Let me give you more details on how Q2 played out. Starting with earnings per share. This quarter we grew adjusted EPS by 20% to the $2.75 and GAAP EPS was $1.85 up 19% from Q2 last year.

On the top line, our reported revenue grew 22% year-over-year. The components of our Q2 reported revenue included 8% organic growth, 12% growth from acquisitions and a 2% benefit from foreign exchange.

Looking at growth by geography. As Marc mentioned, our markets were strong across the globe in Q2. North America grew mid-single digits. Europe grew in the high-single digits. Asia Pacific grew in low-teens with – including another quarter of very strong growth in China, and the rest of the world also grew in the low-teens.

Turning to our operational performance. Q2 adjusted operating income increased 21% and adjusted operating margin was 23.1%, down 10 basis points from Q2 last year. As a reminder, Patheon is the scale acquisition with gross margins and operating income margins lower than the company average. The effect was approximately 90 basis points dilutive to total adjusted operating margins in the quarter in line with our expectations. The addition of Patheon will continue to be dilutive to our adjusted operating margins through Q3.

Foreign exchange contributed about 20 basis points to operating margin during the quarter. So net of acquisitions and FX, our underlying operational performance was strong in the quarter at 60 basis points of expansion driven by good volume leverage and productivity, partially offset by strategic investments and unfavorable business mix.

Moving on to the details of the P&L. Total company adjusted gross margin came in at 47.3% in Q2, down 110 basis points from the prior year. Strong productivity was more than offset by the expected significant dilutive impact of acquisitions.

Adjusted SG&A in the quarter was 20.2% of revenue, which is down 50 basis points versus Q2 2017 and total R&D expense came in at 4% of revenue, down 40 basis points versus Q2 last year. Both of these were primarily due to acquisitions. R&D as a percent of our manufacturing revenue in Q2 was 6.6%.

Looking at our results below the line. Net interest expense was $139 million, up $23 million from Q2 last year mainly as a result of the incremental debt related to our capital deployment activities in 2017. Adjusted other income and expense was a net income in the quarter of $9 million, which is $13 million favorable versus Q2 2017 driven primarily by changes in non-operating foreign exchange.

Our adjusted tax rate in the quarter was 12.3% down 80 basis points versus last year primarily due to the impact of U.S. tax reform and the addition of Patheon. As expected, the adjusted tax rate was slightly higher than last quarter due to the timing of discrete tax planning items. Q2 average diluted shares were 406 million, up 13 million year-over-year.

Turning to cash flow and the balance sheet. Cash flow from continuing operations for the first half of the year was $1.5 billion and free cash flow was $1.2 billion after deducting net capital expenditures of $300 million. This represents 19% year-to-date free cash flow growth. We ended the quarter with $940 million in cash and investments and we returned $70 million to shareholders through dividends in the quarter.

And early in Q3, we completed $250 million of share buybacks. We expect to complete another $250 million later in the year for a total of $500 million for 2018. This is in line with our previous guidance.

Our total debt at the end of Q2 was $19.4 billion down $1.5 billion sequentially from Q1. Our leverage ratio at the end of the quarter was 3.3 times total debt to adjusted EBITDA down from 3.8 times last quarter. And wrapping up my comments on our total company performance, adjusted ROIC was 10.3%, up 20 basis points from last quarter.

So now I'll provide you some color on the performance of our four business segments. Starting with Life Sciences Solutions, reported revenue in this segment increased 12% in Q2 and organic revenue growth was 9%. In the quarter, we saw very good growth across all of our businesses in the segment; clinical next-gen sequencing, bioproduction, biosciences and genetic sciences.

Q2 adjusted operating income in Life Sciences Solutions increased 17% and adjusted operating margin was 33.3%, up 140 basis points year-over-year. In the quarter, we drove very strong volume pull-through, good productivity and had a favorable impact from FX. This was partially offset by strategic investments.

In the Analytical Instruments Segment reported revenue increased 13% in Q2 and organic revenue growth was 9%. In the quarter, we saw very good growth across all of our businesses in the segment, chemical analysis, chromo mass spec and electron microscopy.

Q2 adjusted operating income in Analytical Instruments grew 25% and adjusted operating margin was 22.2%, up 230 basis points year-over-year. In the quarter, we saw very strong productivity and volume leverage, partially offset by strategic investments.

Turning to the Specialty Diagnostics Segment. In Q2, total revenue grew 8% and organic revenue growth was 5%. We saw strong growth in our transplant diagnostics and clinical diagnostics businesses and also in the healthcare market channel.

Adjusted operating income increased 8% in Q2 and adjusted operating margin was 27.2%, flat compared to Q2 of the prior year. In the quarter, we saw good volume leverage, had a favorable impact from FX and this was offset by strategic investments and business mix.

Finally, in the Laboratory Products and Services Segment, which includes the Patheon acquisition, Q2 reported revenue increased 42%. Organic revenue growth was 9%. In the quarter, we saw strong growth across all businesses in the segment, led by our clinical trials logistics business and our research and safety market channel.

Adjusted operating income in the segment increased 37% and adjusted operating margin was 13.2%, down 50 basis points from the prior year. In the quarter, acquisitions were slightly accretive to the segment margins and we saw good volume leverage. However, this was more than offset by business mix and strategic investments.

So now I'll move on to our updated full year 2018 guidance. You saw in the press release, we're raising both our revenue and adjusted earnings per share guidance. Let me walk you through the details. I'll start with revenue. We're raising the midpoint of our revenue guidance by $30 million and tightening the range by $60 million. The $30 million increase to the midpoint consists of three elements.

First, $160 million increase in our organic growth outlook for the year. We now see the most likely outcome for 2018 full year organic growth to be 6%. Second, a $20 million increase from acquisitions, reflecting the continued strong performance of Patheon. And third, given the movement in exchange rates, we now expect a less favorable FX environment for the full year which reduces revenue at the midpoint by $150 million.

Turning to our adjusted earnings per share. We're increasing the midpoint of our adjusted EPS guidance by $0.07. This reflects the following changes from the prior guidance; a $0.06 reduction due to less favorable FX; a $0.03 reduction due to the expected gross impact of tariffs in the second half of the year; and these two headwinds are more than offset by $0.15 increase reflecting stronger operational performance as well as $0.01 increase due to expected lower interest costs.

So to sum this up, our 2018 revenue guidance is now a range of $23.68 billion to $23.86 billion, which represent 13% to 14% growth versus 2017. We now expect acquisitions to contribute about 7% to our reported revenue growth in 2018 and FX is expected to be a benefit of 1%. And our updated adjusted earnings per share guidance for 2018 is now a range of $10.89 to $11.01 with the midpoint of $10.95. This represents growth of 15% to 16% versus 2017.

A few other details behind the revised 2018 guidance. We're now assuming that foreign exchange is a $210 million revenue tailwind for the year or 1% and FX tailwind on adjusted EPS is now assumed to be $0.14 or 1.5%.

We estimate the gross impact of tariffs on the company for the second half of 2018 is approximately $14 million or $0.03 of adjusted earnings per share. We plan to offset this and have reflected the benefit of these offsets in our updated operational guidance. So there's no net impact to tariffs on 2018.

In terms of adjusted operating margins, we continue to expect to deliver 20 basis points to 30 basis points of expansion for the year. Excluding the impact of Patheon, this represents 70 basis points to 80 basis points of expansion, no change from the previous guidance.

We expect net interest expense to be in the range of $540 million to $550 million. We're now assuming that other income and expense to be net income of just over $10 million, a slight improvement to our prior guidance due to non-operating FX benefits realized in Q2. We continue to expect an adjusted income tax rate of 12% for the year.

And as mentioned in my earlier remarks, we've recently completed $250 million of share buybacks and we expect to complete another $250 million later in the year for a total of $500 million in 2018. This is in line with our previous guidance.

The $500 million of buybacks will fully deplete the current authorization. Later in the year, we expect to replenish the authorization at a level consistent with the long-term capital deployment strategy outlined at our recent Analyst Meeting in May.

We continue to expect the full year average diluted shares will be in the range of 405 million to 407 million. We assume that we'll return approximately $275 million of capital to shareholders through dividends, no change from previous guidance. And our guidance does not include any future acquisitions or divestitures. So it doesn't include any impact from the pending acquisition of Gatan.

We're assuming net capital expenditures will be approximately $700 million to $730 million, no change from previous guidance. And for free cash flow, we're expecting about $3.8 billion for the full year, consistent with previous guidance.

And, finally, a couple of comments on phasing for the rest of the year. We expect organic revenue growth rate in Q3 to be higher than Q4 due to the strength of the prior year comparison in Q4. Then in terms of adjusted EPS phasing, we expect Q4 to be just over 25% higher than Q3.

So, in summary, we delivered another excellent quarter in Q2 and we're in a great position at the halfway point to deliver a very successful year.

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

[Kenneth J. Apicerno, Thermo Fisher Scientific, Inc.]

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

[Operator]

Thank you. Our first question comes from the line of Ross Muken with Evercore ISI. Your line is open.

[Ross Muken, Evercore ISI]

Hi. Good morning, gentlemen. Congrats.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Thank you, Ross.

[Ross Muken, Evercore ISI]

So maybe let's start on China, Marc. I mean, the result is just spectacular. You're north of 20%. It's probably going to be the best in the peer group for the quarter. I guess, as you sort of look at the underlying dynamics there, you have some unique exposure, but in general, it sort of implies continued sort of dominance in share and the like. And that's in the face of – obviously, you made the point on sort of some of the tariffs and uncertainty. How are you feeling about the various end markets there and sort of the cadence for the rest of the year, given maybe some of the incremental uncertainties? Some are worried about on the raw materials or sort of basic industry side.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Ross, thanks for the questions. So let me talk first about China and the performance and then I'll talk a little bit about tariffs. The business is performing extremely well with just over 20% growth in the quarter and about 20% for the first half. Very strong momentum, broad-based across the various customer sets. I was there at the beginning of the quarter and looking forward to going back a little later in the year.

One of the things is the customer base is very bullish about their outlook. So, some of the things that you see in the papers about trade and things of that sort is really not a dialog amongst the customer base. So for the customer base it really is business-as-usual and the markets are very strong.

We really do have a unique competitive position there because of our scale and depth of capabilities and the scientific labs we have across the country. Our R&D teams thinks that the scale really helps and our long presence in the market does, and you're seeing us really benefit from that from a performance perspective.

A quick comment on tariffs. Really, tariffs is really targeting things primarily outside of our industry. So there's really very little exposure. It's not affecting the customer outlook. As Stephen said, there is a gross impact on cost of about $0.03 in the second half of the year from those tariffs that have enacted and scheduled to be enacted. And we are fully going to offset that operationally through our pricing actions and our sourcing and supply chain actions. So we gave extra color on the call because it's something new that everybody in the world is looking at and we want to just articulate it, but we will navigate through that and don't anticipate any issues.

[Ross Muken, Evercore ISI]

Great. And maybe just one for Stephen. I think you called out, in terms of the EPS cadence for the second half, sort of, implying obviously core growth better in 3Q, but it seems like earnings growth may be better in 4Q given some of the margin dynamics. I just want to confirm, one, that's the case?

And then secondarily, I want to see if I heard something right. Did you say that Q4 is going to be 25% above 3Q? I just want to make sure that that's – because that seems greater in terms of magnitude than what we normally see.

[Stephen Williamson, Thermo Fisher Scientific, Inc.]

So you got the numbers correct, Ross. I think, a couple of dynamics to call out. One is that the impact of bringing Patheon into the company's numbers and the profitable stub period in Q3 are such that the headwind on our margins in Q3 from the Patheon side of things, equivalent scale to what you've seen in Q2.

And then in Q4, we'll have strong margin expansion, really driven by two factors which are non-repeat, some things that happened in Q4 last year, the impact of the hurricane in Puerto Rico. Site was down for a significant amount of time and we expended a lot of cost to get the site back up and running. And the second factor is, we did a large one-time bonus payment in Q4 last year related to the tax reform and that's not going to repeat in Q4 this year. So that gives you strong margin tailwind for Q4, in fact gives you the dynamic to drive that 25% difference.

[Ross Muken, Evercore ISI]

Great. Thank you so much.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Thanks, Ross.

[Operator]

Our next question comes from the line of Derik de Bruin with Bank of America Merrill Lynch. Your line is open.

[Derik de Bruin, Bank of America Merrill Lynch]

Hi, good morning.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Good morning, Derik.

[Derik de Bruin, Bank of America Merrill Lynch]

Hey, just a question on – so I have one sort of like big picture question and then one more focused one. I think I'll start with the focused question first, like Thermo historically has not been a big player in the small molecule drug quality control, quality assurance market given the Dionex was not yet an (32:17) acquisition.

Can you talk a little bit about how you're positioned in the biologics market for QA/QC and sort of like some of the technologies that are required there and sort of – you do have an opportunity to gain better share. And just curious it's like – how does the profitability and how do these markets sort of compare to each other when you look at the opportunities in those small molecules and biologics?

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah, Derik. Thanks for the question. In terms of the QA/QC applications in biologics, we really are considered one of the thought leaders in how that has evolved with the multi attribute method in mass spectrometry that we've partnered with a number of biotech players on this being adopted.

So based on the strength of our Orbitrap platform, we're very well positioned, as biologics become a bigger and bigger portion of the total pharma and biotech industry from a QA/QC perspective and the profitability of our mass spectrometry franchise is quite strong. So from that perspective, we really are in a great position to drive sustained growth.

[Derik de Bruin, Bank of America Merrill Lynch]

Okay. And then follow up question just more on the big picture. You've had three really spectacularly strong quarters now of growth. I think you did – I think it's 8%, 7%, 8% organic revenue growth in the last three quarters. This obviously begs the question about more difficult comps going forward looking at it.

I guess is there anything you're sort of seeing on the horizon that could potentially pop up. I guess what are your concerns about the end markets? And what are your concerns about as you look forward and look into next year, I know, it's a little bit too early to give guidance but I'm just sort of curious in like your confidence in sort of being able to sort of maintain the upper end of your 4% to 6% core growth target?

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah, Derik. Great question. So if I look at where we are, it's very positive environment and at the same point, our competitive position is really being valued by our customers such that they're driving more business to us. You're seeing in the differential growth versus the others in the industry.

When I look at the outlook, it's great to have 6% organic growth as our guidance for the year and that assumes that there's a small increase versus our previous guidance in the second half for the year. If the market conditions maintain at the rate that we have seen for the last three quarters then obviously we're going to have a spectacular year.

So we are very excited about our second half outlook, our full year outlook and we don't see any storm clouds on the horizon as I think about 2019. Obviously, we'll give you 2019 guidance in late January, but at least sitting here right now it all looks very positive.

[Derik de Bruin, Bank of America Merrill Lynch]

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

[Operator]

Our next question comes from the line of Tycho Peterson with JPMorgan. Your line is open.

[Tycho W. Peterson, JPMorgan Securities LLC]

Hey, thanks. Great quarter. Marc, I'm wondering if you can comment a minute on Gatan. I know you mentioned it in your prepared comments. But just curious how this fits in with FEI overall? How much customer overlap there is? What the opportunity is to maybe cross-sell here?

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah. So we're very excited about Gatan. It is a really good strategic fit with the business. When you think about what we're doing here is we want to be able to help electron microscopy customers get even more value from their investments in the systems and looking to get really the benefits of the components that Gatan provides to the industry including filters, cameras and software.

So the goal here is to make it easier for the adoption of the technology and as you know, electron microscopy business is growing very well. So we're trying to expand the market through this capability. It's an extremely compelling transaction financially as well and we'll get into the details of that when we close the transaction towards the end of the year and we'll lay out all the financials then. But the economics are also very attractive as well.

[Tycho W. Peterson, JPMorgan Securities LLC]

Okay. And then as we think about biopharma, you're obviously putting up great numbers, up mid-teens. You commented on gaining share. We did have a peer yesterday talk about budget flush issues. So is it suffice to say, you didn't necessarily see any of that in the quarter? And can you also comment on bioprocess and the trends you saw there?

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah. So mid-teens growth in pharma and biotech, feel good about that. We saw strength across all of our businesses that serve the customer base and that range from bioproduction was excellent, chromo mass spec, clinical trials logistic and our research and safety channel.

So we saw strength across the board, from consumables, production, chromatography instruments, mass spectrometry instruments, so a very good quarter. I think it really reflects the unique customer value proposition that we have and how we are uniquely positioned to drive our customers' innovation and productivity.

[Tycho W. Peterson, JPMorgan Securities LLC]

Okay. And then one last quick one for Stephen. Just on CapEx around Patheon. Should we assume that this is kind of the current steady-state run rate? Or how should we think about Patheon CapEx? Will that be increasing going forward?

[Stephen Williamson, Thermo Fisher Scientific, Inc.]

Yeah. I think you'll see CapEx within this range. It's built into the number for the full year.

[Tycho W. Peterson, JPMorgan Securities LLC]

Okay.

[Stephen Williamson, Thermo Fisher Scientific, Inc.]

Thanks, Tycho.

[Tycho W. Peterson, JPMorgan Securities LLC]

Thank you.

[Operator]

Our next question comes from the line of Jack Meehan with Barclays. Your line is open.

[Jack Meehan, Barclays Capital, Inc.]

Thanks, and good morning.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Good morning, Jack.

[Stephen Williamson, Thermo Fisher Scientific, Inc.]

Good morning.

[Jack Meehan, Barclays Capital, Inc.]

So obviously, very good growth in the quarter. I was hoping you could elaborate a little bit more on the share gain commentary and just highlight some of the top areas you think this is resonating and just in that, in particular, I'd be curious to get your thoughts on the biopharma services and logistics business.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah. So Jack in terms of the share gains, it's quite broad-based. I mean, when I think about the company, you can look at it and say, well, the company as a whole had a very strong quarter. But as you disaggregate the pieces, we fared very well versus the narrower competitors in the field. So our business has performed well.

Some of the highlights where I think we saw a nice share gain in the quarter, our bioscience reagents business, our chromatography and mass spectrometry business, our research and safety market channel. Those were the three large businesses all strong.

Clinical trials logistics, very strong quarter as customers continue to move more and more of what is in-house activity to a trusted partner like Thermo Fisher Scientific. We're really seeing the benefit there of how customers understand the logic of why we acquired Patheon and they're actually doing even more clinical trials business with us because of it.

[Jack Meehan, Barclays Capital, Inc.]

Great. And then just as a follow up. I want to dig in on the Specialty Diagnostics performance. That was the one that posted only consistent growth this quarter of 5%. So just talk about what you're doing on the innovation side to get the growth up and any updates on Cascadion would be great?

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Sure. So Jack, a good quarter in diagnostics and healthcare, broad-based strength whether it was transplant diagnostics, clinical diagnostics or healthcare market channel. Outside of the business but serving that customer base, we also had good performance in our clinical NGS business serving the diagnostics and healthcare market.

Cascadion, got our CE-IVD clearance in the quarter and we are starting commercialization outside the U.S. Not a meaningful contributor this year. Expect it to really start to ramp in 2019 and we'll be showcasing the instrument at the American Association of (sic) [for] Clinical Chemistry Conference, which is happening in Chicago, next week along with a number of other instruments that we are launching across our portfolio. So lots of good things going on in the diagnostics and healthcare business and a very solid quarter with mid-single digit growth.

[Jack Meehan, Barclays Capital, Inc.]

Great. Looking forward to seeing it then. Thanks guys.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Thank you.

[Operator]

Our next question comes from the line of Doug Schenkel with Cowen & Company. Your line is open.

[Doug Schenkel, Cowen & Co. LLC]

Hey, good morning, guys.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Good morning, Doug.

[Doug Schenkel, Cowen & Co. LLC]

Maybe just to start on Patheon. You appear to have done much better than expected in the quarter with Patheon both in terms of revenue and margins. I'm curious if any of the strength is related to Thermo cross-selling to larger biopharmaceutical customers or if it's still too early for that effort to really move the needle. And then moving down the P&L, I'm just curious what the key drivers were to some of the margin improvement and how we should think about sustainability?

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah. Doug, the integration is going really well and the customer feedback is extraordinarily positive about the combination and also just leveraging the relationships and trust that the two companies have built over time. So it's been very positive.

In terms of the revenue synergies, we are clearly seeing a lot of interest momentum pipeline and some wins. But because of the cadence of the business a win today can show up in revenue 18 months from now. So it doesn't affect the short term but it does affect the long term growth prospects of the business.

Some of the wins are showing up in the clinical trials business which is a much shorter cycle business. So that's clearly positive. So I feel very good about how that's going and it's been great to be able to raise our outlook for that business in each of the last two quarters. So performing well. Stephen, you want to...?

[Stephen Williamson, Thermo Fisher Scientific, Inc.]

Yeah, from a margin standpoint, it's a combination of the kind of higher level of growth that's printing at a decent margin and then good progress on the synergies. And I'd just remind you one of the key synergies there was using our PPI Business System to make an impact across the operational sites and we're getting good traction there. The teams are very engaged and driving that at a very granular level across the key sites across Patheon's business.

[Doug Schenkel, Cowen & Co. LLC]

Okay. That's really helpful. And I guess for my second topic I just want to go back to guidance and give you an opportunity to address one thing that's coming up in a few of our discussions this morning. You increased full year core revenue guidance by $160 million which is close to the magnitude of the second quarter beat. By extension, this implies that core revenue growth targets for the second half really didn't change all that materially.

I just want to make sure this is just largely a function of conservatism and not something that you're seeing that suggest you shouldn't stick your necks out in spite of the fact that you put up pretty monstrous first half. It sure doesn't seem like there's any issues, but I just want to make sure none of us are missing anything here.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah, Doug. It's a good question. We obviously have had a very strong first half. We specifically did raise the outlook a little bit for Q3 and Q4 organically, based on the market conditions. If the market conditions continue the way they were in the first half, it will truly be a spectacular year. Right now there's nothing that we're seeing that is indicating a change in that trajectory.

So I feel good about the prudence of the guidance, but obviously our teams are going to focus on maximizing performance and capitalizing on every opportunity. So we don't see any issues, but as always, we want to be able to close the year and meet or exceed expectations. And I think we've put appropriate guidance at this point.

[Doug Schenkel, Cowen & Co. LLC]

Okay. Very helpful. Thank you.

[Operator]

Our next question comes from the line of Steve Beuchaw with Morgan Stanley. Your line is open.

[Steve Beuchaw, Morgan Stanley & Co. LLC]

Hi. Good morning and thanks for the time. I wonder first if you could just unpack the academic channel for us a little bit. Historically, we've all thought about the NIH as an important barometer and that's something that you flagged lately as being a positive. But there are actually a lot of positive guidelines coming out of Europe now as well and then your China quarter was particularly strong. So wonder if you could unpack academic for us a little bit on a regional basis.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah. So, Steve, very strong quarter with high-single-digit growth, just below the company average in Q2. Geographic strength across the board. Starting with the U.S., it's good performance. NIH funds were flowing well and we were really excited by the NIH's announcement in May to allocate $130 million for research based on cryo-electron microscopy which bodes well for future demand. So that $130 million target had no effect, obviously, on what was in the quarter. But for 2019, it's very encouraging.

Turning to Europe, very positive with the Horizon program that was announced. So Horizon 2020 is – we're getting closer to the end of the decade. They announced the next program which is a seven year program, $100 billion commitment to research funding across the continent which really helps because academic institutions like to know in advance of what the funding environment is going to be. So that was a big commitment in Europe.

And the UK government preparing for Brexit has really had some very focused initiatives to make sure that they maintain their prior heritage in life sciences research and their ministers have had a number of meetings with industry to talk about their commitment as well. So U.S. looks good. Europe looks good. China continues to be strong and you see that obviously in the results. So very encouraging environment right now in terms of what we're seeing as well as the longer-term outlook across the globe.

[Steve Beuchaw, Morgan Stanley & Co. LLC]

Okay. Thanks for that. And then just a couple of little housekeeping items. One to follow-up on Doug's question about Patheon, I wonder if you could zoom out a little bit and just talk about how your thinking is evolving about the category. It sounds like you feel very, very good about your performance relative to the category on the funnel. But as we look across the broader pharma services space across trials, CROs and CMOs, it does seem like the environment is good, maybe better than you thought it might be at the time of the deal. Does that impact your thinking? And then on FEI, any color on growth there organically now and forward relative to the broader AI franchise would be really helpful. Thanks so much.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Sure. So the acquisitions that have been integrated over the last couple years are performing extraordinarily well. In terms of Patheon, our pharma services business on a pro forma basis meaning as if we had owned Patheon in the prior year would have been low-double-digit growth in the first half. So very, very strong performance and it's a reflection of good execution and a very good market as well. In terms of electron microscopy, we would have grown as a company 8% with or without the contribution of electron microscopy. Electron microscopy had a good quarter with growth rates, obviously, similar to the company average.

[Steve Beuchaw, Morgan Stanley & Co. LLC]

Thanks again.

[Operator]

Our next question comes from the line of Patrick Donnelly with Goldman Sachs. Your line is open.

[Patrick Donnelly, Goldman Sachs & Co. LLC]

Great. Thanks. Marc, can you just talk through the performance in the U.S. in the quarter? I've seen some mixed data points particularly on the pharma side. It would be helpful just to hear your perspective and outlook here.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

We had mid-single digit growth in the U. S. in the quarter. It's good, there's good conditions. Academic funding was good and we didn't really see any dramatic pockets of weakness in the U.S. In fact relative to the last number of years, strong mid-single digit growth is actually a really nice spot to be from the domestic perspective. So, we really didn't see anything meaningful on the weakness side.

[Patrick Donnelly, Goldman Sachs & Co. LLC]

Okay. And then maybe just on industrial applied coming in mid-single digits growth, maybe a little bit lighter than high single in the first quarter, but still pretty healthy. Can you just provide some color on what markets performed well here, how are you feeling about the environment going forward given some various macro data points that are out there?

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah. Our Analytical Instruments business had strong growth in the quarter, chrom and mass spec, chemical analysis in particular. We obviously had some challenging comparisons in electron microscopy in that segment, still had nice growth. But those would be some of the factors in driving the mid-single digit growth in industrial and applied.

[Patrick Donnelly, Goldman Sachs & Co. LLC]

Maybe if I could just sneak one last one in on the M&A side. Obviously, you did the Gatan deal during the quarter adding to the FEI franchise. Can you just talk through the general kind of pipeline going forward, any markets you see as particularly attractive? I know last question you touched, it was CDMO, CRO market. Thoughts on adding to your franchise there or would you prefer to just let Patheon execute for the time being?

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah. We have a active M&A pipeline across our businesses. And one of the things as we think about is we have a very disciplined M&A process and the selection criteria that we use really has differentiated our performance, right? So while we look at many things we have a very active pipeline. We're going to be very selective in terms of what we do. And we have a lot of firepower, so from the ability to be able to execute on transactions, both management and financially. So we'll continue to progress that pipeline and do the right transactions for strengthening our competitive position as well as creating shareholder value.

[Patrick Donnelly, Goldman Sachs & Co. LLC]

Great. Thank you.

[Operator]

Our next question comes from the line of Dan Arias with Citigroup. Your line is open.

[Daniel Arias, Citigroup Global Markets, Inc.]

Good morning, guys. Thank you. Marc, to the...

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Good morning, Dan.

[Daniel Arias, Citigroup Global Markets, Inc.]

Morning. Just only the point that's been made a couple of times already. Obviously, you guys are headed where you've been historically in terms of the organic top line. So I guess when you think about the incremental dollars that are just being put back into the business, I'm curious whether you'd call out certain product areas or categories that are being earmarked to bid for more investment or would you say, you're maybe sprinkling it pretty evenly across the business?

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Yeah. No, we don't sprinkle it evenly because we run the company in a very disciplined faction and we invest at the right levels so that our businesses have good outlook. There are a few areas that we are putting a bit more money to work because the market conditions were better than we thought and therefore we want to fully capitalize on them, areas like chromatography and mass spectrometry, just given the momentum there and our strong position. We're increasing rates of investment there, would be an example.

I would even say the acquisition of Gatan would be an example. It's obviously an M&A move, but we have a lot of momentum in electron microscopy and we want to further bolster those capabilities there, would be an example. In biosciences, an area where I highlighted, it's obviously been an area that shows just the benefits of a good strategy and execution every day of the year.

Taking a business that had a number of years of low-single digit growth and we transformed it to mid-single digit, now sustainably high-single digit, that's another area where we've increased our investments in digital, we've increased our investments in the Web to really sustain a very, very bright outlook for that business.

You're seeing it in the new product launches, whether it's in flow cytometry, you're seeing it in cell biology. So we have specific areas that we're investing in to capitalize on our competitive position as well as the momentum we're seeing in the market.

[Daniel Arias, Citigroup Global Markets, Inc.]

Okay. Super. And maybe at the risk of crossing Ken here, if I could sneak one more in for Stephen. Just curious, at a high level, whether there's a particular segment that you think there's more margin opportunity over, call, the next year or so when you're just thinking about mix and investment going forward?

[Stephen Williamson, Thermo Fisher Scientific, Inc.]

Yeah. When you think about how it played out over the last couple of years. The volume leverage really comes through strong in, clearly, the higher margin businesses. So Life Sciences Solutions, Analytical Instruments have shown great volume pull-through on the organic growth. So that's really where you'll see a lot of the margin expansion of the company.

[Daniel Arias, Citigroup Global Markets, Inc.]

Okay. Thank you guys.

[Operator]

Our next question comes from the line of Brandon Couillard with Jefferies & Company. Your line is open.

[Brandon Couillard, Jefferies LLC]

Thanks. Good morning. Most of...

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Hi, Brandon.

[Brandon Couillard, Jefferies LLC]

...my questions have been addressed already, but one for you Stephen. In the context of having raised the full year outlook two quarters in a row now, would be curious if you could just speak to the free cash flow guidance which remains unchanged? And it seems to imply only about 4% growth in the second half. So is that just some conservatism or timing between first and second half of the year?

[Stephen Williamson, Thermo Fisher Scientific, Inc.]

Yeah. It's really around timing. We had a very strong Q4 last year. Look at the two years combined, I think, it's 19% growth for the two years on an average per year, so in terms of free cash flow growth and yes, it's gone up higher in the range of the $3.8 billion and we're going to now work hard to deliver as much free cash flow as we can.

[Brandon Couillard, Jefferies LLC]

Very good, thanks.

[Kenneth J. Apicerno, Thermo Fisher Scientific, Inc.]

We have time for one more.

[Operator]

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

[Steve Barr Willoughby, Cleveland Research Co. LLC]

Good morning. A couple of quick things for you guys. I guess first as it relates to Patheon, I believe you mentioned it's growing in the low-double digit so far this year. Just was wondering if you're expecting a similar level of growth as it enters the organic growth calculation in the back half of the year?

And then secondly, as it relates to tariffs, I know you called out $14 million or $0.03 which you expect to offset. But just wondering, does that take into account the tariffs that have been more recently proposed, but not implemented or just the tariffs that have been implemented so far?

And then I guess finally, in the 9% LPS (sic) [LP&S] growth, just any color on – that's obviously a very strong number for that segment. How much of that is sort of an increase in the overall end market versus the share gains that you're also calling out there? Thanks so much guys.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

So I'll do some of it and I think Stephen will cover some. So in terms of the growth in the Lab Products and Services Segment, as a reminder, the Patheon growth does not flow into the numbers because we haven't anniversaried the transaction. We had very strong performance in our clinical trials logistics business and our channel grew very strong in the quarter. So those were the big drivers there.

[Stephen Williamson, Thermo Fisher Scientific, Inc.]

Yeah. So on the Patheon side, we've got a couple of deferred revenue rev rec comps that we'd be hitting in Q4 and some will hit us in Q3. Underlying the growth in that business is running ahead of the deal model, so when you think about the true underlying pro forma. So it's not going to be a significant contributor in Q3 or Q4, to the total company growth. And then the tariffs piece is really – we basically baked in what's been enacted and what we expect to be enacted in – assuming it's mid second half of the year beginning of Q4.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

Thank you, Steve.

[Steve Barr Willoughby, Cleveland Research Co. LLC]

Okay. Thank you.

[Marc N. Casper, Thermo Fisher Scientific, Inc.]

So let me wrap up the call. We're obviously pleased to deliver an excellent first half of the year. We're in a great position to achieve a very successful 2018. And as always, thank you for your ongoing support of Thermo Fisher Scientific. We look forward to updating you at the end of the next quarter.