賽默飛世爾科技 (TMO) 2004 Q2 法說會逐字稿

Good morning and welcome to the Thermo Electron Corporation 2004 second-quarter earnings conference call.

At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following today's presentation.

If you dialed into the conference and disconnect, you may dial back in to reconnect.

I would like to introduce our moderator for the call, Mr. Tim Corcoran, Vice President of Investor Relations and Communications.

Mr. Corcoran, you may begin.

Thank you.

Thank you for joining us today.

With me on this call is Marijn Dekkers, our President and Chief Executive Officer, and Theo Melas-Kyriazi, our Chief Financial Officer.

Please be aware that this call is being webcast live and will be archived on our website, www.Thermo.com, until August 27, 2004.

To reach the replay of the call on our website click on About Thermo, then on Investors.

Please also be aware that a copy of this press release setting forth our second-quarter 2004 earnings and future expectations is available in the investors section of our website under the heading Press Releases.

I would like to begin the call by reading the 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 provision 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 our Form 10-Q for the quarter ended April 30, 2004, under the caption Forward-looking Statements, which is on file with the Securities and Exchange Commission and available in the investors section of our website under the heading SEC Filings.

While we may elect to update forward-looking statements at some point in future, we specifically disclaim any obligation to do so; and even if our estimates change; and therefore you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

During this call, we're going to be referring to certain financial measures not prepared in accordance with Generally Accepted Accounting Principles or GAAP.

The reconciliation of non-GAAP financial measures used on this call to the most directly comparable GAAP measures is available in the press release setting forth our second-quarter 2004 earnings, in Future Expectations, and in the tables accompanying such release in the investors section of our website, www.Thermo.com., under the heading Press Releases.

Related information is also available in the investors section of our website under the heading Financial Reports.

Now I would like to turn the call over to Marijn.

Thank you, Tim.

Good morning, everyone.

I will make some general comments, and then Theo will give you more specifics on our financial results.

Thanks for taking the time to join us today.

I am very pleased to report that we had a solid quarter in which we delivered at the top of our EPS guidance range and made again a lot of progress in positioning Thermo as a true industry leader.

So, let me go right to the results.

As you can see in our press release, we had a number of highlights this second quarter.

Please note that all these results exclude Spectra-Physics, because we reclassified Spectra-Physics as a discontinued operation in Q2.

Our reported revenues were up 12 percent to $525 million.

Our organic revenues were up 3 percent; and our definition of organic revenues is FX adjusted and we eliminate acquisitions.

Adjusted operating income increased 16 percent.

Adjusted EPS increased 7 percent to 29 cents.

And our mass spectrometry business continues to do phenomenally well.

We closed our acquisition of USCS, which is now part of Thermo's laboratory services business, and then after the quarter ended we closed on our divestiture of Spectra-Physics.

So, all in all, we believe it was another good quarter.

This is now the second consecutive quarter that we had organic growth.

In the first quarter, when you take out Spectra-Physics, we had 4 percent organic growth, and we reported 3 percent this quarter.

Based on the strength of our orders and backlog we believe that number will go up in the third quarter.

Theo will give you more detail on this.

No doubt that the improved economy is helping us to drive organic growth.

But also our own growth initiatives are clearly paying off in new products, in better leveraging our huge sales presence in this industry, and in our focus on increasing services.

Now with Optical Technologies no longer part of the Company, let me just talk a little bit about the two segments.

We have now only two segments in the Company, Life and Laboratory Sciences which is 70 percent of revenue, and Measurement and Control which is 30 percent of revenue.

Both of them are core to the Company.

First, we view Life and Laboratory Sciences as the segment where we concentrate all our activities for the laboratory, particularly for life sciences laboratories.

Every day, we're getting stronger in that marketplace.

The one Thermo brand is getting more and more recognition every day, and we are very successful, as I mentioned, with our new products, and we are providing more and better services and total integrated solutions to our customers.

We view our Measurement and Control segment as the segment where we concentrate all our activities outside of the laboratory.

This is particularly true for analytical instrumentation, for manufacturing process analytics, and for environmental applications such as real-time air monitoring and water quality monitoring.

Now, I believe that Thermo in this industry has a unique capability to leverage the strength of these two different segments and our knowledge of the somewhat different end users for the two segments.

This unique combination is allowing us to come up with new innovative instrument solutions.

Particularly, many of our customers who are today analyzing things in the laboratory would love to be able to do that outside of the laboratory.

This will benefit the Measurements and Control segment over time.

Let me just give you two examples of that.

One example is homeland security where there is a huge need for novel in-the-field measurements of things like explosives, poisonous gases, radiation, etc.

Another example is taking our capabilities outside of the laboratory within pharmaceutical manufacturing.

Our customers would prefer to do much more QA/QC analysis, real-time within the manufacturing process, rather than later in the laboratory.

In fact the pharmaceutical industry has even started a brand-new initiative called PAT, P-A-T, process analytical technology, to address this manufacturing need.

Pharmaceutical manufacturers are looking for new process analytical instrumentation, which Thermo can provide.

So, in summary, Thermo's mission as a company is to provide instrument solutions to our customers that enable them to make the world a healthier, a cleaner, and a safer place.

We at Thermo are spending all our energy and resources accomplishing this goal.

So, that gives you an idea of the two segments and how we view the two segments as core parts of the Company, let me now give you some comments on guidance before I hand it over to Theo.

Summary of the EPS guidance, for the third quarter, we expect to continue our progress and report adjusted EPS of 28 to 30 cents.

For the full year, we are reiterating our guidance of $1.20 to $1.25.

As a reminder, in early June, when we announced the sale of Spectra-Physics and adjusted our full-year guidance to exclude Spectra-Physics, we also raised our guidance on the remaining core business by 4 cents to this $1.20 to $1.25 range.

So, I will now turn the call over to Theo to give you were details on the financials.

Theo.

Thank you, Marijn.

Good morning.

We are very pleased to continue the earnings growth and cash flow momentum that we began in Q1.

As I go through the financial results, and Marijn pointed this out, please keep in mind that all of the numbers are restated to exclude Spectra-Physics.

On Monday, we filed a form 8-K with the SEC that provides a detailed quarterly P&L reconciliation for 2003 and the first quarter of this year between the financials as we originally had reported them and the restated numbers that eliminate Spectra-Physics.

That of course is available online to all of you, to go and take a look at the quarterly -- again, last year's quarterly details of the restated numbers.

Now, before I talk about the details of earnings and revenues, I just want to again point out, as Marijn did, that adjusted EBITDA is up 16 percent versus the year-ago quarter, while adjusted EPS is up 7 percent.

That is due to unfavorable comparisons below the EBITDA line, mostly two items, the tax rate and the share count.

I will give you a little bit more color on this in a few minutes.

Now, in terms of earnings, adjusted EPS up 7 percent to 29 from the restated 27 cents last year.

Last year the GAAP earnings were 54 cents, and as always we have a detailed reconciliation in the earnings release between the GAAP and the adjusted numbers.

I want to point out here that in the second quarter our numbers include a 23 cents per share tax benefit in discontinued operations from Spectra-Physics, and I'm just going to spend 2 seconds explaining what it is.

Basically, the accounting rules require Thermo to recognize gains that relate to the difference between the tax basis and the book basis of any entity that we put into discontinued operations.

So in the second quarter, as we put Spectra-Physics into disco, we took in our P&L $38.5 million of gains as a realization of Spectra-Physics tax assets.

And as we again noted in the earnings release, we expect to recognize an additional gain of about 20 cents in the third quarter relating to the Spectra-Physics divestiture.

Now, let me turn to revenues.

Revenues were up 12 percent to $525 million.

Organically, revenues were up 3 percent with positive growth in both segments.

This organic growth was slightly less robust than the Q1 growth.

However, we continue to see strength in many of our end markets and geographies, and we expect organic revenue growth in Q3 to be stronger than in Q2.

In part this reflects the solid bookings that we had in the past quarter.

Now, as we communicated to you on calls over the last several quarters, we have really increased our intensity and focus on driving top-line growth; and we're making additional investments in sales and marketing to sharpen our commercial execution.

Examples of this are key account management, our new labs initiative, the focus on service, the demo centers that we have built all over the world, and the large investment that we've made in the Thermo brand.

And we absolutely have seen the impact of these initiatives on our revenues.

Now, in Life and Lab Sciences, revenues grew 18 percent and organically 2 percent.

Our mass spec business continues to generate excellent growth in both revenues and bookings across all our life science mass spec platforms, and that includes ion traps, triple quads, and hybrids.

We also saw solid organic growth in our anatomical pathology business and in our lab automation business.

In the Life and Lab Sciences business, organic growth in bookings in the quarter outpaced revenues, and as a result we expect Life and Lab Sciences organic revenue growth to be more robust in the third quarter than what we reported in the second quarter.

In M&C we have 3 percent revenue both organically and on a reported basis; and you see here a little bit of acceleration.

We exceeded the Q1 organic growth of 1 percent, and we saw some strength in our Process Instruments business that serves the steel, cement, coal, and semiconductor market, offset by some weakness in our radiation measurement and protection business, primarily due to some timing issues.

Here again, as in Life and Lab Sciences, we expect organic revenue growth to accelerate in the third quarter.

In terms of bookings, we continued the strong trend that we started in Q1.

Total bookings were up 18 percent.

Organic bookings growth was 6 percent with roughly similar performance in the two segments.

Our book-to-bill was 1-0-1 with both segments above 1.

In terms of geography, the trends really haven't changed very much.

Asia remains the strongest geography at Thermo, with strong growth in China and Taiwan and Hong Kong and Singapore -- really pretty much across the board.

Europe was quite weak.

We had told you in the last couple of quarters that Europe was lagging the U.S. recovery, and we really did not see any pickup of activity in Europe in the second quarter.

North America remains fairly strong especially in Life and Lab Sciences.

Let me just turn now to the P&L quickly.

Gross margins were down both sequentially and compared with the year-ago quarter.

The largest contributor to the decline in gross margin was the impact of recent acquisitions.

On top of that, we had a mix shift in the quarter to lower gross margin businesses.

That also had an impact.

I want to point out that we continued to see good results from our productivity initiatives, and we expect gross margins to expand sequentially in the third quarter.

SG&A was down, down 50 basis points from the year-ago quarter.

The decline in SG&A is really driven by the same mix shift that we talked about that unfavorably affects gross margins and favorably affects SG&A.

On top of that, we have lower trade show spending than in Q1.

Q1 is typically the quarter where we have the highest trade show spending, so that contributed to the sequential decline.

We're seeing some good results from our acquisition efforts, and that also is a contributor to the SG&A trend.

In terms of R&D, 6.2 percent of revenues, down from 7 percent in the year-ago quarter and 6.5 percent in the first quarter.

If you think of R&D in dollar terms, which is obviously how we manage it, R&D is flat with last year.

The percentage decline as a percentage of revenues is driven by a number of things -- our integration efforts, the inclusion in our results of USCS, which of course conducts no R&D.

We're focusing on leveraging our R&D spending.

I think you have heard this over the last year or two; and we want to ensure that we maintain a steady stream of new instruments and solutions for our customers.

Now without Spectra-Physics, we expect R&D to range from 6 to 6.5 percent of sales on a going-forward basis rather than the 7 percent that we had previously communicated to you.

Adjusted operating income was up 16 percent year-over-year to almost $66 million, and the margin was up 40 basis points from last year and 60 basis points sequentially.

In life and life lab sciences the margin declined 20 basis points to 15.6 percent.

But as we pointed out in the earnings release, the recent acquisitions of LMSi, Jouan, and USCS had a 60 basis points negative impact on our margins.

So that on an apples-to-apples basis the operating margins would have been up 40 basis points without these acquisitions.

I want to point out that in terms of the acquisition USCS is off to a good start as part of Thermo, and that Jouan's integration is continuing to proceed well.

We are seeing the benefits of these integration efforts, and we expect Jouan's margins to increase steadily each quarter as it is fully integrated into Thermo.

In the Measurement and Control segment, the adjusted operating margin was up to 9.3 percent from 9.2 percent in the year-ago quarter.

Here we have volume leverage almost totally offset by a mix shift to lower gross margin revenues.

This is a business, and we have talked again about this, that lags economic recoveries on the way up and also lags on the way down.

The revenue growth that we have seen in Q1 and Q2 in M&C has been largely from OEM customers, where the gross margin and EBITDA margin tend to be somewhat lower than in the rest of our businesses.

Here again, we are encouraged by some positive trends in the business, and we expect that you will see better margin in the second half of the year.

Restructuring costs, continue the trend to be significantly below the level of last year.

In the quarter we had $1.2 million of net restructuring costs, mostly the tail cost of actions that we undertook last year; and offset by a gain on the sale of a small business.

Let me spend 1 minute addressing what happened below the operating income line.

There, two items, the tax rate and the share count, cost us 2 cents in adjusted EPS versus last year.

Our tax rate was significantly higher than in the year-ago quarter, 29 percent versus 25.6 percent.

This is mostly as a result of an adjustment in the year-ago quarter to a lower projected rates for all of 2003.

In terms of average diluted shares, the average diluted shares if you look in our earnings release look like they declined by 2 million shares to 170.5 million shares, but this was really the result of the redemption of convertible debentures last year.

So if you exclude these convertibles, diluted shares were up reflecting stock option exercise activity and including the interest add back from the convertibles.

So if you look at the full impact of the diluted shares, the cost of the higher share count was almost 1 cent of EPS this quarter.

We did some buyback activity.

We were basically blacked out during most of the quarter due to the Spectra-Physics divestiture, and we started buying shares in June and ended up buying 2 million shares near the end of the quarter, all after the Spectra-Physics announcement.

Because the repurchases were done late in the quarter, these repurchases only had a very minor impact on average shares outstanding for the quarter.

But obviously we will see the full impact of this in the third quarter.

Cash flow and balance sheet very quickly.

We generated $56 million of GAAP cash flows from continuing operations in the second quarter.

If you subtract capital expenditures, free cash flow from continuing operations was $45 million.

That includes $5 million that we spent on restructuring activities in the quarter.

For the 6 months, our free cash flow from continuing operations was $76 million, up 60 percent from last year.

In addition to that, discontinued operations added another $10 million in year-to-date cash flows, a lot of that obviously from Spectra-Physics.

Our balance sheet has changed somewhat due to the restatement, and I want to point out here that both the restated December balance sheet that we filed and the June balance sheet reflect Spectra-Physics as a discontinued operation.

That means that the receivables inventories, fixed assets, current liabilities of Spectra-Physics have all been reclassified into current and long-term assets and liabilities of discontinued operations.

Now, the restatement did not affect cash, and we ended the quarter with $372 million of cash and investments, down sequentially from 444 due to the acquisition of USCS and repurchases offset by our solid free cash flow.

We ended the quarter with net cash of $112 million.

Of course neither the cash nor the net cash includes the proceeds from Spectra-Physics that we received in mid July.

Not a lot of change in terms of working capital.

Receivables 71 days, down 1 day sequentially, and up 1 day from the year-ago quarter.

Our inventory turns improved 3.5 times versus 3.3 times in the year-ago quarter.

Let me just finish with guidance.

For the first half of 2004, our adjusted EPS is 46 cents; and that is 29 cents that we reported in the quarter that just ended plus 27 cents restated for the first quarter.

We're guiding to 28 to 30 cents for the third quarter, up from 26 in the year-ago period.

The midpoint of this guidance, the 29 cents, is flat versus Q2.

That may not sound very strong, but we need to point out that historically the third quarter is a slow seasonal quarter for Thermo, especially in Europe, so that our Q3 guidance reflects strength in what would normally be a sequentially down quarter.

For the year, we're not changing our guidance of $1.20 to $1.25.

We're basically pleased with the second quarter.

We see some strong positive signs, especially in the bookings; and we're entering the second half of the year with good backlog and some clear optimism that we can deliver some strong financial performance to close out the year on a the strong note.

With that, I would like to it open up to Q&A, please.

(OPERATOR INSTRUCTIONS) Larry Neibor, Baird.

Could you please walk us through why, if your markets are improving, you showed decreased organic sales growth in your Life and Laboratory Science business in the second quarter versus the first quarter?

We had 5 percent organic growth in the first quarter and 2 percent organic growth in the second quarter.

We said in the statement, strong performance mass spectrometry, anatomical pathology, laboratory automation clearly doing better year-over-year.

It is hard to -- it is always easier to talk about sequentially than year-over-year quite honestly.

But if you want to look at it year-over-year, we saw a significant decrease in our point-of-care diagnostics business, which really cost us at a minimum a percent of organic growth.

Because infectious diseases, respiratory diseases were very commonplace in the second quarter of last year and completely absent this year.

So that is one factor in terms of year-over-year performance that grows some negativity organically.

I think the other comment that Theo made was, in Europe, we saw some lack of robustness if I could say it this way.

We had expected by now to see the European economy following the recovery of the U.S. and Asia.

That doesn't seem to be happening yet.

So, there is a weakness there in terms of organic contribution in Europe that we're a little puzzled by.

But again from an order backlog point of view, it doesn't seem to be a concern for the rest of the year.

But quarter-over-quarter comparison, that was disappointing.

Our bookings growth, I want to point out, was nicely better than the 2 percent revenue growth that we reported.

So when we look at the strength of the business on a real-time basis, bookings obviously are an important indication.

What were the bookings growth?

6 percent, the organic bookings growth was 6 percent for the whole Company and very similar in both segments.

Thank you.

Darryl Pardi, Merrill Lynch.

Can you guys discuss the growth rates within Life and Lab Sciences by end market?

Academic, government, pharma, biotech, industrial.

I guess if you could just give us a little view into clinical.

Sorry, (multiple speakers) growth in revenues during the quarter.

We don't break it down that way.

Could you just give us some color?

I can give you some qualitative comments.

I think that pharmaceutical and biotech, the comments are the same.

Pharmaceutical and biotech is still really good.

Now a lot of that obviously is being driven by our mass spectrometry business, which is all Pharma and biotech.

We saw clinical end markets being weak, and that has a lot to do with our point-of-care testing that just happened to have a dry spell in terms of infectious diseases.

On the other hand, on the clinical side, automation is doing very well and anatomical pathology is doing very well.

I would say government and university laboratory is also stronger than you would expect based on NIH funding.

We think that we get -- we're in a good position with the mass spectrometry business from an NIH funding point of view, because it seems that a lot of NIH funds are funneled towards proteomics.

So we probably get our own fair share of the NIH funding at this particular moment in time for mass spectrometry.

So, I would say that overall the trends are very similar.

Industrial is clearly recovering year-over-year.

Pharma and biotech continue their strength.

It is really, as I have said before, Europe with some signs of lack of recovery, and the point-of-care business that was extremely weak, that held us back in the second quarter in Life and Lab Sciences.

As a follow-up, from an order perspective, what are you seeing in each of those markets you just discussed that would lead you to be more positive about the third quarter?

The most important part is that the number is higher.

It is 6 percent rather than 2 percent.

But where is that increase coming from?

Is it broad-based?

It's broad-based.

It's a similar description as what I gave you qualitatively about the performance in the second quarter.

Great.

I will get back into queue.

Franz Tudor, Variant Research.

I'm sorry if you went over this and I missed on the call.

On the gross margins, what should we be expecting going forward?

A second question, looking out to the fourth quarter, I know it is seasonally your strongest quarter; but if I just sort of choose the midpoint of your range for Q3, you would need to do 38 cents to hit the $1.25.

I was just trying to figure out what needs to go right or what could go wrong to prevent that from happening?

Thank you.

Let me just address the gross margin.

We are not giving specific guidance in terms of gross margin.

But very clearly both things that affected the third quarter, both the acquisition and the mix, will be significantly better in the third quarter.

So that we expect our gross margins to increase sequentially from Q2 to Q3.

In terms of the EPS for Q4, you're right that if you look at the midpoint, the 29, then you translate this to 38, that is about a 30 percent increase sequentially.

That is roughly what we did last year.

There doesn't need to be anything really different happening for us to do that.

We're not counting on a huge rebound or a huge acceleration of the markets that we address.

Thank you.

Jim Cerotis (ph), Olean (ph).

Can you talk about, at the beginning of the year you had mentioned you were going to favor acquisitions in lieu of buyback at that particular time.

I guess on this call you just mentioned you bought back some shares at the end of June; and you just put out a note regarding an authorization of more buybacks.

Can you talk about that a little bit?

What does that imply, about the acquisition environment?

Really, the fact that we spent most of the last authorization and got a new authorization from the Board last week hasn't really changed our philosophy.

I just want to repeat this.

We have huge cash resources that are available to grow Thermo, and our primary goal and our clear focus is to continue to make acquisitions to strengthen our Company.

We have an active pipeline, and that is unchanged.

What we have had in the last year is some dilution from option activity, and these are essentially negative buybacks.

So part of the buyback philosophy is to buy back shares, not to let the share count creep up.

In fact as you see from the description and from my notes, in fact average shares are up Q2 over Q2.

Some of the buybacks that we will do in the second half of the year will take the average shares down to a level that was more comparable to 2003.

So, in terms of the acquisition environment though, is there any metric that you can describe in terms of pricing and what you are seeing in terms of properties for sale?

I think it's difficult to generalize on acquisitions.

We are active.

I don't know, maybe Marijn wants to add something to that.

I think if you look at the acquisitions we have done recently, we bought Jouan at the end of last year, which represents about 90 to $100 million.

We bought USCS around 60, 65 million of revenue.

We bought LMSi around 10, 12 million.

So we have been looking at a whole funnel of acquisitions and bought these three companies in the last 6 months.

We are looking at those type of opportunities that really add to the core capability, that really make our business stronger.

We continue to look at these opportunities.

And as Theo says, we have very good financial capability with our balance sheet to buy these type of opportunities.

One last quick one.

The potential impact of the earnings repatriation bill that might be passing through Congress for Thermo?

It has some minor positive impact on us.

I think I will leave it at that.

We do have some cash abroad, but it is not the same bonanza that it is for the pharma companies.

Okay.

Thank you.

Paul Knight, Thomas Weisel Partners.

Could you talk about netting out that Spectra-Physics gain, there is still like a 3.7 other item of gain?

And then some more color on this pretty high tax rate; and also what that tax rate should be, in your view, going forward?

In dollars, let me just address the two things sequentially.

First of all, the Spectra-Physics gain was in discontinued operations.

In other income, we have some gains from the sale of Thoratec that we eliminate out.

We also had some other small gains on securities.

We have some other income including some minority income from some stakes that we have that are less than 50 percent and not consolidated into Thermo.

So, I think that answers -- just the Spectra-Physics gain is below the line into income from discontinued operations.

I think that is very important.

Now I forget the second question, Paul.

Your tax rate was higher.

I know you guys have been talking about 28 percent.

We guided early in the year to a tax rate between 28 and 29 percent depending on where we generate our income across the world, depending on acquisitions.

That is roughly the range that we see it at.

Right now it is an the upper part of the range, closer to 29 percent than to 28 percent.

You're sticking with that guidance?

Yes, we are.

The other question on the operations is acquiring a lot of business in France, for example, do you think -- are you are experiencing any shrinkage there due to salesforce or distributor disruptions?

Does that come up as an issue in your view?

It is always an issue, of course, when you buy a company that has a productline that is complementary to yours and you have two salesforces, two distribution channels.

I think the good news with Jouan is they are very strong in Europe and they were weaker in the U.S. and Asia, while Thermo's business was weaker in Europe and stronger in the U.S. and Asia.

This is the skill of integration, so to speak, that you try to homogenize all of this and integrate this with minimum disruption for the customers and for your salesforce and your sales capability.

I don't think that we have suffered as a result of this integration.

But it is something that usually take a few quarters before it settles.

The benefit of it is you have more products going through more focused channels, which ultimately should lead to higher revenue.

I guess that is it for now.

Thank you.

Derik deBruin, UBS.

I just want to go back to the gross margin issue.

Just give us any more color whatsoever and what type of expansion we can possibly look forward in the next quarter?

We have never really given a lot of specific guidance on it.

I think from the comments for the quarter, I think you should conclude that the drop in gross margin is really more of a onetime event.

In terms of where that is going to go in Q3 and Q4 specifically, I don't think we can give you a lot of color on that.

But understand that as we integrate the acquisitions into Thermo, the impact on the gross margin is going to be lessened.

You also have to understand that as we expand our service business, and we grew our service business very nicely in the second quarter and added some additional service revenues with the acquisitions of USCS, those revenues come at lower gross margins and lower SG&As.

So that there is a little bit of a change in terms of the geography of the P&L.

But that said, we expect these gross margins to improve sequentially as we look at the second half of the year.

That is very clear.

What would the margin have been had you stripped out the acquisitions?

There was a 60 basis points impact from the acquisitions on Thermo's gross margins in the second quarter.

The rest of it -- in fact more than all of the rest of it was due to some mix changes in the quarter that, again, is probably not going to be same as we look at Q3 and Q4.

If you look at the SG&A, you're clearly getting productivity gains and advantages there.

Where do you see that coming in?

Do you expect a lower run rate from here?

The SG&A fluctuates a little bit from quarter-to-quarter.

I don't think we are going to see the SG&A rate down a lot as we look at the next few quarters.

Final question.

There has been a lot of people that are uneasy.

There seem to be some -- many of the life science instrument companies are -- things just seem delayed.

They are talking about customers' sales cycles going out a little bit longer.

Is there anything that has changed in your looking at the market from the fourth and the first quarters, into where we're looking out going forward?

Has there been any qualitative change in spending environments or spending patterns?

No, the fundamental comments that we have made all along in terms of our belief in being able to deliver 4 to 5 percent organic growth over the next 3 years, that the economy is recovering, that pharma and bio are better, the industrial demand is clearly up.

They're all the same.

I think if you want to look for subtlety, what is in a subtle way different is the demand in Europe.

At least for us.

We had really hoped to see some stronger demand coming from Europe in terms of following an economic recovery that is clearly going on in the U.S.; and Asia is just going, particularly China, going gangbusters for us.

So, I think the Europe piece is the one where you say, hmm, that would have been nice if it would have followed some of the trends we see in the rest of the world.

Overall, if you generalize, if you look for subtle effects, that isn't happening yet.

Okay.

I guess one final thing, as you're talking about Europe, what terms of term -- what are you looking for in terms of foreign currency gains for the rest of the year?

The foreign currency gains are going to start to diminish obviously as the currencies now have been flat.

So it's going to trend towards zero as you look at the end of the year.

Okay.

I would like to add one thing in my comments.

I misspoke in terms of cash flow and I just want to correct the numbers.

I said that we had $56 million in GAAP cash flows.

The actual number is 53.

And then free cash flows subtracting CapEx is actually 41.

I just wanted to make sure everybody had these right numbers.

John Harmon, Needham & Co.

My second question was on cash flow.

Thank you for answering it.

Just a general kind of strategic question.

Now that you have divested Spectra-Physics -- this may be difficult to quantify -- but it certainly frees up a lot of management bandwidth to focus on your business.

Anything you can talk about?

New opportunities or things that are more difficult now minus your optical segment?

I think one thing that is more difficult minus our optical segment is that the optical segment was really bouncing back from relatively poor performance last year.

So, some of the incremental improvement year-over-year that we were experiencing with Spectra-Physics doing so much better we don't have anymore.

That said, it is still clearly a much better strategic option for us to have Spectra-Physics being part of Newport.

Spectra-Physics, it's not like we were constantly running over to Spectra-Physics to help them run their business.

It was 10 percent of the Company.

We had very capable management there, so I cannot say that it frees up a lot of time for the people here are in leadership of the Corporation now that we do not have Spectra-Physics anymore.

I think what it really does cement, though, is that we are the leading analytical instruments company in the world.

We are the largest by sales, the largest from a technology breadth point of view, and we are going to spend more time trying to figure out how we can leverage that technology in a broader spectrum of applications.

That is why I was talking in the beginning about we are a very strong leader in the laboratory, but we also have a capability to put analytical instruments in a sophisticated way outside of the laboratory.

And a great opportunity for us is to see how we can take these very advanced technologies from the laboratory into the real world by ruggedize them, so to speak, and opening new markets for us in Measurement and Control.

I think that is an exciting opportunity that Measurement and Control has today that most of their competitors do not have, because they are not part of a company with an enormous wealth of analytical technologies used in the laboratory.

Thank you.

One quick follow-up if I may.

In general terms what kind of a supply agreement do you have with Newport?

I know that their lasers were designed into one of your recent instruments.

Yes, we continue to have -- what we were transferring internally, in terms of products from Spectra-Physics to Thermo, we continued to buy from Newport now.

There is nothing spectacular about it.

These are just regular supply agreements like you would have with any other optical components provider.

Thank you very much.

Tycho Peterson, J.P. Morgan.

Can you give us an idea of what drove the strength in laboratory automation?

Was that new facility build out or upgrades?

I think laboratory automation is making somewhat of a comeback here.

There was a lot of money spent on laboratory automation in the '99-2000 time frame; then people slowed down, trying to figure out what to do with all of this automation equipment, quite honestly.

And it was slow for quite a while, maybe 2, 2.5 years.

Now it seems like there is a new energized demand for these type of technologies.

So, I think it is really more of a reaction to a slowdown that took 2 to 3 years.

Our view on laboratory automation is that this strength actually will accelerate over the next 2, 3, 4 quarters.

On the homeland security front, can you give us some color there as to how we should think about that opportunity for you going forward?

Homeland security, basically we have two basic technologies right now that are specifically homeland security focused, which is explosives detection and radiation detection.

In both cases, these orders come in sort of lumpy.

It is not like every day we get an quarter, but when you get one you get a big one.

Because usually it is government related and sponsored.

So, Theo mentioned that our radiation business was relatively weak in Q2 because of that lumpiness, but that will correct itself in the remainder of the year.

I think the opportunity for us, longer-term, technically is, again, how successful can we be taking our lab technologies into the real world.

There is definitely a need for first responders to have more sophisticated, more quicker type of instrumentation when it relates to poisonous gases or explosives or bioterror type of substances.

We are looking at how can we take our laboratory technologies out of the lab and put them in a rugged way, so to speak, in the hands of first responders.

That is that opportunity that will play out over time.

Last but not least, are you guys still on track to open the manufacturing facility in China by year-end?

Yes, we are.

There is a date for it, and it is before January 1.

Not a lot before January 1.

Perfect.

Thank you.

Bob Aye (ph), Bennett Lawrence.

Just a follow-up for the last question.

When do you expect the China operation to be profitable?

Profitable?

Probably 2 or 3 quarters after we open up the new facility it should generate profit.

We obviously have a lot of startup costs, but the opening is in December, and it should 2 or 3 quarters later that we break even on it.

Okay.

Thanks.

(OPERATOR INSTRUCTIONS) Larry Neibor, Baird.

Could you describe how your bookings in the Measurement and Control business have changed in the past quarter, so that you now expect a better gross margin in the second half of the year?

The better gross margin has to do with mix.

Growth obviously has some leverage and helps us, but it is more as a result of mix.

I think maybe to clarify something that was obviously not clear, we see some strength in the business that typically has lagged always the recovery.

And we see good bookings in excess of revenues in Q2.

We have an organic growth rate that accelerated from Q1 to Q2.

So what we are saying is that we expect better growth in the third quarter; and then separately, we expect also to see the EBITDA margins expand.

Is the change in mix product or customer?

It's a combination.

We said that we had, as in the early phases of the recovery, we saw more growth in OEM; and that OEM business is strong.

But that is not going to be the only leg to grow the M&C business.

There is going to be a change in customers as well as the recovery continues.

This

One follow-up.

You described your mass spec growth in the quarter as great.

Could you please put a number on that?

I said phenomenal, not great.

We don't want to put a number on that.

We never have done that, really, for competitive reasons.

But if we look across the board, all of our 3 basic technologies are growing very, very robustly.

I think we have the benefit there as well of 2 new products, the Finnegan LTQ, the linear trap, and then the hybrid LTQ-SP, the FPMS.

But we introduced both in the second quarter of last year.

So, at that particular point in time, in the second quarter of last year, those products had no sales essentially or very little.

So we now have the full-year benefit of that.

But, when we look at our growth there, we're absolutely convinced that we're gaining share in the life sciences mass spectrometry area.

That is unfortunately all I want to say in terms of quantification, Larry.

I hope you can live with it.

Thank you.

Darryl Pardi, Merrill Lynch.

As you guys add LMSi and USCS, the service organization, what type of growth do you expect from those platforms as you leverage that across Thermo's sales and service?

We have set a goal in total of growing our laboratory services business by 10 percent or better organically.

We now have around a $300 million laboratory services business.

No doubt it is the largest in the world.

We are providing services now that our customers really want.

We know that they have been asking for it, beyond the typical maintenance, repair, and training that any instruments company does.

So, USCS, LMSi, our own internal broadened capability for services, I think have put us in a position of comfortably growing that at a rate higher than 10 percent organically for the next few years.

We actually did do that in Q2.

Anatomical pathology is not a market I typically think of as a growth market.

Is there something unique that is going on there now?

Is there some theme or trend that we should be aware of?

I think we are growing so strongly there on the back of some new products we introduced last year.

We have a new tissue processor, the Excelsior it is called, which is phenomenal new technology, and we really are going gangbusters on that productline.

I think that is helping our competitive position a lot.

You feel that is a sustainable trend through the rest of the year?

Yes, because year-over-year comparison-wise this is all compared to a regular year last year.

Okay.

Great.

Thanks.

Franz Tudor, Variant Research.

On the SG&A side, what I'm also trying to understand here is with the divestiture of the optics business, just trying to figure out why SG&A should not be starting to trend down.

And also if there are any additional cost savings or leverage that we're going to start seeing in the P&L going out the balance of this year and into '05, from all the reorganization.

Or are we pretty much through everything that had to get re-org-ed?

Thanks.

Let me start and Marijn will continue.

In terms of SG&A, we have restated numbers now.

So basically Spectra-Physics is eliminated from all these numbers.

The two segments that we have continue as they are today.

We have said and want to repeat again that we are making investments to strengthen the commercial execution.

Our investments in key accounts and demo and the brand -- nothing is going to stop.

So we don't see in the short term large decreases in SG&A.

You should not expect that.

But of course there is a mix situation, because as you said some businesses, like services, they have no R&D, for instance.

So as we are changing the mix of the Company gradually, there is a change into how gross margin and certain SG&A/R&D cost all lead to EBITDA margins.

Anyway, on the productivity side, we drove a lot of cost productivity in the last few years in what we used to call Act Two, with the whole rationalization and integration of the Company.

Most of that brute force productivity is behind us.

All of it is behind us.

We are really cleaned up and we're much leaner than we used to be.

But what we have done is we have -- a year ago we started it -- initiated a continuous improvement initiative across the Company.

We call it PPI, practical process improvement.

This is very important because this is basically our version of a Six Sigma continuous improvement drive across the Company.

We have now 20 percent of our workforce trained on PI tools.

They are working in teams to improve how we're doing business, how we serve the customer better, and doing that at a lower cost.

So, this type of productivity is over time taking over from the brute force productivity we used to have by shutting facilities down, etc.

Thank you.

We have time for one more.

I'm actually showing no further questions, sir.

Because we are running out of time here, let me just make a few comments in closing.

You have heard that we are continuing to be optimistic about the future.

We are continuing to be optimistic about our opportunities to drive organic growth.

The backlog and the order position bode well for Q3.

We also continue to drive productivity, as I just said, through our PPI initiative.

It is different productivity than the one we used to have, but it still brings dollars to the bottom line and improves ultimately our margins.

Also we have opportunities to make additional strategic acquisitions that make our businesses stronger and enhance our future earnings potential.

If you look at the few acquisitions we have done in the last 6 months, you get an indication of what we're trying to do there.

So, we're optimistic about the remainder of the year.

Also, in closing, I would like to take the opportunity to thank our CFO.

Theo, thank you.

This is Theo's last conference call.

Theo has been a great CFO for Thermo and a wonderful colleague; and I want to thank him for everything he has done for Thermo.

Mix quarter, Peter Wilver will be our CFO.

He is copiously taking notes here, and we will update you then -- he will update you then on the details of our financial performance.

So, with that, I would like to thank you again for joining us and for all of your support of Thermo.

Thank you very much.

Thank you.

This does conclude today's teleconference.

You may now disconnect your lines and have a wonderful day.