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Good morning ladies and gentlemen and welcome to the Thermo Fisher Scientific 2021 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. If you’d like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.
I would like to introduce our moderator for the call, Mr. Rafael Tejada, Vice President, Investor Relations. Mr. Tejada, you may begin the call.
Good morning and thank you for joining us. On the call with me today is Marc Casper, our Chairman, 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, News and Events until August 13, 2021. A copy of the press release of our second quarter 2021 earnings is available in the Investors section of our website under the heading, Financials.
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 this indicated by the forward-looking statements as a result of various important factors, including those discussed in the company’s most recent annual report on Form 10-K and subsequent quarterly reports on Form 10-Q, which are on file with the SEC and available in the Investors section of our website under the heading, Financials - SEC Filings.
While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change, therefore you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.
Also during this call, we will be referring to certain financial measures not prepared in accordance with generally accepted accounting principles, or GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release of our second quarter 2021 earnings and also in the Investors section of our website under the heading, Financials.
With that, I’ll now turn the call over to Marc.
Thanks Raf and good morning everyone. Thank you for joining us today for our second quarter call.
As you saw in our press release, we executed on our growth strategy to deliver another fantastic quarter in Q2 with excellent growth on both the top and bottom line. As I reflect on the first half of the year, three things stand out to me: first, our team’s exceptional execution operating with speed at scale to deliver on our growth strategy and gain share; second, we’re already seeing the benefit of the accelerated investments we initiated in 2020; and third, the power of our PPI business system, which enables our performance. These three factors position us exceptionally well to deliver a fantastic 2021 and provide terrific momentum as we enter 2022.
I’ll cover each of these topics in more depth in my remarks, but first let me recap the financials.
Our revenue in Q2 grew 34% year-over-year to $9.27 billion. Our adjusted operating income for the second quarter increased 44% to $2.69 billion and our adjusted operating margin expanded 200 basis points to 29% for the quarter. Finally, we delivered another quarter of exceptional adjusted EPS performance, achieving a 44% increase to $5.60 per share.
Turning to our end markets, we continue to see excellent conditions driven by three factors: robust fundamentals in the life sciences, strong economic activity globally, and the role our industry is playing in the pandemic response. Our unique competitive position and excellent execution by our team has allowed us to gain share and deliver another outstanding quarter.
Starting with pharma and biotech, we had outstanding performance with growth of over 30% driven by strong underlying market conditions, the benefit of our unique customer value proposition, and our leading role in supporting our customers across a wide range of exciting therapeutic areas, including our significant role in COVID-19 vaccines and therapies. We saw excellent growth across all businesses serving these customers, including bio production, pharma services, bio sciences, chromatography and mass spectrometry, and in our research and safety market channel. We are clearly benefiting from our trusted partner status that we’ve earned over many years with these customers.
In academic and government, we grew 35% this quarter. We saw very strong growth across our businesses supporting this customer base, especially in bio sciences, electron microscopy, and the research and safety market channel.
Turning to industrial and applied, we grew approximately 30% during the quarter as the team continues to execute at a high level to capture opportunities. In Q2, we had particularly strong growth in electron microscopy and chromatography and mass spectrometry business.
Finally in diagnostics and healthcare, we grew in the high teens during the quarter and we’re seeing customer demand in our base business approach pre-pandemic levels. Our immunodiagnostics and transplant diagnostics businesses delivered outstanding growth. Also in diagnostics and healthcare, demand for COVID-19 testing related products grew to approximately $1.4 billion.
Let me wrap up the end market recap with a quick comment on our role in the pandemic response. Since the beginning of the pandemic, we have played the largest role in the life science tools and diagnostics industry in supporting the societal response and delivering critical solutions for our customers and governments around the world. In the second quarter, we generated a total of $1.9 billion, bringing our first half COVID-19 response revenue to $4.7 billion.
One of the benefits of our response activity is the ability it gives us to accelerate investments and position the company for a phenomenal future. You know about the additions to capacity, capabilities and new products that we are making, and we are also continuing to invest in our colleagues. Building on our investments last year, we are again providing all non-executive colleagues with a special recognition payment of two weeks’ additional pay to reflect the incredible contributions to our success. This is just one of the many measures we are taking to ensure we remain the employer of choice across the life sciences industry.
Let me turn to the great progress we made in Q2 on our growth strategy, which is based on three pillars: launching high impact innovative new products, leveraging our scale in the high growth and emerging markets, and delivering a unique value proposition to our customers. Let me give you a few examples.
I’ll start with innovation. We launched a number of new products across our businesses to further strengthen our industry leadership and enable our customers to accelerate scientific breakthroughs. Let me highlight a few.
In chromatography and mass spectrometry, we launched the new Thermo Scientific Orbitrap IQX Tribrid mass spectrometer which further extends the impact of our industry-leading Orbitrap platform to accelerate small molecule analysis for metabolized and other complex compounds. In our electron microscopy business, we introduced the Thermo Scientific Helios 5 EXL wafer dual beam scanning electron microscope, a very important tool to help semiconductor customers more efficiently ramp up production of new smaller and more complex microprocessors and memory devices. In our bio sciences business, we launched several new products including two instruments to advance cell analysis. The Invitrogen Bigfoot Spectral Sorter is a powerful cell sorting tool based on the technology we acquired from Propel Labs in Q1, and the Invitrogen Attune CytPix Flow Spectrometer, which offers enhanced imaging capability to enable researchers and cell therapy developers to better understand cell biology.
Turning to the second pillar of our growth strategy, we continue to leverage our scale to create an outstanding experience for customers in the high growth and emerging markets. This has contributed to the excellent growth and share gain we are delivering across Asia Pacific. Let me cover a couple of the highlights.
In China, we delivered strong growth of just under 30% in the quarter. The team is ramping up our new single use technology facility in Suzhou. In India, we demonstrated speed at scale at our genetic sciences facility in Bengaluru which shipped millions of COVID-19 PCR tests to support the country’s response to the pandemic. We also have contributed $10 million in urgently needed products and donations to help India bring the crisis under control. Our performance across the region demonstrates that we’re creating a differentiated experience for our customers and the significant investments that we’ve made in these markets are fueling growth.
The third pillar of our growth strategy is our customer value proposition, and we continue to increase our capabilities and capacity to be an even better partner for our customers and help them achieve their goals.
Building on our significant investments last year, in 2021 we’re executing on over $2.5 billion in capex to further expand our capacity and capabilities. It’s exciting to see the continued progress of these investments. For example, during the quarter we brought additional capacity online around the world to support customers’ production of vaccines and therapies. These include sterile fill/finish lines in Italy and Greenville, North Carolina, expanding our single use technology capacity in our facility in Logan, Utah, and adding to our Lithuania site for the production of essential raw materials used in the mRNA vaccines. These investments in our value proposition demonstrate our commitment to our customers who rely on us as an essential partner in their work.
During the quarter, we announced a number of collaborations with leading academic medical centers. The combination of our innovation and our unique customer value proposition positions us to move science forward. For example, we’re collaborating with the Mayo Clinic to develop more precise and personalized diagnostics for blood-based cancers, allergy, autoimmunity, and therapeutic drug monitoring. This work will leverage our insight and technology in clinical next-gen sequencing, immunology, and clinical mass spectrometry.
In addition, we announced that we’ll build and operate a state-of-the-art cell therapy development, manufacturing and collaboration center at the University of California San Francisco to advance innovation in cell and gene therapy. These partnerships will lead to new capabilities for our customers and ultimately better outcomes for patients.
As always, our PPI business system was a major factor in our success during Q2. This discipline and our mission-driven culture helps us to find a better way every day so we can continue to bring more innovative new solutions to our customers, work more efficiently and effectively, operate with speed at scale, and create even greater value for all of our stakeholders.
Turning to capital deployment, we announced the acquisition of PPD at the beginning of the quarter. This acquisition will establish Thermo Fisher as a leader in the attractive and high growth clinical research services industry and add highly complementary services for our fastest growing end market. The integration plan is going extremely well. I’ve been very impressed with the world-class talent I’ve met during the integration planning process. We’re looking forward to welcoming our PPD colleagues to Thermo Fisher upon closing of the transaction.
Before turning to guidance, let me update you on our progress on our ESG initiatives. As the world leader in serving science, we know that our role goes beyond the work we do to enable our customers and value we create for our shareholders. It extends to our responsibility to make the world a better place. To that end, we continue to advance our sustainability initiatives. Yesterday, we announced our commitment to achieve carbon neutrality by 2050. This builds on our existing goal to reduce greenhouse gas emissions across our operations by 2030. We’re moving forward on this front by making our facilities more energy efficient, increasing our use of renewable energy, and reducing waste in our operations while also innovating across our portfolio to enable customers to meet their sustainability needs. This is aligned with our commitment to do business the right way and to fulfilling our mission to enable our customers to make the world healthier, cleaner and safer.
Now let me turn to our guidance for 2021.
Driven by our very strong start to the first half of the year and our confidence in the full year outlook, we’re raising both our revenue and earnings guidance for the full year. Stephen will cover the assumptions behind our guidance, I’ll cover the highlights. We’re raising our revenue guidance by $300 million to $35.9 billion, which represents 11% reported growth over 2020. In terms of adjusted EPS, we’re raising our guidance by $0.10 to $22.07, which will represent 13% growth over 2020.
Before I turn the call over to Stephen, let me summarize our key takeaways from Q2.
Our team is doing an outstanding job of executing our proven growth strategy to strengthen our competitive position. Our PPI business system is enabling our ability to operate with speed at scale. Our business is performing extremely well and gaining share. All of this enabled us to deliver excellent first half results and positioned us to deliver a fantastic 2021, and provides terrific momentum as we enter 2022.
Finally, I’d like to thank my 80,000 colleagues for their dedication to our company, our customers, and for once again delivering another excellent quarter.
Now I’ll turn the call over to our CFO, Stephen Williamson. Stephen?
Thanks Marc and good morning everyone. I’ll begin with a high level summary of our Q2 performance.
We had another excellent quarter and grew our revenue 34%, including 28% organic growth. As Marc mentioned, our growth strategy is enabling us to take share on top of strong market conditions. As a result, in Q2 we were able to deliver 27% organic growth in the base business and continue our industry-leading response to the pandemic, generating $1.9 billion of COVID-19 response revenue in the quarter.
Our PPI business system enabled us to generate excellent pull through on the very strong top line growth and is also enabling us to execute really well on our significant growth investments. As a result, we grew our adjusted EPS in Q2 by 44% to $5.60 and delivered $1.7 billion of free cash flow - overall, another excellent quarter.
Now let me provide some more color on the Q2 performance.
GAAP EPS in the quarter was $4.61, up 59% from Q2 last year. On the top line, our Q2 reported revenue grew 34% year-over-year. The components of our Q2 reported revenue increase included 28% organic growth, 2% from acquisitions, and a tailwind of approximately 5% from foreign exchange. As I mentioned, the base business organic growth was 27%.
Turning to our performance by geography during the quarter, North America grew 25%, Europe grew 35%, Asia Pacific and China both grew just under 30%, and rest of the world grew low double digits.
Turning to our operational performance, Q2 adjusted operating income increased 44% and adjusted operating margin was 29%, 200 basis points higher than Q2 last year. In the quarter, our PPI business system enabled us to deliver very strong contributions from volume and productivity. We also had favorable business mix. This was partly offset by the ongoing strategic investments across our businesses to support our near and long term growth.
Included in the investments in the quarter is over $100 million of supplementary cash bonuses for the non-executive colleagues, and we recorded a similar amount in Q1. This is to recognize the extraordinary work that our colleagues continue to do for our customers, communities and shareholders. Our ongoing investment in our colleagues and capacity and capabilities are ensuring a really bright future for the company.
Moving onto the details of the P&L, total company adjusted gross margin in the quarter came in at 50.6%, flat to Q2 of the prior year. In the quarter, we delivered strong productivity and had positive business mix. This was offset by strategic investments.
Adjusted SG&A in the quarter was 17.9% of revenue, a decrease of 200 basis points versus Q2 2020, reflecting strong volume leverage. Total R&D expense was approximately $340 million, representing growth of 29% versus Q2 2020 and reflects the increased investments in high impact innovation to fuel future growth.
Looking at results below the line for the quarter, our net interest expense was $111 million, $17 million lower than Q2 last year largely due to lower net debt. Adjusted other income and expense was a net income in the quarter of $3 million, $13 million lower than Q2 2020 mainly due to changes in non-operating FX.
Our adjusted tax rate in the quarter was 14%. This was 250 basis points versus Q2 last year due to the increase in pre-tax profit.
Average diluted shares were 396 million in Q2, about 2 million lower year-over-year driven by share repurchases net of option dilution.
Turning to cash flow and the balance sheet, the cash flow performance enabled by our PPI business system was very strong in the first half of the year. Year-to-date cash flow from continuing operations was $4.2 billion, up 88% from the same period last year. Year-to-date free cash flow was $3 billion, up 76% over the same period last year, and that’s after investing $1.2 billion of net capital expenditure. This reflects the strong return we’re generating in the short term and the investments we’re making for the long term.
We returned over $100 million to shareholders through dividends in the quarter. This reflects the 18% dividend increase we announced in February. We ended Q2 with $7 billion in cash and $18.8 billion of total debt. Our leverage ratio at the end of the quarter was 1.4 times gross debt to adjusted EBITDA, and 0.9 times on a net debt basis.
In concluding my comments on our total company performance, adjusted ROIC was 22.5%, up 10 percentage points from Q2 last year as we continue to generate exceptional returns.
Now I’ll provide some color on the performance of our four business segments. Similar to the last few quarters, I’ll start with some framing thoughts on the impact of the COVID-19 response on our segment results.
From a revenue standpoint, as was the case in the last three quarters, the majority of the COVID-19 response revenue is recognized in life science solutions with the remainder recognized in laboratory products and services and specialty diagnostics. From a margin standpoint, the impact of COVID-19 differed across the segments based on the scale of the response revenue and the different levels of profitability on that revenue. In addition, during the quarter we continued to make strategic investments across all of our businesses. The size of those investments does not necessarily align with the COVID-19 response revenue in each segment, so that does skew some of the reported segment margins.
Moving onto the segment details, starting with life science solutions, Q2 reported revenue in this segment increased 37% and organic growth was 29%. In the quarter, we delivered exceptionally strong growth in our bio sciences and bio production businesses. Q2 adjusted operating income in life sciences solutions increased 39% and adjusted operating margin was 48.3%, up 90 basis points year over year.
In the quarter, we drove strong volume pull through and saw positive business mix, which were partially offset by the strategic investments. We also had a tailwind on margins from FX in this segment in Q2.
In the analytical instruments segment, reported revenue increased 41% in Q2 and organic growth was 36%. During the quarter, we saw excellent growth in all businesses within this segment. Q2 adjusted operating income in analytical instruments increased 107% and adjusted operating margin was 18.9%, up 600 basis points year over year. During the quarter, we drove very strong volume and pull through and productivity, which more than offset the strategic investments that we’re making across this segment.
Turning to specialty diagnostics, in Q2 reported revenue in this segment increased 25% and organic growth was 21%. During Q2, we delivered exceptionally strong growth in the immunodiagnostics and transplant diagnostics businesses. Adjusted operating income increased 15% in the quarter and adjusted operating margin was 19.9%, down 170 basis points from the prior year. In Q2, the positive volume leverage and favorable business mix were more than offset by the continued strategic investments in this segment.
Finally in the [indiscernible] products and services segment, Q2 reported revenue increased 29%, organic growth was 23%. In the quarter, we saw excellent growth in all our businesses in this segment. Adjusted operating income in the segment increased 59% and adjusted operating margin was 12.4%, which is 230 basis points higher than the prior year. In the quarter we delivered positive volume leverage and favorable business mix, and that was partially offset by strategic investments.
With that, now let me turn to our updated 2021 guidance. As Marc mentioned, we’re raising both our revenue and adjusted EPS guidance, reflecting the strength of our Q2 performance along with a stronger outlook for the base business in the second half of the year. In terms of revenue, we’re raising our full year guidance by $300 million to $35.9 billion and increasing our full year organic growth to 9%.
The increase in revenue guidance is driven by three factors: an increase in the base business organic growth outlook for the full year from 8% to 12%, an updated assumption of $6.7 billion of COVID-19 response revenue for 2021, and a slightly more favorable FX tailwind than previously assumed. Let me give you additional details on each of these factors.
Starting with the base business, here we’re increasing the outlook by $850 million, reflecting our great Q2 performance and a stronger outlook for growth in the second half of the year. This increases our 2021 full year organic growth outlook for the base business by 400 basis points to 12%. Our end markets are very strong and we’re executing very well on our growth strategy and increased strategic investments to drive excellent performance.
Moving onto COVID-19 response revenue, our role in supporting COVID-19 vaccines and therapies continues to increase and we now expect $1.8 billion of related revenue in 2021, up $300 million from the prior guide. Approximately half that $1.8 billion was recognized in the first half of the year. Given the strength of both the base business growth and our vaccine and therapy response, we’ve taken the opportunity in this revised guidance to significantly de-risk the outlook for testing. We’ve lowered the full year testing related response revenue by $900 million from the prior guidance. We’re now assuming it will be $4.9 billion for 2021, of which $3.8 billion was delivered in the first half of the year, leaving just over a billion dollars to go in the second half.
There continues to be a wide range of outcomes for testing in the second half of the year. There are scenarios where the pandemic could increase in intensity, driving a higher need for testing. Should that be the case, we’d be well positioned to support customer needs and will flow this benefit back through our P&L; but for now, we thought it was prudent to take the opportunity to de-risk the outlook.
The third and final element of the revenue guidance raise is FX. Rates continue to fluctuate. They went favorable to those from our prior guidance for most of Q2 and then moderated significantly. The net of this result is an increase in our FX revenue tailwind for the year, which is now assumed to be $525 million, up $50 million versus the prior guidance. Taking account of the different margin profiles of the revenue changes I’ve just outlined, we’re increasing our annual adjusted EPS guidance by $0.10 to $22.07, which will result in 13% growth over 2020. With the revenue mix assumed in the guide, we now estimate that the adjusted operating margin for the full year would be approximately 29.7%, in line with 2020.
The other elements of our guidance remain the same as the prior guide. Let me remind you of some of those assumptions. We’ve not included any operational benefit in 2021 from the acquisition of PPD. When we get more clarity on the actual close date, we’ll provide an estimate of any potential impact in 2021. We expect net interest expense in 2021 to be approximately $510 million. As a reminder, included within that number is $40 million or $0.10 of adjusted EPS as a placeholder for pre-financing for the PPD transaction. We expect the adjusted income tax rate to be 14% in 2021. We’re assuming net capital expenditures of approximately $2.5 billion to $2.7 billion, and free cash flow of approximately $7 billion in 2021.
Our guidance still includes $3.8 billion of capital deployment, which is $2 billion of share buybacks which were completed in Q1, $1.4 billion for completed M&A, and $400 million of capital returned to shareholders through dividends. We estimate the full year average diluted share count to be 397 million shares.
Finally, I wanted to touch on the phasing of revenue dollars and adjusted EPS for the remainder of the year. When I think about the split of the second half P&L between Q3 and Q4, we are assuming that the results will be slightly weighted to Q4. As you think about that split, remember the placeholder for PPD financing is all in Q4.
To conclude, we delivered another excellent quarter and we’re in great position to achieve our 2021 goals as we move into the second half of the year.
With that, I’ll turn the call back over to Raf.
Thank you Stephen. Operator, we’re ready to take questions.
[Operator instructions]
Your first question comes from the line of Vijay Kumar with Evercore.
Hey guys, congrats on a solid [indiscernible] this morning. Marc, one on the guidance here. Overall revenues were up, increased by $300 million for the year, but your COVID response revenues were lower by 600 and the implied math on base is it’s up 850 million ex-FX contribution. That’s a big number, and that’s all coming here--you know, most of it seems to be in the back half. I’m curious, what changed versus the prior assumptions, which segments are coming in better? Clearly we saw analytical tech come in better, and I’m curious if it has any implications for fiscal ’22.
Yes Vijay, thanks for the question. As I look at the base business outlook, really incredibly strong Q2. The performance, the 27% base business organic growth, the business is really firing on all cylinders, and orders were very strong. The informal dialog you have with customers is very bullish about market conditions and also, more importantly, our role in supporting them, and that gave us confidence that 12% organic growth for our base business activities is an appropriate guidance for the full year, so we feel really good about that.
You’re seeing the benefits of the acceleration in our growth strategy investments that we started in the second half of last year. You’re seeing those things start to come into the new products that we launched, the collaborations, new capabilities. It’s really a super exciting time, and we’re excited about it in terms of what the fundamental outlook is for the base business.
Understood, and one for us, Stephen, on the margins here, I think you called it out, one time or maybe two weeks of extra pay. What was the impact, and is that expected to continue in the second half? I think you mentioned a billion dollars of testing in back half, and I think the comment you used was it’s de-risked, so I’m curious, do you have any tenders for orders that gives visibility into those numbers?
Stephen, why don’t you do the margin, and I’ll talk about the testing.
Yes, when we think about the mix of change in our guidance, it brought down the margin profile for the full year down to about 29.7%, which is down about 15 basis points from what I’d assumed in my prior guide. That’s kind of taken into consideration the different mix of contribution margins in the revenue changes.
Yes, and in terms of the response revenue and on the testing side of the equation, we took this strategy around de-risking the outlook. We had a strong quarter, actually, at $1.4 billion of testing, felt reasonably good about that, and we actually have a number of orders for the second half. We felt that given how much dialog there is around testing just generally and so much noise, we just felt that taking that off the table felt like the right thing to do, and we’re well positioned, as you know, given our relationships and capacity. If things like the delta variant continue to drive more demand for testing, then obviously we’re going to be higher than the number we assumed in the guidance.
Your next question comes from the line of Doug Schenkel with Cowen.
Hey guys, can you hear me?
Perfectly.
Okay, sorry about that. I had some technical difficulties.
I guess a question as we think about 2022, and I know you’re not going to guide on this call and I’m going to apologize for--
Don’t apologize.
But I mean, at some level, to maybe just cut to the chase, is it reasonable to take the three-year revenue and EPS targets from your 2019 analyst day at the mid to high end, layer in some lingering COVID-19 relief revenue at the top and bottom line, and then add in whatever we’re going to model for PPD and basically take those three components and add them up and use that as kind of a construct for thinking about 2022? Is there any reason to not just boil it down to that construct at this point?
Doug, I’m going to give you terrific news, which is we’re going to hold an analyst day on September 17 and we’re going to give some early thoughts about 2022 to help with some of the ways to think about modeling, and not what I would call official guidance for the year but at least some scenarios to help that, and then give the three-year outlook going forward. We thought an analyst day would be the best way, because we think it’s a great question.
What I would say, as you think about between now and whatever it is, seven weeks now, as for 2022, the performance of the base business is super cool - you know, 12% organic growth. We’re going to be entering the year with a very strong order book with very strong momentum, and more and more of those investments that we’ve made and are making positions us for great momentum in 2022.
We’re going to play a meaningful role in what our customers need on their response, right? 2022 seems like a long way off, but I’d say obviously vaccines and therapies are going to be super relevant and there will be testing, the question is at what level. We’ll try to do some scenarios to help with that, but nobody knows what the demand is going to be for testing next year, so there will be range of outcomes around that, but I’m excited.
PPD, obviously you’d add whatever assumptions for next year to the numbers from a capital deployment perspective, so 2022 is going to be another great year for the company.
Okay, all right. Thanks for that, Marc. Then I guess as my follow-up, maybe I’ll just throw the two quick ones out there.
The first is as you know as well as anybody, there is a ton of labs globally that built out new infrastructure for COVID-19 testing using Thermo products. What are you seeing at these sites now? Testing volumes, they’re slowing but still robust. What I’m curious about is as we move towards the fall, are you seeing these labs move more into four-in-one testing, and then I guess beyond that, is there any move toward broader infectious disease testing at these sites, because I think that would help us as we think about the durability of what’s occurred in that category.
Then the other one I just want to sneak in for Stephen, COVID-19 revenue has clearly been a boon to operating margins. That said, underlying margin seems to be tracking quite nicely. Maybe I should be able to do this math real quick, but I haven’t. I’m just wondering, if you take COVID-19 revenue contributions out of your 2021 targets, where do you believe 2021 operating margin would come out? Thank you.
Those would be good two or three-hour long conversations, but I’ll take a shot at it, and Stephen, certainly feel free to add.
When I think about the COVID testing demand and what are we seeing, what I would say is we obviously have built--we have and had built during the pandemic a huge installed base around the world. For us, the activities we do across all of the countries is the huge driver of our activity, so a lot of what we read about is what’s going in the U.S., and the U.S. testing demand is definitely less at this moment, although obviously cases are starting to increase, but there’s quite a bit of demand around the world and certain customers are preparing for a respiratory panel for the winter season, and obviously we’ll have that. We’re going to support our customers at whatever level of demand that they need.
In terms of margins, I’ll make it sort of what’s the philosophy, and then Stephen, if you want to add, feel free. We’re not thinking about it base business versus COVID, we’re thinking about how do we manage the company appropriately in terms of the profitability of the company and the investment rate for the going forward. I think one of the things that if you kind of do very simple math, and I’ll do it from an EPS perspective, we raised our--based on the very strong outlook for the year and the very strong first half, we raised our EPS by $0.10 in the guidance. We chose to invest another $0.25 in our colleagues, right - the $100 million in the Q2 additional payment is an investment in the future, right, so we made a conscious decision. Obviously margins are very strong and we’ll manage that appropriately. It really highlights the power of our PPI business system.
Yes, we’re really just focused on that. When you maximize the top line opportunity, invest appropriately for the future, it pays--we’re getting great--we’ll get the right returns off that investment, and then the flow through then comes, so it’s less that we’re trying to manage to a margin expansion number than appropriately manage the P&L and invest appropriately for the future.
Thanks Doug.
The next question comes from the line of Jack Meehan with Nephron Research
Thank you, good morning. Marc, was hoping you could give us your latest thinking on capital allocation within the--you know, if I go back to the 2019 analyst day, you talked about $29 billion of deployment through 2022, though I think there’s a view in the market that it could be a lot higher than that because of the COVID response sales, so my question is what’s your latest view on ability to close deals as the multiples seem to be moving higher, and if not, why not do more buybacks? You’ve only done $3.5 billion since the beginning of 2020.
Jack, thanks for the question. In terms of capital deployment, first of all, it’s been an active year between--and I’ll give you an update on PPD in a minute, but it’s been an active year. We obviously announced PPD, we’ve done a number of smaller bolt-on transactions, so we’ve been active. Our pipeline is quite busy. We’re looking at things, we’re disciplined, and because our industry is so large and fragmented, we’re seeing opportunities to continue to build on our M&A strategy and execute against that, so from that perspective things are good.
From a return of capital perspective, we felt the $2 billion that we did in terms of buybacks and increasing the dividend felt like the right return, given the M&A commitments we’ve made to PPD, and we certainly revisit our return of capital mix with our board periodically and we’ll continue to do so. But right now, we continue to have M&A as the primary focus.
PPD, I’ll spend a moment there because it’s a large commitment of capital. I’ve been super impressed with the team. I’ve gotten to meet a number of the team because of the integration planning. It’s going very smoothly, the colleagues are very excited to become part of the company. As you see from some of the other companies in the CRL field that are reporting, the end markets are super good, the industry is doing well. PPD as a leader is very well positioned, so this is going to be a really good growth asset.
From the pathway to closure of the transaction, we’ve gotten most of the direct investment, the foreign investment approvals done, still got a little bit left to do there but that’s pretty much done. We’re working our way through the various anti-trust filings around the world, we’re collaborating with the FDC on second request, and we’re looking forward to closing the transaction by the end of the year, so that’s a quick recap on capital deployment.
Yes, and Jack, one thing to add. When I think back to 2019, the outlook around that use of cash and ROI, we put significantly higher investments in capex. We’ve identified some great opportunities to invest organically, and we’re putting cash to work and getting great returns in really a short period of time as well, so that’s another element as I think about how the company’s evolved over that period of time.
Yes, definitely hear you on that. Just as a follow-up either for Marc or for Stephen, there’s been a lot of discussion around inflation across the market, so I was curious to get your view, just ability to toggle pricing as a lever in the channel, how that is going, and then any thoughts around the supply chain, have you had any issues?
Yes, I think when you look at the world, it’s unwinding from the recessionary impacts of the pandemic, and as a result you’ve got kinks in supply chain and clearly inflationary pressures in multiple different places. How large that impact is and how long it lasts for is still to be proven out. We’re operating on the basis that it will be with us for some time. Our PPI business system enables us to effectively navigate events like this and run our operations efficiently, use our scale to partner with suppliers, and then maximize opportunities, as you mentioned, around pricing for certain products to help protect our margins. That’s not just [indiscernible] really across the portfolio, that’s kind of the scale benefit of using our pricing discipline across the company, and we’ve navigated through this dynamic really well through the first half of the year, and I expect us to continue to do so going forward.
Your next question comes from the line of Tycho Peterson with JP Morgan.
Hey, good morning. Marc, I’m wondering if you can talk a little bit more about the recovery in analytical instruments. I know you said it was widespread, but you did call out electron microscopy a couple times, so could you maybe just talk to that dynamic, how much of that do you think is pent-up demand how much of that is tied to the semi-cycle? Just curious for some more color there.
Tycho, good morning, thanks for the questions. Yes, our analytical instruments business performed extremely well, grew over 35% in the quarter, and all three businesses really performed very well - chemical analysis, chrom and mass spec, and materials and structural analysis [indiscernible]. When I think about the dynamics here, our new products, they’re very exciting, I mentioned a few of them this quarter as I did last, so the investments we’ve been making in R&D there are really paying off, and the end markets are good. You see that in electron microscopy, both in the adoption of the tools for life sciences applications, so the cryo electron microscopy, but you also see that across the material science applications, including semiconductor, and obviously from everything you read around what’s going on in chip supply and investments there, that bodes well for the electron microscopy business for sure.
Okay, thanks. Then for the follow-up, I’ve actually got two quick ones. On COVID, I think you made a prudent move to take testing down. Just curious your latest thoughts on the durability on the vaccine and therapy side, what you’re hearing from customers, obviously a lot of focus on boosters now. Then on margins, I know a lot of people are focused on 2022 operating margins. You did take up R&D by 20% last year, so maybe another way to ask the question is, how much of the opex do you think will carry through, or do you think you’ll reset R&D a little bit to drive more leverage? Thanks.
Tycho, let me cover the margin question. I think the elevated investments are getting great returns, so we’re going to manage the company appropriately, spend appropriately, and have fueled really strong base business organic growth going forward. Should those returns not be in the right places, we’re going to obviously appropriately manage spend, and then as the pandemic response unwinds, we will appropriately deal with the variable costs that go with that and manage the P&L appropriately. We look forward to giving more details when we’re in a better position to do that around 2022.
Tycho, in terms of the role that we’re playing in supporting the vaccines and therapies for COVID, it’s quite significant, right, and it cuts across both our pharma services capabilities for the active ingredients [indiscernible] as well as in the sterile fill/finish activities for the vaccines. We play obviously a very substantial role as the technology provider in our bio sciences business with things like enzymes, nucleotides, as well as in our single use technologies and cell culture media, so a very large role. We expect that to be about $1.8 billion this year.
Demand is very robust, right, so for the industry it’s mostly about capacity coming online to support the demand, so we look at our momentum going into 2022, we would expect that the vaccine and therapy demand to be very strong given the likely demand for the response to the pandemic, and as our capacity comes more and more online, that positions us very well to meet the strong backlog of orders that we’ve been able to generate because we have the right solutions for our customers.
Your next question comes from the line of Dan Arias with Stifel.
Good morning guys, thanks for the question. Marc, on the new plasmid production site out in Carlsbad, I think you just opened up there, so when do you expect to be fully scaled up and going? Is there anything you can say about the extent to which capacity has already been booked there, just given that it sounds like that’s a pretty supply constrained area? Then I think you’re supporting mRNA vaccine work out there and I’m just curious whether you’re starting to talk to customers about projects maybe down the road with them on mRNA vaccines that are not related to COVID. Just thinking one of the open questions here is where are we headed with mRNA now that we have some proof of concept.
Dan, great question. A few different things that are going on. Let’s do the mRNA more broadly first.
There has been a huge increase in investments in the biotech and pharmaceutical industry given the success that mRNA has had on the COVID vaccine, so that investment is both in next generation vaccines, combination vaccines, as well as just in the class of other diseases altogether. And yes, we’re in numerous dialogs in supporting those activities across our capabilities, so that’s a wonderful tailwind for our largest segment of pharma and biotech in terms of customers, so that looks very strong.
One of the things that we have seen is that in plasmid DNA, there has been a shortage of capacity for some period of time, and we’ve been addressing that by making significant organic investments. We have been able to secure meaningful orders for our new facility in Carlsbad. I had the opportunity to visit the facility in June - it’s awesome and super exciting. It’s open - and we just did the ribbon cutting in early July, and we’ll be producing product in the not distant future there and building momentum on that, and that’s great. The customer base wanted choice and we’re giving them choice, and we’re excited about that.
Okay, appreciate that. Maybe just Stephen, just thinking about some of the other parts of bio production, on Novasep, I think the outlook last time was for $150 million in contributions from Novasep. Is that still the current outlook, because I felt like that was conservative last quarter just given that you had done almost half that, if not a little bit more than half that in Q1 alone, so just wanted to check.
Yes, we secured some additional orders on the COVID response and it’s slightly higher - it’s about another $30 million to $40 million for the year, and that’s included in that increasing guide for the response revenue.
Your next question comes from the line of Derik de Bruin with Bank of America.
Hi, good morning. A couple questions. I guess on the first one, can you talk a little bit about the China market - obviously it wasn’t going to be as strong in the second quarter as it was in the first quarter, the growth, just given that China started to recover in the second quarter, but it was a little bit lower than I would have thought. Can you talk about the dynamics in the Chinese market?
Yes, China is performing very well. When I think about the growth in the quarter of just under 30%, we’ve got 40% growth in the first half. I spent time with the team, activities have returned to pretty much normal. The [indiscernible] five-year plan is being implemented and that has tailwinds for our industry, and Thermo Fisher is well positioned to capitalize also, so I think about China in terms of our outlook and it’s off to a good start through the first half of the year.
Got it. I’m going to squeeze two in. I guess the first one is, can you talk a little bit about academic and government and what you’re seeing in that market? That 35% growth, is any of that, do you think, tied to new funding that’s coming up, is there a pick-up or is that just catch-up spending? Then another question I keep getting from people is I still think there’s some concern over the impact of PPD on the margin, given it’s more of a people business than a razor and blade business. Just your general thoughts on the margin opportunity in PPD, thanks.
Yes, so Derik, academic and government had a very good quarter, 35% growth, that’s exciting. As you think about academic and government, obviously it was one of those segments of the four end markets we serve that was very affected last year in 2020 because of the pandemic, and in the second quarter, that’s really the place you saw it the most. What you’re seeing now is largely activity has returned back to normal around the world - I mean, it might be different, but actually the activity level is pretty normal, and what I’m encouraged about is two things . One is widespread in terms of the performance across our businesses - you know, bio sciences, research and safety market channel that talks about activity is very high, and electron microscopy really excellent funding, so it talks about sort of the big capital funding there also was strong.
Then when you look going forward, that really does look good because there’s so much positive talk around the world about the funding.
Then on PPD, Derik, the margin profile of that whole industry is significantly lower than the company average, and knowing that eyes wide open going into this, the investment thesis in this asset is that margin expansion--we’ll get some margin expansion from cost synergies, but it will be lower than the company average expansion year-over-year but be higher than average growth business. When you think about the growth in operating income dollars, it will be very equivalent to the rest of the company, so it’s just a slightly different P&L profile that we’re bringing into the company and you need to factor that is as you’re thinking about modeling the company going forward. It’s a scale business coming in at lower than the average margins, but that doesn’t change the margin profile or the margin opportunity for the rest of the company and doesn’t change the great outlook that we think PPD has, and we’re excited about bringing it into the company.
Your next question comes from the line of Patrick Donnelly with Citi.
Great, thanks for taking the questions, guys. Marc, maybe one on the specialty diagnostics business - you know, it came in a bit lower than we expected. Obviously a big chunk of that is the COVID testing piece, but can you just talk about the core business trends there, what the recovery path looks like in the back half?
Yes Patrick, thanks for the question. When I look at the specialty diagnostics business, actually underlying what’s going on in the business actually is quite encouraging. Activity levels are pretty much back to the pre-pandemic levels. You see it in really strong growth in our immunodiagnostics business, allergy and autoimmunity. You see it in our transplant diagnostic business. [Indiscernible] businesses were highly disrupted a year ago when procedures were put on hold, but you also saw good growth in microbiology, you saw it as well in our healthcare market channel, so it’s encouraging.
In terms of the--you know, you do see some of the COVID response revenue there as well, and that will have a more challenging comparison in the second half, but I feel good about the underlying outlook within specialty diagnostics.
Operator, we have time for one more question.
I think Patrick just--[indiscernible].
Yes, sorry, just a quick one on PPD. I know, Marc, you mentioned second response from the FTC. Just a quick update there in terms of any surprises from what the discussion has been and the confidence level there in getting that done. Thank you.
No, no surprises there. We’re just working through the process and we’ll work collaboratively and look forward to bringing it to a close at the end of the year.
Operator, we’ll take one more question.
Your last question will come from the line of Puneet Souda with Leerink.
Yes, hi Marc, Stephen. Thanks for taking the question. Just a quick clarification for Marc--actually, for Stephen. On the COVID related, a number of points have been covered, but just in terms of the Mesa acquisition, I know you had highlighted a contribution there, maybe closer to $200 million or so. Does that still remain, or was that removed in part of the de-risking that you mentioned?
Then Marc, just broadly speaking, you mentioned a number of times Orbitrap platform continues to grow. This has been a decade-plus growth opportunity for the company. Could you, maybe just on a very high level, give us a view on where that stands today and where do you expect that to go over the next few years, and if just given the high growth areas of bio pharma and [indiscernible] where its levered to, so I’d appreciate some thoughts there. Thanks so much.
Thanks Puneet. In terms of Mesa, we’re scaling up the manufacturing capacity, we’re working for the longer term as well for building out the menu. It’s a really exquisite technology, so we’re very excited about it, and the revenue assumptions remain the same as where they were last quarter, so from that perspective, very positive.
When I look at the Orbitrap, what a phenomenal technology. It continues to drive very good growth for our analytical instruments business, super relevant for our customers, and we’re able to continually push the technology forward to bring out more and more relevant solutions. The most recent launch really is focused on complex small molecule analysis, but you’re also planning on the technology being used in the multi-attribute method for biologics in terms of QAQC, which is a very large market opportunity and we’re well positioned there, so I feel great about the performance of our chrom mass spec business and even more excited about what the future holds there as well.
Puneet, thank you for the questions, and I’ll turn to just wrapping it up here.
We really had an excellent first half of the year. We’re on track to deliver another outstanding year and we’re going to enter 2022 with great momentum that sets us up for a very bright future, and we’re looking forward to sharing more about our future during our virtual analyst day on September 17, and of course then updating you in October on our Q3 call.
As always, thank you for your ongoing support of Thermo Fisher Scientific. Thanks everyone.