Good morning. Thank you for joining us. On the call with me today is Marc Casper, our President and Chief Executive Officer, and Peter Wilver, Senior Vice President and Chief Financial Officer. Please note this call is being webcast live and will be archived on the investor section of our website, thermofisher.com, under the heading Webcasts and Presentations until August 24, 2012. A copy of the press release of our 2012 second quarter and future expectations is available on our website under the heading Financial Results. Before we begin, let me briefly cover our safe harbor statement. Various remarks that we make about the company's future expectations, plans, and prospects constitute forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995.
Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the company's annual report on Form 10-K for the year ended December 31, 2011, under the caption Risk Factors, which is on file with the Securities and Exchange Commission and available in the Investor section of our website under the heading SEC Filings. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change. Therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today. Also, during this call, we will be referring to certain financial measures not prepared in accordance with generally accepted accounting principles, or GAAP.
A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure is available in the press release of our first quarter 2012 earnings and future expectations and also in the Investor section of our website under the heading Financial Information. I will now turn the call over to Marc Casper.
Good morning. This is Marc, and don't worry, I know Pete is here as well, as is Ken. I know from our investor perspective, Ken is always the highest rated IR executive out there in the industry, and he's smiling next to me, so no anxiety should be on the phone. We actually have good news to report throughout this call. I'm pleased to report that we had another excellent quarter, with record Q2 results on both the top and bottom line. The quarter was all about execution. Our teams executed well to deliver solid revenue growth and another quarter of double-digit growth in adjusted EPS. Our strong performance in the first half puts us in very good position to achieve our revenue and earnings goals for the full year.
I'll frame my remarks this morning by first covering the financial highlights, give you a sense of what we're seeing in our key end markets relative to our results, and then review some of the exciting new developments we announced during the quarter and in recent weeks. First, the financials. As I mentioned, we delivered record adjusted EPS again this quarter, a 23% increase over 2011. Our revenue grew by 9% over last year. Our adjusted operating income increased 16% in Q2, and we achieved 110 basis points of adjusted operating margin expansion. Our Q2 results clearly show that our teams are focused on the right priorities. Our growth initiatives are delivering real value for our customers, and our ongoing cost actions are strengthening the bottom line.
On the growth side of the equation, our investments in Asia-Pacific are really paying off with strong results again this quarter. I'll mention a little more on that in a few moments. In new products, we're seeing nice uptake across our analytical instruments portfolio, and we continue to innovate to keep that pipeline full. Our unique value proposition is clearly resonating across a broader customer set from pharma and biotech, where we initiated the approach to medical device manufacturers, reference and contract testing labs as well. Turning to cost actions for a moment. This is an area that we're always extremely focused on and is a key contributor to our margin expansion. Our PPI and PPI Lean business systems are a way of life at Thermo Fisher, and they've helped earn us a reputation for operational excellence. PPI is just one of the ways that we drive margin expansion.
As you know, we have multiple levers we can pull, and in the environment we're managing through today, this gives us the ability to quickly adapt to changing market conditions. For example, our restructuring actions are being implemented smoothly and are contributing to our growth on the bottom line. Let me now put our second quarter performance in the context of our key end markets. We all know the world is uncertain. We're focused on planning accordingly and adjusting as necessary, always with a sharp eye on using our unique depth of capabilities to gain competitive advantage. I'll start with a focus on our four key end markets, and then I'll comment on our performance in the major geographies. From an overall perspective, our end markets remain consistent with what we've been seeing in recent quarters. Let me provide a bit more detail.
Starting with academic and government, these markets are consistent with what we've been seeing so far this year. They're still down low single digits as we expected, so our outlook here hasn't changed. As we said last quarter, our customers remain active in their research efforts, and laboratory consumable spending has been steady despite the capital equipment side being somewhat constrained. Turning to healthcare and diagnostics, conditions were basically a continuation of what we've seen over the last several quarters. In particular, sales of clinical diagnostic products remained very robust, driven largely by ongoing strength in our biomarkers business. In industrial and applied markets, we continued to do very well in aggregate with high single-digit growth, even though, not surprisingly, we did see some softness in Europe.
We saw strong sales and bookings for our long lead time process analyzers again this quarter, particularly from key customers in the mining industry. Last, we continue to see strength in pharma and biotech, where we believe we continue to gain share. Our bioprocess production business had another great quarter. Demand for sera, media, and single-use disposable products was driven by growth in biotherapeutics in the U.S. and increased production of vaccines and biosimilars in Asia Pacific countries. Let me make a few comments on end markets from a geographic perspective. We did see some weakening in Europe during the quarter, as expected, although the positive news is that we're still growing there. We saw excellent growth in Asia Pacific, and our performance there was slightly stronger than in Q1.
On the topic of Asia Pacific, let me mention here that our company-level strategy to expand our presence in emerging high-growth markets is really paying off. We had good growth in India and South Korea, and our team in China delivered another quarter of revenue growth topping 20%. Growth in China is coming from investments our customers are making across our key end markets, including biopharma, healthcare, and environmental monitoring. We continue to attract top talent in China as we build out our manufacturing, R&D, and commercial capabilities to fully leverage our value proposition and gain market share. Now I'll turn to a few of the business highlights in the second quarter, all of which are great examples of how we're creating value for our customers by strengthening our industry-leading offering. I said last quarter that I believe 2012 will be a banner year for innovation.
Judging from the range of significant new products we've launched so far this year, I stand by that statement. You may recall the long list of products we launched in Q1, including the TRACE 1300 gas chromatograph, the new iCAP Q ICP mass spec, and our next-generation portable Raman instrument, the TruNarc. I'm pleased to report that we're seeing very good customer uptake from these products. We continued our innovation streak in Q2 with a number of launches at two important industry conferences for us, ASMS and ACHEMA. Let me give you a few of the highlights. First, I'll cover ASMS, which as most of you know, is the world's premier gathering of scientists who are interested in learning how the latest mass spec technologies can accelerate their work.
It's always a terrific opportunity for us to showcase our industry-leading offering, specifically our Orbitrap hybrid platform, which remains far and above the industry standard. We launched our Q Exactive system a year ago. It continues to hit the ball out of the park for our research customers. This year, we enhanced the capabilities of this flagship instrument by launching three next-generation software packages that help our customers fully leverage the power of the Q Exactive in key applications, from research to applied markets. These were among the eight software packages we introduced at ASMS. In terms of new instruments, we launched the Exactive Plus LC-MS system for laboratory customers who need to perform high-volume screening in a range of applications, from metabolomics to environmental analysis and food safety testing.
The beauty of the Exactive Plus is that it can be readily upgraded to match the higher performance of the premier Q Exactive. We also introduced a new triple quad at ASMS, the TSQ 8000. Customers can view targeted compounds at much lower concentrations. This is especially relevant for food safety and environmental testing applications. Turning to ACHEMA, which took place in late June, we showcased a range of products designed to help customers meet their productivity goals, whether they're working in pharma and biotech, petrochemical, or applied markets. The headliner at ACHEMA was our new iS50 FT-IR spectrometer, the first research-grade FT-IR instrument designed for simple one-touch operation. The iS50 combines accessories, software, and our industry-leading FT-IR capabilities to create a powerful workhorse instrument capable of extracting vast amounts of information from a wide range of samples.
If you look at all of our new product launches so far this year, you'll see that we've had a significant new development in almost every one of our core analytical instrument platforms. We look forward to updating you on new developments in the balance of the year, as well as the customer uptake of new technologies we've launched in the past few months. We've also strengthened our customer offering by deploying capital on strategic M&A. In May, we announced our acquisition of Doe & Ingalls, a premier channel for specialty production chemicals and supply chain services for the life sciences industry. Doe & Ingalls strengthens our value proposition by adding products and services that address the production market within our customer base, which our channel has historically served from a research perspective.
We now have the ability to help our customers manage risk, quality, and total cost in their chemical supply chain to support their production needs. You all probably saw our announcement last week about our agreement to acquire One Lambda, the global leader in transplant diagnostics. We believe it will be an excellent addition to our Specialty Diagnostics portfolio because it will enhance our leadership with strong technologies that generate high margins and create opportunities for long-term growth. One Lambda has great technology. Its human leukocyte antigen and antibody tests are designed to improve the success rate for transplant patients. It's a nice complement to our immunosuppressant assays for monitoring drugs in transplant patients and gives us a comprehensive offering for the transplant testing workflow. We're also excited about being able to leverage our strength in emerging markets to accelerate One Lambda's penetration there.
We expect the transaction to close in Q4. Both of these acquisitions are a good use of our capital and meet all of our acquisition criteria. They strengthen our strategic position, they expand our offering for our customers, and they create value for our shareholders. Our capital deployment strategy also includes returning capital to our shareholders. Including the $100 million we spent to buy back our stock in Q2, we have repurchased $400 million of our shares during the first half of this year. Last week, we announced an incremental buyback authorization of $500 million. If you add that to the $250 million we had remaining at the end of Q2, we have a total of $750 million available for buying back our stock in the second half of the year. Before I turn it over to Pete, let me give you a high-level view of our full-year guidance.
In thinking about our guidance halfway through the year, we went into it with the view that our end markets are playing out pretty much as we've expected, and strong execution by our teams has delivered very good financial performance. Our guidance reflects the addition of Doe & Ingalls, as well as our decision to divest our laboratory workstations business. It also incorporates somewhat more unfavorable FX rates. I'll let Pete Wilver get into the details, but the net result is that we now expect to achieve revenue between $12.14 billion-$12.26 billion in 2012. This results in 5%-6% revenue growth year-over-year, which is the same growth that we've guided to all year. On the bottom line, we're raising our adjusted EPS guidance to a new range of $4.74-$4.84, which would lead to 14%-16% EPS growth over 2011.
Let me summarize what I believe are the key takeaways from an outstanding quarter. The world has played out as we expected, and our teams executed very well, setting the right growth priorities while tightly managing costs. Our growth initiatives continue to deliver results, especially in new products and emerging markets. We complemented those activities with strategic M&A, and we look forward to adding One Lambda to our Specialty Diagnostics portfolio. All of this added up to a strong first half, and that positions us very well to deliver on our goals for the full year. Now I'll turn the call over to Pete Wilver. Pete?
Thanks, Marc. Good morning, everyone. Similar to last quarter, I'm going to start with an overview of the total company's financial performance, and then I'll provide some color on each of our three segments before moving on to our updated guidance. As Marc mentioned, we moved our laboratory workstations business to discontinued operations effective with Q2 reporting. All the continuing operations numbers I'm going to share with you today have been revised to exclude this business from both current and prior periods. As Marc said, our strong financial results this quarter were driven by really solid execution by our teams. This led to another quarter of double-digit growth in adjusted EPS with a 23% increase to a second quarter record of $1.22. GAAP EPS in Q2 was $0.63, down 54% from $1.36 in the prior year's quarter, primarily as a result of the gain on divestitures last year.
GAAP EPS includes a $0.02 operating loss in the laboratory workstations business. We would have reported $0.02 lower adjusted EPS and 21% growth had we not discontinued this business. Still a great quarter. The top line, total revenue increased 9% year-over-year. On a pro forma basis, as if Dionex and Phadia were owned for the second quarter in 2011, reported revenue was up 1% and organic revenue was up 4%. Pro forma revenue included 1% growth from acquisitions other than Dionex and Phadia, which was more than offset by a 3% headwind from foreign currency translation. Please note that the components of the change in revenue do not sum due to rounding. We continue to strengthen our backlog with bookings exceeding revenue by $15 million or about half a %.
Looking at revenue by geography, our growth profile was pretty consistent with what we've been seeing for the past few quarters. North America and Europe grew in the low single digits. Asia Pacific grew in the low double digits, with China coming in strong once again at over 20% growth. Rest of world grew in the low single digits. Turning to adjusted operating income, our teams once again delivered strong bottom-line results. Q2 adjusted operating income was up 16%, reflecting great execution. Adjusted operating margin was up 19% or 110 basis points. Our margin expansion was driven by good pull-through on our organic growth, strong contribution from our productivity and cost actions, and solid accretion from recent acquisitions.
Similar to the last couple of quarters, inflation on resin and other oil-based products continues to be a minor headwind. We continue to deliver on our sourcing efforts and more than offset these pressures. As I mentioned last quarter, we continue to see the benefit of the $100 million restructuring program that we initiated last year and realized about $16 million of benefit in the quarter. As a reminder, we expect to achieve about $50 million of benefits this year and an incremental $15 million in 2013. We're also evaluating additional restructuring actions and continuing to maintain tight controls on our spending, given the uncertainty in some of our end markets. Moving on to the details of the P&L. As a reminder, the Dionex and Phadia acquisitions both have higher than average gross margins as well as higher than average SG&A and R&D expense.
Until they anniversary, you'll continue to see that impact in our year-over-year margins. Total company adjusted gross margin came in at 44.7% in Q2, up 210 basis points from the prior year, for another strong quarter of gross margin expansion. The improvement in gross margin came as a result of solid productivity driven by global sourcing, site consolidations, and our PPI business system, in addition to the benefit from acquisitions. Adjusted SG&A in Q2 was 22.6% of revenue, up 80 basis points from the 2011 quarter, primarily as a result of acquisitions. Finally, R&D expense came in at 3% of revenues, up 10 basis points year-over-year, again, as a result of acquisitions. Below the line, net interest expense was the same as last quarter at $51 million, which was $18 million above Q2 last year as a result of the debt we issued last year to fund acquisitions.
Our adjusted tax rate in the quarter was 17.2%, down slightly from Q1 and down 280 basis points from last year, primarily as a result of acquisition tax synergies and our ongoing tax planning efforts. During the quarter, we deployed another $100 million of cash to buy back 2 million shares of our stock. Average diluted shares were 369 million in the quarter, down 1 million from Q1 and down 17 million or 4% from last year, reflecting the benefit of our 2011 and 2012 share buybacks. Turning to cash flow and the balance sheet. We had excellent cash flow this quarter. Year-to-date cash flow from continuing operations was $909 million, and free cash flow was $782 million year to date after deducting net capital expenditures of $127 million.
Year to date free cash flow was up 38% year-over-year, primarily as a result of higher income, lower cash taxes, and improved working capital, partially offset by higher interest expense. We ended the quarter with about $735 million in cash and investments, down $56 million from Q1 primarily as a result of paying down some of our outstanding commercial paper. Our total debt at the end of Q2 was $6.5 billion, down $143 million from Q1. With that, let me turn to this quarter's performance by each of our three segments. Starting with Analytical Technologies, total revenue grew 8%. On a pro forma basis, assuming Dionex was owned for the full quarter in the prior year, Analytical Technologies total revenue increased 1%, and organic revenue growth was 5%.
Consistent with last quarter, we saw strong growth in instruments sold to industrial and applied markets, as well as in our businesses serving bioprocess production. Adjusted operating income in Analytical Technologies increased 10%, and adjusted operating margin was 17.5%, up 40 basis points. Margin expansion was driven by strong pull-through on organic growth and contribution from our productivity actions, partially offset by strategic investments, inflation, and product mix. Turning to the Specialty Diagnostics segment, total revenue grew 28%. On a pro forma basis, assuming Phadia was owned in the second quarter of the prior year, total revenue increased 1%, and organic revenue grew 3%. Also consistent with last quarter, we continued to see strong growth in clinical diagnostics, which was partially offset by weak demand in Southern Europe.
Adjusted operating income in the segment increased 47%, with adjusted operating margin at 27.2%, up 340 basis points, primarily as a result of acquisitions. In the Laboratory Products and Services segment, total revenue grew 2%, and organic revenue increased by 4%. In the quarter, we had solid growth in laboratory consumables and our clinical trials logistics business continued to deliver strong results. Adjusted operating income in Laboratory Products and Services grew 1%, with adjusted operating margin coming in at 14.2%. This was 30 basis points below the year ago quarter, but up 20 basis points sequentially from Q1. We're continuing to increase profitability in this segment. Moving on to our guidance. As you saw in our press release, we're updating our 2012 guidance to reflect classification of the laboratory workstations business as a discontinued operation, the acquisition of Doe & Ingalls, and more unfavorable foreign currency exchange.
To bridge from the midpoint of our previous guidance, removing laboratory workstations and lower FX rates reduced revenue by about $185 million and $40 million respectively, offset by about $75 million of additional revenue from Doe & Ingalls. Combined with our solid first half results, this leads to a new revenue guidance range of $12.14 billion-$12.26 billion, which represents reported growth of 5%-6% compared to our prior year revenue of $11.56 billion. On a pro forma basis, as if Dionex and Phadia were owned for all of the prior year, the midpoint of our organic growth guidance remains at about 3%, no change from our previous guidance. In terms of FX, the estimated full year impact has increased to $365 million, which results in a 3% headwind on our reported revenue and adjusted EPS.
We're assuming that completed acquisitions other than Dionex and Phadia will contribute approximately 1% to our expected growth in 2012. We also recently announced the acquisition of One Lambda and an additional $500 million share buyback authorization, along with an expected debt issuance of $1.3 billion to fund these two activities. We've not included any benefit from One Lambda in our guidance, as we don't expect to close that acquisition until Q4. However, we have included the favorable impact of the share buyback and the unfavorable impact of interest expense related to pre-funding the acquisition debt. As usual, we haven't attempted to forecast future foreign exchange rates, and our guidance does not include any future acquisitions or divestitures.
In terms of our full year 2012 adjusted EPS guidance, with a strong first half of the year under our belt and with the impact of these actions that I just described, we're raising the high and low ends of our guidance, as well as tightening the range, resulting in a $0.02 increase to the midpoint. Our revised adjusted EPS guidance range is $4.74 to $4.84, which represents 14%-16% growth over 2011. To again bridge from the midpoint of our previous guidance, Doe & Ingalls adds about $0.02, and there's another $0.02 increase from the net impact of the share buyback and debt issuance. This $0.04 increase is offset by $0.02 of negative pull-through on the more unfavorable foreign currency translation. In terms of adjusted operating margin, we're still expecting expansion of 70 to 90 basis points for the year.
Below the line, we're expecting our net interest expense to be up about $70 million to $75 million over last year, and up about $15 million versus our previous guidance as a result of the expected new debt issuance. Our adjusted income tax rate to remain in the range of 17%-18%. We're estimating our full-year average diluted share count to be in the range of 364 million to 368 million, down 4%-5% from last year and down 1% from our previous range due to the additional share buyback authorization. This estimate assumes that we'll use the remaining $750 million of our current share buyback authorization through December of this year. Finally, we're assuming that we'll deploy $150 million towards dividends this year, and we expect capital expenditures to be in the range of $300 million to $310 million.
In interpreting our guidance ranges, as I've stated previously, you should focus on the midpoint as our most likely view of how we see 2012 playing out. Results above or below the midpoint will depend on the relative strength of our markets during the balance of the year. Before we turn to Q&A, let me say that I'm very pleased to report an excellent second quarter and a strong first half of the year that positions us very well to meet our growth goals in 2012. Ken?
Operator, we're ready to take calls.
Thank you. Ladies and gentlemen, to ask your audio questions, press star one on your touchtone telephone. If your question has been asked or you wish to withdraw your question, you may press star two. Again, press star one to ask your question. Our first question is from the line of Jonathan Groberg from Macquarie. You may proceed.
John, you there?
Hi. Yep. Can you hear me?
Sure.
Yes.
All right. Thanks for taking the question, and congratulations on a really solid quarter, and what everyone else is saying is a tougher environment. First, I really appreciate all the color that you gave, Marc, but I wondered if you could talk a little bit more. I think, unless I missed it, you didn't say much about the U.S., and some people have been talking about a bit of a slowing in the U.S. I'm just curious kind of what you're seeing specifically in the U.S. and what your outlook there is for the second half of the year.
Jon, the U.S. was slightly stronger than the 1st quarter, but not materially so. U.S. is hanging in there with low single-digit organic growth.
Is that your expectation for the second half as well?
As we look at the second half, basically, when we started the year, we looked at organic growth being around 3% for the full year. We are staying with that guidance. We had 4% 1st half organic growth, so that implies a 2% organic growth in the second half, and that basically implies a little bit of a slowdown. That's more likely to be in the U.S. and Western Europe than it is really in Asia Pacific. Probably slightly slower in the second half, but we don't really forecast by geography. We typically forecast by our businesses.
Sure. Understand. If I can just follow up on that, I think you both kind of mentioned the past restructuring, also saying, look, given the environment is very uncertain, considering maybe doing more. Can you maybe just talk about, one, what the trigger would be for that, and two, what that would entail on your end?
Yeah. The way that we think about it is we're always looking at our cost base, right? Last year, we specifically put in a $100 million program that we've been executing against. In addition to that, we've been looking at selective cost actions, and those programs, or not programs, but those actions that make sense and have the right result for the mid and long-term health of the business, we're taking those actions as we go. It's probably incremental to it, but it's not under the banner of some incremental program. It's just more good management of the business.
Okay. Thanks. I'll hop back in.
Thanks, Jon.
Your next question is from the line of Ross Muken from ISI Group. You may proceed.
Hi. Good morning, guys.
Good morning, Ross.
As far back as I can remember, at least since you've taken over, Marc, this was probably the best quarter organically you've had versus peers. As you look at sort of the components of where you saw strains, and I know you probably haven't had much time to check out all the earnings reports like we do. I guess relative to either your internal expectations based on what you're seeing in the macro, based on what you had heard throughout the quarter, regionally, products specific, et cetera, where do you feel like the biggest outperformance was for the business in the environment?
Ross, what do you call? Thanks for the question. Welcome back to the conference call. A couple things. If you look at the results, and we do actually look at all of those reports, and we do read all of the competitor reports as pretty much real time. This quarter is actually very consistent to the last two quarters. Three quarters in a row, our organic growth has been very strong relative to the peer set. I actually think you're seeing a nice consistent trend of us delivering very strong organic growth, 5% in Q4, 4% in Q1, 4% in Q2, and relative to the share gain initiatives we had. If I say where do I feel, I think the teams here are executing extraordinarily well. They're very focused on, we have great products, and are very focused on serving our customer needs.
Our value proposition is incredibly relevant in today's environment, right? Our customers are living in a tougher world. They need productivity. They understand our scale. They understand our depth of capabilities. We've been at this five years in terms of since the merger in building those capabilities, and you're seeing us harvesting those, that hard work, and it's showing up in our organic growth results. It's less about a particular geography or a particular product. It's really about a value proposition that resonates in today's environment. We feel great about it.
Maybe, on the guidance increase on EPS. Obviously, I think that's not something we've seen from many businesses in this environment, given the macro backdrop and what we saw in sort of the June timeframe. As you guys were sort of debating the forecast, and we're looking at sort of early trends in July, how comfortable were you or how did you think about sort of how aggressive you wanted to get with sort of the guidance move vis-a-vis sort of the bigger picture and what other large corporates were doing with their outlooks and then I have sort of a cleanup question on that as well.
Sure. Ross, in terms of guidance, the world has been playing out at least the first half as we expected and articulated in February, right? When we set out our original guidance. We expected Europe to get weaker as the year went on. We expected sequestration would not get resolved during this year. We factored those things into our guidance. When you think about us sitting with good execution at the first half and the world playing out as we laid out back at the beginning of the year, we don't see a big change in those expectations. When you look at the various actions that we've taken, we've kept the organic growth guidance the same, which means that we have a couple points deceleration in the second half, which is a cushion, if you will, right?
Versus the way we've been trending, we think that's realistic given the market outlook. When you look at the fact that we're doing an incremental buyback, you look at the fact that we closed a nice acquisition in Doe & Ingalls, those things are net positives, even offsetting the headwinds from FX. The $0.02 increase to the midpoint is we think a good reflection. We always focus on the midpoint of our guidance, and we feel like the low end protects for a much more challenging world if it unfolds.
Just one quick cleanup on the guidance. I know One Lambda is clearly not in there from a revenue EBIT perspective, but just to be clear, there is a bit of interest expense assumption in there or not, Pete?
Yes, we added about $15 million of interest, that's to pre-fund the acquisition as well as to fund the share buyback.
That'll happen some point in 3 or 4 Q, I'm assuming.
It'll happen sometime probably in the third quarter in terms of the debt issuance.
Great. Thanks so much, guys.
Thanks, Ross.
Yep.
Your next question is from the line of Amiel Divan from Credit Suisse. You may proceed.
Yeah, thanks for taking the question. I guess I just had 2 questions here, more related to what you're seeing kind of sequentially through the course of the quarter. Heard some comments from other companies in terms of April through May to June. Have you seen any significant trends kind of through the course of the quarter or into July that give you any cause for that things are getting better or worse in any way?
No, we looked at that. When we do our guidance, we factor in through the first 2 weeks of the quarter that we're living in as well. We feel that the guidance that we've given is reflecting those trends. We didn't see big changes in June or anything that would lead us to believe of a very different change in trend or trajectory. Fairly consistent throughout the quarter.
Okay. Just 1 other one if I could. In terms of the, I know you guys don't give in terms of quarters looking forward for the rest of the year, you get a lot of questions just in terms of how the fourth quarter might play out with all the questions on sequestration and what's going on in Washington. Any guidance you can kind of give just even more qualitatively in terms of how you expect kind of third quarter versus fourth quarter, just looking at the numbers right now, it looks like we're still seeing quite a difference in terms of what growth expectations are for the third versus the fourth quarter.
In terms of our quarterly phasing, just seasonally, Q3 is always a relatively weak quarter just because of the vacations in Europe and really around the world, I guess. Q4 is always our strongest quarter in terms of the year-end push on instrumentation, probably slightly stronger in Q4. All that depends a little bit on what happens with sequestration.
Okay, thank you.
Your next question is from the line of Dan Brennan from Morgan Stanley. You may proceed.
Hi. Thanks for taking the call. I wanted to ask a question on the Laboratory Products and Services business. Second quarter in a row of solid organic growth there versus some peers pointing to a more challenging environment. Can you just provide some color regarding the strength you're seeing there and the sustainability of those trends?
Sure. When I look at Laboratory Products and Services, we saw another good quarter in our biopharma services. The clinical trials outsourcing business is doing well. Our channel business is also performing well. We like the trajectory that we're on in our Laboratory Products and Services segment.
Maybe related to that, the divestiture of the workstation business, can you just discuss what kind of impact that had on the organic growth in the quarter?
When you look at organic growth, we would have had as a company about 3.5% organic growth if lab workstations was in the numbers. We had 4% organic growth with lab workstations out of the numbers. We would have had $0.02 lower adjusted EPS if lab workstations was in the number versus what we did, as Pete Wilver highlighted. The decision on lab workstations had nothing to do with any of that stuff. It was more a decision that we made as a management team that we really weren't the best owners for this business and decided that we were going to sell it to a business that could really help it thrive and grow for the future.
Thanks, Marc. Maybe if I can just sneak one more in. The gross margin strength in the quarter, it's better than we had modeled. Could you just tease out the components, certainly the Phadia and Dionex coming into the mix are helping margins. Is it possible to quantify the Phadia and Dionex contribution versus cost-cutting? In particular, did the company accelerate any facilities closings or any other cost measures that would have led to better gross margin leverage in the quarter? Thank you.
In terms of gross margin, certainly the acquisitions benefited gross margin. That obviously is going to decrease in terms of the impact throughout the year as we anniversary those and Q2, or excuse me, Q3, Dionex will be fully out, and then Q4, both of them will be fully out. The gross margin improvement on the core business is really coming from the areas that we continually drive productivity in, which is sourcing our PPI business system and restructuring. The benefit there is it's probably about a third, a third, a third between those three in terms of improvement on the core business.
Great. Thanks, Pete.
Yep.
Your next question is from the line of Dan Leonard from Leerink Swann. You may proceed.
Thank you. Two quick ones. First off, in Laboratory Products and Services, now that you've divested or you're planning to divest the workstations business, how should we think about the margin trajectory of that business going forward? Is that a business where you could increase margins commensurate with the corporate average annually, or will that still be more lumpy?
Yeah. I think in Laboratory Products and Services, it's lower than average, and we have the channel business there, which we don't have as much value-added cost that we can actually impact in terms of margin expansion. There's a lot more direct material cost in that segment. That segment over time will, in general, have lower margin expansion than the average for the company just as a result of that.
Okay. Thank you. Housekeeping, Pete, what are the foreign currency rates you're using in your guidance for the euro?
Yeah. For the euro, it's about 121.
Okay. Thank you.
Yeah.
Thanks, Dan.
Your next question is from the line of Amit Bhalla from Citi. You may proceed.
Thanks. Good morning.
Good morning.
I wanted to just have you, Marc, elaborate on your comments on the CapEx budgets releases within academic government. Can you give us a little bit more detail on the types of products that are being impacted and tie in what you're seeing within mass spec and the competitive environment?
Sure. Academic and government really didn't change very much. Didn't really change at all in Q2. Consumables broadly did fine, which means it's logical, right? Customers, they're working, right? They're doing research, so therefore, they're consuming plastics, reagents, and so forth. Instrumentation really was more aligned with how differentiated the technologies were. In particular, our mass spec business had a very nice quarter. Things like lab equipment and more routine instrumentation would really be a little bit softer and more constrained.
Okay. That's helpful. The second part for my question is on Analytical Technologies. You've highlighted biopharma within Analytical Technologies as a strength in the past. This quarter, I don't think Pete brought that one up, but you did talk about biopharma strength overall. Can you talk specifically about Analytical Technologies? Anything going on there that we should be aware of?
Within Analytical Technologies, we have our bioprocess production business, which had another terrific quarter that was there. I would say on the instrument side of the business, it was kind of an okay quarter in terms of biopharma. It was up, but it was not probably as strong as some other quarters.
Anything regionally that's impacting that, or is it just across the board?
I didn't really see any particular regional explanation. I think generally Europe was pretty soft.
Okay. Thank you.
Your next question is from the line of Jon Wood from Jefferies. You may proceed.
Hey, thanks a lot. Good morning.
Morning.
Morning.
Hey, you guys have previously talked about something like 50% of free cash flow back to the shareholder dividends and repurchases. Obviously, you're going to do a lot more than that this year. Just wondering, should we think about a different rule of thumb going forward, specifically in 2013, just given the leverage ratio, post the One Lambda deal? Meaning, is deleveraging a greater priority for 2013 at this point?
I think we'll do that really in the February guidance. At a high level, our capital deployment strategy hasn't changed, which is, a portion of our capital is going to get returned to our shareholders. A portion is going to be used for M&A that meets our strict criteria in any given year. It may vary based on the environment. We're comfortable with our leverage ratios hovering between 2.5 and 3 at year-end. They should be relatively close to 2.5. I wouldn't assume major changes in the capital deployment strategy for 2013. We'll figure that out, and communicate it crystal clear in February.
Got it. Thanks, Marc. One last one. Any view on the timing of Hamilton divestiture? It looks like you've written the book value down to close to 0. Is that accurate? Would you expect to get any material proceeds there?
In terms of the divestiture process, it's ongoing. In terms of the gains and losses, I don't want to speculate on that because I want to wait till we actually have the buyer negotiate, and I don't want to handicap or really comment on the valuation. I think the write-down is a reflection of what we think was an appropriate accounting at the point of the time of the decision to divest it.
It is above zero, though.
Yes.
Okay. Thanks, guys.
Yep.
Your next question is from the line of Doug Schenkel. You may proceed, from Cowen and Company.
Hi, good morning, guys. Thanks for taking the questions. Maybe just building off of that last question. I think the conclusion has been you've done a good job divesting businesses when you think about Athena Diagnostics and Lancaster Laboratories last year. Certainly the one you're in the process of divesting makes sense. Could you just describe what the environment is like for these opportunities? Maybe more importantly, what's the criteria you're going to use moving forward to make divestiture decisions? Is it simply a question of, in your words, whether or not you're the best owner for an asset? Is there something we can also look at in terms of size, margin profile, growth rate, any other criteria that you would be willing to share with us?
Doug, we're not contemplating any material divestitures. If you wanted to find material, anything nearly as large as lab workstations. We always do tiny little things, and we'll continue to do that. We like the portfolio. Our strategy is clearly working. Look at the organic growth that we're delivering over the last few quarters. That's because the package of businesses we have today fit together, work together, and are valued by the customers. I wouldn't expect really much more on the divestiture front. If you think about it, and you go back over the last five years, the ones we've divested are very logical, and they've been telegraphed, if you will. We've never liked competing with our customers. We sold our two testing labs, which was Athena and Lancaster. Lab workstations has been a business that is a very heavy manufacturing business.
It's very different than what we do. When we look at the long-term fit, we think there are companies that have better ownership with it than we would.
Okay. If I have it right, it looks like restructuring expense picked up a little bit, Q1 to Q2. Was this as planned, assuming I have this right, or was it in response to anything that you're seeing in the environment, or is there anything else that caused this to accelerate that was different than planned?
We obviously put together the $100 million restructuring plan last year, and we've been executing against that. Throughout the year, we're always doing some level of restructuring actions. In addition to that, as Marc said, it's not at the, quote, "program level." It's more the one-offs. I wouldn't necessarily read anything into that other than just normal actions that we do throughout the year.
Last one. You continue to pick up shares, the numbers suggest, and as you mentioned in your prepared remarks. Some of this is easy to see via new products and Analytical Technologies like Q Exactive. Beyond specific new product launches, are you evolving how you go to market with products, how you sell products within Analytical Technologies? In our channel checks and our conversations with some of your competitors, we're starting to hear more about Thermo doing a better job selling applications, wide solutions, if you will, really connecting different products and services across your Analytical Technologies product portfolio. Is there something that's changing in terms of how you commercialize customer solutions? If so
How far along are you in this process?
Well, just good comments, right? Not much more to add, Doug. I like the feedback. I would say it's an area that we're focused on. I think we're doing a better and better job of representing our solutions-based capabilities for our customers. I still think we have a lot of work to do and a lot of opportunity ahead. It's still young, if you will, but we've been working at it, and our customers understand the value of it. I actually think when customers are more constrained and customers are trying to make sure they're successful, the broader your capabilities and the deeper your applications are, the better off you're going to be. I think that's really paying off for us.
Okay, thanks. That's all very helpful. I appreciate you taking the questions.
Thanks, Doug.
Your next question is from the line of Tycho Peterson from J.P. Morgan. You may proceed.
Morning, Tycho.
Hey, good morning. I actually want to take a slightly different angle to Doug's last question there. This is really the second quarter in a row we've seen you outperform a lot of your equipment peers. Can you talk to how much of that is share gain versus other factors? We obviously, as Doug said, see it in mass spec. Are there other obvious areas where we should think about you pulling share? And then how much is pricing a factor in this environment, in particular within mass spec?
Each company is a little bit different. When we look at our mix of analytical technology, it's different than the other companies. I do think we had a good share gain in mass spec. I think our biosciences business is doing well. Generally, I view that the performance is strong. Pricing was up slightly in the quarter, but it wasn't a big change from what we've seen. I don't think price is a big factor one way or the other in the performance.
Okay. Just a couple other housekeeping ones. Is Phadia kind of back on track? That was a little bit soft last quarter. There was some seasonality there. Can you just talk to whether that's recovered?
Yeah. Tycho, let me give a more holistic update on both acquisitions that we are almost at the one-year anniversary. I think it's a good question that hasn't been asked. When you think about Dionex, when you think about Phadia, let's look at it in the three criteria that we look at it, which is how's the integration gone, how's the business performing short term, and what's the long-term prospects. Integration for both businesses has gone extraordinarily well. It's Thermo Fisher. I mean, at this point, both of them, they're very well integrated. The culture is very harmonious, and it's very positive. Synergies are ahead of plan. When you look at accretion, which is now the reflection of the full package of performance, in 2012, accretion is going to be better for both of those acquisitions than the acquisition model.
Phadia, in particular, will be fairly meaningfully more accretive than we articulated back on the $0.30 that we had talked about. When you look at the short-term performance of the business, both businesses actually have more European exposure than the company average, both of them actually are growing slightly less than the company average in terms of organic growth. If I look at the longer-term prospects for both businesses, we're very bullish on what both bring to our company and feel good about it. Generally feel good, but European exposure hasn't been particularly helpful.
Okay. Last one, I know you've had a number of questions on Hamilton, not to spend too much time on it, but if we go back years and years ago, this was always viewed as a bad business. I think Marijn used to joke the competition was two guys and a saw. It hasn't gotten better over the years, presumably. Why did it take so long to divest it? Was there a period where you thought you could actually really, truly turn it around?
We have a terrific team of employees in that business. They've worked very hard to make it the very best business that it can. We gave them significant resources to try to make the most of it. When we look at it today, we just think there are companies that it's more core to their activities than ours, and we decided that that's the right thing. It's a decision. It's a tough business, but at the same point, we think it's got good prospects, and we think the right owner will bring it to its full potential.
Okay. Thank you.
Your next question is from the line of Derik de Bruin from Bank of America Merrill Lynch. You may proceed.
Hi, how are you?
Good, Derik.
In Q3, you're going to anniversary the weak academic environment that hit you last September. Since comps get easier, I guess, what's kind of built into your academic numbers? Are you still expecting academic to be down year-over-year, or is it more flat? I'm just kind of wondering where are you on that thought process?
When you look at the comps, industrial gets harder, both in Q3 and Q4. Obviously, in academic, the comparison is easier. When we laid out our guidance, we obviously don't do quarterly guidance, when we laid out our guidance, we assumed that academic and government would be down low single digits for the year. It's down low single digits in the first half, and that sort of implies that it's going to be still down off of an easy comp. That would be what the math would imply, although we don't really sit there and say what's Q3 exactly going to be versus Q4, but hopefully that helps you think about modeling.
Yes, that's very helpful. You've gotten beaten up in the past in your LPS business because organic growth has lagged. Now that you've divested it, I know that where you're planning to divest it's been a 0.5% drag in the over organic growth rate in Q2. Can you just give us a flavor of what it has been historically as a drag on the LPS segment?
Excuse me, lab workstations in particular?
Lab workstations. What was it a drag on the overall LPS business? One of the focuses has been that business did not grow as fast as it had previously thought, and I'm just wondering if this was a large reason why that business had not done as well in the past.
The results in 2011 were relatively weak. The numbers are so small that the accretion dilution on both organic growth and the margins is pretty minimal. For this year, it didn't really even affect our guidance, taking the numbers out.
Okay.
It wasn't so materially off the averages that it was making a big impact.
Gotcha.
Yeah. I think, Derik, you know us well enough on this stuff, which is, it's not big enough to make a material change, but it was the right decision to sell it, so we're selling it. We're not sitting here and trying to change the growth rate by a tenth of a point one way or another. In the scheme of things, it doesn't make a difference.
Right. No, that's right. Finally, can you just give us some more color on Asia? Is the growth you're seeing there share gains from peers, for example, to multinationals that you're selling to, that you're just gaining a bigger share there, you're taking share? Or is it brand new business from domestic Chinese or Asian customers that are showing up? Can you just give a little flavor of where you're seeing the growth and how that's working?
Yeah. Let's focus on China. China was very strong, in excess of 20% of growth organically, again. When you look at it, we had very good performance widely across the business. I think a nice example is, we talked about the five-year plan and the focus on healthcare, the focus on environment. It's not a surprise that our Specialty Diagnostics business is doing very well and growing rapidly in China in particular, because basically there is a better care availability opportunity in China where they're trying to create more capacity, if you will, to serve the population. The other area that's doing incredibly well in China is our environmental business. There is regulations called PM 2.5, which is basically breathing in particulates in your lungs, the government has actually decided to accelerate implementation of those regulations.
We're capturing about 70% share of all of the air monitors that are being used for that particular application. It's not taking share from the New York Stock Exchange listed competitors. It's taking share from companies that might be local or really we don't think as much about. The business is performing very well, and we continue to be optimistic about our outlook in China in particular.
Great. Thank you very much.
Your next question is from the line of Dan Arias from UBS. You may proceed.
Thanks very much. Marc, I guess just given the focus on cost control these days, I'm curious whether you can give us a sense of where you think the biggest need to spend is in order to keep innovation where it needs to be and to keep people in the right places. Can you just update us on your current view on investment focuses?
I think the investment focus is straightforward. We're going to continue to support our R&D efforts, we're going to continue to expand in emerging markets. Those are clear. We'll also make commercial investments around the applications marketing, as Doug asked earlier, some things on the website, things that continue to strengthen the company. We will manage our cost tightly on all other areas, right? We're being prudent and frugal on those other things. Making sure that we're as efficient as we can and looking for opportunities to streamline our cost base.
Okay, thanks. Just to follow up, I'm wondering if you could comment a bit more on applied market demand. Some reports elsewhere of maybe some potential slowing in food and environmental testing areas. Is that something that showed up anywhere for you guys at all?
Nothing that really jumped out from a material perspective one way or the other. We continue to have good momentum in our applied markets.
Very good. Thanks.
Operator, we have time for just one more.
Thank you. That question will come from the line of Isaac Ro from Goldman Sachs. You may proceed.
Hi, guys. Thanks for fitting me in. Just wanted to ask a general question on pricing. I know you guys mentioned in the earlier comments that pricing generally not a big swing factor. If you could maybe add a little bit of color in diagnostics and then in pharma. I think in diagnostics, we're clearly dealing with pretty stagnant volume environment, and the lab companies have generally suggested they're going to look to try and save expenses. What are you seeing in the diagnostics channel with regards to your basic supply side of the franchise? In pharma, some of these larger contracts, just wondering what kind of a tone you see on pricing there.
Yeah. In terms of pricing and diagnostics, that's not an area where we generally get a lot of price, so that's consistent with the past. It's basically flat overall. I don't have a lot of data by market segment in relation to price. In overall, it's about flat.
Okay. In pharma?
In pharma, again, we don't cut the business that way. I would say that probably the takeaway message on pricing in Q2 was pretty similar to what we saw in Q1 in aggregate, not really any major changes that we observed. We pay a lot of attention to it. Obviously, we have a very high focus on pricing and generally do a good job with it. We're not seeing anything, Isaac, on the upside or downside that's material.
That's helpful. Just one last one for me on China. I know you mentioned earlier the comments on the environmental business, if we look at the economic side, there were some questions also in the industry about pacing of government funds getting released over the course of this year. Any updated commentary on that part of the China end market?
When we look at China, we've been consistently growing north of 20%, really there wasn't major swings one way or the other within the business. We feel good about the overall performance in China actually feel good about the outlook as well. Isaac, thank you. Let me just wrap up the call and add a few quick closing thoughts. One is that I think our teams executed very well to deliver a strong first half. Their focus on new products, emerging markets, strategic acquisitions is clearly driving growth. We continue to manage our cost tightly in line with the economic environment, we're confident that we'll deliver on our growth goals for the year. Thanks for your support of Thermo Fisher Scientific, we look forward to updating you on our Q3 call. Thank you, everyone.