Thermo Fisher Scientific Inc.
Q1 2013 Earnings Call Transcript

Published: 24 Apr 2013

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Thermo Fisher Scientific 2013 First Quarter Earnings Conference Call. My name is Sharon and I will be your operator today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would like to introduce our moderator for the call, Mr. Kenneth Apicerno, Vice President, Investor Relations. Mr. Apicerno, you may begin the call.

[Kenneth J. Apicerno:]

Good morning, and thank you for joining us. On the call with me today is Marc Casper, our President and Chief Executive Officer; and Pete Wilver, Senior Vice President and Chief Financial Officer. Please note that this call is being webcast live, and will be archived on the Investors section of our website, thermofisher.com, under the heading Webcasts and Presentations until May 17, 2013. A copy of the press release of our 2013 first quarter earnings and future expectations is available on our website under the heading Financial Results. So before we begin, let me briefly cover our Safe Harbor statement. Various remarks that we may make about the company's future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the company's annual report on Form 10-K for the year ended December 31, 2012, under the caption, Risk Factors, 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 the future, we specifically disclaim any obligation to do so even if our estimates change. Therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today. Also, during this call, we'll be referring to certain financial measures not prepared in accordance with generally accepted accounting principles or GAAP. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release of our first quarter 2013 earnings and future expectations and also in the Investors section of our website under the heading, Financial Information. So with that, I will now turn the call over to Marc.

[Marc N. Casper:]

Thanks, Ken. Good morning, everyone. Thank you for joining us today for our first quarter earnings call. We're very pleased to report a solid Q1, and we'll go through the business highlights in a few minutes as we usually do. But before I discuss the quarter, I want to spend a moment on our exciting announcement last week of our agreement to acquire Life Technologies. This acquisition represents the largest transaction for our company since the merger that created Thermo Fisher Scientific. It will make us an unrivaled leader in our industry, serving customers in research, Specialty Diagnostics and applied markets. Combining the leader in genomics with the leader in proteomics will establish technology and innovation leadership across key life sciences markets. The transaction also expands our commercial infrastructure and global presence, making us the ultimate partner for our customers. We're going out to Carlsbad next week to meet with the members of the Life Technologies team and begin the integration planning. As we said last Monday, we look forward to completing the transaction early in 2014. With that, I'll now move onto our Q1 results, starting with our financial performance, which is what we're focused on discussing today. As you read in our press release, we continued our trend of consistently delivering strong double-digit adjusted EPS growth in Q1. We had a 17% increase year-over-year that set a new record. Revenue was a first quarter record, growing 4% over last year. In terms of our adjusted operating income, we grew 7% with 40 basis points of operating margin expansion. So we performed well and in line with our expectations, even though the underlying market conditions were challenging. Two factors, in particular, created more pressure on the top line

[Peter M. Wilver:]

Thanks, Marc. Good morning, everyone. As Marc said, we had a solid Q1, driven largely by strong operational execution by our teams around the globe. I'm very pleased with our results this quarter given the macro environment. So I'll start with an overview of our financial performance for the total company, and then provide some color on each of our 3 segments before moving on to guidance. As you saw in our press release, we delivered another quarter of solid top and bottom line results with a 17% increase in adjusted EPS to a record of $1.37. GAAP EPS in Q1 was $0.93, up 24% from $0.75 in Q1 last year. Looking at the top line, Q1 total revenue increased 4% year-over-year and we delivered 3% organic growth. Q1 reported revenue includes 3% growth from acquisitions and a 1% headwind from FX. And as in some previous quarters, the revenue components I just mentioned do not sum due to rounding. In terms of bookings, we continued to strengthen our backlog, with bookings exceeding revenue by about 1% in the quarter. By geography, North America grew in the low single digits. Europe was just slightly negative, and consistent with previous quarters. Asia-Pacific grew in the high single digits, with China coming in very strong once again at over 20% growth. Rest of world grew in the mid-teens. Turning to the bottom line. Q1 adjusted operating income was up 7% and adjusted operating margin was 19.3%, up 40 basis points from the prior year. Once again, this quarter, we had very strong contribution from our productivity and cost actions, which was partially offset by unfavorable mix and foreign exchange, specifically the weakening of the Japanese yen. I told you on our Q4 call that we expected to realize $65 million of benefit this year from the $100 million restructuring program that we initiated in 2011 and the $75 million program that we initiated last year. And in March, as a result of sequestration being implemented in the U.S., we triggered an additional $10 million of contingency cost actions, which increases the total expected impact of restructuring actions in 2013 to $75 million. In total, we realized about $20 million of benefit from these actions in Q1. Consistent with last year, we made strategic investments this quarter, primarily in emerging markets to strengthen our global presence and continue our growth momentum there. Moving onto the details of the P&L. Total company adjusted gross margin came in at 44% in Q1, down 90 basis points from the prior year, primarily as a result of unfavorable mix and the medical device tax, partially offset by acquisitions. As I mentioned, we delivered very strong productivity in the quarter, which was driven by our primary productivity levers

[Operator:]

[Operator Instructions] Your first question is from the line of Tycho Peterson with JPMorgan.

[Tycho W. Peterson:]

I'm just wondering if you can give us a sense of how things trended throughout the quarter. Obviously, the macro data got a little bit worse toward the end of the quarter. So can you give us a sense of the monthly progression of trends, in particular, on the industrial business?

[Marc N. Casper:]

Yes. I would say that, as you look at the industrial businesses, Tycho, they continue to be soft for us. We declined in the low single digits, and we didn't see an inflection point in the quarter. So as I look at the 3 months, basically remained weak. Bookings were softer than revenue for our industrial customer base. So it was pretty consistent as a soft end market, so we haven't seen that positive turn yet.

[Tycho W. Peterson:]

Okay. And then you guys didn't call out the 2 fewer days for LPS. Was that just lost in the noise or was there any impact you can quantify from 2 fewer selling days or fewer selling days, I guess?

[Marc N. Casper:]

I think we've learned over the years that when you start talking about billing days, it gets in a circle that is not worth doing. Yes, there were some impact from billing days, but you had some things like the flu that helped and other offsets. So I think it's all lost in the noise.

[Tycho W. Peterson:]

And then on pharma, you're putting up great numbers for that business. Are there larger contract wins that are coming through? And one of your competitors mentioned some delays on the equipment side. Is that anything that you've experienced as well?

[Marc N. Casper:]

So on the pharmaceutical and biotech customers, this is driven by really share of wallet with the existing customers. It's not about big customer wins. It's about just expanding the impact that we're having with our customers, and we clearly are gaining good momentum. I would say that our value proposition is really resonating quite well with that customer set. As I mentioned in the prepared remarks, the greatest strength has really been in the clinical trials, logistics and BioProcess Production. We saw some good progress in instrumentation, but clearly softer than those other 2 businesses.

[Tycho W. Peterson:]

Okay. And then last one, any longer-term thoughts on the dividend? I know, obviously, you're building up cash now for the deal. But as we think about the longer-term delevering story, any thoughts on the dividend on a go-forward basis?

[Marc N. Casper:]

From a capital deployment standpoint, as we highlighted last week, our intention, once we close the Life transaction, is to spend the first 2 years in the mode of debt repayment to get our leverage ratios back to our target of between 2.5x and 3x leverage, and after that, returning back to our more historical returns of capital. I would say that when we look at the world today, if we were right -- if we were through that period of close the transaction, did our 2 years of debt repayment, we would have a higher emphasis on dividends than buybacks. So I think that's -- would be appropriate, but I think given that we're talking probably 2.5 years out, what you're going to hear is a strong commitment on return of capital. As it gets closer, we'll refine our thinking. We plan on continuing to focus on increasing our dividends in line with our growth and earnings in the meantime.

[Operator:]

Your next question is from the line of Ross Muken with ISI Group.

[Ross Muken:]

So as you were debating sort of what to do with the guidance, obviously, lots of sort of pushes and pulls here. You had FX go against you and the macro, as you said, sort of challenging. You had the sequester. And then on the positive side, you've obviously turned on the sort of restructuring spigot a little more and pulled in a bit more cost. But as you were trying to debate where the biggest sort of deltas, as we go throughout the year, sort of positive and negative are, and I think that's a pretty good outcome relative to what many have expected given some of the commentary, where do you feel like the biggest wiggle room is, sort of the upside or downside, given sort of all these moving parts?

[Marc N. Casper:]

So Ross, thanks for the question. First of all, the big factor is, one way or another, that's going to swing the results off of the midpoint, is going to be the strength of the end markets, right. So if we see a positive inflection point in industrials or negative, that's going to be a major swing factor. And then obviously, if there's ever a resolution later in the year on sequestration of some sort, that obviously can be a positive swing factor as well. So that's -- more of the end markets is going to be the delta. As we went through that process of thinking about guidance, basically, our conclusion was the team executed extremely well. We had been taking restructuring actions, as we mentioned at the beginning of the year. We had some additional ones ready to go, should U.S. government not be able to solve sequestration. So things that we just wanted to get a definitive view on, and we implemented those actions. So yes, I mean, the world has its challenges. The end markets are on the lower end of our guidance. The Japanese yen is a real headwind, but our team is doing a real good job of gaining share in biopharma and managing the cost base well. So that's how we thought about our guidance for the year.

[Ross Muken:]

And from an end market perspective, I appreciate all the commentary you gave. I guess where were you sort of most surprised by the magnitude of weakness or softness? And how well do you feel like you're doing relative to peers in terms of both share gains, just from utilizing sort of size, scale and channel in what is a tougher environment, as we heard from several customers, the desire to use Thermo as more as their preferred supplier in new areas given some of the budget pressures? And then also from the new product standpoint, where you highlighted a ton of new instruments, et cetera, where you're really kind of thought leading and driving some new innovation?

[Marc N. Casper:]

I would say that our customers are clearly looking for ways to navigate their own funding challenges, and that is a huge advantage for us. And as we've said for a while, we really optimized the commercial relationship with our big biopharma customers, and then have expanded it to other customer sets. So I think we're particularly well-positioned to grow with customers that are trying to drive productivity and accelerate innovation. So I feel very good about that. And I think the results there show, at least in the biopharma, show that we clearly are performing extremely well relative to the market, where I would think the market growth is quite muted in that customer set.

[Operator:]

Your next question is from the line of Daniel Brennan with Morgan Stanley.

[Daniel Brennan:]

Marc, I wanted to dig back in just one more question on kind of industrial. I know you cited in the -- in your prepared remarks, I believe, China's strong, environmental looked good. So I just wanted to understand a bit more. When you mentioned industrial, is it any particularly geographies? Is it -- within industrial, any more color, maybe food testing, maybe more pure industrial? Just kind of looking for the color on kind of where the weakness resides.

[Marc N. Casper:]

Yes, when you look at our customer set, we have industrial and we have applied markets there, right. So industrial was generally soft around the world, softest in Europe of that group, but generally soft. And if you get down to a further level of detail, kind of the basic infrastructure type products that we provide, certain metals and scrap and those types of things, were soft in the quarter, as a representative example. So that's -- basically what we see now for a couple of quarters is a continued soft market. On applied, there were some interesting pockets of strength, which is also consistent with what we've seen. Food safety continues to be very positive and very good, as I mentioned in my thoughts about China, and environmental's doing very well for us. The publicity in terms of the air quality problems in China, in particular, but elsewhere as well, is leading to very, very strong growth for us in a very attractive market.

[Daniel Brennan:]

Great. Maybe a follow-up just kind of on the sequester. What's your latest intelligence telling you how your U.S. economic customers are behaving in particular? How much of an impact do you think you've been feeling now versus the pacing of the spending as the year unfolds?

[Marc N. Casper:]

So when we talk to -- we talk to a lot of our customers obviously, and in the academic and government, we think that as the year continues on, it will get more challenging, because, effectively, we only had 1 month of sequestration in Q1. So when you look at it, we declined just slightly in the quarter, and when you remember back to our February guidance, we said we expect low single-digit declines in that customer set. So we're expecting, as you have the typical 3 months of sequestration in each of the remaining quarters, that end market's a little bit tighter and that's how we've been planning and why we took some additional contingency actions.

[Operator:]

[Operator Instructions] And your next question is from the line of Steve Willoughby with Cleveland Research.

[Steve Willoughby:]

The incremental $10 million of belt tightening you guys did in March, should demand remain softer, get worse? How much availability is there to find additional restructurings this year?

[Marc N. Casper:]

So a couple of things. The $10 million -- we did a lot more than $10 million in terms of belt tightening, right. We've done a lot of things in addition, but when we called out the $10 million, that's pure restructuring-type activities. So we obviously manage our costs quite tightly, Steve. But as end markets get more and more muted, you continue to get tighter and tighter so that you're protecting the quality of the company going forward. We have 39,000 amazing employees here. So that belt tightening happens first, and then restructuring is a secondary type set of actions. So right now, we're doing what we think is the right level for the end markets, and obviously if the end markets get to a more challenging situation, we'll do what's appropriate for the long-term health of the company.

[Steve Willoughby:]

Okay. And then can you just provide an update on how some of your recent acquisitions are performing like Phadia, Dionex and One Lambda?

[Marc N. Casper:]

Sure. So if we look at the 3 acquisitions, clearly, Dionex is, from an ROIC perspective, is moving ahead of schedule versus the model. Phadia is pretty much on track, a little bit softer overall top line performance, which we've highlighted in previous calls, much better cash flow, tax planning, integration work that has offset it. One Lambda is doing quite well, is on track, and that integration has gone very smoothly. So I feel good about, in general, how those acquisitions are proceeding.

[Operator:]

Your next question is from the line of Derik De Bruin with Bank of America.

[Derik De Bruin:]

Marc, I know you guys aren't -- I wanted to just sort of have the general philosophical question with you in terms of R&D spend and R&D focus, particularly as you started thinking about the Life transaction. I just -- I know I'm just -- I'm curious just in terms of general ways you're sort of going to look at the business and I'm trying to figure out -- I'm just looking at your core Thermo business right know. How much of your general R&D spend goes into high-end molecular cellular biology reagents? How much goes in Analytical Technologies, how much goes into diagnostics? I'm just curious about how you allocate it, and if that's a general guide we can think about for the Life transaction once that's come in.

[Marc N. Casper:]

That's a great question. I would say that if you look at our current spend, the majority of our R&D spend is in our analytical instruments businesses. We spend substantial R&D dollars to support our chromatography and mass spectrometry portfolio, and as you know, it's done very well over the years. We obviously have a number of R&D programs that are significant in things like developing next-generation biomarkers, our new novel biomarkers and a number of technologies across Specialty Diagnostics. When you look at our Biosciences portfolio, there, we obviously have a smaller level of spend, and we'll look at ways to take the best thinking between the combined companies with Life Technologies over time and the integration, to develop really interesting novel products that make a difference for our customers. I would say that the integration teams will work to optimize how we want to spend R&D going forward, and we're looking forward to kicking off that process, really in earnest, starting next week.

[Derik De Bruin:]

Okay. That's helpful. Also, I'm just curious in your clinical trial logistics. I mean, that's -- as I think about the company over the years and just commentary on the business, I mean, I know that was something that you guys -- that was picked up a number of years ago. And I guess, could you just give us a size about what that business is right now and sort of what the growth rate's been and who you compete with it. I just don't really -- I'm just looking for an update on the business, given it's been such a strong driver over the last few quarters.

[Marc N. Casper:]

Yes, order of magnitude, $800-ish million business, in that kind of range. It's growing consistently high single digits well into the double-digit growth, is what we've been experiencing there. We don't really have much competition. We're probably 3x to 4x the next largest competitor. Mostly, it's about customers taking in-house activities and driving that activity to us. Why this business is doing so well is, effectively, we've used our scale to build the highest quality, lowest-cost provider of these services. So we simply are able to do this more effectively than the in-house capabilities, and more and more of our customers are relying on us for that activity. So it's been a really excellent organic growth story for us for quite a number of years, and we feel good about how our team is executing there to build out that business.

[Derik De Bruin:]

And then just one final sort of end-market question, given talking about outsourcing, have you seen an increase in demand from your CRO customers?

[Marc N. Casper:]

Nothing that jumps outs particularly, either on the positive or negative, in terms of what's going on with our CRO base.

[Operator:]

Your next question is from the line of Doug Schenkel with Cowen and Company.

[Doug Schenkel:]

You indicated, Marc, that you're heading out to Carlsbad next week, pursuant to getting the integration process of Life going. What update should investors expect from Thermo between now and deal closing? And what has early feedback been from customers you've spoken with on the deal?

[Marc N. Casper:]

So, Doug, in terms of when we get to major milestones, we'll definitely provide updates. So as we get through the major ones, we'll do that. In terms of the customer feedback, basically, the message -- I've spoken to a number of customers and the feedback is they're really looking forward to working with us once the transaction closes. So it's very good.

[Doug Schenkel:]

Okay. Mass spec was an important growth driver for you last year, where, I think, again, you grew above the market. You have a very big share position there anyway, but it seemed like you were gaining share last year at the high end. Any changes in those dynamics in Q1 or was it really just a continuation of the momentum you had last year?

[Marc N. Casper:]

We had very strong growth in Q1 in our life sciences mass spec business so I think our team is executing very well.

[Doug Schenkel:]

Okay. And last question, what growth rate expectations have you factored into full year guidance by end market and geography?

[Peter M. Wilver:]

So I'll answer that one. In terms of the end markets, it's basically very similar or the same as what we had in our last quarter call. So pharma and biotech, kind of mid- to high- single digits; academic and government, down low single digits; industrial and applied, flat to down low single digits; and health care and diagnostics, low- to mid-single digits; and then in North America, low single digits; Europe, bordering around flat; Asia Pacific, mid- to high- single digits and the rest of the world, low double digits.

[Operator:]

Your next question is from Dan Arias with UBS.

[Daniel Arias:]

Maybe just to go back on the end markets. Marc, on the academic demand, to what extent have the haves and the have-nots sort of separated in terms of buying? Have the more established universities and labs sort of emerged as more resilient spenders or does the softness pretty much evenly apply across the accounts?

[Marc N. Casper:]

I think it's a little too soon to tell how that's going to -- if that's going to -- bifurcate is going to happen or not. We didn't see a particular pattern. Obviously, our scientific advisory board is made up of those folks that come out of the really premier universities, and I have a huge amount of dialogue with them. And they articulated that they are feeling some of the pressure as well. So I'm not sure that we have haves and have-nots. I think people are being mindful of their budgets.

[Daniel Arias:]

Okay. And then maybe just to go back to the industrial side, obviously, more CapEx-intensive focus there. But for the consumable lines that are going into the markets that are soft, just curious how the recurring revenue streams have held up there. Are they generally at the company average?

[Peter M. Wilver:]

Yes, I mean, there's not a lot of consumable business in industrial. It's a very, very small piece of that business.

[Marc N. Casper:]

It's more services supporting the instrumentation, and generally, that's held up okay.

[Operator:]

Your next question is from the line of Paul Knight with CLSA. Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division You had mentioned that the laboratory products business was a driver last year. Was the continuing strength of that area, I guess, that would largely be Fisher, was that a reason for your bid on Life? And then I guess the second question would be, how is that business, continuing to do well or a little slower than last year, midyear?

[Marc N. Casper:]

Yes, so in terms of our lab products and services segment, it's made up of 3 businesses

[Marc N. Casper:]

It's less of a cost savings in that particular case. There are other things that will drive our cost efficiencies, but it's more about giving customers the easiest way to buy things. And I think maybe to make the example most real is, there's a lot of shop by experiment, shop by application capabilities within the Life Technologies e-commerce platform, and there are many things that we produce at Thermo Fisher, in our chemicals and in our lab consumables, that are very naturally used in those workflows, which Life Technologies doesn't make today. So you can imagine a customer just adding different things to their shopping cart simply because that's how they want to do the experiment, and I think that gives us a really nice share gain opportunity over time.

[Operator:]

Your next question is from the line of Vamil Divan with Credit Suisse.

[Vamil Divan:]

So I just wanted to go back on talking about the Life acquisition, and you mentioned some of the initial feedback you've been getting from some of their customers. I guess it's a little bit different than what we were hearing. So I'm just curious more on the, I guess, specifically on their sequencing side of things where I think there's been a lot of focus. Is there anything specific you can share in terms of what you've been hearing from customers? It seems from what we're hearing and also from what we've been reading, I think, there's a fair number of questions as to kind of how that will blend into your business and how that might evolve over time. So anything specific you can share on that front?

[Marc N. Casper:]

No, not really. I mean, if you think about the relationships that we have, I mean, customers like working with us. We have great relationships. A lot of the calls were inbound, just congratulating us. A few of them were outbound from [ph] me as a courtesy, but it's more about their enthusiasm post-close to talk about this stuff. On the sequencing side, it's obviously -- it's an exciting business, but we're not getting into that level of granularity. We're still 2 separate companies and focused on each running our own businesses.

[Vamil Divan:]

Okay. And then one specific question, you mentioned the sepsis biomarker, I think you mentioned in China, it's doing pretty well if I caught your comments correctly. I know your Analyst Day last year, you talked about that product quite a bit, and I was just wondering if you've seen any increased traction in the U.S. with that biomarker.

[Marc N. Casper:]

The answer is yes. I mean, it is gaining traction in the U.S. as well. Interestingly enough, the uptick in China is spectacular, and I think it's a matter of really trying to triage patients very quickly in the ER setting. We had very good success across the country of getting the opinion leaders to just go from hospital to hospital and basically articulate why the sepsis screening, right up front for a very sick patient, why dealing with it that way makes sense. So we've seen huge demand. In the U.S., we're going through the traditional market development process that we have for all of our other -- our assays, and we clearly are seeing good growth as well.

[Operator:]

And your next question is from Amit Bhalla with Citi.

[Amit Bhalla:]

Marc, I just want to come back to industrials for a second. I know you're talking about seeing some softness overall, but in the past, you've also said that your business is a 6-month lag to what's happening in larger industrial companies. Can you tie that to the expectations later in the year for the cadence of your organic growth rate related to industrial weakness?

[Marc N. Casper:]

Yes. What I would say is, in my commentary specifically, that the bookings continue to be soft, means, especially given the lead times of this, that certainly, the conditions here are going to continue to be similar, at least for the next quarter, and it's a little less clear if we're going to see an inflection point for later in the year. We haven't assumed one in how we thought about our guidance so -- but we haven't seen any signs yet that we're seeing a positive turn.

[Amit Bhalla:]

But you don't think it gets worse later in the year because of your lag?

[Peter M. Wilver:]

Well, so in the second half of the year, we do have a little bit easier comps. So if it stays at this level or deteriorates, we can basically hold our current organic growth rate in industrial.

[Amit Bhalla:]

Okay, great. And then second, you brought up the Brazil stimulus. Can you put some numbers behind that and what kind of contribution you expect there?

[Marc N. Casper:]

That business is growing. Rates right now are similar to what we're seeing in China. So it's a much smaller business, but doing quite well.

[Amit Bhalla:]

Okay. And just clean up for you, Pete, the device tax impact?

[Peter M. Wilver:]

It's about 15 basis points in the quarter, as we had expected. It's pretty much flat across the year, so that's the same number for the full year.

[Operator:]

Your next question is from the line of Isaac Ro with Goldman Sachs.

[Isaac Ro:]

First one had to do with just pricing. Wondering if you can maybe comment, Pete, on how much that contributed to growth this quarter. And then if you look at sort of the outlook for the balance of the year, what your expectations are for pricing?

[Peter M. Wilver:]

So pricing is pretty consistent with what we've been seeing, really, for the last couple of years. We did have positive price in the quarter, less than 50 basis points contribution to the growth rate. But it did contribute positively to the bottom line, and I would expect that to be the case for the rest of the year.

[Amit Bhalla:]

Okay, great. And then just one business-specific item on Phadia. I think you mentioned a little softer growth there, and as I recall, I mean, it is coming off some relatively easy comps in the first half of this year. So wondering if you can give us some more detail. Was it a function of the exposure you have to Southern Europe or is it something else? Just curious how should we think about growth in that part of the business for the balance of the year.

[Marc N. Casper:]

Yes, we did have a good quarter, in terms of the Japan pollen season was stronger certainly than last year. We do have large exposure to Southern Europe. That's been a headwind for us. So I think we are factoring in for the rest of the year, Southern Europe continues to be soft, but the key growth drivers continue to develop positively as the year unfolds.

[Operator:]

Your next question is from the line of Peter Lawson with Mizuho Securities.

[Peter Lawson:]

Peter, I'm just wondering if you could give a better breakout on the gross margin pressure this quarter from the mix and med device taxes and FX, please?

[Peter M. Wilver:]

Sure. I mean, basically, the big story was mix. In the gross margin level, it was about 100 basis points of headwind on gross margin. And then as I said, the medical device tax was about 15 basis points, so that was the big impact there. FX didn't actually impact gross margin that much in the quarter. It impacted more on the operating margin level.

[Peter Lawson:]

And just on capital deployment, when do you think you start the buybacks again? Is that kind of a mid-2014 event or is there particularly debt-to-EBITDA number you have to hit? And then will you be increasing the dividend?

[Peter M. Wilver:]

So Marc addressed the dividend question earlier on the call, but in terms of returning to share buybacks, we're focused on paying down debt in 2014 and 2015 basically. So we wouldn't initiate any return of capital other than dividends until after we're down in that 2.5% to 3% range, which should be later in the year in 2015.

[Operator:]

And your next question is from the line of Dan Leonard with Leerink Swann.

[Daniel L. Leonard:]

I'll squeeze in one and one follow-up. So my first question, on the operating expense line. How do you think about your operating expense run rate going forward after seeing a pretty big sequential decline from fourth quarter operating expenses? And then my follow-up, your operating margin in diagnostics was very healthy in the quarter, wondering of that's sustainable.

[Peter M. Wilver:]

So in terms of the SG&A percent of revenue in the quarter, that's going to pretty close approximate what we're expecting for the full year, so around 22% or a little bit under maybe. And then in terms of Specialty Diagnostics, we had very good margin in the quarter. For the full year, we would expect it to be just a little lower than that, probably in the mid-26s instead of the 27.5%.

[Marc N. Casper:]

So let me wrap it up. First, we're very pleased with the start to the year with a very solid Q1 performance. I think our teams executed very well in spite of the challenging economic environment. Our growth strategy's clearly working, and it's helping us to gain share. We're clearly very excited about our pending acquisition of Life Technologies and the new opportunities that the combination will create, and certainly welcoming our new colleagues to the company after the close of the transaction. And as always, I'd like to thank you for your continued support of Thermo Fisher Scientific and we're looking forward to updating you at our Analyst Meeting in May. Thanks, everyone.

[Operator:]

Thank you for joining for today's conference. This concludes the presentation. You may now disconnect. Good day.