Revvity, Inc. (RVTY) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q2 2013 PerkinElmer Earnings Conference Call. My name is Clinton. I'll be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. And now, I'll turn the call over to Mr. Tommy Thomas, Vice President of Investor Relations. Please proceed, sir.

Thanks, Clinton. Good afternoon, and welcome to PerkinElmer's Second Quarter 2013 Earnings Conference Call. With me on the call are Rob Friel, Chairman and Chief Executive of -- and Andy Wilson, Senior Vice President and Chief Financial Officer. If you have not received a copy of our earnings press release, you may get one from the Investors section of our website at www.perkinelmer.com. Please note that this call is being webcast live and will be archived on our website until August 15, 2013. Before we begin, we need to remind everyone of the Safe Harbor statements that we have outlined in our earnings press release issued earlier this afternoon and also those in our SEC filings. Any forward-looking statements made today represent our views only as of today. We disclaim any obligation to update forward-looking statements in the future, even if our estimates change. So you should not rely on any of today's forward-looking statements as representing our views as of any other date after today. During this call, we will be referring to certain non-GAAP financial measures. The reconciliation of the non-GAAP financial measures we plan to use during this call to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent we use non-GAAP financial measures during this call that are not reconciled to the GAAP in the attachment, we will provide reconciliations promptly. I'm now pleased to introduce the Chairman and Chief Executive of PerkinElmer, Rob Friel. Rob?

Thanks, Tommy. Good afternoon, and thank you for joining us today. I'm pleased to report PerkinElmer delivered solid performance in the second quarter. Adjusted and organic revenues each increased 3%, with Human Health up 2% and Environmental Health up 3%. As a result of the strong top line performance, adjusted earnings per share was $0.51, $0.03 above the midpoint of our guidance. Andy will discuss our second quarter results in more detail. But before he does, I would like to highlight a few specific areas. First of all, the 3 parts of our business that resulted in lower revenue last quarter all showed significant improvement. In fact, the improvements in these 3 businesses accounted for approximately 3/4 of the 400 basis points sequential improvement in this quarter's organic growth rate. Other areas of strong growth included our newborn and infectious disease screening businesses, which benefited from further penetration into emerging markets. Our informatics business continued to grow double digits, including significant momentum with Spotfire. And OneSource experienced high-single-digit growth as our differentiated capabilities continue to enable share expansion. Also of note, our radiochemical business was flat in the second quarter, reversing a long period of consecutive revenue declines. Partially offsetting this growth was a mid-single-digit decline in Medical Imaging in the quarter. While we continue to believe revenue in this business will be flat in 2013, relative to the very strong growth we experienced last year, Medical Imaging will experience significant volatility quarter-to-quarter during this year due to anticipated customer ordering patterns. During the second quarter, we completed several major productivity initiatives and announced additional actions to further improve our cost structure and enable our growth investments. Specifically, we completed product line transfers to China and Singapore to rationalize our global footprint, and we made headway in consolidating Western European back-office capabilities in Kraków, Poland. We also completed the consolidation of 3 North American facilities, and efforts are underway to consolidate 2 additional legacy Caliper sites, further simplifying our operational footprint and improving our R&D efficiency. In addition to focusing on our cost structure, we achieved a number of significant commercial wins and continued to invest in high-growth areas, where we can deliver competitive differentiation and disruptive innovation. For example, we announced the launch of our breakthrough AxION iQT, which combines identification and quantification capabilities in a single mass spec instrument. We successfully executed the first customer deployments of the new version of our flagship E-Notebook platform and launched our first ChemDraw scientific applications for iPads. On the diagnostic side, we won additional newborn screening programs in Saudi Arabia and South Africa and continued to expand our newborn and prenatal testing menus, adding additional assays. In China, we launched 2 new SFDA-approved diagnostic analyzers for infectious disease testing, 1 targeted at fully automated larger throughput hospital labs and 1 focused on smaller clinical labs. In the environmental area, we introduced a new photodiode array with an innovative flow cell for liquid chromatography, which will expand our capabilities in environmental and research labs. Turning to our outlook, we feel good about our ability to deliver organic growth and improved profitability in the back half of the year, as we build momentum heading into 2014. The macro environment is tracking as we expected, continuing to be weak with recovery in some pockets. Europe still faces headwinds with economic and political pressures, and the impact from sequestration in U.S. continues to dampen capital spending. In Japan, we expect to see improved growth in the region as funds from the supplemental budget are released. And in China, we expect the government to continue to moderate growth slightly, disproportionately impacting the larger cities in the East with sustained robust growth in the West. This month, we are moving into a larger facility in Beijing. And later this year, opening an office in Ürümqi to improve our access to the growing areas in the far west of China. Despite indications that overall growth may be slowing in China, their increasing need for capabilities to improve both human health and environmental health presents us with excellent opportunities, potentially offsetting any moderation. While we remain confident in our long-term strategy to deliver organic revenue growth in the mid-single digits, in light of the global economic climate, we think it's prudent to assume low-single-digit organic growth rates for the remainder of the year. While Andy will discuss our guidance in more detail, we are forecasting a return to adjusted margin expansion and solid adjusted EPS growth in the back half of the year. More importantly, we believe that we can achieve this forecast while continuing to invest appropriately in our most exciting opportunities to drive profitable growth. I would now like to turn the call over to Andy.

Thanks, Rob, and good afternoon, everyone. Consistent with prior quarters, I'll provide some additional color on our end markets, a financial summary of our second quarter results and details around our revised 2013 guidance. Then we'll open up the call for your questions. As Rob mentioned earlier, we were encouraged by our performance in the second quarter, as both adjusted revenue and organic revenue increased by 3%. Adjusted revenue for the quarter was $547 million, as compared to $532 million in the second quarter of 2012. We experienced organic revenue growth across both segments of our business, with Environmental Health and Human Health growing 3% and 2%, respectively, versus the same period last year. Looking at our geographical results. Organic revenue increased low-double digits in Asia, increased low-single digits in Europe and declined low-single digits in the Americas. In China, organic revenues increased high teens with the BRIC countries, as a whole, increasing mid-teens. As a reminder, emerging market comparisons will continue to be difficult through the third quarter of 2013, which was the high watermark of last year. Looking at organic revenue by product category. Recurring revenue, which includes reagents, consumables and service, grew mid-single digits in the quarter, primarily the result of continuing strength in our OneSource Laboratory Services and our informatics offerings. Instruments and components reported flat organic revenue growth in the quarter, but were up sequentially as compared to the first quarter of this year. As Rob indicated earlier, each of these -- each of the 3 areas negatively impacting our first quarter performance experienced significant sequential improvement. First, organic revenues in our In Vivo business grew organically by more than 20%, despite continuing sequestration pressures in the U S. While a portion of the second quarter growth is attributable to the catch-up of first quarter delays, order demand remained strong. Second, organic revenue for our environmental instrument business in Western Europe was essentially flat in the quarter as compared to our mid-teens decline in the first quarter. We were encouraged by the broad sequential strength experienced across the portfolio. And finally, our Japanese business also improved sequentially as organic revenue declined low-single digits as compared to our mid-teens decline in the first quarter of this year. We expect the ongoing deployment of government stimulus, which began in the second quarter, will continue to help enable our ability to deliver positive organic growth in Japan for the back half of the year. From an end market perspective, our Human Health segment represented approximately 55% of reported revenue in the quarter. We serve 2 end markets in Human Health: diagnostics, which represented 27% of reported revenue; and research, which represented 28% of reported revenue. Organic revenue from our Diagnostics business increased low-single digits during the second quarter, primarily due to tougher comparisons in our Medical Imaging business, which declined mid-single digits. We continued to see good results from both our screening business and our infectious disease and blood screening diagnostic offerings, targeting emerging markets. Our screening business grew mid-single digit in the quarter and continues to benefit from the stabilization of U.S. birthrates and the expansion of our prenatal and newborn screening solutions in key regions outside the U.S. We are also pleased with our ongoing newborn sales uptick in Asia, which saw organic growth in the high teens in the second quarter of 2013. As mentioned earlier, our Medical Imaging business experienced a mid-single-digit decline in organic revenue during the second quarter, a result of very difficult double-digit comparisons in the prior year. You may recall, this business will be facing strong comparisons in every quarter of 2013. Our Research business delivered low-single-digit organic revenue growth in the second quarter versus the comparable period in 2012. As I mentioned earlier, we saw a strong recovery in our In Vivo imaging business, as well a sequential improvement in our radiometric detection business. European and Asian research markets both experienced solid organic revenue growth. Moving to Environmental Health, which represented 45% of reported revenue in the second quarter. We serve 3 end markets: laboratory services, which represented 19% of reported revenue; environmental and safety, which represented 17% of reported revenue; and industrial, which represented 9% of reported revenue. During the quarter, we experienced high-single-digit organic growth in the Laboratory Services business, mid-single-digit organic growth in our industrial business and low-single-digit organic revenue declines in our environmental and safety business. While we are pleased with the second quarter performance in our industrial business, we expect industrial end market demand to remain soft for the second half of the year. We experienced strong acceptance of our laboratory service offering in the quarter, as we help our lab customers better manage their critical laboratory assets and related data needs. Our OneSource offering is a key differentiator for us, as evidenced by the win of a new major pharmaceutical company, while also expanding our presence in other key pharma and health care customers during the current quarter. Turning to our margin performance in the period. Adjusted operating margins in the second quarter were 15.6% as compared to 16.9% in the comparable period a year ago. As we mentioned earlier in the year, the first half of 2013 was going to be a period of investment, and this quarter's results were in line with our expectations. As we move into the second half of this year, we expect adjusted operating margins to show improvement versus the comparable period in 2012. By segment, adjusted operating margins in our Human Health segment were 21% and operating margins in our Environmental Health segment were 13%, representing a decline of approximately 110 basis points and 160 basis points, respectively, as compared to the second quarter of 2012. These declines were primarily the result of increased R&D spending, additional investments in our informatics business, pricing pressures, primarily in the Environmental Health segment, as well as difficult year-over-year comparisons due to 2012 licensing revenue that did not reoccur in the second quarter of 2013. GAAP operating income from continuing operations was $39.7 million in the second quarter of 2013 versus $49.8 million in the same period a year ago. GAAP earnings per share for continuing operations in the second quarter of 2013 were $0.24 compared to $0.29 in the second quarter of last year. Adjusted earnings per share was $0.51 in the second quarter of 2013, $0.03 above the midpoint of our guidance range. On a non-GAAP basis, our adjusted tax rate was approximately 21%. Turning to the balance sheet, we finished the second quarter with approximately $1 billion of debt and approximately $112 million of cash. We exited the quarter with a debt to adjusted EBITDA ratio of 2.6x and a net debt to adjusted EBITDA ratio of 2.3x. Looking at our cash flow performance, year-to-date adjusted operating cash flow from continuing operations was $99 million, as compared to $115 million in 2012. Higher working capital requirements, primarily accounts receivable, negatively impacted our performance in the second quarter, as extended terms and the timing of revenue contributed. I also want to note that as planned, the pension contributions made in the first quarter of 2013 will be funded by the recently announced sale-leaseback of one of our facilities in the Boston area. And therefore, the pension funding will be neutral to our full-year cash balances. To summarize, our performance in the second quarter of 2013 came in ahead of expectations and we remain focused on achieving our longer-term organic growth and adjusted operating margin expansion targets. I'd now like to discuss our 2013 guidance in a bit more detail and highlight a few items impacting our second half outlook. Specifically, in Q4, we will face currency headwinds of approximately $5 million due to the movement of the yen, which will negatively impact our reported revenue. In addition, as I mentioned earlier, there is a fourth quarter revenue weighting in our Medical Imaging business due to the calendarization of end customer demand. Medical Imaging reported revenues are expected to be down high teens in the third quarter, but grow low-double digits in the fourth quarter. This impact represents approximately $6 million shifting between quarters, and should offset the fourth quarter currency headwind I just mentioned. As a result, we expect adjusted revenues for the third quarter 2013 to be in the range of $515 million to $525 million with organic revenue growth to be in the range of flat to 2%. Adjusted earnings per share are expected to be in the range of $0.46 to $0.48. Regarding adjusted operating margins, despite approximately 40 basis points of FX headwinds in the third and fourth quarter, we expect second half adjusted operating margins to improve approximately 50 to 75 basis points, as compared to the second half of last year, but more heavily weighted towards the fourth quarter, primarily due to the aforementioned timing of second half Medical Imaging revenues. Our adjusted tax rate is expected to be 22% for the second half of 2013, and our weighted average diluted share count for the year is assumed to be approximately 113 million shares. Finally, we expect interest and other expense to be approximately $12.5 million in both the third and fourth quarters. So based on these assumptions, we expect our full year organic growth to be low-single digits, and we are narrowing our full year earnings per share guidance, raising the bottom end of our guidance range for adjusted earnings per share for 2013, from a range of $2 to $2.10 to a new range of $2.03 to $2.10. This concludes my prepared remarks. Operator, we'd like to open up the call to questions.

[Operator Instructions] Your first question comes from the line of Isaac Ro of Goldman Sachs.

I just want to talk a little bit about margins. I'm wondering if you could put some more color behind in the margins this quarter, specifically with environmental, what was going on there. Was there something in the way of FX versus sort of other sort of transient factors? And maybe was there something maybe more structural? Just kind of -- if you can kind of separate those 2, that will be helpful.

Well, just let me start off with sort of the margins overall and then Andy can drill into the specific environmental. But the way I would think about our margins is, it was probably 3 things that drove the reduction year-over-year. One is we talked about investments, and those are both productivity and related to growth, and that's probably about 1/3 of it. I think we did see -- continued to see some pricing and mix pressures, and obviously, that was planned. Probably about 1/3 of that was probably mostly related to the mix and those types of things. And then...

Yes, and then the third thing, we had investments, we had the mix and -- yes...

License -- yes, the year-over-year. There was some licensing year-over-year. So about a third on the licensing, about 1/3 on pricing mix and about 1/3 on investments.

Okay, got it. That's helpful. And then just if you could remind us, in back half of the year, what's embedded in your guidance in terms of the geographic outlook in the U.S., Europe and sort of Rest of World? Just kind of -- given the volatility in the macro picture, what you guys are assuming would be helpful.

So I think we're assuming pretty similar geographic growth than what we've experienced in the first half of the year. I would say the only difference is maybe a little moderation in China. And as I mentioned in the prepared remarks, we think there's going to be a little moderation, probably more impact on the eastern side as compared to the western. So we're anticipating a little bit of moderation there. I would say Europe continues to be sort of flat in our view and modest growth in the U. S. So again, in the back half we're assuming similar geographic growth patterns.

Our next question comes from the line of Daniel Brennan of Morgan Stanley.

My first question is on the 3 businesses that were the culprits of the first quarter shortfall. I know you gave some color about, not only the growth this quarter, but the expectation. Maybe could you give a little more color about how we should think about those businesses progressing kind of in the back of the year, implicit in your guidance?

Yes. So first of all, in In Vivo, as we mentioned, we saw good recovery in the second quarter. We think a lot of that was just a make up for the first quarter, although I think the team did a terrific job because we continued to see some pressure in the U.S. from sequestration. So the majority of the growth occurred actually in Europe and Asia. But as Andy said, we feel good about the pipeline there. I would say our expectations for In Vivo is probably mid-single-digit growth for the rest of the -- or the back half of the year. I think in the case of Japan, we saw that recover from mid-teens to low single. We think with some of the release of the supplemental budget in Japan, we could probably return that to low- to mid-single growth in the back half. And we're continuing to be fairly conservative in Europe. Although we did see positive growth in Europe in the second quarter, we do have more difficult comparisons going into the third, and so I think we're assuming Europe will be flat to down slightly.

Okay, great. And then, Andy, terms of the guidance, Q3, Q4, just the way you chase that. I mean, is it fair to assume -- I know your third quarter comp from last year certainly a lot more difficult. I know you discussed some other factors in terms of the shift between Q3 and Q4. Maybe can you just go through that a little more again like, is it really just a tougher comp for the kind of the 0% to 2% in Q3 or just maybe go through the factors again, how we should think about the back half of the year progression?

Well, I think Q3 is a more difficult comp than Q4. We also talked about the Med Imaging shift on the top line. So I think if you're looking at flat- to low-single digit, you're going to see a little bit of sequential improvement in the fourth quarter. And I think if you look at, from a margin expansion, the rollout of our initiatives and some of the restructuring that we have just completed, you will see margin expansion in both periods, but more weighted towards the fourth quarter.

Got it. And maybe one more quick one. Rob, is your expectation in '14 with some of the new product initiatives that you have ongoing, I know there's no '14 guidance but you previously were talking about an accelerating growth rate in '14. I mean, any high-level color about how we should be thinking about the impact of these new products?

Well, I think we continue to feel good about our ability to improve growth going into '14. And one of the things we wanted to do in Q2 when we took the restructuring actions, was not only to respond to what we saw was more difficult sort of macroeconomic conditions, but more importantly, we wanted to create the flexibility to continue to invest in growth. So I think I feel good about the fact that we -- I think we've given ourselves the ability to continue to fund the growth initiatives. So again, a lot of it will be dependent on macroeconomic conditions. But I do feel good about our ability to get the new products out into the marketplace and hopefully, to achieve increasing organic revenue growth as we get into '14.

The next question comes from the line of Ross Muken of ISI.

This is Vijay in for Ross. First one, maybe on Japan. I know that you mentioned, in the south [ph], the stimulus there could benefit in the back half. And how should we think of -- in terms of growth or dollar-wise, what the contribution could be?

So for the second quarter, as I mentioned, we were down low-single. I think as we think about the back half, we could see Japan growing sort of low- to mid-single. So I would say, going from down sort of 3% to probably up in the 4% to 5% in the back half. As you probably know, Japan is about 5% of our revenue. So it gives you a sense of what impact that might have on the back half.

Rob, and just on U.S., could you mention segment-wise sort of pockets of strength and weakness that you're seeing?

So I would say, if we look at the U.S., first of all, academic continues to be a headwind. And so I think while the uncertainty around sequestration is not what it was in the first quarter, I still -- we continue to see funds moving relatively slowly from a capital acquisition perspective. So I would say academic continues to be relatively slow. We mentioned the fact that service was strong, so we continue to see good growth in the service end markets. Diagnostic, particularly in our newborn screening, continues to grow in the U.S. And we're continuing to see positive birth trends. We continue to see birth trending up in the United States, close to 3%. I would say in the environmental area though, we were down there in the U.S. And I think that's more of a sort of an economic environment, where I still think there's some headwinds from a macroeconomic perspective. So Environmental down a little bit, service up, Diagnostics continuing to see good growth. And I would say, within the LST area, academic headwinds, but we are seeing some improvement in our pharma spending. Pharma for us was up low- to mid-single digits.

The next question comes from the line of Dan Leonard of Leerink Swann.

Great. I was hoping you can give us some understanding on some of the bottoms-up efforts to improve the gross margin as the year marches along here.

Yes, well, we've talked a lot about some of the initiatives that we were putting in place. And we did complete one of those and we're almost complete with the second significant leg of that. The first being, moving some manufacturing to Singapore and China, that is complete. There is primarily a supply chain savings that we have baked into the second half, which I think will help grow our gross margin. The other piece is the consolidation of facilities in North America, and we're closing 3 facilities. We've announced 2 other small facilities that we're also going to incorporate into Hopkinton, and that will be completed here shortly. And so we will see some second half savings there. So I think if you look at our 50 to 75 basis points, the majority of those savings are going to be coming in gross margin. We're also making progress around the back-office consolidation, but that really won't be completed until the end of this year. We are underway and so we'll start to see those savings really hit the OpEx in 2014. So it's -- as you look at the 50 to 75 we forecasted for the second half, most of that is going to be around the gross margin side, and then the second -- as we move into next year, it will be more equally split between gross and operating margin.

Got it. And then my follow-up question, it seems from talking to your partner on the cell-free fetal DNA side that you're making some great progress there. I'm wondering if you can give us an update on how we should think about that impacting the P&L and modeling changeover between cash accounting into accrual accounting, and also the trajectory there.

Sure. So I think as we've been fairly consistent this year, we really don't expect it to have a material impact in 2013, from a revenue or profitability perspective. But at the same time, as you alluded to, we feel very good about the rapid and successful contracting with the managed-care providers for the verified test. And we think the willingness of these providers to contract the test is really a terrific testament for the quality and importance of the testing. Today, we actually signed another, we signed CIGNA. And we're now up over $130 million contracted lives. Clearly, the most covered of any provider in NIPT. So we continue to be excited about the uptake, the receptivity from the doctors and the progress we're making with managed-care providers. But we also think it's going to be more of a 2014 from the standpoint of a material impact on our financial results.

The next question comes from Doug Schenkel of Cowen and Company.

Based on today's updates, it seems fair to assert that last quarter you suffered through a bit of a perfect storm at the end of the quarter. It's good to see a nice rebound this quarter. That being said, comps get a bit tougher in the second half, and growth in the first half was at low-single-digit levels and -- that's clearly embedded in your full year guidance. But really, where I'm going with this is, as we look ahead, does revenue growth really need to accelerate in 2014 for you to get to that 18% operating margin target? Or are the initiatives that you're pulling forward now enough to get you there, even if growth continues at low-single digit levels?

Well, I would say we can continue to get margin expansion but I think to get to the level of 18% by 2014, we would need to see accelerated revenue growth. And I think we've said for some time that mid-single-digit organic revenue growth is probably what we would need now. We have taken some additional actions in the second quarter. And as I said before, that was largely driven by the fact that it allows us to continue to invest into growth, but clearly, it will -- should provide some incremental margin expansion in '14. But I think to get to the level of 18%, we would need to see an acceleration of organic revenue growth beyond what we're experiencing in '13.

But with that, I guess it's probably worth keeping in mind, you do have a more -- the set-up from this year to next year will be a pretty favorable one and so if you kind of -- so if you maintain the current pace, that alone, probably would get you to mid-single-digit levels, I would think. Maybe a follow-up on the Verinata question from a second ago. Your main competitor in NIPT talked about some reimbursement challenges and pricing challenges in the quarter. It doesn't sound like you guys are experiencing any of that. Is that the case?

Yes, I think that's fair. I mean, I think when you think about those exchanges really being talked about in the first of the year, I think to a large extent, we factored that in when we thought about our forecasting. And while I don't want to get into the specifics, we feel very good about the pricing we're getting. And clearly, the average rate we're seeing is higher than what we had originally anticipated in our financial models.

Okay. And one last question, maybe a little too early and maybe a little too high level at this. But it was reported in the mainstream press recently that China was going to announce a $275 billion plan to reduce pollution over the next 5 years. Is that an opportunity for you in China in environmental testing? Is this something that you're actively acting on, and any way to quantify the opportunity for you at this time?

Yes, first of all, absolutely. I mean, I think that provides a great opportunity. And again, I talked in my comments about, we're well aligned with what China's trying to do from both a human health and environmental health perspective. So whether it's -- there was also a lot of discussion about soil contamination, in addition to the air and some of the other environmental concerns that they have. So clearly we -- we've -- we are very active in the environment over there in China. We will continue to be -- and in fact, we've targeted specifically air monitoring in China as a significant opportunity for us, probably beginning in '14, but also expanding out over the next couple of years.

The next question comes from the line of Amit Bhalla of Citi.

A question on the changing cost structure of the business. I appreciate that you laid the moving pieces of consolidation, et cetera, that are taking place. But I was hoping you could put some numbers around the reduction in total company headcount, either in absolute terms or in percentage of total employees at the business?

It's a reduction over these initiatives of about 300 people. And if you really look at the dollars, it's about -- with the restructuring we just initiated, it's about $40 million in total. Now again, we've -- we're spending back on about $10 million of that this year on some initiatives, but I think as we look at 2013, we probably have about $10 million worth of upside in the back half. It's offset a little bit by some price and mix in FX.

Okay. And my second question is on Medical Imaging. So I appreciate there's a lot of customer volatility in that business, but I was hoping you could go into a little bit better of a geographic breakdown of how that business has performed, U.S., Europe and then the Asia Pac region.

So if you look specifically in QT -- in Q2, what we saw was America was down quite significantly, sort of greater than 15%, Asia was relatively flat and Europe was actually up mid-single digits. Now the one thing I would caution you here though, is when we talk about our revenue geographically in Medical Imaging, again, this is probably the only business in PerkinElmer where we're not selling necessarily to end customers because we're providing components here. So in a lot of cases, the geographic information really talks to the system, the ultimate system provider. So it can be a little misleading from a geographic perspective. But anyway, if you look at our revenue, that's how it would break out.

Okay. Just a follow-up there, in the Asian markets for Medical Imaging, did you feel like inventory in the channel was stable? Did you see any drawdowns of inventory taking place there?

I think going into 2013, there clearly was some inventory in the channel and we're seeing that drawn down. And that's why I think, as Andy talked about, we're expecting some fairly significant growth in Q4. And then I think as we look out into '14, we think Medical Imaging will return to a more high-single-digit growth rate, which we think is probably more representative of the opportunity in those end markets.

The next question comes from the line of Jon Groberg of Macquarie.

Rob, in Asia, can you maybe just talk a little bit more about some of the geographies? If I'm remembering right, from the fourth quarter, along with Japan, Korea and other parts of Southeast Asia were weaker. And I think you said China was just kind of okay, it wasn't great. It looks like China rebounded to the high teens, you said. But from your comments, it sounds like you're expecting that to slow. And I don't know if that's things you're seeing this quarter or if that's just kind of looking at the first half overall. So maybe just any color you can give around Asia, generally.

So, first of all, I would say in China, I think we've gone probably 10-plus quarters in a row with 20-plus organic growth. And our view is that's probably not sustainable forever so we expect a little moderation of that but still at a very robust rate. So as I mentioned, we were very high teens this quarter. I think as I look out to the back half of the year, it's probably going to be very similar to that. So I would say in the 15% to 20% range, we also have a very significant comp issue in China, specifically in Q3. But generally speaking, I think there's going to be some moderation there, but still very robust growth. I mentioned Japan, I think Japan is going to be sort of mid-single digits as we go back -- go into the second half of the year. And then I -- if I think about the rest of Asia, I think it's going to be in that range. I think it's going to be sort of low- to mid-single digits there. I think that's mostly, for us, being impacted by the industrial end markets.

And just to be clear, again China, you're just looking at the comps. It's nothing that you're seeing there itself that, that would suggest it would be a little bit slower.

No, I think it's mostly the comps.

Okay, and then on the Environmental side or the -- I guess, on the Lab Services side, any -- it seems to be a market that others are trying to get into. You've been pretty successful there, kind of updated views about the opportunities that you're seeing in that segment going forward?

Yes, I think as we said in the prepared remarks, we continue to see strong growth in the Service business. And again, that was against some -- in the second quarter against some difficult comps. So we're pleased with our progress there. It's an area where I think we continue to invest in. We've got a great organization. We've talked about the fact that adding the informatics capabilities -- because I think for us, it's all about providing your customers with differentiated capabilities. And so I think our success there is a recognition by our customers or in the marketplace that we continue to provide a differentiated offering here that our customers feel valuable.

If I can, what percent of Lab is just basic asset management and some basic services tied to the lab versus some of these newer offerings that you have in informatics, I don't know if you want to call them higher value-add type of offerings?

Well, so -- I don't know if we can get into that level of detail. But I would say that at this point, the informatics offerings are still a relatively small piece. Our expectation is that will be a larger piece, but again it's pretty early days. So I would say that's a relatively small piece of our service revenue right now. But I think it -- the capability is a significant enabler. And I think our customers are recognizing that the potential is fairly significant going forward.

The next question comes from the line of Dan Arias of UBS.

Maybe just to go back to In Vivo, with the improvement that you saw in Europe and Asia, did you find that it was a handful of large orders coming through that made the biggest difference? Or really, was it just that the overall funding environment eased and what you saw was broad-based spending improvement?

Well, if you're looking outside the U.S., I think it was a couple of things. First of all, clearly, some of the stuff that moved out of the first quarter, we were able to close in the second quarter. So I think that helped a little bit. I think when you look in the U.S., there are still funding issues. And I think sequestration is having an impact. And then I would say, generally, like I said I think the organization has done a terrific job in trying to get a lot of those orders closed in the quarter and not running into the end-of-quarter issues that we had in Q1.

Okay. And then maybe on the Diagnostic side. As the menu broadens for the noninvasive prenatal stuff over time, to what extent, if any, might Verinata start to compete with the Signature business -- Signature Genomics business? Is that something you think about?

I don't think so. I think we continue to think of Signature as more of a confirmatory test, and the NIPT has continued to be a screen. I do think over time that NGS, or next-gen sequencing, does start to infringe upon the arrays. But I think at this point, again, they are separate enough. And in fact, the 3 pieces of our business, I think, are very complementary because I think of the biochemical screen as sort of low-cost, and then you go into the NIPT and then you go into the arrays as a confirmatory test.

Okay. And then just maybe to sneak in one more, as we sort of triangulate these outlook comments, Rob or Andy, at this point, do you have a growth outlook for instruments overall for the year -- or for the back half?

For analytical instruments?

Yes.

I think it's probably low-single digits.

The next question comes from Derik De Bruin of Bank of America.

It's Rafael in for Derik. Rob, just regarding the business in China, can you maybe compare the customer mix that you have in that country versus developed geographies?

Well, I would say, when you look at China, clearly there's a higher percentage of the environment, the environmental business. So if you look at overall, PerkinElmer, we're 45% Environmental, 55% Human Health. If you look at our Asian businesses, it's probably 60% to 65% Environmental. So I would say that's the first distinction. I would say, the other thing is the Medical Imaging business is a relatively small piece, although growing in the China business. And so the other mix is within the Diagnostic business, much higher percentage of hospitals from infectious disease than we have outside. So it is a little bit of a different mix relative to Environmental and Human, and then even within Human Health, a little bit of different mix from a customer perspective.

And I guess, if I'm -- based on the comments you made earlier, basically in the back half, you're not necessarily expecting any one of these customer segments who radically changed from the other, meaning not -- one of these customers isn't slowing down dramatically in the back half?

We don't. And I think going back to the prior comments, I mean, first of all, on the Human Health side, we think there's going to be continued demand for access to health care. And so we expect, whether it's on the newborn, prenatal or infectious disease, they're going to continue to grow probably north of 20%. And then, of course, we talked a little earlier about the demands on the environmental issues. So whether it's air, soil, water, et cetera. So we think we're going to continue to see strong growth for our products in China.

Okay. And on the mass spec that was introduced at ASMS, can you comment on maybe on the sort of bookings or orders that have come in so far?

Well, we, at this point, are still talking to employees but we haven't started shipping it. We'll probably start shipping that towards the end of the third quarter. But the response to this and the receptivity to the product has been terrific. And so while we're starting to take some orders, we don't expect it to have a material impact in Q3, probably start to see some revenue in the fourth quarter. But I think the significant impact, from an orders and revenue perspective, again, will be in 2014.

Our next question comes from the line of Tycho Peterson of JPMorgan.

I think maybe, Rob, just following up on that last question. I mean, with the new mass spec systems, I mean, you're going after, I guess, like $1 billion GC triple quad market. Maybe just talk about your go-to-market strategy. I mean, you go to Agilent, Shimadzu, Thermo, some fairly entrenched competitors, so can you maybe just touch on your strategy there? And presumably, this will have some pretty interesting appetite in China, so maybe talk about how you see demand for that product over there as well.

Yes, I think our approach on the mass spec side is to try and find those market niches where the innovation within this mass spec can really provide our customers with some great performance enhancements. So as you know, the AxION combines the identification and quantification capabilities of a triple quad and a TAF [ph]. And so we think that's fairly unique in a couple of specific applications. And so our go-to-market is, not to sort of try and blanket the mass spec market, but to really focus on those applications and those end markets where the AxION iQT can be really differentiated. And so -- but as you mentioned, we think it's a fairly sizable market but ones where the combination of the identification and the quantification in one instrument can provide real benefits, both from a result perspective and a lower cost. So it's going to be a much more targeted go-to-market against specific applications.

And do you see an opportunity to add LC upfront? I mean, it seemed like there were some potential there at ASMS when you first talked about it. How do you think about that?

Yes, I think as we talked about ASMS, we think about this as a generation of products. And the first offering had a GC in front of it. I think clearly the opportunity to put an LC is something that we would look to do probably next year.

Okay, and then 2 other quick -- just points of clarification, for academic in the back half of the year, I mean you mentioned Japan continues to be okay, obviously, sequestration here in the U.S. Are you assuming academic in aggregate is down in the back half of the year?

Yes, I would say, we would think globally flat. And the way I would think about that is outside the U.S., low-single-digits up and in the U.S., we think it's going to continue to be a little bit of a headwind, down a couple of points. Our U.S. business is probably a little bigger. So when you sort of average that together, it's probably -- our assumption is probably flattish.

Okay. And then last one, radiochemicals flat in the quarter. I mean, that's been a tough business for a long time. I mean, anything to call out there?

We were quite pleased by that because, as you know, it has been a drag on our revenue for a long period of time. It's a little early to call it trend, but we are getting a sense here that some of the pharmaceutical companies are returning back to screening, particularly with kinase and GPCRs and -- are looking to do it with the radiochemicals. We'd like to see a couple of quarters of this before we're ready, again, to call this a trend. But we are encouraged by the fact that the business was flat in the second quarter.

The next question comes from Brandon Couillard of Jefferies.

Andy, on the operating cash flow in the period, can you describe sort of what happened on the DSO front and whether that should sort of reverse in the second half? I know you mentioned extended payment terms, if you could elaborate there and then, perhaps, give us an outlook for the full year?

Sure. I mean, I think from a payment term perspective, we have seen some of our larger customers continue to put pressure on payment terms. That's a little harder one to turn around in the near term. But I would say, the other piece, which was also a large portion, was around linearity. I think that's a timing issue. And I think that we should see some of those receivable built up at the end of the second quarter. Collected in the third quarter, we continue to try to work on the linearity side of the business as well. But I think, overall, in the second quarter, that really was the impact. I think if you look at it from a year-to-date basis, really, we just had a couple of items, some accrueds, which were -- it's really more of a timing issue. It includes taxes and other things and then some working capital. I mean, had some CapEx, which is really around the consolidation of the business as we've talked about earlier. So I think, overall, our working capital was kind of a neutral to the half, but as you point out, we do have some work to do on the collection side. I think second half, we're anticipating our free cash flow to net income to be a little below 1x, really, more like 90% because we have some additional restructuring. But I think we're starting to make some headway there around working capital.

And then, Andy, just in terms of the -- given where the capital structure is at this point, do you feel like you're in a position to do perhaps more M&A activity? How would you characterize the pipeline? And should we expect any incremental share repurchases in the second half?

Well, I think we certainly have continued to remain active on the diligence side. And I think there's a number of bolt-on acquisitions that we're in the process of reviewing. So I think M&A, more of a tuck-in variety, is still something that we are very interested in. I think, it really depends on how those actions progress through the second half. If we see our ability to bring in more of those coveted acquisitions, we'll probably do that. If not, we'll probably look at share buybacks.

The next question comes from the line of Zarak Khurshid of Wedbush Securities.

I have kind of a multi-part question for the diagnostic analyzer launches in China. Can you just talk about the competitive environment there? How are you differentiated? Can you give us a sense of how big that business could be down the road and is there may be a U.S. opportunity for that product?

In the Chinese diagnostic market, generally speaking, the way we think about our competitive advantage is, to really go after the Tier 2 hospitals. And our approach there is -- and again, these products are both designed and produced in China, so we have a very attractive cost structure. But of course, we have entered a national quality and brand that we can attach that at. So generally, we've been very successful in going after -- and as you know, Tier 2 is the largest piece of the market there. So you've got sort of international branded and produced products going after Tier 3, have the tendency to be higher cost, and then you've got the local producers that are, really, at the Tier 1. And so we're really focused in that Tier 2 area. And again, providing the combination of lower cost with a higher quality and brand and service associated with an international company is basically how we take -- how we win there.

Got it. That's helpful. And then just, if you could clarify an answer to a prior question on Verinata. In the second quarter, did you experience a more significant payment delay associated with the new codes versus what you saw in the first quarter?

Well, first of all, it's a relatively small population for us, but the answer is no.

The next question comes from Steve Willoughby of Cleveland Research.

First, just a follow-up on the new products that you introduced in China. I was just wondering if you could maybe provide a little bit more color on those, and are those something that can even more accelerate your growth for that business in China?

Well, I mean, basically what they are is they're analyzers for infectious disease, and one of them is really targeted at the fully automated, larger-throughput hospital labs. And we've actually had that out in the second quarter, and we're seeing very good receptivity. We actually sold, I think high-single-digit instruments in the second quarter. So good receptivity on that. And then the other one was really targeted more at the -- as I mentioned, the smaller clinical labs. And again, these are products that are produced in China, designed in China, have a very competitive cost structure and have generally seen pretty good receptivity. Could it accelerate our growth? I think, I would say, I would think about it more as it continues to support our ability to grow 20%-plus in that marketplace.

Okay. And then just following up on a comment you made earlier regarding either pricing or mixed issues having an impact on gross margins, was just wondering if you could talk about maybe kind of where or what products you're seeing those on?

Yes, the comment really is focused more on our Environmental business and really around and the instrumentations -- in the instrumentation side of the equation. I think if you really look at the quarter, we did see some significant instrument sales in Asia. A lot of those were government tenders, and those tended to be a little bit lower in price. And then there was the mix with service, which also had an impact there because service is a -- typically lower gross margins.

So as we talked about, service grew very nicely in the quarter and instruments was sort of flattish. And while service has very good operating margins on the gross margin side, that usually causes a little bit of a negative mix.

Got you. And then just my final question, just because I don't think it's been asked and I just wanted to clarify. If you could just talk about the pacing in the quarter and just how did the quarter kind of wrap up compared to your expectations?

So as Andy alluded to on the receivables side, obviously the linearity for us, and I think a lot of our peers, is challenging in the capital equipment side. I would say the linearity returned to similar trends that we've seen prior to Q1. But I would say, in that regard, though, I think the clarity around sequestration is not what it was in the first quarter. I think increased clarity around Japan and the releasing of the supplemental budget, I think, is sort of helpful. So I think what we've seen is more clarity around the customers' ability to spend money. But having said that, clearly, we continue to have a large portion of our instruments occurring in the last couple weeks of the quarter.

The next question comes from the line of Eric Criscuolo of Mizuho Securities.

Just filling in for Peter tonight. The weakness in the industrials market this quarter, what kind of customer types were kind of driving that weakness?

So I would say, first of all, on the environmental side, we actually saw a little growth on the industrial side. And so the weakness was probably more on the environmental side than it was on the industrial side. But historically, our industrial customers -- or in the chemical, petrochemical end markets is increasing some on the energy side. So I would say that's the majority of what we -- or generally, in industrial.

Yes. I think in my -- it may have been confusing, but in my prepared remarks, industrial was up low-single digit. And it is, at least historically over the last several quarters, been down. So we did see a sequential improvement and year-over-year growth. My comments also said we don't see that as being the type of growth rates we expect in the second half. We still expect second half to be flat to down low-single.

Just lastly, your next-generation sequencing services and your informatics around that market, maybe could you talk about how that business has been performing for you and what you see in the future?

So first of all, it's a relatively small business for us. And it’s a business that has been growing fairly significantly, but of course, off of a very low base. One of the things that we're doing is shifting the emphasis of that business from the research market into more of a diagnostic play, and we've got CLIA certified a couple of months ago. And so with that shift, I would say more recently, we're seeing a little bit of the slowing of growth there, but again, that continues to be a relatively small business for us.

And I would now like to turn the call back over to Rob Friel for closing remarks.

Okay, great. Well, first of all, thank you for your questions. And while we're closely watching the macroeconomic environment, we were encouraged by our second quarter performance. And I feel good about our organization and our ability to deliver our improved second half guidance. I would like to close by reiterating our confidence in our long-term strategic plans and the opportunity to create shareholder value. Thank you for your continued interest in PerkinElmer, and have a great evening.

Thank you. Ladies and gentlemen, that concludes your conference call for today. You may now disconnect. Thank you for joining. Have a very good day.